This is a commonly-used accounting method where income is reported when it’s earned and expenses are reported as they occur, whether or not cash has been received or paid. This is in contrast with another method known as cash basis accounting, though this method is less commonly use than accrual basis accounting.
The reason people might prefer accrual basis accounting is that it gives a long term picture of income and expenses over a period of time. The downside is that you can’t see your cash flow as you can with the aptly-named cash basis accounting.
So why are there two methods anyway? Isn’t accounting complicated enough as it is?
The answer is NO. But it’s also probably a good thing that there are two options for small businesses.
Making purchases with credit complicated everything, and it’s actually why the accrual method was invented in the first place.
When you file your first tax return as a new business, you’ll have to choose a side, accrual or cash. Keep in mind that certain kinds of businesses have to use the accrual method. The IRS requires you to use accrual accounting if your business produces, buys or sells merchandise. As with everything related to the IRS, there are of course exceptions. Be sure to check what the rules are when it comes to your specific business before you file.
I use accrual basis accounting for my bubble gun factory warehouse.