What are accrued income and prepaid expenses?

An asset representing a claim to previously unrecorded revenue that has been earned but not yet due for payment as of balance sheet date – until a future period – is accrued income.  Accrued revenue in an accounting period requires an adjusting entry at the end of the period to recognize the asset’s existence.

Accrued Revenue → Revenue is recognized as earned before cash payment is subsequently received

The recognition of accrued revenue is necessary in order to properly match revenues with expenses, where the failure to recognize accrued revenue would show lower revenue and profits.  Moreover, accrued revenue commonly represents revenue that has not yet been invoiced.

Prepaid expenses are advance payments made for economic benefit that is to be received or completely consumed only after balance sheet date, it requiring deferral of the expense recognition.  An adjusting entry is made to expense a portion of the asset’s cost at the end of each future period that benefits from the prepayment.

Prepaid Expense → Cash prepayment is received before revenue is subsequently earned and recognized

Accrual account requires expenditures to be recorded as prepaid expenses in order to match them with the periods in which they are actually incurred.  If prepaid expenses were not recognized, assets and profits would be understated in the short term.

Accounting for a Prepayment (Example)
YourCo paid advance rent of $10,000 to RealCo on December 2016 for January of the following year.  YourCo’s accounting year ends 31 December.
31 Dec 16	Prepaid Rental		10,000
		Cash		10,000
	To record advance payment of rental on 31 Dec 2016.
31 Jan 17	Rent Expense		10,000
		Prepaid Rental		10,000
	To record realization of rental expense on 31 Jan 2017