Common mistakes with accruals and prepayments

Accruals and prepayments test one idea: expenses and income belong to the period they relate to, not the period the cash moves. This is the matching concept. Once that is secure, the adjustments are quick.

But the direction of each adjustment catches students out, and a wrong sign loses marks. Here are the mistakes we see most often.

Not knowing which way to adjust

An accrued expense is a cost the business has used but not yet paid. It is added to the expense in the income statement and shown as a current liability. A prepaid expense is a cost paid in advance for a future period.

It is subtracted from the expense and shown as a current asset. The commonest mistake is reversing these.

A quick check: an accrual is something you still owe (a liability). A prepayment is a future benefit you have already paid for (an asset). Decide whether the item is a debt or a future benefit, and the direction follows.

Confusing the expense side with the income side

The same logic applies to income, in mirror image. Accrued income is earned but not yet received, so it is added to income and shown as a current asset. Income received in advance relates to a future period, so it is deducted from income and shown as a current liability.

Students who learn the expense rules often apply them unchanged to income. Ask whether the money is owed by the business or to it. Rent the business pays is an expense.

Rent it receives from a tenant is income. They adjust in opposite directions even though both are called rent.

A worked mini-illustration

These figures are invented to show the method. A business pays RM12,000 in rent during the year.

At the start of the year, RM1,000 of rent was still owing from last year (an opening accrual). At the year end, RM1,500 has been paid for next year (a closing prepayment).

The charge for the year is RM12,000 less the RM1,000 that belongs to last year, less the RM1,500 that belongs to next year. The rent expense in the income statement is RM9,500. The RM1,500 prepayment is a current asset in the statement of financial position.

The cash figure of RM12,000 never appears in the income statement on its own. It is only a starting point.

Adjusting the wrong figure

Adjust the expense (or income) in the income statement, and put the balancing amount in the statement of financial position. A frequent slip is recording only one half.

Every accrual or prepayment has two effects. Show both.

Using the cash paid instead of the amount due

Some questions give the cash paid during the year and ask for the charge for the year. You must adjust the cash for opening and closing accruals or prepayments. Entering cash paid straight into the income statement ignores the point of the topic.

Forgetting the opening balance

A question may include an accrual or prepayment brought forward from last year as well as one at the end of this year. Deal with both.

If your answer is out by a round number that matches a balance in the question, an opening adjustment has probably been missed.

Muddling the statement of financial position placement

An accrued expense and income received in advance are both current liabilities. A prepaid expense and accrued income are both current assets. Putting an item on the wrong side loses a mark even when the income statement is right.

Ask: is this owed by us, or to us? Accrual and income in advance go on the liabilities side. Prepayment and accrued income go on the assets side.

Why it matters in the real accounts

These adjustments give a fair picture of one trading period. Suppose a full year of insurance is paid in the last month, but only one month has been used. Charging the whole amount would understate profit for no good reason.

Carrying the unused part forward as a prepaid asset matches the cost to the periods that benefit from it.

A reliable routine

For each item, ask three questions in order:

1. Which period does it relate to?
2. Is it an expense or income?
3. Is it owed by us or to us?

The answers settle both the income statement adjustment and the statement of financial position entry. Practise with mixed expense and income items so you do not fall into one pattern.

Presentation

Show the adjusted figure in the income statement with brief working, for example “Rent (12,000 - 1,000 - 1,500)”. Clear working earns method marks. Label the current asset or liability clearly in the statement of financial position.

If accruals and prepayments keep coming out the wrong way round, one of our teachers can work through both adjustments using your child’s past-paper answers. Book a trial class to start.

Syllabus reference: Cambridge 0452 and 0985, syllabus for 2027 to 2029, sub-topic 4.3 Other payables and other receivables (page 14).