6. Accruals And Prepayments

Question 1

What are expenses accrued?

Answer 1

Expenses have been incurred but not paid for at the date to which the P&L is prepared. Therefore, an adjustment is needed and this will have a two fold effect:
1. reduces profit earned as a result of increasing the relevant expense
2. increases sundry creditors (accruals) as it will be reflected in the balance sheet under creditors falling due within one year. This is because the business has used goods and services it has not paid for yet.

Question 2

What are expenses prepaid?

Answer 2

Where expenses have been paid in advance for a period extending beyond the end of the accounting period. The adjustments needed are:
1. increase profit earned by reducing relevant expense in P&L account with the amount paid in advance
2. increase sundry debtors (or prepayments). this is by creating an asset of the same amount which will appear in balance sheet under current assets

Question 3

What is income received in advance?

Answer 3

where sundry income (e.g. rent) is received for a period extending beyond the end of the accounting period. This is called “deferred income” and it is disclosed as a creditor on the balance sheet.

Question 4

What is income accrued?

Answer 4

Sundry income (e.g. interest receivable) has been earned but not received. The business is able to credit the P&L account with income due and so create a corresponding asset, “accrued income”, to represent the business is owed income

Question 5

When does the accruals basis give rise?

Answer 5

It gives rise to accounting adjustments taking place after the initial trial balance of a business has been prepared

Question 6

What is the double entry to record income received in advance?

Answer 6

Dr Income
Cr Deferred income (BS creditor)
Same as accruals, this will be reversed at the start of the next accounting period

Question 7

What is the double entry to record accrued income

Answer 7

Dr Accrued income (BS debtor)
Cr Income
As with prepayments, this will be reversed out at the start of the next accounting period

Question 8

What are 3 steps to set up ledger accounts for the creation of accruals or prepayments?

Answer 8

1. Enter opening balance on expense account
2. Enter cash paid during the year
3. (1) Calculate and enter charge due for the year OR
4. (2) enter closing accrual or prepayment (other side of double entry is taken to accruals or prepayments ledger account)
5. close the expense account and total - missing entry will establish either closing accrual/prepayment or the charge for the year. This depends on which step 3 used.

Question 9

What does the accruals basis state?

Answer 9

We include in the P&L account items of income and expenditure which relate to the period; not only those which are paid or received

Question 10

How can we reflect necessary adjustments?

Answer 10

We do so by calculating closing accrual or closing prepayment