Prepayments and accruals: worked examples and journals

What is the difference between a prepayment and an accrual?

A prepayment is a cost you've paid in advance for something you will use later. An accrued expense, often shortened to an accrual, is a cost for something you've already used, but whose bill hasn't yet been recorded.

Think of an annual insurance policy paid in January. You pay once, but receive cover throughout the year. Electricity can work the other way round: you use it in December and receive the bill in January. Prepayments and accruals help put those costs into the months they belong to.

You'll also see a prepayment where a bill has been recorded in advance of the service, even if payment is still due. The key question is which period the cost belongs to. ACCA explains this accounting principle: costs should appear in the period they relate to, regardless of when they are paid.

A few useful terms before the examples

An expense is a cost of running the business, such as insurance or electricity. An accounting period is the span of time you're preparing figures for, perhaps a month, a quarter or a year. The reporting date is its final day.

The profit and loss report shows income and expenses over a period. If all of an annual insurance payment appears as January's expense, January can look unusually costly while the following months look too cheap. Spreading the cost across the period of cover gives a clearer picture.

The balance sheet is a snapshot at one date. It includes assets, things the business owns or has a right to benefit from, and liabilities, amounts it owes. Unused insurance cover is a prepayment asset because the business can still benefit from it. Electricity already used but not yet billed creates an accrued expense liability because the business owes for that service.

These examples use accrual accounting: recording costs when they belong in the accounts. This is different from cash-basis tax records, which generally follow when money is received or paid. If you're a sole trader, check HMRC's cash-basis guidance before applying the same timing to your tax records.

Debits and credits, in plain English

In bookkeeping, an account is a labelled record, such as “Insurance expense” or “Prepayments”. It isn't necessarily a bank account. A journal entry is a set of instructions that updates these records. To post a journal means to add it to the books.

Debit means an entry in the left-hand column; credit means an entry in the right-hand column. They don't simply mean money coming in or going out. Whether an entry increases or reduces a figure depends on the type of account.

Every journal has equal total debits and credits. For the insurance example below, taking £2,750 out of this period's expense and recording it as future cover means making these two entries:

Read the account name first, then use the table to work out what the debit or credit does. You'll sometimes see them shortened to Dr and Cr. OpenStax's introduction to journal entries shows how these columns fit together.

Worked example: an annual insurance prepayment

A business pays £3,650 on 1 January 2026 for insurance covering 1 January to 31 December 2026. We'll use this amount to keep the daily calculation easy: £3,650 spread over 365 days is £10 a day. All the examples in this guide are fictional.

1. Record the original payment

One way to start is to record the whole £3,650 as insurance expense when it is paid. Debit insurance expense £3,650 to increase that cost, and credit bank £3,650 to reduce the money in the business's bank account.

2. Work out how much belongs to January–March

At 31 March, January's 31 days, February's 28 and March's 31 add up to 90 days of cover used. At £10 a day, that is £900 of expense. The other £2,750 pays for cover from April to December.

If you leave the full payment as an expense, the January–March costs will be £2,750 too high. The next entry moves that unused part into prepayments.

3. Record the prepayment adjustment

The accounts now show £900 of insurance expense and a £2,750 prepayment asset. The adjustment doesn't change the bank balance; the payment already happened in January.

4. Use up the prepayment as time passes

April has 30 days, so another £300 of insurance cover is used. Debit insurance expense £300 and credit prepayments £300. This increases April's cost and reduces the unused cover from £2,750 to £2,450. Accountants call this releasing the prepayment. Continue until all the cover has been used and the asset reaches zero on 31 December.

If you've already adjusted January and February, the prepayment at 28 February would be £3,060. March then needs a £310 release, rather than another £2,750 adjustment. Enter that existing £3,060 in the calculator to work out the change needed.

What if the original payment went straight into prepayments?

You can also start by recording the full £3,650 as a prepayment asset. With that approach, the 31 March entry debits insurance expense £900 and credits prepayments £900. It gives the same final figures: £900 of cost and £2,750 of future cover. Always check how the original payment was recorded before choosing the adjustment.

Why a monthly calculation can give a different answer

A £1,200 subscription spread equally over twelve complete months costs £100 a month, leaving £900 unused after three months. That's equal monthly spreading. The calculator here uses actual days, so longer months get a little more cost than shorter ones. Use a method that reflects the service and your accounting policy, and apply it consistently.

Worked example: an electricity accrual

A business uses electricity in December 2026, but the bill hasn't arrived by 31 December. A meter reading and the supplier's tariff suggest that December's electricity cost £600. Nothing has been recorded for it yet.

Waiting for January's bill would leave December's costs too low. The business makes an accrual to include the missing £600 expense and the £600 it expects to owe.

If £450 has already been recorded as an accrual for the same December electricity, only another £150 is needed. The calculator's existing-accrual field lets you allow for that amount.

What happens when the actual bill arrives?

Suppose January's bill is £630, all for December's electricity. You need to remove the £600 estimate and record the actual bill so the cost isn't counted twice.

One common approach is to reverse the accrual on 1 January. Reversing means undoing the earlier journal: debit accrued expenses £600 to remove the estimated amount owed, and credit electricity expense £600 so that credit can offset the cost of the real bill in January. Then record the real bill in the usual way.

Trade creditors means suppliers the business owes for bills it has recorded. Once the electricity bill is recorded, that supplier balance replaces the estimated accrual.

The £630 expense less the £600 reversal leaves a £30 difference in January's records. If you're still preparing December's accounts, update December's estimate to the known amount. If those accounts have been finalised, ask your accountant how to treat the difference under the relevant reporting rules.

You can also clear the accrual directly against the bill instead of reversing it first. The important check is that the same cost and amount owed appear only once.

Calculate your own prepayment or accrual

Start with the insurance example, then change the amount and dates to match your own item. The calculator shows how much of the service has been used, the balance to keep in the accounts and the adjusting journal. A schedule is simply the month-by-month breakdown you can download.

Use “Existing prepayment” or “Existing accrual” for the amount already recorded for this item before your new adjustment. Leave it at £0 if there is no existing balance. The standalone calculator explains the method and download in more detail.

Checks before you add an adjustment

• Check the dates of the service. An invoice's date doesn't necessarily tell you which months its cost covers.
• Check what is already in the books. Allow for earlier adjustments so you don't record the same cost twice.
• Keep the evidence. Save the bill or contract for a prepayment, and the meter reading, tariff or other basis for an accrual estimate.
• Keep VAT separate. These examples leave out VAT. If the business can claim it back, allocate the cost without that recoverable VAT. Include VAT it cannot recover in the cost. These calculations don't decide when VAT can be claimed.
• Review changes. A cancellation, refund or revised estimate can change what remains. Unused days alone don't establish a right to a refund.

If you keep the books yourself, your accountant can help decide which costs need adjusting and how to handle small amounts consistently. For the wider process, our month-end close guide explains the checks made when a month's accounts are finished.

If you use Briefcase, see how prepayment schedules work and how accrued expenses are handled. Those pages explain the product workflow; the examples here explain the accounting behind it.