Under cash basis accounting, which item may be understated on the balance sheet?

• A. Liabilities
• B. Assets
• C. Equity
• D. Revenue

Answer: (A)

Cash-basis accounting records transactions only when cash actually changes hands. Because of that, obligations that will require future cash outflows aren’t recognized as liabilities until the cash is paid. In practice, this means the balance sheet can understate what you owe because payables and other commitments aren’t recorded until you settle them with cash. For example, if you purchase on credit or owe wages that you haven’t paid yet, those potential liabilities aren’t captured on the balance sheet under cash basis.

Revenue is recognized only when cash is received, which affects income and thus equity indirectly, but it doesn’t create a liability. Assets on the balance sheet reflect cash transactions or non-cash purchases you’ve paid for in cash, while liabilities are the line most likely to be understated due to the lack of recording for unpaid obligations.