The Accrual Basis of Accounting

E

Accrual accounting principles are the decision rules that state when to recognize the revenue and expense consequences of cash flows and other events.

The accrual basis of accounting is a method of recording and reporting financial transactions in which revenues and expenses are recognized when they are earned or incurred, regardless of when the cash is received or paid. This method aims to provide a more accurate representation of a company's financial position and performance over a specific period.

Now, let's go through each of the answer choices and determine which one accurately describes the accrual basis of accounting:

A. "Does not pertain to revenue recognition-only expense recognition." This answer choice is incorrect. The accrual basis of accounting pertains to both revenue recognition and expense recognition. Under the accrual basis, revenues are recognized when they are earned, even if the cash is received at a later date. Similarly, expenses are recognized when they are incurred, regardless of when the cash is paid.

B. "Recognizes the development of assets and liabilities externally." This answer choice is incorrect. The accrual basis of accounting focuses on recognizing revenues and expenses, rather than the development of assets and liabilities externally. It provides a method for matching revenues with the expenses incurred to generate them, ensuring a more accurate depiction of financial results.

C. "Is used only for tax reporting purposes." This answer choice is incorrect. While the accrual basis of accounting is used for tax reporting in many cases, it is not limited to tax reporting purposes. The accrual basis is widely used in financial reporting, as it provides a more comprehensive and accurate view of a company's financial performance.

D. "Begins with the cash basis of accounting and proceeds to make the necessary adjustments." This answer choice is incorrect. The accrual basis of accounting is not based on the cash basis of accounting. The cash basis recognizes revenues and expenses when cash is received or paid, whereas the accrual basis recognizes revenues when earned and expenses when incurred, regardless of cash flows. The accrual basis does require adjustments, but these adjustments are made to ensure that revenues and expenses are appropriately recognized.

E. "Allocates many transactions that produce cash flows to time periods other than those in which the cash flows occur." This answer choice is correct. One of the key characteristics of the accrual basis of accounting is that it allocates transactions to the time periods in which they are earned or incurred, rather than when the associated cash flows occur. This means that revenue can be recognized even if the cash is received later, and expenses can be recognized even if the cash is paid at a different time.

Therefore, the correct answer is E. The accrual basis of accounting allocates many transactions that produce cash flows to time periods other than those in which the cash flows occur.