What are accruals in accounting?

Published Thursday 23 July 2026

Table of contents

• What are accruals?
• How accruals work
• Types of accruals
• Examples of accruals
• Accrual vs. cash accounting
• Advantages of accrual accounting
• When to use accrual accounting
• Simplify your accrual accounting with Xero
• FAQs on accruals

Key takeaways

• Accruals are amounts of money your business has earned or spent but hasn't yet received or paid. They help your financial statements reflect what's actually happening in your business, not just what's hit your bank account.
• Accrual accounting records revenue when it's earned and expenses when they're incurred, regardless of when cash changes hands. This gives you a more accurate picture of your financial health.
• The Internal Revenue Service (IRS) requires businesses with more than $25 million in average annual gross receipts to use the accrual method. Smaller businesses can choose either method.
• Cloud accounting software like Xero can simplify accrual accounting by automating bank reconciliation, tracking accounts receivable and payable, and generating real-time financial reports.

What are accruals?

Accruals are amounts of money that your business has earned or spent but not yet received or paid. They represent financial activity that has occurred but hasn't been settled in cash.

In accounting, accruals exist because of the matching principle. This principle states that revenue and expenses should be recorded in the period they occur, not when cash is exchanged. If you complete a project for a client in March but don't get paid until April, the revenue belongs in March's financial records. This approach is the foundation of accrual accounting.

On your balance sheet, accruals show up as either assets or liabilities. Accrued revenue (money you've earned but haven't received) appears as an asset under accounts receivable. Accrued expenses (costs you've incurred but haven't paid) appear as liabilities under accounts payable.

For small business owners, understanding accruals matters because they directly affect how profitable your business looks at any given time. Without accruals, your financial statements would only reflect cash that has already moved, which can be misleading if you have outstanding invoices or unpaid bills.

How accruals work

Accruals are recorded through adjusting journal entries at the end of an accounting period, such as a month, quarter, or year. These entries ensure your financial statements capture all economic activity for that period, even if no cash has changed hands yet.

Here's how the process works in practice. When you deliver a service or receive a bill, you create a journal entry that records the transaction immediately. This follows the double-entry bookkeeping method. For accrued revenue, you'd debit (increase) your accounts receivable and credit (increase) your revenue. For accrued expenses, you'd debit (increase) the expense account and credit (increase) your accounts payable.

When the cash eventually arrives or goes out, you record a second entry that reverses the accrual and reflects the actual payment. This 2-step process keeps your books accurate across reporting periods.

On your financial statements, accruals affect both the income statement and the balance sheet. The income statement shows the revenue earned and expenses incurred during the period. The balance sheet reflects the outstanding amounts as receivables or payables until they're settled.

Types of accruals

There are 4 main types of accruals you'll encounter in business accounting. Each one handles a different timing gap between when a transaction happens and when cash moves.

Accrued expenses

Accrued expenses are costs your business has incurred but hasn't paid yet. Common examples include wages your employees have earned but won't receive until payday, utility bills that cover a period before you receive the invoice, and interest on a loan that accumulates between payment dates.

These show up as current liabilities on your balance sheet because they represent money you owe. Once you make the payment, the liability is removed and your cash balance decreases.

Accrued revenue

Accrued revenue is income your business has earned by providing goods or services but hasn't invoiced or collected yet. For example, if you're a consultant who completes 2 weeks of work in June but doesn't send the invoice until July, that revenue is accrued in June.

On the balance sheet, accrued revenue appears as an asset under accounts receivable. It ensures your income statement accurately reflects the work you've done during each period, even if the payment comes later.

Prepaid expenses

Prepaid expenses are the opposite of accrued expenses. You've already paid for something, but you haven't used or consumed it yet. Insurance premiums are a classic example: you might pay for 12 months of coverage upfront, but the benefit is spread across the entire year.

These start as assets on your balance sheet. Each month, a portion is moved from the prepaid asset to an expense on the income statement. This process is called amortization, and it ensures each period only carries its fair share of the cost.

Deferred revenue

Deferred revenue is money your business has received before delivering the product or service. Think of annual subscriptions, retainers, or deposits. You have the cash, but you haven't earned it yet.

Deferred revenue appears as a liability on your balance sheet because you still owe the customer the goods or services they've paid for. As you deliver, you gradually move the amount from deferred revenue to earned revenue on your income statement.

Examples of accruals

Accruals come up in everyday business situations more often than you might think. Here are some of the most common scenarios where they apply.

• Unpaid invoices: You've sent an invoice to a client for completed work, but they haven't paid yet. The amount is recorded as accrued revenue (accounts receivable) until the payment arrives.
• Utility bills: Your business uses electricity, water, and internet throughout the month, but the bills don't arrive until the following month. The estimated cost is recorded as an accrued expense.
• Employee wages: If your pay period ends on a Friday but the month ends on a Wednesday, you need to accrue 3 days of wages that employees have earned but won't be paid until the next pay cycle.
• Taxes: Income tax, payroll tax, and sales tax obligations accrue over time. Even though you may pay them quarterly or annually, the expense is recognized in each period it relates to.
• Interest: Loan interest accrues daily, even if you only make monthly payments. The accumulated interest between payments is an accrued expense on your balance sheet.
• Credit sales: When you sell products on credit terms (for example, net 30), the sale is recorded immediately as revenue, and the outstanding amount becomes an accrual until the customer pays.

In the US, small businesses waited an average of 27.9 days to be paid in Q4 2025, with payments arriving 7.8 days past the due date, both figures below their long-term averages, according to Xero Small Business Insights. During that gap between invoicing and payment, the outstanding amount is recorded as an accrual.

Accrual vs. cash accounting

The main difference between accrual and cash accounting is timing. Accrual accounting records transactions when they happen; cash accounting records them when money moves. Both methods are valid, but they give you different views of your business finances.

With cash accounting, revenue is recorded when you receive payment, and expenses are recorded when you pay them. It's simpler to manage and gives you a clear picture of how much cash you actually have on hand. Many small businesses and sole proprietors start with this method because it's straightforward and easy to maintain.

With accrual accounting, revenue is recorded when it's earned and expenses when they're incurred, regardless of cash flow. This method is more complex but gives you a fuller picture of your financial position. It shows what your business is truly worth at any point in time, including money owed to you and money you owe others.

Here's a practical example. Say you complete a $5,000 project in December but don't get paid until January. Under cash accounting, that revenue shows up in January. Under accrual accounting, it shows up in December, which is when you actually did the work. The accrual method gives a more accurate picture of December's performance.

The trade-off is complexity. Cash accounting is easier to manage but can be misleading during periods with large outstanding invoices or prepayments. Accrual accounting takes more effort but aligns your financial records with real business activity.

Advantages of accrual accounting

Accrual accounting offers several benefits that help you understand and manage your business finances more effectively.

• More accurate financial picture: Because revenue and expenses are recorded when they occur, your financial statements reflect real business activity. You can see how your business is performing in any given period without being thrown off by delayed payments.
• Better financial planning: When you can see all your expected income and obligations, you're in a stronger position to make decisions about hiring, inventory, expansion, and cash flow management.
• Compliance with standards: Generally Accepted Accounting Principles (GAAP) require accrual accounting for most businesses. If you plan to seek investors, apply for a loan, or eventually sell your business, having GAAP-compliant financials makes the process smoother.
• Easier to spot trends: Accrual accounting helps you identify patterns in revenue and expenses over time. You can compare periods fairly because each one includes all related activity, not just what happened to hit the bank account.
• Investor and lender confidence: Banks and investors prefer accrual-based financials because they provide a more reliable view of a company's health. If you're seeking funding, accrual accounting can help you present a stronger case.

When to use accrual accounting

For some businesses, accrual accounting is a legal requirement. For others, it's a strategic choice that improves financial clarity.

The IRS requires businesses with average annual gross receipts over $25 million (calculated over the prior 3 tax years) to use the accrual method. If your business falls below that threshold, you can choose either cash or accrual accounting.

Publicly traded companies and businesses that follow GAAP must also use accrual accounting. If you're working with investors, preparing for an audit, or planning to sell your business, accrual-based records are typically expected.

Beyond legal requirements, accrual accounting is a smart choice for businesses that carry inventory, extend credit to customers, or have significant time gaps between delivering a service and getting paid. These situations create timing differences that cash accounting can't capture accurately.

Service-based businesses with long project timelines, subscription businesses, and companies with complex billing cycles also benefit from the accrual method. It keeps your financial reporting aligned with your actual business activity, making it easier to plan, budget, and track growth.

If your business is small and straightforward with mostly same-day transactions, cash accounting may be sufficient. But as your operations grow, switching to accrual accounting gives you a clearer foundation for decision-making.

Simplify your accrual accounting with Xero

Accrual accounting gives you a more accurate picture of your business finances, but it doesn't have to be complicated. Xero's cloud accounting software helps you stay on top of your accruals by automating bank reconciliation, tracking invoices and bills, and generating real-time financial reports.

With Xero, you can monitor what's owed to you and what you owe, all from one dashboard. Automated bank feeds pull in transactions daily, so your records stay current without manual data entry. Customizable reports let you see your accrued revenue and expenses at a glance, helping you make confident decisions about your cash flow and business planning.

Whether you manage your own books or work with an accountant, Xero gives you the tools to handle accrual accounting with less effort, so you can focus on what matters most. Get one month free.

FAQs on accruals

Here are some frequently asked questions about accruals.

What is the difference between accrual and cash accounting?

Accrual accounting records revenue when earned and expenses when incurred, regardless of when cash is exchanged. Cash accounting records transactions only when money is received or paid out.

Who is required to use accrual accounting?

The IRS requires businesses with average annual gross receipts exceeding $25 million to use accrual accounting. Publicly traded companies and those following GAAP standards are also required to use this method.

What are common examples of accrued expenses?

Common accrued expenses include employee wages earned but not yet paid, utility bills for services already used, loan interest that accumulates between payment dates, and taxes that build up over a reporting period.

How do accruals affect the balance sheet?

Accrued revenue appears as an asset (accounts receivable) because it's money your business has earned but not yet collected. Accrued expenses appear as liabilities (accounts payable) because they represent costs incurred but not yet paid.