Accrual Accounting
Also: Accrual Basis Accounting, Accruals
Accrual accounting records revenue and expenses when they are earned or incurred, not when cash changes hands, giving a more accurate picture of financial performance.
What It Is
Accrual accounting is a method of recording financial transactions when economic events occur, regardless of when cash is received or paid. Revenue is recognized when it is earned (the product is delivered or the service is performed), and expenses are recognized when they are incurred (the cost contributes to generating revenue), not when the related cash moves.
This contrasts with cash basis accounting, which records transactions only when money actually enters or leaves the bank account.
Why it matters
Accrual accounting is required under both GAAP and IFRS for most companies above a certain size, and it underpins two core principles:
- Revenue recognition principle: record revenue when earned.
- Matching principle: match expenses to the revenue they help produce in the same period.
The result is financial statements that reflect the true economic activity of a period. This matters because:
- It prevents misleading spikes or gaps caused by payment timing.
- It lets investors, lenders, and managers compare performance across periods.
- It supports accurate profitability analysis and forecasting.
How it is used in practice
CFOs and finance teams apply accrual accounting through several mechanisms:
- Accounts receivable: revenue booked before cash is collected.
- Accounts payable: expenses booked before bills are paid.
- Deferred revenue: cash received in advance, recognized later as the obligation is fulfilled.
- Prepaid expenses: cash paid in advance, expensed over time.
- Accrued liabilities: costs like wages or interest recognized before payment.
At period end, teams post adjusting journal entries to align the books with the accrual principle before producing financial statements.
Concrete Example
A SaaS company signs a 12 month contract for 12,000 USD, paid upfront in January.
- Cash basis: records 12,000 USD of revenue in January.
- Accrual basis: records 1,000 USD of revenue each month, holding the rest as deferred revenue (a liability) until earned.
Similarly, if the company receives a 3,000 USD electricity bill in March but pays it in April, accrual accounting books the 3,000 USD expense in March, the month the power was consumed.
This matching gives a faithful monthly profit figure, which is essential for SaaS metrics, board reporting, and valuation.
See also
Frequently asked questions
What is accrual accounting in one sentence?
Accrual accounting records revenue when it is earned and expenses when they are incurred, regardless of when cash actually moves. A service delivered in March counts as March revenue even if the client pays in June. It is the method required under GAAP and IFRS for most companies above a certain size.
What is the difference between accrual accounting and cash basis accounting?
Cash basis accounting records a transaction only when money enters or leaves the bank account; accrual accounting records it when the economic event happens. On a 12,000 USD annual contract paid upfront in January, cash basis shows 12,000 USD of revenue in January while accrual basis shows 1,000 USD per month. Accrual gives a truer monthly profit figure, cash basis tracks liquidity more directly.
Why do investors and lenders insist on accrual-based statements?
Because payment timing would otherwise create artificial spikes and gaps that make periods impossible to compare. Accrual accounting smooths those distortions by matching revenue and costs to the period of real activity, which supports profitability analysis, forecasting and valuation. It is also the basis on which GAAP and IFRS statements are audited.
Which two accounting principles does accrual accounting rest on?
The revenue recognition principle and the matching principle. Revenue recognition says to book revenue when it is earned, meaning when the product is delivered or the service performed. The matching principle says to record expenses in the same period as the revenue they helped produce.
Which accounts show accrual accounting at work on the balance sheet?
Five mechanisms carry the timing gap: accounts receivable (revenue booked before cash is collected), accounts payable (expenses booked before bills are paid), deferred revenue (cash received in advance, recognized as the obligation is fulfilled), prepaid expenses (cash paid in advance, expensed over time) and accrued liabilities (wages or interest recognized before payment). At period end, finance teams post adjusting journal entries to align the books before issuing statements.