Which accounting method records income when collected and expenses when paid?

Which accounting method records income when collected and expenses when paid?

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

Answer: (A)

This question tests cash basis accounting, which records income when cash is received and expenses when cash is paid. Under this approach, revenue isn’t recognized until the cash actually arrives, and costs aren’t recognized until the cash leaves the business. The appeal of cash basis lies in its simplicity and its direct link to cash flow. For small businesses, it makes it easy to see how much cash is on hand and how cash moves in and out. It’s also commonly used for certain tax reporting because it tracks actual cash activity rather than theoretical timing of revenue and expenses. However, this method doesn’t reflect money earned but not yet received (accounts receivable) or expenses incurred but not yet paid (accounts payable). Accrual accounting records those items, providing a fuller picture of profitability in a period, which is why larger firms and GAAP-based reporting rely on accrual. A modified cash basis combines elements of both, but it still hinges on the timing of cash. So, the approach described—recognizing income when cash is collected and recognizing expenses when cash is paid—is cash basis accounting.

This question tests cash basis accounting, which records income when cash is received and expenses when cash is paid. Under this approach, revenue isn’t recognized until the cash actually arrives, and costs aren’t recognized until the cash leaves the business.

The appeal of cash basis lies in its simplicity and its direct link to cash flow. For small businesses, it makes it easy to see how much cash is on hand and how cash moves in and out. It’s also commonly used for certain tax reporting because it tracks actual cash activity rather than theoretical timing of revenue and expenses.

However, this method doesn’t reflect money earned but not yet received (accounts receivable) or expenses incurred but not yet paid (accounts payable). Accrual accounting records those items, providing a fuller picture of profitability in a period, which is why larger firms and GAAP-based reporting rely on accrual. A modified cash basis combines elements of both, but it still hinges on the timing of cash.

So, the approach described—recognizing income when cash is collected and recognizing expenses when cash is paid—is cash basis accounting.