Lecture Notes: Chapter Three - Cash Basis vs Accrual Basis Accounting

Key Concepts

Definition: Transactions are recorded only when cash is received or paid.
Revenue Recording: Revenue is booked when cash is received.
Expense Recording: Expenses are recorded when cash is paid.
GAP Compliance: Not compliant with Generally Accepted Accounting Principles (GAP).

Definition: Transactions are recorded when revenues are earned and expenses are incurred, regardless of cash flow.
Revenue Recording: Revenue is recorded when the service is performed or the good is delivered, not when cash is received.
Expense Recording: Expenses are recognized when they are incurred, not necessarily when cash is paid.
GAP Compliance: Compliant with GAP as it provides a better picture of financial activities during a period.

Scenario: A business pays $1,200 on May 1st for insurance covering the next six months.
- Cash Basis Accounting: Entire expense is recorded immediately on May 1st ($1,200).
- Accrual Basis Accounting: Expense is recorded over six months as it is incurred ($200 per month).

Scenario: A neighbor prepays $600 on April 30th for babysitting services over the next six months.
- Cash Basis Accounting: Entire revenue is recorded on April 30th ($600).
- Accrual Basis Accounting: Revenue is recorded as services are performed, evenly distributed over six months ($100 per month).

Cash Basis: Focuses on immediate cash transactions.
Accrual Basis: Provides a more accurate reflection of financial status over time by aligning revenue and expenses with actual earned and incurred periods.

The next lecture will explore deeper concepts related to accrual basis accounting.