Accruals and Prepayments Flashcards
Accounting Adjustments
Accounting Adjustments are necessary… (2)
- If the trial balance does not balance
- To comply with the key accounting conventions and assumptions
What is the IASB Framework
- Sets out the concepts which underlie the preparation of financial statements
Key accounting assumptions
- Accruals or Matching…
- Going concern
Accruals or Matching
- Expenses/Income should be matched to the period they relate and to the income/expenses they generate
Going concern
- Assume entity will continue to trade for the foreseeable future
IASB Framework
Other assumptions (8)
- Consistency
Of accounting treatment or presentation - Prudence
Slow to recognise profits/gains, quick to anticipate losses - Materiality
Influence economic decision making of users - Offsetting
Report items separately - Comparative information
Disclose previous period - Substance over form
Report reality, not legal form - Neutrality
Free from bias - Completeness
No material omissions
Other Important Concepts
- Business entity
Separation of owner from the business - Money Measurement
Only deal with items to which a monetary value can be
attributed - Historical Cost
Transactions recorded at cost when occurred - Stable Monetary Unit
Eg £ or $ - Assume value of unit is constant - Realisation
Recognise income and profits when realised - Duality
Every transaction has two effects
Adjustments needed as a result of the key accounting concepts (why for each one)
- Accruals & Prepayments
- Inventory (stock) and the cost of sales
- Bad and doubtful debts
- Depreciation
- Accruals & Prepayments
To match expenses to the period they relate - Inventory (stock) and the cost of sales
To match sales with actual cost of those sales - Bad and doubtful debts
To be prudent in recognising debts that may not be recoverable - Depreciation
To match cost of a non current asset over its useful economic life
Profit and cash flow
Formula for cash flow vs profit
Definition of income and expenses
Point about profit and cash flow
Biggest difference
Cash flow = Cash in – Cash out
Profit = Income – Expenses
Income:
- Value of goods and services sold during a period
Expenses:
- value of goods and services consumed in generating income
Profit is not a measure of cashflow.
A profitable business may need an overdraft. A loss making business may have cash .
Income and expenses involve receivables and payables whereas cash is not about credit or what is owed, just what you have or have given out
Matching/Accruals – Key accounting concept
What is the aim?
What is it about?
What should we remember?
The aim is to show expenditure in the period to which it belongs, and not to the period when payment is made.
- Many expenses ‘overhang’ more than one accounting period. Eg Rent, Rates, Insurance, Licence costs, Electricity, Telephone, accountancy/audit fees etc.
- Remember we should recognise an expense when the goods or services are consumed
Matching/Accruals – Key accounting concept EXAMPLE
Accountancy fees
The accountant will prepare the accounts after the year end and therefore send their invoice after the year end.
However the expense is “_________” in the year and so
needs to be accounted for __ ____ _____.
The accountant will prepare the accounts after the year end and therefore send their invoice after the year end.
However the expense is “consumed” in the year and so
needs to be accounted for in the year.
Accruals
What is it?
What do we need to recognise?
Expense incurred but not yet invoiced
We need to recognise the expense and also recognise the liability
Rates - Example
Business rates are normally required to be paid annually in advance
If a business paid its business rates for the 12 month period to 31 March 2024 in April 2023 and had a year end of 30th June 2023 then 9 months of this payment relates to the next year
Prepayments
When is the expense paid?
We need to…?
- Expense paid in advance
- We need to remove the prepaid expense and recognise the asset
Balance sheet as at … (picture)
Susan started to trade on 1 June 2023 and has prepared the following trial balance after her first 4 months as at 30 September 2023
- The £1,000 rates expense relates to the 10 months to 31st March 2024 (£100 pm)
- This expense covers 10 months to 31 March 2024 but we only want the 4 months to 30 September 2023
The £150 electric expense relates to the 3 months to 31st August 2023
- The £1,000 rates expense relates to the 10 months to 31st March 2024 (£100 pm)
- This expense covers 10 months to 31 March 2024 but we only want the 4 months to 30 September 2023
Susan has prepaid
The £150 electric expense relates to the 3 months to 31st August 2023
This expense covers 3 months but we need 4 months to 30 September 2023
Susan needs an accrual for
