Difficulty: Easy

Average Score: 84%

A DISADVANTAGE of cash basis accounting is that

Rationale

Expenses are not matched with revenues.

In cash basis accounting, revenues are recorded when cash is received, and expenses are recorded when cash is paid. This timing often leads to a mismatch between expenses and the revenues they help to generate, which can distort the financial picture of a business.

A (income is not recorded until it is earned) YOUR ANSWER

This statement is misleading in the context of cash basis accounting, where income is actually recorded when cash is received, not necessarily when it is earned. In contrast, accrual accounting recognizes income when it is earned, regardless of cash flow. Therefore, this is not a disadvantage unique to cash basis accounting.

B (journals and ledgers are not used.) YOUR ANSWER

Cash basis accounting can still utilize journals and ledgers for recording transactions. While it may be simpler and less formal than accrual accounting, the absence of these tools is not a fundamental disadvantage of the cash basis method itself.

C (financial statements cannot be completed.) YOUR ANSWER

Financial statements can still be prepared under cash basis accounting, although they may not provide a complete picture of the company's financial health. This ability to generate financial statements means that this option does not represent a true disadvantage of using cash basis accounting.

Conclusion

In cash basis accounting, the primary disadvantage is the inability to match expenses with revenues effectively, leading to potentially misleading financial results. This mismatch can obscure a company's actual profitability and financial position, making it difficult for stakeholders to make informed decisions. Understanding this limitation is crucial for proper financial analysis and reporting.

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