Accruals and prepayments Whats Inside Learning Objectives hink
Accruals and prepayments
What’s Inside ? Learning Objectives hink Corner Prepaid expenses uiz Corner Accruals and prepayments
Learning Objectives After reading this chapter, you will be able to: Briefly explain what accrual accounting is. Explain the term ‘accrued expenses’ and adjust expenses accounts for accruals. Explain the term ‘prepaid expenses’ and adjust expenses accounts for prepayments. Explain the term ‘revenues in arrears’ and adjust revenues accounts for amounts in arrears. Explain the term ‘revenues in advance’ and adjust revenues accounts for amounts in advance. Disclose accruals, prepayments, revenues in arrears and revenues in advance in a balance sheet. Become familiarised with the alternative method of recording.
Accrual accounting is based on the ______. accrual concept Accrual concept states that: Revenues are recognised in the profit and loss account for the period in which they have been earned, not when they are received. Expenses are recognised in the profit and loss account for the period in which they have been incurred, not when they are paid. Therefore, when we draw up the profit and loss account at the year end, we need to make adjustments to _______ revenues and _______ expenses for any accruals and _____. prepayments _______ Learning Objectives
Accrued expenses Accrued expense is the expense _______ incurred in a period paid for by the end of but which has not yet been _______ that period. Example 1: Longway Company paid electricity charges every three months. The following are the dates of payments: Expenses due 31 March 20 X 7 30 June 20 X 7 30 September 20 X 7 31 December 20 X 7 Expenses paid Amount 3 April 20 X 7 5 July 20 X 7 2 October 20 X 7 4 January 20 X 8 $ 1, 500 1, 800 2, 000 1, 600
Accrued expenses The total electricity charges for the year 20 X 7 should be ($1, 500 + $1, 800 + $2, 000 + $1, 600) = $6, 900. And this is the amount needed to be profit and loss account at the transferred to the _________ year end. However, at the year end, the electricity charges for the last three months were still outstanding. Electricity 20 X 7 Apr 3 Bank Jul 5 Bank Oct 2 Bank $ 1, 500 1, 800 2, 000
Accrued expenses This outstanding amount is called _______ accrued expense or accrual and is to be carried forward to the following ______ liability year as a ______. Electricity 20 X 7 Apr 3 Jul 5 Oct 2 Dec 31 Bank Accrued c/f The balance to be carried forward to the next financial year. $ 1, 500 1, 800 2, 000 1, 600 6, 900 20 X 7 $ Dec 31 Profit and loss 6, 900 The amount of electricity actually The amount ofofelectricity paid in but theincurred current incurred electricity not yet paid year. inin thecurrentyear. 6, 900 Learning Objectives
Prepaid expenses Prepaid expense is an expense which has been ____ paid in a period but will not be incurred until the _______ following period. Example 2: Longway Company paid insurance every three months. The following are the dates of payments: Expenses due 31 March 20 X 7 30 June 20 X 7 30 September 20 X 7 31 December 20 X 7 31 March 20 X 8 Expenses paid 28 March 20 X 7 25 June 20 X 7 27 September 20 X 7 Amount $ 5, 000 29 December 20 X 7 10, 000
Prepaid expenses The total insurance for the year 20 X 7 should be ($5, 000 x 4) = $20, 000. And this is the amount profit and loss needed to be transferred to the ______ account ______ at the year end. At the year end, the company had paid three months’ insurance in advance. Insurance 20 X 7 Mar 28 Jun 25 Sep 27 Dec 29 Bank $ 5, 000 10, 000
Prepaid expenses This excess amount is called _______ prepaid expense or prepayment and is to be carried forward to the _____ asset following year as an _____. Insurance 20 X 7 Mar 28 Bank Jun 25 Bank Sep 27 Bank Dec 29 Bank The amount of insurance actually paid in the current year. $ 5, 000 10, 000 25, 000 20 X 7 $ Dec 31 Profit and loss 20, 000 “ 31 Prepaid c/f 5, 000 The amount of insurance The amount of Theincurred balance in tothe be 25, 000 insurance paid but carried forward to current year. which has not been the next financial incurred in the current year. hink Corner uiz Corner
hink Corner The amount paid for stationery is usually treated as an expense. For the stock of unused stationery at the end of a period, what is the accounting treatment? Stationery not entirely used up in the nswer period in which it is bought should be treated as a prepayment. The balance of the stationery account should be carried forward to the following period as a debit balance. The stock of stationery is seldom added to the stock of unsold goods in the balance sheet; it is added to other prepayments. Learning Objectives
Revenues in arrears accrued revenue is other Revenue in arrears (_______) revenue (other than sales) earned but which has received in the period. not yet been _______ Example 3: Longway Company received a commission every three months. The following are the dates of receipts: Revenues due 31 March 20 X 7 30 June 20 X 7 30 September 20 X 7 31 December 20 X 7 Revenues received 4 April 20 X 7 2 July 20 X 7 5 October 20 X 7 6 January 20 X 8 Amount $ 10, 000 8, 000 12, 000 9, 000
Revenues in arrears The total commission receivable for the year 20 X 7 should be ($10, 000 + $8, 000 + $12, 000 + $9, 000) = $39, 000. And this is the amount needed to be transferred to the _________ profit and loss account at the year end. At the year end, the company had not yet received the commission for the 3 months to 31 December 20 X 7. Commission Receivable 20 X 7 Apr 4 Bank Jul 2 Bank Oct 5 Bank $ 10, 000 8, 000 12, 000
Revenues in arrears This outstanding amount is called accrued _______ revenue and is to be carried forward to the following year asset as an _____. Commission Receivable 20 X 7 $ Dec 31 Profit and loss 39, 000 Apr 4 Bank 10, 000 Jul 2 Bank 8, 000 The amount of Oct 5 Bank 12, 000 commission Dec 31 In arrears c/f 9, 000 earned in the The amount of 39, 000 current year. commission The amount actually of The balance to be received in the current commission earned but carried forward to year. not yet received in the next financial current year. Learning Objectives
Revenues in advance Revenue in advance (_______) prepaid revenue is the other revenue which has been received in a period but will not be earned _____ until the following period. Example 4: Longway Company received rent every three months. The following are the dates of receipts: Revenues due Revenues received 31 March 20 X 7 30 June 20 X 7 30 September 20 X 7 31 December 20 X 7 31 March 20 X 8 24 March 20 X 7 27 June 20 X 7 25 September 20 X 7 Amount $ 10, 000 26 December 20 X 7 20, 000
Revenues in advance The total rent receivable for the year 20 X 7 should be ($10, 000 x 4) = $40, 000. And this is the amount needed to be transferred to the profit and loss account at the year end. _________ At the year end, the company has received the rent for the 3 months to 31 March 20 X 8 in advance. Rent Receivable 20 X 7 Mar 24 Jun 27 Sep 25 Dec 26 Bank $ 10, 000 20, 000
Revenues in advance This amount received in advance is called prepaid revenue and is to be carried forward to _______ the following year as a liability ______. Rent Receivable 20 X 7 $ 20 X 7 Dec 31 Profit and loss 40, 000 Mar 24 Bank “ 31 In advance c/f 10, 000 Jun 27 Bank Sep 25 Bank Dec 26 Bank The amount of rent The balance be 50, 000 earned in thetocurrent received but not yet The amount of carried year. forward to earned in the current actually the next financial year. received in the year. current year. $ 10, 000 20, 000 50, 000 Learning Objectives
Disclosure in the balance sheet As we mentioned before, prepaid expenses and assets revenues in arrears are ______. Prepaid expenses represent the resources to be used up in the near future. _______ Revenues in arrears represent the monies to be received in the near future. _______ Therefore, both prepaid expenses and revenues in current assets in arrears should be shown under ______ the balance sheet.
Disclosure in the balance sheet As we mentioned before, accrued expenses and liabilities revenues in advance are ____. Accrued expenses represent the debts to be ______ settled in the near future. Revenues in advance represent the obligations to provide services in the near future. ______ Therefore, both accrued expenses and revenues in current liabilities advance should be shown under _______ in the balance sheet.
Disclosure in the balance sheet Refer to Examples 1 – 4. They will be shown in Longway Company’s balance sheet as follows: Longway Company Balance Sheet as at 31 December 20 X 7 (extract) Current Assets $ Current Liabilities $ Stock XXX Creditors XXX Debtors Revenues in advance 10, 000 XXX 1, 600 Revenues in arrears 9, 000 Accrued expenses Prepaid expenses 5, 000 Bank XXX Cash XXX Learning Objectives
Alternative method Using this method, instead of carrying forward the accrued or prepaid balance in the expenses account, we now transfer the balance to an accruals account or a prepayments account. The double entry for recording an accrued expense is: Dr Expenses account Cr Accruals account The double entry for recording a prepaid expense is: Dr Prepayments account Cr Expenses account
Alternative method Refer to Example 1. The double entries would be: Electricity 20 X 7 Apr 3 Jul 5 Oct 2 Dec 31 Bank Accruals $ 1, 500 1, 800 2, 000 1, 600 6, 900 20 X 7 $ Dec 31 Profit and loss 6, 900 Accruals 20 X 7 Dec 31 Balance c/f $ 1, 600 20 X 7 Dec 31 Electricity $ 1, 600
Alternative method Refer to Example 2. The double entries would be: Insurance 20 X 7 Mar 28 Jun 25 Sep 27 Dec 29 Bank $ 5, 000 10, 000 25, 000 20 X 7 $ Dec 31 Profit and loss 20, 000 “ 31 Prepayments 5, 000 25, 000 Prepayments 20 X 7 Dec 31 Insurance $ 5, 000 20 X 7 Dec 31 Balance c/f $ 5, 000
Alternative method Likewise, a revenues in arrears account and a revenues in advance account are opened to record all accrued revenues and prepaid revenues, respectively. The double entry for recording an accrued revenue is: Dr Revenues in arrears account Cr Revenues account The double entry for recording a prepaid revenue is: Dr Revenues account Cr Revenues in advance account
Alternative method Refer to Example 3. The double entries would be: Commission Receivable 20 X 7 $ 20 X 7 Dec 31 Profit and loss 39, 000 Apr 4 Jul 2 Oct 5 Dec 31 39, 000 Bank Revenues in arrears $ 10, 000 8, 000 12, 000 9, 000 39, 000 Revenues In Arrears 20 X 7 $ Dec 31 Commission 9, 000 receivable 20 X 7 Dec 31 Balance c/f $ 9, 000
Alternative method Refer to Example 4. The double entries would be: Rent Receivable 20 X 7 $ Dec 31 Profit and loss 40, 000 “ 31 Revenues in advance 10, 000 20 X 7 Mar 24 Jun 27 Sep 25 Dec 26 Bank 50, 000 $ 10, 000 20, 000 50, 000 Revenues In Advance 20 X 7 $ Dec 31 Balance c/f 10, 000 20 X 7 Dec 31 Rent receivable 10, 000 $
- Slides: 26