Accrual basis accounting: What it is, benefits and examples

Accrual basis accounting is all about capturing the true story of your business’s finances—recording income and expenses right when they happen, not just when cash hits or leaves your account. By doing so, it reveals a fuller, more accurate picture of financial health, making it easier to plan, grow, and make smart decisions.

In this guide, we’ll dive into the essentials of accrual accounting, explore examples, key benefits, and show how it can streamline financial management for your business.

Key takeaways:

• Accrual basis accounting records revenue when it’s earned and expenses when they’re incurred, giving a more accurate picture of financial health.
• This method relies on accounts like accounts receivable, accounts payable, and prepaid expenses to track upcoming cash transactions.
• Accrual-based accounting is ideal for businesses managing credit, inventory, or long-term projects and is required for GAAP compliance in larger companies.
• While it provides detailed insights, accrual accounting can be complex and impact cash flow.
• Accounting software can simplify the process by automating entries and generating real-time reports.

In this article, we’ll cover:

What is accrual accounting?

Accrual accounting is a method that recognizes revenue and expenses when they are incurred rather than when cash actually changes hands. In accrual accounting, an “accrual” refers to recording revenues and expenses that are earned or incurred but haven’t yet been paid in cash.

This approach follows two key principles. The matching principle, which records expenses in the same period as the revenue they support, and the revenue recognition principle, which recognizes revenue when it’s earned.

By aligning revenue with related expenses, accrual basis accounting offers a clearer view of profitability and provides a more accurate picture of assets and liabilities on the balance sheet. That’s why this accounting method is required by GAAP for publicly traded companies and is favored by many businesses looking to get a clear view of their financial standing.

How does accrual basis accounting work?

Accrual basis accounting captures the full financial picture by recording revenue when it’s earned and expenses when they’re incurred, regardless of when cash actually moves.

This means anticipated payments, like unpaid customer invoices, appear on the balance sheet under “accounts receivable.” Similarly, expected outgoing payments are noted under “accounts payable.”

These balance sheet entries, called accruals, serve as placeholders, reflecting upcoming cash transactions.

By recognizing income and expenses in this way, the accrual-based method of accounting ensures businesses have a timely and accurate view of profitability, helping them track financial health and make informed decisions—even before cash exchanges hands.

Core principles of accrual basis accounting

At the heart of accrual-based accounting are two core principles. The revenue recognition principle and the matching principle. These concepts help create a clear, accurate picture of a business’s financial health by linking income and expenses to the periods they actually impact, regardless of cash movement.

Revenue recognition principle

This principle states that revenue is recorded when it’s earned, not when payment is received.

For example, imagine you run a custom furniture business and complete a client’s order in August, but the client doesn’t pay until September.

Under the revenue recognition principle, you would record the revenue in August, when you fulfilled your obligation by delivering the furniture, even though you haven’t been paid yet. This way, your income reflects the actual work done in that period.

Matching principle

The matching principle requires that expenses are recorded in the same period as the revenue they help generate.

Continuing with the furniture example, if you spent $1,800 on materials and labor to complete the client’s order in August, those costs should also be recorded in August. This alignment ensures that revenue and related expenses are matched, giving a true sense of profitability for each period.

By following these principles, accrual basis accounting helps you see the real economic activities of your business, offering a comprehensive view of financial performance and helping you make better-informed decisions.

Types of accrual accounting methods

The accrual-based method of accounting includes several techniques to track financial activities even before cash exchanges hands. These methods—deferred revenue, accrued revenue, prepaid expenses, and accrued expenses—are essential for accurately representing a business’s financial position.

Deferred revenue

Deferred revenue, also called unearned revenue, is money a business receives before delivering a product or service. Think of it as an advance payment.

For example, if a client pays upfront for a year-long software subscription, that payment is initially recorded as deferred revenue—a liability—since the service is ongoing.

In accrual basis accounting, this advance payment is recorded as a liability because it represents a service the business still owes.

Example of deferred revenue entry

In January (when the payment is received):

• Debit: cash $1,200
• Credit: deferred revenue (liability) $1,200

This entry shows an increase in cash and recognizes a liability for the unearned portion of the revenue.

In February (and each subsequent month as service is provided):

• Debit: deferred revenue $100 (reducing the liability)
• Credit: revenue $100 (recognizing the earned revenue)

Each month, $100 (1/12 of the subscription) is moved from deferred to earned revenue, matching the service provided with the recognized revenue. This gives a clearer picture of actual income earned.

Accrued revenue

Accrued revenue is income you’ve earned by providing a product or service, even though you haven’t been paid yet.

Let’s say you complete $300 worth of consulting work in January, but the client won’t pay until February. Since the work is already done, you record the revenue in January to match when it was earned.

Example of accrued revenue entry

In December (when the service is provided):

• Debit: accounts receivable $300 (to reflect what’s owed)
• Credit: revenue $300 (to record the earned income)

This entry shows the revenue as earned, even though the payment is still pending.

In January (when payment is received):

• Debit: cash $300 (increasing cash)
• Credit: accounts receivable $300 (removing the outstanding amount)

By recording accrued revenue, your financial statements show income in the period it was earned, helping you track profitability accurately, even if payment comes later.

Prepaid expenses

Prepaid expenses are payments you make in advance for goods or services you’ll use later. For example, if you pay $1,200 upfront in January for a year-long insurance policy, that payment is recorded as a prepaid expense (an asset) since it covers future benefits.

Example of prepaid expense entry

In January (when you make the upfront payment):

• Debit: prepaid expenses $1,200 (recording the future benefit)
• Credit: cash $1,200 (reflecting the cash payment)

This entry shows that the insurance payment was made upfront, but you haven’t yet used the coverage.

Each month (February through December, as you “use” the insurance):

• Debit: insurance expense $100 (for each month’s portion of the policy)
• Credit: prepaid expenses $100 (reducing the prepaid amount)

Each month, $100 (1/12 of the $1,200) is moved from prepaid expenses to insurance expenses, matching the cost to the benefit period. This way, your records accurately reflect the insurance cost over the entire year, giving a clear view of monthly expenses.

Accrued expenses                     

Accrued expenses are costs you’ve incurred but haven’t paid yet. Let’s say you receive $200 worth of supplies in October, but the payment isn’t due until November. Even though you haven’t paid for the supplies, you record the expense in October to reflect when they were actually used.

Example of accrued expense entry

In October (when you receive the supplies):

• Debit: supplies expense $200 (recording the cost of supplies)
• Credit: accounts payable $200 (showing the amount owed)

This entry ensures your expenses match the month you used the supplies, even if payment hasn’t been made.

In November (when you make the payment):

• Debit: accounts payable $200 (clearing the amount owed)
• Credit: cash $200 (reflecting the cash outflow)

Recording accrued expenses like this helps keep your finances accurate, showing the true costs in the periods they’re incurred.

Cash basis versus accrual basis: Key differences

The cash and accrual accounting methods differ in how they record income and expenses, impacting the financial picture they provide. Here is a table describing the key differences between cash vs. accrual-based accounting to help you decide which accounting method is best for your business: 

Variable	Cash basis accounting	Accrual basis accounting
Timing	Records transactions only when cash is exchanged (when payment is received or paid).	Records revenue and expenses when they are earned or incurred, regardless of when cash is actually exchanged.
Complexity	Simple, immediate, and easy to manage, often with minimal bookkeeping requirements.	Requires more detailed tracking, especially of receivables and payables, and is generally more complex to maintain.
Ideal for	Small businesses, freelancers, and sole proprietors with straightforward transactions.	Larger companies, businesses with inventory, and those seeking a long-term financial view or needing investor support.
View of financial health	Provides a short-term view of cash flow, showing only the current cash balance.	Offers a comprehensive view of financial health by accounting for all income and expenses, even if unpaid.
Cash flow management	Easier to track available cash since only cash transactions are recorded.	May show profitability even if cash is unavailable, requiring more careful monitoring of actual cash flow.
Legal requirements	Generally allowed for small businesses below a revenue threshold and for tax deferral on unpaid income.	Required by law for larger companies, public companies, and those following GAAP or IFRS standards.
Tax implications	Taxes are paid only on income received, potentially reducing the tax burden in low-cash months.	Taxes may be due on earned revenue even if payment hasn’t been received, potentially impacting cash reserves.
Example	Similar to managing personal finances by tracking cash in and out with a banking app.	Like using a budgeting app that logs all expected income and expenses for a complete financial picture.
Pros	Simpler to manage, provides real-time cash flow insight, lower bookkeeping costs.	More accurate long-term view, supports financial planning, meets investor and lender requirements.
Cons	Doesn’t show full financial commitments; may miss unpaid revenue or expenses.	More complex, can be costly, requires careful cash management to avoid liquidity issues.

Accrual accounting examples

Accrual basis accounting ensures that income and expenses are recorded in the period they’re earned or incurred, regardless of when cash exchanges hands. Here are some unique accrual accounting examples to illustrate how this method works for various types of transactions.

Revenue example: Project-based services

BluePrint Design Studio is an interior design company, that has completed a project for a client in September worth $8,000. They invoice the client at the end of the month, with a payment deadline of October 31. Under the accrual basis, BluePrint records the revenue in September when the service was completed, not in October when payment is received.

September entry:

• Debit: accounts receivable $8,000
• Credit: revenue $8,000

(This entry records the income earned, even though payment hasn’t been received yet.)

October entry (when payment is received):

• Debit: cash $8,000
• Credit: accounts receivable $8,000

(This entry reflects the payment received and clears the outstanding amount.)

This approach shows income in the month the service was provided, giving a clear view of September’s earnings.

Expense example: Utilities billed in arrears

CityBuild Construction uses electricity for its operations in November, but the utility company invoices them in December. Although the bill won’t be paid until December, CityBuild records this as an expense in November to match when the electricity was used.

November entry:

• Debit: utilities expense $400
• Credit: accounts payable $400

(This entry recognizes the expense in November, the month the utility was used.)

December entry (when the bill is paid):

• Debit: accounts payable $400
• Credit: cash $400

(This entry clears the liability once payment is made.)

Recording the expense in November provides an accurate view of costs aligned with operations.

Deferred revenue example: Annual subscription service

Ace Fitness offers an annual membership plan that requires customers to pay $1,200 upfront in January. This payment covers access to services for the entire year. Initially, Ace records the payment as deferred revenue because the service hasn’t yet been provided.

January entry:

• Debit: cash $1,200
• Credit: deferred revenue $1,200

(This entry records the payment received as a liability, as services are still owed.)

Monthly entry (February through December):

• Debit: deferred revenue $100
• Credit: revenue $100

(Each month, $100 is moved from deferred revenue to earned revenue as the service is delivered.)

This monthly adjustment ensures income is recognized gradually, providing a clearer picture of earned revenue throughout the year.

Prepaid expense example: Advertising campaign

SmartAds Inc. pays $3,000 upfront in August for a six-month online advertising campaign. Since the service spans multiple months, the initial payment is recorded as a prepaid expense.

August entry:

• Debit: prepaid expense $3,000
• Credit: cash $3,000

(This entry records the advance payment as an asset, as the service hasn’t fully occurred yet.)

Monthly entry (September through February):

• Debit: advertising expense $500
• Credit: prepaid expense $500

(Each month, $500 is moved from prepaid expense to advertising expense, aligning cost with the service period.)

This approach spreads the cost over six months, accurately reflecting monthly expenses and avoiding a one-time expense that would distort the August budget.

When to use accrual basis accounting

Accrual basis accounting is often essential or beneficial in certain situations, especially when detailed and standardized reporting is needed:

Regulatory compliance (GAAP requirements): accrual accounting is required for filings that follow GAAP, such as SEC 10-K reports. Many investors and lenders also prefer GAAP-compliant financials for transparency and accuracy.

Complex revenue structures: if your business offers credit, long-term contracts, or subscriptions, accrual accounting helps by recording income and expenses in the periods they apply, giving a more accurate view of financial health.

IRS rules and exceptions: the IRS requires larger companies with over $25 million in revenue to use accrual accounting, but smaller businesses, like sole proprietors or S-Corps, can choose either cash or accrual. Switching methods, however, needs Form 3115 filed with the IRS.

Preparing for growth: if your business plans to grow, attract investors, or go public, using accrual accounting from the start builds consistency, making financial comparisons easier down the line.

Inventory management: for businesses with inventory, accrual accounting better matches costs with related sales, providing a clearer picture of profit margins.

Advantages of accrual accounting

Why use accrual accounting? Accrual accounting offers several practical benefits, making it a smart choice for many businesses.

A clearer financial picture

By recording income and expenses when they’re earned or incurred, rather than when cash changes hands, accrual basis accounting gives a more accurate view of your business’s financial health. This is especially helpful for companies that work with credit or manage long-term projects, as it shows the true state of income and costs.

Better for funding and investment

Many investors and lenders prefer accrual accounting because it meets GAAP accounting standards and provides a consistent financial picture. For businesses looking to grow or secure funding, accrual accounting can boost credibility and improve chances of attracting investment.

Informed financial planning

Accrual-based accounting helps match expenses directly to the revenues they support, giving you a clearer view of profitability. This accuracy is invaluable for budgeting, forecasting, and making strategic decisions about where to allocate resources.

Effective project tracking

For businesses managing long-term contracts, accrual accounting keeps revenue and expenses aligned with the actual work done. This makes it easier to track the financial progress of each project and understand profitability over time.

Budget control

Since accrual accounting shows which expenses support which revenues, it’s easier to see where you’re over or under budget and adjust as needed. This leads to better resource management and helps you stay on track financially.

Clearer reporting for stakeholders

Accrual accounting provides a transparent view of your business’s operations and financial stability, giving investors, creditors, and other stakeholders confidence in your numbers and making it easier for them to make informed decisions.

Disadvantages of accrual accounting

While accrual basis accounting gives a detailed view of financial performance, it does come with some challenges that are important to consider.

Increased complexity

Accrual accounting requires a good understanding of accounting principles and accurate record-keeping. Small business owners or those without an accounting background may find it difficult to manage and often need specialized software or external help to handle the added workload.

Time-intensive record-keeping

Since transactions are recorded when they’re earned or incurred, even if cash hasn’t changed hands, accrual accounting requires careful tracking of accounts receivable and accounts payable. This adds more administrative work, which can be tough for small businesses without dedicated accounting staff.

Potential cash flow mismatch

One drawback of accrual accounting is that it records revenue when it’s earned rather than when cash is received. This can sometimes make the business look profitable on paper while actually facing a cash shortage. It’s essential to monitor cash flow statements regularly to maintain a clear picture of cash on hand.

Delayed cash-based feedback

In accrual basis accounting, a sale is recorded as soon as it’s made, even if payment won’t arrive until much later. This delay can make it harder for businesses to quickly address cash-based issues or seize opportunities, as the financials might not reflect the actual cash available.

Higher costs and resources needed

Accrual-based accounting’s complexity often means more time and costs, whether for software, accounting services, or additional team resources. For smaller businesses with simpler transactions, this extra investment may not be necessary or practical.

Is accrual basis accounting the right method for your business?

Deciding if an accrual-based method of accounting is right for your business depends on how you operate and your future plans. Here are some key points to consider.

Cash versus credit transactions: if your business deals mainly in cash, accrual accounting may not be necessary. But if you extend credit to customers or buy on credit from suppliers, accrual accounting gives a more accurate picture of your finances.

Timing of payments: the longer the wait between making sales and getting paid, the more helpful accrual accounting becomes. It records income when it’s earned, not received, showing profitability more clearly.

Inventory tracking: product-based businesses, even small ones, often benefit from accrual accounting to accurately manage inventory and cost of goods sold. This provides a clearer view of profit.

Revenue size and requirements: companies with over $25 million in revenue or those that are publicly traded must use accrual accounting. As your business grows, this may become a requirement.

Growth and funding goals: if you’re planning to expand or attract investors, accrual accounting is often preferred by lenders and investors, as it’s GAAP-compliant and shows financial health more clearly.

Accrual accounting best practices

Here are some straightforward ways to make accrual accounting work smoothly for your business.

Be mindful of when to record revenue

If your business offers subscriptions or bundles of products and services, it’s important to time revenue recognition accurately. You might record income over the subscription period or at key milestones. For bundled products, break down each part’s value so you can log revenue correctly.

Standardize recurring expenses

Set up a routine for tracking regular costs like rent, utilities, and payroll to help ensure they’re accurately recorded on time. Use past data to estimate costs like bad debts or warranties and keep your estimates updated.

Keep an eye on potential liabilities

For any possible liabilities—like warranties or legal claims—have a process to track and record them. If a liability is likely, make sure it’s recorded, and note any others in your financial statement footnotes to be fully transparent.

Separate duties for accuracy and security

Divide up tasks for approving, recording, and reconciling transactions to reduce mistakes and protect against fraud. This way, each part of the process is handled accurately.

Regularly review your processes

Schedule routine check-ups on your accrual basis accounting, including your estimates and entries, to catch any mistakes early. Keep clear records of your accounting policies and processes to support audits and stay transparent.

Use data for insights

Analyzing data can help you spot trends, catch any unusual activity in revenue or expenses, and improve your forecasting. Tracking these patterns can lead to smarter financial planning.

How accounting software can help

Accrual basis accounting requires detailed tracking of accounts receivable, accounts payable, and deferred revenue on a regular basis, which can be time-consuming for businesses without a dedicated accounting team.

Good accounting software, like Sage Intacct, simplifies this process by automating accruals, tracking revenue and expenses, and generating reports in real time. This automation not only saves time but also reduces the risk of errors, ensuring accuracy across all accounts.

With Sage Intacct, you can keep your books up to date effortlessly, allowing you to focus on growing your business with confidence in your financial data.

Accrual basis accounting FAQs 

What is an accrual in simple terms?

An accrual is money that a business has earned or owes but hasn’t yet received or paid. It’s a way to keep track of income and expenses as they happen, even if the cash hasn’t moved yet, giving a clearer picture of what’s owed.

What is the difference between accruals and actuals?    

Accruals are amounts that a business expects to receive or pay but hasn’t yet. Actuals are amounts that have already been received or paid. Accruals show what’s due, while actuals show what’s been completed.

When is revenue recognized in accrual accounting?

In accrual accounting, revenue is recorded as soon as a sale is made or a service is completed, even if the payment hasn’t arrived yet. This amount shows up as revenue on the income statement, and any unpaid amount is listed as accounts receivable on the balance sheet, either as a short-term or long-term asset depending on when it’s due.

Is accrual accounting required by GAAP?     

Yes, GAAP requires most companies, especially public ones, to use accrual accounting. This method records income and expenses when they happen, not when cash is exchanged, giving a clearer view of financial performance. While companies might use other methods internally, only accrual accounting meets GAAP standards for official financial reporting.