How does cash accounting differ from accrual accounting?

The distinction between cash accounting and accrual accounting is a fundamental concept in accounting practices. Accrual accounting, which is best described by the correct choice, recognizes revenues and expenses when they are earned or incurred, regardless of when cash is actually exchanged. This means that if a service is performed or a product is delivered, the revenue is recorded at that point in time, even if the payment is received later. Similarly, expenses are recorded when they are incurred, not when they are paid. This method provides a more accurate picture of a company's financial health, as it reflects all obligations and receivables on the financial statements during the appropriate accounting period.

In contrast, cash accounting records revenues and expenses strictly when cash is exchanged. This means revenue is only recognized when payment is received, and expenses are recorded when they are paid, which can lead to discrepancies in financial reporting, especially if transactions span multiple accounting periods.

Overall, the accrual basis of accounting aligns more closely with the matching principle in accounting, which seeks to recognize revenues and their related expenses in the same period, leading to better forecasting and analysis of financial performance over time.