What accounting method records revenues when earned and expenses when incurred?

The accounting method that records revenues when earned and expenses when incurred is known as accrual accounting. This approach is grounded in the principle that financial events should be recognized in the period in which they occur, rather than when cash transactions take place.

Accrual accounting aligns with the matching principle, which mandates that revenues and their corresponding expenses are recorded in the same accounting period. This provides a more accurate picture of a company's financial performance and condition by reflecting all economic events that impact the business, even if cash has not yet changed hands. For example, if a company completes a service in one month but receives payment in the next, the revenue is recorded in the month the service was performed, not when the cash is received.

The other methods mentioned, such as cash accounting, record revenues and expenses based on cash flow rather than the timing of when transactions occur, leading to potential misrepresentations of a company's financial health if the cash flow does not mirror the actual business activities.