Prepaids and accruals relate to the two types of adjusting entries in accounting. Prepaids are ether prepaid revenues or prepaid expenses. On the other hand, accruals are either accrued revenues or accrued expenses.
Companies don’t record prepaid and accrual-related revenues and expenses during an accounting period because some transactions are incomplete. But at the end of an accounting period, companies must make entries to adjust revenues that have been earned and accrued and expenses that have been incurred and accrued.
What Are Prepaids?
Prepaids are paid by customers for future sales or paid by companies themselves on purchases for future uses. Companies may refer to prepayments as prepaid revenues or prepaid expenses, but they are revenues that are unearned and expenses that have not been incurred, and thus cannot be recorded as revenue or expense until earned or incurred, usually by the end of an accounting period.
Prepayments received from customers as unearned revenue are company liabilities until they become fully earned over time. Prepayments paid by companies as prepaid expense are company assets until they are fully allocated to future uses.
What Are Accruals?
Accruals are revenues earned but not yet received in cash from customers or expenses incurred but not yet paid in cash by companies. Unlike prepaids, which cannot be recorded as revenue or expense at the time of the transactions, accruals may be left out in recording by companies when they should be recognized as revenue earned or expense incurred.
Compared to prepaid revenue as a company liability, accrued revenue results in accounts receivable, a company asset. Contrary to prepaid expense as a company asset, accrued expense results in accounts payable, a company liability.
Read More: Accrued Revenue vs. Unearned Revenue
Prepaids and Cash Transactions
While prepaids involve cash transactions on both prepaid revenues and prepaid expenses, accruals involve no cash transactions for either accrued revenues or accrued expenses. Companies do make journal entries to record the cash transactions on prepaids at the time they take place during an accounting period, but make no journal entries on accruals during an accounting period. Accruals can happen without an apparent business transaction taking place.
Read More: How Does Unearned Revenue Arise?
Prepaid Adjustments for Revenues Earned
Adjustments are journal entries made at the end of an accounting period to record revenues earned or expenses incurred from both the prepaids and accruals, and to report changes to their related asset and liability accounts. When a revenue is earned and recognized out of customers’ sales prepayments, the unearned revenue liability is reduced by the amount of recorded revenue. When an expense is incurred and recognized out of a company’s purchase prepayments, the prepaid expense asset is also reduced by the amount of recorded expense.
When companies record an accrued revenue, they also increase the asset of accounts receivable by the same amount. When companies record an accrued expense, they also increase the liability accounts payable.
An investment and research professional, Jay Way started writing financial articles for Web content providers in 2007. He has written for goldprice.org, shareguides.co.uk and upskilled.com.au. Way holds a Master of Business Administration in finance from Central Michigan University and a Master of Accountancy from Golden Gate University in San Francisco.