An accrual, in accounting, is an entry that records revenue when it’s earned or an expense when it’s incurred, regardless of when cash actually changes hands. A consulting firm that finishes $50,000 of work in December but doesn’t collect until January still books that $50,000 as December revenue. The same rule runs the other way: if employees put in their last week of work in March but payday falls in April, those wages belong on March’s books. Accruals exist to close the gap between when economic activity happens and when money moves.
How Accruals Work
Accrual accounting tracks economic activity as it occurs. When your business earns revenue, you record it then, even if the customer hasn’t paid. When you incur an expense, you record it in the period it relates to, even if the check hasn’t gone out. The Financial Accounting Standards Board describes the method as one that “attempts to record the financial effects on an entity of transactions and other events and circumstances in the periods in which those transactions, events, and circumstances occur.”1FASB. Conceptual Framework for Financial Reporting (September 2024)
The alternative is cash-basis accounting, which records transactions only when money moves. Cash basis is simpler, but it distorts the picture whenever earning and collecting happen in different periods. Picture a landscaping company that finishes $80,000 of work in June but doesn’t get paid until August. Under cash basis, June looks like a terrible month with heavy costs and no revenue, and August looks like a windfall. Accrual accounting ties the income and the costs back to June, where the work actually took place.
There’s also a matching principle at work on the expense side. Costs are recorded in the same period as the revenue they helped produce. A commission owed to the salesperson who closed a December deal belongs to December’s income statement, even if the commission gets paid in January’s payroll run.
Accrued Expenses
An accrued expense is a cost your business has already incurred but hasn’t paid for yet. It sits on the balance sheet as a liability until the cash goes out.
Wages are the classic example. Say your employees work Monday through Friday but payday is the following Wednesday. At month-end, you’ll have several days of labor costs that belong on that month’s income statement even though no paychecks have been cut. You record the estimated payroll as a wage expense and create a matching wages payable liability. When payday arrives, the cash payment clears the liability.
Interest on debt works the same way. If your company carries a bank loan with quarterly interest payments, interest accumulates every day between those payments. A company that owes $1,200 in quarterly interest accrues roughly $400 per month, recording interest expense and a corresponding interest payable liability each month. The quarterly cash payment then wipes out what’s built up.
Rent is another familiar one. If you occupy office space for the full month of March but the lease payment isn’t due until April 1, March’s financials still need to reflect the rent expense, with a rent payable liability on the balance sheet.
Accrued Revenue
Accrued revenue is the mirror image: income your company has earned but hasn’t collected. It shows up on the balance sheet as an asset, usually accounts receivable or something similar.
Interest income fits this pattern. A company holding a bond that pays interest semiannually doesn’t wait six months to recognize what it earns. Each month, it records the proportionate share of interest as accrued interest receivable and as interest income on the income statement. The cash arrival simply replaces the receivable.
Long-term service contracts generate accrued revenue constantly. A cybersecurity firm on a $120,000 annual contract recognizes $10,000 per month as it delivers monitoring, regardless of whether the client pays monthly, quarterly, or in a single lump sum. Each month without payment creates an asset representing revenue earned but not yet collected.
Accruals vs. Deferrals
Accruals and deferrals both exist to move revenue and expenses into the right accounting period, but they run in opposite directions. With an accrual, the economic event happens first and cash follows. With a deferral, cash arrives first and the economic event follows.
- Accrued revenue: you delivered the product in November and the customer will pay in December. Revenue goes on November’s books, with an accounts receivable asset for the money owed.
- Deferred revenue: a customer pays you in November for a service you’ll perform in December. November gets a liability (unearned revenue) because you owe the customer something. Revenue hits the books in December when you deliver.
- Accrued expense: employees worked this week but won’t be paid until next week. Record the expense now, with a wages payable liability.
- Deferred expense: you pay a full year of insurance premiums in January. Only one month is an expense in January. The rest is a prepaid asset that gets expensed month by month over the year.
The pattern holds: accruals pull a transaction into the current period before cash moves; deferrals push recognition into a future period after cash has already moved.
How Accruals Get Recorded
Accruals don’t record themselves. They enter the books through adjusting entries made at the end of each accounting period, whether that’s monthly, quarterly, or annually. The point is to update the general ledger so financial statements reflect what’s actually happened before they’re finalized.
Every accrual adjusting entry touches at least one income statement account and one balance sheet account. An adjustment for accrued wages increases wage expense on the income statement and increases wages payable on the balance sheet. An adjustment for accrued revenue increases accounts receivable on the balance sheet and increases revenue on the income statement. Cash never appears in an accrual adjusting entry, because the whole point is that cash hasn’t moved.
Many companies reverse accrual entries on the first day of the next period. That isn’t a correction. It’s a shortcut. When the actual cash transaction later occurs, the bookkeeper can record it normally instead of splitting the payment between the existing liability and any new expense.
When Accrual Accounting Is Required
Not every business gets to choose. All publicly traded companies in the United States file financial statements under Generally Accepted Accounting Principles, which are built on accrual-basis accounting.2Financial Accounting Foundation. GAAP and Public Companies
For federal tax purposes, IRC §448 generally bars three types of entities from using the cash method: C corporations, partnerships that have a C corporation as a partner, and tax shelters.3Office of the Law Revision Counsel. 26 USC 448 – Limitation on Use of Cash Method of Accounting Those entities have to use accrual unless they qualify for an exception.
The biggest exception is the gross receipts test. If your C corporation or qualifying partnership has average annual gross receipts of $32 million or less over the prior three tax years (the inflation-adjusted threshold for tax years beginning in 2026), the cash method is still on the table.4Internal Revenue Service. Rev. Proc. 2025-32 Qualified personal service corporations in fields like health, law, engineering, accounting, and consulting are also exempt regardless of size.3Office of the Law Revision Counsel. 26 USC 448 – Limitation on Use of Cash Method of Accounting
Sole proprietors, most partnerships without corporate partners, and S corporations under the gross receipts threshold generally get to pick. If your business carries inventory and exceeds the threshold, the IRS requires accrual-basis accounting for purchases and sales.5Internal Revenue Service. Publication 538, Accounting Periods and Methods
Why Accuracy Matters
Getting accruals wrong isn’t an academic problem. For public companies, a material error can force a restatement of previously issued financial statements, meaning the company has to publicly correct numbers investors already relied on. Identified errors also trigger a reassessment of internal controls over financial reporting.
For private businesses, the fallout looks different but is just as real. Understating accrued expenses inflates profit, which can lead to overpaying estimated taxes, distributing more to owners than the business can afford, or handing a misleading picture to a lender reviewing a loan application. Overstating accrued revenue creates phantom assets on the balance sheet. In either direction, the financial statements stop being a reliable tool for decisions, which is the reason to keep them in the first place.