Your bank statement is honest. Your profit, on the last day of the financial year, usually is not. Cash leaves and arrives on its own schedule, but profit has to be measured for one fixed period — and closing that gap is exactly what prepaid and outstanding expenses, and the adjusting entries that settle them, are built to do. Miss these four year-end adjustments and you either overstate profit and pay tax on money you never really earned, or understate it and misjudge your own business. This guide walks through outstanding expense, prepaid expense, accrued income and income received in advance: the entry for each, where it sits on the balance sheet, and a worked example that moves real rupees between your P&L and your balance sheet.
Why year-end adjustments exist: the matching concept
Accounting measures a business over a defined period — usually the year to 31 March in India. The trouble is that money rarely respects that boundary. You pay a full year's insurance in February. A supplier's March bill lands in April. You bill a client in March but collect in May. If you simply recorded profit as "cash in minus cash out", every one of those timing quirks would distort the result.
The fix is the matching concept (the accruals basis): recognise income and expenses in the period they actually relate to, regardless of when the cash moves. Adjusting entries are the tool that enforces it. They are passed on the last day of the period, after the trial balance is drawn up but before the final accounts, and each one nudges a figure into the right year.
This is the whole difference between the two bases of bookkeeping. If the distinction is still fuzzy, our explainer on accrual versus cash accounting sets up the ground this post builds on. Getting these adjustments right is the single most common place beginners lose marks and business owners lose clarity — and it is exactly the foundation a structured Financial Accounting course drills until it is second nature.
The four adjustments: prepaid, outstanding, accrued and income in advance
Every period-end adjustment for expenses and income is one of four cases. Two involve cash that has already moved; two involve cash that still has to move. Learn them as a set and you never have to guess which side of the balance sheet the figure lands on.
Outstanding (accrued) expense
An expense you have incurred but not yet paid by year-end — March salaries paid in April, an electricity bill still outstanding, interest due but unpaid. The benefit has been used up this year, so the cost belongs to this year. It becomes an extra expense and a current liability, because you owe the money.
Prepaid expense
An expense you have paid in advance for a benefit you have not yet consumed — insurance, rent or an annual subscription paid up front. The portion relating to next year is not this year's cost. It is pulled out of expenses and parked as a current asset, because it is a benefit you are still owed.
Accrued income
Income you have earned but not yet received — interest accrued on a deposit, commission earned but not collected, rent due from a tenant. You did the work or lent the money this year, so the income is this year's. It is added to income and shown as a current asset.
Income received in advance
Income you have received but not yet earned — a year's fees collected up front, advance rent, a deposit for services still to be delivered. The cash is in the bank, but the obligation to earn it remains. It is removed from this year's income and shown as a current liability, often called unearned or deferred income.
Two questions — expense or income, and has the cash moved — decide asset or liability every time
Source: NIFM Editorial Team, 2026 (accruals framework, ACCA FA)
The journal entries, entry by entry
Each adjustment is a single, ordinary double entry — one debit, one credit. If debits and credits still feel shaky, our walkthrough of double-entry bookkeeping basics covers the debit and credit rules these entries rely on. The pattern below is worth memorising, because the same four entries recur in every set of final accounts.
| Adjustment | Journal entry | Final-accounts effect |
|---|---|---|
| Outstanding (accrued) expense | Dr Expense a/c Cr Outstanding Expense a/c |
Added to the expense in P&L; shown as a current liability |
| Prepaid expense | Dr Prepaid Expense a/c Cr Expense a/c |
Deducted from the expense in P&L; shown as a current asset |
| Accrued income | Dr Accrued Income a/c Cr Income a/c |
Added to the income in P&L; shown as a current asset |
| Income received in advance | Dr Income a/c Cr Income Received in Advance a/c |
Deducted from the income in P&L; shown as a current liability |
Read the table as a mirror. The two expense entries move a cost into or out of the P&L; the two income entries do the same for revenue. Notice the symmetry: whenever cash has already moved (prepaid expense, income in advance) you are parking a figure on the balance sheet for next year; whenever cash still has to move (outstanding expense, accrued income) you are pulling a figure into this year. That single insight replaces rote memorisation.
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Explore the ACCA Knowledge Level course →A worked example: one insurance premium through the accounts
Numbers make this concrete. Say your financial year ends 31 March. On 1 February you pay a full year's fire insurance in advance: ₹12,000, or ₹1,000 a month, covering February this year through January next year.
By 31 March, only two months of cover — February and March — have actually been used. That is ₹2,000 of genuine expense for this year. The remaining ten months, ₹10,000, are cover you have paid for but not yet consumed. If you left the whole ₹12,000 in the expense account, you would understate profit by ₹10,000 and misstate your assets. The adjusting entry corrects both in one move:
Dr Prepaid Insurance ₹10,000 Cr Insurance Expense ₹10,000
The insurance expense in the P&L falls to ₹2,000. A new current asset, prepaid insurance of ₹10,000, appears on the balance sheet and carries into next year, where it becomes that year's expense.
One ₹12,000 payment, split by the period it belongs to
Source: NIFM Editorial Team, 2026 (illustrative worked example)
Now flip the direction. Suppose March salaries of ₹8,000 are still unpaid on 31 March. The staff worked this year, so the cost is this year's even though the cash goes out in April. You pass Dr Salaries ₹8,000 Cr Outstanding Salaries ₹8,000: salaries expense rises by ₹8,000 and a current liability of ₹8,000 appears. One adjustment lifted profit by ₹10,000; the other trimmed it by ₹8,000. Together they replace a cash-tinged number with a figure that tells the truth about the year.
Follow both figures into the next year and the logic closes neatly. That ₹10,000 prepaid insurance asset is not lost — it becomes an expense in the new year as the remaining ten months of cover are consumed, so the cost lands in the year that actually benefits. The ₹8,000 outstanding-salaries liability is settled the moment April's salaries are paid, cancelling the amount you owed. Nothing disappears and nothing is counted twice; each rupee is simply reported in the year it belongs to. That is the entire discipline of accrual accounting, expressed in two small entries.
Why the trial balance still balances (and the reversing-entry trick)
A fair worry: if you are moving figures around after the trial balance is already drawn, does it stop balancing? No — and the reason is simple. Every adjustment is a full double entry with an equal debit and credit, so the total of debits and the total of credits both rise (or fall) by the same amount. The trial balance's grand total is untouched; only the composition changes. This is a different matter from a genuine mistake, and it is worth knowing which slips a trial balance can and cannot expose — our guide to the errors a trial balance never catches maps exactly that.
There is one professional habit that saves confusion the following year: the reversing entry. On the first day of the new period, you reverse the accrual or prepayment you just made. Take the outstanding salaries: on 1 April you pass Dr Outstanding Salaries ₹8,000, Cr Salaries ₹8,000. When the actual salary payment is booked later in April, you record it normally as a full expense — and because the reversal created a matching credit, the year's figures do not double-count. Reversing entries are optional, but they keep next year's routine bookkeeping clean and are standard practice in most computerised systems.
The commonest errors are boringly avoidable: forgetting the adjustment entirely, adjusting for the wrong number of months, or putting the balance on the wrong side of the balance sheet. The 2x2 map above exists precisely to kill that last one.
What to do next
Prepaid and outstanding expenses are not an advanced topic — they are the exact point where cash-basis intuition has to give way to real accounting. Master the four cases, the four entries, and the one question that routes each figure to an asset or a liability, and a large share of final-accounts and ACCA FA questions simply fall into place. From here, the natural next steps are the mirror-image entries for income timing, then how these adjustments flow into a complete statement of profit and loss and balance sheet.
Learn it in sequence rather than in fragments and it sticks. That is what a structured programme is for.
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Start the ACCA Knowledge Level courseFrequently Asked Questions
What is the difference between outstanding expenses and prepaid expenses?
An outstanding expense is a cost you have incurred but not yet paid by the year-end, so it is added to expenses and shown as a current liability. A prepaid expense is a cost you have paid in advance for a benefit not yet used, so it is deducted from expenses and shown as a current asset. One is money you owe; the other is value you are still owed.
Are adjusting entries and journal entries the same thing?
Adjusting entries are a specific type of journal entry. All adjusting entries are journal entries — equal debit and credit — but they are passed only at the period-end to apply the matching concept, after the trial balance and before the final accounts. Ordinary journal entries record everyday transactions throughout the year.
Is accrued income an asset or a liability?
Accrued income is a current asset. It is income you have earned during the year but not yet received in cash — interest, commission or rent due to you. Because someone still owes you that money, it is recorded as an asset on the balance sheet and added to income in the profit and loss account.
Do adjusting entries change the trial balance total?
No. Each adjusting entry has an equal debit and credit, so total debits and total credits both change by the same amount and the trial balance still agrees. Adjustments re-time and re-classify figures into the correct period; they never make the trial balance disagree, which is why a balanced trial balance is not proof the accounts are error-free.
What happens to a prepaid expense in the next accounting year?
The prepaid expense sits on the balance sheet as a current asset at year-end and is released into the next year's profit and loss account as the benefit is used. In the insurance example, the ₹10,000 prepaid becomes next year's insurance expense across the remaining months of cover. Many bookkeepers pass a reversing entry on day one of the new year so the release happens automatically.
How are accruals and prepayments tested in the ACCA FA exam?
ACCA Financial Accounting (FA/F3) treats accruals, prepayments, accrued income and deferred income as core, examinable content. You are typically asked to calculate the year's correct expense or income after an adjustment, prepare the journal entry, or state where the balance appears in the financial statements — all driven by the accruals concept. NIFM's ACCA Knowledge Level course covers this exam preparation in full.
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