Accrual vs Cash Basis Accounting
Two methods for timing when income and expenses are recognized: cash basis records transactions when money changes hands, accrual records them when economic activity occurs.
Detailed Explanation
Cash basis is simpler and used by most sole proprietors and small service businesses (under $30 million average gross receipts). Accrual basis is required for C corporations above the threshold, businesses with inventory in many cases, and most lenders/investors who want GAAP-conformant statements. The two methods can produce dramatically different reported income for the same business in any given year. Switching methods generally requires Form 3115, Application for Change in Accounting Method, and IRS approval.
Key Points
- Cash basis records income when received and expenses when paid; accrual records when earned or incurred.
- Cash basis is simpler and common for small service businesses; accrual matches revenue to related expenses.
- Accrual is generally required for businesses with inventory and C corporations above the gross-receipts threshold (about $30M).
- GAAP financial statements use accrual; lenders and investors usually expect it.
- Switching methods requires IRS consent via Form 3115 (Change in Accounting Method).
Practical Example
A consultant invoices $40,000 in December but is paid in January. Under cash basis the $40,000 is income next year; under accrual it is income this year (when earned). For a business with inventory, accrual is generally required so the cost of goods sold matches the revenue from selling that inventory.
Related TS CPA Service
Reliable, CPA-managed bookkeeping that keeps your financials clean, accurate, and tax-ready year-round.
Learn about Bookkeeping ServicesRelated Terms
Bookkeeping
The systematic recording, classification, and reconciliation of a business's financial transactions to produce accurate financial statements.
Generally Accepted Accounting Principles (GAAP)
The standard set of accounting rules and guidelines used by US businesses for financial reporting, set by the Financial Accounting Standards Board (FASB).
Profit and Loss Statement (P&L / Income Statement)
A financial report summarizing revenue and expenses over a period of time (month, quarter, year) to show net profit or loss.
Balance Sheet
A point-in-time financial statement showing what a business owns (assets), what it owes (liabilities), and the residual claim of owners (equity), with the fundamental equation Assets = Liabilities + Equity.
Have a Question About Accrual vs Cash Basis Accounting?
Get a free, no-obligation answer from a licensed CPA. We respond the same day.
Free Consultation