What is an accrual basis accounting?

In plain English

Under the accrual basis, a December invoice counts as December income even if the customer pays in January. A bill for December work counts as a December expense even if you pay it later.

Many small businesses use the cash basis for taxes. Which method your return uses is a decision to make with your preparer, and your books can be kept to match.

Why it matters

Accrual reports match the work you did in a month with the costs of doing it. That makes it far easier to see whether a job, a product line or a whole quarter actually made money. Under cash timing, one big customer payment can make a slow month look great and hide a real problem.

Banks, investors and buyers of a business usually want accrual statements because they show obligations and earned income that have not moved through the bank yet. If you plan to borrow, raise money or sell someday, keeping accrual books, even if your tax return uses another method, can save a painful cleanup later.

Worked example

You finish a $3,000 job on December 28 and invoice January 5. On the accrual basis, December revenue includes $3,000. On the cash basis, it counts in the month you are paid.

How to handle it

1. Record sales as invoices on the date the work is done or goods are delivered, not when payment lands.
2. Enter supplier bills on the bill date so the expense lands in the period it belongs to.
3. At month end, add entries for costs you have incurred but not been billed for, such as unbilled wages or utilities.
4. Spread prepaid costs and customer prepayments across the months they cover.
5. Run the profit and loss with the report basis set to accrual and compare it with the cash version to see the timing gap.

Common mistakes

• Switching the report basis back and forth without noting which one you used, so month to month comparisons do not line up.
• Recording annual insurance or software as an expense in the month paid, which makes one month look poor and the others look too good.
• Assuming accrual books mean you must file taxes on accrual, which is a separate decision to make with your accountant.
• Forgetting month end accruals, which leaves the books on a hybrid basis that is neither fully cash nor fully accrual.

Not the same as: Cash basis accounting

Accrual records income when earned and expenses when incurred. Cash basis records them only when money actually comes in or goes out. See Cash basis accounting.

Go deeper

• Accrued Expenses and Accrued Revenue Explained: Understand accruals: how to record expenses you owe but have not been billed for, and income earned but not invoiced, with simple examples.

Related terms

• Accrued expense: A cost you have incurred but not yet paid or been billed for, recorded so the right period carries it.
• Accumulated depreciation: The total depreciation recorded on an asset since you started using it, shown as a reduction of the asset's cost.
• Accounts receivable: Money customers owe you for goods or services you have already delivered and invoiced.

Common questions

General information, not tax, legal or accounting advice. Confirm rules with the IRS, the NJ Division of Taxation or a licensed professional.