Cash vs. Accrual Accounting

Concept

Two Methods of Accounting

Cash basis recognizes revenue when cash is received and expenses when cash is paid. Accrual basis recognizes revenue when earned and expenses when incurred, regardless of cash flow. GAAP requires accrual accounting for most businesses.

Example

Why It Matters

A law firm completes work in December but the client pays in January. Under cash basis, revenue appears in January. Under accrual basis, revenue is recorded in December when the service was performed — matching revenue to the period it was earned.

Key Point

Revenue Recognition Principle

Revenue should be recognized in the period in which it is earned, not necessarily when cash is received. This is a cornerstone of accrual accounting.

Deferrals: Prepaid Expenses & Unearned Revenue

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Practice questions from this module to reinforce what you learned.

Practice Questions