Michigan Residential Builders License Practice Test

What are the two bases for accounting?

1. Fixed and variable

2. Cash and accrual

3. Long-term and short-term

4. Public and private

The correct answer is: Cash and accrual

The two primary bases for accounting are cash and accrual. The cash basis of accounting records revenues and expenses when cash is actually exchanged. This means that income is recognized only when it is received, and expenses are recorded only when they are paid. This approach is straightforward and often used by small businesses due to its simplicity and the ease of tracking cash flow. On the other hand, the accrual basis of accounting recognizes revenues and expenses when they are incurred, regardless of when cash is exchanged. Under this method, income is recorded when earned, and expenses are recorded when obligations are incurred. This method provides a more accurate picture of a company’s financial position by matching revenues to the expenses incurred to generate those revenues within the same accounting period. Understanding these two bases is fundamental for anyone involved in residential building and construction, as it directly impacts financial reporting, tax obligations, and overall business management. The choice of accounting method can influence profitability reporting, cash flow assessments, and long-term financial planning, which are critical in the construction industry.