Cash basis and accrual basis

Bookkeeping Basics / Lesson 4

The difference in one sentence each

• Cash basis: income is recorded when the money arrives and expenses when the money leaves.
• Accrual basis: income is recorded when it is earned (usually when you invoice) and expenses when they are incurred (usually when the bill arrives), whenever the cash moves.

Worked example: December and January

A landscaping company does a $4,000 job in December and invoices it on December 20. The customer pays on January 15. The company also receives a $1,200 equipment repair bill on December 28 and pays it on January 10. Nothing else happens.

The total over the two months is the same, $2,800, either way. What changes is when it shows up. If December is the last month of your tax year, that timing moves $2,800 of profit from one tax year into the next.

The entries under accrual

Under cash basis there would be just two entries: income of $4,000 on January 15 and an expense of $1,200 on January 10.

Which gives the truer picture?

Accrual matches income with the costs of earning it in the same period, so it shows how the business actually performed. It also shows what customers owe you and what you owe suppliers. Cash basis is simpler and tells you exactly what went through the bank, but a big payment arriving or a bill being paid late can make one month look great and the next terrible.

What the tax rules say

United States. Many small businesses may use the cash method for their tax return. The IRS limits it mainly by a gross receipts test (average annual gross receipts for the prior three years below a threshold that is adjusted for inflation), and has special rules for inventory. Once you choose a method you must use it consistently; changing it generally requires IRS approval on Form 3115. Publication 538 has the details.

Canada. The CRA generally requires business and professional income to be reported on the accrual method. Farmers and fishers may use the cash method, and some self-employed commission salespeople have their own rules. See CRA guide T4002.

Sales tax and GST/HST. These follow their own timing rules regardless of the income tax method. In Canada, GST/HST generally becomes reportable in the period you invoice the customer or are paid, whichever comes first.

Accruals you will meet later

• Accrued expense: a cost incurred but not billed yet, such as wages earned in the last days of the month but paid next month.
• Prepaid expense: paid in advance, such as a year of insurance paid in January, then expensed a month at a time.
• Deferred revenue: a customer pays before you do the work, so it is a liability until you earn it.

Key terms

• Cash basis
• Accrual basis
• Accrued expense
• Prepaid expense
• Deferred revenue
• Accounts payable (A/P)

Try it

• Cash vs accrual accounting (guide): A longer comparison with more examples.
• Profit and loss template: Try the example above in both columns.
• Cash flow forecast template: Plan the cash even when you keep accrual books.

Sources

• IRS Publication 538, Accounting Periods and Methods
• CRA Guide T4002, Self-employed Business, Professional, Commission, Farming, and Fishing Income

Part of Bookkeeping Basics, a free course from AcboBooks LLC. General information, not tax, legal or accounting advice. Last reviewed October 25, 2026.