What Is Accrual Accounting? Definition, Examples & Rules

If a customer pays for a year of software upfront, the whole payment does not become revenue on day one. If a vendor sends an invoice after month-end, the cost can still belong to the previous month.

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That is the basic idea behind accrual accounting. It allows a company to report what it earned and incurred during a period, while accounts such as receivables, payables, deferred revenue, and prepaids carry those timing differences on the balance sheet.

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This guide explains how the method works, how it differs from cash accounting, and the journal entries that make it work.

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[tldr]

What is accrual accounting?

Accrual accounting is an accounting method that records transactions based on when the underlying activity occurs rather than simply when cash is received or paid.

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For example, suppose a consulting firm completes $10,000 of work in March and gives the customer 30 days to pay. The company records the revenue in March because that is when it earned it, even if the customer does not pay until April.

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The same principle applies to costs. If employees work the final week of March but are paid in April, the related payroll cost still belongs in March.

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This is why accrual accounting uses balance-sheet accounts such as accounts receivable, accounts payable, accrued liabilities, prepaid expenses, and deferred revenue. Those accounts hold amounts where the accounting activity and the cash movement happen in different periods.

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Accrual accounting also works alongside the revenue recognition principle, which determines when revenue belongs in the financial statements.

How accrual accounting works

Assume a SaaS company receives $3,000 on January 1 for three months of service covering January through March. It also uses $600 of cloud hosting in January, but the hosting provider bills and receives payment in February.

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Here is what the same activity looks like under the two methods:

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Both approaches eventually show $2,400 of profit. The difference is where that profit appears.

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The cash view puts all $3,000 of revenue in January because that is when the customer paid, then records the $600 hosting cost in February when the company pays the bill. January therefore looks much stronger than February.

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Accrual accounting spreads the $3,000 of revenue across the three months in which the company provides the service. It also records the hosting cost in January because that is when the infrastructure was used. The result gives finance a better view of what actually happened during each month.

Accrual accounting vs. cash accounting

Cash accounting follows the movement of money more closely. Accrual accounting follows when the underlying revenue is earned or the cost belongs in the accounts.

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Cash accounting can work well for a small business where customers pay immediately and relatively few transactions span multiple periods.

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As the business starts selling on credit, collecting annual payments upfront, receiving invoices after month-end, or paying for future services in advance, the difference between cash movement and business activity becomes more significant.

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That does not make cash less important. A company can report a profit under accrual accounting and still have a cash problem because customers have not paid. Accrual financial statements and cash-flow reporting answer different questions.

Four common timing adjustments in accrual accounting

Accrual accounting has to account for situations where the business activity and the related cash happen in different periods. 

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Four common adjustments cover many of those situations:

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Accrued revenue: Revenue has been earned but not yet billed or collected [1]. Once the customer is invoiced, the amount becomes an ordinary receivable. For example, a consulting company that completes $8,000 of work in March but invoices the customer in April may still recognize the revenue in March.

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Accrued expenses: A cost has been incurred before it has been paid or fully captured through the normal payable process. If a company uses $20,000 of cloud services in March and receives the invoice in April, the cost can still be recorded in March.

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Deferred revenue: Cash has been collected before the company has earned the revenue. A $12,000 annual subscription paid upfront, for example, may initially create a liability that is reduced as the company provides the service.

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Prepaid expenses: The company has paid before consuming the related benefit. If it pays $24,000 upfront for 12 months of insurance, the unused portion remains a prepaid asset and is recognized as expense over the coverage period.

When is accrual accounting required?

Whether a company has to use accrual accounting depends partly on what the financial statements are being prepared for.

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Financial statements prepared under U.S. GAAP rely on accrual accounting procedures [2]. For a private company, the practical reason for moving to accrual accounting may therefore be an audit, lender requirement, investor reporting, board reporting, or another need for GAAP financial statements. FASB's Conceptual Framework provides the underlying basis for accrual financial reporting.

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This becomes increasingly relevant for venture-backed startups, where financing, investor reporting, revenue recognition, and diligence can make accrual-based reporting increasingly important.

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Tax accounting follows a separate set of rules. Under IRC Section 448, C corporations, partnerships with a C corporation partner, and tax shelters generally cannot use the cash method, although C corporations and those partnerships can still use it if they pass a gross-receipts test [3]. For taxable years beginning in 2026, IRS Revenue Procedure 2025-32 sets that Section 448(c) threshold at $32 million, based on average annual gross receipts for the preceding three taxable years [4]. The amount is inflation-adjusted annually.

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That does not mean every business above $32 million automatically switches its entire accounting system to accrual accounting. Sole proprietors, S corporations, and partnerships without a C corporation partner are not subject to Section 448 unless they are tax shelters, and qualified personal service corporations can use the cash method regardless of size. Inventory and other tax rules can introduce additional accounting-method requirements.

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Companies should therefore treat the $32 million figure as one part of the analysis rather than a universal accrual threshold.

Switching from cash to accrual accounting

Moving from cash to accrual accounting means identifying transactions that belong in the financial statements even though they have not yet appeared through cash.

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A practical conversion usually involves:

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1. Choose a conversion date: Month-end or the beginning of a fiscal year usually provides a clean starting point.
2. Record outstanding receivables: Bring in revenue the company has earned but has not yet collected.
3. Record unpaid vendor obligations: Capture outstanding AP and costs already incurred but not yet invoiced.
4. Identify customer payments received in advance: Move the unearned portion into deferred revenue.
5. Set up prepaid balances: Payments relating to future periods should remain assets until the related benefit is consumed.
6. Review other balance-sheet accounts: Inventory, fixed assets, depreciation, deposits, debt, and similar balances may also need adjustment.
7. Reconcile the opening balances: Each receivable, payable, accrual, prepaid, and deferred-revenue balance should agree with supporting records.
8. Review the first close carefully: The team should check for transactions that were omitted, duplicated, or left in the wrong period as part of the month-end close process.

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A financial-reporting conversion and a tax-method change are not necessarily the same project. If the business also changes its overall method for federal tax purposes, it files Form 3115 to request the change. A change from the overall cash method to an accrual method is on the IRS list of automatic changes (section 15.01 of Revenue Procedure 2025-23), so it does not need advance IRS consent [5].

What accrual accounting means for SaaS companies

SaaS companies regularly deal with transactions where cash and accounting timing do not line up.

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An annual customer prepayment is one example. A customer might pay $120,000 at the beginning of a one-year contract, but the company recognizes revenue according to when it satisfies its performance obligations under ASC 606. The unearned portion remains on the balance sheet as deferred revenue.

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That is also why ARR and GAAP revenue are different. ARR is an operating metric based on recurring contract value, while GAAP revenue reflects what the company recognizes in its financial statements during a particular period. 

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Costs can create the same timing issues. Cloud infrastructure, professional services, and contractors may be used before the vendor invoice arrives, creating accrued expenses. Other software or insurance contracts may be paid upfront and sit in prepaid assets until the benefit is consumed.

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Sales commissions and other incremental costs of obtaining a contract are generally capitalized and amortized under ASC 340-40 when the company expects to recover them, although a practical expedient allows immediate expensing when the amortization period would be one year or less [6]. These transactions are why accrual accounting becomes increasingly important as a SaaS company grows: cash collections and payments alone no longer explain the economics of a reporting period.

Manage accruals and prepaids with DualEntry

As transaction volume grows, managing accruals and prepaids can mean maintaining more schedules, journal entries, reversals, supporting documents, and reconciliations every month. 

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DualEntry's prepaid and accrual accounting software brings that work into the same system as the general ledger and close process.

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With DualEntry, finance teams can:

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• Post accruals with automatic reversals: Record an accrual as a journal entry with a reversal date, usually the first day of the next period, and DualEntry creates the reversing entry on that date. Accrual templates can be rerun each period, and recurring entries can generate drafts or post automatically.
• Manage prepaid amortization schedules: Create a schedule from a bill or expense line, or import schedules by CSV. DualEntry generates the monthly straight-line amortization entries up front and posts each one as its date arrives.
• Keep supporting records connected: A schedule can hold attachments such as the underlying contract, and linking it to the source bill keeps the audit trail from the schedule back to the original transaction.
• Connect accruals and prepaids to the close: DualEntry's close management software supports account reconciliations, a close checklist, tasks with a preparer and reviewer, and period locking.

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Keeping these workflows together makes it easier to see what makes up each accrual or prepaid balance, what needs to reverse or amortize in the next period, and whether the account is reconciled before the books are closed.

Accrual Accounting FAQs