In its first year of operations, roma co. earned $45,000 in revenues and received $37,000 cash from these customers. the company incurred expenses of $25,500 but had not paid $5,250 of them at year-end. the company also prepaid $6,750 cash for costs that will not be expensed until the next year. calculate the first year's net income under both the cash basis and the accrual basis of accounting.

To calculate the net income under both the cash basis and the accrual basis of accounting, we'll need to apply the principles of each method to Roma Co.'s transactions.

**Cash Basis Accounting:** Under cash basis accounting, revenues are recognized when cash is received, and expenses are recognized when cash is paid.

Revenues (cash received): $37,000 Expenses (cash paid): $25,500 - $5,250 (not paid) + $6,750 (prepaid costs not considered because they relate to next year) = $20,250 Net Income (Cash Basis) = Revenues - Expenses Net Income (Cash Basis) = $37,000 - $20,250 Net Income (Cash Basis) = $16,750

**Accrual Basis Accounting:** Under accrual basis accounting, revenues are recognized when they are earned (regardless of when cash is received) and expenses are recognized when they are incurred (regardless of when cash is paid).

Revenues (when earned): $45,000 Expenses (when incurred): $25,500 + $5,250 (still to be paid from current expenses) - $6,750 (subtracting the prepaid costs that relate to next year) = $24,000 Net Income (Accrual Basis) = Revenues - Expenses Net Income (Accrual Basis) = $45,000 - $24,000 Net Income (Accrual Basis) = $21,000

On the cash basis, Roma Co.'s net income for the first year is $16,750, and on the accrual basis, it is $21,000.

Extra: Let's delve deeper into some concepts:

**Cash Basis Accounting:** This is a simple accounting method that records revenues when cash is actually received and expenses when they are actually paid. This method doesn't take into account accounts receivable or accounts payable. It's not commonly used for larger businesses and is not accepted under Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) because it may not reflect the true financial position of a company, as transactions are only recorded when cash changes hands.

**Accrual Basis Accounting:** This method records revenues when they are earned and expenses when they are incurred, regardless of when the money is actually received or paid. This approach is the standard for larger businesses and is required by GAAP and IFRS because it gives a more accurate picture of a company's financial position and performance, as it takes into account all earned revenue and incurred expenses within the period they occur.

The difference in net income under the two methods arises because under the cash basis, some expenses and revenues might not be recorded until the cash is actually exchanged, which can delay or accelerate the recognition of those revenues and expenses. Conversely, accrual accounting records these amounts when they are earned or incurred, resulting in a potentially different net income figure.