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Michael Paul Accountants

Prepayments

3rd July 2011

Ahead of a serious of articles regarding the Sage Accounts month end process Paul from Michael Paul Accountants Northamptonshire explains the concept of prepayments which form part of the month end procedure.  This article is relevant to both users and non users of Sage

What is a prepayment?

A prepayment is a payment in advance of the period to which it pertains.

A good example of a prepayment would relate to insurance.  Say a company which produces a monthly profit and loss report receives an invoice dated 1 January totalling £1,200 for 12 months insurance. Without making a prepayment adjustment the whole of the cost will be shown in January.  As accounts should always be prepared on an accruals basis (accounting for income when earned and expenses when incurred) the monthly profit and loss results would be inaccurate because  insurance costs would show £1,200 in January and nil for the remaining 11 months of the year.  The correct way to account for the expense is to show £100 occurring in each of the 12 months. This is achieved via prepayment adjustments.

So how does the prepayment adjustment work?

The easiest way to account for the prepayment is to initially transfer the total amount of the insurance to the prepayment account. The journal for this will be to credit the insurance expense account and debit the prepayments account with £1,200.

Before the January profit and loss account is finalised a further journal adjustment will need to be made to bring £100 of the insurance cost back into the insurance expense account in January.  The journal for this is to credit the prepayments account and debit the insurance expense account with £100.  This will then leave a balance of £1,100 in the prepayment account at the end of January.

Throughout the year as each months profit and loss account is prepared the same £100 journal will need to be made until at the end of December the insurance prepayment will be nil. When the invoice for the next years insurance is received then the whole process is repeated.

At Michael Paul Accountants Kettering, Corby, Northampton and Market Harborough are conveniently located near to our premises in Lamport although we have clients from all over the UK.  We are a firm of Chartered Certified Accountants ensuring you receive a professional and competent service at all times.  We specialise in small businesses, medium sized businesses, sole traders, partnerships and individuals who have to file a tax return.

If you need any advice regarding prepayments or any other accounting or taxation matters please don’t hesitate to contact us.

 

 

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