‘Quality PC Repairs’ operates from a rented shop in a busy Melbourne street. The business pays its rent in advance on 1 January each year, for the whole year ahead. The rent is $4,000 per month. (a) How much rent expense would be recorded for the month of January under CASH basis accounting? (b) How much rent expense would be recorded for each month between February and December under CASH basis accounting? (c) How much rent expense would be recorded for the month of January under ACCRUAL basis accounting? (d) How much rent expense would be recorded for each month between February and December under ACCRUAL basis accounting? (e) Which approach provides more relevant information to users, internal and external?
Question
‘Quality PC Repairs’ operates from a rented shop in a busy Melbourne street. The business pays its rent in advance on 1 January each year, for the whole year ahead. The rent is $4,000 per month. (a) How much rent expense would be recorded for the month of January under CASH basis accounting? (b) How much rent expense would be recorded for each month between February and December under CASH basis accounting? (c) How much rent expense would be recorded for the month of January under ACCRUAL basis accounting? (d) How much rent expense would be recorded for each month between February and December under ACCRUAL basis accounting? (e) Which approach provides more relevant information to users, internal and external?
Solution
(a) Under cash basis accounting, the rent expense recorded for the month of January would be $48,000. This is because the entire year's rent is paid in advance in January.
(b) For each month between February and December, under cash basis accounting, the rent expense would be $0. This is because the rent for these months has already been paid in January.
(c) Under accrual basis accounting, the rent expense recorded for the month of January would be $4,000. This is because under this method, expenses are recorded in the period they are incurred, regardless of when they are paid.
(d) For each month between February and December, under accrual basis accounting, the rent expense would also be $4,000. This is because the expense is spread evenly across the year, regardless of when the payment was made.
(e) The accrual basis of accounting provides more relevant information to users, both internal and external. This is because it matches revenues with the expenses incurred in earning them, providing a more accurate picture of a company's financial performance during a specific period. The cash basis, on the other hand, can be misleading as it might show a high cash flow in January (when the rent is paid) and low or no cash flow in the other months, which does not accurately reflect the company's ongoing operational expenses.
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