Who it's for: finance assistants and accountants who post month-end accruals and prepayments, and the controllers who review them.
What you'll get: plain-English rules for when to accrue and when to prepay, a monthly process, worked examples with journals, a prepayment schedule layout, and a one-slide summary to take to your boss.
Reading time: about 11 minutes. Longer if you stop to fix last month's schedule.
Why accruals and prepayments matter
Invoices rarely arrive in the month the cost belongs to. Without accruals, costs land late and profit looks better than it is. Without prepayments, a big annual bill makes one month look terrible and the next eleven look great. Both are about the same idea: putting costs in the month they were actually used. Get them right and month-on-month numbers start to mean something.
Key terms
- Accrual (accrued expense): a cost you've used this month but haven't been invoiced for yet. It's a liability on the balance sheet.
- Prepayment: a cost you've paid (or been invoiced for) in advance of using it. It's an asset on the balance sheet, released to the P&L as it's used.
- Accrued income: revenue earned but not yet billed. The income-side cousin of an accrual.
- Deferred income (deferred revenue): revenue billed but not yet earned. The income-side cousin of a prepayment.
- Reversing journal: a journal that automatically undoes itself on the first day of the next month.
- Matching (accruals basis): recognising costs in the period they relate to, not when cash moves. FRS 102 and IFRS both work on this basis.
The quick test: accrue, prepay or neither?
| Situation | Treatment | Where AI helps |
|---|---|---|
| Service used this month, no invoice yet | Accrue | Listing regular suppliers with no invoice this month |
| Invoice received and dated this month, covers this month only | Neither: post the invoice | Reading invoices and suggesting coding |
| Invoice covers several future months | Prepay, then release monthly | Spotting service periods on invoices |
| Invoice received in advance for next month only | Prepay, release next month | Flagging invoices with a future service date |
| Cost not yet used, no invoice | Neither: it's a future cost | Not needed |
| Small or one-off items under your threshold | Commonly expensed as invoiced | Grouping small items by size |
Many teams set a materiality threshold (for example, items under a few hundred pounds are expensed as invoiced). The level depends on the business and is worth writing down and agreeing with your auditors.
The monthly process
Accruals
| Step | What "done" looks like | |
|---|---|---|
| ☐ | Check last month's accruals reversed on Day 1 | Accruals account shows only this month's items |
| ☐ | List recurring suppliers and compare with invoices received | Every recurring supplier is either invoiced or on the accrual list |
| ☐ | Ask budget holders about services received but not invoiced | Responses saved with the working paper |
| ☐ | Estimate each accrual using the best evidence available | Each line has a basis: PO, contract, usage report, last invoice |
| ☐ | Post as a reversing journal, net of VAT | Journal posted with support attached |
| ☐ | Compare last month's accruals with the actual invoices | Big misses noted and the estimate method improved |
AI shortcut: give an approved AI tool three months of purchase ledger exports and this month's to date. Ask: "Which suppliers invoiced in each of the last three months but not yet this month? Give their average monthly net amount." That's a first draft of your accrual list. You confirm each one with the budget holder or usage data.
Prepayments
| Step | What "done" looks like | |
|---|---|---|
| ☐ | Review the month's invoices for anything covering future periods | New prepayments identified with start and end dates |
| ☐ | Add each to the prepayment schedule | Schedule shows cost, period, monthly release and balance remaining |
| ☐ | Post the monthly release from the schedule | Release journal matches the schedule total |
| ☐ | Agree schedule closing balance to the ledger | No difference, or every difference explained |
| ☐ | Remove items that have ended or been cancelled | No stale lines with zero or negative balances |
AI shortcut: ask an approved AI tool to read the month's supplier invoices and pull out any service period ("1 Nov 2026 to 31 Oct 2027", "annual licence") into a table with supplier, net amount, start date and end date. Check each line against the invoice before it goes on the schedule.
Worked example 1: an accrual and its reversal
MonthEndClub Co Ltd (fictional) used an external law firm in October for a contract review. The firm bills in arrears, and the invoice won't arrive until mid-November. The engagement letter and the partner's email put October's work at £4,500 plus VAT.
October: accrue the net cost. VAT isn't accrued, because it can only be reclaimed once there's a valid VAT invoice.
| Account | Dr | Cr |
|---|---|---|
| Legal and professional fees | £4,500 | |
| Accruals | £4,500 |
1 November: the accrual reverses automatically.
| Account | Dr | Cr |
|---|---|---|
| Accruals | £4,500 | |
| Legal and professional fees | £4,500 |
Mid-November: the real invoice arrives at £4,800 plus VAT at 20% (the standard rate as at October 2026).
| Account | Dr | Cr |
|---|---|---|
| Legal and professional fees | £4,800 | |
| VAT input tax | £960 | |
| Trade creditors | £5,760 |
Net effect in November: £4,800 − £4,500 = £300 of extra cost. October carries £4,500, which was the best estimate at the time. That's how it's meant to work.
Worked example 2: an annual software prepayment
On 1 September, MonthEndClub Co Ltd paid £24,000 plus VAT for a 12-month licence for a sales tool, running 1 September to 31 August.
September: post the invoice to prepayments.
| Account | Dr | Cr |
|---|---|---|
| Prepayments | £24,000 | |
| VAT input tax | £4,800 | |
| Trade creditors | £28,800 |
Each month: release one-twelfth. £24,000 ÷ 12 = £2,000.
| Account | Dr | Cr |
|---|---|---|
| Software subscriptions | £2,000 | |
| Prepayments | £2,000 |
The prepayment schedule at 31 October (with one other item, an insurance policy):
| Item | Cost (£) | Period | Monthly (£) | Released to date (£) | Balance 31 Oct (£) |
|---|---|---|---|---|---|
| Sales tool licence | 24,000 | Sep to Aug | 2,000 | 4,000 | 20,000 |
| Business insurance | 9,000 | Jul to Jun | 750 | 3,000 | 6,000 |
| Total | 33,000 | 2,750 | 7,000 | 26,000 |
The October release journal is £2,750, and the £26,000 balance is what the prepayments account in the ledger should show. (Insurance premiums are generally exempt from VAT and carry Insurance Premium Tax instead, which isn't reclaimable, so the full premium goes on the schedule.)
Worked example 3: when an accrual estimate is way off
MonthEndClub Co Ltd accrued £6,000 for September contractor costs, based on the previous month. The actual invoices came to £9,200 because a project ran late. The £3,200 difference hit October, making October's contractor line look high for no October reason.
The fix isn't to restate September. It's to improve the method: next time, ask the contractor's manager for days worked before the close, or use the timesheet system. Tracking estimate vs actual each month shows which accruals need a better basis.
AI shortcut: keep a simple table of each month's accruals and the actual invoices that followed. Ask an approved AI tool to rank the accruals by average percentage miss over six months. The top three are where a better estimate method pays off most.
If you report under US GAAP (ASC 606)
Accruals and prepayments work the same way under US GAAP. ASC 606 covers revenue rather than costs, so it affects accrued and deferred income, not the expense side. The terms differ a little: "accrued liabilities" and "prepaid expenses" are the common US labels.
Common mistakes and audit watch-outs
- Accruals that don't reverse. The cost gets counted twice once the invoice is posted. Use reversing journals.
- Accruing VAT. VAT generally isn't reclaimable until there's a valid invoice. Accrue the net cost.
- Prepayments with no schedule. A balance on the prepayments account that nobody can break down is an audit finding waiting to happen.
- Accruing for future costs. An accrual is for something already used. Next month's rent isn't an accrual, however certain it is.
- "Round number" accruals with no support. Every accrual needs a basis an auditor can follow.
- Forgetting cancelled contracts. If a subscription is cancelled early, the remaining prepayment may need writing off or claiming back.
- Posting AI-suggested accruals unchecked. An AI list based on past invoices will miss new suppliers and keep ones you've cancelled. Confirm each line with a person who knows.
Tools that can help
Xero, QuickBooks and Sage all support reversing journals, and some offer prepayment or repeating journal features. NetSuite has amortisation schedules for prepayments. Spend tools such as Pleo show committed spend before invoices arrive, which helps with accrual lists. Many teams still run the prepayment schedule in Excel or Google Sheets, which works fine if it's agreed to the ledger monthly. None of these replace the review; they just reduce the typing.
Take it to your boss: one slide
Making accruals and prepayments reliable
The problem: late invoices and annual bills make monthly costs jumpy, and month-on-month comparisons don't tell us much.
Three changes
- Recurring supplier check: every month, any regular supplier without an invoice is accrued or explained.
- One prepayment schedule: every prepayment listed with dates and monthly release, agreed to the ledger monthly.
- Estimate vs actual tracking: AI ranks the worst-estimated accruals; we fix the method for the top three.
| Risk | Control |
|---|---|
| Costs missed or double-counted | Reversing accruals; recurring supplier check |
| Prepayment balance unsupported | Schedule agreed to ledger monthly |
| AI suggestions wrong or incomplete | Approved tools only; budget holders confirm each line |
How we'll measure it: total accrual estimate vs actual (aim to narrow each month), number of late cost surprises, and schedule-to-ledger differences (aim for nil).
Rates, thresholds and rules in this guide
Figures were checked against the pages below in October 2026. They change regularly (often each April or at Budget time), and we can't guarantee they're still current or right for your situation. Always check the official page before relying on them.
- VAT rates (GOV.UK): the UK standard VAT rate of 20%
- VAT guide (VAT Notice 700) (HMRC, GOV.UK): needing valid evidence (normally a VAT invoice) before input VAT can be reclaimed
- Insurance (VAT Notice 701/36) (HMRC, GOV.UK): insurance being exempt from VAT and Insurance Premium Tax not being recoverable
Key takeaways
- Accrue for costs already used but not invoiced; prepay for costs paid ahead of use.
- Accrue net of VAT and use reversing journals.
- Keep every prepayment on one schedule, and agree it to the ledger every month.
- Every accrual needs a basis someone else can follow.
- Track estimates against actuals and fix the worst methods first.
- Use AI to build the first draft of the lists; people confirm each line.
FAQs
What's the difference between an accrual and a provision?
An accrual is for a cost you've already received the goods or service for, with a fairly certain amount. A provision is a liability where the timing or amount is uncertain, such as a legal claim, and it has its own rules under FRS 102 and IFRS.
Do I need a prepayment for a monthly subscription?
Usually not. If you're billed each month for that month, the invoice already lands in the right period. Prepayments matter for invoices covering several months.
What materiality threshold do teams use?
It varies with the size of the business. Many smaller SaaS companies use a few hundred pounds; larger ones go higher. The key is that it's written down, applied consistently and understood by the auditors.
Can AI build my accruals list?
It can build a strong first draft from past invoices, purchase orders and usage reports. It won't know about a new supplier or a cancelled contract, so budget holders confirm the list and a person approves the journal. Only use company-approved tools for supplier and financial data.
Related guides
- Managing Prepaid Software Subscriptions
- Cloud Hosting Costs: Accruing, Allocating, and COGS vs Opex
- Payroll Journals and Bonus Accruals at Month-End
- Journal Entry Cheat Sheet: Debits and Credits for Common SaaS Transactions
More in Costs and Accruals guides.
From the Club
Accrued, reversed, and still thirsty. The Team Mug · The Debits Credits Done Bag
Join the Club. New guides, early access and members-only batches. Join here.
This guide is general information about common practice. It isn't tailored to any business, and standards, tax rules and figures change. Check your own circumstances, the latest rules and, where needed, a qualified professional before acting.
Last reviewed: October 2026.