How does accrual accounting differ from cash accounting?

Accrual accounting recognizes revenues and expenses when they are earned or incurred, regardless of when cash transactions actually occur. This means that in accrual accounting, revenue is recorded when a product or service is delivered to a customer, not necessarily when payment is received. Likewise, expenses are recorded when they are incurred, which means you recognize the cost at the point of obligation, not when the cash payment is made.

This principle allows accrual accounting to provide a more accurate representation of a company’s financial position and performance over a specific period, as it matches revenues earned with the expenses incurred to generate them. This matching principle is essential for understanding the profitability and the operational results of a business, which may be obscured if only cash transactions are considered.

In contrast, cash accounting records revenues and expenses strictly based on when cash is exchanged. While this method is straightforward and may work well for smaller businesses, it does not provide a complete picture of a company’s financial health, as it overlooks receivables and payables that can significantly impact overall profitability and liquidity.

The other options misrepresent key aspects of accrual and cash accounting. For instance, one option implies that cash accounting records revenues when earned, which contradicts the definition of cash accounting. Another claims