Accrual Accounting
Definition
Accrual accounting records revenue when earned and expenses when incurred, regardless of when cash actually changes hands. This method provides a more accurate picture of financial performance over time than cash-basis accounting and is required under GAAP for companies above a certain size.
Overview
Accrual accounting follows the matching principle: revenues and their associated costs are recorded in the same period, even if the cash flows happen at different times. When a customer signs an annual contract and pays upfront, accrual accounting recognizes only one month of revenue immediately and defers the rest.
This approach gives a more accurate view of a company's ongoing financial performance because it matches economic activity to the period in which it occurs. However, it creates a gap between reported profitability and actual cash position. A profitable company on an accrual basis can still run out of cash if its receivables are slow to collect.
Most VC-backed startups adopt accrual accounting early because it is required by GAAP, expected by investors, and necessary for accurate SaaS metrics. The transition from cash-basis to accrual accounting can significantly change reported revenue figures, particularly for companies with a mix of monthly and annual plans, so it is important to make this switch before it creates confusion during fundraising.
Example
A customer pays $12,000 upfront for an annual subscription in January. Under accrual accounting, $1,000 is recognized as revenue each month, with the remaining $11,000 recorded as deferred revenue.
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