Final Answer:
Accrual basis accounting recognizes revenues and expenses when they are incurred, regardless of when the cash transactions occur. Cash basis accounting, on the other hand, records transactions only when cash is exchanged.
Step-by-step explanation:
Accrual Basis Accounting:
Under accrual accounting, transactions are recorded when they are incurred or when the economic activity takes place, regardless of the timing of cash flows. This method provides a more comprehensive view of financial performance and obligations.
Cash Basis Accounting:
Cash basis accounting, on the contrary, recognizes transactions only when cash is received or paid. This method is simpler but may not accurately reflect the financial health of an entity, especially in cases of delayed payments or credit transactions.
Recognition of Revenues and Expenses:
Accrual accounting aligns with the matching principle, recognizing revenues and expenses in the period they contribute to the generation of income. Cash basis accounting, however, only considers actual cash transactions.
Applicability and Complexity:
Accrual accounting is commonly used in business entities, providing a more accurate picture of financial activities. Cash basis accounting is often employed by small businesses due to its simplicity.