Principles of Accounting: Introduction to Prepayments and Accruals

• It has been stated in another topic that financial statements are prepared using the matching concept
• The concept states that when calculating profit:
• Revenue must be matched with expenditure incurred in generating that revenue
• In a simple and very small business most if not all transactions are in the form of cash/bank transactions
• The resultant effect is that at the end of the accounting period all expenses are paid up and all revenue would have been received
• This results in a simple Income Statement as shown here and another here
• Most businesses however have transactions that involve prepayments and accruals
• Given that transactions shown in the income statements can be grouped as either income or expenses
• This results in four types of transactions that have to be accounted for both in the books and
• In the financial statements
• These are:
  • Prepaid expenses
  • Prepaid income
  • Accrued income
  • Accrued expenses
• Prepayment- is when an amount is paid in advance to the period for which it relate
• For example when rent is paid for the next period/month
• Accrual-is when an amount is still owed at the end of the trading period i.e. it has not yet been paid
• For example rent is usually paid on an accrual basis i.e. rent is paid after the period/month to which it relates has lapsed
• Accruals are also known as amounts owing

To learn more about the treatment and adjustments required for each of the above click on the relative item

To access more topics go to the Principles of Accounts Notes.