Move costs that have been paid for in advance (prepayments) to a different period

This article explains what prepayments are and how to record them in FreeAgent if you're preparing your accounts using the accrual accounting basis. It also explains how to reverse the prepayment.

Please note that the steps below don't apply if you're preparing your accounts using the cash accounting basis.

What is a prepayment?

If you choose to prepare your accounts using the traditional accruals accounting basis, you need to record costs that your business incurs on your profit and loss account at the time when the business uses what it's paid for, which may not be when the cost was paid for.

For example, you might pay £600 for your business's home office insurance on 1st June 2021, which covers your office for a whole year up to 31st May 2022.

If your business prepares accounts to 31st March each year and you only include your office insurance in your accounts when you pay for it on 1st June 2021, the £100 worth of monthly costs for April and May 2022 will be recorded incorrectly. Instead of being recorded in your accounts prepared to 31st March 2023, they will be recorded incorrectly in your accounts prepared to 31st March 2022 instead. This will mean that your profit will be too low in your accounts prepared to 31st March 2022 and you might not pay enough tax.

Therefore, you need to remove the £100 costs for April and May 2022 from your profit and loss account prepared to 31st March 2022 by recording a prepayment.

As the £100 relates to your accounting year to 31st March 2023, you'll need to make sure you record it in your profit and loss account for that year by reversing the prepayment.

Please note that when working out the prepayment, you should use the amount on the bill excluding VAT. However, if you're on the VAT Flat Rate Scheme, you should use the amount on the bill including VAT.

If you’re unsure about how to record a prepayment, please speak to your accountant.

How to record a prepayment in FreeAgent

You can record a prepayment in FreeAgent by creating journal entries.

To do this, navigate to the 'Accounting' tab at the top of the screen and select 'Journal Entries' from the drop-down menu.

Next, select 'Add New Journal Entries'.

For the example above, you would need to create two journal entries for the original prepayment of £100, dated 31st March 2022:

• Debit code ‘620 Prepayments’
• Credit the code where the original cost was recorded in your accounts - in the example of office insurance, this is ‘364 Insurance’.

You will see a record of the prepayment being created in the ‘Audit Trail’ report.

How to reverse the prepayment

You’ll also need to record the costs in the relevant accounting year by reversing the prepayment.

To do this, navigate to the 'Accounting' tab at the top of the screen and select 'Journal Entries' from the drop-down menu.

Select ‘Actions’ on the right-hand side of the relevant journal entries and select ‘Reverse in new journal entries’ from the drop-down menu.

This will create a reversed set of those journal entries. Choose the beginning of your new accounting year as the date of the reversal, ‘01 Apr 22’ for the insurance example, and enter a description in the field provided.

Select ‘Create Journals’ at the bottom of the screen to complete the process. For more information on reversing journal entries, please see this article.

You will see a record of the journal entries being reversed in the ‘Audit Trail’ report.