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Accrual Accounting

What Is Accrual Accounting?

Accrual accounting is a financial accounting method that allows a company to record revenue before receiving payment for goods or services sold or expenses are recorded as incurred before the company has paid for them.

In other words, the revenue earned is recognized on the company's accounting books regardless of when cash transactions have occurred. Accrual accounting is one of two accounting methods; the other is cash accounting. Cash accounting only records the revenue when the cash transaction has occurred for the goods and services.

Key Takeaways:

  • Accrual accounting is an accounting method where revenue or expenses are recorded when a transaction occurs versus when payment is received or made.
  • The method follows the matching principle, which says that revenues and expenses should be recognized in the same period.
  • Cash accounting is the other accounting method, which recognizes transactions only when payment is exchanged.
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How To Decipher Accrual Accounting

How Accrual Accounting Works

The general concept of accrual accounting is that economic events are recognized by matching revenues to expenses (the matching principle) at the time when the transaction occurs rather than when payment is made or received. This method allows the current cash inflows or outflows to be combined with future expected cash inflows or outflows to give a more accurate picture of a company's current financial position.

Qualifying for Accrual Accounting

Accrual accounting is considered the standard accounting practice for most companies except for very small businesses and individuals. The Internal Revenue Service (IRS) allows qualifying small businesses to choose their preferred method. Companies can use the accrual method of accounting if their revenue is below a specific threshold set by the IRS called the gross receipts method.

A corporation or partnership meets the gross receipts test for any taxable year if the average annual gross receipts for the 3-taxable-year period ending with the taxable year, which precedes such taxable year, does not exceed $26 million in 2021 and $27 million in 2022.

Benefits of Accrual Accounting

The accrual method does provide a more accurate picture of the company's current condition, but its relative complexity makes it more expensive to implement.

This method arose from the increasing complexity of business transactions and a desire for more accurate financial information. Selling on credit, and projects that provide revenue streams over a long period, affect a company's financial condition at the time of a transaction. Therefore, it makes sense that such events should also be reflected in the financial statements during the same reporting period that these transactions occur.

Under accrual accounting, firms have immediate feedback on their expected cash inflows and outflows, making it easier for businesses to manage their current resources and plan for the future.

Accrual accounting provides a more accurate picture of a company’s financial position some small businesses use cash accounting.

Accrual Accounting vs. Cash Accounting

Accrual accounting can be contrasted with cash accounting, which recognizes transactions only when there is an exchange of cash. Accrual accounting is almost always required for companies that carry inventory or make sales on credit.

For example, consider a consulting company that provides a $5,000 service to a client on Oct. 30. The client received the bill for services rendered and made a cash payment on Nov. 25. The accounting entry would be recorded differently under the cash versus the accrual method.

Cash Method

The revenue generated by the consulting services will only be recognized under the cash method when the company receives payment. As a result, if the company uses the cash accounting method, the $5,000 in revenue would be recorded on Nov. 25, which is when the company receives the payment.

Accrual Method

However, accrual accounting says that the cash method is not accurate because it is likely, if not certain, that the company will receive the cash at some point in the future because the services have been provided.

The accrual method recognizes the consulting company's $5,000 in revenue when the client's services have been concluded even though the cash payment has yet to be received from the client. As a result, the $5,000 in revenue is recognized as earned on Oct. 30. The sale is recorded in an account known as accounts receivable, found in the current assets section of the balance sheet. Accounts receivables represent the money owed by clients that have yet to be received.

A company that incurs an expense that it has yet to pay for will recognize the business expense on the day the expense arises. Under the accrual method of accounting, the company receiving goods or services on credit must report the liability no later than the date the goods were received. The accrued expense will be recorded as an account payable under the current liabilities section of the balance sheet and as an expense in the income statement. On the general ledger, when the bill is paid, the accounts payable account is debited, and the cash account is credited.

What Are the Types of Accrual Accounts?

There are various types of accrual accounts. The most common include accounts payable, accounts receivable, goodwill, accrued interest earned, and accrued tax liabilities.


Accounts payable refers to debts a company incurs when it receives goods or services from its vendors before it has actually paid for them. Using the accrual accounting method, when a company incurs an expense, the debt is recorded on the balance sheet as an accounts payable liability and the income statement as an expense.

What Is an Example of Accrual Accounting?

Suppose an appliance store sells a refrigerator to a customer on credit. Depending on the terms of its agreement with its customers, it may take many months or years before the store receives payment in full from the customer for the refrigerator. Using the accrual accounting method, the store will record the accrued revenue from the sale when the refrigerator leaves the store, not at some date in the future.

Does the IRS Require Accrual Accounting for Companies?

While the IRS does not require a single method of accounting for all businesses, it does impose certain limitations that impact which accounting method a company can use. For example, a company cannot use the cash method if it is a corporation (other than an S corporation) with average annual gross receipts greater than $26 million in 2021 and $27 million in 2022.

In these situations, the IRS requires the corporation to change to an accrual accounting method.

What Is Modified Accrual Accounting?

Modified accrual accounting is an alternative accounting method that combines elements from accrual accounting with cash basis accounting. Public companies do not use it because modified accrual accounting does not comply with generally accepted accounting principles (GAAP). However, the accounting method is widely accepted and used by government agencies.

Article Sources

Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. Internal Revenue Service. "FAQs Regarding the Aggregation Rules Under Section 448(c)(2) That Apply to the Section 163(j) Small Business Exemption." Accessed Nov. 27, 2021.

  2. Internal Revenue Service. “Rev. Proc. 2021-45," Pages 18-19. Accessed Nov. 27, 2021.

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