1. The Principle behind Accruals and Prepayments Flashcards
Define accruals (accrued expenses)
Accruals are expenses which are charged against the profit for a particular period, even though they have not yet been paid for.
Define prepayments (prepaid expenses)
Prepayments are expenses which have been paid in one reporting period but are not charged against profit until a later period, because they relate to that later period.
Explain why accruals and prepayments are necessary?
Expenses should be matched against income in the period to which they relate. Accruals and prepayments are the means by which we move expenses into the the correct reporting period.
If we pay in this period for goods/services that relate to the next reporting period, we use a prepayment to transfer that expense forward to the next period.
If we have incurred an expense in this period which will not be paid for until the next period, we use an accrual to bring the expense back to into this period.
How should a professional accountant use the accrual concept if an invoice has not yet been received?
Sometimes an invoice for goods or services used in the year will not yet have been received at the year end, but that does not mean that we should not accrue for the expense.
The accountant may have to use their professional judgement to estimate the accrual based on similar expenses incurred in the past.
Why is application of the accruals principle important?
Application of the accruals principle is essential if the financial statements are to present a true and fair view of the performance and position of an entity.
Adjusting for accruals and prepayments is therefore an essential step in preparing the financial statements for communication to external stakeholders.
