What is the difference between accruals and cash accounting in practice?
- Expert answer
- Undergraduate
- Asked
The question
In an accounting case study, the company paid a year's insurance of £12,000 in October with a December year end. I am not sure whether the whole amount goes in the income statement.
Short answer
Under accruals accounting, expenses are recognised in the period they relate to, not when cash is paid. Only three months of the insurance, £3,000, is an expense this year. The remaining £9,000 is a prepayment shown as a current asset.
Full expert answer
Financial accounting tutor
BSc Accounting, ACA
Cash accounting records transactions when money moves. Accruals accounting, which IFRS and UK GAAP require for companies, matches income and expenses to the period they belong to. Your insurance example shows the difference clearly.
Working the example
- Monthly cost: £12,000 ÷ 12 = £1,000
- Months covered in this financial year: October, November, December, so three months
- Expense in the income statement: £3,000
- Prepayment in the statement of financial position: £9,000, a current asset
The journal at year end is to debit prepayments £9,000 and credit the insurance expense £9,000, reducing the expense from the £12,000 originally posted. Next year, the prepayment is released to the income statement as the cover is used.
This answer explains a method for you to apply to your own work. Copying it into a submission would count as plagiarism, and it is indexed by similarity checkers.
All questions