What is the Accrual Method of Accounting?
There are two methods of accounting; cash (income is reported when you receive it), and Accrual. In accrual accounting, you report income in the tax year that you earned it, even if you don't collect payment until the following year. The accrual method of accounting is often used by larger businesses that carry inventory or offer credit.
If you billed a client $500 in 2016 and received payment in 2017, under accrual accounting, you would report the $500 income in 2016 (when you performed the service) rather than 2017.
However, If you used cash accounting, the $500 would be reported as income in 2016, when you receive it.
This also applies with expenses. Under accrual accounting you deduct expenses when you incur them. Let's say you received office supplies in 2016 but didn't pay for them until 2016. You'd deduct the expenses in 2016, the year you were able to start using the supplies.
If you have inventory and your business earned over $1 million in gross receipts in each of the past three years, you'll generally use the accrual method for sales and related costs. However, for most small businesses, the cash method of accounting is easier because, among other things, you don't have to calculate cost of goods sold.
A business can use the accrual method for bookkeeping purposes and the cash method for tax purposes, but this is not common.
To change your accounting method, you'll need to file IRS Form 3115, Application for Change in Accounting Method. This form is included in TurboTax Business.