Question

In its first year of operations Tower Ltd purchased and paid for widgets costing $50,000. During
that year Tower Ltd sold 60 per cent of the widgets. The widgets on hand at the end of the year
cost $20,000. The sales were on credit terms. Tower Ltd received $37,000 in cash from
customers and $3,000 remained uncollected at the end of the year. During the last quarter of the
year of operations Tower Ltd entered into a property insurance contract for losses arising from
fire or theft. The annual premium of $4,000 was paid in cash and the insurance expired nine
months after the end of the reporting period.
Calculate Tower Ltd’s profit for the first year of operations on an accrual basis and on a
cash basis. Explain the difference between the two measures. Which of the two profit
measures is more useful for assessing Tower Ltd’s performance during its first year of
operations? Give reasons for your answer.

Answer 1

Accrual base: income earned 40,000- cost of item 30,000-(4,000*3/12)=9,000

Cash base: cash received 37,000- cost of item 30,000- insurance 4,000=3,000