Final answer:
The method of accounting where revenues are recorded when cash is received and expenses when cash is paid is known as cash basis accounting. This method is simple and reflects actual cash flow, but may not always represent a company's financial health accurately because it does not match revenues with related expenses in the same period.
Step-by-step explanation:
A method of accounting under which revenues are recorded when cash is received and expenses are recorded when cash is paid is known as cash basis accounting. This approach is in contrast to accrual basis accounting, where revenues are earned and expenses are incurred regardless of when the cash transaction occurs. In cash basis accounting, the financial transactions are straightforward and are recorded only when the actual cash changes hands. This method is favored by small businesses and individuals because of its simplicity and the direct reflection of cash flow.
For example, if a business receives cash from a customer for a service in March, the revenue would be recorded in March under the cash basis method even if the service was performed in February. Likewise, if that business pays for its expenses in April, the expense is recorded in April, regardless of when the expense was actually incurred or the service was received.
One of the critical aspects of cash basis accounting is that it does not match revenues with the related expenses in the same period. This can lead to a misleading representation of a company's financial health and performance, especially if large revenues or expenses are accounted for in periods that do not align with the actual economic activity. Therefore, while cash basis accounting is simpler, it may not always present an accurate picture of a company's financial position and could entail limitations for more extensive accounting purposes.