In its first year of operations, Grace Company reports the following: Earned revenues of $60,000 ($52,000 cash received from customers); Incurred expenses of $35,000 ($31,000 cash paid toward them); Prepaid $8,000 cash for costs that will not be expensed until next year. Net income under the cash basis of accounting is:
A)$21,000.
B)$13,000.
C)$25,000.
D)$17,000.
E)None of the above.

Question

Quizplus · Accepted Answer

Under the cash basis of accounting, revenues are recognized when cash is received and expenses are recognized when cash is paid. Therefore, the earned revenues of $60,000 are not all considered under the cash basis because only $52,000 was received in cash. Similarly, the expenses incurred of $35,000 do not all count because only $31,000 was paid in cash. Thus, the net income under the cash basis of accounting is calculated as follows:

Cash basis revenue = $52,000
Cash basis expenses = $31,000
Net income under cash basis accounting = Cash basis revenue - Cash basis expenses
= $52,000 - $31,000
= $21,000

However, because $8,000 was prepaid for next year's costs, it is not included as an expense in the current year. Therefore, the net income under the cash basis of accounting is reduced by $8,000 to account for this prepaid expense:

Adjusted net income = Net income under cash basis - Prepaid expenses
= $21,000 - $8,000
= $13,000

Therefore, the best choice is B, $13,000.

In Its First Year of Operations, Grace Company Reports the Following