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Worked example
Accruals and prepayments, worked through a bakery
The accruals concept means expenses belong to the period they relate to, not the period you pay them. Here it is worked step by step through a bakery’s year-end insurance and electricity.
Updated August 2026 · 7 min read
Accruals and prepayments are where new students first meet the difference between cash and profit. The rule behind them, the accruals concept, is one of the most important ideas in accounting: an expense belongs to the period it relates to, not necessarily the period you happened to pay it. Two short adjustments at the year-end put that right. Here they are, worked through a bakery.
The accruals concept
Profit is not the same as cash. If you pay a year's insurance in advance, it would flatter this year's profit to count the whole payment now; and if you have used electricity that has not yet been billed, it would flatter this year's profit to ignore it. The accruals concept fixes both by matching expenses to the period they belong to. A prepayment carries part of a payment forward to next year; an accrual brings an unpaid expense into this year.
The scenario
Rosewood Bakery has a year-end of 31 December. Two items need adjusting. It paid £1,200 for a year's insurance on 1 October, covering the twelve months to 30 September next year. And it has paid £2,000 of electricity bills during the year, but those bills only run to 30 November; the electricity used in December, estimated at £250, has not yet been billed.
The prepayment: insurance
The £1,200 covers twelve months, so £100 a month. Only three of those months, October, November and December, fall in this year, so only £300 is this year's expense. The remaining nine months, £900, relate to next year and are carried forward as a prepayment, which sits as a current asset on the statement of financial position.
So insurance in this year's profit or loss is £300, not the £1,200 paid, and a £900 prepayment appears as an asset.
The accrual: electricity
The £2,000 of bills only covers up to 30 November, but the bakery used electricity in December too. That December cost of £250 belongs to this year even though no bill has arrived, so we accrue it: add £250 to the expense and record a £250 accrual as a current liability.
So electricity in this year's profit or loss is £2,250, not the £2,000 paid, and a £250 accrual appears as a liability.
The two adjustments together
The quick way to remember which is which: a
prepayment is paid in advance, so it is an asset (something owed to you); an
accrual is an amount you still owe, so it is a liability. In both cases the profit or loss shows the expense for the period, not the cash that moved.
Where this comes up in ACCA
Accruals and prepayments are core to Financial Accounting (FA), both as standalone questions and as adjustments inside a larger set of financial statements. The accruals concept then underpins almost everything that follows, from preparing statements in FR to the judgement papers beyond, so it is worth getting completely solid early.
The best way to make these automatic is to do lots of them. The free ACCA FA course on Clevernest teaches the year-end adjustments inside a real business, with instant marking as you go.
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Frequently asked questions
What is the difference between an accrual and a prepayment?
An accrual is an expense that has been incurred but not yet paid or billed, so it is added to this year's expenses and shown as a current liability. A prepayment is an expense paid in advance for a future period, so it is removed from this year's expenses and shown as a current asset.
How do you calculate a prepayment?
Work out how much of the amount paid relates to a future period and carry that forward as a current asset; the rest is this year's expense. In our example £1,200 of insurance covers twelve months, only three of which fall in this year, so £300 is the expense and £900 is the prepayment.
What is the accruals concept?
The accruals concept, also called the matching concept, means expenses and income are recognised in the period they relate to, regardless of when the cash is paid or received. It is what makes profit different from cash flow.
Is a prepayment an asset or a liability?
A prepayment is a current asset, because it represents a future benefit you have already paid for. An accrual is a current liability, because it represents an amount you still owe for something you have already used.
Where are accruals and prepayments tested in ACCA?
They are core to Financial Accounting (FA), both as their own questions and as adjustments within a larger set of financial statements. The underlying accruals concept then runs through Financial Reporting and the later papers.