Accrual vs cash basis accounting

The short answer

Cash basis accounting records income when money is received and expenses when money is paid. Accrual basis accounting records income when it is earned and expenses when they are incurred, whatever the timing of the cash. The difference matters because the same business can report very different profits under each, and financial statements prepared under IFRS or most national frameworks must use the accrual basis.

Both bases record the same transactions and, over the whole life of a business, arrive at the same total profit. What differs is timing: which month or year each euro of income and cost belongs to. Timing is exactly what lenders, owners and tax authorities care about, because decisions are made period by period.

How cash basis accounting works

Under the cash basis there are no receivables, payables, prepayments or accruals in the books. A sale is income on the day the customer pays; a supplier bill is an expense on the day it is paid. The records are essentially a categorised cash book, which is why the method is popular with sole traders and very small businesses: it is simple, and taxable profit follows the money available to pay the tax.

The weakness is that cash timing is often chosen, not earned. A business can pay next year's rent in December to reduce this year's profit, or delay chasing customers to push income into next year. Large unpaid customer balances and unpaid supplier bills are invisible, so the books cannot say what the business is owed or what it owes. Pure cash accounting also struggles with inventory and equipment, which is why tax rules that allow a cash basis usually add exceptions for them.

How accrual basis accounting works

Under the accrual basis a transaction is recorded when its economic effect happens. Delivering a service creates income and a receivable, even if the invoice is paid next quarter. Using electricity creates an expense and a liability, even if the bill arrives next month. Paying a year's software licence in advance creates an asset that is expensed month by month as the service is consumed.

IFRS requires the accrual basis for everything except cash flow information: this requirement sits in IAS 1 and, for annual periods beginning on or after 1 January 2027, in IAS 8 Basis of Preparation of Financial Statements, where IFRS 18 moves it unchanged. The UK's FRS 102, Canada's ASPE and the accounting directives underlying EU national GAAP rest on the same principle.

The accrual basis is closely tied to the idea of matching: costs are recognised in the same period as the income they help to earn. Cost of goods sold is expensed when the goods are sold, not when they are bought; a salesperson's commission is expensed in the period of the sale it relates to. Modern standards express this through their recognition rules rather than as a separate principle, but matching remains a good test of whether a set of accounts makes sense. Our guide on IFRS 15 revenue recognition explains when revenue counts as earned under IFRS.

Worked example: one quarter measured both ways

Studio Nord, a two-person design studio in Rotterdam, has the following first quarter. VAT is ignored to keep the timing clear. Wages of EUR 5,000 are paid at the end of every month, which gives the same result on both bases.

Cash basis: January shows receipts of 0 and payments of 7,400 (software 2,400 and wages 5,000), a loss of 7,400. February shows 10,000 received less 5,000 wages, a profit of 5,000. March shows 8,000 received less 5,000 wages, a profit of 3,000. The quarter's profit is 600.

Accrual basis: January shows income of 10,000 less wages 5,000 and one month of software 200, a profit of 4,800. February shows 12,000 less 5,000 and 200, a profit of 6,800. March shows 9,000 less wages 5,000, software 200 and electricity 300, a profit of 3,500. The quarter's profit is 15,100.

The cash basis says the studio lost money in January and barely broke even over the quarter. The accrual basis shows a steadily profitable business that is simply waiting to be paid. Both are true, and they answer different questions: the accrual figures show performance, and the cash figures show liquidity.

• January: work worth 10,000 is completed and invoiced; the client pays in February.
• January: a one-year software subscription of 2,400 is paid in advance.
• February: work worth 12,000 is completed and invoiced; the client pays 8,000 in March and 4,000 in April.
• March: work worth 9,000 is completed but not invoiced until April, and paid in April.
• March: electricity of 300 is used; the bill is paid in April.

Reconciling the two profits

The gap of 14,500 between the accrual profit of 15,100 and the cash profit of 600 is fully explained by balance sheet items that exist only on the accrual basis. Listing them is the best way to prove both calculations are right, and it is exactly what the operating section of an indirect cash flow statement does in reverse.

• Receivable still unpaid from the February invoice: plus 4,000.
• Accrued income for March work not yet invoiced: plus 9,000.
• Prepaid software for April to December, nine months of 200: plus 1,800.
• Accrued electricity for March, not yet paid: minus 300.
• Total: 4,000 plus 9,000 plus 1,800 minus 300 equals 14,500, the exact difference.

Converting cash basis records to the accrual basis

Bookkeepers often inherit a year of cash-basis records that must become accrual accounts, for a bank, a buyer or a first audit. The conversion uses opening and closing balances. Accrual revenue equals cash received from customers, minus opening receivables, plus closing receivables, plus opening deferred revenue, minus closing deferred revenue. Accrual expenses equal cash paid, minus opening accrued expenses, plus closing accrued expenses, plus opening prepayments, minus closing prepayments.

Example: a business received 180,000 from customers in the year. Receivables were 20,000 at the start and 32,000 at the end; customer deposits (deferred revenue) fell from 5,000 to 3,000. Accrual revenue is 180,000 minus 20,000 plus 32,000 plus 5,000 minus 3,000, which is 194,000. It paid 120,000 of expenses; accrued expenses rose from 4,000 to 6,000 and prepayments fell from 3,000 to 2,000. Accrual expenses are 120,000 minus 4,000 plus 6,000 plus 3,000 minus 2,000, which is 123,000.

Accrual profit is therefore 194,000 minus 123,000, which is 71,000, against a cash profit of 60,000. The 11,000 difference is the net movement in the four balances: receivables up 12,000, deferred revenue down 2,000 (income earned from earlier deposits), accruals up 2,000 and prepayments down 1,000. Inventory, equipment and loans need their own adjustments: stock is added back at closing value and removed at opening value, equipment is capitalised and depreciated, and loan repayments are taken out of expenses altogether. Our guide on deferred revenue accounting shows the customer-deposit side of this conversion in detail.

Going the other way: from accrual profit to cash

Owners who read accrual accounts often ask where the profit went. The same logic answers them in reverse: start from accrual profit, add back non-cash expenses such as depreciation, subtract increases in receivables, inventory and prepayments, and add increases in payables and accruals. That is the indirect method used in the operating section of a statement of cash flows under IAS 7, which our guide on the cash flow statement works through in full.

In the Studio Nord example: accrual profit of 15,100, minus the increase in receivables and accrued income of 13,000, minus the prepayment of 1,800, plus the accrued electricity of 300, gives 600, the cash profit. Our guides on cash flow versus profit and on working capital explore why growing businesses see this gap widen.

Who may use the cash basis (as of September 2026)

For published financial statements the answer is simple: IFRS and the main national frameworks require the accrual basis. The cash basis survives mainly in tax rules for small unincorporated businesses, and in special VAT schemes, which are a separate question from how profit is measured.

• United Kingdom, income tax: since 6 April 2024 the cash basis is the default for self-employed individuals and for partnerships without corporate partners, with no turnover limit; a business may elect to use accruals instead. Limited companies and limited liability partnerships cannot use it.
• United Kingdom, VAT: the separate VAT Cash Accounting Scheme lets a business account for VAT when paid, if estimated taxable turnover for the next 12 months is 1.35 million pounds or less; it must normally leave above 1.6 million pounds.
• Canada: the Canada Revenue Agency requires self-employment income to be reported on the accrual method, except that farmers, fishers and self-employed commission agents may choose the cash method; GST/HST is still accounted for separately.
• European Union: member states may offer an optional cash accounting scheme for VAT to small businesses under the EU VAT Directive; rules and thresholds differ by country, and statutory accounts of companies remain on the accrual basis.
• Companies preparing statutory financial statements in the EU, the UK, Canada and the Gulf use the accrual basis, whatever method they use to track cash day to day.

Choosing, and the hybrid in between

For a business that must file accrual accounts, the choice is really about day-to-day bookkeeping. Keeping the books on the accrual basis all year, with receivables and payables recorded as invoices arrive, is almost always cheaper than converting at year end, and it gives management accurate monthly results. The cash basis can be reasonable for a sole trader with no stock, no staff and no credit customers.

Some small businesses keep a modified cash basis: cash for everyday income and costs, but equipment capitalised and depreciated and loans recorded as liabilities. It is not a recognised basis under IFRS, but it can be a practical internal stepping stone. Whatever the choice, the tax basis and the accounting basis can differ; many small businesses report taxable profit on the cash basis while keeping accrual books for their bank.

• Cash basis advantages: simple, cheap to maintain, tax follows cash available.
• Cash basis drawbacks: profit can be managed by timing payments, no view of debts owed or owing, poor for stock or credit sales, not accepted for statutory statements.
• Accrual basis advantages: shows true performance per period, reveals receivables and payables, required by IFRS and national GAAP, comparable across businesses.
• Accrual basis drawbacks: more entries, needs judgement for estimates, and profit can look healthy while cash runs short.

Accrual accounting in Skyline Nexus ERP

The general ledger in Skyline Nexus ERP is kept on the accrual basis. When automatic posting is switched on, a final sales invoice posts revenue and VAT against accounts receivable when it is saved, and the customer's payment is a separate record that posts its own journal, clearing the receivable. Purchases post to accounts payable in the same way. The AR and AP ageing reports then show what is owed in buckets of current, 1 to 30, 31 to 60, 61 to 90 and over 90 days, which is precisely the information a cash-basis record cannot give.

For the cash view, the Cash Flow statement under Fiscal Authority reports is built from movements on accounts flagged as cash or bank, each classified as operating, investing or financing through the account type's Cash Flow Activity setting. It is a direct analysis of cash movements. For the bridge from accrual profit to cash, as in the Studio Nord example, the Balance Sheet's Compare With option (Previous Period or Previous Year) gives the opening and closing balances the bridge needs. Accruals and prepayments at period end are entered as manual journals, dated in the period they belong to.

Related guides

Accruals connect most of the accounting basics series. These guides take the ideas above further.

• Adjusting entries explained: how accruals, prepayments and deferred revenue are recorded at period end.
• Cash flow is not profit: why a profitable business can still run out of cash.
• Working capital and the cost of growth: how receivables, stock and payables absorb cash.
• How to read financial statements: seeing profit and cash side by side in a real set of accounts.
• Deferred revenue accounting: customer deposits and subscriptions from receipt to recognition.
• Cash flow statement, indirect method: the full bridge from profit to cash, worked.
• Accounts payable versus accounts receivable: the two balances the accrual basis creates.