Accrual vs. Cash Basis: When a Sale and a Bill Actually Count

Accrual accounting

Accrual accounting is the method that records revenue in the period it is earned and expenses in the period they are incurred, whether or not cash has moved yet. A business on an accrual accounting basis is therefore reporting what it did in a month, while a business on a cash basis is reporting what it collected and paid in that month.

The two methods answer different questions. Cash basis answers "what came in and what went out". Accrual answers "what did we earn and what did it cost us to earn it". For a business that invoices customers, buys on supplier terms, takes deposits, or pays anything in advance, those two answers drift apart every month, and the gap is where most surprises about profit and cash live.

GAAP (Generally Accepted Accounting Principles) statements are prepared on the accrual basis. The reason is comparability: when revenue is tied to the period the work happened, one month can be compared with the next without being distorted by which customers happened to pay. Cash basis remains common for small businesses, and tax rules permit it below certain revenue levels, but the moment a bank or an investor asks for GAAP statements, they are asking for accrual books.

Structure

The basis you choose changes which accounts your chart needs. A cash basis chart can get by with Cash, revenue, and expense accounts, because nothing is recorded until money moves. An accrual chart adds a set of balance sheet accounts whose only job is to hold the gap between the event and the cash. Each one records a timing difference in one direction.

Read the four balance sheet accounts as a two-by-two grid. Accounts Receivable and Accrued Liabilities cover events that happened before the cash: a sale you have not been paid for, a cost you have not been billed for. Prepaid Expenses and Unearned Revenue cover cash that arrived before the event: a premium paid for months of coverage still ahead, a deposit taken for work still to do. The OpenStax text groups the first pair as accruals and the second as deferrals, and every month-end adjustment falls into one of those two families.

Moving a chart from cash basis to accrual is mostly an addition, not a rewrite. The revenue and expense accounts stay. The new rows are the ones that carry timing.

Recording

Take one job. A design studio finishes a branding project on March 28 and sends a $9,000 invoice. The client pays on April 19. Under cash basis there is one entry, in April, and March shows nothing for the work. Under accrual there are two entries, and the first one lands in March. Figures are illustrative.

The same shape applies on the cost side. A supplier bill dated March 30 for $2,400 of print production is debited to an expense and credited to Accounts Payable in March, then paid out of Accounts Payable in April. The expense sits in the same month as the revenue it helped produce, which is the point of the whole method. The textbook calls this pairing the expense recognition principle, and it is why accrual profit for a month is a meaningful number rather than an artifact of payment timing.

Deferrals run the other way. If the studio pays a $3,600 annual insurance premium on March 1, cash basis expenses all of it in March. Accrual debits Prepaid Expenses for $3,600, then moves $300 into Insurance Expense each month as coverage is used up. A $5,000 client deposit for work not yet started is credited to Unearned Revenue, and stays there until the work is delivered.

Reporting

The clearest way to see the difference is the same month on both bases. March, for the studio above, with $9,000 invoiced, $2,400 of production billed, and only $4,000 collected from an older invoice. Under cash basis the numbers below are what the bank saw. Under accrual they are what the business did.

Same business, same month, a $4,800 loss on one basis and a $1,100 profit on the other. Neither report is wrong. The cash report describes liquidity and the accrual report describes performance. The problem is reading one as if it were the other, which is what happens when a cash basis profit and loss is used to judge whether a month went well.

The balance sheet shows the other half. On the accrual basis, March 31 carries $9,000 in Accounts Receivable, $2,400 in Accounts Payable, $3,300 of Prepaid Expenses, and any deposits in Unearned Revenue. On cash basis none of those lines exist, so the balance sheet is cash and equity and little else, and the question "how much are we owed" has to be answered from a spreadsheet outside the books.

Insight

Every industry chart on this site assumes the accrual basis, because job costing, inventory, retainers, and deposits all depend on separating the event from the cash. See how each industry applies it in the industry guides built on this foundation, or check whether your own chart has the timing accounts it needs.

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