Accruals and prepayments, explained

Accruals and prepayments are the two adjustments that separate real accrual accounting from just watching the bank account. They exist to answer one question honestly: which period does this actually belong to? Get them right and your monthly numbers reflect performance, not the accident of when money moved.

Accruals: recognise it before the cash

An accrual records an expense you’ve incurred (or income you’ve earned) before the cash changes hands. You used electricity in March but the bill arrives in April — accrual accounting puts that expense in March, when you actually consumed it, by recording a liability (accrued expenses) for the amount owed. Same on the income side: work delivered in March but invoiced in April is earned in March.

Prepayments: defer it past the cash

A prepayment is the mirror image — cash paid before the expense belongs to a period. Pay a year’s insurance up front and it’s not all a January expense; it’s an asset (prepaid insurance) that you amortise one month at a time as the coverage is used. Each month, a slice moves from the asset to expense.

Why they matter

Without these adjustments, a big prepayment makes one month look terrible and eleven look great, and an unbilled cost makes a month look better than it was. Accruals and prepayments match revenue and costs to the period that produced them — the heart of accrual-basis accounting.

Where they live in practice

Posting recurring accruals and amortising prepayments is a standing step in the month-end close — the routine entries that keep each period honest.