Accrual Accounting
An accounting method that records revenues and expenses when earned or incurred, regardless of when cash changes hands.
Accrual accounting is the standard method of accounting required by Generally Accepted Accounting Principles (GAAP) for most businesses above a certain revenue threshold. Under this method, revenues are recognized when they are earned — meaning when goods are delivered or services are performed — and expenses are recorded when they are incurred, not when payment is actually made or received.
This approach provides a more accurate picture of a company's financial health at any given point in time. For example, if a SaaS company closes a $120,000 annual contract in January, accrual accounting requires recognizing $10,000 of revenue each month as the service is delivered, even if the customer paid the full amount upfront.
Accrual accounting requires two main types of adjustments: accruals (recording revenue earned or expenses incurred before cash moves) and deferrals (postponing recognition of cash already received or paid). Common accrual entries include accrued salaries payable at month-end, prepaid insurance, and deferred subscription revenue.
For growing startups and established enterprises alike, accrual accounting enables meaningful period-over-period comparisons, supports compliance with audit requirements, and is required for companies seeking venture funding or planning an IPO. Modern cloud accounting platforms like QuickBooks Online, Xero, and NetSuite all operate on accrual basis by default, with automation features to handle recurring accrual journal entries.
FAQs
When must a business switch from cash to accrual accounting?
The IRS generally requires businesses with average annual gross receipts exceeding $30 million over the prior three years to use accrual accounting. Many businesses switch voluntarily well before that threshold to satisfy investors, lenders, or audit requirements.
What is the main disadvantage of accrual accounting?
Accrual accounting can show profit on the income statement even when a business has no cash on hand, because revenue is recognized before payment is collected. This disconnect between profit and cash flow is why monitoring the cash flow statement alongside the income statement is essential.
Does accrual accounting affect taxes?
Yes. Under accrual accounting, you may owe taxes on income you haven't yet collected in cash. However, it also allows you to deduct expenses before you've paid them, which can create timing advantages for tax planning.
Related Terms
Cash Basis Accounting
An accounting method that records income and expenses only when cash is actually received or paid.
Revenue Recognition
The accounting principle determining when and how much revenue can be recorded on the income statement under GAAP.
Deferred Revenue
Cash received from customers for services not yet delivered, recorded as a liability until the service obligation is fulfilled.
General Ledger
The master record of all financial transactions in a business, organized by account and used to produce financial statements.
