Cash and accrual are the two fundamental accounting methods. For most Canadian freelancers and sole proprietors, the choice is straightforward — cash basis is correct. Here is what each method means and why it matters for your T2125 and CRA reporting.
Cash Basis Accounting
Income is recorded when cash is received. Expenses are recorded when cash is paid.
Example: You complete a project in December 2025 and invoice the client for $5,000. The client pays in January 2026. Under the cash method, the $5,000 is 2026 income — not 2025.
Similarly, you order accounting software in December 2025 and pay the credit card bill in January 2026. Under cash basis, that expense is a 2026 deduction, not 2025.
Cash basis matches your actual bank account activity. It is simpler to maintain and easier to understand. Most accounting software defaults to cash basis.
Accrual Basis Accounting
Income is recorded when earned (invoice date), regardless of when paid. Expenses are recorded when incurred, regardless of when paid.
Example: Using the same scenario above — under accrual, the $5,000 project invoiced in December 2025 is 2025 income, even though payment arrives in January 2026.
Accrual gives a more accurate picture of business performance in a given period — it matches revenue to the period it was earned and expenses to the period they were incurred. This matters for management decisions and for audited financial statements, which are required for incorporated businesses.
Which Should Canadian Freelancers Use?
Most sole proprietors use cash basis. The CRA allows self-employed individuals to use either method, but the cash method is simpler, matches your intuitive understanding of income, and is the default for service-based businesses where there is no inventory.
Exceptions where accrual is required or advisable:
- Incorporated businesses (corporations must use accrual for T2 corporate returns)
- Businesses with inventory (accrual matches cost of goods sold to revenue more accurately)
- Businesses with revenue over $1 million (CRA may require accrual)
- Businesses with complex timing differences between earning and receiving income (significant work-in-progress at year-end)
Tax Timing Implications
Cash basis creates opportunities to time income and expenses within the same tax year:
- Delaying a December invoice until January defers that income to the next tax year
- Paying a December 2026 insurance premium before December 31 pulls the deduction into 2026
These timing strategies are legitimate for cash-basis filers. Accrual filers cannot use them — income and expenses attach to the period in which they were earned or incurred, regardless of payment timing.
Consistency Requirement
The CRA expects you to use the same accounting method consistently from year to year. Switching from cash to accrual (or vice versa) requires a change in accounting method, which has specific rules for how to handle transitional income and expenses. Consult a CPA before changing methods.
Frequently Asked Questions
Does my accounting software automatically use cash or accrual?
Most accounting software (Wave, FreshBooks, QuickBooks Online) allows both — the method is determined by when you record transactions. If you record income when invoices are paid (rather than when issued), you are on cash basis. If you record income when invoices are issued, you are on accrual. Typically, cash basis is the default for sole proprietors and can be explicitly set in QuickBooks Online under Settings → Accounting Method.
Can I switch from cash to accrual if I incorporate?
Yes — and you will likely need to. Corporations file a T2 return which typically uses accrual accounting. When you incorporate, the transition is often complex: accounts receivable (income earned but not yet received) needs to be brought into the opening accrual records. Your CPA handles this during the incorporation tax transition year. The Section 85 rollover election (if applicable) addresses some of these issues.
Does using accrual create additional GST/HST obligations?
For GST/HST, the default is that tax is collected and remitted on an invoice date (accrual) basis. Cash basis GST/HST accounting is available to businesses with under $1 million in revenue and must be elected with the CRA. If you are on cash basis for income tax but have not elected cash basis for GST/HST, you have a mismatch — discuss with a CPA to ensure your methods are aligned.