Cash versus accrual basis of accounting. McKindly Consultants, Inc., opens a consulting business on July 1, Year 2. Dick Gray and Paula Mosenthal each contribute \(\$ 50,000\) cash for shares of the firm's common stock. The corporation borrows \(\$ 60,000\) from a local bank on August 1, Year 2. The loan is repayable on July 31, Year 3, with interest at the rate of 8 percent per year.

The firm rents office space on August 1, paying two months' rent in advance. It pays the remaining monthly rental fees of \(\$ 1,500\) per month on the first of each month, beginning October 1. The firm purchases office equipment with a five-year life for cash on August 1 for \(\$ 24,000\).

The firm renders consulting services for clients between August 1 and December 31 , Year 2 , totaling \(\$ 135,000\). It collects \(\$ 109,000\) of this amount by year-end.

It incurs and pays other costs by the end of the year as follows: utilities, \(\$ 3,460\); salaries, \(\$ 98,500\); supplies, \(\$ 2,790\). It has unpaid bills at year-end as follows: utilities, \(\$ 580\); salaries, \(\$ 11,300\); supplies, \(\$ 840\). The firm used all the supplies it had acquired.

a. Prepare an income statement for the five months ended December 31, Year 2, assuming that the corporation uses the accrual basis of accounting and recognizes revenue at the time it renders services.

b. Prepare an income statement for the five months ended December 31, Year 2, assuming that the corporation uses the cash basis of accounting.

c. Which basis of accounting do you believe provides a better indication of the operating performance of the consulting firm for the period? Why?