Accrual Accounting Explained: How It Works with Journal Entry Examples for Small Businesses

If you’ve ever wondered why your business bank account shows $5,000, but your profit feels like half that—you might be using the wrong accounting method. Enter accrual accounting: the gold standard for most businesses (and required by GAAP for companies over a certain size) that matches revenues and expenses to the time they’re earned or incurred—not just when cash changes hands.

This isn’t just for accountants: whether you’re a freelance designer, café owner, or e-commerce seller, accrual accounting gives you a clearer picture of your business’s true financial health. And to make it actionable, we’ll break down core accrual concepts with real journal entry examples—the same entries you’d use to track projects, bills, and prepayments.

By the end, you’ll know exactly when to record a sale (even if you haven’t gotten paid yet) and how to log expenses (before you write a check)—plus how it compares to cash accounting.

What Is Accrual Accounting?

At its simplest, accrual accounting is an accounting method that records:

• Revenues when they’re earned (e.g., when you finish a project, deliver a product)—not when the customer pays you.
• Expenses when they’re incurred (e.g., when you receive a service, buy supplies)—not when you pay the bill.

The goal? To match revenues with the expenses that helped generate them (called the “matching principle”). This way, your financial statements (like the income statement) show your actual performance for a period—not just your cash flow.

Example to Start: Cash vs. Accrual

Let’s use a freelance writer to see the difference:

• Scenario: You write a blog post for a client in December 2025, but the client pays you $800 in January 2026.
  • Cash accounting: Record the $800 revenue in January 2026 (when cash is received).
  • Accrual accounting: Record the $800 revenue in December 2025 (when you earned it)—even though cash comes later.

Why does this matter? If you only use cash accounting, your December 2025 income statement will look like you made $0 (when you actually earned $800), and January 2026 will overstate your profit. Accrual accounting fixes this mismatch.

Key Concepts in Accrual Accounting (With Journal Entries)

Accrual accounting revolves around four core transactions: accrued revenues, accrued expenses, deferred revenues, and deferred expenses. Each has a specific journal entry to ensure revenues and expenses are recorded in the right period. We’ll break down each with small business examples.

1. Accrued Revenues: Revenues Earned, Not Yet Received

What they are: Revenues you’ve earned (e.g., finished work, delivered goods) but haven’t been paid for yet. This is common for businesses that work on credit (e.g., freelancers, contractors, B2B services).

Golden rule for journal entries: Debit an asset account (to track what you’re owed) and Credit a revenue account (to record what you’ve earned).

Journal Entry Example: Freelance Web Design Project

You design a website for a client in November 2025. The project is done on November 30, and the client agrees to pay $2,000 in December 2025.

• When to record: November 2025 (when the work is finished, not when cash is received).
• Accounts affected:
  • Debit: Accounts Receivable (asset—tracks the $2,000 the client owes you)
  • Credit: Service Revenue (revenue—records the $2,000 you earned)

Journal Entry (November 30):

When you get paid (December 15):
Record the cash receipt and reduce what the client owes you:

2. Accrued Expenses: Expenses Incurred, Not Yet Paid

What they are: Expenses you’ve incurred (e.g., received a service, used supplies) but haven’t paid for yet. Common examples include rent, salaries, and utility bills that are billed after use.

Golden rule for journal entries: Debit an expense account (to record the cost) and Credit a liability account (to track what you owe).

Journal Entry Example: Monthly Rent

You rent office space for $1,500/month. The landlord sends the bill on the 5th of the next month (e.g., December’s rent bill arrives January 5).

• When to record: December 2025 (when you used the office space, not when you pay the bill).
• Accounts affected:
  • Debit: Rent Expense (expense—tracks the cost of using the office)
  • Credit: Accounts Payable (liability—tracks the $1,500 you owe the landlord)

Journal Entry (December 31):

When you pay the bill (January 10):
Record the cash payment and reduce your liability:

3. Deferred Revenues: Cash Received, Not Yet Earned

What they are: Cash you’ve received from a customer before you’ve earned the revenue (e.g., prepayments for projects, annual subscriptions, gift cards). This is a liability because you owe the customer goods or services.

Golden rule for journal entries: Debit Cash (to record the money received) and Credit a liability account (to track what you owe). Later, when you earn the revenue, debit the liability and credit revenue.

Journal Entry Example: Annual Subscription for a SaaS Tool

You sell a $1,200 annual subscription to your project management tool in January 2025. The customer pays upfront for 12 months of access.

• Step 1: Record the upfront cash (January 1):
  You haven’t earned the revenue yet—this is a liability.

  Account Name	Debit Amount	Credit Amount
  Cash	$1,200
  Deferred Revenue		$1,200

• Step 2: Earn the revenue monthly (January 31, February 28, etc.):
  Each month, you “earn” $100 ($1,200 ÷ 12 months) and reduce the liability.

  Account Name	Debit Amount	Credit Amount
  Deferred Revenue	$100
  Subscription Revenue		$100

Why this works: Your January income statement only shows $100 in revenue (what you earned that month), not the full $1,200—so you don’t overstate your profit.

4. Deferred Expenses: Cash Paid, Not Yet Incurred

What they are: Cash you’ve paid before you’ve incurred the expense (e.g., prepaying rent, buying supplies in bulk, insurance premiums). These are assets because they represent future benefits (you’ll use the supplies or space later).

Golden rule for journal entries: Debit an asset account (to track the future benefit) and Credit Cash. Later, when you use the asset, debit the expense and credit the asset.

Journal Entry Example: Prepaid Insurance

You pay $600 for a 6-month business insurance policy in March 2025 (covers March–August).

• Step 1: Record the prepaid cash (March 1):
  The insurance is an asset—you’ll use it over 6 months.

  Account Name	Debit Amount	Credit Amount
  Prepaid Insurance	$600
  Cash		$600

• Step 2: Record the expense monthly (March 31, April 30, etc.):
  Each month, you “use up” $100 ($600 ÷ 6 months) of the insurance.

  Account Name	Debit Amount	Credit Amount
  Insurance Expense	$100
  Prepaid Insurance		$100

Why this works: Your March income statement only shows $100 in insurance expense (what you used that month), not the full $600—so you don’t understate your profit.

Accrual vs. Cash Accounting: Which Is Right for You?

Now that you understand accrual accounting, how do you know if it’s better than cash accounting? Here’s a side-by-side comparison for small businesses:

Example: Which Method Gives a Better Picture?

A café buys $500 in coffee beans in June (pays in July) and sells $800 in coffee in June (gets paid in August).

• Cash accounting: June profit = $0 (no cash received/payed). July loss = $500 (paid for beans). August profit = $800 (received for sales).
• Accrual accounting: June profit = $300 ($800 revenue – $500 expense). July/August show no profit/loss for this transaction.

Accrual accounting tells you the café made $300 on that batch of beans in June—cash accounting makes it look like the business had a slow June and volatile July/August.

How to Switch to Accrual Accounting (Step-by-Step)

If you’re currently using cash accounting and want to switch (e.g., your business is growing, you need better financial insights), follow these steps:

Step 1: Choose a Start Date

Pick the first day of a month or quarter (e.g., January 1, July 1) to avoid mid-period confusion.

Step 2: Identify Accruals and Deferrals

On your start date, list:

• Accrued revenues: Customers who owe you money for work done before the start date.
• Accrued expenses: Bills you owe but haven’t paid (e.g., December rent due in January).
• Deferred revenues: Cash you received before the start date but haven’t earned (e.g., a prepayment for a project starting in February).
• Deferred expenses: Cash you paid before the start date but haven’t used (e.g., prepaid insurance from last year).

Step 3: Record Opening Journal Entries

For each item above, record a journal entry to “catch up” your books. For example:

• If you have $1,000 in accrued revenues (customers owe you), debit Accounts Receivable $1,000 and credit Revenue $1,000.
• If you have $800 in accrued expenses (you owe a supplier), debit Expense $800 and credit Accounts Payable $800.

Step 4: Update Your Accounting System

Set up accounts for accruals/deferrals in your software (e.g., QuickBooks, Xero):

• Add “Accounts Receivable” (asset) and “Accounts Payable” (liability).
• Add “Deferred Revenue” (liability) and “Prepaid Expenses” (asset).

Step 5: Train Yourself on Ongoing Entries

Use the journal entry examples above to record new transactions (e.g., when you finish a project on credit, when you prepay rent). Set a monthly reminder to adjust accruals/deferrals (e.g., recognize monthly subscription revenue).

Common Accrual Accounting Mistakes (And How to Fix Them)

Even with the right method, small business owners make these common errors—here’s how to avoid them:

Mistake 1: Forgetting to Record Accruals at Month-End

Problem: You do work in December but forget to record accrued revenue—your December profit is understated.
Fix: Set a monthly checklist to review:

• Did you do work for clients who haven’t paid yet? (Record accrued revenue.)
• Did you receive bills you haven’t paid yet? (Record accrued expenses.)

Mistake 2: Confusing Deferred Revenue with Revenue

Problem: You receive a $5,000 prepayment for a project and record it as “Revenue” immediately—your profit is overstated.
Fix: Always record upfront cash as “Deferred Revenue” (liability) first. Only move it to “Revenue” as you earn it.

Mistake 3: Not Adjusting Prepaid Expenses

Problem: You pay $1,200 for annual software and record it as “Expense” upfront—your first month’s profit is understated.
Fix: Record prepaid expenses as assets first. Adjust them monthly to recognize the expense as you use the service.

Final Takeaway: Accrual Accounting = Better Business Decisions

Accrual accounting isn’t just about following rules—it’s about seeing your business clearly. By matching revenues and expenses to the right period, you can:

• Understand which months are truly profitable (not just when cash comes in).
• Plan for future cash flow (e.g., “I have $3,000 in accrued revenues—cash will come in next month”).
• Make smarter decisions (e.g., “Should I hire another employee? My accrual profit shows I can afford it”).

And with the journal entry examples in this guide, you don’t need to be an accountant to use it. Start small: pick one accrual type (e.g., accrued revenues) and practice recording those entries. Over time, it will become second nature.