October 20, 2017 Year end accruals and prepayments I run a small PR agency as a limited company and I am just coming up to my first year end which is 30th September 2017. I am a little confused with what income and costs I should be including in my accounts as I have some timing issues around them. For example I bill a client for a quarterly retainer of £5,000 which will have been invoiced in September 2017 but some of this will relate to next year. Also I have an annual subscription for some software which I have just paid for. Can you help explain how I deal with these timing differences? Answer Oct 2017: Accounts for limited companies have to be prepared on an “accruals basis”. When doing so, the basic rule to remember is the “matching principle”. Match income with the costs incurred in earning that income. To keep it simple, imagine a small shop where everything is bought and sold for cash. Its income for the period is the total money received for the goods that it has sold. Its costs are its purchases of the goods that it has sold. Any goods that it has bought but not sold are excluded from its costs (and instead are accounted for as stock). Taking this example a little further, the shop owner may also have to pay rent for his shop. Let’s assume he normally pays this on the last day of each month, but was a few days late paying for the last month. So, he’s only actually paid 11 month’s rent during the 12 month period. He’s used the shop to earn income in the last month and so must include the 12th month’s rent in his costs, so that income and costs match. Of course, things get a bit more complicated for most businesses, so there are a couple more rules that need to be followed. The first of these is that accounts for limited companies have to include all the sales invoices that you’ve issued in the accounting period and, on the other side, all the purchase invoices that you’ve received during the period. This is regardless of whether or not they’ve been paid. This is so that your full accounts show how much your company owes to other people and how much other people owe you. The second rule could be called time apportionment or pro-rating. Accruals and deferrals On the sales side you need to include your best estimate of the income you’ve earned but haven’t yet issued a sales invoice for. This is called “accrued income”. You also need to exclude any work that you’ve invoiced for, but hadn’t completed before the end of your accounting period. This is called “deferred income”. On the purchases side, you need to exclude any physical stock you’re holding at the end of your period. This is your “closing stock”. You also need to include the costs of any goods or services you’ve had but not yet been billed for. These are your “accrued expenses”. Finally, you need to exclude the portion of any bills that relate to goods or services you’ll be provided with after your accounting period has ended. These are called “prepaid expenses”. It sounds complicated but, if you bear in mind the matching principle, it’s quite logical. Worked example Going back to the question at hand, your year end is 30th September 2017, so you’ll need to include all the sales invoices you’ve issued up to that date, you’ll then need to estimate and accrue for the sales value of any work you’ve started before 30th September but haven’t yet invoiced, and you’ll need to treat any work you’ve invoiced for, but haven’t completed by 30th September, as deferred income. This will mean that the income shown in your accounts truly represents the work you’ve done in your first year as a limited company. Do the equivalent on the costs side, accruing for expenses incurred but not yet billed, and treating goods and services you’ve been billed for, but not yet received, as prepaid expenses. Assuming the quarterly retainer of £5,000 billed in September covered the months of September, October and November, you’ll treat 2/3rd of it (£3,333) as “deferred income”. This means that only £1,667 of it will be included as your income – the difference will sit on your balance sheet as deferred income and will be treated as income in the following years accounts. With the annual subscription you’ve just paid for software, check when the subscription period starts and work out what proportion of the bill relates to the time up to 30th September 2017. Treat just this bit as the cost for your first accounting period. The rest of the amount you’ve paid will be a “prepaid expense” and doesn’t get included in your costs until the next accounting year.