Accruals and prepayments

Applying the accruals concept to the P&L means that all of, and only,

expenses relating to the accounting period in question, should be recognised

(included) in the P&L. However, these expenses will not always be paid

during the accounting period to which they relate.

Expenses such as electricity, heating and lighting costs, are typically incurred

before they are paid, because electricity bills only arrive after the business

has used the electricity. These expenses are paid in arrears.

In contrast, expenses such as rent and insurance are often paid in advance.

When the cash payments happen in the ‘wrong’ accounting period, we need

to make sure that we calculate the correct figure for the expense to appear in

the P&L. Because the cash paid during the accounting period will not usually

be equal to the P&L charge for the expense, the difference appears in the BS

as either an accrual or a prepayment