Correct Answer:
The key difference between the cash accounting method and the accrual accounting method lies in when transactions are recorded:
- Cash Accounting Method:
- Transactions are recorded only when cash changes hands. Revenue is recognized when it is received, and expenses are recorded when they are paid.
- Used by: Small businesses and individuals who do not have complex financial activities.
- Example: If a business receives a payment from a customer in cash, the revenue is recognized immediately, and if a bill is paid, the expense is recognized when the payment is made.
- Accrual Accounting Method:
- Revenue is recognized when earned, and expenses are recognized when incurred, regardless of when cash is exchanged.
- Used by: Larger businesses or those seeking loans, as it provides a more accurate reflection of financial performance.
- Example: If a business delivers a product or service and the customer agrees to pay later, the revenue is recognized when the service is provided, not when payment is received.
Explanation:
- The cash accounting method is simpler and often used by small businesses due to its ease of understanding and application.
- The accrual accounting method provides a clearer picture of a business’s financial health because it matches revenues with the expenses incurred to generate them, offering a more accurate financial view over time.
