Chapter 8 Flashcards
In regards to accruals and prepayments what is the fundamental principle when it comes to accounts preparation?
That income and expenditure are recognised in the period in which they occur (are earned/consumed)
RATHER THAN
the period in which cash is received or paid (the accruals or matching concept)
What are the consequences of the fundamental principle?
- Simply recording transactions in the ledgers when they arise may not necessarily reflect the true use of resources or assets for a particular period.
We use accruals and prepayments adjustments to match the income or expense for a period to the actual use of resources and assets
Define accrual
Accruals are expenses incurred by the business, using up resources, before the year-end, but are paid for after the year end
How are accruals show in financial statements?
Accrual is a liability in the statement of financial position
this reflects the obligation to pay for the service already used
How are accruals shown in double entry?
Dr Expense
Cr Accruals
What is a prepayment?
Prepayments occur when a business pays an invoice for an expense that relates wholly or partly to the following period
What are examples of prepayments
Business Rates
Rent
Insurance
Advertising (e.g. cost of next years campaign
How do you calculate amounts to be charged to the statement of profit or loss? (high level)
T accounts
What are the steps of calculating accruals and prepayments?
1) Post the reverse of the b/f prepayment or accrual to the expense account
2) post the invoices received into the expense account
3) calculate the correct y/e prepayment or accrual and post the double entry
4) The correct expense for the period should then be the balancing figure in the expense
How is accrued and deffered income treated?
Exactly same principles apply
T account: ‘To accrue expenses at period end’
Dr Expense
Cr Accruals (liability)
T account: ‘ To set up a prepayment at period end’
DR Prepayment (asset)
Cr Expense
T account: ‘To record income received in advance at period end
Dr Income
Cr Deferred income (liability)
T account: ‘ to record income due but not yet received at period end’
Dr Accrued income (asset)
Cr Income
Where does an accrual sit
it is a liability in the SFP
What is the difference between an accrual and a prepayment?
accruals relate to expenses or revenues that have occurred but not yet been recorded,
while prepayments refer to payments made in advance for future benefits
Example of an accrual
Gas - bill in feb and may
statement in march - extract from second bill
T accounts for a gas example of an accrual: first period
Gas Expense T account
D Invoice received
Accrued gas expense
C
To SPL
Accrual (payables)
D
balance c/f
C Accrued gas expense
T accounts for a gas example of an accrual: next period
Gas Expense
D Invoice
C
Reversal of opening accrual
To statement of PL
Accrual (payables)
D reversal of opening accrual
C
balance b/f
In terms of DEADCLIC what is an accrual?
a LIABILITY a PAYABLE in the SFP
In terms of DEADCLIC what is a pre-payment?
An asset in the SFP (current asset)
reflecting the amount already paid for the service not yet used
What is the example of a prepayment
Paying rent from jan-may on 1st Jan 1000
statement on 31st March
until 31st March £600
after £400
Prepayment example: rent: t-account
Rent Expense
D
Invoice
C
Prepaid rent (£400) for next section
St of P/L (£600)
Prepayment (current asset)
D
Prepaid rent 400
C
Balance c/f
400
What is accrued and deferred income?
Similar to accruals and prepayments,
but a business may receive rental income or receive interest on cash deposits
SAME principles apply
