Accruals and prepayments
Also known as: accrued and prepaid expenses, accruals and deferrals
Accruals and prepayments are period-end adjustments that match income and expenses to the period they relate to. An accrual records an expense incurred but not yet paid, while a prepayment records a payment made for a future period's expense.
Accruals and prepayments are the adjustments accountants make so that financial statements reflect the matching (accruals) concept: income and expenses are recognized in the period they are earned or incurred, not the period cash happens to change hands.
An accrual arises when an expense has been incurred but not yet paid or invoiced by the period end. If a company's year ends December 31 and it has used electricity in November and December that won't be billed until January, it accrues the estimated cost — recording an expense in the income statement and a liability (accrued expense) on the statement of financial position. A prepayment is the mirror image: cash paid in advance for a benefit that belongs to a future period. If the company pays $12,000 of annual rent on October 1, only three months ($3,000) belong to the current year; the remaining $9,000 is carried as a prepayment, a current asset.
The same logic applies to income. Accrued income is income earned but not yet received, recognized as an asset, while income received in advance (deferred income) is a liability until it is earned. Getting these adjustments right directly affects reported profit: omitting an accrual overstates profit, while omitting a prepayment understates it.
Accruals and prepayments are a core topic on the ACCA Financial Accounting (FA) exam, which tests the underlying concept, the double entries, and profit calculations when payments span two accounting periods.
Key takeaways
- Accruals and prepayments apply the matching concept, tying income and expenses to the period they relate to rather than when cash moves.
- An accrual is an expense incurred but not yet paid — an expense in the income statement and a liability on the statement of financial position.
- A prepayment is cash paid for a future period's expense and is carried as a current asset until it is used up.
- Omitting an accrual overstates profit; omitting a prepayment understates it.
- The ACCA FA exam tests the double entries and profit effects of accruals and prepayments that straddle period ends.