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3. Classify capital, liabilities and Assets
3.2. Accrued expenses and prepaid expenses are determined as per the accounting principles
Accrued Expenses and Prepaid Expenses
These are adjustments made at the end of an accounting period to comply with the accrual principle of accounting, which states that expenses must be recorded in the period they are incurred, not necessarily when they are paid.
1. Accrued Expenses (Accrued Liabilities)
Definition:
Expenses that have been incurred during an accounting period but have not yet been paid by the end of the period.
Classification:
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Current liabilities on the Statement of Financial Position (Balance Sheet).
Examples:
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Salaries and wages payable
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Rent payable
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Utilities payable
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Interest on loans
Accounting Treatment (Double Entry):
| Transaction | Debit | Credit |
|---|---|---|
| Record accrued expense | Expense Account | Accrued Expense (Liability) |
Purpose:
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Recognizes expenses in the correct accounting period
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Ensures accurate profit or loss calculation
2. Prepaid Expenses (Prepayments)
Definition:
Expenses paid in advance for goods or services to be received in a future accounting period.
Classification:
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Current assets on the Statement of Financial Position.
Examples:
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Prepaid rent
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Prepaid insurance
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Prepaid subscriptions
Accounting Treatment (Double Entry):
| Transaction | Debit | Credit |
|---|---|---|
| Record prepaid expense | Prepaid Expense (Asset) | Cash/Bank |
Adjusting Entry at the End of Period:
When the prepaid expense is used up, it becomes an expense:
| Transaction | Debit | Credit |
|---|---|---|
| Allocate prepaid expense to current period | Expense Account | Prepaid Expense (Asset) |
Purpose:
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Ensures expenses are recorded in the period they relate to
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Prevents overstating expenses or understating assets
3. Key Accounting Principle
Both accrued and prepaid expenses are determined according to the accrual principle, which ensures:
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Expenses are matched with the revenue they help generate (Matching Principle)
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Financial statements reflect the true financial position of the business
Short Exam-Ready Summary
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Accrued expenses: Expenses incurred but not yet paid → liability → Dr Expense, Cr Accrued Expense.
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Prepaid expenses: Expenses paid in advance → asset → Dr Prepaid Expense, Cr Cash/Bank.
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Both are adjustments made to comply with the accrual principle for accurate financial reporting.