topic6 year end adjustments: accruals and prepayments Flashcards
accruals concept
-reflect transactions when they occur not when cash paid or received
-income from sales should appear in the same accounting period as the expenses which have generated those sales
-revenue is recognised when all the risk and rewards of the goods have been transferred to the buyer
-timing can be different
-profit is the difference between the revenues earned and the costs incurred in generating this revenue
if we ignored the accruals concept
-timing issues could cause all costs to appear In the first year and all income in the second year
-would look like massive losses in the first year and massive profit In the second year
-business would appear volatile
-no distinction between capital and revenue expenditure
-whole non cost of non current assets would appear in the year they were purchased but might be used to generate profits for 20 years
basis of accrual/prepayment adjustments
-time matched, expenses are recognised in the period they are incurred: e.g. rent charged in the period to which it relates, similarly rates
-both income and expenditure can be accrued or prepaid
accrued expenses
-these are expenses that have been incurred but not yet paid for
-incurred means businesses had the benefit:
goods received and invoiced but not yet paid for
electricity, gas or water used but not yet billed
work done by employees
service received after year end but related to previous year
-the expenditure is recorded in the statement of profiteer loss in the period it is incurred
-until the amount is settled an accrued expense is shown on the SFP
-in the following period the adjustment is reversed so that the items are removed from the new years figures and also cleared off the SFP
-we use a best estimate when estimating year end accruals figures
prepaid expenses
-these follow the accruals principle but are not called accruals but not called accruals
-prepaid expenses is the opposite an accrued expense
-these are expenses paid in advance e.g. cash paid before benefit is received
insurance
rent payable in advance
rates payable in advance
-prepaid element of the expense will benefit a future accounting period and is carried forward in the SFP
-on the SFP prepayment is a current asset
-in the following period the adjustment is reversed so that the item is added to the new years figures and is also cleared off the SFP
deferred (prepaid)/ accrued income
-same principle but relates to income rather than expenses
-deferred income e.g. subscriptions received in advance
-all transactions are the opposite way round to expenses
-as with expense adjustments the deferred income adjustment will be reversed in the new year so that the income is recognised in that year instead of the current year
-accrued income adjustment will be reversed In the new year and when income is received it will cancel against the reversal adjustment
income
reducing- DR
increasing- CR
expenditure
reducing- CR
increasing- DR
expenditure accrual
need to increase expenditure in the current year:
-DR expense account/ CR accrual
remove expenditure from the future year:
-DR accrual/ CR expense account
expenditure prepayment
need to decrease expenditure in the current year:
-DR prepayment/ CR expense account
need to increase expenditure in the future year:
-DR expense account/ CR prepayment
income accrual
need to increase income in the current year:
-DR accrued income/CR income account
need to remove income from the future year:
-DR income account/CR accrued income
deferred income
need to decrease income in the current year:
-DR income account/CR deferred income
need to increase income in the future year:
-DR deferred income/CR income account
