ACCA Applied Knowledge · Financial Accounting
Accruals, Prepayments, Accrued Income and Deferred Income Explained
Accruals, prepayments, accrued income and deferred income adjust the ledger so that profit shows only the expenses and income that belong to the period, whatever the cash flows. To solve questions, compare the amount paid or received with the amount earned or used, then record the difference as a year-end asset or liability.
What this chapter covers
This chapter applies the accruals (matching) concept to the ledger. Cash paid or received in a year often does not equal the expense or income that belongs to that year. You fix the gap with four adjustments. An accrued expense is an expense used but not yet paid, so it is a current liability. A prepaid expense is paid in advance for a future period, so it is a current asset. Accrued income is income earned but not yet received, so it is a current asset. Deferred income is cash received for a future period, so it is a current liability.
You will work in ledger accounts. You post the cash paid, add or subtract the closing balance, and move the balancing figure to the statement of profit or loss. Then you carry the closing balance down to the next period as the opening balance. The same logic gives you the figures for the statement of financial position.
This chapter links to much of the paper. It feeds the preparation of financial statements from a trial balance, which is tested in Section B accounts preparation questions. It also sits close to topics such as irrecoverable debts, depreciation and bank reconciliations, which are all period-end adjustments. Section A tests the chapter with quick two-mark objective questions, often with number entry.
Almost every set of financial statements needs accrual and prepayment adjustments, so this chapter appears both in stand-alone objective test questions and inside the longer accounts preparation question. The calculations are short, which makes them reliable marks if you are accurate. An error here also carries into profit, current assets and current liabilities, so one slip can cost marks in several places. The chapter is also a quick win for new students because the rules follow one pattern, and you can learn that pattern in a few sessions.
Accrued expenses (accruals), prepaid expenses (prepayments), accrued income and deferred income: topics in the order to study them
- 1Accruals and Matching ConceptStart here because the concept explains why every adjustment in the chapter exists, and accrued expenses are the simplest case.
- 2Prepaid Expenses (Prepayments)This is the mirror image of an accrual, so it is easiest to learn straight after accruals while the logic is fresh.
- 3Accrued Income and Deferred IncomeOnce you know the expense side, you apply the same ideas to income and learn which side is an asset and which is a liability.
- 4Ledger Accounts and Adjustments for Accruals/PrepaymentsFinish with full ledger accounts, because they combine all four adjustments and match the way exam questions are set.
How to prepare Accrued expenses (accruals), prepaid expenses (prepayments), accrued income and deferred income
Aim to make the method automatic. Every question in this chapter has the same shape, so practise the shape until you can do it quickly on a phone or on a computer-based exam screen.
- Learn the four terms with one-line definitions and note whether each is an asset or a liability. Say it aloud: accrued expense and deferred income are liabilities; prepayment and accrued income are assets.
- For each item, ask two questions: what has been paid or received, and what belongs to this period? The expense or income for the period is the second figure, not the first.
- Practise time-apportionment. For example, an annual payment of $12,000 covering 12 months from 1 October has 3 months in a year ending 31 December, so $3,000 belongs to that year and $9,000 is a prepayment.
- Draw ledger accounts by hand. Enter the opening balance, the cash paid or received, the closing balance carried down, and the balancing figure to profit or loss. Check which side each opening balance sits on.
- Work through objective test questions in all three formats: multiple choice, multiple response and number entry. For number entry, check whether the question wants the expense, the closing balance or the cash paid.
- Finish with a short trial balance exercise. Apply the adjustments, then state the effect on profit, current assets and current liabilities, and check your answer makes sense.
Common mistakes in Accrued expenses (accruals), prepaid expenses (prepayments), accrued income and deferred income
Treating the cash paid as the expense for the year.
Fix: Always adjust for opening and closing accruals and prepayments before you take the figure to profit or loss.
Putting an accrual in current assets or a prepayment in current liabilities.
Fix: Remember that you owe an accrual, so it is a liability, and you own a prepayment, so it is an asset. Do the same for income, but reverse the thinking: accrued income is owed to you, deferred income is owed by you.
Adding the opening accrual instead of subtracting it when finding the expense.
Fix: Use a ledger account and let the balancing figure show the answer. The opening accrual reduces this year's expense because last year already charged it.
Getting the time period wrong when apportioning an annual cost.
Fix: Write the start and end dates of the cover, count the months to the year end, and then count the months after it.
Confusing accrued income with deferred income.
Fix: Ask whether the cash has arrived. If the income is earned but cash has not arrived, it is accrued. If cash has arrived but the income is not yet earned, it is deferred.
Answering the wrong quantity in a number entry question.
Fix: Underline what is asked before you calculate, and check the final answer against the question wording and the required units.
Last-day revision: Accrued expenses (accruals), prepaid expenses (prepayments), accrued income and deferred income
- Accruals concept: record income and expenses when earned or incurred, not when cash moves.
- Accrued expense: used but unpaid, so a current liability and an extra charge to profit or loss.
- Prepaid expense: paid for a future period, so a current asset and a reduction of the charge.
- Accrued income: earned but not yet received, so a current asset and extra income.
- Deferred income: received for a future period, so a current liability and a reduction of income.
- Expense for the year = cash paid + closing accrual − opening accrual − closing prepayment + opening prepayment.
- An opening accrual is a credit balance brought down and an opening prepayment is a debit balance brought down.
- Closing balances are carried down in the ledger and become next year's opening balances.
- Time-apportion annual payments by the months that fall in the period.
- Accruals and prepayments change profit; they do not change cash.
- Always check whether the question asks for the profit or loss charge or the statement of financial position figure.
Accrued expenses (accruals), prepaid expenses (prepayments), accrued income and deferred income practice questions
- At 30 June, Orwell Co's trial balance shows a rent expense of $15,000 for the year. It is then discovered that rent for the final month, $1,…
- Brightway Ltd has a year end of 31 December. On 1 January it owed $1,200 for electricity. During the year it paid $9,000 in cash for electri…
- Barton Co has a year end of 31 December. Electricity paid during the year was $9,400. The accrual at 31 December last year was $1,100 and th…
- Which journal correctly records, at the year end, a prepayment of $1,500 for insurance that was originally debited in full to the insurance …
- Which of the following best explains why a business records an accrual for electricity used in December when the bill will only be received …
- Zeta Co has a year end of 31 December 2025. On 1 October 2025 it let a warehouse to a tenant for 12 months at 48,000 payable annually in adv…
- Which statement best describes how the accruals (matching) concept applies to expenses in the statement of profit or loss?
- Kestrel Co has a year end of 31 December. On 1 October 20X4 it paid $12,000 for insurance covering the 12 months to 30 September 20X5. What …
Accrued expenses (accruals), prepaid expenses (prepayments), accrued income and deferred income in other exams
The same ground in other exams, if you are preparing for more than one or want another angle on it.
Accrued expenses (accruals), prepaid expenses (prepayments), accrued income and deferred income: frequently asked questions
What is the difference between an accrual and a prepayment?
An accrual is an expense that has been used but not yet paid, so it is a current liability. A prepayment is an expense paid in advance for a future period, so it is a current asset. Both adjust the expense in profit or loss to match the period.
Is deferred income an asset or a liability?
It is a current liability. You have received cash, but you have not yet provided the goods or services, so you owe the customer performance. You release it to income in the period you earn it.
How do I find the expense for the year from a ledger account?
Open the ledger account with the opening balance, add the cash paid, and enter the closing accrual or prepayment. The balancing figure is the expense for profit or loss. Check that an accrual sits as a credit balance and a prepayment as a debit balance.
How is this chapter tested in the FA exam?
It appears in Section A as two-mark objective test questions, including multiple choice, multiple response and number entry. It also appears inside the 15-mark accounts preparation question in Section B, where you adjust a trial balance. You need to be both accurate and quick.