What is Accrual Accounting?
An accounting method that records income when earned and expenses when incurred, regardless of when cash actually moves.
Definition
Accrual accounting is an accounting method that records revenues when they are earned (when you deliver a service or send an invoice, regardless of when payment arrives) and records expenses when they are incurred (when you receive a service or product, regardless of when you pay the bill), following the generally accepted accounting principles (GAAP). This method provides a more accurate picture of a business's financial health at any given moment than cash basis accounting.
How Accrual Accounting Works
Under accrual accounting, when you send an invoice to a client, you immediately record that amount as accounts receivable (an asset) and as revenue — even if the client will not pay for 30 days. Similarly, when you receive a service such as a software subscription for the month, you record the expense in that month even if you have not yet paid the credit card bill. The cash may move later, but the financial event is recorded in the period it occurred.
Accruals: Accrued Revenue and Accrued Expenses
Accruals are adjusting entries made at the end of an accounting period to record revenues earned or expenses incurred that have not yet been captured by a cash transaction. Accrued revenue is money you have earned but not yet invoiced — for example, work completed in the last week of the month that will be invoiced in the following month. Accrued expenses are costs you have incurred but not yet paid — for example, an electricity bill received in January that covers December usage. Accruals ensure your financial statements reflect the true economic activity of the period.
Why Accrual Accounting Gives a Better Picture
Accrual accounting prevents a business from looking artificially profitable in one period and artificially unprofitable in another simply because of the timing of cash receipts and payments. If you close a major deal and invoice a client on December 31, accrual accounting counts that as December revenue — which it is. Cash basis would not record it as revenue until the check arrives, potentially weeks or months later. For freelancers with irregular invoicing cycles, accrual accounting gives a truer picture of monthly performance.
Accrual vs. Cash Basis
Cash basis records when cash actually moves; accrual records when the economic event occurs. Cash is simpler and harder to manipulate; accrual is more accurate for measuring business performance. The best choice depends on your business size, structure, and needs. Many freelancers start with cash basis for simplicity, then switch to accrual as the business grows and they need more accurate financial reporting for decision-making, lending applications, or investor updates.