Accruals and prepayments: how do I know which way round the adjustment goes?

Stop trying to remember which is which. Work it out from one question, every time: has the expense been used up, and has it been paid for? Those two things come apart, and the adjustment exists to put them back together.

The one rule underneath both

The income statement should show the expense for the period, not the cash that happened to leave the bank during it. That is the whole idea. Everything else follows.

So ask the two questions in order.

Used up but not paid for → accrual. You have had the benefit, the cash has not gone. The expense belongs in this year's income statement, and you owe somebody, so there is a liability on the statement of financial position.

Paid for but not used up → prepayment. Cash has gone, the benefit has not arrived. The expense belongs in next year, so you take it out of this year and carry it forward as an asset: somebody owes you a service.

Why "accrual = liability" is worth memorising as a pair

Most of the lost marks are not in the income statement, they are in the statement of financial position, where candidates put the figure on the wrong side or leave it out entirely. Tie them together:

• Accrual → an expense you still owe → liability (current liabilities)
• Prepayment → an expense you paid early → asset (current assets)

If you can say the word "owe" about it, it is a liability. If you can say "owed to me", it is an asset.

Working it on a question

Say rent is 12,000 for the year and you have paid 15,000 by the year end.

Ask the questions. Used up: 12,000. Paid: 15,000. You have paid for more than you used, so 3,000 is a prepayment. Income statement shows 12,000. The 3,000 sits in current assets.

Now reverse it: paid 9,000 against a 12,000 charge. Used 12,000, paid 9,000, so 3,000 is accrued. Income statement still shows 12,000. The 3,000 sits in current liabilities.

Notice the income statement figure did not move. It is 12,000 either way, because that is what the period consumed. Only the balance sheet side changes. Once you see that the income statement is the fixed point and the adjustment is the balancing figure, the direction stops being something you have to recall.

The trap in exam questions

Questions frequently give you the opening accrual or prepayment as well as the closing one, and the mark is for dealing with both. The brought-forward figure reverses: last year's accrual was an expense last year, so it must not be charged again this year.

Set it out as a T account for the expense rather than trying to do it in your head. Opening balance, cash paid, closing balance, and the income statement charge falls out as the balancing figure. It takes thirty seconds and it is almost impossible to get the sign wrong that way.