Last reviewed: July 2026.
Accruals and prepayments allocate income and expenses to the period in which economic activity occurs rather than simply following cash receipts and payments. These adjustments are essential for meaningful profit measurement and complete statements of financial position.
Accrual accounting principle
Under accrual accounting, expenses are recognised when resources are consumed and income is recognised according to the applicable revenue requirements, not merely when cash moves. The reporting period therefore includes unpaid expenses relating to the period and excludes payments that relate to future periods.
The same logic applies to income: accrued income is earned but not yet received, while income received in advance relates to future performance and is normally a liability until earned.
Expense accruals
An expense accrual records a cost incurred before the supplier invoice or cash payment is processed. Common examples include utilities, wages, interest and professional fees. The adjusting entry debits the expense and credits an accrual or payable.
| Account | Debit | Credit |
|---|---|---|
| Utilities expense | $3,800 | |
| Accrued expenses | $3,800 |
The expense enters profit or loss and the liability appears in the statement of financial position.
Expense prepayments
A prepayment arises when cash is paid before the related benefit is consumed. The future portion is an asset. If annual insurance of $12,000 is paid on 1 October and the year-end is 31 December, three months or $3,000 is expense and nine months or $9,000 is a prepayment.
| Account | Debit | Credit |
|---|---|---|
| Prepayments | $9,000 | |
| Insurance expense | $9,000 |
This entry assumes the full payment was initially recorded as expense. Alternative posting methods lead to the same final balances.
Accrued and deferred income
Accrued income is recognised when the entity has earned income but has not yet billed or received it, subject to the applicable recognition requirements. The entry debits an accrued-income asset and credits income. Cash received in advance is normally credited to a contract liability or deferred-income account and recognised as performance occurs.
Avoid treating every receivable as accrued income. A trade receivable may arise after billing, while accrued income may exist before invoicing. The exact presentation depends on the underlying contract and reporting framework.
Calculating the adjustment
Start with the period covered by the payment or invoice. Determine the portion relating to the current reporting period and the portion belonging to future or prior periods. Use service dates, contracts, meter readings, payroll records and interest schedules rather than dividing by twelve automatically.
For uneven services, time apportionment may not reflect consumption. A maintenance contract concentrated in one season or a volume-based utility charge should use the best available estimate of activity.
Ledger and reversing entries
Some entities reverse routine accruals on the first day of the next period. When the supplier invoice is later posted, the reversal prevents double counting. Reversals are a processing technique, not a substitute for validating the original estimate and reconciling the final invoice.
Prepayments are often released monthly through recurring journals. The schedule should show opening balance, additions, expense releases, reclassifications and closing balance by contract.
Worked year-end example
| Item | Cash/ledger before adjustment | Correct period amount | Adjustment |
|---|---|---|---|
| Wages paid | $136,000 | $139,800 | Accrue $3,800 |
| Insurance paid | $4,000 | $3,400 | Prepay $600 |
| Rent received | $18,000 | $15,000 | Defer $3,000 |
The adjustments change both profit or loss and the statement of financial position. Wages increase expense and liabilities; the insurance prepayment reduces expense and creates an asset; deferred rent reduces income and creates a liability.
Estimation and subsequent review
Accruals often rely on estimates because the final invoice is unavailable. Use current rates, prior usage, purchase orders, timesheets or supplier confirmation. When the invoice arrives, compare it with the accrual, clear the balance and analyse significant differences.
Repeated under-accruals may indicate management bias or weak closing procedures. A retrospective accuracy report helps improve methods and highlights unusual estimates.
Controls and common errors
- Omitting expenses because invoices arrived after year-end.
- Leaving old accruals or prepayments unreconciled.
- Using invoice date instead of service period.
- Recording the full cash payment as current expense.
- Reversing an accrual and then failing to post the invoice.
- Netting unrelated accrued income and accrued expenses.
Maintain contract-level schedules, approval evidence and a period-end checklist. Reconcile schedule totals to the general ledger every month.
Related accounting guides
Authoritative references
Practical takeaway
A good accrual or prepayment is tied to a contract, service period and supportable calculation. Record both sides of the adjustment, reconcile the schedule to the ledger, reverse or release it systematically and compare estimates with final invoices so the process improves over time.
Implementation note
Build an adjustment schedule that lists the supplier or customer, service period, gross amount, amount recognised to date, balance carried forward and reversal date. Reconcile the schedule to contracts, invoices, payroll records and subsequent cash payments. Review recurring accruals for stale estimates and confirm that prepayments still provide future economic benefits. Automating reversals can reduce errors, but the underlying estimate must still be reassessed. Clear descriptions and supporting documents make the next period’s reversal and settlement easier to verify. Reviewer sign-off should confirm the account, amount, period and reversal logic before the close is approved.