Accruals and Prepayments

Accruals
are effectively a form of creditor and Prepayments a form of Debtor.

Accruals
are a way of accounting for an expense that has been incurred in the period
that we are reporting on, but not yet invoiced.

An
example of this would be you are doing bookkeeping for a client for the month
of April.

When
you work out his profit and loss you haven’t yet invoiced him for the work but
the work is relevant to the month of April, therefore needs showing as an
expense on the profit and loss account.

The T accounts we need are Bookkeeping Fees and Creditors-Accruals


In
order to post an accrual, you would Debit the expense and Credit Accruals which
is in the liabilities section on accounts so let’s post our transaction for a
£100 bookkeeping accrual.

The
accrual would increase the expense and, therefore, decrease the net profit of the
business. It would also increase the liabilities.

Prepayments
are for when the client has paid for something during the period being reported
on but not yet had full use of that cost and example would be on 1st
March he paid 12 months road tax (to run from 1st March to 28th February) when doing his accounts to 31st March he has only used 1
month out of 12 months paid for. 

The T accounts we need are:


the calculation used is:


Let’s assume he paid £240 for his road tax his
prepayment would be:

£240 divided by 12 (months paid for) and multiplied by 11 (unused months) which would
equal £220.

Now
let’s post our entries for the road tax prepayment


The
prepayment would be entered as a debit to Prepayments in Current Assets and
Credit to the appropriate expense account in this case Motor Expenses.

A
prepayment will decrease the expense in the profit and loss account and also increase
the net profit of the business. It would also increase the Current Assets.

It
has never ceased to amaze me in my years of being an accountant how few
bookkeepers and even accountants who don’t use accruals and prepayments for some
businesses it can make quite a difference to the profits of the business (just
imagine a delivery firm with 20 vans and paying for road tax and insurance in
advance the prepayment could be many thousands of pounds) clients use their
accounts for the calculation and payment of tax but also so they can see how
their business has performed it can be very misleading to find the bookkeeper
hasn’t entered the accruals or prepayments.

Without
entering accruals and prepayments, we simply are showing the amounts paid not
the actual amounts due.

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