Accruals and prepayments stand on the basis of the double-entry bookkeeping system and modern financial accounting.
The accruals concept is often used to refer to both accruals (outstanding or unpaid expenses) and prepayments (payments in advance) (payments in advance).
You may recall that previously in this section, we examined some of the accounting principles and, in particular, we highlighted the importance of the accruals concept, where the accruals concept refers to the process of matching income and costs of the same accounting period.
A firm will prepare its accounts for a set period of time. Generally, at least every year and accountants spend substantial work at the conclusion of each financial year, ensuring that the final accounts include only those numbers that pertain to a certain financial year.
Suppose that you are preparing the profit and loss account for the year ended 31 December 2019. You should include only revenue and expenses that relate to 2019 and not include any revenue or expenses relating to matters which should properly be accounted for in 2018 or 2020.
A business that has a year-end of 31 December 2019 should include in the profit and loss account only those amounts that relate to the period between 1 January and 31 December 2019. Therefore, if you are preparing the final accounts for the business, you should not include any expenses that were incurred or relate to any time before 1 January 2019 or after 31 December 2019.
Likewise, suppose a cost, such as the rent of an office, was paid 12 months in advance on 1 October 2019. In that case, just three months of the rent expense (1 October 2019 to 31 December 2019) will be relevant for inclusion in the profit and loss statement for the year ending 31 December 2019.