Question

In Question 18, our authors focus on the Revenue Recognition and Matching Principles to distinguish between the Income Statement and the Cash Flow Statement. Is there another way to think of the Cash Flow Statement? What type of statement might it be? Think about the two different bases of Accounting (cash vs accrual).

Answer 1

Cash vs Accrual Basis of Accounting

An accounting method wherein revenues are recognized when cash is received and expenses are recognized when paid. This method is inferior to the accrual basis of accounting where revenues are recognized when they are earned and expenses are matched to revenues or the accounting period when they are incurred (rather than paid). The cash basis of accounting is usually followed by individuals and small companies, but is not in compliance with accounting's matching principle.

Revenue Recognition

Revenue recognition covers the tools, procedures and guidelines a business follows to record income data. In a financial lexicon, "revenue" and "income" often are interchangeable, as are "recognition" and "recording." Generally, a company can recognize revenue if it fulfills its part of the underlying contractual agreement, whether it be delivering a product or providing a service. For example, an organization's revenue recording procedures may require that a bookkeeper post income data as soon as a customer takes possession of goods and the shipping company notifies salespeople and in-house treasurers.

Matching Principle

The matching principle requires that a company tie revenue it generates during a given period -- say a month, quarter or fiscal year -- with expenses it incurred to reap that revenue. The principle also can apply to a project or long-term initiative -- say, the construction of a highway. Matching revenue items with operating expenses enables financial managers to accurately calculate how much money a business makes on a project or product, taking into account cash and noncash expenses, such as depreciation and amortization.