What is accrual accounting? Types, benefits, examples and best practices

The mercantile system is India's traditional approach to accrual accounting, where you record transactions when they occur rather than when cash is exchanged.

Under this system, you recognize income when it's earned and expenses when they're incurred, regardless of payment timing. This method is mandatory for companies and businesses with an annual turnover exceeding specified thresholds under the Income Tax Act.

You'll find the modified accrual system primarily used by government entities and non-profit organizations in India. This hybrid approach combines elements of both cash and accrual accounting, where you record revenues on an accrual basis but expenses on a cash basis, or vice versa, depending on your organization's specific requirements.



Indian Accounting Standards (Ind AS) mandate a comprehensive accrual basis of accounting for larger companies. Under this framework, you must recognize all assets, liabilities, equity, income, and expenses when they meet specific recognition criteria, ensuring your financial statements reflect true economic substance rather than just cash flows.



For tax compliance, you must follow prescribed accrual methods based on your business turnover. Companies with turnover above ₹25 crores must compulsorily adopt accrual accounting for tax purposes, ensuring consistency between commercial and tax accounting.



Certain industries like banking, insurance, and telecommunications follow specialized accrual accounting norms. These methods address unique revenue recognition patterns and regulatory requirements specific to each sector, ensuring accurate financial reporting within industry frameworks.

Accrual accounting

You record transactions when they occur, regardless of cash flow timing. Revenue is recognized when earned, and expenses are incurred when charged. If you deliver services in December but receive payment in January, you record the revenue in December. This provides real-time insights into your business performance and operational efficiency.

Cash accounting

You only record transactions when cash actually changes hands. Using the same example, you would record revenue in January when payment is received. This method is simpler but may not accurately reflect your business's true performance during specific periods, especially for businesses with significant credit transactions.

Accrual accounting

This method provides a more accurate picture of your financial position by including all outstanding receivables, payables, and obligations. Your balance sheet reflects actual assets you own and liabilities you owe, giving stakeholders a comprehensive view of your business's financial health and future cash flow potential.

Cash accounting

Your financial statements only show cash transactions, potentially misleading stakeholders about your true financial position. Outstanding invoices, unpaid bills, and future obligations aren't reflected, making it difficult to assess your business's complete financial status and creditworthiness.

Accrual accounting

Required for larger businesses, publicly traded companies, and those exceeding specified turnover thresholds. Most accounting standards, including Ind AS and GAAP, mandate this method. Banks and investors typically prefer accrual-based financial statements for credit decisions and investment evaluations.

Cash accounting

Permitted for smaller businesses, sole proprietorships, and those below prescribed turnover limits. While simpler to maintain, it may limit your access to certain business opportunities, loans, or investment options that require accrual-based financial reporting.

Accrual accounting

You may pay taxes on income before receiving cash, potentially creating cash flow challenges. However, you can also claim deductions for expenses before paying them, which may provide tax planning opportunities. Tax compliance requires careful coordination between book and tax accounting methods.

Cash accounting

Taxes are based on actual cash receipts and payments, aligning tax obligations with cash flow. This can provide better cash flow management for tax purposes but may limit certain deduction timing strategies and business expense planning opportunities.

Accrual accounting

Your financial statements present a comprehensive view of business performance, including earnings quality, profitability trends, and operational efficiency. Stakeholders can better analyze your business cycles, seasonal patterns, and long-term financial sustainability through detailed income statements and balance sheets.

Cash accounting

Financial statements focus primarily on cash flow activities, providing limited insights into business performance, profitability, and financial position. This simplified presentation may be adequate for very small businesses but lacks the depth required for complex business analysis.

Accrual accounting

Enables better strategic decision-making by providing accurate profitability analysis, budget planning, and performance evaluation. You can identify trends, manage working capital effectively, and make informed decisions about pricing, inventory, and expansion based on comprehensive financial data.

Cash accounting

Decision-making is limited to cash flow considerations, potentially missing important business performance indicators. While suitable for cash-intensive businesses, it may lead to suboptimal decisions regarding credit policies, inventory management, and long-term strategic planning.

One of the most frequent mistakes occurs when you record transactions in the wrong accounting period. You might recognize revenue before earning it or delay expense recognition beyond the incurrence date.

For example, recording December sales in January or failing to accrue year-end bonuses can significantly distort your financial statements and mislead stakeholders about your true business performance.

You may overlook certain accruals, particularly those involving estimates or less obvious transactions. Common missed items include accrued interest, utility bills, professional fees, or amortization in accounting, as well as warranty obligations.

These omissions can understate your liabilities and expenses, presenting an overly optimistic view of your financial position and potentially creating compliance issues.



When creating adjusting entries for accruals in accounting, calculation errors, incorrect account codes, or reversed debits and credits can occur.

These manual mistakes can compound over time, leading to significant discrepancies in your financial statements. Regular review and approval processes are essential to catch these errors before they impact your reporting.

Without proper documentation, you cannot substantiate your accrual entries during audits or reviews. Missing invoices, contracts, or agreements that support accrued amounts can create compliance problems and reduce the credibility of your financial statements.

Maintaining organized records is crucial for defending your accrual accounting practices.

You might incorrectly classify accrued items between current and long-term categories, or between different expense types.

For instance, misclassifying accrued rent as utilities or placing short-term accruals in long-term liability accounts can confuse financial statement users and affect key financial ratios.

Failing to regularly reconcile accrued amounts with actual transactions can lead to persistent errors.

You should establish monthly reconciliation procedures to verify that accrued items are properly reversed when actual transactions occur, preventing double-counting and maintaining accurate balances.

When your accounting team lacks proper training in the accrual basis of accounting, mistakes become inevitable.

Insufficient understanding of accrual principles, timing rules, and documentation requirements can lead to systematic errors that compromise your financial reporting quality and regulatory compliance.

You can significantly reduce manual errors by automating recurring accruals such as salaries, rent, and utilities through modern accounting software. Set up templates for monthly accruals that automatically generate journal entries based on predetermined schedules and amounts.

This automation ensures consistency, reduces processing time, and minimizes the risk of missed entries while maintaining accurate records.

Develop comprehensive written policies that clearly define when and how to record different types of accruals. Create step-by-step procedures for common scenarios, establishing thresholds for materiality and approval requirements.

These standardized processes ensure consistency across your organization and help new team members understand the accrual basis of accounting requirements.

Conduct ongoing training sessions to keep your finance team updated on accrual accounting principles, regulatory changes, and best practices. Focus on practical scenarios, common mistakes, and proper documentation requirements.

Well-trained staff are essential for maintaining accurate accruals in accounting and ensuring compliance with accounting standards.

Schedule regular internal reviews of your accrual processes to identify potential issues before they become significant problems. Examine supporting documentation, verify calculation accuracy, and assess compliance with established policies.

These periodic audits help maintain the integrity of your financial reporting and catch errors early.

Create detailed checklists that outline all required accrual entries for each closing period. Include specific items to review, deadlines to meet, and approval requirements.

These checklists ensure you don't miss critical accruals and help maintain consistency in your closing processes across different accounting periods.

Maintain organized files with all supporting documents for accrual entries, including contracts, invoices, estimates, and calculations. Implement document management systems that make it easy to locate and retrieve supporting evidence during audits or reviews.

Proper documentation strengthens the credibility of your financial statements.

Connect your accrual accounting processes with enterprise resource planning (ERP) systems to automate data flow and reduce manual entry requirements.

This integration improves accuracy, provides real-time visibility into accrued amounts, and streamlines your overall financial reporting processes.

You must identify transactions where economic benefits have been earned or obligations incurred, but cash hasn't changed hands. Look for completed services not yet billed, received goods or services not yet paid for, earned interest not yet received, or incurred expenses without invoices.

Regular review of contracts, agreements, and business activities helps identify these items systematically.

When recording accruals in accounting, you typically debit an expense or asset account and credit a liability or revenue account. For accrued expenses, debit the expense account and credit accrued liabilities.

For accrued revenue, debit accounts receivable and credit revenue. These entries ensure your financial statements reflect actual business activity during each period.

At month-end or year-end, you create adjusting entries to record all accrued items. These entries update your accounts to reflect the accrual basis of accounting principles.

Document each adjustment with supporting calculations, relevant dates, and business rationale to maintain audit trails and ensure accuracy.

Your company pays monthly salaries on the 5th of each month. If your accounting period ends March 31st and you haven't paid April salaries yet, you must accrue March salary expenses.

Journal Entry:

Debit: Salary Expense ₹5,00,000

Credit: Accrued Salaries Payable ₹5,00,000

When you pay salaries in April, you reverse this entry and record the actual payment.

You completed consulting services worth ₹2,00,000 in March but will invoice the client in April.

Journal Entry:

Debit: Accounts Receivable ₹2,00,000

Credit: Service Revenue ₹2,00,000

This ensures March revenue reflects actual services delivered during that period.

You should reverse accrual entries in the subsequent period when actual transactions occur. This prevents double-counting and maintains accurate balances.

Set up systematic reversal procedures to ensure all accruals are properly handled.

Use spreadsheet templates, accounting software features, or specialized accrual management tools to track and calculate accruals efficiently.

Implement approval workflows, maintain supporting documentation, and establish regular review processes to ensure accuracy and completeness.

The Companies Act, 2013 mandates that all companies maintain books of accounts on the accrual basis of accounting. Section 128 requires you to record transactions when they occur, not when cash changes hands.

This legal requirement applies to all companies regardless of size, making accurate accrual accounting essential for statutory compliance and avoiding director liability under the Act.

Under the Income Tax Act, you must follow the mercantile system (accrual method) if your turnover exceeds ₹25 crores in any of the three preceding years. The Act requires you to offer income for taxation when it accrues or is received, whichever is earlier.

This creates timing differences between book and tax accounting that you must carefully manage through proper documentation and reconciliation.

GST liability arises when you issue invoices or receive payments, whichever is earlier. This creates complexities when implementing accruals in accounting, as GST timing may differ from revenue recognition under accounting standards.

You must maintain separate tracking systems for GST compliance while ensuring your accrual accounting accurately reflects business transactions.

Your accrual accounting system must support various regulatory filings, including annual returns, tax returns, and statutory audits.

Maintain detailed supporting documentation for all accrual entries, implement proper internal controls, and ensure your accounting records can withstand scrutiny from statutory auditors, tax authorities, and regulatory bodies.

Certain industries face additional accrual accounting requirements. Banking companies must follow RBI guidelines, insurance companies adhere to IRDAI regulations, and listed companies comply with SEBI requirements.

These sector-specific rules may mandate particular accrual treatments, disclosure requirements, or reporting formats that you must incorporate into your accounting systems.