Which accounting method records revenue when earned and expenses when incurred?

• A. Cash basis
• B. Accrual
• C. Modified cash basis
• D. Hybrid

Answer: (B)

The question tests understanding of when revenue and expenses are recognized in the accounting method. Accrual accounting records revenue when it is earned and expenses when they are incurred, regardless of when cash actually changes hands. This follows the revenue recognition principle and the matching principle, providing a more accurate picture of a period’s performance and financial position.

Why this is the best fit: If a service is performed in one period but the customer pays later, accrual recognizes the revenue in the period of service. Similarly, if an item is used or an obligation is incurred to earn revenue, the expense is recorded in that same period, even if payment occurs later. This timing aligns income with the activities that generate it and aligns expenses with the related revenues, giving a truer view of profitability.

In contrast, cash basis would wait to record revenue until cash is received and expenses until cash is paid, which can distort timing and profitability. A modified cash basis or hybrid method mixes approaches for specific items, but the defining feature of the described approach is accrual recognition of revenue earned and expenses incurred.