Question

Al is a medical doctor who conducts his practice as a sole proprietor. During 2020, he received cash of $661,000 for medical services. Of the amount collected, $40,800 was for services provided in 2019. At the end of 2020, Al had accounts receivable of $96,500, all for services rendered in 2020. In addition, at the end of the year, Al received $16,500 as an advance payment from a health maintenance organization (HMO) for services to be rendered in 2021. a. Compute Alls gross income for 2020 using the cash basis of accounting. b. Compute Al's gross income for 2020 using the accrual basis of accounting, C. Advise Al on which method of accounting he should use Al should use the of accounting so that he will not have to pay income taxes on the

Answer 1

a) cash basis

gross income

medical services $661000 +

health maintenance organisation $16500

Total = 677500

under cash basis of accounting all cash received and paid will be accounted irrespective of the period for which payment is received or paid.

b) accrual basis

medical services $661000

less amount received for previous year $40800

add outstanding income at the year end $96500

gross income = 716700

under accrual basis only income or expenses related to particular period is recorded irrespective of the amount received or paid. so accrual will be added up, last years income excluded and next years income is also not taken.

c) Advice

AI should use the cash basis of accounting so that he will not have to pay the income taxes on the  income that has not been received yet (Accrued income).

From the above answers it is clear that if he uses cash basis his income is only 677500 on which he has to pay income tax. This amount has been received by him.

But if he uses accrual basis his gross income is 716700 out of which 96500 is still owing from his customers which is not yet received and he has to pay income taxes even on the this amount which is not yet received.