Accrual accounting is a method that records revenue when it is earned and expenses when they are incurred, regardless of when cash actually moves. It is the foundation of GAAP-compliant reporting and the standard expected by most investors and lenders.
The core difference is timing.
Cash accounting records a transaction when money is received or paid. Complete a project in March, get paid in April — the revenue shows up in April.
Accrual accounting records that revenue in March, when the work was performed.
The gap matters. A business that closes $300,000 in contracts in December but collects nothing until January looks flat in December under cash accounting. Accrual shows the true performance picture.
Accrual accounting is built on the matching principle: expenses should be recorded in the same period as the revenue they helped generate. This produces financials that reflect economic activity, not just cash timing.
Example
You pay $12,000 for annual software in January. Under cash accounting, that is a $12,000 January expense. Under accrual, it is $1,000 per month across all 12 periods, matched to when the software was actually used.
Accrued revenue: You complete work in March but invoice in April. The revenue belongs in March, and an accrued revenue asset is created on the balance sheet until payment arrives.
Accrued expenses: Staff work the last week of December and get paid in January. The wage expense belongs in December.
Deferred revenue: A customer pays upfront for a service you have not yet delivered. That payment is a liability until you earn it by performing the service.
Prepaid expenses: You pay six months of rent in January. Only one month is an expense. The remaining five months sit as a prepaid asset and are recognized month by month.
The IRS requires accrual accounting for businesses with average annual gross receipts exceeding $25 million over the prior three years. C corporations, partnerships with C corporation partners, and tax shelters face accrual requirements regardless of size.
Outside of legal requirements, most investors, banks, and acquirers expect accrual-basis statements. Bringing cash-basis books to a due diligence process or a lender will typically require restatement.
The transition involves restating prior period financials and adjusting opening balances. The cleaner your existing books, the less painful the process. If transactions have accumulated uncategorized or mismatched over several years, the cleanup workload increases substantially.
Using accrual for financial reporting does not automatically mean using it for taxes. Many businesses keep accrual-basis books for GAAP purposes and use a modified or hybrid method for tax filings. A CPA can identify the right combination for your business structure and jurisdiction.
