What is an accrual or prepayment?

These are options that allow your accounts to be adjusted for any payments already made in advance of a future period (prepayments) or allowance of payments to be paid in arrears (accruals) in one accounting period which relate to future or past periods.

They are used to stop distortion of the profit and loss account in the months that these payments are already made / due. Often critical if you want a true like for like comparison.

Not all businesses use accruals and prepayments, but you may wish to consider for your own business to enable you to better compare periods on a like for like basis.

Accruals are used when the business incurs an expense in a period for which invoices have not been received at the end of an accounting period (eg month).

These outstanding amounts are not strictly creditors because invoices have not been received. However, in order to for the accounts to be consistent these costs need to be included on the P & L for the period.

Similarly if you get billed quarterly in arrears (eg your phone bill, accountancy costs)  then you need to account for the current usage even though the bill has not arrived. 

The accrual is then released as the invoice is received to contra out the expense at that time.

Prepayments are used when a company may pay for goods or services before they have been received. If you buy a years supply of something in one go, for example paying in advance the annual insurance premium, then the profit for that period will be reduced unfairly as the years supply should be spread evenly of the coming twelve months. Any amounts that have been paid for goods and services not received in total by the end of an accounting period are shown in the balance sheet as prepayments. These amounts will then not be shown in full as costs in the P & L.

This also applies to quarterly arrangements such as rent or maintenance payments where the cost should be spread over three months.

The prepayment is then released across the period (eg on a monthly basis) to accurately show when the goods or service have been used.

Before you start though you need to consider if this is something that needs to be taken into account. You need to make your own judgement dependant on the amount, the degree of accuracy you want and the cost of time in making the adjustments. For example a £500 quarterly phone bill may not be a material amount if your overheads are £100,000 per month, but could be if overheads were £5000 per month. 

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