The Beach House Accounting firm needs to adjust its books at the end of the year. The firm’s year end is December 31st. The accountant noted the following transactions:
- On June 1st, the firm prepaid one year of its rent.
- On July 1st, the firm received a payment from a client in the amount of $5,000. The client paid $5,000 as a prepayment of the current year accounting fees. At year end, the firm had only completed 75% of the current year’s accounting services for the client.
At December 31st, how much rent expense should the firm record under the cash basis and under the accrual basis? Also, at December 31st, how much revenue should the firm record from the client under the cash basis and under the accrual basis? Explain your answers.
Which basis of accounting more clearly reflects the income and expense of the organization? Why? How might the method of reporting skew the true picture of the year’s record?