Lecture 19 (Prepayments and accruals)

Question 1

What are prepayments and accrued income? (asset/liability)

Answer 1

Current asset

Question 2

What are accruals and prepaid income? (asset/liability)

Answer 2

Current liability

Question 3

When should revenue be recorded (according to IAS)?

Answer 3

When:

1. Significant risks and rewards of ownership have been transferred to the buyer.
2. Managerial involvement and control have passed.
3. The amount of revenue can be measured reliably.
4. It is probable that economic benefit will flow to the enterprise.
5. The costs of the transaction, including future costs, can be measured reliably.

Question 4

PREPAYMENTS

Answer 4

Expenses paid in advance, so defer the expense to the next accounting period (Dr prepayment, Cr Expense).

This is an asset, as the business has paid for something that will help generate revenue in the future.

Question 5

ACCRUED INCOME

Answer 5

Similar to prepayments, but deals with income instead of expenses. Sales do not neatly fall to line with the financial year end, there will be sales made but not yet invoiced.

If these sales relate to the accounting year the accruals concept says they should be included. (Dr Accrued Income, Cr Sales)

two stages:

1. Record this year
2. Reverse next year.

Question 6

What balances have brought forward balances?

Answer 6

Rent does not because it is an expense account and appears on the income statement, so no brought forward balance.

Prepayments (current asset on SoFP) will have a brought forward balance.

Question 7

In year two what are the debit and credit entries required for prepayments?

Answer 7

Reverse prior year payment:
Dr Rent (Expense)
Cr Prepayments

Include current year prepayment:
Dr Prepayments
Cr Rent

Question 8

ACCRUALS

Answer 8

Expenses incurred but not yet paid or included in AIS
(Dr Expense, Cr Accruals)

This is a liability, as the business has received something that still needs to be paid for, e.g. heat and light.

Question 9

PREPAID INCOME

Answer 9

Similar to accruals, but deals with income instead of expenses. Income received in advance (i.e. goods or services paid for by the customer but not yet provided). Therefore a liability.
Dr Sales
Cr Prepaid income

2 stages:

1. Record this year
2. Reverse next year

Question 10

Double entries for accruals in year 2.

Answer 10

Reverse year 1 accruals:
Dr Accruals
Cr Expense

Add year 2 accruals:
Dr Expense
Cr Accruals