Timing Adjustments: Accruals, Prepayments, Accrued Income, Deferred Income

Learning objectives

By the end of this chapter you should be able to:

• Explain why period-end timing adjustments are required under the accrual basis to report performance and position for the correct period.
• Calculate and record accruals and prepayments for operating expenses, ensuring costs are charged to the period of consumption.
• Calculate and record accrued income and deferred income for revenue, ensuring income is recognised only when earned.
• Prepare clear schedules that reconcile timing items to closing statement of financial position balances.
• Avoid common timing errors including cut-off mistakes, double counting, and incorrect classification between assets and liabilities.

Overview & key concepts

Bookkeeping is often driven by cash: payments are posted as expenses and receipts as income. Financial statements, however, must report what belongs to the period, not simply what was paid or received in that period.

Timing adjustments correct this difference by separating:

• Cash timing (when money moves), from
• Economic timing (when goods/services are consumed or provided).

Four adjustments recur throughout accounts preparation:

• Accruals (expenses owing): cost consumed in the period but not yet paid/invoiced.
• Prepayments (expenses paid in advance): cash paid, but some benefit belongs to a later period.
• Accrued income (earned but not yet billed/received): work done in the period, invoice/cash later.
• Deferred income (received in advance): cash received, but the related service/goods will be delivered later.

A reliable sense-check is the accounting equation:

Assets = Liabilities + Equity

• Prepayments and accrued income are assets (future benefit or amounts due to the entity).
• Accruals and deferred income are liabilities (amounts owed by the entity or obligations to deliver).

Core theory and frameworks

1) A statement of financial position first approach (reporting date logic)

Start at the reporting date and decide what should appear on the statement of financial position. Then build the journal to get there.

At the reporting date, does anything remain outstanding?

• If the entity still owes something (money to a supplier, or goods/services to a customer) → expect a liability.
• If the entity still has something of value (unused benefit, or an amount due from a customer) → expect an asset.

Once the correct closing asset or liability is identified, the journal entry follows directly.

2) Quick link between the adjustment and the two statements

Timing item	Closing statement of financial position caption	Profit or loss direction (typical)
Accrued expense	Liability: accrued expenses	Expense increases
Prepayment	Asset: prepayments	Expense decreases
Accrued income	Asset: accrued income / unbilled receivable	Income increases
Deferred income	Liability: deferred income / income received in advance	Income decreases

These effects assume no tax and no other adjustments.

3) Double-entry logic (debits and credits)

Accruals (expenses owing)

• Year-end journal:
  • Dr Expense
  • Cr Accrued expenses (liability)

Prepayments (expenses paid in advance)

• Year-end journal (if the payment was posted to expense):
  • Dr Prepayments (asset)
  • Cr Expense

Accrued income (earned but not yet billed/received)

• Year-end journal:
  • Dr Accrued income (asset)
  • Cr Income

Terminology note: In practice this may be described as an unbilled receivable (and, in more advanced reporting language, sometimes a contract asset). Once an invoice is raised, it is typically presented as a trade receivable.

Deferred income (received in advance)

• Year-end journal (if the receipt was posted to income):
  • Dr Income
  • Cr Deferred income (liability)

Worked example

Narrative scenario

Consider a company, ABC Ltd, with the following transactions during the year ending 31 December 2025:

1. Paid £1,200 for insurance covering 12 months from 1 October 2025.
2. Received £900 in December for a three-month subscription starting January 2026.
3. Used electricity worth £500 in December, billed in January 2026.
4. Completed services worth £1,350 in December, invoiced in January 2026.
5. Paid £2,000 for rent covering four months from 1 November 2025.
6. Received £600 in December as a service advance for work to be carried out in January 2026.
7. Wages of £780 relating to the last week of December 2025 were unpaid at 31 December 2025 and were paid in January 2026.
8. Completed consulting services worth £2,000 in December, invoiced in January 2026.
9. Paid £1,440 for a software licence covering 12 months from 1 January 2026.
10. Received a £500 deposit in December for a January 2026 job.

Required

• Calculate and record the necessary timing adjustments for the year ending 31 December 2025.
• Prepare schedules for each adjustment.
• Determine the impact on the statement of financial position and the statement of profit or loss.
• Identify and correct any misclassifications.

Solution

A) Calculations and journals (year ending 31 Dec 2025)

1) Insurance prepayment

• Payment: £1,200 for 12 months (1 Oct 2025 – 30 Sep 2026)
• Portion relating to 2025: 3 months (Oct–Dec)
• Expense for 2025: £1,200 × 3/12 = £300
• Prepayment at 31 Dec 2025: £1,200 − £300 = £900

Year-end journal:

• Dr Prepayments £900
• Cr Insurance expense £900

2) Deferred income (subscription)

• Cash received: £900 in Dec 2025
• Service period: Jan–Mar 2026
• Income earned in 2025: £0
• Deferred income at 31 Dec 2025: £900

Year-end journal:

• Dr Subscription income £900
• Cr Deferred income £900

3) Accrued expense (electricity)

• Electricity used in Dec 2025: £500
• Not yet billed/paid at 31 Dec 2025

Year-end journal:

• Dr Electricity expense £500
• Cr Accrued expenses £500

4) Accrued income (services)

• Services completed in Dec 2025: £1,350
• Invoiced in Jan 2026

Year-end journal:

• Dr Accrued income £1,350
• Cr Service income £1,350

5) Rent prepayment

• Payment: £2,000 for 4 months (Nov 2025 – Feb 2026)
• Portion relating to 2025: 2 months (Nov–Dec)
• Expense for 2025: £2,000 × 2/4 = £1,000
• Prepayment at 31 Dec 2025: £2,000 − £1,000 = £1,000

Year-end journal:

• Dr Prepayments £1,000
• Cr Rent expense £1,000

6) Deferred income (service advance)

• Cash received: £600 in Dec 2025 for January 2026 work
• Income earned in 2025: £0
• Deferred income at 31 Dec 2025: £600

Year-end journal:

• Dr Service income £600
• Cr Deferred income £600

7) Accrued expense (wages)

• Wages relating to Dec 2025 unpaid at year end: £780

Year-end journal:

• Dr Wages expense £780
• Cr Accrued expenses £780

8) Accrued income (consulting)

• Consulting completed in Dec 2025: £2,000
• Invoiced in Jan 2026

Year-end journal:

• Dr Accrued income £2,000
• Cr Consulting income £2,000

9) Software licence prepayment

• Payment: £1,440 for 12 months (1 Jan 2026 – 31 Dec 2026)
• Portion relating to 2025: £0
• Prepayment at 31 Dec 2025: £1,440

Year-end journal:

• Dr Prepayments £1,440
• Cr Software licence expense £1,440

10) Deferred income (deposit for January job)

• Deposit received: £500 in Dec 2025 for January 2026 work
• Income earned in 2025: £0
• Deferred income at 31 Dec 2025: £500

Year-end journal:

• Dr Income (as initially credited) £500
• Cr Deferred income £500

B) Supporting schedules

The schedules below reconcile each statement of financial position caption to its closing balance at 31 Dec 2025. (Opening balances are assumed to be nil.)

Prepayments (asset) — closing balance at 31 Dec 2025

Description	£
Opening balance (1 Jan 2025)	0
Add: year-end prepayments recognised (see breakdown)	3,340
Closing balance (31 Dec 2025)	3,340

Breakdown of closing prepayments:

• Insurance £900
• Rent £1,000
• Software licence £1,440
  Total £3,340

Accrued income (asset) — closing balance at 31 Dec 2025

Description	£
Opening balance (1 Jan 2025)	0
Add: income earned but not yet invoiced (see breakdown)	3,350
Closing balance (31 Dec 2025)	3,350

Breakdown:

• Services £1,350
• Consulting £2,000
  Total £3,350

Accrued expenses (liability) — closing balance at 31 Dec 2025

Description	£
Opening balance (1 Jan 2025)	0
Add: expenses incurred but unpaid at year end (see breakdown)	1,280
Closing balance (31 Dec 2025)	1,280

Breakdown:

• Electricity £500
• Wages £780
  Total £1,280

Deferred income (liability) — closing balance at 31 Dec 2025

Description	£
Opening balance (1 Jan 2025)	0
Add: cash received for work/services not yet provided (see breakdown)	2,000
Closing balance (31 Dec 2025)	2,000

Why the addition equals the full receipts: in this scenario none of the receipts relate to work performed by 31 Dec 2025, so the entire amount is reclassified from income to a liability at the year end.

Breakdown:

• Subscription received in advance £900
• Service advance for January work £600
• Deposit for January job £500
  Total £2,000

C) Impact on the financial statements (net effect of adjustments)

These effects assume no tax and no other adjustments.

Statement of financial position (closing balances created)

• Assets
  • Prepayments: £3,340
  • Accrued income: £3,350
  • Total asset increase: £6,690
• Liabilities
  • Accrued expenses: £1,280
  • Deferred income: £2,000
  • Total liability increase: £3,280
• Equity
  • Net increase in equity (balancing figure): £6,690 − £3,280 = £3,410

Statement of profit or loss (net profit effect)

Income movement

• Income recognised (accrued): £1,350 + £2,000 = £3,350
• Income removed (deferred): £900 + £600 + £500 = £2,000
  Net income increase = £1,350

Expense movement

• Expenses recognised (accrued): £500 + £780 = £1,280
• Expenses removed (prepaid): £900 + £1,000 + £1,440 = £3,340
  Net expense decrease = £2,060

Net profit increase: £1,350 + £2,060 = £3,410

D) Misclassifications to watch for

• The £900 subscription, £600 service advance and £500 deposit are deferred income (cash received, performance still outstanding).
• The £1,350 services and £2,000 consulting are accrued income (performance complete, invoice/cash later).

Next-period mechanics (how to avoid double counting)

Timing adjustments must be handled correctly when invoices are raised and cash moves in the next period.

1) Accrued expenses

At 31 Dec 2025 you recognised a liability.

When the invoice arrives or cash is paid in January 2026, either approach is acceptable if applied consistently:

Approach A: Post the invoice/payment against the accrual

• Dr Accrued expenses
• Cr Cash / Payables

Approach B: Reverse the accrual on 1 Jan, then post the invoice normally

• 1 Jan reversal: Dr Accrued expenses / Cr Expense
• When invoice/payment is posted: Dr Expense / Cr Cash / Payables

Either way, the expense is recorded once overall.

2) Prepayments

As the benefit is used in 2026, release the asset to expense:

• Dr Expense
• Cr Prepayments

3) Deferred income

As goods/services are provided in 2026, release the liability to income:

• Dr Deferred income
• Cr Income

Common pitfalls and misunderstandings

• Starting from the cash entry instead of the reporting date: decide what the statement of financial position must show at year end, then adjust.
• Treating receipts as income automatically: cash received can represent an obligation (deferred income).
• Cut-off errors: late supplier invoices and unbilled sales are frequent sources of misstatement.
• Double counting next period: clear accruals correctly and release prepayments/deferred income over time.
• Unclear labelling in workings: distinguish similar items (e.g., “service advance” vs “deposit”) to avoid mixing balances.

Summary and further reading

Timing adjustments ensure that income and expenses are recorded in the period they relate to, and that the statement of financial position shows the correct assets and liabilities at the reporting date.

• Accrued expenses and accrued income recognise amounts belonging to the period even though cash/invoices occur later.
• Prepayments and deferred income carry forward amounts where cash has occurred but the related expense or income belongs to a future period.

Strong answers show: (1) the calculation, (2) the adjusting journal, and (3) a clear schedule that reconciles to the closing statement of financial position balance.

FAQ

Why are timing adjustments necessary?
Because cash movements do not reliably match the period in which costs are consumed or income is earned. Adjustments ensure profit reflects the period’s activity and the statement of financial position includes the correct closing assets and liabilities.

How do accruals affect the financial statements?
They increase expenses and create a liability at the reporting date for amounts owed, preventing profit from being overstated.

What is the difference between accrued income and deferred income?
Accrued income is earned before the reporting date but billed/collected later (asset). Deferred income is cash received before the reporting date for goods/services to be delivered later (liability).

How do prepayments affect profit?
They reduce current period expenses because the unexpired portion is carried forward as an asset, increasing profit compared with expensing the full cash payment.

Quick classification without memorising rules
Think “what exists at the reporting date?” If there is an obligation, it will sit as a liability; if there is a resource the business controls (future benefit or an amount due in), it will sit as an asset.

Example: a customer pays in advance and the work is still to be done at year end → an obligation exists, so a liability is shown (deferred income).

Example: the business has completed work but hasn’t invoiced yet → an amount is due in, so an asset is shown (accrued income).

Glossary

Accrual basis
Accounting that records income in the period it is earned and costs in the period they relate to, rather than when cash is received or paid.

Accrued expense (accrual)
A liability for costs already consumed by the reporting date that have not yet been invoiced or paid.

Prepayment
An asset representing the unexpired portion of a payment made for benefits that will be received after the reporting date.

Accrued income
An asset representing income earned by the reporting date that has not yet been billed or received (often described as an unbilled receivable).

Deferred income
A liability representing cash received before the related goods or services have been provided.

Cut-off
Ensuring transactions are recorded in the correct accounting period, especially around the year end.

Adjusting journal entry
A period-end journal made to correct timing and classification so the statements report the correct period’s income, expenses, assets and liabilities.

Statement of financial position
A statement showing assets, liabilities and equity at a specific date.

Statement of profit or loss
A statement showing income and expenses for a period, resulting in profit or loss for that period.