Guide to Prepayments in Accounting

What are Accruals and Prepayments ?

Accruals and Prepayments are adjustments which Accountants make to the bookkeeping records so that accounting reports make more sense and be more meaningful, particularly for good decision making.

Accruals and Prepayments are used in Management Accounts and Year End Accounts.

Accruals and Prepayments are therefore used to fill a gap in Accounts to help the reader more accurately understand the performance of the business.

Without the proper use of Accruals and Prepayments, Accounts will not conform to the required standards for publication and tax purposes.

Accruals and Prepayments are normally processed through the accounting records by Journals.

Please see our Accruals page for a more details of accruals.

Prepayments

A Prepayment is an adjustment to the Accounts when a significantly large cost or expense is incurred in advance, or partly in advance, of the period to which it relates.

Here are some examples of Prepayments, ie. bills which can be spread over a future period of time:

• Rent
• Insurance
• Advertising
• Subscriptions

Accountants usually try and 'smooth' these expenses over all the relevant months covered by the bill. The Accounts make more sense this way.

For example, if the year end is 31st December, and the annual insurance bill for £400 is dated 1st April. Therefore the last 3 months of the insurance cover is next year, January to March.

These types of adjustment are done by accountants, the year end Journal is:

Debit    Prepayments     £100  Balance Sheet - Liabilities
Credit   Insurance         £100  Profit and Loss Account - Expenses

The next year the insurance bill is entered dated 1st April of the next year, so the next year will not have an insurance cost for January to March. Therefore a prepayment reversal is required in the second year which will create the January to March costs. The journal is:

Debit    Insurance          £100  Profit and Loss Account - Expenses
Credit   Prepayments     £100  Balance Sheet - Liabilities