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Accounting Equation
to Help Students
Understand Differences
Between the Cash Basis
and Accrual Basis
B Y N E A L VA N Z A N T E , P H . D . , C M A , C F M , C PA , C F E
THE DIFFERENCES BETWEEN THE CASH BASIS AND ACCRUAL BASIS OF ACCOUNTING ARE
NOT OFTEN DISCUSSED IN ENOUGH DETAIL IN TEXTBOOKS. THERE ARE A FEW WAYS TO
any small businesses and nonprofit the accrual basis is represented by a series of adjusting
collected $160,000 in revenue and paid $97,000 in Increase Prepaid $300 300
Expenses
expenses. Determine the following:
Accrual Basis Income $63,600
1. Cash basis operating income
2. Accrual basis revenue
3. Accrual basis expenses THE SECOND CASE
4. Accrual basis operating income Before the second case is assigned (after discussion of
inventories), return to the expanded equations and con-
Elaborate on the solutions after students have com- sider the additional factors involved in a retail company
pleted the case. For the purpose of this article, the that owns depreciable assets. Even though more details
answers are provided without details. Question 1 is easy are involved, students can still use the same tables to
to answer: ($160,000 – $97,000 = $63,000). Questions 2 convert the cash basis income into the accrual basis
and 3 involve converting the cash numbers correctly to income. When companies have inventories, cost of
derive $161,900 and $98,300, respectively. The answer goods sold is the amount that is paid to merchandise
to question 4 is calculated by subtracting answer 3 from suppliers under the cash basis. Under the accrual basis,
answer 2: ($161,900 – $98,000 = $63,600). The answer however, COGS is the amount of inventory actually
to question 4 can also be calculated by adding and sub- sold. Thus, when converting COGS, students must
tracting account balances (or changes in them) to the consider both the change in accounts payable and
cash basis operating income. The answer would still be inventory. An example using T-accounts for inventory