accrual method of accounting

The accrual method of accounting includes accounts payable and accounts receivable instead of ignoring those pending payments. Therefore, unlike cash method of accounting, accrual method of accounting does not mislead a business’s stakeholders, thereby providing the full picture of a business’s financial health, potential risks, and profitability. The shortcoming of the accrual method of accounting lies in its complexity; because it involves both pending and settled payments, complex accounting knowledge would be necessary to accurately manage a business’s account practice under accrual method of accounting.

The accrual method of accounting is the method of accounting used by most large businesses in reporting their liabilities and expected income before receiving or dispensing payment. The Internal Revenue Service (IRS) requires most businesses with income above $25 million to use this method of accounting because it more accurately reflects the current financial status of businesses with very complex and numerous transactions occurring.

Conversely, some businesses also use the cash method of accounting, which only reports transactions after receiving or dispensing payment. For example, if ABC Co. signed a sale contract to purchase XYZ Co 's warehouse but did not pay yet, the accrual method would require ABC Co. to report the transaction because it is likely to occur, but the cash method would not require reporting the transaction until the payment occurred.

[Last reviewed in February of 2025 by the Wex Definitions Team] 

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