Cash vs accrual accounting comes down to the balances only accrual keeps
Accrual books hold six balances cash books never record. Each opening figure comes from a document, the first month looks wrong without them, and for 2026 the IRS line that forces the switch sits at $32 million.
Cash accounting records a sale when the money arrives and accrual records it when it is earned, so accrual books carry receivables, inventory, prepaid expenses, payables, accrued expenses and customer deposits that a cash-basis file never records.
Switching a QuickBooks Online file to accrual changes how reports read the transactions already entered; the opening balances for unpaid invoices, unpaid bills, stock on hand and paid but unshipped orders still have to be entered from documents as of the cutoff.
For tax years beginning in 2026 the section 448(c) gross receipts test is $32 million (IRS Rev. Proc. 2025-32), so a business turning over $250,000 to $5 million that is not a tax shelter is not forced onto accrual by the cash-method limit or the inventory rule.
Cash vs accrual accounting is a question of timing. Cash books record a sale when the money arrives and a cost when the money leaves. Accrual books record each one when it is earned or owed. That single difference leaves accrual books holding six balances a cash-basis file never records: what customers owe you, what you owe suppliers, stock on the shelf, costs paid in advance, costs run up but not yet billed, and money taken for orders not yet shipped.
The rest of this page follows one business through the switch. The examples come from an online homeware shop that sells direct through its own store and wholesale to a dozen retailers on 30-day terms, which is the usual shape of a business that sells on several channels. Every dollar figure is illustrative.
What is the difference between cash and accrual accounting?
Cash accounting records income when you receive it and expenses when you pay them; accrual accounting records income when you earn it and expenses when you incur them, whoever has paid whom. IRS Publication 538 (revised January 2022) states both rules in those terms, and adds the accrual test: an amount goes into income in the year all events have occurred that fix your right to receive it and the amount can be determined with reasonable accuracy. Getting paid is not one of them.
The clearest way to see it is to put the same five December events through both sets of books.
What happened | Cash books record it | Accrual books record it |
|---|---|---|
A $9,000 wholesale order ships on December 12 and the retailer pays on January 11 | January income | December income, and a $9,000 receivable until January 11 |
A $4,200 packaging bill arrives on December 20 and is paid on January 19 | January expense | December expense, and a $4,200 payable until January 19 |
Twelve months of insurance, $3,600, is paid on December 1 | December expense, all of it | $300 a month of expense, December to November, with the unexpired part held as a prepaid asset |
A customer pays $1,800 on December 28 for a preorder that ships January 8 | December income | January income; until then the $1,800 is a liability, because you owe the customer the goods |
$14,000 of stock bought in November is still on the shelf on December 31 | November expense | No expense yet; it sits as inventory until it is sold |
That is why accrual is the reason the balance sheet and the income statement can both look fine while the bank balance does not: every row above is a gap between the profit and the cash, held on the balance sheet until the money catches up. FASB's conceptual framework puts the same idea in one sentence: accrual accounting depicts the effects of transactions in the periods in which they occur, even if the cash moves in a different period (Concepts Statement No. 8, Chapter 1, paragraph OB17, as amended December 2021).
Which balances appear on the day you switch to accrual?
Six balances appear on the first day of accrual books, and each one needs an opening figure taken from a document as of the last day of cash. None of them can be calculated from the bank feed, because the bank feed only knows about money that moved.
Balance | What it holds on day one | Where the opening figure comes from | What goes wrong if it is missing |
|---|---|---|---|
Accounts receivable | Invoices sent and not yet paid | The open-invoice list at the cutoff, checked against what customers paid in the following weeks | Collections on old invoices are booked as new sales, so the first month's revenue is overstated by exactly that amount |
Inventory | Stock on hand, at cost | A count on the cutoff date, priced from supplier invoices | Stock the cash books expensed when it was bought is sold with no cost against it, so gross margin in the first months is overstated |
Prepaid expenses | The unexpired part of anything paid ahead: insurance, annual software, a deposit on a trade show | The policy or invoice, with its coverage dates | The cash books expensed the whole payment, so the months it covers carry no cost and look more profitable than they were |
Accounts payable | Supplier bills received and not yet paid | The unpaid-bills file and supplier statements at the cutoff | Payments of old bills are booked as new costs, so the first month's profit is understated |
Accrued expenses | Costs already run up but not yet billed or paid: wages for the last days of the year, a freight bill for December shipments that arrives in January | The first payroll register after the cutoff, and any bill dated after the cutoff for work done before it | Payments for those costs are booked as new expenses, so the first accrual month carries costs that belong to the year before |
Customer deposits | Money taken for orders not yet shipped: paid preorders, deposits on wholesale orders | The store's list of paid, unfulfilled orders at the cutoff | The cash books already counted that money as income, so the goods ship in the new year with cost and no revenue against them |
The receivables row is the one most owners already half have: the aging report that lists every open invoice by how long it has been outstanding is its source document, provided it is run as of the cutoff date rather than today.
Switching to accrual is not a setting. It is a list of what you were owed, what you owed and what you had already paid for on the last day of cash, entered once, from documents.
Why does the first month on accrual look wrong?
The first month on accrual looks wrong when the opening balances are missing, because it mixes two methods: old invoices and old bills settle in that month and are recorded as if they were new business. Take the homeware shop's January. It invoiced $96,000 and was billed $61,000 for January itself. It also collected $38,000 on December invoices and paid $21,500 of December bills.
January | Opening balances missing | Opening balances entered |
|---|---|---|
Revenue | $134,000 ($96,000 of January invoices plus $38,000 of December invoices collected) | $96,000 |
Expenses | $82,500 ($61,000 of January bills plus $21,500 of December bills paid) | $61,000 |
Profit | $51,500 | $35,000 |
The first column overstates January's profit by $16,500, which is the $38,000 of old sales counted again minus the $21,500 of old costs counted again. Neither column has an arithmetic error in it. One of them is a month of accrual books with the last weeks of the cash books stitched into it, and anyone comparing January with February will draw the wrong conclusion from it. With stock, prepaids, accruals and deposits added, the distortion moves in whichever direction those balances push.
What does the accrual setting in QuickBooks Online actually change?
The accrual setting in QuickBooks Online changes how reports read the transactions already in the file; it does not create the six opening balances. Intuit's help article on choosing between cash and accrual (read in October 2026) puts the company-wide default under Settings, Account and settings, Advanced, Accounting method, and lets you run any individual report on either basis from the report itself.
So the setting can only find what was entered in a form accrual reports understand. A supplier bill entered as a bill when it arrived shows up as a payable. The same bill recorded as an expense on the day it was paid does not, and no setting can put it there. If the file was kept from the bank feed, the receivables and payables have to be built from the documents in the table above.
How they are entered matters too. Intuit's help article on opening balances (read in October 2026) states that an opening balance typed into an account is posted as a journal entry against Opening Balance Equity. The other side of each opening accrual balance belongs in equity, because each one corrects profit the cash books already reported, but it should land in a named account agreed with your preparer rather than accumulate there. If some of it has already landed there, trace the balance posting by posting before clearing it.
Does the IRS make a small business switch to accrual?
For tax years beginning in 2026, the gross receipts test in section 448(c) is $32 million of average annual gross receipts over the three prior tax years, according to IRS Revenue Procedure 2025-32. Publication 538 prints the same test as $26 million indexed for inflation; $32 million is the indexed figure for 2026.
The test does two jobs:
The cash-method limit. Section 448 bars a C corporation, or a partnership with a C corporation as a partner, from the cash method unless it meets the gross receipts test; a tax shelter cannot use cash at any size. An S corporation, a sole proprietorship or an LLC taxed as either is not on that list, per Publication 538.
The inventory rule. Publication 538 states that a business that must account for inventory generally has to use accrual for its purchases and sales, and that a small business taxpayer, one meeting the same gross receipts test, may instead treat inventory as non-incidental materials and supplies or follow the treatment in its own books. Treasury Decision 9942 (January 2021) ties that exemption to the section 448(c) test.
A business turning over $250,000 to $5 million that is not a tax shelter is far below $32 million, so neither rule forces it onto accrual. Its move to accrual is a choice about its books. That choice still has a tax consequence, covered next, and whether to make it is a conversation for you and whoever files your return.
Can you switch from cash to accrual for taxes?
You can switch from cash to accrual for tax purposes with the IRS's consent, which is requested on Form 3115, and the change comes with a section 481(a) adjustment. IRS Publication 334, the 2025 Tax Guide for Small Business, states that you must use the same accounting method to figure your taxable income and to keep your books, so a change in the books is a change your preparer needs to know about before it happens rather than after.
Consent. The Internal Revenue Manual (IRM 4.11.6) states that a taxpayer must secure the Commissioner's consent before changing a method of accounting for federal income tax purposes, and that consent is requested by filing Form 3115.
The adjustment. A section 481(a) adjustment prevents amounts from being counted twice or not at all when the method changes, and it is computed as of the beginning of the tax year of change (IRM 4.11.6). A cutoff on the first day of a tax year puts the books' day one and that computation on the same date.
The spread. The Instructions for Form 3115 (revised December 2022) and Rev. Proc. 2015-13 set the adjustment period at one tax year for a negative adjustment and four tax years, the year of change and the next three, for a positive one.
As a guide to its direction and not its amount: receivables, which a cash return never taxed, push the adjustment positive; payables and accrued expenses, which a cash return never deducted, push it negative. Your preparer computes the figure, and which way it nets out for your business decides how quickly it reaches the return.
In QuickBooks Online, run last month's profit and loss on the cash basis, then again on the accrual basis. If the two are identical, the file held no unpaid invoices or bills at month-end: either everything settled inside the month, or invoices and bills were never entered as such. If they differ, the difference is mostly open invoices and unpaid bills, which are the receivables and payables rows of your day-one list.
Does GAAP require accrual?
Financial statements prepared under US GAAP are accrual statements; cash-basis statements are a different framework. FASB's conceptual framework describes financial reporting in accrual terms (Concepts Statement No. 8, Chapter 1, paragraph OB17), and the AICPA classifies the cash, modified cash and tax bases as special purpose frameworks, which are alternatives to US GAAP rather than versions of it (AICPA & CIMA, Frequent questions about special purpose frameworks, read October 2026). A lender or investor who asks for GAAP financial statements is asking for accrual books.
Can you write off bad debt on a cash basis?
A business on the cash method generally cannot deduct an unpaid invoice as a bad debt, because the amount was never included in its income. IRS Topic no. 453 (read October 2026) states that a business bad debt can be deducted only if the amount owed was previously included in gross income, and that a cash method taxpayer generally cannot take a bad debt deduction for unpaid fees and similar items. On accrual the invoice was income when it was raised, so the deduction exists to undo that inclusion.
Know what your file needs before day one of accrual
If moving to accrual is something you are weighing for the new year, we can look at what your books already hold and what would have to be built first. If it is not, everything above works without us.
This article explains how the rules generally work. It is not tax advice for your situation.
Spent a decade closing books for multi-entity SMBs before deciding month-end close deserved better than a spreadsheet and a prayer. Writes about reconciliation, accruals, and the boring things that break at scale.
