Adjustment 3 Prepayments and
Accruals
Mr. Barry
A-level Accounting Year 12
What we have studied so far…
•
•
•
•
•
•
Depreciation of Non-current Assets
Disposals of Non-current Assets
Revaluations of Non-current Assets
Bad Debts written off
Provision for doubtful debts
Bad debts recovered
Mr. Barry
A-level Accounting Year 12
The Accruals Concept
• We are concerned with the value of resources used
by a business and the benefits derived from the use
of those resources by the business in one financial
year.
• The value of the resources used in any one time
period may be different from the price paid to
acquire the resources.
• Therefore, the matching of expenses and revenues to
the same goods or services and the same time
period – applies to closing stock, accruals and
prepayments.
Mr. Barry
A-level Accounting Year 12
Accruals and Prepayments
• So we assume that money paid on RENT in
February was for the use of premises in
February.
• OR wages paid in July was payment for work
done in July
• We have assumed that figures shown in the
trial balance prepared at 31st Dec 07 showed
all incomes and all expenses for the year
ended 31st Dec 2007 nothing more or nothing
less
Mr. Barry
A-level Accounting Year 12
Accruals and Prepayments
• The accruals concept recognises the difference between
actual payment of cash and the legal obligation to pay cash.
• Jimmy runs a small newsagent’s shop. He signed a tenancy
agreement with his landlord stating that he can use the shop
for the next 5 years on payment of a rental of £6,000 per
annum payable quarterly in advance on 1st Jan, 1 April, 1st
July and 1st October.
At 31st Dec 2006, Larry’s financial year ended, Larry has only
paid his landlord £4,500 (i.e. he owes the rent that was due
to be paid on 1st October).
The amount shown on Larry’s Profit & Loss account for Rent
is £6,000 since Larry has had the use of the resource (the
shop) worth £6,000 to help him generate profit.
Mr. Barry
A-level Accounting Year 12
Accruals and Prepayments
When preparing a trading and profit and loss account, a trader must
include all items of expenditure paid and payable.
The accruals concept also recognises the distinction between receipt of
cash and the legal right to receive cash.
So from now on when we prepare a set of final accounts we shall include
all items that apply to the accounting period under consideration.
Some expenses listed in the trial balance are ALWAYS paid in advance:
• Insurance
• Business rates
Other expenses listed on the trial balance might NOT be paid up to date:
• Part of Larry’s rent payable had not been paid
• Wages earned for work already done may not be due to be paid until next
month.
Mr. Barry
A-level Accounting Year 12
Dealing with ACCRUED expenses
• Trade Creditors are amounts owed to the suppliers of goods for
resale
• Trade Debtors are amounts owed by credit customers who have
not yet settled their accounts
• An extract from Larry’s trial balance as at 31st Dec 2006 would
show:
Dr
Cr
£
£
Rent Payable
4,500
When we prepare the profit and loss account for the year
ended 31st Dec 2006 the entries above would show:
Profit and Loss account for year ended 31st Dec 2006
Cr
£
£
Rent Payable
4,500
But this cannot be totally correct.
Larry has increased his debit entries by £1,500, with no corresponding
increase in credit entries. Not the done thing in double entry.
Dr
Mr. Barry
A-level Accounting Year 12
Dealing with Accruals
He needs to include an extra credit in his final
accounts….
Rent payable owed at the end of the final year
In the balance sheet prepared at the year end, trade
creditors represent amounts owed to suppliers that
have supplied goods but who have not been paid yet.
Since the rent payable is owed at the balance sheet
date, this too must be a creditor.
Larry has used the premises and not yet paid for the
use.
Mr. Barry
A-level Accounting Year 12
Dealing with Accruals
Rent payable must be shown as a current liability along with
trade creditors.
NOTE
• The balance sheet has not been credited
• The balance sheet is not part of the double entry system; it is
merely a sheet showing balances outstanding at the end of
the financial year.
• The outstanding rent is included in current liabilities with
other credit balances e.g. trade creditors
The balance sheet as at 31st Dec 2006 would show:
£
Current Liabilities
Accrued expenses (rent)
Mr. Barry
A-level Accounting Year 12
£
1,500
Dealing with Accruals – Question 1
The following items are shown on the trial balance extracted on 30th June
2006:
£
Wages
43,000
Motor Expenses
8,600
Telephone
2,400
Advertising
1,800
Heating and Lighting expenses
2,000
At the year end the following amounts remained outstanding and unpaid:
£
Wages
872
Motor expenses
750
Telephone
280
Advertising
560
Heating and Lighting
391
Write out each stating the amounts to be included as an expense in the profit &
loss account for year end 30th June 2006 and the amount to be shown as a
current liability in the balance sheet as at 30th June 2006
Mr. Barry
A-level Accounting Year 12
Dealing with Prepaid Expenses
Sometimes a Co will pay for services before it actually
receives the service.
Since we are accounting for resources used in the period
covered by the final accounts any amounts paid in advance
must be disregarded
WORKED EXAMPLE
An extract from Larry’s trial balance as at 31st Dec 06 shows:
£
£
Insurance
2,300
Business Rates
1,200
Insurance paid for January 2007 amounts to £100
Business rates paid for the 3 months ending 31st March 2007
amount to £300
REQUIRED –
Prepare an I/S extract for the year ended 31st Dec 2006
Mr. Barry
A-level Accounting Year 12
Dealing with Prepaid Expenses
Answer
Dr
P & L account extract for year ended 31st Dec 2006
£
Insurance
2,200
Business Rates
900
Cr
£
Larry does not include the £100 paid for NEXT YEAR’S insurance or the £300
for NEXT YEAR’S business rates.
He only includes the payments made to acquire the resources that have been
used to run his business this year.
But it can’t reduce debits by increasing credits
In effect, Larry credited Insurance with £100; he has credited business rates
with £300.
He needs to include two extra debits – two extra debtors
Mr. Barry
A-level Accounting Year 12
Dealing with Prepaid Expenses
Larry’s balance sheet as at 31st Dec 2006 will show:
£
£
CURRENT ASSETS
Amounts prepaid insurance
100
business rate 300
Mr. Barry
A-level Accounting Year 12
Question 2
The following items appear in a trial balance extracted on 31 Aug 2007:
£
Rent
7,500
General expenses
5,412
Insurance
1,872
Salaries
45,670
Rates
1,750
the following additional info is available as at 31 Aug 2007
Amounts Owing
Rent
500
General Expenses
521
Salaries
729
Amounts paid for the year ending 31 Aug 2008:
Insurance
341
Rates
812
State the amount to be included in the I/S for the year ended 31st Aug 2007
and the amount to be shown on the balance sheet as at 31 Aug 2007
Mr. Barry
A-level Accounting Year 12
Expense
I/S acc entry Current
Asset
Rent
General
Expenses
Salaries
Insurance
Rates
Mr. Barry
A-level Accounting Year 12
Current
Liability
Dealing with Outstanding Revenues
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•
•
•
When preparing a trading and profit and loss account, a
trader must include all items of revenue received or
receivable for the time period under review.
ACCRUAL of an Income
‘something that a Co is expected to be paid but hasn’t been
paid it yet’
In the P&L account you add it to income on our trial balance
In the Balance Sheet the amount of accrued income is put as a
Current Asset
PREPAID Income
‘Paid up front for work you have not yet carried out’
In the P&L account you take it away from the income
amount on trial balance
In Balance Sheet the amount of prepaid income will be
entered as a Current Liability
Mr. Barry
A-level Accounting Year 12
Dealing with Outstanding Revenues
When revenue has been earned during a financial year
but has not been paid, the revenue due must be
included in the final accounts. (accrued income)
EXAMPLE
Larry sub lets a room above his shop to Dan for a rental of
£50 per week. At 31st Dec, Dan owes two weeks rent.
Larry’s profit and loss account would show a full year’s
rental income of £2,600 even though he has actually
received only £2,500 from Dan
When preparing an income statement, a trader
must include all items of revenue received or
receivable for the time period under review
Mr. Barry
A-level Accounting Year 12
Murray traders has received £4,800 in interest
on an investment account during the year ended
31st Sept 2008. At Sept 2007 interest of £420 is
due but not yet received.
How should this info be recorded in the Interest
received account? Show how interest received
should be recorded in the trial balance, P&L acc
31st Sept 2008 and Balance Sheet 31st Sept 2008
Mr. Barry
A-level Accounting Year 12
Dr
Interest Received ACCOUNT
Cr
Sept 31st I/S account 5,240 Sept 31st Total Receipts 4,800
31st Balance c/d
420
5,240
5,240
Oct 1st Balance b/d
420
Step 1 – Record the receipt of £4,800 in the interest received acc
Step 2 – transfer the appropriate amount to the p & l acc (5,240)
Step 3 – balance the account (420)
Trial Balance – enter rent receivable £4,200 as a Credit
I/S acc – add (4,800 + 420) to Gross Profit
Balance Sheet – Add interest received due in CA’s (420)
Mr. Barry
A-level Accounting Year 12
Income Received in Advance
‘Paid up front for work you have not yet carried out’/
Income received in advance (prepaid income)
Taking rent receivable as an example of income
received in advance, it is possible for the tenant to
pay rent in advance. It will be necessary to adjust
the amount to be recorded in the I/S account, so
that it records rent receivable only for that financial
year.
Rent receivable received in advance is a current
liability
Mr. Barry
A-level Accounting Year 12
How to record income received in advance
Murray traders sublets part of its premises. The
Co had received a total of £3,900 from it’s tenant
for rent during the year ended 31 Dec 2008. This
amount includes a payment for 1 month’s rent of
£300 for jan 2009.
How would this info be recorded in the Co’s rent
receivable account? Show how rent receivable
will appear in the trial balance, P&L account for
year ended 31st Dec 2008 and Balance Sheet at
31st Dec 2008.
Mr. Barry
A-level Accounting Year 12
Dr
RENT RECEIVABLE ACCOUNT
Cr
Dec 31st P& L account 3,600 Dec 31st Total Receipts 3,900
31st Balance c/d
300
3,900
3,900
Jan 1st Balance b/d
300
Step 1 – Record the receipt of £3,900 in the rent receivable acc
Step 2 – transfer the appropriate amount to the p & l acc
Step 3 – balance the account
Trial Balance – enter rent receivable £3,900 as a Credit
P&L acc – add (3,900 – 300) to Gross Profit
Balance Sheet – Add rent received in advance in CL’s (300)
Mr. Barry
A-level Accounting Year 12