What is the difference between accrual and cash accounting?

Cash accounting records transactions only when money is received or paid. Accrual accounting records transactions when they occur economically. For example, under accrual accounting you record revenue when you complete a service (even if the client hasn't paid yet), and expenses when you receive a bill (even if you haven't paid it yet).

When is accrual accounting required?

GAAP requires accrual accounting for publicly traded companies and any business with average annual gross receipts over $25 million. However, advisory professionals often recommend it for smaller businesses too, as it provides more accurate financial data for decision-making.

Accrual Accounting: What It Is, How It Works & Examples (2026)

Q: What is accrual accounting?

Accrual accounting records revenue when earned and expenses when incurred, regardless of when cash changes hands. It's required by GAAP for companies above $25 million in revenue and gives a more accurate picture of financial performance than cash-basis accounting.

Accrual accounting is the foundation of modern financial reporting — and understanding it deeply is what separates basic bookkeepers from fractional CFOs and financial advisors. If you're doing any kind of advisory work, you need to be fluent in accrual concepts.

What Is Accrual Accounting?

Accrual accounting records revenue when it's earned and expenses when they're incurred — regardless of when cash actually changes hands. This matching principle ensures financial statements reflect the true economic activity of a period.

The Matching Principle: Expenses should be recorded in the same period as the revenues they help generate. This gives a far more accurate picture of profitability than waiting for cash to move.

Accrual vs. Cash Accounting

Feature	Cash Basis	Accrual Basis
Revenue recorded	When cash received	When earned (service delivered/goods shipped)
Expenses recorded	When cash paid	When incurred (bill received/service consumed)
Accounts Receivable	Not used	Used (tracks unpaid invoices)
Accounts Payable	Not used	Used (tracks unpaid bills)
Accuracy	Reflects cash flow	Reflects economic reality
Complexity	Simple	More complex (adjusting entries needed)
GAAP compliant	Only for very small businesses	Yes — required above $25M revenue
Best for	Very small cash businesses	Growing businesses, advisory clients

Real-World Example: Why Accrual Matters

Imagine a consulting firm completes a $50,000 project in December but doesn't get paid until February:

Cash Basis View

December revenue: $0 (no cash received)
February revenue: $50,000 (cash received)

This makes December look like a terrible month and February look amazing — neither is accurate.

Accrual Basis View

December revenue: $50,000 (service delivered, revenue earned)
December: Accounts Receivable increases by $50,000
February: Cash increases, AR decreases (collection, not new revenue)

The accrual view correctly shows that December was a productive month. This is the data advisory clients need for real decision-making.

Key Accrual Journal Entries

1. Recording Revenue (Before Cash Received)

Dr. Accounts Receivable — $50,000

Cr. Service Revenue — $50,000

(To record revenue earned for completed project)

2. Recording an Expense (Before Cash Paid)

Dr. Rent Expense — $3,000

Cr. Accrued Expenses — $3,000

(To accrue December rent not yet paid)

3. Prepaid Expense Allocation

Dr. Insurance Expense — $500

Cr. Prepaid Insurance — $500

(To allocate one month of annual insurance premium)

4. Deferred Revenue Recognition

Dr. Unearned Revenue — $2,000

Cr. Service Revenue — $2,000

(To recognize revenue as service is delivered)

The Four Types of Adjusting Entries

Type	Description	Example
Accrued Revenue	Revenue earned but not yet billed	Consulting work completed, invoice not sent
Accrued Expenses	Expenses incurred but not yet paid	Employee wages earned but payday is next month
Deferred Revenue	Cash received before service delivered	Annual subscription paid upfront
Prepaid Expenses	Cash paid before expense incurred	12-month insurance premium paid in advance

When to Recommend Accrual to Clients

As an advisory professional, here's when you should recommend clients switch from cash to accrual:

Revenue exceeds $1M: At this scale, cash basis creates misleading financials
Seeking funding or loans: Banks and investors require GAAP-compliant (accrual) financials
Significant receivables/payables: If there's a big gap between invoicing and collection
Inventory-based business: GAAP requires accrual for businesses with inventory
Planning to sell: Business valuation requires accrual-basis financials

Common Accrual Accounting Mistakes

Not reversing accruals: Month-end accruals must be reversed when the actual transaction is recorded
Double-counting: Accruing an expense AND recording the cash payment without reversing
Improper revenue recognition: Recording revenue before the performance obligation is satisfied — learn more about revenue recognition (ASC 606)
Forgetting depreciation: Monthly depreciation entries are often skipped by smaller firms
Mixing methods: Some businesses accidentally use cash for some transactions and accrual for others

Accrual Accounting and the Monthly Close

A proper monthly close process under accrual accounting includes:

Record all accrued revenues (work completed but not yet billed)
Record all accrued expenses (costs incurred but not yet paid)
Allocate prepaid expenses for the month
Record depreciation
Review and reconcile AR and AP aging
Prepare the adjusted trial balance
Generate financial statements

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