An accrual is a cost your business has run up by the end of a period but has not yet been billed for or paid. A prepayment is the opposite: a cost you have paid in advance that belongs to a later period. Both are timing adjustments that put costs into the period they relate to, so your profit reflects what actually happened and not simply when money left the bank.
Key takeaways
- An accrual is a liability: you owe for something already used.
- A prepayment is an asset: you have paid for something not yet used.
- Neither changes the total cost, only the period it falls into.
- Limited companies must prepare accounts on the accruals basis.
- Sole traders on the cash basis generally do not need either adjustment.
What is accruals accounting?
Accruals accounting, which HMRC calls traditional accounting, records income and costs in the period they relate to, not when cash moves. If you use electricity in December, it is a December cost even if the bill arrives in January. If you pay a year of insurance in October, only part of it is a cost of the current year.
The alternative is the cash basis, where you record income when you receive it and costs when you pay them. Our comparison of cash basis vs accruals covers the choice in full.
Accruals explained
An accrual recognises a cost incurred by the period end for which no invoice has been recorded yet. Common examples are:
- gas, electricity and phone bills that arrive after the period end
- accountancy fees for preparing that year's accounts
- work done by a subcontractor who has not yet invoiced
- interest that has built up on a loan but has not been charged
Because you owe the money, an accrual sits on the balance sheet as a liability, and it increases the costs in your profit and loss account. Where the exact figure is unknown, you use a sensible estimate based on usage or past bills.
Prepayments explained
A prepayment recognises that part of a payment you have already made covers a later period. Common examples are:
- annual insurance premiums
- rent paid quarterly in advance
- software subscriptions paid for a year up front
- vehicle tax and annual licences
The unused part is something the business still has the benefit of, so it sits on the balance sheet as an asset and is taken out of this period's costs. It becomes a cost in the next period as the time passes.
Accrual and prepayment compared
| Point | Accrual | Prepayment |
|---|---|---|
| What it is | A cost incurred but not yet invoiced or paid | A cost paid in advance for a later period |
| Example | December electricity billed in January | Insurance paid in October for the next 12 months |
| Balance sheet side | Liability | Asset |
| Effect on this period's profit | Reduces it | Increases it |
To see where these lines appear in a set of accounts, read how to read a company balance sheet.
The sales side: accrued and deferred income
The same idea applies to income. Accrued income is work you have done by the period end but not yet invoiced, so it is added to sales and shown as an asset. Deferred income is money a customer has paid you in advance for work you have not yet done, so it is held back from sales and shown as a liability until you deliver.
Who needs to make these adjustments?
Limited companies must prepare their accounts on the accruals basis, so accruals and prepayments are a normal part of every company year end. Companies must also keep records of what they owe and are owed, as GOV.UK explains under company and accounting records.
For sole traders and partnerships, the cash basis has been the default since 6 April 2024, and under it these adjustments are generally not needed. You can elect to use accruals accounting instead, which some businesses do because they hold a lot of stock or because a lender wants to see fuller accounts. GOV.UK sets out the rules in its cash basis guidance.
Step by step: working them out at the period end
- Finish the bookkeeping first. Complete the bank reconciliation so every payment is recorded.
- List payments that cover a span of time, such as insurance, rent, subscriptions and licences.
- Calculate the unused part. Divide the cost by the months covered and multiply by the months falling after the period end. That is the prepayment.
- Look at bills received after the period end. Any that relate to the period just finished need an accrual.
- Estimate what has not arrived. Use meter readings, contracts or last year's bills.
- Post the adjustments and keep a note of how each figure was worked out.
- Reverse them at the start of the next period so costs are not counted twice when the real invoices are entered.
Doing this monthly gives more reliable management figures. Our month end bookkeeping checklist shows where it fits.
Worked example (illustrative)
"Marlow Print Studio Ltd", an illustrative example, has a year end of 31 December 2026. Before adjustments, its records show a profit of £40,000.
Prepayment. On 1 October 2026 the company paid £1,200 for a year of insurance, covering 1 October 2026 to 30 September 2027. That is £100 a month. Three months fall in 2026, so £300 is a cost of this year. The other nine months, £900, are a prepayment and are taken out of this year's costs.
Accrual. The electricity bill for October to December 2026 arrives on 20 January 2027 and comes to £600. Nothing has been recorded for it by 31 December, so the company accrues £600 as a cost of 2026.
The adjusted profit is £40,000 plus £900 less £600, which is £40,300. The balance sheet shows a £900 prepayment as an asset and a £600 accrual as a liability. In 2027 both are reversed: the £900 becomes an insurance cost of that year, and the £600 accrual cancels out the January bill.
The company and figures are invented for illustration and are not a real client.
Common mistakes
- Mixing the two up. Owed but not billed is an accrual. Paid but not used is a prepayment.
- Forgetting to reverse. This counts the same cost in two periods.
- Accruing a bill already entered. If the invoice is in the books as a creditor, no accrual is needed.
- Ignoring small annual payments. Several modest subscriptions can add up to a meaningful figure.
- Using guesses with no workings. An estimate should be supported by a reading, a contract or a previous bill.
- Applying them under the cash basis. If you are a sole trader on the cash basis, these adjustments generally do not belong in your figures.
How we can help
We keep your books up to date through the year and work out accruals and prepayments at each period end, so your figures are ready for the accounts. Bookkeeping starts from £150 per month on a fixed fee. See our bookkeeping service, view our pricing, or contact us to talk through your year end.
Frequently Asked Questions
What is the difference between an accrual and a prepayment?
An accrual is a cost you have incurred by the period end but not yet been invoiced for or paid, so it is a liability. A prepayment is a cost you have already paid that relates to a later period, so it is an asset. Accruals reduce this period's profit, while prepayments increase it by moving cost forward.
Do sole traders need accruals and prepayments?
Usually not. Since 6 April 2024 the cash basis has been the default for sole traders and partnerships, and under it you record income and costs when money moves, so accruals and prepayments are generally not needed. If you elect to use accruals accounting instead, you will need to make these adjustments at each period end.
Does a limited company have to use accruals and prepayments?
Yes. Limited companies must prepare their accounts on the accruals basis and cannot use the cash basis. That means income and costs are recorded in the period they relate to, and the year end accounts will normally include accruals and prepayments, however small the company is. Your accountant or bookkeeper usually calculates them from your records.
Is a prepayment an asset or an expense?
A prepayment is an asset at the period end. You have paid for something you have not yet received, such as the remaining months of an insurance policy, so the unused part sits on the balance sheet under current assets. It becomes an expense in the later period as the benefit is used up.
What happens to an accrual in the next period?
It is reversed. At the start of the next period the accrual is released, and when the actual bill arrives it is recorded as normal. The two offset each other, so the cost is not counted twice. Any small difference between the estimate and the real bill falls into the new period's profit.
Related reading
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Schedule a consultation →Written by the Berber Accounts & Tax team, 124 City Road, London EC1V 2NX, United Kingdom.
Last reviewed: 10 October 2026.
This article is general information, not personal tax advice. Speak to a qualified accountant about your own circumstances before acting on it.