Differentiate between accrual basis and cash basis accounting.

• A. Accrual basis records revenues and expenses when cash is received or paid; cash basis records them when earned.
• B. Accrual basis records revenues and expenses when earned or incurred; cash basis records them when cash is received or paid.
• C. Both methods record revenue and expenses at the same times.
• D. Cash basis is always more accurate than accrual.

Answer: (B)

Recognition timing for revenues and expenses under accrual vs cash basis. In accrual accounting, revenues are recorded when the earning process is complete (when the service is performed or goods delivered) and expenses are recorded when they are incurred, regardless of when cash is received or paid. This mirrors the economic activity of the period and supports matching revenues with the related costs. For example, a sale on credit records revenue immediately and increases accounts receivable; a rent bill for a future period is recorded as an expense now, with a liability created. In cash basis accounting, revenues are recorded only when cash is received and expenses only when cash is paid, so the timing depends on actual cash flows. This approach is simpler but can distort the picture of profitability and obligations for businesses with outstanding receivables or payables.