Accruals And Prepayments
Peter Marshall Bsc (Econ) BA MBIM is a Fellow of the Society of Business Teachers, and an experienced educator in business subjects. He is also a prolific author and his books have been translated and sold worldwide. He lives in London, UK.
Adjustments to accounts
Accruals and prepayments are adjustments we need to make to the accounts at the end of the year (or other management accounting period).
- Accruals are sometimes called accrued expenses, expense creditors or expenses owing. Accruals are a liability for expenses for goods or services already consumed, but not yet billed (invoiced).
- Prepayments are an asset of goods or services already paid for, but not yet completely used. Prepayments are, therefore, in a sense the opposite of accruals.
Example of accrued expenses
Suppose we are drawing up accounts for the year ended 31 March. We know there will be an electricity bill for the three months ended 30 April, a month after the end of our financial year. By 31 March, even though we haven’t had the bill, we would already have used two months’ worth of it, but as things stand the cost of this won’t appear in our accounts because it is too soon to have received a source document (i.e. the invoice) from which to enter it. Still, electricity clearly was an expense during the period, so we have to ‘accrue’ a sensible proportion. For example:
Wages and rent
Other items that often have to be accrued are wages and rent. The firm receives the benefit of work, and of premises, before it pays out wages and rent (assuming rents are payable in arrears; if rent is payable in advance we would need to treat it as a prepayment).
The balance c/d will be a debit one, but the ultimate effect on the expense account (the balance b/d) will be a credit entry.
The balance c/d will be a credit one, but the ultimate effect on the expense account (the balance b/d) will be a debit entry.
Example of prepayment
A prepayment arises, for example, where an insurance premium or professional subscription is paid annually in advance but only one or two month’s benefit has been used by the end of the year. We must adjust the figures so that we don’t charge the whole amount against profits for the year. Clearly, much of the benefit remains as an asset for use in the next year. Example, again assuming that our accounting period ends on 31 March:
Carrying down accruals and prepayments
When these amounts have been calculated or assessed, you place them in the relevant ledger accounts as ‘carried down’ balances. In this way you increase or decrease the amount to be transferred to the profit and loss account for the year, depending on which side the posting is made. The resulting ‘b/d’ balances are listed in the balance sheet just like any other balance remaining on the nominal ledger at the end of the year. If they are credit balances (accruals) they are current liabilities. If they are debit balances (prepayments) they are assets.