You cannot simply start using accrual accounting in July. Changing from cash to accrual is a change in accounting method under the tax rules, which means filing Form 3115 and recognizing a Section 481(a) adjustment that prevents income from being counted twice or skipped entirely. What you can do mid-year is convert your internal books to accrual immediately for management reporting, then make the tax method change effective for a full tax year. Those are two separate projects and confusing them is the most common mistake.
The two changes, kept separate
Management reporting change. Internal. Immediate. No filing. You restate your books so that revenue is recognized when earned and expenses when incurred, giving you a profit figure that describes the business rather than the bank account. Do this whenever you want.
Tax method change. Formal. Requires Form 3115. Applies to a full tax year, not a partial one. This is what determines how income gets reported on the return.
Most businesses that say they are converting mid-year mean the first one. The confusion arises because the work of restating the books serves both purposes, so it feels like one project.
Why the change matters for a product business
Cash basis records revenue when money arrives and expense when money leaves. For a business that buys inventory months before selling it, this produces results that mislead.
A seller spends $90,000 on inventory in October for a holiday season. Under cash basis, October shows a $90,000 expense and a large loss. December shows the sales with almost no cost against them and an enormous profit. Neither month describes what happened. Under accrual, the $90,000 sits as inventory until units sell, and each month shows revenue matched against the cost of the specific goods that produced it.
The practical consequence: cash basis businesses make purchasing and pricing decisions from numbers that are wrong by the size of their inventory swing.
Who is required to change
Section 448(c) of the tax code sets a gross receipts test. For 2026, a business generally meets it, and may continue using the cash method, if average annual gross receipts over the prior three-year period are $32,000,000 or less, per the inflation adjustments published in Revenue Procedure 2025-32.
Very few sellers hit that ceiling. The more common trigger is voluntary: the business has grown to the point where cash basis reporting stops being usable, or a lender, investor or buyer requires accrual statements. Tax rules around method changes and inventory are specific to each business, and the decision about whether and when to file belongs with a CPA rather than with a checklist.
Converting your books: the five steps
Step 1. Pick a conversion date and freeze it
Use the first day of a month, and ideally the first day of a quarter. Everything before that date stays as recorded. Everything after it follows accrual rules. A mid-month date creates a partial period that nothing will reconcile against later.
Step 2. Build the opening balance sheet
This is the real work. Four items matter most.
Accounts receivable. Money earned but not yet received. For marketplace sellers this includes sales made before the cutover whose settlement lands after it, plus any reserve the marketplace is holding.
Accounts payable. Costs incurred but not yet paid. Supplier invoices on terms, freight billed and unpaid, services delivered in the prior period.
Inventory. Units on hand at landed cost, including freight, duties and inbound fees. Not purchase price alone.
Prepaid and accrued items. An annual software subscription paid in March has nine months of value remaining in July. Payroll earned but not yet paid goes the other direction.
Step 3. Work a real example
Take a seller converting on July 1.
Under cash basis, June showed revenue of $140,000 and expenses of $170,000, for a loss of $30,000. The owner concluded June was bad.
The accrual restatement finds the following. Sales of $22,000 were made in June but settled in July, so they belong in June. A marketplace reserve of $8,000 was earned in June and held. Of the $170,000 in expenses, $95,000 was an inventory purchase, and only $61,000 of that inventory actually sold in June. A supplier invoice for $12,000 of June freight arrived in July.
Accrual June looks like this. Revenue of $170,000, being $140,000 received plus $22,000 settled late plus $8,000 held in reserve. Cost of goods sold of $61,000. Other operating expenses of $75,000, being the $170,000 cash out, less the $95,000 inventory purchase, plus the $12,000 freight invoice that belongs in June. Net profit of $34,000.
A $30,000 loss becomes a $34,000 profit, a swing of $64,000, and nothing about the business changed. Only the measurement did.
Step 4. Change the recording rules going forward
From the conversion date, record sales when the order ships rather than when the payout lands, record inventory purchases to an asset account, relieve that account to cost of goods sold as units sell, and accrue supplier invoices when the obligation arises.
The marketplace settlement is where this most often breaks. A payout is a net figure with referral fees, fulfillment, storage, advertising, refunds and reserves already deducted. Accrual accounting requires that deposit split into components with each piece landing in the right period. Doing this by hand past a few hundred orders a month stops working, which is why platforms such as ConnectBooks exist to decompose marketplace settlements and carry cost of goods sold automatically.
Step 5. Run both bases for one quarter
Keep producing the cash figure alongside the accrual figure for three months. Not because the cash number is better. A large unexplained divergence between the two points to an error in the conversion rather than a real timing difference.
The tax side: Form 3115 and the 481(a) adjustment
The formal method change is made by filing Form 3115, Application for Change in Accounting Method. Many cash-to-accrual changes qualify as automatic changes, which means no advance consent is needed, though the form still gets filed.
The Section 481(a) adjustment is the mechanism that stops income being counted twice or missed. Converting typically produces a positive adjustment, because receivables and inventory that were never recognized under cash basis now enter the calculation.
The timing is favorable. Per the IRS instructions for Form 3115, the adjustment period is one tax year for a negative adjustment that decreases income, and four tax years, being the year of change plus the next three, for a positive adjustment that increases income. A $200,000 positive adjustment spreads at $50,000 a year rather than landing all at once. That four-year spread is worth planning around, and it argues against delaying a change that is coming anyway.
What to hand your accountant
Three things make this a short conversation rather than a long engagement: a clean opening balance sheet as of the conversion date, the inventory valuation with the method used to calculate landed cost, and a schedule of receivables and payables at that date.
Whatever the outcome, keep the supporting detail. The retention periods in the IRS recordkeeping guidance for small businesses run longer than most sellers expect, and a method change is exactly the kind of position you may need to explain years later.
