Which accounting method recognizes revenue when earned and expenses when incurred?

Which accounting method recognizes revenue when earned and expenses when incurred?

• A. Accrual
• B. Cash
• C. Tax
• D. Modified cash

Answer: (A)

The main concept being tested is the accrual basis of accounting: revenue is recognized when earned and expenses are recognized when incurred. Under this method, you record revenue when you have substantially earned it (the goods are delivered or the service is performed), regardless of when cash is received. Similarly, you record expenses when the obligation arises (the service is used or the good is received), not when you actually pay for them. This approach helps match income and the associated costs to the same time period, giving a clearer picture of profitability and financial position. For example, if you provide a service this month but won’t bill or receive payment until next month, revenue is still recognized this month. If you incur a utility bill this month but pay it next month, the expense is recognized this month. Other methods behave differently with timing. The cash method records revenue only when cash is received and expenses only when cash is paid, which can distort when earnings and costs occur. Tax accounting and modified cash methods may follow their own rules or blending practices, but they do not consistently match revenues with the expenses in the period they are earned and incurred, as the accrual method does.

The main concept being tested is the accrual basis of accounting: revenue is recognized when earned and expenses are recognized when incurred. Under this method, you record revenue when you have substantially earned it (the goods are delivered or the service is performed), regardless of when cash is received. Similarly, you record expenses when the obligation arises (the service is used or the good is received), not when you actually pay for them.

This approach helps match income and the associated costs to the same time period, giving a clearer picture of profitability and financial position. For example, if you provide a service this month but won’t bill or receive payment until next month, revenue is still recognized this month. If you incur a utility bill this month but pay it next month, the expense is recognized this month.

Other methods behave differently with timing. The cash method records revenue only when cash is received and expenses only when cash is paid, which can distort when earnings and costs occur. Tax accounting and modified cash methods may follow their own rules or blending practices, but they do not consistently match revenues with the expenses in the period they are earned and incurred, as the accrual method does.