Virginia Contractor General Practice Test

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What does accrual basis accounting recognize?

Income when cash is received
Income when it is earned
Expenses when paid
Expenses when incurred

The correct answer is: Income when it is earned

Accrual basis accounting recognizes income when it is earned, regardless of when the cash is actually received. This accounting method adheres to the matching principle, which states that revenues should be matched with the expenses incurred in generating them, providing a more accurate picture of a company's financial performance within a specific period. For example, if a contractor completes a project in December but does not receive payment until January, the income from that project is still recognized in December under accrual accounting. This approach contrasts with cash basis accounting, where income is only recognized when cash changes hands, which can lead to misleading financial statements if cash flow does not align with revenue generation. Therefore, using accrual accounting provides stakeholders with timely and relevant information about the company’s operations and financial status, which is crucial for effective decision-making.