Cash basis vs accrual accounting

Vocabulary flashcards covering the key concepts and terminology related to cash basis vs accrual accounting as discussed in the lecture.

Cash basis accounting

An accounting method that records revenue when cash is received and expenses when cash is paid; no recognition of receivables or payables and a focus on actual cash flows.

Accrual basis accounting

An accounting method that records revenues when earned and expenses when incurred, regardless of when cash is received or paid; requires recognizing receivables and payables and is GAAP-based.

Revenue recognition (accrual)

Under accrual accounting, revenue is recorded when the work is performed or goods are delivered, not when cash is collected.

Expense recognition (accrual) / Matching principle

Under accrual accounting, expenses are recognized in the period incurred and matched to the related revenues they helped generate.

Accounts receivable

A current asset representing amounts billed to customers for goods or services that have been delivered but not yet paid.

Accounts payable

A current liability representing amounts owed to suppliers for goods or services received but not yet paid.

GAAP

Generally Accepted Accounting Principles; framework that requires accrual-based accounting for most entities.

Adjusting entries

End-of-period journal entries used in accrual accounting to recognize revenues earned or expenses incurred that have not yet been recorded.

Income statement (cash basis)

An income statement that reflects actual cash inflows and outflows, not revenues earned or expenses incurred until cash is received or paid.

Income statement (accrual basis)

An income statement that shows revenues earned and expenses incurred in a period, regardless of cash flows, aligning with the matching principle.

Timing difference

A mismatch between when revenue/expenses are earned or incurred and when cash is received or paid, causing different results under cash vs accrual accounting.

Example scenario (accrual vs cash)

In accrual accounting, recognize revenue when earned and expenses when incurred (e.g., $100,000 revenue and $60,000 expenses in the period, net $40,000), regardless of when cash is received or paid.

Receivable vs payable recognition (accrual)

Record a receivable when revenue is earned and a payable when an expense is incurred, even if cash flows occur later.

Cash basis limitations (GAAP)

Cash basis statements may not reflect economic reality and are not GAAP-compliant for most entities because they ignore timing of earnings and obligations.

Purpose of adjusting entries (accrual)

To align the financial records with accrual basis by recognizing revenues earned and expenses incurred that have not yet been recorded.