Chapter 5 - Accruals And Prepayments Flashcards
Accrual of expenses
An accrual is an amount due in an accounting period which is unpaid at the end of that period. Eg an insurance premium or electricity bill not paid yet.
In financial statements accrued expenses are:
Added to the expense account shown in the trial balance before it is listed in the statement of profit or loss
Shown as a liability in the year end statement of financial position
Prepayment of expenses
A prepayment is a payment made in advance of the accounting period to which it relates.
In financial statements prepaid expenses are:
Deducted from the expense account shown in the trail balance before it is listed in the statement of profit or loss
Shown as an asset in the year end statement of financial position
Private expenses
Sometimes the owner of a business uses business facilities for private purposes. Eg telephone or car. The owner will agree that part of the expenses should bring charged as drawings while other parts are a business expense.
The balance of a telephone account is £600 at year end. The owner agrees this should be split 1/4 private use 3/4 to the business. Bookkeeping entires are as follows:
Debit drawings account
Credit telephone account
Debit statement of profit or loss
Credit telephone account
When using a trial balance, private expenses should be adjusted by deducting from the expense account and adding to drawings.
Goods for own use
When the owner of a business takes some of the goods in the business trades for their own use the double entry bookkeeping is:
Debit drawings account
Credit purchases or sales
Where a business is vat registered, vat must be accounted for on goods taken by the owner.
When using a trial balance to produce the financial statements, goods for own use should be adjusted to drawings and deducting from purchases or adding to sales.
Income and expenditure accounting
We have made adjustments for accruals and prepayments to ensure that the statement of profit or loss shows the correct amount of income and expenses for the financial year, ie what should have been paid instead of what has actually been paid. This is the principle of income and expenditure accounting.
If we simply used the trial balance figures we would be following the principle of revised payments accounting which is comparing money coming in with money going out. This gives us a false view of profit for the year.
Accruals principle of accounting
The way in which financial statements are adjusted to take note of accruals and prepayments is recognised in the accruals principle of accounting.
Accruals - extended trial balance
In the adjustments columns you would debit the accural amount in the expenses row, and credit the accural amount in the accruals row
On the debit side of the profit or loss column the total cost of the expense is now calculated from adding the trial balance column and the adjustment column which includes the accrued expense.
On the credit side of the statement of financial position column the accrued expense amount in the accruals row is show as a liability
Accruals - double entry bookkeeping
The accrued expenses are debited to the expenses account which will mean the debit balance of the expenses account will include the b/d balance and the accrued expenses. The transfer to the statement of profit or loss is credited to the expenses account.
In the accrued expenses account the amount of the accrued expense will be credited. In the new financial year the accrued expenses account will be reversed which will mean the accrued expenses account will be debited and the expenses account will be credit.
When the payment is made for accrued expenses it will be debited to the expenses account so that the account will balance, meaning this expense will not be recorded in the next financial year.
Prepayments - the extended trail balance
In the adjustments columns record the prepaid amount on the credit side of the rent paid row and record the amount on the debit side of the prepayments row
This means on the debit side of the profit or loss the total cost of rent is the amount from the trial balance minus the prepayment.
One the debit side of the statement of financial position column the £75 from the prepayments row is shown as an asset
Prepayments - the double entry bookkeeping
The transfer to the statement of profit or loss is credited in the rent paid account aswell as the prepayment. This balances the rent paid account at the end of the year.
The pre paid expense is then debited to the prepaid expenses account.
In the new financial year amounts held in prepaid expenses account are reversed to the expenses account. The transfer is debit rent paid, credit prepaid expenses.
This now gives rent paid a debit balance of £75 which will be included for rent paid in the new year.
Accrual of income
Income of a business is due but unpaid at the end of the financial year. In the extended trial balance and financial statements, accrual of income is:
Added to the income amount in the trial balance before it is listed in the statement of profit or loss.
Shown as an asset in the statement of financial position.
Prepayment of income
The income of a business has been paid in advance by the buyer. In the extended trial balance and financial statements prepayment of income is:
Deducted from the income amount in the trial balance before it is listed in the statement of profit or loss
Shown as a liability in the year end statement of financial position
