Under the accrual basis of accounting, revenues are recorded when earned and expenses are recorded when incurred—regardless of when cash actually changes hands. This is the opposite of cash basis accounting, where transactions are only recorded when money is received or paid. Accrual accounting provides a more accurate picture of a company’s long-term profitability by matching efforts (expenses) with results (revenues) in the same reporting period.
Example: You deliver a $10,000 project in December and invoice the client. They pay in January. Under accrual accounting, you record $10,000 revenue in December (when earned). Under cash basis, you’d record it in January (when received).
Accrual vs Cash Basis Accounting
| Feature | Accrual Basis | Cash Basis |
|---|---|---|
| Revenue recognized | When earned | When cash received |
| Expense recognized | When incurred | When cash paid |
| Matches revenue to expenses? | Yes | No |
| More accurate picture? | Yes | Simpler but less accurate |
| Required for GAAP? | Yes | No |
| Who uses it | Most businesses, all public companies | Small businesses, freelancers |
| Complexity | Higher | Lower |
The Two Core Accrual Concepts
Revenue Recognition Principle
Revenue is recorded when it is earned – when the service is performed or goods are delivered, not when cash arrives.
- Invoice sent in March, paid in April → Record revenue in March
- Subscription paid in advance in January for 12 months → Recognize 1/12 each month
Matching Principle
Expenses are matched to the revenues they helped generate in the same period.
- You pay $5,000 for inventory in February and sell it in April → Record COGS in April (when revenue is earned)
- Annual insurance premium paid upfront → Expense 1/12 each month
Common Accrual Accounting Entries
| Situation | Journal Entry |
|---|---|
| Revenue earned, not yet collected | Debit Accounts Receivable / Credit Revenue |
| Cash received before service delivered | Debit Cash / Credit Deferred Revenue |
| Expense incurred, not yet paid | Debit Expense / Credit Accrued Liability |
| Expense paid before it’s used | Debit Prepaid Expense / Credit Cash |
When Accrual Accounting Is Required
In the US, GAAP (Generally Accepted Accounting Principles) requires accrual accounting for:
- All public companies (SEC requirement)
- Companies with annual revenues over $25 million (IRS requirement)
- Businesses with inventory (in most cases)
Smaller businesses can use cash basis for tax purposes, but most benefit from switching to accrual as they grow – it gives a far more accurate picture of financial performance.
The Bottom Line
Accrual basis accounting gives businesses an accurate picture of financial performance by matching revenues and expenses to the period in which they occur. It’s more complex than cash accounting, but it’s the standard for any business serious about understanding its true financial position – and required for GAAP compliance and most external reporting.
