Chapter 10

Accruals and
prepayments

• Accruals and prepayments

 Syllabus learning outcomes 1
• Understand how the matching concept applies to accruals
and prepayments.
• Identify and calculate the adjustments needed for accruals
and prepayments in preparing financial statements.
• Prepare the journal entries and ledger entries for the
creation of an accrual or prepayment
• Illustrate the process of adjusting for accruals and
prepayments in preparing financial statements.
• Understand and identify the impact on profit and net
assets of accruals and prepayments.
Two methods of recording transactions

1. Cash Based Accounting – Cash based accounting says that

transactions are recorded in the period when cash changes
hands.

2. Accrual Based Accounting – Accrual based accounting says

that transactions are recorded in the period to which they
belong, and not when cash changes hands.
1. Accrued Expenses – Expenses Incurred not yet paid for – Liability

2. Prepaid Expenses – Expenses paid for but not yet incurred - Asset

3. Accrued Income – Income earned not yet received - Asset

4. Prepaid Income
Differed Income Income received not yet earned - Liability
Advance Income
 Month of March

Paid $ 300 for electricity

Feb’s unpaid
electricity bill was Paid advance for
$100 April 100$

March Electricity expense is $100, though cash paid is 300

• On 01.01.2018 Alpha Co paid $3,000 as advance rent
• for three months.
Advance Rent
01.01.2018
Cash / Bank 3,000 Rent Exp 1,000
Dr. Advance Rent 3,000
Cr. Cash / Bank 3,000 Rent Exp 1,000

31.01.2018 Rent Exp 1,000

Dr. Rent Exp 1,000
Cr. Advance Rent 1,000
Rent Expense
28.02.2018
Dr. Rent Exp 1,000 Advance Rent 1,000
Cr. Advance Rent 1,000
Advance Rent 1,000
31.03.2018
Dr. Rent Exp 1,000 Advance Rent 1,000
Cr. Advance Rent 1,000
 Cash Based Method
On 01.01.2018 Alpha Co paid $3,000 as advance rent
for three months.
Rent Expense
Dr. Rent Expense 3,000
Cr. Cash / Bank 3,000 Cash 3,000

Cash
Rent Exp 3,000
Overview
Accruals and
prepayments

Accounting
treatment

Reversing out Presentation in

Year end
accruals and the statement
adjustments
prepayments of financial position

Accrued income Accounting

and deferred income treatment
 Accruals and prepayments 3
Prepayment
 Accruals and prepayments 4
Accruals

Expense incurred – no invoice yet

Part relating to current accounting period is an accrual

Debit SPL / Income Statement
Credit SOFP / Balance Sheet payables (liability)

• Remember that the financial statements are prepared on an accruals

basis.
 Lecture example 1
• Fiona set up a business on 1 January 20X7. Her cash
payments for the year to 31 December 20X7 included:
 Lecture example 1 (cont'd)
Date paid Amount Period
$
Electricity
10.3.X7 96 2 months to 28 February 20X7
12.6.X7 120 quarter to 31 May 20X7
14.9.X7 104 quarter to 31 August 20X7
10.12.X7 145 quarter to 30 November 20X7

Rent
1.2.X7 375 3 months to 31 March 20X7
6.4.X7 1,584 12 months to 31 March 20X8

Note: On 6 March 20X8 Fiona received an electricity bill for $168 for
the quarter to 28 February 20X8.
 Lecture example 1 (cont'd)
Required
(a) Calculate the expense incurred by Fiona for electricity and
rent for the year ended 31 December 20X7.
(b) Calculate the amount of any accruals/prepayments at
the end of the year.
(c) State the journal entry required for the year-end
adjustments.
Answer to lecture example 1

(a) $
Electricity expense
Cash paid: 10.3.X7 96
12.6.X7 120
14.9.X7 104
10.12.X7 145
465
December expense missing (1/3 × $168) 56
521
Answer to lecture example 1 (cont'd)

$
Rent expense
Cash paid: 1.2.X7 375
6.4.X7 1,584
1,959
Less: expense relating to Jan – March × (3/12× $1,584) (396)
1,563
Answer to lecture example 1 (cont'd)

(b) & (c)

Electricity accrual is $56
$ $
Dr Electricity expense (SPL) 56
Cr Accruals (SOFP) 56
Being: electricity expense accrued at 31 December 20X7.

Rent prepayment is $396

$ $
Dr Prepayments (SOFP) 396
Cr Rent expense (SPL) 396
Being: rent expense prepaid at 31 December 20X7.
 Lecture example 2
Required
Using the figures from Lecture example 1:
Complete the necessary entries in Fiona's ledger accounts
as at 31 December 20X7, then balance off the accounts.
Answer to lecture example 2

Electricity expense (SPL)

$ $
10.3.X7 Cash 96
12.6.X7 Cash 120
14.9.X7 Cash 104
10.12.X7 Cash 145
31.12.X7 Accruals 56 31.12.X7 Transfer to SPL
521
521 521
Answer to lecture example 2 (cont'd)

Rent expense (SPL)

$ $
1.2.X7 Cash 375
6.4.X7 Cash 1,584 31.12.X7 Transfer to SPL 1,563

31.12.X7 Prepayments 396

1,959 1,959
Answer to lecture example 2 (cont'd)

Accruals (SOFP)
$ $
31.12.X7 Bal c/d 56 31.12.X7 Electricity 56
56 56
1.1.X8 Bal b/d 56
Answer to lecture example 2 (cont'd)

Prepayments (SOFP)
$ $

31.12.X7 Rent 396

31.12.X7 Bal c/d 396
396 396
1.1.X8 Bal b/d 396
 Lecture example 3
In 20X8 Fiona paid the following electricity bills:

Date paid Amount Period

$
12.3.X8 168 quarter to 28 February 20X8
9.6.X8 134 quarter to 31 May 20X8
12.9.X8 118 quarter to 31 August 20X8
12.12.X8 158 quarter to 30 November 20X8

During March 20X9 Fiona received an electricity bill for $189 for the quarter to 28
February 20X9.
 Lecture example 3 (cont'd)
Required
Calculate the electricity expense and accrual for the year ended
31 December 20X8 and complete the ledger accounts.
Answer to lecture example 3
Electricity expense (SPL)
$ $
12.3.X8 Cash 168 1.1.X8 Accrual reversed 56
9.6.X8 Cash 134 31.12.X8 To statement of 585
profit or loss
12.9.X8 Cash 118
12.12.X8 Cash 158
31.12.X8 Accruals
(1/3 × 189) 63
641 641
Accruals and prepayments from the previous year are
reversed at the beginning of the next accounting period so
that the current year expense is correct.
Answer to lecture example 3 (cont'd)
Accruals (SOFP)
$ $
1.1.X8 Accrual 56 1.1.X8 Bal b/d 56
reversed
31.12.X8 Bal c/d 63 31.12.X8 Electricity accrual 63
119 119
1.1.X9
Bal b/d 63
 Lecture example 4
Jimmy Co prepares its financial statements for the year to 30
June each year. The company pays for its insurance quarterly
in advance on 1 March, 1 June, 1 September and 1 December
each year.
The annual insurance premium was $24,000 until 31 August
20X6, after that date it increased to $30,000 per year.
 Lecture example 4 (cont'd)
Required
What insurance expense and end of year prepayment should be included in the
financial statements for the year ended 30 June 20X7?

Expense Prepayment
A $29,000 $2,500
B $29,000 $5,000
C $28,500 $2,500
D $28,500 $5,000
 Answer to lecture example 4
B
$
Insurance expense
July X6 – August X6 ( 2/12 × $24,000) 4,000
Sept X6 – June X7 ( 10/12 × $30,000) 25,000
29,000
Prepayment
1 June X7 paid ( 1/4 × $30,000) 7,500
Less: June X7 ( 1/3 × $7,500) (2,500)
5,000
 Tackling the exam
Exam focus point:

You will almost certainly have to deal with accruals and/or prepayments in the exam.
Make sure you understand the logic, then you will be able to do deal with whichever
question comes up.
Chapter summary 1
1 Introduction
 An entity should produce its financial statements using the
accruals basis. This is an implied assumption in the IASB
Conceptual Framework.
 Accruals are made when expenses are paid in arrears,
whereas prepayments arise when expenses are paid for in
advance.
Chapter summary 2
2 Accounting treatment
 Accruals increase expenses and are shown as a liability on the
statement of financial position at the year end.
 Prepayments reduce expenses and are an asset on the
statement of financial position.
Chapter summary 3
3 Reversing out accruals and prepayments
 Accruals and prepayments from the previous year are
reversed at the beginning of the next accounting period so
that the current year expense is correct.
Chapter summary 4
4 Accrued income and deferred income
 These follow a similar theory to accruals and prepayments but
relate to income.
 An entity will accrue income where it has earned the income
during the period but not yet invoiced for it. This will increase
income and be shown as a receivable at the year end.
 Where an entity has received income in advance of it being
earned it should be deferred to the following period. This will
reduce income and be shown as a payable at the year end.