Key Takeaways
- An accrual records revenue or an expense in the period it actually happened, regardless of when cash is received or paid.
- Accrued expenses and accrued revenue are the two core categories, and most of the manual work in a close comes from expenses, not revenue.
- GAAP requires the accrual method for companies that issue GAAP-basis financial statements, because it matches revenue to the expenses that generated it.
- Most manual accrual errors come from a handful of predictable failure points: missed reversals, inconsistent estimates, and no audit trail for how a number was calculated.
If you've ever closed the books and had a number feel slightly off, one that didn't match what actually happened that month, there's a good chance an accrual was missing. Accruals are the mechanism that keeps your financial statements honest about timing: what was actually earned or owed in a period, not just what cash moved.
This guide covers what an accrual actually is, the two types you'll run into, why the method is effectively mandatory once a company reaches a certain size, and where the process typically breaks down.
What Is an Accrual?
An accrual is a journal entry that recognizes revenue earned or an expense incurred in the period it actually occurred, independent of when the associated cash is received or paid. It's the core mechanic behind accrual accounting, the method that most companies past a certain size are required to use.
The simplest way to think about it: if the work happened, the goods moved, or the service was delivered in a given month, the financial impact belongs in that month's books, whether or not an invoice has been sent, received, or paid yet. If a consulting firm does work in December but doesn't send the invoice until January, an accrual books that expense in December, when the client actually benefited from the work.
Without accruals, a company's monthly financials would just be a record of cash movement, which can make a business look far better or worse than it actually is in any given period, depending on when invoices happen to land.
Accrued Expenses vs. Accrued Revenue
Accruals split into two categories, depending on which direction the timing gap runs.
Accrued expenses happen when a company has incurred a cost, received a service, taken delivery of goods, or had work performed for it, but hasn't yet been billed or paid for it. A vendor completes a project in December; the invoice doesn't arrive until January. The expense still belongs in December.
Accrued revenue is the mirror image: a company has delivered a good or service, and has therefore earned the revenue, but hasn't yet invoiced the customer or received payment. A software company that completes a custom implementation in December but doesn't invoice until the following billing cycle recognizes that revenue in December, when it was actually earned.
In practice, most of the manual close work sits on the expense side. Accrued revenue tends to follow predictable billing schedules a company controls itself; accrued expenses depend on vendors, contractors, and internal teams confirming what happened, which is exactly the part that's hardest to track consistently by hand.
Why Accrual Accounting Matters
Accrual accounting exists to solve a specific distortion: cash timing doesn't reflect economic reality. A company could look wildly profitable in a month where a big customer happened to pay a stale invoice, and look terrible the next month when a large vendor bill happens to clear, even if the underlying business performed identically both months. Accrual accounting matches revenue to the expenses that generated it, in the period both actually occurred, which is what the matching principle in GAAP is built around.
That's also why GAAP requires accrual accounting for companies that issue GAAP-basis financial statements: investors, lenders, and auditors need financials that reflect actual business performance, not the accident of when checks got cut. In the US, businesses above a certain average annual revenue threshold are generally required to use accrual accounting for tax purposes as well; that threshold is indexed for inflation and changes periodically, so check current IRS guidance or with a tax advisor for the exact figure that applies to your business.
Beyond the compliance angle, accrual accounting is simply a more accurate way to run a business. If you're making decisions based on monthly numbers, you want those numbers to reflect what actually happened in the business that month.
Common Types of Accruals
Some accrual categories recur every period and are relatively easy to standardize. Others are exactly the ones that cause the most manual work.
- Accrued payroll and wages. Employees earn wages between the last pay date and month-end that haven't been paid yet.
- Accrued interest. Interest on a loan or credit facility accumulates daily but is typically paid monthly, quarterly, or at maturity.
- Accrued utilities and recurring services. The utility bill for December usage often doesn't arrive until well into January.
- Accrued taxes. Property tax, payroll tax, and income tax obligations that build up before the actual payment or filing date.
- Accrued vendor and services expenses (unbilled accruals). Work delivered, or goods received, with no invoice yet, often confirmed only through an email, a Slack message, or a verbal check-in with a vendor. This is usually where the most manual hours go, since there's no invoice or PO trail to work from. Our complete guide to unbilled accruals covers this category in depth.
- Accrued commissions and bonuses. Compensation tied to performance metrics that are finalized after the period closes.
How the Accrual Process Works at Month-End Close
The basic mechanics are consistent regardless of the type of accrual: identify what's been incurred or earned but not yet recorded, estimate the amount if there's no invoice to work from, book the entry, and reverse it in the following period once the actual invoice or payment arrives.
In practice, that process breaks into a few steps every cycle: reviewing open purchase orders and contracts for anything delivered but not yet invoiced, checking in with vendors or internal teams on work that might not have generated a document yet, estimating amounts for anything still unconfirmed based on historical run-rate or contract terms, and scheduling the reversal for the following month so the eventual real invoice doesn't get double-counted.
The reversal step is where a lot of manual processes quietly break. If nobody tracks which accruals were reversed and which weren't, expenses start getting counted twice, or accruals silently pile up on the balance sheet. Our guide on how accrual automation cuts month-end close by 4+ days goes into where that time actually gets lost.
Accrual vs. Cash Basis Accounting, Briefly
Cash basis accounting records revenue and expenses only when cash actually changes hands. It's simpler and matches your bank balance exactly, which is why some very small or early-stage businesses use it. The tradeoff is that it can make a business look more or less profitable in a given month than it actually was, purely based on when invoices happened to be paid.
| Question | Cash Basis | Accrual Basis |
|---|---|---|
| When is revenue recorded? | When cash is received | When it's earned |
| When is an expense recorded? | When cash is paid | When it's incurred |
| GAAP-compliant? | No | Yes |
| Reflects business performance accurately? | Can be distorted by payment timing | Matches revenue to related expenses |
This is a deep enough topic to deserve its own breakdown; our complete guide to accrual vs. cash basis accounting covers when each method makes sense and what changes when you switch.
Common Accrual Mistakes
Forgetting to reverse. An accrual that never gets reversed either double-counts the expense when the real invoice lands, or sits stale on the balance sheet indefinitely.
Inconsistent estimates across periods. If the same vendor gets accrued differently depending on who's covering the close that month, the number stops being defensible to an auditor.
No documentation for the estimate. An accrual with no record of what it was based on, a PO, a vendor email, a historical average, is a number nobody can explain six months later when an auditor asks.
Missing unbilled accruals entirely. The accruals with no PO or invoice trail are the easiest to forget, and usually the largest source of surprise adjustments at year-end.
These are exactly the failure points that accrual automation software is built to close: consistent logic applied the same way every period, with the supporting evidence built into every entry instead of living in someone's inbox.
Frequently Asked Questions
What is an accrual in simple terms?
An accrual is a journal entry that records revenue or an expense in the period it actually happened, even though cash hasn't changed hands yet. If a company receives a service in December but doesn't get the invoice until January, an accrual books that expense in December, when it was actually incurred.
What's the difference between an accrual and a prepaid expense?
They're opposite timing problems. An accrual records an expense or revenue that's already happened but hasn't been paid or billed yet. A prepaid expense is the reverse: cash has already gone out for something the company hasn't fully used or received yet, like a 12-month software contract paid upfront, and gets recognized gradually over the period it covers.
Is accrual accounting the same as GAAP?
Not exactly. Accrual accounting is a method of recognizing revenue and expenses; GAAP is the broader set of accounting standards. GAAP requires the accrual method for companies that issue GAAP-basis financial statements, but a company can technically use accrual accounting without following every other GAAP rule. In practice, if you need GAAP-compliant financials, you need accrual accounting as the foundation.
What happens if you don't reverse an accrual?
The expense or revenue gets counted twice. If you accrue an expense in December because the invoice hasn't arrived, then the actual invoice posts in January without reversing the December accrual first, January's books show the cost twice. Missed reversals are one of the most common manual-accrual errors and a frequent source of audit findings.
Do small businesses have to use accrual accounting?
Not always. Many small businesses use cash basis accounting because it's simpler and matches their bank balance. In the US, businesses above a certain average annual revenue threshold are generally required to use accrual accounting for tax purposes, and that threshold is indexed for inflation, so it's worth confirming the current figure with a tax advisor. Companies with investors, a bank covenant, or an eventual audit requirement typically move to accrual accounting well before it's legally required.
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