Accruals & Prepayments in Xero

Accruals are an accounting technique used to match costs with goods / services received and income with goods / services provided.

For instance, you may buy utilities from January to March, but only receive the bill in April. If you don't account for the bill until April, your business may look more profitable than it really is. That's why we accrue the cost in January, February and March in anticipation of April's utility bill.

A 'prepayment' is a payment for an expense or income that was made or received in a previous financial period but relates to an expense or income incurred in the current financial period.

Here are some examples:

Proforma Invoices

A proforma invoice is a commercial document typically sent (or received) when payment is required before delivery of goods or services.

If you receive (or make) a payment in one financial period but you don't deliver (or receive) the goods or services until a later period, you should post the payment you've received (or made) to prepayments.

Once you have delivered (or received) the goods or services, then you should issue (or receive) an invoice. You should post this to the expense account and allocate the prepayment to the invoice.

Here's how to do this in Xero.

Invoices

If you receive an invoice for a service or event which takes place in a future period, we can use a Manual Journal to move the payment to prepayments in the Balance Sheet. We then release the payment to the expense account when the activity takes place.

If you order and pay for goods on invoice, ahead of delivery in a future period, we can also use a Manual Journal to move this to prepayments in the Balance Sheet and release it to the expense account when you receive the goods.

Spreading the cost

If you receive and pay an invoice for an annual expense, for example, a subscription, we can move this to prepayments in the Balance Sheet and release 1/12th (or the appropriate fraction) to the expense account each month.

This spreads the cost throughout the year and means your profit is not adversely affected in one period.

Cash accounting simply records income and expenditure when money changes hands.

On the other hand, accrual accounting recognises:

• income when sales are made (even if the customer won't be paying immediately);

• expenses when they are incurred (even if the bill won't be paid for a while).

Accrual accounting will also recognise things like the value of stock and work-in-progress. This method helps ensure profits each month or quarter can be meaningfully compared with each other, and aren't subject to variation simply on the basis of when invoices were issued and paid.

Our team use manual journals to process accruals.

Here's a 3-minute article from Xero covering the basics of accrual accounting.