What Is the Difference Between Prepaids & Accruals?
Every business is concerned with managing its expenses, since its main goal is to maximize its profit. The timing of when expenses are incurred and paid determines how they are shown on a company's financial statements. Accruals and prepaids are made to the general ledger when a company uses the accrual basis of accounting.
Difference Between Prepaids and Accruals
Prepaids and accruals relate to the services and goods a company receives from its vendors for which payment has been or will be made. Prepaid expenses are the advance payments for goods and services that are to be used up in the future and are classified as an asset on the balance sheet, while expense accruals are liabilities, amounts that have been incurred but have not been paid by a period's end.
To further explain the difference between prepaids and accruals, assume that on January 8, a company pays $12,000 in advance to a local contractor after signing a maintenance agreement that has a contractual period of February 1 through January 31 of the following year.
On August 31, the initial entry to record the advance payment related to the maintenance agreement on the customer's books is as follows:
Debit Prepaid Expense 12,000 Credit Cash 12,000
Since the contract does not begin until February 1, the prepaid expense account on January 31 remains at the contract amount. At the end of each month beginning with February, the accountant will increase, or debit, repairs and maintenance expense by $1,000, and decrease, or reduce, the prepaid expense account by the same amount.
Assume instead that the maintenance agreement still has a contractual period of February 1 through January 31 of the following year in the amount of $12,000, but requires the company to make quarterly payments at the end of each quarter totaling $3,000. At the end of the first month of service, February, the company has incurred maintenance expenses from the service benefits of the agreement.
Although the payments are made on a quarterly basis, the expense must still be recognized for the services that were used for the month. The entry to record the expense at the end of February will occur as follows:
Debit Maintenance and Repairs Expense 1,000 Credit Services Payable 12,000
Note that services payable, a liability account on the company's balance sheet, is increased to show the outstanding amount the business owes to the vendor.
Keela Helstrom began writing in 2010. She is a Certified Public Accountant with over 10 years of accounting and finance experience. Though working as a consultant, most of her career has been spent in corporate finance. Helstrom attended Southern Illinois University at Carbondale and has her Bachelor of Science in accounting.