Accruals and prepayments with worked journals

The rule behind them

FRS 102 requires an entity to prepare its financial statements, except for cash flow information, using the accrual basis, under which the effects of transactions are recognised when they occur and reported in the periods to which they relate (FRS 102, paragraph 2.48 and Glossary). A company's taxable trading profit is calculated under generally accepted accounting practice, so the same adjustments flow into the tax computation (Corporation Tax Act 2009 s46).

ACCA puts it plainly: the profit and loss account must include the expenses relating to the period, whether or not they have been paid (ACCA: adjustments to financial statements).

The four adjustments

Adjustment	What it is	Period-end journal
Accrual	A cost of the period not yet invoiced or paid	Debit the expense, credit accruals
Prepayment	A cost paid in this period that relates to the next	Debit prepayments, credit the expense
Accrued income	Income earned in the period not yet invoiced	Debit accrued income, credit sales
Deferred income	Income invoiced or received in advance of the work	Debit sales, credit deferred income

An accrual, worked

For example, a company with a 31 March year end uses electricity every month but the quarterly bill for January to March arrives on 20 April for £900. At 31 March nothing has been posted for those three months. The journal at 31 March debits electricity £900 and credits accruals £900. The profit and loss account now carries the cost, and the balance sheet shows the liability within creditors (ACCA).

On 1 April the accrual is reversed: debit accruals £900, credit electricity £900. When the bill is posted in April it debits electricity £900, and the two April entries cancel. The cost appears once, in March.

A prepayment, worked

For example, the same company pays its annual insurance of £2,400 on 1 January for the calendar year. At 31 March, three months have been used and nine months, £1,800, relate to the next financial year. The journal at 31 March debits prepayments £1,800 and credits insurance £1,800, leaving £600 as this year's cost (ACCA).

A prepayment covering many months can be reversed in full on 1 April, so the next year carries the whole £1,800, or released at £200 a month to give accurate monthly management accounts.

Where accruals and prepayments come from

Supplier invoices dated after the period end for goods or services received before it.
Utilities, phone and fuel cards billed in arrears.
Rent, rates, insurance, software subscriptions and memberships paid in advance.
Accountancy and audit fees for the year, billed after the year end.
Wages, overtime, bonuses and employer's National Insurance earned in the period and paid later.
Interest on loans charged after the period end.
Work done for customers and not yet invoiced, and deposits received for work not yet done.

Presentation in the accounts

In balance sheet Format 1 of the Companies Act regulations, prepayments and accrued income and accruals and deferred income each have a lettered heading of their own, and may instead be shown within debtors and creditors (SI 2008/409 Schedule 1 Part 1). Where they are included in debtors and creditors, the notes give the analysis.

Questions

Does a sole trader on the cash basis post accruals?

No. On the cash basis income and expenses are recorded when money is received or paid (GOV.UK: cash basis). A business moving onto the cash basis makes transitional adjustments for the accruals and prepayments in its last accruals-basis accounts, so nothing is taxed or deducted twice (HMRC BIM72066). See cash basis and accruals basis.

Is there a size limit below which accruals can be ignored?

No rule sets one. The accounts must give a true and fair view, which in practice means small, recurring amounts that are similar every year can be left out. The practice's own working papers should record the level it uses.

How is VAT treated on an accrual?

The accrual is posted net of VAT. VAT is reclaimed on the return for the period in which the valid VAT invoice is held, so the VAT is recorded when the invoice is posted.

In Accountin

In Accountin an accrual or prepayment is posted as a reversing journal, which posts its own reversal dated the first of the next month with the debits and credits swapped.