2. Accruals and prepayments

3. What’s Inside ? Learning Objectives Learning Objectives hink Corner uiz Corner Accruals and prepayments Prepaid expenses

4. Learning Objectives  Briefly explain what accrual accounting is.  Explain the term ‘accrued expenses’ and adjust expenses accounts for accruals.  Explain the term ‘prepaid expenses’ and adjust expenses accounts for prepayments.  Explain the term ‘revenues in arrears’ and adjust revenues accounts for amounts in arrears.  Explain the term ‘revenues in advance’ and adjust revenues accounts for amounts in advance.  Disclose accruals, prepayments, revenues in arrears and revenues in advance in a balance sheet.  Become familiarised with the alternative method of recording. After reading this chapter, you will be able to:

5. Accrual accounting Accrual accounting is based on the ____________. Accrual concept states that:  Revenues are recognised in the profit and loss account for the period in which they have been earned, not when they are received.  Expenses are recognised in the profit and loss account for the period in which they have been incurred, not when they are paid. Therefore, when we draw up the profit and loss account at the year end, we need to make adjustments to _______ and _______ for any _______ and __________. accrual concept revenuesexpenses accrualsprepayments Learning Objectives

6. Accrued expenses Accrued expense is the expense _______ in a period but which has not yet been _______ by the end of that period. Example 1: Longway Company paid electricity charges every three months. The following are the dates of payments: Expenses dueExpenses paidAmount $ 31 March 20X73 April 20X71,500 30 June 20X75 July 20X71,800 30 September 20X72 October 20X72,000 31 December 20X74 January 20X81,600 incurred paid for

7. Accrued expenses However, at the year end, the electricity charges for the last three months were still outstanding. The total electricity charges for the year 20X7 should be ($1,500 + $1,800 + $2,000 + $1,600) = $6,900. And this is the amount needed to be transferred to the __________________ at the year end. Electricity 20X7$ Apr3Bank1,500 Jul5Bank1,800 Oct2Bank2,000 profit and loss account

8. This outstanding amount is called _____________ or ______ and is to be carried forward to the following year as a ______. Accrued expenses Dec31Accrued c/f1,600 Electricity 20X7$ Apr3Bank1,500 Jul5Bank1,800 Oct2Bank2,000 20X7$ Dec31Profit and loss6,900 6,900 accrued expense accrual liability The balance to be carried forward to the next financial year. The amount of electricity actually paid in the current year. Learning Objectives The amount of electricity incurred in the current year. The amount of electricity incurred but not yet paid in the current year.

9. Prepaid expenses Prepaid expense is an expense which has been ____ in a period but will not be incurred until the _______ period. Example 2: Longway Company paid insurance every three months. The following are the dates of payments: Expenses dueExpenses paidAmount $ 31 March 20X728 March 20X75,000 30 June 20X725 June 20X75,000 30 September 20X727 September 20X75,000 31 December 20X7 31 March 20X8 paid following 29 December 20X7 10,000

10. Prepaid expenses At the year end, the company had paid three months’ insurance in advance. The total insurance for the year 20X7 should be ($5,000 x 4) = $20,000. And this is the amount needed to be transferred to the ____________ ______ at the year end. Insurance 20X7$ Mar28Bank5,000 Jun25Bank5,000 Sep27Bank5,000 profit and loss Dec29Bank10,000 account

11. The amount of insurance incurred in the current year. 25,000 This excess amount is called _____________ or _________ and is to be carried forward to the following year as an _____. Prepaid expenses Dec31Profit and loss20,000 prepaid expense asset The balance to be carried forward to the next financial year. 20X7$ Insurance Mar28Bank5,000 Jun25Bank5,000 Sep27Bank5,000 Dec29Bank10,000 20X7$ “ 31Prepaid c/f5,000 The amount of insurance paid but which has not been incurred in the current year. uiz Corner The amount of insurance actually paid in the current year. hink Corner prepayment

12. uiz Corner On 31 December 20X8, Ng’s Company extracted the following information. Prepare the ledger account, showing the amounts transferred to the profit and loss account at the year end. $ Rent accrued at the end of 20X7 (Oct — Dec 20X7)12,000 Rent paid during 20X8: 2 January (Oct — Dec 20X7)12,000 4 April (Jan — Mar 20X8)12,000 5 July (Apr — Jun 20X8)12,000 7 October (Jul — Sep 20X8)12,000 31 December (Oct 20X8 — Mar 20X9)24,000

13. uiz Corner Jan1Accrued b/f12,000 20X8$ Rent 20X8$ Jan2Bank12,000 Apr4Bank12,000 Jul5Bank12,000 Oct7Bank12,000

14. Dec31Bank24,000 uiz Corner Jan1Accrued b/f12,000 20X8$ Rent 20X8$ Jan2Bank12,000 72,000 Apr4Bank12,000 Jul5Bank12,000 Oct7Bank12,000 Dec31Profit and loss48,000 “ 31Prepaid c/f12,000

15. uiz Corner On 31 December 20X8, Ng’s Company extracted the following information. Prepare the ledger account, showing the amounts transferred to the profit and loss account at the year end. $ Rent accrued at the end of 20X7 (Oct — Dec 20X7)12,000 Rent paid during 20X8: 2 January (Oct — Dec 20X7)12,000 4 April (Jan — Mar 20X8)12,000 5 July (Apr — Jun 20X8)12,000 7 October (Jul — Sep 20X8)12,000 31 December (Oct 20X8 — Mar 20X9)24,000

16. uiz Corner Jan1Accrued b/f12,000 20X8$ Rent 20X8$ Jan2Bank12,000 Apr4Bank12,000 Jul5Bank12,000 Oct7Bank12,000

17. Dec31Bank24,000 uiz Corner Jan1Accrued b/f12,000 20X8$ Rent 20X8$ Jan2Bank12,000 72,000 Apr4Bank12,000 Jul5Bank12,000 Oct7Bank12,000 Dec31Profit and loss48,000 “ 31Prepaid c/f12,000

18. Stationery not entirely used up in the period in which it is bought should be treated as a prepayment. hink Corner nswer The amount paid for stationery is usually treated as an expense. For the stock of unused stationery at the end of a period, what is the accounting treatment? The balance of the stationery account should be carried forward to the following period as a debit balance. The stock of stationery is seldom added to the stock of unsold goods in the balance sheet; it is added to other prepayments.

19. Stationery not entirely used up in the period in which it is bought should be treated as a prepayment. hink Corner nswer The amount paid for stationery is usually treated as an expense. For the stock of unused stationery at the end of a period, what is the accounting treatment? The balance of the stationery account should be carried forward to the following period as a debit balance. The stock of stationery is seldom added to the stock of unsold goods in the balance sheet; it is added to other prepayments. Learning Objectives

20. Revenues in arrears Revenue in arrears (_____________) is other revenue (other than sales) earned but which has not yet been _______ in the period. Example 3: Longway Company received a commission every three months. The following are the dates of receipts: Revenues dueRevenues receivedAmount $ 31 March 20X74 April 20X710,000 30 June 20X72 July 20X78,000 30 September 20X75 October 20X712,000 31 December 20X76 January 20X89,000 received accrued revenue

21. Revenues in arrears At the year end, the company had not yet received the commission for the 3 months to 31 December 20X7. The total commission receivable for the year 20X7 should be ($10,000 + $8,000 + $12,000 + $9,000) = $39,000. And this is the amount needed to be transferred to the __________________ at the year end. profit and loss account Commission Receivable 20X7$ Apr4Bank10,000 Jul2Bank8,000 Oct5Bank12,000

22. 39,000 Dec31In arrears c/f9,000 Oct5Bank12,000 Commission Receivable 20X7$ Apr4Bank10,000 Jul2Bank8,000 20X7$ This outstanding amount is called _____________ and is to be carried forward to the following year as an _____. Revenues in arrears accrued revenue asset Dec31Profit and loss39,000 The amount of commission earned in the current year. The amount of commission actually received in the current year. The amount of commission earned but not yet received in the current year. The balance to be carried forward to the next financial year. Learning Objectives

23. Revenues in advance Revenue in advance (_____________) is the other revenue which has been received in a period but will not be _____ until the following period. Example 4: Longway Company received rent every three months. The following are the dates of receipts: Revenues dueRevenues receivedAmount $ 31 March 20X724 March 20X710,000 30 June 20X727 June 20X710,000 30 September 20X725 September 20X710,000 31 December 20X7 31 March 20X8 earned prepaid revenue 26 December 20X720,000

24. Revenues in advance At the year end, the company has received the rent for the 3 months to 31 March 20X8 in advance. The total rent receivable for the year 20X7 should be ($10,000 x 4) = $40,000. And this is the amount needed to be transferred to the __________________ at the year end. profit and loss account Rent Receivable 20X7$ Mar24Bank10,000 Jun27Bank10,000 Sep25Bank10,000 Dec26Bank20,000

25. 50,000 20X7$ Rent Receivable Mar24Bank10,000 Jun27Bank10,000 Sep25Bank10,000 Dec26Bank20,000 20X7$ This amount received in advance is called _____________ and is to be carried forward to the following year as a ______. Revenues in advance prepaid revenue liability Dec31Profit and loss40,000 The amount of rent earned in the current year. The balance to be carried forward to the next financial year. “ 31In advance c/f10,000 The amount of rent actually received in the current year. Learning Objectives The amount of rent received but not yet earned in the current year.

26. Disclosure in the balance sheet As we mentioned before, prepaid expenses and revenues in arrears are ______. Prepaid expenses represent the resources to be _______ in the near future. Revenues in arrears represent the monies to be _______ in the near future. Therefore, both prepaid expenses and revenues in arrears should be shown under ____________ in the balance sheet. assets used up received current assets

27. Disclosure in the balance sheet As we mentioned before, accrued expenses and revenues in advance are ________. Accrued expenses represent the debts to be ______ in the near future. Revenues in advance represent the obligations to ______ services in the near future. Therefore, both accrued expenses and revenues in advance should be shown under ______________ in the balance sheet. liabilities settled provide current liabilities

28. Disclosure in the balance sheet Revenues in advance10,000 Accrued expenses1,600 Revenues in arrears9,000 Prepaid expenses5,000 Current Assets $ Current Liabilities $ Longway Company Balance Sheet as at 31 December 20X7 (extract) CreditorsXXXStockXXX DebtorsXXX BankXXX CashXXX Refer to Examples 1 – 4. They will be shown in Longway Company’s balance sheet as follows: Learning Objectives

29. Alternative method Using this method, instead of carrying forward the accrued or prepaid balance in the expenses account, we now transfer the balance to an accruals account or a prepayments account. The double entry for recording an accrued expense is: Dr Expenses account Cr Accruals account The double entry for recording a prepaid expense is: Dr Prepayments account Cr Expenses account

30. Alternative method Refer to Example 1. The double entries would be: Dec31Accruals1,600 Electricity 20X7$ Apr3Bank1,500 Jul5Bank1,800 Oct2Bank2,000 20X7$ Dec31Profit and loss6,900 6,900 Dec31Balance c/f1,600 Accruals 20X7$ Dec31Electricity1,600

31. Alternative method Refer to Example 2. The double entries would be: Dec31Insurance5,000 Prepayments 20X7$ Dec31Balance c/f5,000 Dec31Profit and loss20,000 20X7$ Insurance Mar28Bank5,000 Jun25Bank5,000 Sep27Bank5,000 Dec29Bank10,000 20X7$ “ 31Prepayments5,000 25,000

32. Likewise, a revenues in arrears account and a revenues in advance account are opened to record all accrued revenues and prepaid revenues, respectively. Alternative method The double entry for recording an accrued revenue is: Dr Revenues in arrears account Cr Revenues account The double entry for recording a prepaid revenue is: Dr Revenues account Cr Revenues in advance account

33. Alternative method Refer to Example 3. The double entries would be: Oct5Bank12,000 Commission Receivable 20X7$ Apr4Bank10,000 Jul2Bank8,000 20X7$ Dec31Revenues in arrears9,000 Dec31Profit and loss39,000 39,000 Dec31Commission 9,000 receivable Revenues In Arrears 20X7$ Dec31Balance c/f9,000

34. Alternative method Refer to Example 4. The double entries would be: Dec31Balance c/f10,000 Revenues In Advance 20X7$ Dec31Rent receivable10,000 20X7$ Rent Receivable Mar24Bank10,000 Jun27Bank10,000 Sep25Bank10,000 Dec26Bank20,000 20X7$ Dec31Profit and loss40,000 50,000 “ 31Revenues in advance10,000