Switching From Cash to Accrual Accounting: What Business Owners Need to Know
For many small businesses, managing finances starts with the cash method of accounting. It’s simple, straightforward, and reflects actual cash flow. However, as your business grows, you may find that the cash method no longer gives you the full picture. That’s where the accrual method of accounting comes in.
Switching from cash to accrual can seem intimidating, but it’s often an important step toward better financial management, improved reporting, and even meeting IRS requirements. In this article, we’ll explore what the switch involves, why it matters, and how to do it correctly.
What’s the Difference Between Cash and Accrual Accounting?
Before diving into the transition process, it’s important to clarify the difference between the two methods:
Cash Method: Income is recorded when cash is received, and expenses are recorded when cash is paid. This method is simple and aligns closely with cash flow.
Accrual Method: Income is recorded when it is earned (regardless of when payment is received), and expenses are recorded when they are incurred (not necessarily when they’re paid).
For example:
If you invoice a client in December but don’t get paid until January, the cash method records the revenue in January. The accrual method records it in December, when you performed the work.
Why Switch to Accrual Accounting?
Many businesses start with the cash method because it’s easier, but as operations expand, accrual becomes more useful—and sometimes required.
1. IRS Requirements
The IRS requires businesses with more than $25 million in gross receipts (over a three-year period) to use the accrual method. Certain industries, such as C-corporations and those with inventory, may also be required to use accrual accounting.
2. More Accurate Financial Picture
Accrual accounting matches income with the expenses incurred to generate that income, giving you a more accurate view of profitability.
3. Better for Planning and Growth
By recognizing revenue and expenses when they occur, accrual accounting provides insight into future obligations and expected income, which helps in budgeting and forecasting.
4. Improved Credibility with Investors and Lenders
Banks, investors, and stakeholders often prefer accrual-based financial statements because they more accurately reflect the health of a business.
Steps to Switching from Cash to Accrual
Transitioning from cash to accrual requires adjustments to your books. Here’s how the process generally works:
1. Review IRS Guidelines
Check whether your business is required to switch, or whether you’re choosing to do so voluntarily for better reporting. If required, you may need to file Form 3115 (Application for Change in Accounting Method) with the IRS.
2. Adjust Income Records
Add accounts receivable (money owed to you but not yet received). This ensures revenue is recognized when earned, not just when cash is received.
3. Adjust Expense Records
Record accounts payable (expenses you owe but haven’t paid yet). This includes bills, payroll liabilities, and other accrued expenses.
4. Account for Inventory
If you sell products, you may need to track inventory under accrual accounting. This means recording cost of goods sold (COGS) when the sale occurs, not when inventory is purchased.
5. Update Your Accounting Software
Most software, including QuickBooks Online, allows you to switch from cash to accrual reporting. However, adjustments may need to be made manually or with the help of a bookkeeper.
6. Work with a Professional
Because this process can affect tax filings and financial reporting, it’s highly recommended to work with a CPA or bookkeeper to ensure accuracy and compliance.
Common Challenges When Switching
Double-counting revenue or expenses if entries aren’t adjusted properly.
Inventory tracking can be complex for businesses new to accrual.
Tax implications — switching may change when income and expenses are recognized, which could affect taxable income.
Q&A: Switching From Cash to Accrual
Q: Do I need IRS approval to switch to accrual?
A: In many cases, yes. Filing IRS Form 3115 is required when making the switch to accrual accounting for tax purposes.
Q: Will accrual accounting change my taxes?
A: It might. Since revenue and expenses are recognized at different times, your taxable income could shift in the year you transition. Consulting with a tax professional is critical.
Q: Can I use accrual accounting in my books but cash for taxes?
A: Some businesses use accrual for internal financial reporting and cash for taxes, but consistency is generally recommended. Discuss this with your CPA.
Q: Is accrual accounting harder to manage?
A: It can be more complex than cash, but modern accounting software makes it much easier to handle. With proper setup, it provides far more valuable insights.
Q: What if I’m a very small business — should I stick with cash?
A: If your business is simple, has minimal receivables or payables, and the IRS doesn’t require you to switch, cash may be sufficient. But if you plan to grow, accrual could benefit you in the long run.
How Brecken Business Solutions Can Help
Switching accounting methods is a big step, and accuracy is crucial. At Brecken Business Solutions, we help businesses:
Assess whether accrual accounting is the right move.
File the necessary IRS paperwork.
Adjust books properly to avoid errors or double-counting.
Train your team to understand and use accrual-based reports.
Set up or optimize QuickBooks Online for accurate accrual reporting.
Don’t navigate the switch alone—our team is here to make it simple and stress-free.
Call to Action
Contact us today to get expert support in switching from cash to accrual accounting and ensure your financials are accurate, compliant, and ready for growth.
