Adjust expenses and income for accruals and prepayments
Match income and expenses to the period they relate to, then show any accrued or prepaid amount in the statement of financial position.
Section 1.5 · Preparation of financial statements
Exam scope and assessment notes
Cambridge International AS & A Level Accounting 9706, 2026–2028 syllabus, Version 2. These lessons cover objective 1.5.1 only: adjustments to draft financial statements. Sole traders (1.5.2), partnerships (1.5.3) and limited companies (1.5.4) remain to be mapped. Practice is self-checked, not an official Cambridge grade; the separately published 2029 syllabus, timed papers and human subject-teacher review remain outstanding.
Before you begin
- Use double-entry and accrual concepts from Topics 1.2 and 1.4. Each adjustment must update the correct statement-of-profit-or-loss and statement-of-financial-position accounts.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
A business pays rent before the rental period begins. What is the unused portion at year-end?
What you will learn
- Distinguish accruals from prepayments
- Calculate period income and expense adjustments
- Explain the effect of each adjustment on both financial statements
Record the amount for the period, not just the cash
Under the matching/accruals concept, recognise income when earned and expenses when incurred, even if the cash is paid or received in another period. An accrual is an amount earned or used but not yet recorded or settled; a prepayment is cash paid or received before the related expense or income is earned.
An accrued expense increases the current-period expense and creates a liability. A prepaid expense reduces the period expense and creates an asset. Accrued income increases income and creates a receivable; income received in advance reduces current-period income and creates a liability.
Calculate the adjustment from dates and amounts
For a time-based amount, find the portion that belongs to the reporting period and the portion that belongs to a later period. Use the service dates, invoice terms and year-end; do not allocate by cash-payment date alone.
Check whether the trial balance has already recorded an amount. If a full payment was debited to expense, transfer the future-period portion to a prepayment. If an expense has been omitted, add the expense and accrual. This prevents both omission and double counting.
Pause and explain
A customer pays $2,400 in December for services to be provided in January. How should the December accounts treat it?
Worked example
On 1 October, a business pays $12,000 for 12 months of insurance and debits the full amount to insurance expense. Its year ends on 31 December. Calculate the expense and prepayment.
Show the worked solution
- Monthly insurance = 12,000 ÷ 12 = $1,000.
- Three months relate to October–December: expense = 3 × 1,000 = $3,000.
- The remaining nine months are prepaid: 9 × 1,000 = $9,000. Reduce expense by $9,000 and recognise a prepayment asset.
Answer Insurance expense for the year is $3,000 and the prepayment at 31 December is $9,000. If the full payment was expensed, Dr Prepayments $9,000; Cr Insurance expense $9,000.
Try a topic test
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Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
A $9,600 annual maintenance contract runs from 1 November. The year ends 31 December, and all cash was paid on 1 November and debited to expense. Find current expense and prepayment.
Give me a hint
Count the two months used by year-end and the ten months remaining.
Compare my reasoning
- Monthly cost = 9,600 ÷ 12 = $800.
- Current expense = 2 × 800 = $1,600.
- Prepayment = 10 × 800 = $8,000; transfer that amount from expense to a prepayment asset.
Current-period expense is $1,600 and the year-end prepayment is $8,000.
Look for these in your work
- Monthly amount correct
- Period split correct
- Asset and expense effects stated
A business received $18,000 on 1 December for six months of consulting work beginning that day. Its year ends on 31 December. Calculate income earned and income received in advance.
Give me a hint
Only one of the six service months has been completed.
Compare my reasoning
- Monthly fee = 18,000 ÷ 6 = $3,000.
- December income earned = $3,000.
- Income received in advance = 18,000 − 3,000 = $15,000; recognise a liability.
Recognise $3,000 income and a $15,000 liability for services still owed.
Look for these in your work
- Service period used
- Income calculated
- Liability stated
A bookkeeper argues that an unpaid electricity bill should be left out because no cash has left the bank. Explain the year-end adjustment and its effect on profit and liabilities.
Give me a hint
Apply the expense to the period in which electricity was used.
Compare my reasoning
- Electricity used before year-end is an expense of the current period.
- Record the expense and an accrued expense liability even though payment is later.
- Profit falls by the expense and liabilities rise by the accrued amount.
The bill must be accrued if it relates to electricity used by year-end. Record the expense and liability; cash payment date does not determine the expense period.
Look for these in your work
- Period identified
- Expense and liability recorded
- Profit effect explained
Common mistakes
- Using the payment date instead of the service period
- Recording an accrual without adding the expense to the correct period
- Leaving the full cash payment as expense and also adding a prepayment without reducing expense
What can you explain now?
An expense has been incurred by year-end but remains unpaid. What is the adjustment?
Compare with the explanation
Increase the expense and recognise an accrued liability
The business has used the service even though it has not paid yet.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
State the four year-end balances: accrued expense, prepaid expense, accrued income and income received in advance.
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.