Prepaid Expenses and Accruals: Getting Expenses Into the Right Month

Accrual accounting puts expenses in the month the benefit is received, not the month cash moves. Two families of entries do most of that work: prepaid expenses for things paid before they are used, and accruals for things used before they are billed or paid. Without them, monthly results swing for reasons that have nothing to do with the business.

Prepaid expenses

You paid in advance; the expense belongs to future months.

Item	Treatment
Annual software subscriptions	Prepaid, amortized monthly over the term
Insurance (D&O, cyber, general liability)	Prepaid, amortized over the policy period
Annual conference sponsorships	Prepaid until the event, then expensed
Deposits on leases	An asset until returned; not amortized

Keep a prepaid schedule: vendor, amount, start and end dates, monthly amortization and remaining balance. Tie the total to the balance sheet every close.

Accruals

You received the benefit; the bill or payment comes later.

Item	Treatment
Contractor and agency work not yet invoiced	Accrue the estimated amount
Hosting and usage-billed services billed in arrears	Accrue based on usage reports
Legal and accounting fees for work performed	Accrue from engagement status
Bonuses and commissions earned	Accrue monthly as earned
Payroll for days worked but not yet paid	Accrue at month end
Vacation liability, where policy creates one	Accrue per policy

Use reversing entries for recurring accruals so the invoice can be entered normally when it arrives.

Materiality

Not every small item needs a schedule. Set thresholds in writing: for example, prepaid only above a set amount, accruals only above a set amount. Consistency matters more than precision on small items.

Where it goes wrong

Annual payments expensed in one month, making that month look like a spending spike.
Contractor invoices arriving late and landing in the wrong month.
Bonuses recorded only when paid, understating expense all year.
Prepaid balances that never get amortized because nobody owns the schedule.

In our close

The prepaid and accrual schedules are steps 4 through 6 of every close we run. Both tie to the balance sheet, and both go in the close file so an auditor can test them without asking.

A sample prepaid schedule

Vendor	Paid	Term	Monthly amortization	Balance at month end
CRM annual license	$36,000	Jan to Dec	$3,000	$27,000 (after March)
D&O insurance	$18,000	Apr to Mar	$1,500	$18,000 (before April)
Monitoring platform	$9,600	Feb to Jan	$800	$8,000 (after March)

The schedule's total must equal the prepaid balance on the balance sheet.

Estimating accruals well

Use the vendor's usage dashboard or the statement of work, not last month's invoice, when costs vary.
Ask budget owners before close about work in progress with agencies and contractors.
Compare accruals to the invoices that arrive next month and adjust your method when estimates are consistently off.

Payroll accruals

If payroll is paid on a schedule that does not end on the last day of the month, accrue wages for days worked but unpaid, plus employer taxes. Accrue earned bonuses and commissions monthly, not when paid, so each month carries its share.

The audit angle

Auditors test both directions: prepaid balances that should have been expensed, and unrecorded liabilities discovered in invoices paid after year end. A clean schedule and a search of January payments for December services answers both.

Sources

Questions founders ask

Do small annual subscriptions need to be prepaid?

Set a materiality threshold. Annual payments below it can be expensed when paid; larger ones go on the prepaid schedule and are amortized monthly.

What is a reversing entry?

An accrual booked at month end that is automatically reversed on the first day of the next month, so when the actual invoice is entered it does not double-count the expense.