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CHAPTER1
ACCRUALS AND
PREPAYMENTS
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PreviewofCHAPTER1
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Accrual-Basis Accounting Concept
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Adjusting Entries for Prepayments
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Adjusting Entries for Accruals
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The impact of prepayments and accruals on
financial statement
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Accrual-Basis Accounting and
Adjusting Entries
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Accrual-Basis Accounting
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Transactions recorded in the periods in which the
events occur.
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Income (Revenues) are recognized when earned,
rather than when cash is received.
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Expenditure (Expenses) are recognized when
incurred, rather than when paid.
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Accrual-Basis Accounting and
Adjusting Entries
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Cash-Basis Accounting
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Income (Revenue) recognized when cash is
received.
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Expenditure (Expense) recognized when cash is
paid.
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Accrual-Basis Accounting and
Adjusting Entries
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In accordance with Accurual
Basis Accounting Concept
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Accrual-Basis Accounting and
Adjusting Entries
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Q&A
Question 1. One of the following statements about the
accrual basis of accounting is false. That statement
is:
a. Events that change a company’s financial statements
are recorded in the periods in which the events occur.
b. Income is recognized in the period in which it is
earned.
c. The accrual basis of accounting is in accord with
generally accepted accounting principles.
d. Income is recorded only when cash is received, and
expenditure is recorded only when cash is paid.
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Accrual-Basis Accounting and
Adjusting Entries
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The Basics of Adjusting Entries
Adjusting entries are necessary because:
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Ensure that the revenue recognition and expense
recognition principles are followed.
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Required every time a company prepares financial
statements.
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Will affect one Profit or loss statement account and
one financial position statement account.
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Accrual-Basis Accounting and
Adjusting Entries
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Q&A
Question 2. Adjusting entries are made to ensure
that:
a. expenditure are recognized in the period in which
they are incurred.
b. Income is recorded in the period in which they are
earned.
c. Financial position statement and Profit or loss
statement accounts have correct balances at the
end of an accounting period.
d. all of the above.
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Accrual-Basis Accounting and
Adjusting Entries
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The Basics of Adjusting Entries
Types of Adjusting Entries
Prepayments
Accruals
1. Prepaid Expenditure.
Expenditure paid in cash and
recorded as assets before
they are used or consumed.
3. Accrued Expenditure.
Expenditure incurred but not
yet paid in cash or recorded.
2. Prepaid Income.
Cash received and recorded
as liabilities before income is
earned.
4. Accrued Income.
Income earned but not yet
received in cash or recorded.
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Adjusting Entries for Prepayments LOGO
I.
Prepayments
are expenditure or income that are recognized at a date
later than the point when cash was originally exchanged.
1. Prepaid Expenditure.
2. Prepaid Income.
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Adjusting Entries for Prepayments LOGO
Prepaid Expenditure
Cash Payment
BUT
in current period
Expense Recorded
in future period
Period 1:
Accounting for payment of prepaid expense in the
period
Dr. Expense account
Cr. Cash/Bank
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Adjusting Entries for Prepayments LOGO
Period 2:
Accounting for allocation of prepayment expense at
end period
Dr. Prepayment (Asset)
Cr. Expense Account
Adjusting
entries
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Adjusting Entries for Prepayments LOGO
Illustration: The annual insurance charge for a business is
$24,000 per annual. $30,000 was paid on 1 January 20X5 in
respect of future insurance charge.
For the year-ended 31 December 20X5 what is the closing
prepayment and the insurance expense for the year?
Show the relevant entries in the ledger accounts.
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Adjusting Entries for Prepayments LOGO
Question 3:
At 1/1/20X8, ABC Co signed a contract to rent an office at
$500 per month with payment in advance in 7 months at
beginning of each interval. The company prepares the
financial statement at 30/6/20X8.
Journal the adjusting entry
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Adjusting Entries for Prepayments
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Question 4:
EDF Co prepares its financial statements for the year
ended 30/4 each year. The company pays rent for its
premises quarterly in advance on 1 Jan, 1 Apr, 1 Jul, and 1
Oct. The annual rent was $84,000 per year until 30/6/20X7.
From 1/7/20X7, the rental price was increased to $96,000
per year.
Calculate rent expense and the remaining repayment
should be included in the financial statements for the
year ended 30/4/20X8?
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Adjusting Entries for Prepayments
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Prepaid Income
Cash Receipt
BEFORE
Revenue Recorded
in current period
in next period
Period 1:
Accounting for customers’s payment
Dr. Cash/ Bank
Cr. Income account
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Adjusting Entries for Prepayments
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Period 2:
Accounting for revenue earned at the end of period
Dr. Income account
Cr. Prepaid Income (Liability)
Adjusting
entries
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Adjusting Entries for Prepayments
❖Illustration:
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A business rents out a property at an
income of $4,000 per month. $64,000 has been received in
the year ended 31 December 20X5.
What is the year-end liability and what is the rental
income for the year?
Show the relevant entries in the ledger accounts.
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Adjusting Entries for Prepayments LOGO
Question 5: Libby Farquar receives income from the rental units 1 as
follows:
What is Libby’s rental income in the statement of profit or loss for the
year ended 31 December 20X5 and year-end liability in the statement
of financial position?
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Adjusting Entries for Accruals
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II. Accruals
An accrual arises where expenses or revenues of the
business relating to the accounting period, have not been
paid by the period end.
1. Accrued Expenditure
2. Accrued Income
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Adjusting Entries for Accruals
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Accrued Expenditure
Expense Recorded
in current period
BUT
Cash Payment
in next period
Period 1: Accounting for unbilled expenses at the
end of period
Dr. Expenses account
Cr. Accrual (Liabilities)
Adjusting
entries
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Adjusting Entries for Accruals
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Accrued Expenditure
Period 2: Accounting for payment of expenses in the
next period
Dr
Accrual (Liability)
Cr
Cash
Dr/Cr Expense (Under/over accrual)
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Adjusting Entries for Accruals
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❖ Illustration:
A business’ electricity charges amount to $12,000 per annual. In
the year to 31 December 20X5, $9,000 has been paid. The
electricity for the final quarter is paid in January 20X6.
What year-end accrual is required and what is the electricity
expense for the year?
Show the relevant entries in the ledger accounts.
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Adjusting Entries for Accruals
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Question 6: John Simnel’s business has an accounting year end of 31
December 20X1. He rents factory space at a rental cost of $5,000 per
quarter, payable in arrears.
During the year to 31 December 20X1 his cash payments of rent have
been as follows:
31 March (for the quarter to 31 March 20X1)
$5,000
29 June (for the quarter to 30 June 20X1)
$5,000
2 October (for the quarter to 30 September 20X1) $5,000
The final payment due on 31 December 20X1 for the quarter to that
date was not paid until 4 January 20X2.
Show the ledger accounts required to record the above
transactions.
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Adjusting Entries for Accruals
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Accrued Income
Revenue Recorded
In current period
BUT
Cash Receipt
In next period
Period 1: Accounting for billed revenue (but no payment received
yet) at the end of period
Dr. Accrued Income (Assets)
Cr. Income
Adjusting
entries
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Adjusting Entries for Accruals
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Accrued Income
Period 2: Accounting for payment of revenue from
customers in the next period
Dr. Cash/ Bank
Cr. Accrued Income
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Adjusting Entries for Accruals
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❖ Illustration:
A business earns bank interest income of $300 per month.
$3,000 bank interest income has been received in the year
to 31 December 20X5.
What is the year-end asset and what is the bank
interest income for the year?
Show the relevant entries in the ledger accounts.
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• The total amount credited to the statement of profit or
loss in respect of interest should be $3,600 (12 × $300).
• The year-end accrued income asset is the $600 that has
not yet been received.
• The accounting entries required are:
Dr Accrued income (SFP)
Cr Bank interest income (P/L)
$600
$600
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Ledger accounts
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Adjusting Entries for Accruals
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Question 7:
Libby Frquar receives income from rental unit 2, as follows:
What is Libby’s rental income in the statement of profit or
loss for the year ended 31 December 20X5?
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Chapter summary
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