These are the essential accounting concepts used in closing accounting periods. Closing these accounting entries in the real world is often more challenging and technical.

Let’s review the concept and related examples for accrual and prepaid expenses.

Accrual in the balance sheet

We are expected to have utilized some service at the time of closing the accounting period, but we don’t have bills/invoices in hand. So, we have no other option but to provide accrual. A final entry can be posted once we have bills in hand.

So, the next question arises: why do we need to record accrual?

We have already utilized the services but do not have bills/invoices. So, we must record expenses as we have utilized the services. However, we do not have confirmed figures. Hence, we have to record accrual.

Additionally, recording accrual is in line with the matching concept of accounting which states expenses and revenues should be recorded in the accounting periods when they were incurred/earned.

Examples of situations when we need to provide accrual

The following are situations where accrual is posted on the balance sheet.

• Electricity was consumed, but the bill was not received at the end of the accounting period.
• Security services were utilized, but the invoice was not received until the end of the accounting period.
• Telephones were used throughout the accounting period, but no invoice/bill was received from the telephone company, so we need to record the accrual.

It’s important to note that accrual can only be recorded once we have utilized the service in the accounting period.

Accounting for accrual

Accruals are liabilities, as we have utilized the services but haven’t made the payment. Hence, they should be posted in the current accounting period.

We need to provide accrual for the electricity expenses as we have utilized the electricity but haven’t made payment or even have a bill/invoice. So, we are not sure about the amount to be paid. In this case, we need to accrue by looking at the electricity expense incurred in the previous accounting period and adjusting current utilization.

The following journal entry must be posted in the accounting record for accrual.

Description	Debit	Credit
Expense (profit and loss)	XXX
Accrued liability		XXX

The debit impact of the given transaction records expense in the accounting record as we have utilized the electricity or economic benefits in the current accounting period. In other words, not having an invoice/bill does not prevent us from recording expenses in the accounting period in which they were incurred.

So, once we have a bill/invoice after the accounting period ends, the accrual is removed by debit, and cash/bank can be credited.

Prepaid concept in accounting

Prepaid is when the business has paid cash in advance but did not utilize the economic benefits. It’s simple: you have purchased an insurance policy for one year and paid fully in advance; at the end of the first month, you’ll be required to record expenses for one month and keep eleven months as a prepaid balance. Let’s understand prepaid with the example.

Consider you paid $1200 for the insurance policy covering the next 12 months. At the end of the first month, the following journal entry will be posted in the accounting records.

Description	Debit	Credit
Insurance expense	100
Prepaid assets		100

The debit impact of this transaction is to record expenses for one month. This is because the business has utilized one-month insurance coverage. On the other hand, the credit impact reduces the prepaid asset for a month by only $100 ($1200/12×1). It’s important to note that $100 remain as prepaid balance in the business balance sheet.  

The same journal entry for this insurance policy is posted at the end of each accounting month. Let’s explain the difference between accrual and prepaid succinctly.

Difference between accrual and prepaid

Accrual is posted in the accounting record when we have utilized some services but have not received the invoice/bill. Hence, we cannot ascertain the amount of the bill with certainty. So, we post accrual liability to ensure the expense is recorded in the relevant and appropriate accounting period in compliance with the matching concept of accounting. On the other hand, prepaid expense is an asset or payment made in advance for services that were not yet utilized.

Conclusion

Accrual or accrued liability is recorded in the balance sheet against relevant expenses. It needs to be recorded when the business has utilized the services but is unsure about the final amount of the bill. The accrued liability/expense is recorded per the matching accounting concept.

Prepaid expense occurs when the business has paid in advance for specific expenses to be incurred shortly. The prepaid asset is removed, and the expense is recorded in line with the proportion of economic benefit utilization.

Accrued expense is different from prepaid expense as accrued expense is a liability, while prepaid expense is an asset.