Accounting: Understanding Accrual Basis and Net Income Calculation
What is Accrual Basis of Accounting?
The method of accounting that considers financial transactions based on the actual events that led to them rather than when money is collected or paid.
What was the net income for Melody's Piano School in May?
Assuming accrual, what was the net income for Melody's Piano School for May?
Accrual Basis of Accounting Explanation:
The accrual basis of accounting involves recording revenue when it is earned and expenses when they are incurred, rather than when cash is received or paid. This method provides a more accurate representation of a company's financial position by matching revenues with related expenses in the same accounting period.
Net Income Calculation for Melody's Piano School in May:
Net income is calculated by taking into account both the cash fees received and the accrued fees for piano lessons provided. In the case of Melody's Piano School for May:
Net income = (cash fees + accrued fees) - rental bill
Net income = ($800 + $620) - $375
Net income = $1,045
Hence, the net income for Melody's Piano School in May is $1,045.
Understanding Accrual Basis of Accounting:
The accrual basis of accounting recognizes revenue when it is earned, regardless of when the cash is actually received. It also records expenses when they are incurred, rather than when they are paid. This method provides a more accurate picture of a company's financial standing as it reflects the complete impact of transactions on the business.
By using the accrual basis, Melody's Piano School can better match its revenues with the expenses incurred to generate those revenues. This helps in accurately determining the net income for a given period.
For Melody's Piano School in May, the net income calculation takes into consideration the cash fees received for piano lessons provided to students who paid in cash, as well as the accrued fees for students who paid on account. This method ensures that all revenue and expenses related to the month of May are accurately accounted for, resulting in a net income of $1,045.
By following the accrual basis of accounting, Melody's Piano School can make informed financial decisions and have a clear understanding of its financial performance.