Accounting
Accrual Basis Accounting
An accounting method that records revenue when earned and expenses when incurred, regardless of when cash moves. The GAAP-required foundation for meaningful monthly financials.
Accrual basis matches revenue with the cost of producing it, giving a clearer picture of true profitability period over period. It uses receivables, payables, deferred revenue, and accrued expense accounts to bridge cash and reality.
Required for companies above ~$30M average gross receipts (with C-corp partner) and effectively required by most lenders and investors. Accrual is the default for GAAP financial statements.
The five accrual accounts that carry the difference between cash and accrual books are: accounts receivable (revenue earned but not collected), accounts payable (expenses incurred but not paid), accrued expenses (unbilled recurring costs like payroll spanning a period), deferred revenue (cash collected before the service is delivered), and prepaid expenses (cash paid ahead of expense recognition). Every close cycle should verify all five agree with source data.
The switch from cash to accrual is filed via Form 3115 (Change in Accounting Method) with a §481(a) catch-up adjustment. The catch-up is the cumulative difference between the two methods as of the change date, spread over 4 years for most method changes. Waiting to switch until forced by an audit or loan is usually the most expensive option — every year in the wrong method compounds the eventual catch-up.
For businesses with meaningful inventory, deferred revenue, or long-cycle billing, cash-basis books actively mislead the owner about monthly performance. A SaaS business collecting an annual prepayment shows a huge cash-basis month followed by 11 empty months; accrual smooths that into 12 comparable months. Every meaningful monthly decision — pricing, hiring, cash-flow forecasting — requires accrual to be trustworthy.
Common pitfalls
- Waiting to convert to accrual until an audit or loan forces it — the catch-up gets more expensive every year
- Running the books hybrid (some accounts accrual, some cash) without a documented policy — hybrid records confuse everyone including the tax preparer
- Missing accrued payroll at year-end (wages earned in December, paid in January belong in December)
- Forgetting to reconcile deferred revenue to signed contracts monthly — the number quietly drifts out of trust
- Assuming §471(c) small-business relief covers all accrual timing questions — it only covers inventory; other accrual accounts still apply
Related service
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Monthly close, accrual-basis financials, and a ledger that holds up when a lender, a buyer, or an examiner asks to see it.