Utah Contractor Practice Exam

When using the accrual method, what is recorded first in an income journal?

1. Debits only

2. Credits only

3. Credits and debits

4. Neither, only cash transactions

The correct answer is: Credits and debits

In the accrual method of accounting, financial transactions are recorded when they are earned or incurred, rather than when cash is exchanged. This principle is fundamental because it provides a more accurate reflection of a company's financial position by recognizing revenues when goods or services are provided and expenses when incurred. In an income journal, both credits and debits are recorded to accurately reflect the economic activity of the business. When revenues are earned, they are recorded as credits, which increase the income accounts. Concurrently, any associated expenses incurred in generating that revenue would be recorded as debits, which serve to reduce the net income and reflect the costs of operations. This dual recording is essential for maintaining the accounting equation (Assets = Liabilities + Equity) and ensuring the financial records are complete and accurate. This approach contrasts with the cash basis of accounting, where transactions are only recorded when cash changes hands. As such, neither solely debits nor solely credits would effectively illustrate the financial situation under the accrual method. Additionally, exclusion of non-cash transactions would lead to an incomplete understanding of a company's financial health. Consequently, the correct approach involves recording both credits and debits in the income journal to ensure a comprehensive representation of the business's financial activities.