Which accounting method recognizes revenue at the time cash is received?
Accrual accounting
Cash basis accounting
Double-entry accounting
Revenue recognition accounting
The correct answer and explanation is:
The correct answer is Cash basis accounting.
Cash basis accounting is a method where revenue is recognized when cash is actually received, and expenses are recognized when cash is paid out. This is different from accrual accounting, where revenues are recognized when they are earned (regardless of when cash is received), and expenses are recognized when they are incurred (regardless of when cash is paid).
In cash basis accounting, transactions are recorded only when there is an exchange of cash. For example, if a company provides a service in January but does not receive payment until March, the revenue would be recognized in March, when the cash is received. Similarly, if the company incurs an expense in January but does not pay it until April, the expense would be recorded in April when the payment is made. This method is simpler and more straightforward compared to accrual accounting, which requires tracking receivables and payables, making it suitable for small businesses or individuals without complex transactions.
One of the main advantages of cash basis accounting is that it provides a clearer picture of cash flow because it directly ties revenue and expenses to actual cash movement. This can help businesses better manage their cash position and make more informed decisions about their finances. However, the main limitation is that it does not always provide a complete picture of a company’s financial health. Since it does not recognize receivables or payables, a business might look more profitable or financially stable than it actually is if it has significant outstanding debts or future revenue that has not yet been received.
In contrast, accrual accounting is the standard method used by larger businesses and is required for publicly traded companies, as it provides a more accurate reflection of financial performance over time.