Accrual Accounting
Accrual accounting assigns expenses and income to the financial year in which they are economically caused, regardless of when the payment actually flows. This lets the annual financial statements show a period-accurate result.
Accrual accounting is the bookkeeping principle of assigning expenses and income precisely to the accounting period in which they are economically caused – not to the period in which cash flows. In practice, payment and profit impact often fall apart: an insurance premium is paid in December for the whole of the following year, a rent for January only arrives in the new year, a maintenance contract runs across a year-end. Accrual accounting separates these cash flows from profit and assigns each financial year only the portion that actually concerns it.
Legally this is anchored in the accrual principle under Section 252 (1) No. 5 HGB: expenses and income of the financial year must be recognised in the annual financial statements regardless of the dates of the corresponding payments. Together with the realisation principle, accrual accounting forms the basis of double-entry bookkeeping on the accrual basis (economic causation) and distinguishes commercial profit determination from a pure cash-basis income statement that only looks at payments.
At a glance
- Assigns expense and income to the year of economic causation, not the year of payment
- Legal basis: the accrual principle under Section 252 (1) No. 5 HGB
- Tools: prepaid and deferred items (ARAP/PRAP), other receivables and payables, provisions
- Distinguishes transitory items (payment before profit) from anticipatory items (profit before payment)
- Ensures a period-accurate, comparable profit statement and correct tax assessment
What accrual accounting means and why it is necessary
Without accrual accounting, a company would determine its profit solely by when cash comes in and goes out. That distorts the picture: an annual contract paid in full in December would heavily burden the December profit and leave the eleven following months, in which the service is actually used, unburdened. Accrual accounting corrects this by decoupling the cash flow from the consumption of value and from service delivery, assigning each amount proportionally to the period to which it economically belongs.
Accrual accounting therefore serves the principle of period-accurate profit determination: in each period exactly the income and the expenses needed to earn it should meet (matching). Only in this way can financial years be compared with one another, trends be identified and reliable key figures be derived from the profit and loss statement. Accrual accounting is thus not a technical detail of the annual financial statements, but the precondition for the balance sheet and P&L to show a meaningful profit at all.
How accrual accounting works: transitory and anticipatory items
In practice, the need for accruals always arises when payment and expense or income fall into different periods. Bookkeeping distinguishes two basic cases for this, ordered according to whether the payment precedes the profit or follows it. Both are recorded at the balance sheet date via accrual postings and reversed again in the following period.
Transitory accruals (prepaid and deferred items)
Transitory items exist when the payment has already been made, but the associated expense or income only concerns the next period. They are posted as prepaid and deferred items under Section 250 HGB. A prepaid expense (ARAP) arises when you pay before the reporting date and only use the service afterwards – for example a rent or insurance paid annually in advance. A deferred income (PRAP) arises as the mirror image, when you receive money before the reporting date but only render the counter-performance afterwards, for example an annual fee collected in December.
Anticipatory accruals (other receivables and payables)
Anticipatory items are the reverse case: the expense or income already concerns the old year, while the payment only follows in the new one. They are recorded not as prepaid and deferred items, but as other receivables (income earned but not yet received) or other payables (expenses caused but not yet paid). Typical examples are rent arrears, interest incurred in the old year but only settled later, or wage-related costs for December that only fall due in January.
Accrual accounting in the ERP system
In an ERP system, accrual accounting runs via financial accounting and the control of posting periods. Every posting carries a posting date and a service date; through the document date and defined periods, the system recognises which month or which financial year a transaction belongs to. At period-end close, periods can be locked so that subsequent postings only flow into open periods on an accrued basis and the profit once determined remains unchanged.
Many systems automate recurring accruals via distribution or accrual postings: an annual invoice paid in advance is recorded once, and the ERP automatically distributes the amount linearly across the affected months by reposting a portion of the prepaid item into expense month by month. This reduces manual reclassifications, makes the accrual traceable and delivers a period-accurate, audit-proof P&L for the monthly close. How conveniently automatic accruals and parallel financial reporting are mapped differs greatly between products; examples can be found under "Related systems".
Distinction: accruals vs. provisions and depreciation
Accrual accounting is easily confused with provisions, because both link future payments to the old year. The difference lies in certainty: anticipatory accrual items concern expenses that are fixed in principle and amount and merely not yet paid. A provision, by contrast, sets aside cover for a future obligation that is probable but still uncertain in amount or timing – for example for an impending lawsuit or warranties.
Depreciation too is a form of accrual accounting, but works with a different tool: it distributes the one-off acquisition cost of a fixed asset systematically over its useful life and thus takes effect over many years. Classic accrual accounting via prepaid and deferred items, by contrast, usually concerns a single period change and is fully reversed again in the following period. What all three have in common is the goal of assigning profit to the year of economic causation.
DACH specifics and international classification
In German commercial law, accrual accounting is governed by Section 252 (1) No. 5 HGB as a general valuation principle and by Section 250 HGB for prepaid and deferred items; in Austria, substantively equivalent rules apply under the UGB. Fiscally, accrual accounting has a direct effect, because the result determined via the P&L is the starting point for tax profit determination – incorrectly accrued expenses shift profit into the wrong year.
Important is the boundary with the cash-basis income statement: smaller companies and freelancers who determine their profit on the cash-receipts-and-payments basis generally do not use classic accrual accounting via prepaid and deferred items. Internationally, both IFRS and the national GAAP require accounting on the accrual basis, so accrual accounting is a core principle of almost all professional financial reporting – the specific recognition and presentation rules, however, differ in detail.
Example
Example: a prepaid maintenance contract in a mid-sized company
A mid-sized retailer signs a maintenance contract for its warehouse equipment at the beginning of December and pays the annual fee of EUR 12,000 net immediately in advance. Economically, the contract concerns the period from December to November of the following year – that is, only one month of the current financial year. Without an accrual, the full amount would burden the December profit, even though eleven twelfths of the service are only used in the new year.
The accounting department therefore forms a prepaid expense: in December only one twelfth, i.e. EUR 1,000, is recognised as expense of the old year; the remaining EUR 11,000 stand as an ARAP on the balance sheet at the reporting date. In the ERP system this is handled by an automatic distribution posting that, from January onwards, reposts EUR 1,000 month by month from the prepaid item into maintenance expense. Thus each of the twelve months bears exactly its share, and both financial years show a period-accurate result.
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