Accruals and Prepayments Explanation
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At the end of an accounting period, payments owing by us and owing to us are often outstanding. As far as debtors and creditors are concerned, this is normal.  Expenses and additional revenues are different in that they concern the profit and loss account and balance sheet, rather than just the balance sheet.  This is where accruals and prepayments come in.  Accruals and prepayments allow expenses and sales to be recognised in the period they are incurred or earned, rather than when cash changes hand, and includes them in financial statements in the related accounting period.  


Accruals
An accrual refers to something that is owing at the end of a financial period i.e. expenses which have been incurred in the period but will be invoiced after the period end.  Distinguish this from a creditor, which has been invoiced within the period, but remains unpaid at the period end date.  Accruals allow you to include the cost of the expense in the accounts for the period in which it was incurred, regardless of the period in which it is paid. 

For example, accruals can be used where a telephone bill will be received one month after the year-end, but charges on it relate to the previous three months. Here, you would accrue for 2/3 of the total to brings this portion of the bill into the current year, making your overheads accurate.  The accrued cost may need to be estimated, based on the bills received in previous quarters.

Accruals are included in the balance sheet as a liability.  The double-entry posting for an accrual journal is:

            Expenses/Overheads                      Debit
            Accrual Control Account                 Credit

These journals need reversed after the period end.  The Power-Gx Accrual Journals program automatically posts the credit entry to the Accrual Control Account for every expense transaction you enter.  It also reverses the accrual journals automatically after the nominal period end.  See below for an example of the effect of accrual journals. 

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Prepayments
Prepayments are the opposite of accruals.  They are used where money is paid in advance of the period to which it pertains i.e. where an invoice has been received before the period-end which relates in whole or in part to the next period.  Prepayments allow you to include the costs in the correct accounting period, regardless of the period in which it is actually paid.

An example of when to use a prepayment journal is for rates that are paid six monthly, due one month before the year-end.  5/6 of the total bill relates to the next financial year so a prepayment should be set up for 5/6 of that bill to defer it until the next period.   

Prepayments are included on the balance sheet, as an asset.  The double-entry posting for each prepayment is:
            
            Expenses/Overheads                      Credit
            Prepayments Control Account       Debit

These journals need to be reversed after the period end.  The Power-Gx Prepayment Journals program automatically posts the debit entry to the Prepayment Control Account for every expense transaction you enter.  It also reverses the prepayment journals automatically after the nominal period end. See below for an example of the effect of prepayment journals. 

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Posting the Invoice
When the invoice is received, you should post it to the purchase ledger as normal, into the financial period the invoice is actually received.  The accrual or prepayment journals will alter the month to date and year to date balances for the expense so that accurate figures show for each month that the expense relates to, as well as the month it is actually posted to.  This is illustrated in the following examples.

Example Accrual Journal: an invoice for £100 will be received in month 2 but relates to charges incurred in month 1 and month 2.  Half the invoice value should therefore be accrued in month 1.  The postings to the expense account would be: 

  
Period
Action
Debit
Credit
MTD
YTD
Month 1
1. Post accrual journal for ½ the invoice
50
 
50
50
Month 2
1. System reverses the accrual journal
2.  Post the invoice

100
50

50

100

The MTD balances accurately show £50 incurred each month for this expense, and the YTD figure correctly shows the amount actually invoiced to this expense. 

Example Prepayment Journal: a £600 invoice covering charges for the next 6 months is due in month 12.  Prepayment journals should be posted for 5/6 of the invoice to show this proportion of the charge relates to the new financial year.  The postings to the expense account would be: 

  
Period
Action
Debit
Credit
MTD
YTD
Year 1
Month 12
1. Post the invoice
2. Post prepayment for 5/6 of the invoice
600

500

100

100
Year 2
Month 1
1. Year End Process clears P&L YTD balances
2. System reverses the prepayment journal

500
 

500
0
500

The YTD balances accurately show that £100 of the invoice relates to Year 1 and £500 relates to charges incurred in Year 2.

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