# Accrual Accounting vs. Cash Accounting: Key Differences and When Each Is Used

Published: 2026-03-17
Author: Warren Team
URL: https://www.heywarren.com/blog/accrual-vs-cash-accounting

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A contractor completes a $50,000 project in December and sends an invoice. Under cash accounting, zero revenue appears until the client pays, maybe January. Under accrual accounting, $50,000 in revenue is recorded the moment the work is done. Same economic reality, dramatically different numbers. The accrual accounting vs cash distinction is not a technicality, it determines whether financial statements reflect what a business actually earned or just when money moved through a bank account.

Most readers default to cash thinking: "Did we get paid? Then we made money." That instinct leads to misreading income statements, overstating business health in flush months, and missing warning signs buried in [accounts receivable](/blog/accounts-receivable). The two systems answer a fundamentally different question. Cash accounting asks "What moved?" Accrual accounting asks "What happened?"

This guide breaks down both methods side by side, walks through real examples, and explains how to cross-reference accrual income statements against the cash flow statement, the most critical skill for any investor or business owner reading financial reports. GAAP requires accrual accounting for all public companies, and the [IRS](https://www.irs.gov/) bars cash-basis accounting for businesses with average annual gross receipts above $27 million.

## What Is Cash Accounting?

Cash accounting records revenues when cash is actually received and expenses when cash is actually paid, regardless of when the underlying economic activity occurred. It is the simpler of the two methods, used primarily by small businesses and individuals. If money hasn't hit your bank account, it hasn't happened yet under this method.

![Under cash accounting, revenue records when payment arrives; under accrual, it records when work is completed.](data:image/svg+xml,%3Csvg%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F2000%2Fsvg%22%20viewBox%3D%220%200%20875%20125%22%20width%3D%22875%22%20height%3D%22125%22%20role%3D%22img%22%3E%3Ctitle%3EFlow%20diagram%3C%2Ftitle%3E%3Crect%20width%3D%22100%25%22%20height%3D%22100%25%22%20fill%3D%22%23f8fafc%22%2F%3E%3Crect%20x%3D%2230%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22115%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EWork%20Done%3C%2Ftext%3E%3Ctext%20x%3D%22115%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3ENov%3C%2Ftext%3E%3Cline%20x1%3D%22205%22%20y1%3D%2262.5%22%20x2%3D%22237%22%20y2%3D%2262.5%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cpolygon%20points%3D%22244%2C62.5%20235%2C57.5%20235%2C67.5%22%20fill%3D%22%2364748b%22%2F%3E%3Crect%20x%3D%22245%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22330%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EInvoice%20Sent%3C%2Ftext%3E%3Ctext%20x%3D%22330%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3ENov%3C%2Ftext%3E%3Cline%20x1%3D%22420%22%20y1%3D%2262.5%22%20x2%3D%22452%22%20y2%3D%2262.5%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cpolygon%20points%3D%22459%2C62.5%20450%2C57.5%20450%2C67.5%22%20fill%3D%22%2364748b%22%2F%3E%3Crect%20x%3D%22460%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22545%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ECash%20Received%3C%2Ftext%3E%3Ctext%20x%3D%22545%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3EJan%3C%2Ftext%3E%3Cline%20x1%3D%22635%22%20y1%3D%2262.5%22%20x2%3D%22667%22%20y2%3D%2262.5%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cpolygon%20points%3D%22674%2C62.5%20665%2C57.5%20665%2C67.5%22%20fill%3D%22%2364748b%22%2F%3E%3Crect%20x%3D%22675%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22760%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ERevenue%20Recorded%3C%2Ftext%3E%3Ctext%20x%3D%22760%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3ECash%3A%20Jan%20%2F%20Accrual%3A%20Nov%3C%2Ftext%3E%3C%2Fsvg%3E)

*Under cash accounting, revenue records when payment arrives; under accrual, it records when work is completed.*

**[Revenue recognition](/blog/recognise-revenue)**: When the customer pays.
**Expense recognition**: When the check is written.

**Example**: A law firm does $40,000 of legal work in November. The client pays in January.
- **Cash accounting**: $40,000 revenue recognized in January (when paid)
- November income statement: $0 for this engagement

Cash accounting is intuitive, it tracks cash flow directly. It is used primarily by small businesses below certain revenue thresholds, and by individuals for personal tax purposes.

**IRS threshold**: Businesses with average annual gross receipts exceeding $27 million (2023 threshold, indexed for inflation) generally cannot use cash accounting for tax purposes under the Tax Cuts and Jobs Act. They must use accrual.

## What Is Accrual Accounting?

Accrual accounting records revenues when earned, when a service is performed or goods are delivered, and expenses when incurred, regardless of when cash changes hands. A business completing a project in November records that revenue in November, even if the client pays in February. This method produces a more accurate picture of period performance than tracking cash alone.

This is based on the **matching principle**, match expenses to the revenues they help generate in the same period.

**Revenue recognition**: When the service is performed or goods delivered.
**Expense recognition**: When the cost is incurred.

**Example (same law firm)**:
- November: $40,000 earned → recognized as revenue in November; recorded as accounts receivable ($40,000)
- January: Client pays → cash received, accounts receivable cleared; no new revenue impact

The income statement for November correctly shows $40,000 in revenue from actual work performed.

**GAAP requires accrual accounting** for all public companies and larger private companies. This is the accounting method used in audited financial statements.

## Accrual Accounting vs Cash: Key Differences at a Glance

The core difference in accrual accounting vs cash accounting is timing. Accrual accounting ties revenue and expenses to economic activity; cash accounting ties them to cash movement. This timing gap can make the same business look profitable or unprofitable in a given period, depending solely on when invoices get paid or bills get settled.

![Business size and reporting requirements determine whether cash or accrual accounting is appropriate.](data:image/svg+xml,%3Csvg%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F2000%2Fsvg%22%20viewBox%3D%220%200%20720%20480%22%20width%3D%22720%22%20height%3D%22480%22%20role%3D%22img%22%3E%3Ctitle%3EQuadrant%20matrix%3C%2Ftitle%3E%3Crect%20width%3D%22100%25%22%20height%3D%22100%25%22%20fill%3D%22%23f8fafc%22%2F%3E%3Crect%20x%3D%2290%22%20y%3D%2225%22%20width%3D%22300%22%20height%3D%22190%22%20fill%3D%22%23dbeafe%22%2F%3E%3Crect%20x%3D%22390%22%20y%3D%2225%22%20width%3D%22300%22%20height%3D%22190%22%20fill%3D%22%23d1fae5%22%2F%3E%3Crect%20x%3D%2290%22%20y%3D%22215%22%20width%3D%22300%22%20height%3D%22190%22%20fill%3D%22%23ffedd5%22%2F%3E%3Crect%20x%3D%22390%22%20y%3D%22215%22%20width%3D%22300%22%20height%3D%22190%22%20fill%3D%22%23ede9fe%22%2F%3E%3Cline%20x1%3D%2290%22%20y1%3D%22215%22%20x2%3D%22690%22%20y2%3D%22215%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cline%20x1%3D%22390%22%20y1%3D%2225%22%20x2%3D%22390%22%20y2%3D%22405%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22240%22%20y%3D%22100%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2213%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3ECash%20OK%3C%2Ftext%3E%3Ctext%20x%3D%22240%22%20y%3D%22120%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%E2%80%A2%20Sole%20props%3C%2Ftext%3E%3Ctext%20x%3D%22240%22%20y%3D%22136%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%E2%80%A2%20Simple%20books%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22100%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2213%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3EAccrual%20Required%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22120%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%E2%80%A2%20Public%20cos%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22136%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%E2%80%A2%20%26gt%3B%2427M%20revenue%3C%2Ftext%3E%3Ctext%20x%3D%22240%22%20y%3D%22290%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2213%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3ECash%20Preferred%3C%2Ftext%3E%3Ctext%20x%3D%22240%22%20y%3D%22310%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%E2%80%A2%20Freelancers%3C%2Ftext%3E%3Ctext%20x%3D%22240%22%20y%3D%22326%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%E2%80%A2%20Personal%20tax%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22290%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2213%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3EAccrual%20Advised%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22310%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%E2%80%A2%20Seeking%20capital%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22326%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%E2%80%A2%20Audited%20stmts%3C%2Ftext%3E%3Ctext%20x%3D%2290%22%20y%3D%22425%22%20text-anchor%3D%22start%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3ESimple%3C%2Ftext%3E%3Ctext%20x%3D%22690%22%20y%3D%22425%22%20text-anchor%3D%22end%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3EComplex%3C%2Ftext%3E%3Ctext%20x%3D%22390%22%20y%3D%22453%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EReporting%20Needs%3C%2Ftext%3E%3Ctext%20x%3D%2280%22%20y%3D%2237%22%20text-anchor%3D%22end%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3ELarge%3C%2Ftext%3E%3Ctext%20x%3D%2280%22%20y%3D%22405%22%20text-anchor%3D%22end%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3ESmall%3C%2Ftext%3E%3Ctext%20x%3D%2235%22%20y%3D%22215%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%20transform%3D%22rotate%28-90%2035%20215%29%22%3EBusiness%20Size%3C%2Ftext%3E%3C%2Fsvg%3E)

*Business size and reporting requirements determine whether cash or accrual accounting is appropriate.*

| Feature | Cash Accounting | Accrual Accounting |
|---|---|---|
| Revenue recognized | When cash received | When earned |
| Expenses recognized | When cash paid | When incurred |
| Accounts receivable | Not tracked | Tracked (asset) |
| Accounts payable | Not tracked | Tracked (liability) |
| Accuracy of period performance | Lower (cash timing distorts) | Higher (economic reality) |
| Complexity | Simple | More complex |
| Required by GAAP? | No | Yes (for public companies) |
| Used by | Small businesses, individuals | Public companies, larger businesses |
| Income timing | Matches cash flow | May differ significantly from cash flow |

## Practical Example: Seasonal Business

A seasonal business illustrates why the accounting method matters for period reporting. Total annual profit is identical under both methods, but the month-by-month income statement and balance sheet look very different. Accrual accounting matches costs to the revenue period; cash accounting records them only when money actually moves.

A retailer that sells primarily in Q4 (holiday season):

**October**: Purchases $500,000 in inventory on credit (net 60 terms)
**November–December**: Sells all inventory for $800,000 cash

**Cash accounting**:
- October P&L: $0 revenue, $0 expenses (neither paid yet)
- November–December P&L: $800,000 revenue, $500,000 cost (paid in December)
- Profit: $300,000

**Accrual accounting**:
- October: $500,000 inventory purchased → recorded as asset; accounts payable created
- November–December: Revenue recognized as sold: $800,000; COGS recognized: $500,000 (goods sold)
- Profit: $300,000 (same total, but timing and balance sheet match reality)

The totals end up the same over a full year, but the period-by-period picture differs significantly, especially for the balance sheet.

## Why Accrual Accounting Provides Better Insight

Accrual accounting gives a more complete picture by matching every expense to the revenue it helped generate in the same reporting period. This matching principle prevents distortions caused by payment timing. It also produces a balance sheet that reflects real assets and obligations, not just the current cash balance.

### Matching Revenue and Expenses

Accrual accounting ensures all costs of generating revenue appear in the same period as that revenue. If a company pays a $2 million salesperson bonus in January for deals closed in December, accrual accounting records the bonus expense in December, properly matching the cost to the period it relates to.

Cash accounting records the bonus in January. This makes December's income look artificially high and January's look artificially low.

### Revealing the Balance Sheet

Under cash accounting, there are no accounts receivable, accounts payable, or [deferred revenue](/blog/deferred-revenue), the balance sheet is impoverished. Under accrual accounting:

- **Accounts receivable**: Revenue earned but not yet collected, a real economic asset
- **Accounts payable**: Expenses incurred but not yet paid, a real obligation
- **Deferred revenue**: Cash received for future services, a genuine liability
- **Accrued liabilities**: Obligations incurred but not yet invoiced (payroll, bonuses, utilities)

These balance sheet items provide a more complete picture of what the company owns and owes.

## The Cash Flow Statement: Bridging the Gap

The cash flow statement bridges the gap between accrual-based net income and actual cash generated. Because accrual accounting records transactions before cash moves, net income can diverge sharply from operating cash flow. The cash flow statement reconciles the two, making it the most important document for evaluating real financial health.

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*The indirect method starts with accrual net income and adjusts to arrive at actual operating cash flow.*

Because the accrual income statement doesn't equal cash generated, GAAP requires a separate **cash flow statement** that reconciles net income to actual cash flows.

The **indirect method** cash flow statement starts with net income and adjusts for:

**Adds back**: Non-cash expenses (depreciation, amortization, stock-based compensation)
**Adjusts for**: Working capital changes, increases in accounts receivable (cash not yet collected) reduce cash; decreases in accounts payable (cash paid for prior obligations) reduce cash

This reconciliation allows investors to see both the accrual-based income picture and the cash reality.

**Example**:

| | Amount |
|---|---|
| Net income | $50,000,000 |
| + Depreciation & amortization | $15,000,000 |
| + Stock-based compensation | $8,000,000 |
| − Increase in accounts receivable | ($12,000,000) |
| + Increase in accounts payable | $5,000,000 |
| **Cash from operations** | **$66,000,000** |

Cash from operations ($66M) exceeds net income ($50M) because non-cash charges were added back. Working capital changes were also a modest source of cash.

## Modified Accrual: Government Accounting

Modified accrual accounting is a hybrid method used in government and public-sector accounting. Revenues are recognized when measurable and available; expenditures are recorded when incurred, with exceptions for long-term obligations. GASB governs this standard, separate from [FASB](https://www.fasb.org/), which sets rules for commercial entities.

This approach includes:
- Revenues recognized when available and measurable (slightly different from full accrual)
- Expenditures recognized when incurred (like full accrual), with exceptions for long-term obligations

## Tax Accounting: Accrual Accounting vs Cash for IRS Purposes

For US income tax purposes, small businesses below the gross receipts threshold can generally choose either cash or accrual accounting. Once chosen, the method must be applied consistently, the IRS does not allow annual switches to minimize taxes. Changing methods requires formal IRS approval and an income adjustment.

For US income taxes:
- Small businesses (under the gross receipts threshold) can generally choose either method
- The IRS requires consistency, you can't switch methods each year to minimize taxes
- Changing accounting methods requires IRS approval (Form 3115) and a Section 481(a) adjustment to prevent income from being duplicated or omitted

## Key Practical Point for Investors

When reading public company financial statements, always treat the income statement and the cash flow statement as a pair. Accrual-based net income reflects economic activity but includes estimates and timing judgments. Operating cash flow reflects cash reality and is far harder to manipulate.

When reading public company financial statements:
- **Income statement**: Accrual basis, revenue and expenses may not match cash timing
- **Cash flow statement**: Cash basis, actual cash in/out
- **Never evaluate a company on net income alone**: Always check operating cash flow and [free cash flow](/blog/cashflow-free), which track economic reality more closely and resist manipulation

Companies can boost accrual income through aggressive revenue recognition while generating poor cash flows. Red flags include accounts receivable growing much faster than revenue, a sign customers aren't paying. Watch also for deferred revenue shrinking despite high reported revenue (backlog is depleting), and large gaps between net income and operating cash flow that working capital investments cannot explain.

## Conclusion

The accrual accounting vs cash debate comes down to one question: do you want to track when money moves, or when economic value is created? For small businesses and personal finances, cash accounting's simplicity wins. For any business seeking outside capital, preparing audited financial statements, or understanding true profitability, accrual accounting is the right, and usually required, method.

Key takeaways:
- **Timing is everything**: Accrual accounting records revenue when earned and expenses when incurred; cash accounting records both only when cash changes hands.
- **GAAP and the IRS both weigh in**: Public companies must use accrual; businesses with average gross receipts above $27 million cannot use cash-basis accounting for taxes.
- **The matching principle prevents distortion**: Expenses must appear in the same period as the revenue they generate, preventing artificially inflated or deflated results.
- **Always pair the income statement with the cash flow statement**: Net income alone is not a reliable measure; operating cash flow is harder to manipulate and closer to economic reality.
- **Watch for red flags**: Accounts receivable growing faster than revenue, or persistent large gaps between net income and operating cash flow, signal potential earnings quality issues.

For related accounting topics, see our guides on [profit and loss statements](/blog/profit-and-loss-statement), [deferred revenue](/blog/deferred-revenue), and [deferred tax assets](/blog/deferred-tax-assets).

Ready to put this knowledge to work? Try Warren, your AI financial advisor, get personalized, conflict-free guidance at heywarren.com

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## Related Reading

**More from Warren**:
- [Centralized Market: Definition, How It Works, and Why It Matters for Investors](/blog/centralized-market)
- [Bills Payable: Definition, Examples, and How They Differ From Accounts Payable](/blog/bills-payable)
- [What Is Underwriting? Definition, Types, and How the Process Works](/blog/what-is-underwriting)

**Authoritative sources**:
- [FASB, Accounting Standards Codification](https://asc.fasb.org/)
- [AICPA, Financial Reporting](https://www.aicpa-cima.com/topic/audit-assurance/financial-reporting)
- [SEC EDGAR, Company Filings](https://www.sec.gov/edgar/searchedgar/companysearch)