Ch 4: Accruals, Prepayments and Period-End Matching

Learning objectives

By the end of this chapter, you should be able to:

• Explain what accruals, prepayments, accrued income, and deferred income are, and why they matter at the reporting date.
• Calculate and post period-end adjustments so that income and expenses are recognised in the correct period.
• Explain how each adjustment affects profit and the statement of financial position (assets and liabilities).
• Apply a consistent period-end routine, including reversals where they are used.
• Identify typical cut-off errors and correct them using appropriate journal entries.

Overview & key concepts

Period-end cut-off: what the statements must capture

At the reporting date, the accounts should reflect what has been used and what has been earned up to that date. Cash is often a poor guide because payments and receipts may occur before or after the related activity.

A reliable way to spot period-end adjustments is to take each major expense and income line and ask:

1. Does it relate to this accounting period? (Has it been consumed/earned by the reporting date?)
2. Has it already been recorded in the ledger? (Not just paid/received.)
3. Has cash moved? (Helpful context, but not the deciding factor.)

Use the answers to diagnose the adjustment:

• Relates to this period but missing from the ledger → accrual (expense) or accrued income (income).
• Recorded in the ledger but partly relates to a future period → prepayment (expense) or deferred income (income).

These adjustments prevent profit being distorted by timing and ensure the statement of financial position includes the related rights (assets) and obligations (liabilities) at the reporting date.

Overview definitions (exam-focused)

Accruals (expenses payable)

Meaning: An expense belongs to the current period, but it has not been recorded by the reporting date (often because the invoice has not arrived yet or has not been entered, or because an amount is estimated).

Effect:

• Expense increases (reduces profit)
• Liability increases (amount owed)

Examiner-style clarification (invoice received): If the supplier invoice has already been processed in the ledger, the credit is normally sitting in trade payables, so no additional accrual is needed. An accrual is used when the expense relates to the period but is not yet recorded at the reporting date (whether invoiced or not).

Prepayments

Meaning: Cash has been paid and recorded, but the benefit will be received partly or wholly after the reporting date.

Effect:

• Expense decreases (increases profit)
• Asset increases (future benefit)

Accrued income (income receivable)

Meaning: Income has been earned by the reporting date but has not yet been received and may not yet have been invoiced. The adjustment recognises the income earned and the related right to receive it.

Effect:

• Income increases (increases profit)
• Asset increases (amount due)

Deferred income (income received in advance)

Meaning: Cash has been received, but the income has not yet been earned at the reporting date because goods/services are still owed.

Key link (earning, not cash): Deferred income arises because performance is still outstanding at the reporting date — cash received does not determine when income is recognised.

Effect:

• Income decreases (reduces profit)
• Liability increases (obligation to provide future goods/services)

Core theory and frameworks

Debit/credit anchor (quick reference)

• Expenses: debit increases, credit decreases
• Income: credit increases, debit decreases
• Assets: debit increases, credit decreases
• Liabilities: credit increases, debit decreases

Accruals (expense not yet recorded)

Period-end entry:

• Dr Expense
• Cr Accrued expenses (liability)

Prepayments (expense recorded but not yet consumed)

Two bookkeeping routes exist; both end with the same year-end balances.

If payment was posted to expense during the year (common in questions):

• Dr Prepayments (asset)
• Cr Expense

If payment was posted to a prepayment asset during the year:

• Dr Expense
• Cr Prepayments (asset)

Accrued income (income earned but not yet recorded/received)

Period-end entry:

• Dr Accrued income (asset)
• Cr Income

Deferred income (income recorded/received but not yet earned)

Two bookkeeping routes exist; both end with the same year-end balances.

If receipt was posted to income during the year (common in questions):

• Dr Income
• Cr Deferred income (liability)

If receipt was posted to deferred income during the year:

• Dr Deferred income (liability)
• Cr Income

Presentation note (typical classification)

Accrued income and prepayments are typically presented as current assets, and accrued expenses and deferred income as current liabilities, unless the timing clearly extends beyond 12 months.

Time apportionment (even pattern)

Where costs or income accrue evenly:

• Monthly amount = total ÷ months covered
• Period portion = monthly amount × months in the period
• Balance becomes prepayment (expense) or deferred income (income).

Reversing entries

A reversing entry cancels certain year-end accrual-type adjustments at the start of the next period to simplify routine posting.

Important exam note: Reversals are rarely required in exam answers unless the question asks for them or the narrative indicates they are used in the bookkeeping system.

Worked example

Narrative scenario

ABC Ltd provides services and prepares accounts to 31 December.

Assume that, unless stated otherwise:

• Cash payments are recorded to the relevant expense account when paid.
• Cash receipts are recorded to the relevant income account when received.
• Outstanding items at year end have not yet been recorded.

The following items require period-end adjustment:

1. On 1 October, ABC Ltd paid £3,600 for insurance covering 12 months.
2. A December utilities bill for £500 has been received but is unpaid at 31 December.
3. On 1 December, ABC Ltd received £12,000 for a 6-month service contract running from 1 December.
4. Interest income of £300 has been earned by 31 December but not yet received.
5. Rent of £2,000 per month for December is unpaid at 31 December.
6. On 31 December, ABC Ltd paid a £1,200 subscription covering the next 12 months (January to December).
7. Training fees received total £9,000, of which £2,400 relates to courses delivered next year.
8. Commission income of £1,850 has been earned by 31 December but not yet received.
9. An electricity invoice for £620 relating to December is unpaid at 31 December.
10. A customer paid £5,000 in advance for a project that starts next year.

Required

• Calculate and record the required adjustments for accruals and prepayments.
• Calculate and record the required adjustments for accrued income and deferred income.
• Show the impact of the adjustments on profit and on the statement of financial position.
• Identify and correct cut-off issues within the transactions.

Solution

Step 1: Diagnose each item before journalling

For each item ask: (a) Does it relate to this year? (b) Is it already recorded? (c) Has cash moved?

Then choose the adjustment:

• Missing cost for this year → accrual
• Cost recorded but future benefit remains → prepayment
• Missing income for this year → accrued income
• Income recorded/received but not earned yet → deferred income

A) Prepayments (assets)

1) Insurance prepayment

• Total paid: £3,600 for 12 months from 1 October
• Monthly cost: £3,600 ÷ 12 = £300
• Months used in current year (Oct–Dec): 3
• Expense for the year: 3 × £300 = £900
• Prepayment at 31 December: £3,600 − £900 = £2,700

Adjusting entry (remove unexpired portion from expense):

• Dr Prepayments £2,700
• Cr Insurance expense £2,700

2) Subscription prepayment

Payment made on 31 December covering the next 12 months (all future benefit).

• Prepayment at 31 December: £1,200
• Expense for the year: £0

Adjusting entry:

• Dr Prepayments £1,200
• Cr Subscription expense £1,200

B) Accruals (liabilities)

3) Utilities accrual (invoice received, not recorded)

Utilities bill for December £500 received but unpaid and not recorded.

Adjusting entry:

• Dr Utilities expense £500
• Cr Accrued expenses £500

Examiner-style clarification: If that invoice had already been entered during December, the credit would normally be in trade payables already (Dr utilities expense / Cr trade payables). In that case, you would not create a second liability via an accrual.

4) Rent accrual

Unpaid rent for December: £2,000

Adjusting entry:

• Dr Rent expense £2,000
• Cr Accrued expenses £2,000

5) Electricity accrual

Unpaid December electricity invoice: £620

Adjusting entry:

• Dr Electricity expense £620
• Cr Accrued expenses £620

Cut-off note: This scenario includes both “utilities” and “electricity”. Treat them as separate December costs unless evidence suggests duplication.

C) Accrued income (assets)

6) Interest accrued

Interest earned by year end not yet received: £300

Adjusting entry:

• Dr Accrued income £300
• Cr Interest income £300

7) Commission accrued

Commission earned by year end not yet received: £1,850

Adjusting entry:

• Dr Accrued income £1,850
• Cr Commission income £1,850

D) Deferred income (liabilities)

8) Service contract income received in advance

Cash received 1 December: £12,000 for 6 months from 1 December.

• Monthly earning: £12,000 ÷ 6 = £2,000
• Earned by 31 December: 1 month = £2,000
• Unearned at 31 December: £12,000 − £2,000 = £10,000

Because receipts were credited to income during the year, defer the unearned portion:

Adjusting entry:

• Dr Service income £10,000
• Cr Deferred income £10,000

9) Training fees received in advance

Total training fees received: £9,000 Portion relating to next year: £2,400 (unearned at year end)

Adjusting entry:

• Dr Training fee income £2,400
• Cr Deferred income £2,400

10) Customer advance for next-year project

Advance received for a project starting next year: £5,000 (entirely unearned)

Adjusting entry:

• Dr Project income £5,000
• Cr Deferred income £5,000

What happens next year (timing reversal concept)

These adjustments reverse through normal activity in the following period:

• Prepayment becomes expense as the benefit is consumed (expense increases next year).
• Accrual becomes a recorded payable settlement when the invoice is processed and/or cash is paid (liability reduces next year).
• Accrued income becomes cash received or an invoice raised and settled (asset reduces next year).
• Deferred income becomes income as services are delivered (liability reduces; income increases next year).

Impact on profit and statement of financial position

1) Impact on profit for the year (net effect)

Increases profit (reduce expenses / increase income):

• Insurance: reduce expense by £2,700
• Subscription: reduce expense by £1,200
• Interest accrued: add income £300
• Commission accrued: add income £1,850

Total increase = £2,700 + £1,200 + £300 + £1,850 = £6,050

Decreases profit (add expenses / reduce income):

• Utilities accrual: add expense £500
• Rent accrual: add expense £2,000
• Electricity accrual: add expense £620
• Service contract deferred: reduce income £10,000
• Training fees deferred: reduce income £2,400
• Customer advance deferred: reduce income £5,000

Total decrease = £500 + £2,000 + £620 + £10,000 + £2,400 + £5,000 = £20,520

Net impact on profit: £6,050 − £20,520 = £14,470 decrease

2) Impact on statement of financial position at 31 December

Assets increase (typically current):

• Prepayments: £2,700 + £1,200 = £3,900
• Accrued income: £300 + £1,850 = £2,150

Total asset increase = £6,050

Liabilities increase (typically current):

• Accrued expenses: £500 + £2,000 + £620 = £3,120
• Deferred income: £10,000 + £2,400 + £5,000 = £17,400

Total liability increase = £20,520

Net decrease in equity (via profit effect): £20,520 − £6,050 = £14,470, matching the reduction in profit.

Common pitfalls and misunderstandings

• Accrual vs trade payables confusion: If an invoice has already been posted, the liability is in trade payables already; do not create a second liability using an accrual.
• Treating cash received as proof of income earned: income is recognised when earned; unearned receipts belong in deferred income.
• Wrong direction journals: remember the debit/credit anchor for assets, liabilities, income and expenses.
• Partial periods: always calculate the portion up to (and after) the reporting date carefully.
• Double counting similar expenses: if two items look like they might overlap (e.g., utilities vs electricity), confirm whether they are separate costs or duplicates before adjusting.

Summary

Period-end adjustments correct timing differences between cash flow and economic activity:

• Accruals (expense payable): Dr expense / Cr accrued expenses (liability)
• Prepayments: Dr prepayment (asset) / Cr expense
• Accrued income: Dr accrued income (asset) / Cr income
• Deferred income: Dr income / Cr deferred income (liability)

These entries ensure profit reflects what is earned and consumed in the period, and the statement of financial position shows the related assets and liabilities at the reporting date.

FAQ

What is the difference between accruals and prepayments?

Accruals recognise missing costs for the period (liability created). Prepayments remove costs already recorded that belong to a future period (asset created).

How does deferred income affect the financial statements?

Deferred income is a liability because the entity has not yet earned the income at the reporting date. It reduces current-period income so profit is not overstated.

Are reversing entries required?

Reversals are optional and depend on the system described. They are rarely needed in exam answers unless specifically requested or clearly implied by the scenario.

How do you apportion amounts over time?

Where the pattern is even, calculate a periodic rate (e.g., monthly) and allocate based on the portion relating to the current period. The balance becomes a prepayment (expense) or deferred income (income).

What are typical cut-off errors?

Common errors include recognising income too early (cash received but not earned), omitting unpaid expenses for the period, and failing to split payments/receipts that cover more than one accounting period.

Glossary

Accrual (expense payable) A period-end adjustment recognising an expense relating to the period that has not yet been recorded by the reporting date. Creates a liability.

Prepayment An amount paid and recorded, where the related benefit will be received after the reporting date. The unexpired portion is shown as an asset.

Accrued income (income receivable) Income earned by the reporting date that has not yet been received (and may not yet be invoiced). Shown as an asset.

Deferred income (income received in advance) Cash received for goods/services that will be provided after the reporting date. The unearned portion is shown as a liability.

Adjusting entry A period-end journal entry that corrects income/expense timing and recognises any related asset or liability.

Reversing entry An optional entry at the start of the next period that cancels certain accrual-type adjustments, used to simplify routine posting.

Cut-off Recording transactions in the correct reporting period so income and expenses reflect the activity up to the reporting date.

Learning objectives

By the end of this chapter you should be able to:

• Calculate and record accruals, prepayments, accrued income, and deferred income so that profit reflects the correct period.
• Prepare period-end adjusting journals and update statement extracts to show the correct assets, liabilities, income, and expenses.
• Explain how period-end matching improves reported profit by linking income and related costs to the period in which they arise.
• Analyse the effect of timing adjustments on profit, assets, liabilities, and equity, using the accounting equation.
• Identify and avoid common year-end cut-off and classification errors.

Overview & key concepts

Most businesses do not receive or pay cash at exactly the same time as they earn income or consume resources. If accounts were prepared purely from cash movements, profit would fluctuate for timing reasons rather than reflecting underlying performance.

Period-end timing adjustments correct this by ensuring that:

• expenses are recognised when resources are consumed (not simply when paid), and
• income is recognised when earned (not simply when received).

These adjustments are made at the reporting date and affect both profit and the statement of financial position.

The accounting equation link

Every adjustment must keep the accounting equation in balance:

Assets = Liabilities + Equity

Because profit increases equity (and expenses reduce it), timing adjustments often change equity indirectly through profit.

Core theory and frameworks

A quick way to get the journal right (exam method)

Start by asking: What must the statement of financial position show at the reporting date?

• If an obligation exists at year-end (something is owed), the adjustment usually creates or increases a liability.
• If a future benefit remains at year-end (something already paid or recognised will benefit a later period), the adjustment usually creates or increases an asset.
• If income has been earned but not yet billed/collected, recognise an asset (amount due).
• If cash has been received before the work is done, recognise a liability (the remaining obligation to provide goods/services).

Then link it to profit:

• If the adjustment makes this year’s costs higher, profit falls (expense increases).
• If the adjustment makes this year’s income higher, profit rises (income increases).

Finally, post the double entry: one side to profit (income/expense) and the other to the year-end asset or liability that explains the timing difference.

1) Accruals (accrued expenses)

Meaning: An expense belongs to the current period but is unpaid and/or unrecorded at the reporting date.

Effect:

• Profit decreases (expense increases)
• Liabilities increase (amount owing)

Journal (period-end): Dr Expense Cr Accrued expenses (liability)

2) Prepayments (prepaid expenses)

Meaning: Cash has been paid (or an invoice recorded) but part of the benefit relates to a future period. The unused portion is an asset at the reporting date.

Effect:

• Profit increases compared with charging the full amount now (expense decreases)
• Assets increase (prepayment)

Journal (period-end): Dr Prepayments (asset) Cr Expense

Classification reminder: If the benefit will be consumed within 12 months of the reporting date, it is generally presented as current. If not, it is generally non-current (or split between current and non-current).

3) Accrued income

Meaning: Income has been earned in the current period but is unbilled and/or not yet received at the reporting date.

Effect:

• Profit increases (income increases)
• Assets increase (amount due)

Journal (period-end): Dr Accrued income (asset) Cr Income

4) Deferred income (income received in advance)

Meaning: Cash has been received (or a receivable recorded) before the related goods or services have been provided. The unearned portion is a liability at the reporting date (sometimes described as a “contract liability”).

Effect:

• Profit decreases compared with recognising all receipts as income (income decreases)
• Liabilities increase (obligation remaining)

Journal (period-end): Dr Income Cr Deferred income (liability)

Why cash causes confusion

Cash is about payment. Financial statements are about performance in the period. At the reporting date you are not “moving cash”; you are explaining what portion of amounts paid/received (or invoiced) belongs to this period and what portion belongs to another period. That is why the balancing entry is usually an asset (future benefit) or a liability (amount owed / performance still required), rather than bank.

Other high-yield period-end adjustments (often tested alongside timing)

Inventory and cost of sales cut-off

A quick check is to reconcile purchases to usage: start with what you had at the start of the year, add what came in, then remove what is still on hand at the end. The remainder is what was consumed/sold in the period (cost of sales).

Cost of sales = Opening inventory + Purchases − Closing inventory

Cut-off focuses on what belongs in this year’s numbers. For inventory, focus on whether the entity has taken control/ownership of the goods by the reporting date (often evidenced by delivery terms). If it has, the goods normally appear in closing inventory, with a matching payable if unpaid. For revenue, do not use “invoice issued” or “goods dispatched” as your trigger. Use the point when the customer obtains the goods or services under the contract terms (often aligned with delivery/acceptance conditions).

Interest on borrowings (notes payable / loans)

Interest is time-based and commonly accrues.

Interest = Principal × Annual rate × Time fraction

If interest is unpaid at period end:

Journal (period-end): Dr Finance cost (interest expense) Cr Interest payable / Accrued expenses

Impairment allowance on receivables (valuation adjustment)

Receivables may require an allowance where not all balances are expected to be collected. This is a valuation adjustment at the reporting date (an estimate reducing receivables to a realistic recoverable amount). It is not a timing cut-off item in the same sense as accruals/prepayments, but it is a common period-end adjustment.

Typical entries:

• To recognise/increase an allowance: Dr Impairment loss (expense), Cr Allowance (contra-asset)
• To write off a specific irrecoverable balance:

Dividends (equity-related)

Dividends are distributions to owners, not operating expenses. A dividend is recognised as a liability at the reporting date only when it has been appropriately authorised/approved and is no longer at the entity’s discretion. Amounts that are proposed or recommended but not yet authorised by the reporting date are not liabilities at that date.

Reversing entries (optional technique)

Some entities reverse selected adjusting entries on the first day of the next period to simplify processing, most commonly for accruals (for example, wages).

If an accrual was recorded at year-end:

Year-end adjustment: Dr Expense Cr Accrued expenses

Reversal next period (day 1): Dr Accrued expenses Cr Expense

Reversals are optional and should be used only where they improve clarity and control.

Worked example

Narrative scenario

ABC Ltd has a year-end of 31 December 20X8. During the year, the following information is available:

1. Electricity paid during the year: £5,400, of which £600 relates to January 20X9.
2. Wages for the final week of December, unpaid at year-end: £1,250.
3. Rent paid on 1 October for six months in advance, including tax at 20%: £1,440.
4. Insurance paid during the year: £2,400, with £500 relating to the next period.
5. Rent paid during the year: £9,000, with one month’s rent of £900 unpaid.
6. Consultancy income received/recorded: £7,800, with £1,100 of work completed but not yet invoiced.
7. Maintenance income received on 1 December for a four-month contract: £3,600.
8. Heating expense paid: £4,200, with £700 relating to April and May 20Y0.
9. Cleaning expense recorded: £3,100, with £450 still unpaid.
10. Service income recorded: £24,000, with £4,500 received in advance and £1,200 earned but not yet invoiced.

Assumption for item 3 (tax): the 20% tax is recoverable input tax and should not form part of rent expense. In many exam-style questions tax is ignored unless specifically mentioned; here it is included, so it must be separated from the expense.

Required

1. Calculate the electricity expense for the year and the prepayment.
2. Show the adjustment for wages accrual.
3. Calculate the rent expense for the year and the prepayment (item 3).
4. Show the adjustment for insurance prepayment.
5. Calculate the total rent expense charged to profit (item 5).
6. Show the adjustment for accrued income (consultancy).
7. Calculate the income for the current year and deferred income (maintenance contract).
8. Calculate the final expense figures for heating and cleaning.
9. Prepare the year-end journals for service income.

Solution

1) Electricity: prepayment

Paid during the year: £5,400 Amount relating to January 20X9: £600

Electricity expense (20X8) = £5,400 − £600 = £4,800

Prepayment at 31 December 20X8 = £600

Journal (year-end): Dr Prepayments (electricity) £600 Cr Electricity expense £600

2) Wages: accrual

Unpaid wages at year-end: £1,250

Journal (year-end): Dr Wages expense £1,250 Cr Accrued expenses (wages payable) £1,250

3) Rent paid in advance on 1 October (six months), including 20% tax

Gross cash paid: £1,440 Tax at 20% (recoverable): £240 Net rent: £1,200

Period covered: 1 October 20X8 to 31 March 20X9 (6 months) Monthly net rent: £1,200 / 6 = £200

Expense in 20X8 (Oct–Dec): 3 × £200 = £600 Prepayment at 31 December 20X8 (Jan–Mar): 3 × £200 = £600

Rent expense (net) in 20X8 = £600

Prepayment (rent) at 31 December 20X8 = £600

Journal (timing adjustment, assuming net rent has been recorded as expense): Dr Prepayments (rent) £600 Cr Rent expense £600

If the full gross £1,440 was incorrectly posted to rent expense, first reclassify the tax portion (no cash movement; this is not a second payment):

Reclassification journal: Dr Input tax receivable £240 Cr Rent expense £240

(After this reclassification, the timing adjustment above is applied to the net rent figures.)

4) Insurance: prepayment

Paid during the year: £2,400 Amount relating to next period: £500

Insurance expense (20X8) = £2,400 − £500 = £1,900

Prepayment (insurance) at 31 December 20X8 = £500

Journal (year-end): Dr Prepayments (insurance) £500 Cr Insurance expense £500

5) Rent: one month unpaid (accrual)

Rent paid during the year: £9,000 One month unpaid at year-end: £900

Total rent expense (20X8) = £9,000 + £900 = £9,900

Journal (year-end): Dr Rent expense £900 Cr Accrued expenses (rent payable) £900

6) Consultancy income: accrued income

Consultancy income recorded/received: £7,800 Additional work completed but not invoiced: £1,100

Accrued income (consultancy) at 31 December 20X8 = £1,100

Journal (year-end): Dr Accrued income (consultancy receivable) £1,100 Cr Consultancy income £1,100

7) Maintenance contract: deferred income

Cash received on 1 December: £3,600 Contract length: 4 months (Dec to Mar) Monthly income: £3,600 / 4 = £900

Earned in 20X8 (December): £900 Unearned at 31 December 20X8 (Jan–Mar): 3 × £900 = £2,700

Maintenance income recognised in 20X8 = £900

Deferred income at 31 December 20X8 = £2,700

Journal (year-end): Dr Maintenance income £2,700 Cr Deferred income £2,700

8) Heating and cleaning: final expense figures

Heating (prepayment)

Heating paid: £4,200 Relating to April and May 20Y0: £700 (future benefit at year-end)

Heating expense (20X8) = £4,200 − £700 = £3,500

Prepayment (heating) at 31 December 20X8 = £700

Journal (year-end): Dr Prepayments (heating) £700 Cr Heating expense £700

Presentation note: this is an unusually long prepayment in the scenario. If it will be consumed more than 12 months after the reporting date, it would typically be presented as non-current (or split current/non-current if partly within 12 months).

Cleaning (accrual)

Cleaning expense recorded: £3,100 Still unpaid at year-end: £450

Cleaning expense (20X8) = £3,100 + £450 = £3,550

Journal (year-end): Dr Cleaning expense £450 Cr Accrued expenses (cleaning payable) £450

9) Service income: received in advance and accrued income

Service income currently recorded: £24,000 Included in this is:

• Income received in advance (unearned): £4,500
• Income earned but not yet invoiced: £1,200

Correct service income = £24,000 − £4,500 + £1,200 = £20,700

Journals (year-end):

1. Defer unearned portion:
2. Dr Service income £4,500
3. Cr Deferred income £4,500
4. Accrue earned but unbilled portion:
5. Dr Accrued income £1,200
6. Cr Service income £1,200

Mini statement extract (closing balances created by the adjustments)

Receivables / accrued income assets (presentation depends on the format used):

• Consultancy earned but unbilled: £1,100
• Service income earned but unbilled: £1,200

Prepayments (assets):

• Electricity £600
• Rent £600
• Insurance £500
• Heating £700 (classification may be non-current depending on timing)

Accrued expenses (liabilities):

• Wages £1,250
• Rent £900
• Cleaning £450

Deferred income (liabilities):

• Maintenance £2,700
• Service income £4,500

Common pitfalls and misunderstandings

• Letting cash timing drive profit: Recognition depends on earning/consumption, not payment/receipt.
• Posting adjustments to bank: Most adjustments post to an asset or liability, not to cash.
• Mixing up prepayments and accruals: A prepayment is a remaining benefit (asset). An accrual is an unpaid obligation (liability).
• Treating deferred income as “extra income”: It is a liability for work still to be done.
• Treating accrued income as “future income”: It is current-period income that is unbilled/unreceived at year-end.
• Not separating tax from the expense (where relevant): Recoverable input tax is not part of the cost.
• Cut-off mistakes: For inventory, assess when control/ownership transfers (often evidenced by delivery terms). For revenue, use the point when the customer obtains the goods or services under the contract terms, not invoice date.
• Not updating figures after journals: Marks are often lost by calculating the adjustment correctly but leaving statements unadjusted.
• Dividends misclassification: A liability arises only when the distribution is authorised/approved and no longer at the entity’s discretion at the reporting date.

Summary

Timing adjustments ensure that financial statements reflect the correct period’s income and expenses. Accruals recognise unpaid expenses as liabilities so costs are not understated. Prepayments carry forward unconsumed costs as assets so expenses are not overstated. Accrued income recognises earned income not yet billed/received as an asset. Deferred income records unearned receipts as liabilities so income is not recognised too early. Alongside these, other period-end adjustments such as inventory cut-off, interest accruals, and receivables impairment ensure that profit and the statement of financial position are complete, realistic, and aligned with the period’s activity.

FAQ

What is the main purpose of timing adjustments?

To ensure profit reflects the period’s activity by recognising income when earned and expenses when incurred/consumed, rather than when cash moves.

How do accruals and prepayments affect profit?

Accruals increase expenses and reduce profit. Prepayments reduce expenses and increase profit (compared with charging the full amount in the current period).

Is deferred income “income” at the reporting date?

No. Deferred income is a liability representing goods/services still to be provided in future periods.

Where is accrued income shown in the statement of financial position?

It is shown as part of receivables (or separately described as accrued income) depending on the statement format used. The key point is that it represents income already earned but not yet invoiced/received at the reporting date.

Is the impairment allowance on receivables a timing adjustment?

It is primarily a valuation adjustment at period-end (an estimate of non-recoverable amounts), not a cut-off item based on timing of payment.

When do dividends become a liability?

Only when they have been authorised/approved so that the entity no longer has discretion to avoid the distribution at the reporting date.

Glossary

Accrual (accrued expense) An expense relating to the current period that is unpaid and/or unrecorded at the reporting date; recognised as a liability.

Prepayment (prepaid expense) A payment made (or cost recognised) where part of the benefit relates to a future period; recognised as an asset.

Accrued income Income earned in the current period that has not yet been billed and/or received at the reporting date; recognised as an asset.

Deferred income Cash received (or receivable recognised) for goods or services not yet provided by the reporting date; recognised as a liability.

Matching (period-end matching) Recognising income and related costs in the period they arise so reported profit reflects performance for that period.

Reporting date / reporting period The end of the time period covered by the financial statements (for example, a year-end).

Adjusting entry A journal posted at the reporting date to update income, expenses, assets, and liabilities so the financial statements are complete and correctly stated.

Cut-off Ensuring transactions are recorded in the correct reporting period, particularly around the reporting date, by assessing when control/ownership transfers and when the contract terms are met.

Allowance for receivables impairment A contra-asset reducing receivables to reflect amounts not expected to be collected, based on a period-end estimate.