Accruals and deferrals

What it means

Accruals and deferrals place a cost or a revenue in the period it actually belongs to, regardless of when the invoice was issued or paid. Annual insurance paid in January belongs to twelve months, not to January.

Four accounts do the work: prepaid expenses, deferred income, accrued income and accrued expenses. What they share is that both the amount and the period are known precisely.

Accruals and deferrals follow directly from the accrual principle: the books record when something actually happened, not when it was paid for. They belong to double-entry bookkeeping. Single-entry books record income and expenses on payment, so deferrals are essentially not made there, and annual insurance paid in December is a December expense.

How it works in practice

Typical items are rent paid up front, twelve-month software licences, subscriptions, insurance, a domain and hosting. At the annual closing every such contract is reviewed and spread across months.

If either the amount or the period is unknown, it is not a deferral but an estimated accrual or a provision. That distinction is the first thing an inspection looks at.

With monthly bookkeeping we do not defer only at year end. If a client wants to see the true result of each month, annual insurance, licences and rent are released month by month. The March profit and loss statement then shows no loss merely because a full year’s invoice arrived in March, and months can be compared with one another.

What to watch out for

A missed deferral shifts profit between years, and with it the tax base. With advances received the error runs the other way and costs more: booking them straight to revenue means paying tax on money you have not yet earned.

Small, regularly recurring amounts may be left undeferred on grounds of materiality, provided the company sets this out in its internal policies and does the same every year. The mistake is deferring one year and not the next, depending on which profit suits. That is exactly the pattern that draws attention in an inspection.