Prepaid and Accrued Expenses: The Month-End Entries
- The four adjustments at a glance
- 1. Prepaid expense: annual insurance
- 2. Accrued expense: the electricity bill that arrives late
- 3. Accrued income: interest on a fixed deposit
- 4. Income received in advance: an annual contract
- A month-end routine that catches them
- Errors that surface at the year-end audit
- Where this fits
Month-end adjustments move income and expenses into the month they belong to, when the cash moved in a different month. There are only four kinds: an expense paid in advance, an expense owed but not yet paid, income earned but not yet received, and income received before it is earned. Each creates a balance sheet item that unwinds later.
Get these four right and the monthly profit and loss account becomes something you can compare across months. Skip them and every month is distorted by when bills happen to be paid.
The four adjustments at a glance
| Situation | Balance sheet item | Type |
|---|---|---|
| Paid now, covers future months | Prepaid expense | Asset |
| Used this month, paid later | Accrued expense, or expense payable | Liability |
| Earned this month, received later | Accrued income | Asset |
| Received now, earned in future months | Income received in advance | Liability |
The logic is the same in every row. The profit and loss account takes only what relates to the month. The balance sheet holds the rest until its month comes.
1. Prepaid expense: annual insurance
On 1 January a business pays ₹1,20,000 for a year’s fire and burglary insurance, January to December.
| Date | Debit | Credit | ₹ |
|---|---|---|---|
| 1 Jan | Prepaid insurance | Bank | 1,20,000 |
| 31 Jan, and each month-end | Insurance expense | Prepaid insurance | 10,000 |
At 31 March, three months have been charged, ₹30,000 in total, and ₹90,000 remains as a prepaid asset for the nine months still to come. If the business closes its books on 31 March, that ₹90,000 appears in the balance sheet, not in the year’s expenses.
2. Accrued expense: the electricity bill that arrives late
March electricity is used in March, but the bill arrives on 12 April. The meter reading and the previous bills suggest about ₹18,000.
| Date | Debit | Credit | ₹ |
|---|---|---|---|
| 31 Mar | Electricity expense | Expenses payable | 18,000 |
| 12 Apr, bill received | Expenses payable | Creditor, electricity board | 18,000 |
| 12 Apr, difference | Electricity expense | Creditor, electricity board | 600 |
The actual bill is ₹18,600. The ₹600 difference is charged to April. An estimate that is close enough is far better than no entry at all: leaving March’s power out of March understates the month’s cost by the whole ₹18,000.
Many businesses use reversing entries instead: reverse the accrual on 1 April, then book the actual bill normally when it comes. The net effect on April is the same ₹600, and nobody has to remember to match the bill to the accrual.
3. Accrued income: interest on a fixed deposit
The business holds a ₹5,00,000 fixed deposit at 7.2% a year, with interest paid at maturity. Interest is earned every month even though it is not credited.
Monthly interest, on a simple basis: 5,00,000 × 7.2% ÷ 12 = ₹3,000.
| Date | Debit | Credit | ₹ |
|---|---|---|---|
| Each month-end | Interest accrued on FD | Interest income | 3,000 |
| On maturity | Bank | Interest accrued on FD | Total accrued |
If the bank compounds interest quarterly, use the bank’s own interest certificate or schedule at year-end to adjust the accrual to the exact figure. Tax deducted by the bank on the interest is a separate entry and is not covered here.
4. Income received in advance: an annual contract
A client pays ₹2,40,000 on 1 January for a twelve-month maintenance contract.
| Date | Debit | Credit | ₹ |
|---|---|---|---|
| 1 Jan | Bank | Income received in advance | 2,40,000 |
| Each month-end | Income received in advance | Maintenance income | 20,000 |
Recording the whole ₹2,40,000 as January income would make January look like the best month of the year and the next eleven look poor. It is also wrong in substance: until the service is delivered, the business owes it, which is exactly what a liability is. GST on the invoice follows its own timing rules and is left out of this example.
A month-end routine that catches them
- Keep a schedule of every annual or multi-month payment: insurance, software, AMC contracts, rent paid ahead. Post the monthly amortisation from it.
- List regular bills that arrive after month-end: electricity, phone, courier, professional fees. Accrue an estimate for each.
- Review contracts where you bill in advance or deliver before billing.
- Check that each prepaid and accrued balance at month-end can be explained from the schedules. A balance nobody can explain is usually an entry that was never reversed.
Errors that surface at the year-end audit
- A prepaid balance that never runs down. The annual payment was booked to prepaid, but the monthly amortisation entry was never set up. The expense is understated all year and the asset is overstated.
- Accruals booked twice. The month-end estimate was posted, then the actual bill was posted to expense as well, without clearing the accrual. The cost appears twice and the payable balance grows every month.
- Advance receipts sitting in income. A large receipt credited straight to sales in the last month of the year inflates the year’s revenue with work that belongs to the next.
Each of these is found the same way: by asking someone to explain every balance on the prepaid, accrued and advance accounts line by line. If that is done monthly, the year-end has nothing left to find.
Where this fits
- Why these adjustments exist: accrual or cash basis
- The wider close process: month-end close checklist
- How the balances appear in the statements: trial balance to balance sheet
- The debit and credit mechanics: debits and credits explained