What is the core difference between accrual and cash-basis accounting?

What is the core difference between accrual and cash-basis accounting?

• A. Accrual accounting dictates cash movements.
• B. Cash-basis accounting recognizes revenue based on delivery.
• C. Accrual accounting recognizes revenue when earned, regardless of cash flow.
• D. Cash-basis accounting reflects liabilities.

Answer: (C)

The core difference between accrual and cash-basis accounting lies in the timing of when revenues and expenses are recognized. Accrual accounting operates on the principle that transactions are recorded when they are earned or incurred, rather than when cash is exchanged. This means that under accrual accounting, revenue is recognized as soon as it is earned—regardless of whether the cash has been received at that time. This approach provides a more accurate picture of a company’s financial performance during a specific timeframe since it aligns income and expenses to when they actually occur, thereby reflecting the company’s operations more faithfully. In contrast, cash-basis accounting recognizes revenues and expenses only when cash changes hands. This method can lead to significant discrepancies in financial reporting, particularly for businesses that operate on credit, as it does not take into account outstanding invoices or accrued expenses. Therefore, while cash-basis accounting is simpler and might suit smaller businesses with straightforward cash transactions, it does not provide the comprehensive overview of financial performance that accrual accounting does, making it less suitable for larger or more complex businesses.

The core difference between accrual and cash-basis accounting lies in the timing of when revenues and expenses are recognized. Accrual accounting operates on the principle that transactions are recorded when they are earned or incurred, rather than when cash is exchanged. This means that under accrual accounting, revenue is recognized as soon as it is earned—regardless of whether the cash has been received at that time. This approach provides a more accurate picture of a company’s financial performance during a specific timeframe since it aligns income and expenses to when they actually occur, thereby reflecting the company’s operations more faithfully.

In contrast, cash-basis accounting recognizes revenues and expenses only when cash changes hands. This method can lead to significant discrepancies in financial reporting, particularly for businesses that operate on credit, as it does not take into account outstanding invoices or accrued expenses. Therefore, while cash-basis accounting is simpler and might suit smaller businesses with straightforward cash transactions, it does not provide the comprehensive overview of financial performance that accrual accounting does, making it less suitable for larger or more complex businesses.