Accrual Basis

Accounting system in which revenues and expenses are recognized in the period in which they arise, regardless of when the cash for the revenue or the expenditure actually occurs. Accrual accounting is the only basis of accounting approved under Generally Accepted Accounting Principles and is used by public companies and most privately owned companies. See also Cash Basis.

A method of accounting that reflects expenses incurred and income earned for income tax purposes for any one year.

Taxpayers who use the accrual method must include in their taxable income any money they have the right to receive as payment for services once it has been earned. Any expenses that they may take as deductions when computing taxable income must be due at the time the deduction is taken. For example, a surgeon performed a tonsillectomy in October 1997, and on December 31, 1997, he received a bill for carpeting installed in the waiting room of his office. He was paid the surgical fee on January 3, 1998, the same day he paid for the carpeting. The surgical fee will be included in his taxable income for 1997, the year in which he earned it, regardless of the fact that he was not paid until the following year.

His expenses for the carpeting can be deducted from his 1997 income because once he received the bill, he was bound to pay it. The fact that he did not pay for the carpeting until the following year does not prevent him from taking the deduction.

The accrual method of accounting differs from the cash basis method, which treats income as only that which is actually received, and expense as only that which is actually paid out. If the cash method were used in the above example, the payment of the surgical fee would be included as income for the 1998 tax year, the year in which it was received by the surgeon. The surgeon could deduct the cost of the carpeting only when he actually paid for it in 1998, although it had been installed in 1997.

Unearned income, such as interest or rent, is generally taxed in the year it is received, regardless of the method of accounting used by the taxpayer.