Accrued, Prepaid, Deferred and Capitalised Expenses Explained

An accrued expense is a cost you have already incurred but not yet been billed for or paid, so you record it as an expense and a liability at period-end. A prepaid expense is the reverse: you have paid but not yet used the benefit, so it sits as an asset until it is used up. A deferred expense is essentially a prepaid expense, a term often used when the benefit stretches beyond a year, and a capitalised expense is a cost recorded as a long-term asset and spread over its useful life through depreciation or amortisation.

All four exist for one reason: under accrual accounting, an expense belongs in the period whose revenue it helped to earn, not the period in which the cash happened to move.

The four timing types at a glance

• Accrued expense — used now, paid later. Expense now; liability on the balance sheet until paid.
• Prepaid expense — paid now, used over the next few months. Asset now; expensed as each month passes.
• Deferred expense — paid now, used over a longer period. Same mechanics as a prepaid; the part beyond twelve months is usually shown as a non-current asset.
• Capitalised cost — paid for something that will serve the business for years. Recorded as a fixed or intangible asset; expensed gradually through depreciation or amortisation.

Worked example: one December close at a dance school

Lumen Dance Academy runs classes for 300 students from a rented studio. Its financial year ends on 31 December, and here is everything its bookkeeper has to deal with at the December close.

1. Accrued expenses: electricity and instructor pay

The December electricity bill will not arrive until mid-January. Based on the meter reading, the bookkeeper estimates $1,800. Instructors are paid on the 5th of the following month, and December's hours come to $9,600. Both costs belong to December:

• Dr Utilities expense $1,800
• Dr Instructor wages $9,600
• Cr Accrued expenses $11,400

When the real electricity bill arrives on 12 January for $1,840, the accrual is cleared and only the $40 difference hits January:

• Dr Accrued expenses $1,800
• Dr Utilities expense $40
• Cr Accounts payable $1,840

Many bookkeepers instead post the accrual as a reversing entry: it automatically reverses on 1 January, and the full bill is then entered as normal. Either way, December carries December's cost.

2. A prepaid expense: annual insurance

On 1 October Lumen paid $7,200 for twelve months of liability insurance, October to September. It was recorded as an asset:

• Dr Prepaid insurance $7,200
• Cr Bank $7,200

Each month, one-twelfth is released to expense:

• Dr Insurance expense $600
• Cr Prepaid insurance $600

By 31 December, $1,800 has been expensed and $5,400 remains as a current asset, representing nine months of cover still to come. So yes, a prepaid expense is an asset: it is a right to a service you have already paid for.

3. A deferred expense: a two-year floor maintenance contract

On 1 December Lumen paid $4,800 up front for a 24-month maintenance contract on its sprung floors, which works out at $200 a month. The mechanics are the same as the insurance, but the time frame is longer, so at 31 December the balance is split:

• Expensed in December: $200
• Current portion (next 12 months): $2,400
• Non-current portion (months 13 to 23): $2,200

You will see deferred expense, deferred charge and prepaid expense used almost interchangeably. What matters is the substance: cash out now, benefit later, expense recognised as the benefit is received.

4. A capitalised cost: the new sound system

In November Lumen spent $18,000 on a studio sound system, including installation. It will be used for about eight years, so it is capitalised rather than expensed:

• Dr Studio equipment $18,000
• Cr Bank $18,000

With no expected resale value, straight-line depreciation is $18,000 ÷ 8 = $2,250 a year, or $187.50 a month. In the same week, the school bought $150 of replacement cables and expensed them immediately; they are too small and short-lived to be worth tracking as an asset.

Capitalising means recognising a cost as an asset because it will benefit several future periods. Accounting standards set the test (a probable future benefit and a reliably measurable cost), and most businesses add a written threshold below which items are simply expensed. Tax rules can have their own thresholds. In the US, for example, the IRS de minimis safe harbour election lets a business without an applicable financial statement (such as an audited set of accounts) deduct items costing up to $2,500 per invoice or item, or up to $5,000 with one. It must expense those items on its own books under a policy in place at the start of the year, written down if it has an applicable financial statement, and make the election with its return each year.

What the December close changes

Without these entries, Lumen's December profit and loss would show none of the following, because each one only reaches the profit and loss through a period-end entry:

• Utilities accrued — $1,800
• Instructor wages accrued — $9,600
• Insurance released from prepaid — $600
• Floor maintenance released from deferred — $200
• Depreciation on the sound system — $187.50
• Total December expense added by the close — $12,387.50

That is the difference between knowing December's real margin and guessing at it.

Other expense labels you will meet

Is COGS an expense?

Yes. Cost of goods sold is the expense of the inventory you sold in the period. Lumen sells dance shoes in its front office; the cost of the pairs sold each month is COGS. It is presented separately from operating expenses so that gross profit can be shown, but it is still an expense. Shoes still on the shelf are inventory, an asset, until they are sold.

Overhead expenses

Overhead means costs that keep the business running but cannot be traced to a single product, class or job: studio rent, the office manager's salary, accounting software, insurance. A manufacturer allocates part of its production overhead into inventory cost; a service business like Lumen usually expenses overhead as incurred and tracks it to see what each class has to earn to cover it.

T&E expenses

T&E stands for travel and entertainment: flights, hotels, mileage, meals and client entertainment. Lumen's instructors travelling to a regional competition generate T&E. It is usually managed through expense claims with receipts and an approval step, because these costs are easy to mis-code, often have tax restrictions, and are a common audit focus.

Common mistakes

• Expensing a 12-month prepayment in the month it is paid. October's profit looks terrible and November to September look better than they are.
• Forgetting to reverse an accrual. If the accrual stays and the real bill is also expensed, the cost is counted twice.
• Accruing without evidence. An accrual should rest on something: a contract, a meter reading, hours worked, a supplier's quote.
• Capitalising repairs. Restoring an asset to its original condition is a repair and is expensed; capitalise only improvements and new assets.
• Expensing a long-lived purchase above your threshold. It understates assets and distorts the year's profit.
• Treating every prepaid as current. Amounts benefiting periods more than a year away belong in non-current assets.

hellobooks< / a > -helps-you-get-the-timing-right">How HelloBooks helps you get the timing right

HelloBooks includes period-end closing tools for accruals, prepayments and depreciation, so the December close above becomes a checklist you review rather than a set of entries you remember to make. Journal entries go through approval and can be reversed, which suits month-end accruals that reverse on the first day of the next month. The fixed assets register calculates straight-line or written-down-value depreciation for capitalised items like the sound system.

On the spending side, bills can be routed through approval and scheduled to pay on their due date, vendor prepayments are tracked against later bills, and expense claims with receipt OCR and approvals handle T&E. Document extraction pulls vendor, amount and tax from an uploaded invoice and matches it to the bank line, so you have the evidence behind each accrual. Your accountant still decides the capitalisation policy and reviews the close.

This is general information as of November 2026, not tax, legal or accounting advice; check the official source or a qualified CA/CPA for your situation.