Introduction to Prepayments and Accruals

Prepayments

Prepayments are the payments you make before you get the advantages from them. For instance, rental is a prepayment as it typically has to be settled in advance.

Accruals

Accruals are costs that you have incurred, but you have not paid. For instance, an unpaid water bill is an accrual expenditure, since the water has been used up (you have incurred the cost), but the bill is not settled.

Ways to Manage a Prepaid Expenditure In An Account

A debtor of a business is the individual to whom a settlement has been made ahead of time. When doing bookkeeping, you have to state the debtor on the expenditure account by carrying down a debit balance (Also see Debits and Credits).

For instance, Clement rents a factory at a rate of RM20,000 per year. The rent is payable in advance on 1 January, April, July and October. In 2018, Clement settled the rent on each of these days. However, he paid the rental payment due on the first day of 2019 on 31 December 2018. So, on 31 December 2018, the landlord is a debtor for the prepayments Clement has made (Also see Tips on How to Sort Out Your Chaotic Finances).

Note

– In 2018, the total amount of rental payment was RM25,000, but Clement will only debit the rental fee for one year only in the Profit and Loss Account.

– The landlord who acts as the debtor is shown on the account by the debit balance.

– In the Balance Sheet, the debit balance will be recorded under current assets as a prepayment. This is to differentiate it from trade debtors.

Ways to Manage an Accrued Expenditure in an Account

An accrued expenditure is an amount which you owe to someone else. This indicates that the person is an account payable (Also see How Does Accounts Payable and Accounts Receivable Differ?). You have to state that creditor in the expenditure account by carrying down a credit balance on the account.

For instance, the accounting year of a company finished on 31 December 2018. In the first 11 months, that is until 30 November 2018, the total amount of payment for electricity is RM1,400. On 31 December 2018, there was an electricity bill that you have not paid costs you RM120. In this case, you have to carry down the amount as a credit balance on the account.

Notes:

– You have only paid RM1,400, but you will debit the full cost for electricity for the whole year, which is RM1,520, in the Profit and Loss Account.

– On the account, you will generate a creditor for the unpaid amount for electricity by a credit balance carried down.

– You can see the creditor being displayed in the Balance Sheet under current liabilities as an ‘expense creditor’ or an ‘accrued expense’ so that you can differentiate it from ‘trade creditors’.

Ways to Adjust Income for Prepayments and Accruals

You may have to adjust several income accounts, for example, interest receivables or rental, for the income you obtain before or after the payment is due. Income received ahead of time shows that a creditor exists. This also means that you need a credit balance that has the same amount as the prepayment and you have to carry down the amount on the account using double entry system.  Income obtained after its due date shows that you have a debtor. This indicates that you need a debit balance that is equal to the amount and you have to carry it down in the account.

If you are not familiar with accounting-related tasks, adjusting your earnings for prepayments and accruals could be a bit complicated. To keep an eye on your finances, look for an accounting firm in Johor Bahru to assist you.