Bookkeeping
Accrual vs Cash Basis Accounting: Which Method Should Your Business Use?
Cash basis recognizes income when received and expenses when paid. Accrual recognizes income when earned and expenses when incurred. Most small businesses use cash basis — it's simpler and usually defers more income. But some businesses must use accrual, and the choice has real tax consequences.
Written by Matt Reese, CPA · 5 min read · Published April 2026·Share on LinkedIn
Key Takeaways
- Cash basis: income is recognized when cash is received, expenses when paid. Simple to maintain and generally defers income tax — you only owe tax on money you've actually collected.
- Accrual basis: income is recognized when earned (invoice sent), expenses when incurred (bill received). More accurately reflects the business's economic activity but can generate taxable income before cash is received.
- Most small businesses qualify for and should use cash basis. C-corps with over $30 million in average annual gross receipts must use accrual. Businesses with inventory historically had to use accrual, but tax law changes have relaxed this for many small businesses.
- Switching accounting methods requires IRS approval (Form 3115) and may create a one-time adjustment. You typically can't switch methods year-to-year for tax purposes without permission.
The core difference
| Situation | Cash basis | Accrual basis |
|---|---|---|
| Customer pays invoice in same month as work | Income when cash received ✓ | Income when invoice sent ✓ |
| Work done in December, paid in February | Income in February (next year) | Income in December (this year) |
| Pay supplier invoice in January for December delivery | Expense in January | Expense in December |
| Receive advance payment for future services | Income when received | Deferred revenue — income when earned |
| Employee payroll accrued December 31, paid January 5 | Expense in January | Expense in December |
| Purchase equipment on credit (not yet paid) | Expense when paid (or depreciated) | Same — capitalized and depreciated |
Cash basis defers income tax: you pay tax on money you’ve actually received, not on invoices waiting to be collected. For service businesses, this is usually the better choice.
Who must use accrual
Certain businesses are required by the IRS to use the accrual method:
- C-corporations with over $30 million in average gross receipts (3-year average)
- Tax shelters (regardless of size)
- Certain farming corporations
- Businesses required to use accrual for a material income item under a specific code section
Under the TCJA 2017 (effective for tax years after 2017), most businesses with under $30 million in average gross receipts are permitted to use cash basis, including those with inventory. This was a significant expansion from the prior $5 million threshold.
The year-end timing strategy on cash basis
Cash basis allows strategic timing of income and expenses:
- Defer income: Mail invoices in late December so payment arrives in January (next tax year). Acceptable as long as you’re not constructively receiving income (the money is in your control but not cashed).
- Accelerate expenses: Pay December bills in December rather than January. Pay January rent early if needed. Purchase supplies before year-end.
- Prepaid expenses: The 12-month rule allows deducting certain prepaid expenses if the coverage period doesn’t extend beyond 12 months and doesn’t go beyond the end of the year following payment. A prepaid business insurance policy paid in December for the next 12 months is deductible in December under cash basis.
Constructive receipt: you can't ignore income you could have deposited
Simple year-end timing on cash basis can defer $20,000+ in taxes to the following year. The money isn't forgiven — it's deferred. But deferral has real value: the cash stays in your hands earning a return for another year.
Matching principle and accrual accuracy
The main argument for accrual accounting is matching: expenses are recognized in the same period as the revenues they generate. A December project with December expenses should show December results. Cash basis can distort financial statements by misaligning income and expense timing.
For internal management purposes — understanding true profitability and cash flow trends — accrual basis usually produces a more accurate picture. Many businesses maintain accrual-basis books internally while filing taxes on cash basis.
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Frequently asked
Questions owners actually ask
- Does my bookkeeping method have to match my tax reporting method?
- Not always. Some businesses maintain books on accrual for internal management purposes while filing taxes on cash basis. Your books and your tax return can use different methods — but your tax return must be consistent year to year with the elected method. Many small service businesses use cash basis for taxes even if their accounting software shows accrual-basis financial statements.
- I have inventory. Do I have to use accrual?
- Not necessarily — the rules changed with the TCJA 2017. Businesses with under $30 million in average annual gross receipts (over a 3-year period) can use cash basis even with inventory, under Section 471(c). This was a major change that benefited many small retailers and product businesses. However, businesses over the threshold must use accrual for inventory.
- What is the modified cash basis?
- Modified cash basis is a hybrid approach: cash basis for most items, but accrual for certain accounts (like accounts receivable or accounts payable) when it produces more accurate results. It's common in financial statement preparation for management use, but for tax purposes, you're using either cash or accrual as your overall method.
- How does accrual affect my December receivables?
- Under accrual, an invoice sent in December for $50,000 is income in December — even if you don't receive payment until February. Under cash basis, you recognize the $50,000 when the check arrives in February. This is the most common cash vs accrual difference for service businesses: accrual moves year-end income recognition up.
- Can I switch from accrual to cash to save taxes?
- You can switch with IRS approval via Form 3115 (Application for Change in Accounting Method). The change isn't automatic — you need to file the form and handle the Section 481(a) adjustment, which reflects cumulative differences from the old method. Switching from accrual to cash typically creates a large negative adjustment (reducing income) in year one as prepaid income and receivables are removed, but this is a one-time benefit that may be worthwhile.
Take the next step
Turn tax questions into a plan. Talk with Matt or see how we work with operating business owners.
Educational content only.This article is for informational purposes and does not constitute tax, legal, or investment advice. Every owner’s facts are different; consult a qualified CPA and advisor before acting. Tax and accounting services are provided through Matt Reese, CPA; investment advisory services are provided through Measured Risk Portfolios, a registered investment adviser. Matt Reese, CPA and Measured Risk Portfolios are separate entities; clients are not required to engage both.