---
title: "Prepaid and accrued expenses: contracts, bonuses and cut-off"
description: "How an annual contract, a bonus being earned and December's unbooked charges reach the P&L in the right month, with reversing entries."
canonical: "https://lopifi.com/learn/expense-prepaids-accruals-and-cutoff"
---

# Prepaid and accrued expenses: contracts, bonuses and cut-off

> How an annual contract, a bonus being earned and December's unbooked charges reach the P&L in the right month, with reversing entries.

Source: https://lopifi.com/learn/expense-prepaids-accruals-and-cutoff
Part of: Lopifi — Planned: US GAAP books on autopilot, checked by a CPA (https://lopifi.com)

---

**How do prepaid contracts, accrued bonuses and unbooked expenses reach the P&L?** How an annual contract, a bonus being earned and December's unbooked charges reach the P&L in the right month, with reversing entries.

Two kinds of cost reach the profit and loss in a different month than the cash. A [prepaid](https://lopifi.com/md/glossary/prepaid-expense) is paid first and used later. An [accrued](https://lopifi.com/md/glossary/accrual) expense is used first and paid later. [The schedules lesson](https://lopifi.com/md/learn/prepaid-and-accrual-schedules) ran the insurance, the software and the power bill. This one applies them to the spend that is not a vendor bill: an annual contract on a card, a bonus that is being earned, and the charges nobody has booked at the close.

## An annual contract

On November 1, 2026 Northwind pays $2,400 for a year of a tool. The cash left on one day; the benefit arrives over 12 months. [Amortized](https://lopifi.com/md/glossary/amortization) evenly it releases $200 a month. At December 31, 2026 two months are released, $400, and $2,000 is still a prepaid.

| Month end | Released | Remaining prepaid |
| --- | --- | --- |
| November 30, 2026 | $200 | $2,200 |
| December 31, 2026 | $200 | $2,000 |
| January 31, 2027 | $200 | $1,800 |
| October 31, 2027 | $200 | $0 |

The schedule, first months and last.

Tax has its own view of a prepayment. Under the 12-month rule a payment for a benefit that does not run past 12 months, or past the end of the next tax year, need not be capitalized. This contract is inside it; a 24-month term would be outside it. Whether the deduction then falls in the year paid also depends on whether the company is on the cash or the accrual method for tax, so ask your preparer. The books defer the cost either way.

> “12 months after the first date on which the taxpayer realizes the right or benefit”

— [Treas. Reg. §1.263(a)-4(f), the 12-month rule](https://www.law.cornell.edu/cfr/text/26/1.263(a)-4), A payment for a benefit of 12 months or less need not be capitalized for tax

> **Tip.** Put the term and start date on the invoice record the day the bill or card charge arrives, and let the schedule post the releases. A prepaid kept in someone's head is released late or never.

> **Tip.** Review the prepaid account every month against its schedules. If the account says more than the schedules do, a release was missed; if less, one posted twice. The schedule names the month.

## Accruing a bonus

The operations manager's bonus plan runs October 1, 2026 for 12 months. Her target is $6,000 and the plan expects 85 percent attainment, so the expected payout is $5,100. Under the accrual basis the cost is recognized as the months pass, provided the payout is probable and can be estimated, not when the check is cut, and the employer's share of Social Security and Medicare on it is accrued with it. At December 31, 2026, 3 of 12 months are done.

|  | Amount |
| --- | --- |
| Expected payout | $5,100 |
| Accrued after 3 months | $1,275 |
| Employer payroll tax on it | $97.54 |
| Liability at the close | $1,372.54 |

Each month's slice is $425; any odd cents sit in the later months so the twelve tie to the expected payout.

When the bonus is paid it will not match the estimate. If it comes in at $5,400, the difference is not a prior-period error: it is a [true-up](https://lopifi.com/md/glossary/true-up), expensed in the month of payment, along with the change in the employer's payroll tax. The accrual is a best estimate, and the estimate was reasonable when it was made.

> “Accrual accounting attempts to record the financial effects on an entity of transactions and other events and circumstances that have cash consequences for the entity in the periods in which those transactions, events, and circumstances occur rather than only in the periods in which cash is received or paid by the entity.”

© Financial Accounting Foundation. All rights reserved.

— [CON 8, Introduction — as amended by Ch. 4, App. A (carrying forward CON 6, ¶139)](https://www.fasb.org/concepts-statements), What accrual accounting is for

> **Tip.** Accrue the payroll tax with the bonus. A bonus accrued without its employer taxes understates the cost by 7.65% of it, and the shortfall lands in the month it is paid.

> **Watch for.** The tax deduction for an accrued but unpaid bonus has its own timing rules, separate from when GAAP says the cost is incurred. Tell the preparer about the plan and the payout date when it is adopted, not when the return is being prepared.

## The spend nobody has booked

An expense belongs to the period it was incurred in. The day it was approved, submitted or paid does not matter. At December 31, 2026 four records sit around the close: two incurred in December and not yet booked, one booked in December that belongs to January, and one that is simply right. [Cut-off](https://lopifi.com/md/glossary/cutoff) is the work of putting each in its month, and it is what an auditor's [search for unrecorded liabilities](https://lopifi.com/md/glossary/unrecorded-liabilities-search) looks for.

| Item | Incurred | Amount | In December? | At the close |
| --- | --- | --- | --- | --- |
| Card charge, freight forwarder | December 29, 2026 | $318.40 | No | Accrue |
| Expense report, approved January 4 | December 18, 2026 | $207.35 | No | Accrue |
| Hotel deposit, January trade show | January 5, 2027 | $450 | Yes | Take out of December |
| December software seats | December 15, 2026 | $96 | Yes | Leave |

December's four records.

> **Tip.** Close on a calendar with a deadline for submissions, such as the third business day, and publish it. Anything still unsubmitted at the close is estimated from the card feed and the pending items, not left out.

> **Tip.** Read the last week of the month and the first week of the next in the card feed, line by line. Cut-off errors cluster there, and the amounts are small enough that nothing else will catch them.

> **Mistake.** Booking an expense report in the month it was approved. The trip happened in December; approving it on January 4 does not move the cost. The same goes for a card charge that posts on the 2nd for a purchase made on the 30th.

**Use case — A trip across a quarter end.** A team spends a week at a customer site in the last days of the quarter and submits expenses in the first days of the next. The reports are approved on the 5th and paid on the 12th. If the close ignores them, the quarter's travel is understated, the next quarter's overstated, and the budget owner is told the quarter came in under when it did not.

> **The month a cost belongs to is the month it was used, not the month it was approved or paid.**

**Scenario — Challenge: cut off December.** It is the December 31, 2026 close. For each of four records, say whether December must accrue it, leave it alone, or take it out of December. Remember that the date that counts is the date the cost was incurred, and check whether December already carries it.

**Exercise — Cut off December's expenses.** It is the close for 2026-12-31. An expense belongs to the period it was incurred in, not the day it was approved or paid. For each item, say what the close does with December. Type it in the workbook at https://lopifi.com/playground.

## Where this lesson's rules come from

- [ASC 340-10](https://asc.fasb.org/340/tableOfContent) — Other Assets and Deferred Costs — prepaid expenses (codification)
- [CON 8, Introduction — as amended by Ch. 4, App. A (carrying forward CON 6, ¶139)](https://www.fasb.org/concepts-statements) — What accrual accounting is for (concepts)
- [ASC 450](https://asc.fasb.org/450/tableOfContent) — Contingencies (codification)
- [Treas. Reg. §1.263(a)-4(f), the 12-month rule](https://www.law.cornell.edu/cfr/text/26/1.263(a)-4) — A payment for a benefit of 12 months or less need not be capitalized for tax (regulation)

## Read further

- https://lopifi.com/md/journal-entries/prepaid-software-subscription
- https://lopifi.com/md/journal-entries/accrued-expenses
- https://lopifi.com/md/journal-entries/accrued-wages
- https://lopifi.com/md/differences/prepaid-expense-vs-accrued-expense
- https://lopifi.com/md/differences/reversal-vs-reversing-entry
- https://lopifi.com/md/startups/accrued-expenses-vs-accounts-payable
- https://lopifi.com/md/startups/why-close-your-books-monthly
- https://lopifi.com/md/accounting/prepaids
- https://lopifi.com/md/accounting/accrued-expenses
- https://lopifi.com/md/accounting/cutoff
- https://lopifi.com/md/tools/prepaid-release
- https://lopifi.com/md/tools/amortize
- https://lopifi.com/md/docs/domain/schedules-and-accruals
- https://lopifi.com/md/docs/domain/periods-and-close

- **Track:** [Accounts payable](https://lopifi.com/md/learn/ap)
- **Lesson:** Lesson 20 of 21 — 12 min
- **Terms taught:** [Prepaid expense](https://lopifi.com/md/glossary/prepaid-expense), [Accrual](https://lopifi.com/md/glossary/accrual), [Accrued liability](https://lopifi.com/md/glossary/accrued-liability), [Reversing entry](https://lopifi.com/md/glossary/reversing-entry), [Cutoff](https://lopifi.com/md/glossary/cutoff), [True-up](https://lopifi.com/md/glossary/true-up), [Unrecorded liabilities search](https://lopifi.com/md/glossary/unrecorded-liabilities-search), [Amortization](https://lopifi.com/md/glossary/amortization)
- **Previous:** [Capitalize or expense: equipment, freight and the small-purchase rules, AP · Lesson 19](https://lopifi.com/md/learn/capitalize-or-expense-purchases)
- **Next:** [Closing the expense side: department spend, budget and burn, AP · Lesson 21](https://lopifi.com/md/learn/expense-close-and-spend-analytics)
- **The course:** https://lopifi.com/md/learn