Recap: Accruals and prepayments

The adjustment adds the cost to the expense account and records what is owed.

• Debit the expense account: the cost for the year goes up
• Credit Accrued expenses: a liability, because the business owes this money

Accrued expenses is shown under current liabilities in the statement of financial position.

A prepaid expense is a cost paid before the year end that will be used after it. It is taken out of this year's expense and carried forward.

The joinery's insurance account shows £3,760 paid in the year. Of that, £2,400 was paid on 1 September for a new policy that runs for 12 months, to 31 August.

The months from 1 January to 31 August have been paid for, but the cover has not yet been used.

Beckside Joinery makes fitted furniture. Its accounting year ends on 31 December.

The accruals idea is this: income and costs go into the year they are earned or used. The date the money moves does not decide it.

Accrued expense

a cost used this year that has not been paid or billed by the year end

Prepaid expense

a cost paid this year that will be used next year

Both are put right with a year-end adjustment, so that profit is measured on twelve months of costs, no more and no less.

A prepaid expense is a cost paid before the year end that will be used after it. It is taken out of this year's expense and carried forward.

The joinery's insurance account shows £3,760 paid in the year. Of that, £2,400 was paid on 1 September for a new policy that runs for 12 months, to 31 August.

The months from 1 January to 31 August have been paid for, but the cover has not yet been used.

The accruals idea works for income too. Income goes into the year it is earned.

The joinery lets a corner of its workshop to Dunmore Upholstery for £250 a month. Dunmore pays every three months, after the quarter ends. Its next payment, on 31 January, covers November, December and January.

At 31 December the rent for November and December has been earned but not received. That is accrued income, and it is shown under current assets.

• Debit Accrued income: an asset, because Dunmore owes this money
• Credit Rental income: the income for the year goes up

Beckside Joinery makes fitted furniture. Its accounting year ends on 31 December.

The accruals idea is this: income and costs go into the year they are earned or used. The date the money moves does not decide it.

Accrued expense

a cost used this year that has not been paid or billed by the year end

Prepaid expense

a cost paid this year that will be used next year

Both are put right with a year-end adjustment, so that profit is measured on twelve months of costs, no more and no less.