On April 1, Ivy Corp. began operating a service company with an initial cash investment by...


On April 1, Ivy Corp. began operating a service company with an initial cash investment by shareholders of $1,000,000. The company provided $3,200,000 of services in April and received full payment in May. Ivy also incurred expenses of $1,500,000 in April that were paid in June. During May, Ivy paid its shareholders cash dividends of $500,000. What was the company's income before income taxes for the two months ended May 31 under both cash basis and accrual basis of accounting?

Basis of Accounting:

The Basis of accounting is the methodology used to record income and expenses in the accounting books of the business firm. The business firm mainly used two basis for accounting purposes, one is accrual and the other is cash basis of accounting.

Answer and Explanation: 1

The Cash basis of accounting records revenue and expenses only when it is received or paid respectively. The company has received income for services in May of $3,200,000 and hence included in the income before taxes. The amount of investment by shareholders will be included in the equity part and the dividend payment will be made through retained earnings.

Hence, Income before taxes under Cash basis of accounting will be $3,200,000.

The Accrual basis of accounting records revenue when the services are provided or goods are delivered. Its records expenses when it becomes due. So, the income before taxes under accrual basis of accounting will be:

{eq}\begin{align*}{\rm\text{Income}}\,{\rm\text{before}}\,{\rm\text{tax}}\,{\rm\text{for}}\,{\rm\text{two}}\,{\rm\text{months}}&={\rm\text{Income}}\,{\rm\text{for}}\,{\rm\text{service}}\,{\rm\text{provided}}\,{\rm\text{in}}\,{\rm\text{April}} -{\rm\text{Expenses}}\,{\rm\text{in}}\,{\rm\text{April}}\\&= \$ \,3,200,000 - \$ \,1,500,000\\&= \$ \,1,700,000\end{align*}\ {/eq}

Learn more about this topic:

The Differences Between Accrual & Cash-Basis Accounting


Chapter 4 / Lesson 3

Learn about the difference between cash and accrual accounting. See accrual vs. cash basis accounting examples, and identify benefits of the two types of accounting.

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