[Hussainsajwani]

Why would a company use cash basis and convert to accrual basis? For example, see question below.

A company records items on the cash basis throughout the year and converts to an accrual basis for year-end reporting. Its cash-basis net income for the year is $70,000. The company has gathered the following comparative Balance Sheet information:

Beginning of year End of year

Accounts payable $ 3,000 $ 1,000

Unearned revenue 300 500

Wages payable 300 400

Prepaid rent 1,200 1,500

Accounts receivable 1,400 600

What amount should the company report as its accrual-based net income for the current year?

A. $68,800

B. $70,200

C. $71,200

D. $73,200

[J]

Some companies do not have the accounting expertise to use full accrual accounting during the fiscal year and hence use the cash basis (i.e. perhaps they just have a bookkeeper), but are required by the IRS to use the accrual basis. For example, the majority of C corporations cannot use the cash basis of accounting (unless they meet some specific, rather restrictive requirements).

I can tell you that this concept is quite practical in terms of what you need to know if you go into tax, especially at a smaller firm. I don't have tons of experience in tax but I had to convert from cash to accrual quite often when I was working in that field.

[Author]

Replies