Practical Bookkeeping Tips for Monthly Accruals and Prepayments
Just saying the terms accruals and prepayments can strike fear into the hearts of even the most confident of bookkeepers, but these processes are really quite simple.
You make a prepayment when you receive an invoice for something that your business will benefit from for the full year but that needs to be paid for upfront.
Examples include insurance and annual subscriptions. You don’t want the accounts to suffer the full cost of an annual invoice in one month, because it would understate profits for that month and potentially make them look a lot worse than they really are. Instead, you create a prepayment for the full value of the invoice and then release the prepayment on a monthly basis, until it has been used up.
If that sounds difficult, don’t worry; you can see an example!
Suppose that you pay your domain hosting fee upfront for the full year as it’s more cost-effective than paying on a monthly basis. You receive a bill for £120, which covers hosting for the full year. In order to smooth the costs through the accounts, here’s what you do.
Firstly, you post the whole value of the invoice (net of VAT) to your prepayments nominal code. Assuming you use a computerised system, the double entry that takes place (automatically) is as follows:
|Credit||Creditor’s control account||£120|
Then, assuming you don’t have an automatic prepayments function within your accounts, you create the following manual month-end journal:
|Debit||Domain hosting fees (£120/12)||£10|
You should carry out this same journal every month for the next 12 months, which will reduce the balance of that prepayment to zero while charging your profit and loss account with £10 each month.
You accrue a cost when the business has incurred an expense and the goods or service has been received, but an invoice has not yet been received.
For example, you review your invoices and notice that you still haven’t received an invoice for goods worth £250 that were delivered earlier in the month. You need to record the liability in your books because you now owe money to that supplier, despite the fact that they haven’t yet sent you an invoice.
You create a journal in your accounts as follows:
When you eventually receive the invoice, make sure you code it to accruals! If you don’t, and code it to materials purchased instead, you’ll double-count your costs but also still have a balance sitting in your balance sheet for £250 worth of accruals.
When you record the invoice to accruals, your computer accounting system will do the following double-entry bookkeeping for you:
|Credit||Creditor’s control account||£250|
The effect is that the accruals account will be reduced by the £250 that you originally posted to it, and your materials purchased account will correctly show the £250 charge for the goods that have been purchased.