Tomasz had been the bookkeeper at Lantern Yoga Studio for two months when Nadia, the studio manager, handed him his first year-end job: an insurance schedule and the rent payments. "Just tell me what this year really cost us," she said. "Not when the money left the bank — when we used the thing we paid for." Matching expenses to the period that uses them is the accruals concept.
One. Insurance paid in advance
On 1 October the studio paid a full year of insurance, $4,800, and the whole amount was posted to the insurance expense account. Tomasz counted the calendar: 3 months of cover had passed by 31 December and 9 were still to come.
He wrote down: insurance expense $3,600, carried forward $1,200. Nadia frowned at the sheet. "Your two figures have swapped places. This year we were covered for only 3 months, so the expense is $1,200. The other 9 months, $3,600, are cover we have already paid for and will use next year. That is a prepayment — an asset."
"So I multiplied by the months left instead of the months used." Left alone, his schedule would have shown insurance of $3,600 instead of $1,200.
Two. Rent not yet paid
Next, the rent. Cash paid during the year was $19,200. But that figure included $1,600 of last December's rent, paid late in January. And this December's rent of $2,400 had not been paid at all.
"We paid last year's rent this year, so surely it's a cost to us now? Then I add the $1,600…" Adding both balances would give rent of $23,200. Nadia shook her head. "Don't ask who paid when. Ask which year we were in the building."
She wrote on the whiteboard: rent used last year but paid this year belongs to last year — take it out. Rent used this year but not yet paid belongs to this year — put it in. An expense used but not yet paid is an accrual, and because we still owe it, it is a liability. $19,200 − $1,600 + $2,400 = $20,000.