Which accounting basis does GAAP require for financial reporting?

• A. Cash basis accounting
• B. Accrual basis accounting
• C. Tax basis accounting
• D. Modified cash basis accounting

Answer: (B)

Under GAAP, financial statements are prepared on an accrual basis. This means revenues are recorded when earned and expenses when incurred, not when cash is received or paid. This approach ties revenues to the costs incurred to generate them and requires recognizing assets and liabilities (like accounts receivable, accounts payable, unearned revenue, depreciation). The result is a more accurate view of the company’s economic performance and financial position, and it improves comparability across periods and among different entities.

Cash basis, by contrast, records only cash inflows and outflows, which can distort profitability and liquidity because it ignores receivables, payables, and other timing differences. A modified cash basis is a hybrid used in some contexts but is not the GAAP basis for general-purpose external reporting, and tax basis accounting is used for tax purposes, not GAAP financial statements.