accruals and prepayments

System

why is it necessary to ntroduce accruals and prepayments into accounting

System

Re:accruals and prepayments

One of the key concepts of accounting is that of matching (aka the accruals concept). That is, income and expenditure should be matched to a specific accounting period. Thus, the profit and loss account will show all income and expenditure for the year regardless of payment. This concept is part of the regulatory framework for accounting - specificallly FRS 18.

Say for a given business the end of year is 31st December and rent is paid quarterly in advance on 30th November. Only one month's rent is an expenditure in the current financial year and should show as an expense in the year's P&L account. Two months' rent has been prepaid and needs to be treated as part of next year's expenditure.

Accruals are much the same but concern expenses incurred but not yet paid for. If we paid the quarterly rent in arrears in February, then one month's rent would be an expense in the previous financial year and only two months' in the current year.

Hope that helps

Chris