Accruals and prepayments · Trial Balance

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What it is: Changes made at the end of the year so that each year shows only the costs and income that belong to that year.

Why you need it: The date of a payment is often different from the date the cost is used. The accounts must follow when the cost is used, not when the money is paid.

The two main types: An accrual is a cost used this year but not paid yet. You add it to this year’s expense. A prepayment is a cost paid this year for next year. You take it out of this year’s expense.

Example. On 1 October, a business pays £1,200 for 12 months of insurance. On 31 December, 3 months have been used. This year’s cost is 3/12 × £1,200 = £300. The other £900 is a prepayment. It is a current asset because it is for next year.

Key words

Accruals concept: The rule that income and costs go in the year they relate to. The date the cash is paid or received does not decide the year.Example: Rent for December is paid on 5 January. It is still December’s cost.
Accrual: A cost that belongs to this year, but has not been paid by the year end. It is added to this year’s costs and shown as a liability (an amount owed).Example: The December electricity bill arrives in January. It is still a December cost, so it goes in this year’s accounts as an accrual.
Prepayment: A cost paid this year that belongs to next year. It is taken out of this year’s costs and shown as an asset.Example: £1,200 of insurance paid on 1 October for 12 months: 9 months (£900) belong to next year, so £900 is a prepayment.
Deferred income: Money received now for goods or services the business will provide in a later period. It is a liability until it is earned.Example: £600 of rent received in December for January to March is deferred income at 31 December.

Learn

The accruals concept: income and expenses go in the year they belong to. The date the cash was paid or received does not decide this. At the year end, you make adjustments where the two dates are different.

Situation	Name	Journal	Shown on the balance sheet as
A cost used this year but not paid yet	Accrued expense (accrual)	Debit the expense. Credit Accruals.	Current liability
A cost paid this year for next year	Prepayment	Debit Prepayments. Credit the expense.	Current asset
Income earned this year but not received yet	Accrued income	Debit Accrued income. Credit the income.	Current asset
Income received this year for next year	Deferred income	Debit the income. Credit Deferred income.	Current liability

Steps

Draw a timeline. Mark the date the cash moved, the months the payment covers, and the year end.
Count the months that are inside this financial year. That fraction is this year’s expense or income.
The rest is the adjustment. If it was paid early, it is a prepayment (or deferred income). If it is not paid yet, it is an accrual (or accrued income).

Example (accrual): The year ends 31 December. The December electricity bill of £300 arrives in January. December’s electricity was used this year. So debit Electricity £300 and credit Accruals £300.

When there are adjustments at the start and the end of the year

Expense for the year = Cash paid − Opening accrual + Closing accrual + Opening prepayment − Closing prepayment

Example: Cash paid for rent £5,000. Opening accrual £400. Closing accrual £600. Expense = £5,000 − £400 + £600 = £5,200.

Watch it explained

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Videos from YouTube tutors

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Worked example

Year end 31 December. Rent of £2,400 was paid on 1 April for 12 months. A £150 telephone bill for December hasn’t arrived.

April to December is 9 months, so this year’s rent is 9/12 × £2,400 = £1,800. The other 3/12, £600, is paid in advance. The telephone cost belongs to this year, so it is accrued.

Account	Dr £	Cr £
Prepayments	600
Rent		600
(Rent prepaid for January to March)
Telephone	150
Accruals		150
(December telephone accrued)

Practice questions

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