What Is Accrual Accounting? Definition and Benefits
By Markets & Investing DeskUpdated Nov 10, 2026
Definition
Accrual accounting records revenue when it is earned and expenses when they are incurred, regardless of when cash changes hands, to show what a business truly earned and spent in a period.
Key takeaways
- Unpaid sales sit on the balance sheet as accounts receivable until the customer pays the invoice.
- End-of-period adjusting entries capture accrued revenue, accrued expenses, deferred revenue and prepaid expenses.
- Companies reporting under U.S. GAAP or IFRS must use accrual accounting; the cash basis is not accepted.
- C corporations generally must use accrual for taxes unless average gross receipts are $25 million or less.
Accrual accounting is an accounting method that records revenue when it is earned and expenses when they are incurred, regardless of when cash changes hands. A sale made on credit counts as revenue in the period the goods or services are delivered, even if the customer pays weeks later. An expense counts in the period the business uses the resource, even if the bill is paid later. Under the matching principle, related expenses are placed in the same period as the revenue they helped produce. The aim is to show what a business earned and spent during a period, not just what moved through its bank account.
How Accrual Accounting Works
Every transaction is recorded when the underlying event happens. If a company performs a service in March and invoices it with 30-day terms, March gets the revenue. Until the customer pays, the amount sits on the balance sheet as accounts receivable, an asset representing money owed to the company.
The same logic runs in reverse for costs. Employees who work the last week of December but are paid in January generate a December wage expense. The unpaid amount becomes a liability (accrued wages) until payday.
Because day-to-day bookkeeping does not always capture these items, accountants make adjusting entries at the end of each period. The common categories are:
- Accrued revenue: earned but not yet billed or collected (for example, interest earned on a loan to a customer).
- Accrued expenses: incurred but not yet paid (wages, utilities, interest owed).
- Deferred revenue: cash received before it is earned, such as an annual subscription paid upfront. It starts as a liability and moves into revenue as the service is delivered.
- Prepaid expenses: cash paid before the benefit is used, such as insurance paid a year ahead. It starts as an asset and is expensed month by month.
Depreciation follows the same principle: the cost of equipment is spread over the years it helps generate revenue rather than expensed in the year it is bought.
Example of Accrual Accounting
Hypothetical example. A consulting firm completes a $5,000 project for a client on October 30. The client pays on November 25.
Accrual basis entries:
| Date | Account | Debit | Credit |
|---|---|---|---|
| Oct. 30 | Accounts receivable | $5,000 | |
| Oct. 30 | Service revenue | $5,000 | |
| Nov. 25 | Cash | $5,000 | |
| Nov. 25 | Accounts receivable | $5,000 |
The October income statement shows $5,000 of revenue. The November payment changes nothing on the income statement; it swaps one asset (the receivable) for another (cash).
Cash basis treatment: nothing is recorded on October 30. The $5,000 appears as revenue on November 25, when the money arrives.
Now add an expense. Suppose the firm owed a subcontractor $2,000 for work on the same project and paid the invoice on December 5. Under accrual accounting, the $2,000 is an October expense (debit expense, credit accounts payable), so October shows $3,000 of profit from the project. Under the cash method, October shows nothing, November shows $5,000 of income, and December shows a $2,000 loss.
Accrual vs. Cash Accounting
| Accrual basis | Cash basis | |
|---|---|---|
| Revenue recorded | When earned | When cash is received |
| Expenses recorded | When incurred | When cash is paid |
| Receivables and payables | Tracked on the balance sheet | Not tracked in the books |
| Matching of revenue and costs | Yes | Only if payments happen to fall in the same period |
| Complexity | Higher | Lower |
| Accepted under GAAP/IFRS | Yes | No |
A third approach, the modified cash basis (a hybrid), records most day-to-day items on a cash basis but treats long-lived assets and certain liabilities on an accrual basis, for example by depreciating equipment instead of expensing it at purchase.
Who Must Use the Accrual Method
Financial reporting. Companies that prepare statements under U.S. GAAP or IFRS must use accrual accounting. That includes public companies filing with the SEC, and private companies whose lenders or investors require GAAP statements.
U.S. taxes. Under Section 448 of the Internal Revenue Code, C corporations and partnerships with a C corporation as a partner generally must use the accrual method unless they pass the gross receipts test: average annual gross receipts of $25 million or less over the prior three tax years. The Tax Cuts and Jobs Act of 2017 set this threshold, which is indexed for inflation. Businesses under it can usually choose cash or accrual. The same law also let many of them use the cash method even if they carry inventory, which previously generally required accrual treatment. Tax shelters cannot use the cash method regardless of size. A business can use one method for its books and another for taxes, but changing its tax method generally requires IRS consent.
Benefits of Accrual Accounting
- A more accurate view of profitability. Revenue and the costs that produced it land in the same period, so margins reflect performance instead of payment timing.
- Comparable periods. A large customer payment arriving a few days late does not swing a fiscal quarter from profit to loss.
- Visibility into future cash. Receivables show cash expected to come in; payables and accrued liabilities show cash that must go out.
- Fit for credit sales and long contracts. Sales on terms and multi-month projects are recorded when they affect the company’s financial condition.
- Acceptance by outside users. Lenders, investors and auditors rely on accrual-based statements, and figures such as operating income and EBITDA are built from them.
Limitations of Accrual Accounting
- Profit is not cash. A company can report strong earnings while running short of money if customers pay slowly. That is why accrual statements are paired with a cash flow statement and why analysts watch free cash flow alongside net income.
- Estimates and judgment. Allowances for bad debts, accrued bonuses, warranty reserves and useful lives for depreciation all require assumptions. Wrong estimates distort results, and aggressive ones can be used to manage earnings.
- More work and cost. Adjusting entries, reconciliations and tracking receivables and payables take more effort, which is why many very small businesses prefer the cash method when allowed.
- Tax timing. Income recorded on the accrual basis can be taxable before the cash is collected.
Terms Readers Confuse
Accrual vs. an accrual. Accrual accounting is the method. An accrual is a single adjusting entry for revenue earned or an expense incurred but not yet recorded through cash, such as accrued interest.
Accrual vs. deferral. An accrual records the economic event before the cash moves. A deferral handles cash that moves before the event (deferred revenue, prepaid expenses). Accrual accounting uses both.
Accrual vs. mercantile system. “Mercantile system of accounting” is another name for the accrual basis, used in countries such as India. The two mean the same thing.
Accrual vs. double-entry. Double-entry bookkeeping records every transaction as equal debits and credits. It is a recording system, not a timing method; a cash-basis business can also keep double-entry books. Accrual accounting, however, cannot work without it, because receivables, payables and accrued liabilities need their own accounts.
FAQs
Is there an accrual accounting formula?
There is no single formula. The method relies on the accounting equation (assets = liabilities + equity) and on recognition rules. Accrued expense for a period is often estimated as the amount used multiplied by the rate, for example hours worked but unpaid multiplied by the hourly wage.
The Bottom Line
Accrual accounting matters to companies that report under GAAP or IFRS, larger C corporations, and any business selling on credit or running long contracts. It gives a truer picture of profit and makes periods comparable, but it takes more work and relies on estimates. Because reported profit is not cash, readers of accrual statements should check the cash flow statement alongside net income.
