Difference Between Accruals and Prepayments

Accruals vs Prepayments
 

Both accruals and prepayments are equally important in accounting, and therefore, clear understanding on the key difference between accruals and prepayments is important for an accountant to ensure that they are accurately recorded. Accruals and prepayments are known as adjusting entries in the study of accounting. Both accruals and prepayments are important entries in a firm’s financial statements as they serve the purpose of providing better insight and information into a company’s current financial status and the changes that are to be expected in the future. The following article offers a clear explanation on both accruals and prepayments and will highlight the similarities and differences between accruals and prepayments.

What are Accruals?

Accruals consist of accrued expenses and accrued revenues. Accrued revenues are those that the company has already earned, but has not received cash for. Accrued expenses, on the other hand, are the expenses that have been incurred, but cash has not physically been paid out. Accruals are made for the expenses or revenue that are already known by the firm, and are recorded in the financial statements as and when they occur, before the exchange of cash and funds take place. This form of accounting ensures that all financial information including sales on credit and end of month interest to be paid are recorded for the period. Accruals make up of those which are to be paid such as wages due at the end of the month and accruals which are to be received such as funds to be received by debtors.

What are Prepayments?

Prepayments also can be divided into prepaid income and prepaid expenses. If a customer paid for the purchase of goods and services in advance, this would be recorded as a prepaid income. In this case, even though the customer paid early, they have not received the product yet and therefore the company cannot record it as an income. Once the product is received by the customer the product is realised as income in the company accounts. On the other hand, if the company paid for raw material purchases in advance before these raw materials were received this is recorded as a prepaid expense. Prepaid income is recorded as a liability and prepaid expenses are recorded as assets.

What is the difference between Accruals and Prepayments?

Accruals and prepayments are important components in the accounting statements because they show the amounts that the firm is known to receive and pay in the future, which can help the company better prepare their resources and plans for the future by incorporating this information in decision making.

Accruals include accrued expenses and accrued income whereas prepayments include prepaid income and prepaid expenses. The recording of accruals and prepayments ensure that accounting data is recorded as and when the incomes or expenses are made known, instead of waiting for the funds to actually exchange hands. The main difference between the two is that accrued income and expenses are those that are yet to be paid or received, and prepaid income or expenses are those that have been paid or received in advance. At the end of the accounting term, the company assess the status of their accruals and prepayments and make entries to adjust the income that was earned and expenses that were incurred.

Difference Between Accruals and Prepayments

Summary:

Accruals vs Prepayments

• Accruals and Prepayments are essential as they show the company’s stakeholders the types of revenues and expenses expected by a firm, and help the company managers in decision making and planning.

• Accrued revenues are those that the company has already earned, but has not received cash for. Accrued expenses, on the other hand, are the expenses that have been incurred, but cash has not physically been paid out.

• If a customer paid for the purchase of goods and services in advance, before the goods or service were delivered or provided, this would be recorded as a prepaid income. On the other hand, if the company paid for raw material purchases in advance before these raw materials were received this is recorded as a prepaid expense.

• The main difference between accruals and prepayments is that accrued income and expenses are those that are yet to be paid or received, and prepaid income or expenses are those that have been paid or received in advance.

 

Further Reading:

  1. Difference Between Accrual and Deferral
  2. Difference Between Accruals and Provisions
  • Kim

    Accounting for contracts? If I have not received an invoice for an IT contract, can I book a debit to prepaid asset and a credit to liability account. B/S entry only?