Accruals And Prepayments Flashcards
In order for our financial statements to be accurate and reliable we must ensure we include ___ in the correct period as they must be matched to the period to which they relate and contribute revenue generation to.
Expenses
Describe accruals
- Accruals are expenses which have been incurred by a business during an accounting period but at the period end no invoice has been received so they haven’t been paid yet.
- Accruals relate to expenses that are paid in arrears.
- Many utility bills work this way (paying for each quarter after the quarter has finished).
Describe prepayments
- Prepayments arise when we have paid for an item of expense before we have used it.
- Prepayments are expenses paid for in advance.
How do we account for an accrual?
Dr Expense (SPL) (we have used the goods/services but not paid for them so our expenses are initially understated)
Cr Accruals (SFP) (a current liability, we have not yet paid for the expense which has the effect of showing a liability on our SFP)
What’s the double entry for a prepayment?
- Dr Prepayment (SFP as a current asset) — we have not yet used the goods/services we have paid for so we are owed that
- Cr Expense (SPL) — We need to reduce the total expense; part of the cash paid relates to next year’s expense but is currently included in this year. When the expense was paid the full amount would have been a debit to the expense account and a credit to the cash.
How do we reverse an accrual?
Dr Accrual
Cr Expense
How do we reverse a prepayment?
Dr Expense
Cr Prepayment
What is the 3 step process to dealing with subsequent years?
- Reverse out last year’s accrual/prepayment
- Post any cash paid this year
- Post any closing accrual or prepayment
What are the other ways to refer to prepaid income?
Deferred income, unearned revenue, unearned income
Describe prepaid income
- In accrual accounting, money received for goods/services which have not yet been delivered.
- The business therefore has received some cash but owes the customer for the service to be delivered at a later date.
- As the service is owed this is a liability on the SFP
The adjustment for prepaid income is…
To calculate the amount which relates to the service to be provided in a later period end
What is the double entry for prepaid income
Dr Sales (P/L to reduce the revenue for the period)
Cr Prepaid income (SFP liability created for the service which is owed)
Describe accrued income
- Income earned but not yet received.
- An asset at the end of a period as the work has been done but the income not received.
- ## The income will need to be included in the sales for the period in question
What is the double entry for accrued income?
Dr Accrued Income (SFP to recognise the asset for the income earned but not yet received)
Cr Sales (P/L to increase the sales income)
What are commissions receivable?
Accrued income—a current asset
Describe the difference between prepaid income and prepaid expenses
Prepaid income
- Reduces profit in current period
- Reduces income in current period
—> Dr Income, Cr Liability
Prepaid Expenses
- Increase profit in the current period
- Reduces expenses in current period
—> Dr Asset, Cr Expense
Describe the difference between accrued income and accrued expenses
Accrued income
- Increases income in current period
- Increases profit in current period
—> Dr Asset, Cr Income
Accrued expenses
- Increases expenses in current period
- Reduces profit in current period
—> Dr Expense, Cr Liability
What are recurring entries?
- An efficient way to post accrual/prepayment adjustments in the accounts software.
- These entries can automatically post the necessary period-end journals and reverse them back out again in the following period (if set up right).
- It is important to enter dates and amounts accurately when relying on automated accounting entries to avoid errors being made.
Period end adjustments such as accruals and prepayments can be used to ___ the financial statements. Making an incorrect entry for them can affect the ___ of a business.
- Manipulate
- Profit
How are some ways you could increase profits of a business via manipulation (accruals/prepayments)?
- Not making entries for accruals that are requires therefore not recording legitimate expenses from the P&L
- Overstating prepayments therefore removing too much expense from the P&L
- Not prepaying income to a future period therefore overstating come in the P&L
- Making accrued income adjustments when not required therefore including income in the P&L that has not yet been earned
