Accruals and prepayments are year end adjustments that put income and costs into the period they relate to, rather than the period in which cash moved. An accrual records a cost already incurred but not yet paid or invoiced; a prepayment carries forward a cost paid in advance for a later period. Unless a business uses the cash basis, its taxable profit follows these adjustments.

What are accruals and prepayments?

Both come from the accrual basis of accounting. FRS 102 requires an entity to prepare its financial statements, except for cash flow information, using the accrual basis, so that items are recognised when they meet the definitions and recognition criteria rather than when money is received or paid (paragraph 2.48 of the September 2024 edition, which applies to accounting periods beginning on or after 1 January 2026). For small companies, Schedule 1 paragraph 14 of the Small Companies and Groups (Accounts and Directors’ Report) Regulations 2008 (SI 2008/409) says that all income and charges relating to the financial year must be taken into account, without regard to the date of receipt or payment.

In practice there are four adjustments:

  • Accrued expense (accrual): a cost for goods or services already received in the period that has not been invoiced or paid by the year end. It is a current liability.
  • Prepayment: a cost paid in the period that covers goods or services to be received after the year end. It is a current asset.
  • Accrued income: income earned in the period, for example work done, that has not yet been invoiced. It is a current asset.
  • Deferred income (income received in advance): money received before the work is done or the goods are supplied. It is a current liability.

How do you calculate an accrual or a prepayment?

Most adjustments are either time apportioned or taken from an invoice received after the year end. A twelve month insurance policy paid part way through the year is split by months. A utility bill for a quarter that straddles the year end is split by days or months. Where no invoice has arrived when the accounts are prepared, the accrual is a reasonable estimate based on usage, contract terms or past bills.

The double entries are straightforward. ACCA’s technical guidance shows accrued wages as a debit to the wages expense and a credit to accruals, and prepaid insurance as a debit to prepayments and a credit to the insurance expense. At the start of the next period the entries are reversed, so that when the invoice is posted or the prepaid service is used, the cost falls into the correct year and is not counted twice.

What does a worked example look like?

Illustration only. A sole trader has a year end of 31 March 2027.

Item Cash movement Adjustment at 31 March 2027 Cost in the year
Insurance, 12 months from 1 January 2027 £1,200 paid in January 2027 Prepayment £900 (9 months unexpired) £300
Electricity, quarter 1 February to 30 April 2027 £600 invoice paid in May 2027 Accrual £400 (2 of 3 months used) £400
Rent, quarter to 30 June 2027 £1,500 paid on 25 March 2027 Prepayment £1,500 Nil

On a cash view the costs charged in the year would be £2,700 (the insurance and the rent paid). On the accruals basis they are £700. The difference of £2,000 is carried into the balance sheet as prepayments of £2,400 less an accrual of £400, and it reverses in the following year.

Why does HMRC follow these adjustments?

For income tax, section 25 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005) says the profits of a trade to which the cash basis does not apply must be calculated in accordance with generally accepted accounting practice, subject to any adjustment required or authorised by law. Section 46 of the Corporation Tax Act 2009 (CTA 2009) applies the same rule to companies. Correct accruals and prepayments are therefore part of computing taxable profit, not just presentation.

HMRC’s Business Income Manual is clear that paying for something does not of itself earn a deduction. BIM42210, citing Threlfall v Jones, says there is no general principle that a deduction is available for revenue expenditure when it is incurred or paid, and that a trader cannot take a more conservative view for tax than for other purposes. On the income side, BIM31080 says income is generally earned when goods are provided or services are performed, and the timing of invoices or receipts does not determine when income is recognised. That is why work done but not billed at the year end belongs in the year as accrued income.

Are there any special timing rules for tax?

Yes. The main one concerns pay. Under section 36 ITTOIA 2005 and section 1288 CTA 2009, remuneration for employees that is charged in the accounts for a period is only deductible for that period if it is paid before the end of the 9 months immediately following the end of the period of account. If it is paid later, the deduction moves to the period in which it is paid, and if it is never paid there is no deduction.

Illustration only. A company with a 31 March 2027 year end accrues a £20,000 director’s bonus. If the bonus is paid by 31 December 2027 it is deductible in the year to 31 March 2027. If it is paid in January 2028, the accounts still show the accrual, but the corporation tax deduction falls into the year to 31 March 2028. This interacts with decisions on salary and dividends, so the payment date needs planning, not just the accounting entry.

Other specific rules, such as those for bad debts and stock, sit alongside the general accruals principle; see bad debts and stock valuation.

What happens when a business moves onto or off the cash basis?

Under the cash basis, income and expenses are generally taken when received and paid, so accruals and prepayments disappear. The switch needs transitional adjustments so that nothing is relieved twice or missed. HMRC’s example at BIM72066 shows a £200 electricity accrual at the end of the last accruals year being deducted from the £3,000 of power bills paid in the first cash basis period, giving £2,800, because the £200 was already relieved. It also shows a £1,000 prepayment for cleaning being added to the costs of the first cash basis period, because otherwise it would be relieved under neither method. Income received in advance is treated the same way in reverse. For the wider comparison, see cash basis vs accruals accounting.

What mistakes come up most often?

  • Not reversing last year’s adjustments. If last year’s electricity accrual is not reversed, this year’s charge includes the same cost twice.
  • Prepaying to reduce profit. Paying next year’s subscriptions or rent before the year end does not move the cost into this year. The unexpired element is a prepayment.
  • Accruing round sums with no basis. An accrual should relate to goods or services actually received. A general reserve for possible future costs is not an accrual, and HMRC will expect a specific justification for any deduction.
  • Ignoring unbilled work. Service businesses often leave work in progress or accrued income out of the accounts. BIM31080 makes clear that billing dates do not set the recognition point.
  • Accruing bonuses that are paid too late. The 9 month rule above catches unpaid remuneration, including amounts credited but not drawn.
  • Treating capital costs as prepayments. A deposit on equipment is not a revenue prepayment; it belongs with fixed assets and capital allowances. See allowable business expenses for the revenue and capital split.

What records support accruals and prepayments?

GOV.UK guidance for self employed people says that if you use traditional accounting you must also keep records of money owed to you but not yet received, money you have committed to spend but not yet paid, and stock and work in progress at the end of the accounting period. For companies, section 386 of the Companies Act 2006 requires accounting records sufficient to disclose with reasonable accuracy, at any time, the financial position of the company, including a record of its assets and liabilities.

A short schedule for each adjustment, showing the supplier, the period covered, the calculation and the invoice or contract it came from, is usually enough. These schedules feed the year end journals on the trial balance, and they are among the first things an adviser looks at if HMRC asks how a figure in the accounts was arrived at.

Solar Protect provides tax investigation insurance for businesses and fee protection schemes for accountancy practices. Read how our cover works or get a quote.

Related Accountapedia entries

Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.