Accrual and valuation adjustments
Under strict cash basis accounting
, revenue is recorded only when cash is received and expenses are recorded only when cash is paid. Net income is cash revenue minus cash expenses. The matching principle is ignored here, resulting inconformity with generally accepted accounting principles.
Most companies use accrual basis accounting
, recognizing revenue when it is earned (the goods are sold or the services performed) and recognizing expenses in the period incurred without regard to the time of receipt or payment of cash. Net income is revenue earned minus expenses incurred.
Although operating a business is a continuous process, there must be a cut-off point for periodic reports. Reports are prepared at the end of an accounting period.
- A balance sheet must list all assets and liabilities at the end of the accounting period.
- An income statement must list all revenues and expenses applicable to the accounting period.
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