Financial Accounting

The concept of accruals and prepayments

Accruals and prepayments lie at the heart of the double-entry bookkeeping system and modern financial accounting. The accruals concept is often used to refer to both accruals (outstanding or unpaid expenses) and prepayments (payments in advance).

You may remember that earlier in this part we discussed some of the accounting concepts and, in particular, we stressed the importance of the accruals concept where the accruals concept refers to the process of matching revenue and expenses of the same accounting period.

A business will prepare its accounts for a defined period of time, typically at least every year and accountants spend considerable time at the
end of each financial year ensuring that the
final accounts include only those amounts that relate to a specific financial year.

Suppose that you are preparing the profit and loss account for the year ended 31 December 2019. You should include only revenue and expenses that relate to 2019 and not include any revenue or expenses relating to matters which should properly be accounted for in 2018 or 2020.

A business which has a year-end of 31 December 2019 should include in the profit and loss account only those amounts that relate to the
period between 1 January and 31 December 2019. Therefore, if you are preparing the final accounts for the business, you should
not include any expenses that were incurred or relate to any time before 1 January 2019 or after 31 December 2019.

Likewise, if an expense, such as the rent of an office, was paid 12 months in advance on the 1 October 2019, then only three months of
the rent expense (1 October 2019 to 31 December 2019) will be relevant for inclusion in the profit and loss account for the year ending
31 December 2019.

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