Business Degree Certification Practice Test

Which method of accounting recognizes revenues and expenses when they are incurred, regardless of cash flow?

1. Cash basis accounting

2. Accrual basis accounting

3. Deferral accounting

4. Management accounting

The correct answer is: Accrual basis accounting

Accrual basis accounting is the method that recognizes revenues and expenses when they are incurred, rather than when cash is exchanged. This approach aligns the financial reporting with the actual economic events and activities of a business. For example, under accrual accounting, a company will record revenue when goods or services are delivered, even if the payment will be received later. Similarly, expenses are recorded when they are incurred, not when they are paid. This method provides a more accurate picture of a company's financial health and performance during a specific period, as it reflects all transactions that affect the business in that time frame. On the other hand, the other choices represent different accounting methods or focuses. Cash basis accounting records revenues and expenses only when cash changes hands, which can lead to a misleading portrayal of financial health if there are significant receivables or payables. Deferral accounting relates to the timing of recognizing revenues and expenses but is part of adjusting entries rather than a standalone method. Management accounting focuses on internal reporting and decision-making processes rather than how revenues and expenses are recognized. Thus, the characteristics of accrual basis accounting make it the correct answer as it emphasizes transactions over cash flow, providing a clearer financial picture.