Cash basis vs accrual basis, the practical difference.
Cash basis records a transaction when cash moves. You pay $720,000 rent in July, the entire amount is July expense. You receive $480,000 advance subscription, the entire amount is July revenue. Simple, but it makes monthly P&Ls look erratic. July looks terrible because of huge prepaid rent; August through June look artificially profitable because rent is "free."
Accrual basis records the transaction when the economic event happens. Rent paid in July covers 12 months, so $60,000 is July expense; the remaining $660,000 is an asset (prepaid rent) that becomes expense over time. Subscription received in July covers 6 months, so $80,000 is July revenue; the remaining $400,000 is a liability (deferred revenue) that becomes revenue over time. P&L now reflects what actually happened, not just cash movement.
Prepaid rent, the most common case.
July 1: pay $720,000 for 12 months of rent. Initial entry: DR Prepaid Rent 720,000 / CR Bank 720,000. Prepaid Rent is an asset on the balance sheet because you have a right to occupy the premises for 12 months.
July 31: amortize one month: DR Rent Expense 60,000 / CR Prepaid Rent 60,000. P&L shows $60,000 rent expense; balance sheet shows $660,000 prepaid rent remaining. Repeat each month. By the following June 30, prepaid rent is zero and total rent expense for the year is $720,000. Same total expense as cash basis but spread evenly across 12 months.
In Nonari, you set up the amortization schedule once at the time of payment, and the monthly entries auto-post on closing. Manual systems require a discipline to remember each month, which is why prepaid rent on a manual system often sits unamortized for 4 months, then someone catches it and posts a chunky catch-up.
Insurance, AMCs, software licenses.
Same pattern, different assets. Annual vehicle insurance of $180,000 paid in March: DR Prepaid Insurance 180,000 / CR Bank 180,000. Monthly amortization for 12 months: DR Insurance Expense 15,000 / CR Prepaid Insurance 15,000.
Annual software subscription of $600,000 paid in January: DR Prepaid Software 600,000 / CR Bank 600,000. Monthly amortization $50,000.
AMC contracts on equipment, prepaid memberships, prepaid advertising, all follow the same pattern. The general rule: cash paid for services to be received over more than one month becomes a prepaid asset, amortized over the service period. Anything for less than one month can usually be expensed immediately for materiality.
Deferred revenue, the mirror image.
You receive cash for services you have not yet delivered. Examples: customer pays 6 months of subscription up front. Customer pays an annual maintenance contract. Customer pays a deposit for a future shipment. Initial entry: DR Bank / CR Deferred Revenue. Deferred Revenue is a liability because you owe the customer the service or product.
Worked example: receive $480,000 in July for 6 months of subscription. DR Bank 480,000 / CR Deferred Revenue 480,000. July 31: recognize one month: DR Deferred Revenue 80,000 / CR Subscription Revenue 80,000. Repeat through December. By December 31 the liability is zero and total recognized revenue is $480,000.
On the balance sheet during these 6 months, deferred revenue is a current liability. Auditors and bankers look at it because high deferred revenue means strong forward visibility (customers committed to pay), but it also means an obligation to deliver. Both data points are useful.
A worked monthly close on accruals.
For a typical growing SMB at month end, the accrual journal entries look like this. Rent: DR Rent Expense 60,000 / CR Prepaid Rent 60,000. Insurance: DR Insurance Expense 15,000 / CR Prepaid Insurance 15,000. Software AMC: DR Software Expense 50,000 / CR Prepaid Software 50,000. Deferred revenue recognition: DR Deferred Revenue 80,000 / CR Service Revenue 80,000. Accrued utilities: DR Utilities Expense 35,000 / CR Accrued Liabilities 35,000 (then reverse next month when the bill arrives).
Five journal entries take 5 minutes. They smooth the P&L, satisfy IFRS for SMEs, give you accurate gross margin, and prevent the "huge expense in July, nothing for 11 months" pattern that confuses every reader of the books. With Nonari, all five are auto-generated from the underlying schedules; you review and post.
Tax implications, and why they matter.
tax law generally accepts accrual accounting for trading and manufacturing businesses. Section 33 requires accrual basis for businesses above certain thresholds. Cash basis is allowed for very small businesses but creates a mismatch between the books (often accrual for management) and the tax computation. Maintaining one consistent method across both reduces reconciliation work at year end.
Specific items: prepaid rent is deductible only when amortized, not when paid. Some advance payments are treated as expenses immediately if the period is short enough (under 12 months and within the same tax year). Deferred revenue is taxable when recognized as revenue, not when received as cash. Tax timing differs slightly from book timing on some items, creating temporary differences and deferred tax positions that auditors will check.
Building the prepaid and deferred schedules.
A prepaid expense schedule is a simple table: account, description, original amount, start date, end date, monthly amount, balance remaining. One row per active prepayment. At each month end, reduce the balance by the monthly amount and post the corresponding entry. When the balance hits zero, close the row.
Deferred revenue schedule mirrors: account, customer, description, original amount, start date, end date, monthly amount, balance remaining. The two schedules together drive month-end accrual entries. Maintaining them in Excel is fine for 5-10 active items; beyond that the manual workflow breaks down. Nonari's scheduled-entries module handles 100+ active schedules automatically.
- List every prepayment with its term.
- List every customer advance with its delivery schedule.
- Auto-post or manually post monthly entries.
- Reconcile balance sheet to schedule each month.
- Close rows when balance reaches zero.
Common errors that break the P&L.
Error one: expensing the full prepayment in the month of payment. Easy to do on cash basis, wrong on accrual. P&L is volatile and the asset never appears on the balance sheet. Error two: forgetting to amortize for several months and posting a catch-up. Acceptable if the amount is small but distorts the months in between. Error three: amortizing for the wrong period (treating a 6-month prepayment as 12 months halves each month's expense and inflates profit).
Error four: deferring revenue that should have been recognized. If a customer pays for a service and you delivered it the same month, the entire amount is current month revenue, not deferred. Deferred revenue applies only when you have a legal obligation to perform in future periods. Error five: not reconciling balance sheet prepaid and deferred balances back to the schedules. Once a schedule and the GL diverge, every period after compounds the error.