Record prepayments and accruals
It's important for you to know how much profit your business is making in any given month. If you receive an invoice or make a payment that covers several months, and you record it as a lump sum in one month, this can affect your profit for that month.
Rather than record it as a lump sum, you can spread the cost over the number of months the invoice or payment covers using journals. By doing this, you get a more realistic picture of your monthly profits and how your business is performing. Spreading the cost like this is known as making a prepayment or an accrual.
Prepayments - A prepayment is when you pay an invoice or make a payment for more than one period in advance. For example, you may pay for your rent for three months in advance but want to show this as a monthly expense on your profit and loss.
Accruals - An accrual is when you pay for something in arrears. For example, you may receive an invoice for your electricity at the end of a quarter but want to record the payments before this. An accrual is usually based on an estimate. Therefore, when the invoice is received, you may need to make an adjustment to the final amount.
To record a prepayment
These steps only apply if you make a lump sum payment and want to spread the cost. If you're making a payment in installments, you should record the payments as normal as and when you make them.
To record a prepayment, you need to:
Record the original transaction - When you receive the original invoice or make the payment, you should record this as normal as a bill or an other payment. The steps below assume you've already done this.
Reverse the effect of the vendor bill or other payment - Once you've posted the original transaction, you need to reverse the effect of it using journals. This moves the value from your profit and loss to the prepayments balance sheet account.
Post the monthly prepayment journals - After reversing the effect of the original transaction, you should then move the monthly values back from the prepayments account to the relevant expense account. You need to repeat this for each month affected by the prepayment.
To reverse the original vendor bill or other payment
In the following steps, we'll use the example that you make a $600 payment for rent in January to your rent account, 6300. This payment covers three months and you want to spread the cost to show $200 for each month on your profit and loss.
- Go to Adjustments, Journals, New Journal and complete the following information:
Date Enter the date you want to use for the journal. This should be the same as the original transaction. Reference Enter a reference, for example, Rent prepayment. Description If required, enter a description for the journal. - Enter the relevant information to reverse the original transaction, for example:
Ledger Account Details Debit Credit Prepayments (1400) Rent prepayment reversal 600 Rent and rates (6300) Rent prepayment reversal 600 - Click Save.
You've successfully reversed the effect of the payment or vendor bill. The balance now appears on your prepayment account on your balance sheet. To move the monthly value back to your profit and loss, you should now record the first monthly prepayment journal.
To record the monthly prepayment journal
- Go to Adjustments, Journals, New Journal and complete the following information:
Date Enter the date you want to use for the monthly prepayment, for example, the last day of the month. Reference Enter a reference, for example, Monthly rent prepayment. Description If required, enter a description for the journal. - Enter the relevant information to record the monthly prepayment, for example:
Ledger Account Details Debit Credit Rent and rates (6300) Monthly rent prepayment 200 Prepayments (1400) Rent prepayment reversal 200 - Click Save.
You've now recorded the monthly prepayment and this reduces the balance on your prepayment accounts and posts one month's value to your profit and loss. You need to repeat these steps for each month the original transactions covers. In this example, you'd post these journals for January, February, and March.
To record an accrual
To record an accrual, you need to:
Post the monthly accrual journal - To record an accrual, for each month affected by the accrual, you need to post a charge to a profit and loss account. The charge also posts to the accruals balance sheet account.
Post a journal to reverse the accrual - The balance on your accruals account, increase each month until the final month, when you need to reverse it. The reversal clears the value from the accrual account. When you view your profit and loss for the final month, the balance on the relevant account appears as a credit value. This is corrected when you record the bill or other payment.
Record the vendor bill or other payment - When you receive the actual invoice or make the payment, record this as normal. When you record this, the final month's credit balance on the relevant profit and loss account changes to a debit balance. As the accrual value is an estimate, the actual invoice or payment may be different. The difference appears in the final month.
To post the monthly accrual journal
In the following steps, we'll use the example that you pay for your electricity every three months in arrears. The average charge is $300 which you want to record as $100 a month.
- Go to Adjustments, Journals, New Journal and complete the following information:
Date Enter the date you want to use for the journal, for example the last day of the month. Reference Enter a reference, for example, Electricity accrual. Description If required, enter a description for the journal. - Enter the relevant information to record the monthly accrual, for example:
Ledger Account Details Debit Credit Utility Expense (6400) January electricity bill 100 Accruals (2101) January electricity bill 100 - Click Save.
You've successfully posted the first monthly accrual. You need to repeat this for each month the final invoice or payment covers. As you post each monthly journal, a debit value posts to the relevant overhead account, in this example utility expense, 6400, which appears on your profit and loss. The credit value posts to the accruals account and this appears on your balance sheet as the accrual is a current liability. At the end of the accrual period, you need to reverse the effect of these postings from your accounts.
To reverse the accrual postings
- Go to Adjustments, Journals, New Journal and complete the following information:
Date Enter the date you want to use for the journal, for example the last day of the month. Reference Enter a reference, for example, Accrual reversal. Description If required, enter a description for the journal. - Enter the relevant information to record the reversal, for example:
Ledger Account Details Debit Credit Accruals (2101) Accrual reversal 300 Utility Expense (6400) January electricity bill 300 - Click Save.
You've reversed the monthly accrual postings and when you view your profit and loss for the final month, the balance on your utility expense account appears as a credit value. To correct this, you need to record the bill or an other payment as usual. As the monthly accruals are estimates, it's normal for the actual bill to be different to the values you posted. This difference is recorded in the final month, when you enter details of your bill.