Florida General Contractor Practice Exam

What does "accrual" refer to in accounting?

1. Recording revenue when received

2. Recognizing expenses as they are incurred

3. A method of recording based on cash flow

4. Paying liabilities only when due

The correct answer is: Recognizing expenses as they are incurred

In accounting, "accrual" refers to the recognition of expenses as they are incurred, regardless of when the actual cash payment is made. This concept is a fundamental principle in the accrual basis of accounting, which ensures that financial statements reflect the economic activity of a business more accurately than cash basis accounting. Under the accrual basis, expenses are recorded at the time they are recognized—when they are earned or incurred—rather than when cash is actually paid out. This approach aligns with the matching principle, which states that expenses should be matched with the revenues they help generate during the same accounting period. As a result, the financial statements will provide a clearer picture of a company's financial health, enabling better decision-making and a more accurate representation of financial performance over time. The other methods mentioned, such as recording revenue when received, rely primarily on cash transactions and do not reflect the economic reality of the business's operations as accurately as the accrual method does.