Virginia Contractor General Practice Test

What is the key difference between cash basis and accrual basis accounting?

1. Timing of revenue recognition

2. Types of expenses recognized

3. Method of calculating profit

4. Types of revenue generated

The correct answer is: Timing of revenue recognition

The key difference between cash basis and accrual basis accounting lies in the timing of revenue recognition. In cash basis accounting, revenues are recorded only when cash is received, meaning that income is recognized the moment payment is made. This method emphasizes cash flow and is often simpler for small businesses or individuals who primarily handle cash transactions. Conversely, accrual basis accounting recognizes revenue when it is earned, regardless of when cash is exchanged. This approach provides a clearer picture of financial performance over time, as it matches revenues to the expenses incurred to generate them, hence offering a more accurate depiction of a company's profitability. By focusing on when income is earned as opposed to when cash is received, accrual accounting aligns with the matching principle, which is central to generally accepted accounting principles (GAAP). This principle seeks to reflect the financial condition of a business more accurately, making it essential for businesses with credit sales or those that manage inventory.