Nominal accounts are the income and expense accounts. At the end of the period their balances must be adjusted so that only the part relating to the current period is charged or credited to the profit and loss account.
Prepaid and Accrued Expenses
A prepaid expense is removed from this period's expense and carried forward as a current asset. An accrued expense is added to this period's expense and recognised as a current liability.
Key idea
Expense for the period = Total paid − closing prepaid + closing accrued. Prepaid = current asset; accrued = current liability.
The Double Entry
| Prepaid expense: | Dr Prepaid expense Cr Expense account |
| Accrued expense: | Dr Expense account Cr Accrued expense |
| Accrued income: | Dr Accrued income Cr Income account |
| Prepaid income: | Dr Income account Cr Prepaid income |
Accrued and Prepaid Income
Accrued income is added to this period's income and recorded as a current asset. Prepaid income (received in advance) is removed from this period's income and recorded as a current liability.
Example
Insurance paid during the year totals RM1,200. On 31 December, RM300 is prepaid (for next month). The insurance expense for the year is RM1,200 − RM300 = RM900. The RM300 is carried to the statement of financial position as a current asset.
Adjusting the Expense Account
In the ledger, the expense account is closed with a prepaid balance carried down as a debit balance and an accrued balance carried down as a credit balance. The net figure transferred to the profit and loss account is the true expense for the period. A common mistake is to add the prepaid or subtract the accrued — it is actually the other way round. Always ask: does this amount relate to this period? If not, take it out of the current period's expense.
Remember
For expenses: subtract prepaid, add accrued. For income: add accrued, subtract prepaid. Prepaid expense and accrued income are assets; accrued expense and prepaid income are liabilities.