The cash basis is acceptable in practice only under those circumstances when it approximates the results that a company could obtain under the accrual basis of accounting. Under the cash basis, the revenue would not be reported in the year the work was done but in the following year when the cash is actually received.īecause the cash basis of accounting does not match expenses incurred and revenues earned in the appropriate year, it does not follow Generally Accepted Accounting Principles (GAAP). For example, a company could perform work in one year and not receive payment until the following year. The cash basis of accounting recognizes revenues when cash is received and recognizes expenses when cash is paid out. Professionals such as physicians and lawyers and some relatively small businesses may account for their revenues and expenses on a cash basis. An expense is the outflow or using up of assets in the generation of revenue. The matching principle states that expenses should be recognized (recorded) as they are incurred to produce revenues. Matching PrincipleĮxpense recognition is closely related to, and sometimes discussed as part of, the revenue recognition principle. Under the revenue recognition principle, revenues should be earned and realized before they are recognized (recorded). However, the crucial question for the accountant is when to record a revenue. Revenue is not difficult to define or measure it is the inflow of assets from the sale of goods and services to customers, measured by the cash expected to be received from customers. The complete cycle is: Accounting Cycleīefore we can prepare adjusting journal entries, we need to understand a little more theory. Now we will finish the remainder of the accounting cycle. In the previous section, you learned the first column of the accounting cycle.
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