Prepayments, Accruals and Deferred Revenue: Month-End Adjustments Explained, With Examples
A bank statement tells you when money moved. Accrual accounts need to know when a cost was used and when income was earned. The gap between the two is closed by four month-end adjustments. If you've read accrual vs cash bookkeeping, this is the next step: the actual entries.
The four adjustments
| Item | Cash has… | But the cost or income belongs to… | On the balance sheet |
|---|---|---|---|
| Prepayment | gone out | a later period | Asset |
| Accrual (accrued expense) | not gone out yet | this period | Liability |
| Deferred revenue | come in | a later period | Liability |
| Accrued income | not come in yet | this period | Asset |
Each one moves an amount out of the period where the cash happened and into the period it belongs to, using a balance sheet account to hold it in between.
1. Prepayments
You pay now for something you'll use over several months: insurance, a software subscription paid annually, rent paid in advance, an annual maintenance contract. The payment goes to a prepayment (an asset), and each month the share used is moved to the expense.
| When | Entry | Prepayment balance |
|---|---|---|
| 1 Dec: pay the premium | Dr Prepayments 12,000 Cr Bank 12,000 | HK$12,000 |
| 31 Dec: December's share | Dr Insurance expense 1,000 Cr Prepayments 1,000 | HK$11,000 |
| Each month after | Dr Insurance expense 1,000 Cr Prepayments 1,000 | falls by HK$1,000 |
| 30 Nov next year | last HK$1,000 released | nil |
Without it, December carries a HK$12,000 insurance cost and the next eleven months carry none: one bad month and eleven flattering ones.
2. Accruals
You've used something this month but haven't paid for it, and often haven't been billed: rent paid in arrears, the electricity bill that arrives next month, professional fees, staff bonuses earned but paid later, the audit fee for the year. The cost is recorded now, with an accrual (a liability) for the amount owed.
| When | Entry |
|---|---|
| 31 Dec: the month is over, nothing paid | Dr Rent expense 30,000 Cr Accruals 30,000 |
| 2 Jan: pay the landlord | Dr Accruals 30,000 Cr Bank 30,000 |
When the actual bill arrives and differs from the estimate, the difference goes to the period in which you find out; you don't reopen the old month.
3. Deferred revenue
The mirror image of a prepayment: a customer pays you in advance for something you'll deliver over time, such as an annual subscription, a retainer or a support contract. The money is in the bank, but it isn't yet income. It sits as deferred revenue (a liability: you owe the customer the service) and is released as you deliver.
| When | Entry | Deferred revenue |
|---|---|---|
| 1 Oct: invoice and payment | Dr Bank 24,000 Cr Deferred revenue 24,000 | HK$24,000 |
| Each month-end | Dr Deferred revenue 2,000 Cr Revenue 2,000 | falls by HK$2,000 |
| 31 Dec | three months earned: HK$6,000 revenue | HK$18,000 |
4. Accrued income
The mirror image of an accrual: you've done the work this month but haven't invoiced it yet, for example a project billed at a milestone next month. The income belongs to this month, so it's recorded with accrued income (an asset) until the invoice is raised.
Keeping them right month by month
- A schedule for each balance. List every prepayment and deferred revenue item with its start date, end date and monthly release, so the balance on the balance sheet can be explained line by line.
- Release every month, not in one go at the year end; otherwise monthly profit is wrong all year.
- Reverse accruals when the bill arrives. Otherwise the cost is counted twice: once as the accrual, once as the bill.
- Check the regulars. Rent, utilities, payroll-related costs and professional fees: has each month got its cost, whether or not it was paid?
- Agree a threshold. Many small companies don't spread small items, a HK$300 annual subscription for example. Agree the threshold with your accountant or auditor and apply it consistently.
At the year end
Your auditor will usually ask for a schedule of prepayments, accruals and deferred revenue at the year end, test some items against invoices and contracts, and look at payments made just after the year end for costs that belonged to the old year. (See the year-end checklist and what your auditor will ask for.)
Common mistakes
- Expensing a prepayment in full. The annual premium hits one month; profit swings.
- Forgetting the accrual. A month's rent or the audit fee missing, so profit looks better than it is.
- Double-counting. An accrual left in place after the real bill is booked.
- Treating an advance payment as income. A customer's upfront payment counted as revenue the day it arrives.
- Balances nobody can explain. A prepayment balance with no schedule behind it will be questioned at the audit.
How Certanta handles them
- Prepayments spread over the months they cover, and deferred revenue released as it's earned, every month.
- Accruals for the month's regular costs, cleared when the bill is booked so nothing is counted twice.
- Every balance explained, with the documents behind it in the general ledger, and the year-end schedules ready for your auditor.
- Monthly profit you can trust in your income statement and management pack.
Frequently asked questions
What is a prepayment in accounting?
An amount paid in advance for something used over later periods, such as a year's insurance. It is recorded as an asset and released to expenses month by month as the period it covers passes.
What is an accrual?
A cost that belongs to the current period but has not yet been paid or billed, such as rent paid in arrears or a utility bill that arrives next month. It is recorded as an expense now, with a liability for the amount owed, and cleared when the bill is booked or paid.
What is deferred revenue?
Money received from a customer in advance for goods or services you will deliver later, such as an annual subscription. It is a liability until it is earned, and is released to revenue as you deliver.
What is accrued income?
Income you have earned in the period but not yet invoiced, such as project work billed at a later milestone. It is recorded as revenue now, with an asset until the invoice is raised.
Do small companies have to spread small prepayments?
Many set a threshold below which small items are simply expensed. Agree the threshold with your accountant or auditor and apply it consistently.
What happens if an accrual estimate is wrong?
When the actual bill arrives, the difference between the bill and the accrual is recorded in the period in which you find out. The earlier month is not reopened.
Month-end adjustments, done every month
Certanta keeps your prepayments, accruals and deferred revenue up to date month by month, so each month's profit is right and the year end has nothing to catch up on.
Open the demo See pricingThis article is general information about bookkeeping, not accounting, tax or audit advice for your company. How a particular item is treated, and any threshold below which costs are not spread, should be agreed with your accountant or auditor.