Recording Accruals and Prepayments
How to record accruals and prepayments in UK bookkeeping, with worked journal entries, balance sheet treatment and practical examples for common business expenses.
Accruals and prepayments are adjusting entries made to ensure that income and expenses are recorded in the accounting period to which they relate, regardless of when cash changes hands. They are fundamental to the accrual accounting method required by all UK limited companies and are among the most common year-end bookkeeping adjustments.
Without these adjustments, the income statement would only reflect cash received and paid, which can significantly misstate the true profit or loss of a period.
Accruals explained
An accrual recognises an expense that has been incurred but not yet invoiced or paid by the end of the accounting period. The business has received the benefit (used the electricity, received the service, occupied the premises) but has not yet received a bill or made a payment.
Why accruals are needed
If a business has a December year end and receives its quarterly electricity bill in January covering October to December, the electricity cost relates to the current year. Without an accrual, the expense would not appear until the following year when the bill arrives, understating expenses in the current year and overstating them in the next.
How to record an accrual
The journal entry at the year end:
| Account | Debit | Credit |
|---|---|---|
| Expense account (e.g. electricity) | £X | |
| Accruals (current liability) | £X |
The expense is charged to the income statement in the correct period. The accrual appears on the balance sheet as a current liability – it represents an amount the business owes but has not yet been invoiced for.
Reversing the accrual
At the start of the next period, the accrual is reversed:
| Account | Debit | Credit |
|---|---|---|
| Accruals (current liability) | £X | |
| Expense account | £X |
When the actual invoice arrives and is recorded, the expense for the new period is correctly stated because the reversal has offset the portion already recognised.
Practical accrual examples
Utility bills
A company with a 31 March year end receives quarterly gas bills. The last bill covered January to March but arrives in April.
Estimated gas cost for January-March: £1,800
Year-end journal:
| Account | Debit | Credit |
|---|---|---|
| Gas expense | £1,800 | |
| Accruals | £1,800 |
Audit fees
The audit of the 31 December 2025 accounts will not take place until March 2026, but the cost relates to the 2025 year end.
Estimated audit fee: £6,000
| Account | Debit | Credit |
|---|---|---|
| Audit fee expense | £6,000 | |
| Accruals | £6,000 |
Prepayments explained
A prepayment arises when a business pays for a service or expense in advance of the period to which it relates. The cash has left the bank, but the benefit has not yet been fully consumed.
Why prepayments are needed
If a business pays £12,000 for annual insurance cover starting 1 October and has a 31 December year end, only three months of the insurance (£3,000) relates to the current year. The remaining nine months (£9,000) is a prepayment that belongs to the next year.
How to record a prepayment
When the payment is initially made, the full amount is recorded as an expense:
| Account | Debit | Credit |
|---|---|---|
| Insurance expense | £12,000 | |
| Bank | £12,000 |
At the year end, the unexpired portion is moved from the expense to the balance sheet:
| Account | Debit | Credit |
|---|---|---|
| Prepayments (current asset) | £9,000 | |
| Insurance expense | £9,000 |
The income statement now shows only £3,000 of insurance expense (the amount relating to the current period). The £9,000 prepayment sits on the balance sheet as a current asset.
Reversing the prepayment
At the start of the next period, the prepayment is reversed:
| Account | Debit | Credit |
|---|---|---|
| Insurance expense | £9,000 | |
| Prepayments (current asset) | £9,000 |
The expense is then recognised in the period to which it relates.
Practical prepayment examples
Rent paid in advance
A business pays quarterly rent of £6,000 on 1 December, covering December to February. At the 31 December year end, two months (£4,000) are prepaid.
| Account | Debit | Credit |
|---|---|---|
| Prepayments | £4,000 | |
| Rent expense | £4,000 |
Balance sheet presentation
| Item | Balance sheet classification | Balance sheet position |
|---|---|---|
| Accruals | Current liability | Creditors: amounts falling due within one year |
| Prepayments | Current asset | Debtors |
| Accrued income | Current asset | Debtors |
| Deferred income | Current liability | Creditors: amounts falling due within one year |
Estimating accruals
Accruals often require estimation because the exact amount may not be known at the year end. Common approaches include:
- Using the prior year invoice as a guide, adjusted for known changes (e.g. price increases)
- Taking the daily or monthly rate from the most recent invoice and extrapolating
- Obtaining a quote or estimate from the supplier
- Using contractual terms (e.g. interest rates, service level agreements)
The estimate should be the best estimate available at the time the accounts are prepared. When the actual invoice arrives, any difference between the accrual and the actual amount is recognised in the next period.
Common mistakes
Forgetting to reverse accruals and prepayments
If the opening balances are not reversed at the start of the new period, expenses will be double-counted (for accruals) or understated (for prepayments). Most accounting software can automate reversals.
Accruing immaterial amounts
Not every small unpaid bill needs to be accrued. Apply the concept of materiality – if the amount would not influence a user’s decision, accruing it adds effort without improving the accounts. Many businesses set a minimum threshold below which accruals are not made.
Inconsistent treatment between periods
If a business accrues for certain expenses in one year but not the next, the year-on-year comparison is distorted. The consistency concept requires that the same approach is applied each year.
Incorrect period allocation
The calculation must accurately reflect the portion of the expense relating to each period. A common error is allocating based on calendar months when the service period does not align with month boundaries.