Accruals and prepayments explain why an accounts report can show a different expense from the amount paid through the bank. They help put costs into the period they relate to, rather than making performance depend entirely on when a supplier sends a bill or collects payment.
In this article
- Identify the service period
- Check the payment date
- Allocate to the correct period
- Review the adjustment next month
Under accrual accounting, a bank transaction is evidence of cash movement, but not the whole accounting story. FRS 102 sets out the accrual basis in paragraph 2.48. The examples below describe simple expense adjustments; recognition still depends on the relevant facts and framework.
An accrual: cost incurred, bill or payment later
An expense accrual records a cost relating to the period when the supplier bill has not yet been recorded. The accounts show both the expense and an amount owed. It does not create a bank payment.
Illustrative example: a business has received electricity during March, but the bill will arrive in April. A supported estimate of the March charge is £300, ignoring VAT. A £300 March expense and £300 accrued liability allow the March report to include the electricity used.
The estimate should have a basis: meter readings, tariff information or recent bills adjusted for known usage changes. “Same as last month” may be a starting point, but it needs review if production doubled or the price changed.
When the actual bill arrives, connect it to the accrual. If it is £320 for the same service period, replace or clear the £300 estimate through the agreed procedure and account for the £20 difference appropriately. Do not leave both £300 and £320 as separate charges for the same electricity.
A prepayment: cash paid, benefit still to come
A prepayment represents a payment for a benefit that relates partly or wholly to a future period. The unexpired portion is recorded as an asset and released as an expense over the relevant coverage period.
Illustrative example: a business pays £1,200 for insurance covering 1 January to 31 December. Assuming an even monthly allocation is appropriate, the expense is £100 per month. At 31 March, £300 has been recognised and £900 remains prepaid.
| At 31 March | Amount |
|---|---|
| Cash paid for annual policy | £1,200 |
| January–March expense | £300 |
| Remaining prepayment | £900 |
The bank has fallen by £1,200, but the three-month profit report includes £300 of insurance cost. The £900 balance explains the difference; it is not cash that can be withdrawn.
Not every upfront payment is a prepayment. An equipment purchase, refundable deposit and advance for services require different questions. Read the contract and describe what the payment actually buys.
Build schedules that can be checked
For accruals, list the supplier, service, period covered, estimation method, amount and expected bill date. Assign a reviewer and retain evidence. Separate a known amount from an estimate so uncertainty is visible.
For prepayments, list the invoice, total cost, coverage start and end dates, allocation method, expense released and remaining balance. Keep the schedule linked to the ledger account and original invoice.
Review both monthly. Old accruals that never receive a bill and prepayments that remain unchanged after coverage ends are warning signs. A schedule should roll forward: opening balance, additions, releases or clearances and closing balance.
Avoid common double counts
Agree whether accruals reverse automatically in the next period or are cleared when invoices arrive. Either process needs controls. If one person reverses the journal and another separately clears the same accrual, the adjustment may happen twice.
For prepayments, ensure the original invoice and monthly release are not both expensed in full. Check that recurring software rules stop at the correct date and adjust when a policy is cancelled or refunded.
If the actual bill differs substantially from the estimate, investigate the reason. It may reveal an incorrect period, missed service or supplier dispute rather than ordinary estimation error. Raise material differences with the accountant, especially where earlier accounts have been approved.
Use the adjusted reports sensibly
Accruals and prepayments make monthly comparisons more useful. Without them, the month containing an annual insurance payment can look artificially weak, while later months look too strong. They also help explain why profit and bank movements differ.
Your cash forecast still needs actual payment dates and full cash amounts. The illustrative insurance expense of £100 does not mean the annual £1,200 bill can be paid in monthly instalments.
Tax treatment can follow a different method or require separate adjustments. Do not assume these examples apply to every sole trader’s tax calculation. For help preparing meaningful period reports, discuss EPOS financial accounts or management accounts, with the accounting basis made clear.