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.
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:
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.
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:
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
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
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
1. Post accrual journal for ½ the invoice
1. System reverses the accrual journal
2. Post the invoice
The MTD balances accurately show £50 incurred each month for this
expense, and the YTD figure correctly shows the amount actually invoiced to
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:
1. Post the invoice
2. Post prepayment for 5/6 of the invoice
1. Year End Process clears P&L YTD balances
2. System reverses the prepayment journal
The YTD balances accurately show that £100 of the invoice relates to Year 1
and £500 relates to charges incurred in Year 2.