How to Apply the Accrual Method in QuickBooks

Introduction

Many small businesses, particularly those just starting out or operating on a purely cash basis, often begin their financial journey using the cash method of accounting. Under the cash method, revenue is recognized only when cash is received, and expenses are recorded only when cash is paid out. While simple, this approach provides a limited and often misleading view of a company’s performance, especially for businesses that use credit, manage inventory, or handle large client invoices.

The accrual method in QuickBooks changes this entirely. Accrual accounting provides a far more accurate and truthful picture of financial performance by recognizing revenues when they are earned (regardless of when the cash is collected) and expenses when they are incurred (regardless of when they are paid). This alignment of income and related expenses in the same reporting period is fundamental to calculating true profitability.

Fortunately, QuickBooks—whether you use the Online or Desktop version—offers powerful, built-in tools for applying the accrual method effectively. This guide provides a clear, step-by-step roadmap to setting up QuickBooks for accrual reporting, detailing the correct way to record accruals and deferrals, and ensuring you generate accurate, compliance-ready financial statements.

Setting Up QuickBooks — Ensuring Your Software is Configured for Accrual Reporting

The first step in using accrual accounting is ensuring your QuickBooks software is properly configured to process and display data using this method. While QuickBooks automatically records transactions to both cash and accrual bases in the background, you must tell the system which method to use for generating your primary financial reports.

Enabling Accrual Accounting (Primary Setting)

For long-term consistency, you should set your default accounting method to accrual.

For QuickBooks Online (QBO):

1. Navigate to the Settings gear icon (top right).

2. Select Account and Settings.

3. Click the Advanced tab on the left.

4. Scroll down to the Accounting section and click the edit pencil.

5. Under the Accounting Method drop-down menu, choose Accrual.

6. Click Done to save your changes.

For QuickBooks Desktop (QBD):

1. Go to the Edit menu at the top.

2. Select Preferences.

3. Click on Reports & Graphs from the left-hand menu.

4. Select the Company Preferences tab.

5. Under Summary Reports, ensure the "Accrual" option is selected as the default method.

Verification and Rationale

Once this setting is enabled, all financial statements (Profit and Loss, Balance Sheet) generated from the Reports menu will default to the accrual method. This matters profoundly for revenue and expense recognition. Under the accrual method, QuickBooks records sales and purchases using Accounts Receivable and Accounts Payable accounts, respectively, ensuring your Profit and Loss statement accurately reflects activity based on the date of the invoice or bill, rather than the date of payment.

Tip Box: Consulting Your Accountant Before Switching

Switching from Cash to Accrual? Always consult your accountant or tax professional first. While accrual is essential for management reporting (GAAP/IFRS), the IRS allows most small businesses to file taxes on a cash basis. A complete system-wide change should only be made after confirming the proper tax and regulatory implications for your specific business structure.

Recording Accrued Expenses and Revenues — Proper Journal Entries in QuickBooks

Accruals are adjustments that must be made at the end of a reporting period to account for transactions that have occurred but for which cash has not yet changed hands. These are typically handled using Journal Entries in QuickBooks.

Defining Accruals

1. Accrued Expenses: These are expenses the company has incurred but has not yet received or paid a bill for. Example: Utilities used in December that won’t be invoiced until January.

2. Accrued Revenues: This is income the company has earned by performing a service or delivering a product, but has not yet invoiced or received cash for. Example: A consulting project completed on the last day of the month that will be invoiced on the first day of the next month.

How to Record Accruals in QuickBooks

You use the Journal Entry feature to record these adjustments, ensuring they hit the correct asset/liability and revenue/expense accounts.

QuickBooks Instructions (QBO and QBD):

1. Go to the + New button (QBO) or Company menu → Make General Journal Entries (QBD).

2. Select Journal Entry.

3. Set the Date to the last day of the reporting period (e.g., Dec 31).

4. Input your debit and credit lines, ensuring the total debits equal total credits.

5. Click Save and Close.

Accrued Expense Example (Recognizing December’s estimated utility bill of $500):

Accrued Revenue Example (Recognizing earned but unbilled service fee of $2,500):

These journal entries ensure that your Profit and Loss statement accurately reflects all revenue earned and expenses incurred during the period, while the corresponding liability or asset accounts are updated on the Balance Sheet.

Handling Deferred Revenue (Unearned Income) in QuickBooks for Subscription Businesses

Deferred revenue, also known as unearned income, is the opposite of an accrual. It represents cash payments the business has received for goods or services that have not yet been delivered or earned. This is common in subscription models, retainers, and gift card sales. Under the accrual method, this payment cannot be recognized as income immediately.

Setting Up the Unearned Revenue Account

First, you must set up the correct liability account in your Chart of Accounts:

1. Navigate to your Chart of Accounts.

2. Create a new account.

3. Set the Account Type to Other Current Liability.

4. Name the account "Unearned Revenue" or "Deferred Income."

This account will hold the cash you’ve received until the service is rendered.

Step-by-Step Process for Deferred Revenue

Let’s use the example: A subscription service collects $12,000 upfront on January 1st for a 12-month annual plan.

Step 1: Record the Initial Payment as a Liability

When the $12,000 payment is received, it is recorded in QuickBooks as a liability, not as income.

Step 2: Recognize the Revenue Monthly (The Amortization)

Since the service is delivered monthly, you must recognize $1,000 of revenue each month for 12 months. This is done by moving the earned portion from the liability account to the revenue account using a recurring journal entry.

By creating this journal entry (and setting it as recurring for the next 11 months), you ensure compliance with accrual principles, prevent the overstatement of income in January, and accurately reflect revenue only as it is earned over the full year. This is a critical component of accurate QuickBooks deferred revenue tracking.

Generating Accrual-Based Financial Reports (P&L, Balance Sheet) from QuickBooks Data

The greatest benefit of proper accrual setup is the ability to generate financial reports that offer true insight into performance. QuickBooks allows you to toggle between cash and accrual methods for reporting, providing a powerful comparison tool.

How to View Accrual Reports

To ensure you are viewing the most accurate results, always verify the report settings:

1. Go to the Reports menu.

2. Select a report (e.g., Profit and Loss).

3. Near the top of the report screen, locate the Customize button or Accounting Method drop-down.

4. In the customization panel, select Accrual under the Accounting Method option.

5. Click Run Report.

Repeat this process for the Balance Sheet and Statement of Cash Flows (though the latter always reconciles to changes in accrual-based balance sheet accounts).

Accrual vs. Cash QuickBooks Reports: Key Differences

Understanding the difference is vital for interpretation.

Accrual reporting is often mandatory for larger organizations, is heavily favored by banks when reviewing loan applications, and is necessary for robust investor reporting and compliance with GAAP. It reveals the true economic activity during a period, making it a superior tool for strategic management.

Tips for Making Year-End Adjusting Entries for Accruals and Deferrals in the System

The period-end, especially the year-end, is when the meticulous application of the accrual method comes to a head. Year-end adjustments are necessary to ensure that all income and expenses are correctly allocated to the proper accounting period, finalizing the financial picture before closing the books.

Common Adjusting Entries in QuickBooks

These are the most frequent adjustments needed to align cash transactions with accrual principles:

1. Accrued Payroll and Utilities: Recording the expense of salaries earned and utilities used right up to December 31st, even if payment is not due until January.

2. Deferred Revenue Recognition: The final journal entry to move the last earned portion of prepaid services from the "Unearned Revenue" liability account to the Income account.

3. Prepaid Expense Amortization: Recording the portion of a prepaid expense (like 12 months of insurance or rent paid upfront) that has actually been consumed during the period. The Prepaid Expense Asset account is credited, and the corresponding Expense account is debited.

How to Enter Adjusting Entries

All year-end accrual and deferral adjustments are entered into QuickBooks via the Journal Entry screen (as outlined in Section 2).

Pro Tip for Accountants: When using QuickBooks Desktop, accountants often use the "Adjusting Entry" checkbox located at the bottom of the Journal Entry screen. Checking this box flags the entry, making it clear in the audit trail that this transaction was an adjusting entry made specifically to comply with accrual accounting principles, separating it from standard day-to-day transactions.

After all adjustments are entered, run the Journal report (Reports → Accountant & Taxes → Journal) for the period. Reviewing this report ensures all entries are posted to the correct accounts and that debits equal credits, providing a final layer of verification before officially closing the books for the year.

Frequently Asked Questions (FAQ)

Can I switch between cash and accrual reports anytime?

Yes. While you should set one method (usually accrual) as your company's default, QuickBooks allows you to toggle the accounting method on virtually any report at any time via the Customize menu. This is extremely useful for seeing how your accounts look both for strategic management (accrual) and for monitoring immediate cash liquidity (cash).

What happens if I file taxes on a cash basis but use accrual for management reporting?

This is a very common and acceptable practice. Many small businesses with revenue under a certain threshold use the cash method for tax filing (which simplifies the process) but use the accrual method for internal management. Your accountant handles the necessary adjustments and reconciliations (often called Schedule M adjustments) to convert your accrual-based records into the cash-based format required for tax purposes.

Do I need to reverse accrual entries in the following month?

Yes, usually. Accrual entries (like the Accrued Expense example) are often "reversing entries." Because you recorded the expense in December that was paid in January, the entry must be reversed on January 1st to prevent double-counting. When the actual utility bill is paid later in January, the entry will accurately record the payment against the cash account and clear the temporary liability.

Conclusion

Mastering the accrual accounting in QuickBooks elevates your financial reporting from reactive data collection to proactive strategic insight. By recognizing revenue and expenses when they happen, rather than when the money moves, your business gains the ability to calculate true profitability, accurately forecast cash flow, and confidently assess performance month over month.

While QuickBooks streamlines the complex process of handling accruals, deferrals, and adjusting entries in QuickBooks, the need for human oversight remains essential. Consistent review, expert reconciliation, and the ethical judgment of an accountant are necessary to maintain the precision that underpins all sound financial decision-making. View the mastery of accrual in QuickBooks not just as a compliance task, but as a commitment to the highest professional standard of financial clarity.