Accrual and prepayment

Accruals are expenses incurred but not yet paid while prepayments are payments for expenses for that are not yet incurred. Accruals and prepayments give rise to current liabilities and current assets respectively in accordance with the matching principle and accrual accounting.

Matching principle requires accountants to record revenues and expenses in the period in which they are incurred regardless of when the relevant payments are made. In order to create this 1-on-1 correspondence between revenue and expenses, expenses are recorded if they are incurred in a particular period even if they are not yet paid, because they were necessary to earn the revenue for that period. On the other hand, prepayments are recorded to represent payments related to goods and services that are to be consumed in future periods. It is this matching principle that differentiates accrual accounting from cash-basis accounting, which records revenues and expenses when they are received and not when they are earned or incurred.