Financial Accounting: An Integrated Statements Approach, 2nd Edition

Chapter 3 Accrual Accounting Concepts 117

your primary accounting record. You keep track of your deposits (cash receipts) and

checks (cash payments). Periodically, your bank sends you a statement that you use to

verify the accuracy of your record keeping.

Using the Cash Basis of Accounting

Under the cash basis of accounting, a business records only transac-

tions involving increases or decreases of its cash. To illustrate, assume

that a real estate agency sells a $300,000 piece of property on December

28, 2006. In selling the property, the agency earns a commission of 8%

of the selling price. However, the agency does not receive the $24,000

commission check until January 3, 2007. Under the cash basis, the real

estate agency will not record the commission (revenue) until January

3, 2007.

Under the cash basis, expenses are recorded only when cash is paid.

For example, a December cellular phone bill that is paid in January

would be recorded as a January expense, not a December expense.

Thus, under the cash basis, the matching concept does not determine

when expenses are recorded. That is, expenses are recorded when paid

in cash, not necessarily in the period when the revenue is earned. As a

result, adjusting entries are not required under the cash basis.

Using the Accrual Basis of Accounting

Under the accrual basis of accounting, revenue is recorded as it is earned, regardless of

when cash is received. To illustrate, using the preceding example, the real estate

agency would record the commissions (revenue) of $24,000 as earned on December

28, 2006, even though the check (cash) is not received until January 3, 2007. Once

revenue has been earned and recorded, any expenses that have been incurred in gen-

erating the revenue are recorded and thus matched

against that revenue. For example, a December cel-

lular phone bill would be recorded in December as

an increase in expenses and liabilities, even though

it is not paid until January. In this way, the December

phone expense is matched against the revenue it

helped generate in December. We used the accrual

basis of accounting to record the November transac-

tions of Family Health Care. In addition, as we illus-

trated earlier in this chapter, the accrual basis

requires adjusting entries to update the accounting

records at the end of the period. Exhibit 8 summa-

rizes the basic differences of how revenue and ex-

penses are recorded under the cash and accrual bases

of accounting.

Q.On June 30, a lawyer
billed a client for $4,000
for legal services provided
during June. The client
paid $1,500 in July and
$2,500 in August. Under
the cash basis, when are
the fees earned recorded?

A.June, $0; July, $1,500;
August, $2,500

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Cash Basis Accrual Basis

Revenue is recorded When cash is received When revenue is earned

Expense is recorded When cash is paid When expense is incurred in

generating revenue

Adjusting entries Not required Required in order to prepare

financial statements

Exhibit 8

Cash versus Accrual

Accounting