Accrual Accounting
Recording revenue when earned and expenses when incurred, not when cash changes hands.
Definition
Accrual accounting records transactions when they occur—revenue when earned (invoice sent), expenses when incurred (work performed)—regardless of when cash is received or paid. This contrasts with cash accounting, which only records transactions when cash moves.
Under accrual accounting, sending an invoice creates revenue and accounts receivable, even if payment won't arrive for 30 days. Receiving an invoice for services creates an expense and accounts payable, even if you'll pay next month.
Why It Matters
Accrual accounting provides accurate financial statements by matching revenue and expenses to the period when economic activity occurred. This shows true profitability and financial position.
Most businesses over $25M revenue must use accrual accounting for tax purposes. It's also required under GAAP (Generally Accepted Accounting Principles), making it necessary for audited financial statements and investor reporting.
Examples
- 1
In December, invoice $50,000 for services (revenue recognized). Customer pays in January—December revenue is still $50,000.
- 2
Receive utility bill in January for December services—expense recorded in December under accrual method.
- 3
Annual insurance premium paid January 1—under accrual, expense is spread over 12 months ($1,000/month for $12,000 premium).
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