Auditing and Attestation- Certified Public Accountant (CPA) Practice Exam -

Which of the following is a characteristic of the cash basis of accounting?

1. Revenues are recognized when earned

2. Expenses are recorded when obligations arise

3. Transactions are recorded when cash is received or paid

4. Financial reports are required to conform to GAAP

The correct answer is: Transactions are recorded when cash is received or paid

The cash basis of accounting is distinct in its approach to recognizing revenues and expenses based on cash transactions. In this method, revenues are recognized only when cash is actually received, and expenses are recorded at the moment cash is paid out. This principle provides simplicity and a straightforward reflection of cash flow, making it easier for small businesses or individuals without complex accounting needs to manage their expenses and revenues. Choosing this characteristic accurately reflects the operational mechanism of cash basis accounting, which directly correlates financial activity with cash movement, rather than with the occurrence of transactions or obligations that may not involve immediate cash exchange. Consequently, this method does not align with the accrual basis of accounting, where revenues are recognized when earned and expenses are matched to when obligations arise regardless of cash flow. In contrast, the remaining options describe elements associated with the accrual basis of accounting or principles that require adherence to Generally Accepted Accounting Principles (GAAP), which do not apply to the cash basis approach. Thus, selecting the characteristic that emphasizes cash transactions aligns perfectly with the fundamental principles of cash basis accounting.