CHAPTER 11: Visual Overview

Objective: To explain the period-end adjustments for prepayments and accruals.

1.1 Accrual Basis

The accrual basis of accounting (“accrual accounting”) concerns the timing of the recognition of transactions. Under the accrual
basis, the statement of profit or loss must include all income and expenses related to the period, regardless of the timing of cash
receipts or payments.
The mismatches between the timing of transactions and their cash flow give rise to the following in the statement of financial
position:

Key Point

Under the accrual basis, revenue and costs are both:

• accrued (recognised as earned or incurred) and
• recorded in the financial statements of the period they relate.
The matching concept requires expenses incurred in generating revenue to be matched against the revenue in determining
profit or loss for the period.
• When revenue is recognised because it has been earned, the costs incurred in generating such revenue are also recognised
(matched).
• However, a future sale cannot be recognised merely because it can be matched with costs incurred. This would be contrary to
the accrual basis and the concept of prudence (which calls for the exercise of caution so that, for example, income is not
overstated).
The accruals concept is applied to:
 • Receivables and Payables
When goods are sold or bought on credit, the sale or the purchase is recorded immediately, and receivables and
payables are created. As a result, the income (Sales) and expense (Purchases) is recognised even though there
has been no actual payment.
• Business Expenses and Income
The same logic used for credit sales and purchase transactions is applied to other expenses or income of the
business, such as rental, electricity and insurance fees.
Example 1
Desmond owns a business that makes made-to-measure wooden window frames, doors and furniture. The business is known
as DPQ Joinery, and all the wooden furniture is made at a single workshop premise that the business owns. Any painting
required is done at a separate workshop space, which the business rents.
The office where all the accounting and administrative functions are carried out is attached to the business's workshop
premises.
DPQ Joinery would most likely incur numerous expenses to operate his business, such as wages, electricity, repairs,
maintenance, telephone, insurance, rental of the painting workshop, advertising and stationery.
Broadly, expenses can be split into two categories:
• Those related to a specific transaction on a particular date, for example, stationery.
• Those related to an ongoing service received over time, for example, electricity, rent or telephone service.
For example, DPQ Joinery uses electricity daily, incurring an expense. However, the electricity supplier may only invoice DPQ
Joinery each quarter for the electricity used over the past three months.
At DPQ Joinery's year-end, the business will owe the electricity supplier for electricity used but not yet invoiced. This used but
unpaid electricity will need to be accrued to ensure that the total cost of the electricity used in the year is reflected in the profit
figure within the statement of profit or loss.
The business expense reflected in the final accounts should be based on the electricity use rather than how much has been
invoiced or paid.
Electricity was used as an example, but the same logic applies to other business expenses with ongoing use – such as
telephone service, rent or insurance.

1.2 Accruals Concept on Accruals, Prepayments, Accrued Income and Deferred Income
Payment received from income and made for expenses may be made in arrears (received/paid later) or in advance
(received/paid earlier).
This chapter discusses accruals, prepayments, accrued income and deferred income. The double entries below will only be
made at the financial year-end.
Category Explanation Asset Liability Double Entry
Accruals Expenses incurred before payment made ✓ DR Expenses
CR Accruals
Prepayments Payment made before expenses incurred ✓ DR Prepayments
CR Expenses
Accrued Income Income earned before payment received ✓ DR Accrued Income
CR Income
Deferred Income Payment received before income earned ✓ DR Income
CR Deferred Income
A business may incur expenses with payments made in arrears or in advance:
• Accruals are expenses paid in arrears. For example, electricity incurred from January to March is paid only at the
end of March. Accruals are reported as a liability in the statement of financial position.
• Prepayments are expenses paid in advance. For example, yearly business insurance is paid once at the start of
the year. Prepayments are reported as an asset in the statement of financial position.
A business may generate income with payments received in arrears or in advance:
• Accrued Income is income generated for payments received in arrears. For example, a business may rent out
additional space in an office and collect rental income at the end of the month. Accrued income is reported as
a asset in the statement of financial position.
• Deferred Income is income generated with payments received in advance. For example, a business may
collect rental income at the start of the month or quarter. Deferred income is reported as a liability in the statement
of financial position.

2.1 What is an Accrual?

Key Point

An accrual is recognised when an expense incurred has not been paid or invoiced for by the end of the financial period.

Usually, a business recognises an expense when it receives a purchase invoice (credit purchase) or makes a payment (cash
purchase); the double entry would be DR Expenses, CR Payables/Bank.
However, certain ongoing expenses may only be paid after the services have been incurred. This is known as a payment in
arrears. The expense that has yet to be paid at year-end is recognised as an accrual.
Example 2
DPQ Joinery's electricity supplier sends its invoice every quarter (three months).
The quarterly invoice will be for the electricity used in the previous quarter (three months). This means that the electricity
supplier will invoice DPQ Joinery after it has used the electricity. This is known as invoicing in arrears.
At the year-end, DPQ Joinery will owe the electricity supplier for electricity used since the last invoice date. A liability, therefore,
needs to be recorded in the statement of financial position to reflect the amount owed.
This liability is an accrual, which will also be recorded in the electricity expense account.

2.2 Accounting for Accruals

Once the accrual amount is established, the amount is recognised as an expense and a liability.
At year-end, the business will adjust for accruals creation for expenses incurred before receiving the invoice/making payment.
In the subsequent accounting period, where the business receives the invoice and makes the payment, it will reverse the
accruals and account for the expense payment. The accruals creation and the reversal of accruals are posted to the relevant
ledgers using journals.
The double entry for creating accruals at year-end to recognise the expense incurred that has not been paid is:
Individual Account Category Explanation
DR Individual Expense Expense Expenses increased
CR Accruals Liability Accruals (Liability) increased
The adjustment for accruals creation will have an impact on the business’s profits and net assets as follows:
• Profits – The double entry to create accruals is to debit the expenses account. Expenses increases, which will lead to a reduced
profit figure.
• Net Assets – The corresponding entry is to credit the Accruals liability account. Net assets or capital is the assets less liabilities
of a business. Since liability has increased, the net assets of the business will decrease.
In the next accounting period, the supplier will invoice the business for the expense, and the business will make payment. As a
result, double entries are made for:
• the accruals reversal
• the expense payment
The double entry to reverse the accruals adjustment is:
Individual Account Category Explanation
DR Accruals Liability Accruals (Liability) decreased
CR Individual Expense Expense Expense decreased
The double entry for the expense payment is:
Individual Account Category Explanation
DR Individual Expense Expense Expense is recorded (increased)
CR Bank/ Payables Asset Bank (Asset) decreased
Example 3
During the year ended 31 December 20X2, the electricity supplier sent the following invoices to DPQ Joinery, which were paid
immediately:
Date Period of electricity use $
2 May 1 January to 30 April 8,460
2 August 1 May to 31 July 6,190
2 November 1 August to 31 October 7,230
21,880
DPQ Joinery paid a total of $21,880 for electricity during the year. However, this relates only to the electricity used by the
business from 1 January to 31 October. An additional two months of electricity use (1 November to 31 December) have not
been invoiced and paid.
At year-end 31 December 20X2, DPQ Joinery needs to adjust for Accrual creation.
st

There are two options to calculate the value of the Accrual:

1. Calculate the accrual amount based on the invoice for the same period last year (This will reflect consumption at the same time
of year).
2. Calculate the accrual amount based on the last invoice received.
Note: Since there is no information on the last year's invoice for the same period, DPQ Joinery will use the previous invoice
received.
The last invoice received was $7,230 and relates to electricity use for August to October. However, we only need to make an
accrual for two months (November and December) of electricity use.
From the last invoice,
The average cost for one month: $7,230 ÷ 3 months = $2,410
Therefore, two months' worth of electricity: $2,410 × 2 months = $4,820
So, the estimated value of the accrual required to be created at year-end: $4,820
DR Electricity Expense $4,820
CR Accruals $4,820
The debit to the expense account increases the expense for the year. As a result, this accrual adjustment will reduce profits
during the year.
The impact of the Accruals creation adjustment to the general ledger accounts for the year is as follows (assuming no opening
balance in the Accruals account):
DR Accruals (Liability) CR

31-Dec-X2 Electricity Expense $4,820

DR Electricity Expense (Expense) CR

02-May-X2 Bank $8,460 31/12/X2 Statement of Profit or Loss $26,700

02-Aug-X2 Bank $6,190

02-Nov-X2 Bank $7,230

31-Dec-X2 Accruals $4,820

$26,700 $26,700

In this example, we assumed there is no opening accrual on 1 January 20X2 for electricity expenses, meaning there is no
accrual balance at 31 December 20X1.
This is slightly unrealistic because electricity expense is paid in arrears, and there should be an accrual balance at the end of
each accounting period.
In this scenario, the closing accruals balance of $4,820 is the following period’s opening accruals balance.
Example 4 (with opening balance)
DPQ Joinery’s employees are paid on an hourly basis. The employees are paid once a week in arrears for hours worked in the
previous week. The year-end is 31 December 20X2. At the end of the year, DPQ Joinery owes its employees a week's worth of
wages for the hours that they have worked.
During the year-ended 20X2, DPQ Joinery has the following information:
1. At the end of 20X1, DPQ Joinery owed its employees $1,560 for wages.
On 31 Dec 20X1, the double entry is made to create an accrual.
DR Wages Expense $1,560
CR Accruals $1,560
The accrual balance of $1,560 is brought forward in 20X2 as an opening balance. The expense is transferred to the
profit or loss for the year and not brought forward to the following period.
2. DPQ Joinery paid $1,560 due to its employees on the first week of 20X2.
Since DPQ Joinery has paid its employees in the current financial period for opening accruals balance, we will
reverse the Accrual balance in 20X2 as DPQ Joinery no longer owes that balance to its employees. The expense
payment of $1,560 is then recorded.
• The accrual adjustment is reversed:
DR Accruals $1,560
CR Wages Expense $1,560
• The payment of expenses is recorded:
DR Wages Expense $1,560
CR Bank $1,560
3. In weeks 2 to 52 of 20X2, a further $84,934 of wages was paid to the employees.
The payment of expenses is recorded as follows:
DR Wages Expense $84,934
CR Bank $84,934
4. At the end of 20X2, the business owes its employees $1,790 for wages.
At the end of 20X2, DPQ Joinery creates an accrual for the balance owed to its employees who have not been
paid.
DR Wages Expense $1,790
CR Accruals $1,790
The impact of the accruals adjustment to the general ledger accounts is as follows:
DR Accruals (Liability) CR

Week 1 Wages Expense (2) $1,560 01-Jan-X2 Balance b/d (1) $1,560

31-Dec-X2 Balance c/d $1,790 31-Dec-X2 Wages Expense (4) $1,790

$3,350 $3,350

01-Jan-X3 Balance b/d $1,790

DR Wages Expense Account (Expense) CR

Week 1 Bank (2) $1,560 Week 1 Accruals (2) $1,560

Week 2-25 Bank (3) $84,934 31-Dec-X2 Statement of Profit or Loss $86,724

31-Dec-X2 Accruals (4) $1,790

$88,284 $88,284

DR Bank Account (Asset) CR

Week 1 Wages Expense (2) $1,560

Week 2-25 Wages Expense (3) $84,934

Example 4
Anne owns a business with an accounting year-end of 30 September 20X5. A lease on office premises is taken on 1 January
20X5. Rent for the year to 31 December 20X5 is $2,400. On 1 January 20X5, $1,000 was paid regarding rent due.
For the year-ended 30 Sept 20X5 (Year 1):
The Year 1 financial period is from 1 October 20X4 to 30 Sept 20X5, while the lease rental period is from 1 Jan X5 to 31 Dec
X5.
1. On 1 Jan X5, Anne paid rent of $1,000. The double entry to record the expense payment is:
DR Rent Expense $1,000
CR Bank $1,000
2. At year-end 30 Sept X5, the portion of rental expense used but not paid is recognised as an accrual. The lease on office premises
was taken from 1 Jan X5 to 31 Dec X5. On 30 Sept X5, Anne incurred 9 months of expense ($2,400 × 9/12 months) = $1,800.
Anne paid $1,000 at the start of the lease period; the total expense incurred but not paid is $800 ($1,800 − $1,000).
The double entry to create the accrual is:
DR Rent Expense $800
CR Accruals $800
The ledger account during the financial year-end 30 Sept 20X5 will show the following after the double entries have been
recorded.
DR Accruals (Liability) CR

30-Sep-X5 Balance c/d $800 30-Sep-X5 Rental Expense (2) $800

$800 $800

01-Oct-X5 Balance b/d $800

DR Rental (Expense) CR

01-Jan-X5 Bank (1) $1,000

30-Sep-X5 Accruals (2) $800 30-Sep-X5 Profit or Loss $1,800

$1,800 $1,800
 DR Bank (Asset) CR

01-Jan-X5 Rental Expense (1) $1,000

For the year-ended 30 Sept 20X6 (Year 2):

The Year 2 financial period is from 1 October 20X5 to 30 Sept 20X6, while the rental lease period is from 1 Jan X6 to 31 Dec
X6.
1. Anne pays rent on the office building lease of $1,400 on 31 Dec 20X5.
The double entry to record the lease payment on 31 Dec X5 is:
DR Rent Expense $1,400
CR Bank $1,400
2. The rental for the lease for the first year would have been paid in total ($1,000 + $1,400) = $2,400. On 31 December 20X5, the
accruals made of $800 in the previous year would have been incurred. The accruals adjustment will be reversed:
DR Accruals $800
CR Rent Expense $800
Anne has identified that the rent for the year to 31 December 20X6 is $2,800. On 15 June 20X6, she pays rent of $1,400.
3. The double entry to account for the rental payment of $1,400 on 15 June X6 is:
DR Rent Expense $1,400
CR Bank $1,400
4. At the year-end of 30 Sept X6, Anne will adjust for accruals for rental expenses incurred but not paid. The expense incurred for the
year is $2,800 × 9/12 months = $2,100. Only $1,400 has been paid in respect of this expense. Therefore $700 ($2,100 − $1,400). The double
entry is:
DR Rent Expense $700
CR Accruals $700
The ledger accounts during the financial year-end 30 Sept 20X6 will show the following after the double entries have been
recorded.
DR Accruals (Liability) CR

31-Dec-X5 Accrual Reversal (2) $800 01-Oct-X5 Balance c/d (opening) $800

30-Sep-X6 Balance b/d $700 30-Sep-X6 Accruals (4) $700

$1,500 $1,500

01-Oct-X6 Balance c/d $700

DR Rental (Expense) CR

31-Dec-X5 Bank (1) $1,400 31-Dec-X5 Accrual Reversal (2) $800

15-June-X6 Bank (3) $1,400 30-Sep-X6 Profit or Loss $2,700

30-Sep-X6 Accruals (4) $700

$3,500 $3,500

DR Bank (Asset) CR

31-Dec-X5 Rental Expense (1) $1,400

15-June-X6 Rental Expense (3) $1,400

Activity 1

The accounting year end is 31 December 20X6. A gas bill for $300 arrives on 2 February 20X7 for the quarter to 31 January
20X7.
Show the 31 December 20X6 ledger entries for the accrued expense.
The Year 2 financial period is from 1 Jan 20X6 to 31 Dec 20X6. Therefore, the gas bill of $300 for the quarter to 31 January
20X7 is only invoiced in the following year.
This means that the gas bill is from the quarter 1 Nov X6 to 31 Jan X7.
At the year-end, 31 Dec X6, 2 months of gas expenses have been incurred but not invoiced/paid. Therefore, an accrual
adjustment is needed.
Amount accrued = $300 × 2/3 months = $200. The double entry to record the accruals is DR Gas Expense $200, CR Accruals
$200.
The ledger account will be as follows once the double entry is posted:
Gas expense a/c

$ $

31.12 Accrual 200

Accrued expense a/c

$ $

31.12 Gas 200

3.1 What is a Prepayment?

Key Point

A Prepayment is recognised when a business pays in the current financial period for an expense that relates to the next financial period.

A business recognises an expense when it receives an invoice and makes payment. However, certain expenses may be
invoiced and paid before they are incurred. This is known as a payment in advance. The amount paid for expenses not yet
incurred is recognised as a prepayment.
Example 6
DPQ Joinery rents a workshop and pays rent quarterly in advance. This means payment must be made on the first day of each
rental period. This payment is for the rental expense for the next three months.
The business started renting this workshop on 1 June 20X2. So far, the following invoices for rent have been received and paid:
Date Period invoice relates to $
1 June 1 June 20X2 to 31 August 20X2 1,200
1 September 1 September 20X2 to 30 November 20X2 1,200
1 December 1 December 20X2 to 28 Februray 20X3 1,200
3,600
In 20X2, a total of $3,600 is paid for rent covering the period from 1 June 20X2 to 28 February 20X3. Some of this payment
relates to 20X3, so if the total amount of $3,600 were included as the rent expense for 20X2, then it would be overstated.
In this situation, you need to reduce the expense. This reduction to the expense is known as a prepayment.
Example 7
The accounting year-end is 30 June. Insurance on the business property runs from 1 October to 30 September and is paid
annually in advance.
Paid:
1 October 20X5 $1,200
1 October 20X6 $1,800
What is the insurance expense for the year ended 30 June 20X7?
Consider the timeline:

The expense for the accounting period under consideration must include all the amounts which accrue to (belong in) the year to
30 June 20X7:

July X6 to September X6 (3/12 × $1,200) $300

 October X6 to June X7 (9/12 × $1,800) $1,350

Expense in profit or loss $1,650

Note: Because $1,800 was paid in advance, there will be a prepayment of $450 on 30 June 20X7. This is recognised as a
current asset, increasing net assets/capital in the statement of financial position and profit (by reducing the expense).

3.2 Accounting for Prepayments

During the year, the business makes payments for expenses not yet incurred and records expense payments. At year-end, the
business identifies which payments were made for expenses not yet incurred. Since expenses are not incurred in the year, an
adjustment for prepayment creation is made (credit/reduces expenses).
When the business continues using the expenses in the next accounting period, it will adjust for prepayment reversal.
In a financial year, a supplier sends invoices to the business, and the business makes payments for the expenses. However, at
year-end, it is identified that the amount paid does not relate to expenses incurred during the year. Therefore, a prepayment is
recognised to reduce the expense charge for the year.
During the year, two entries occur for payments of expenses not yet incurred:
• the Expense Payment
• the Prepayment Creation
The double entry for the expense payment is:
Individual Account Category Explanation
DR Individual Expense Expense Expense increased
CR Bank Asset Bank decreased
The above double entry reflects the business paying the expense in cash to the supplier.
The double entry for prepayment creation is:
Individual Account Category Explanation
DR Prepayment Asset Prepayment (Asset) increased
CR Individual Expense Expense Expense is reduced
Since expenses have been recognised earlier, although they have not yet been incurred (only incurred in the next accounting
period), a prepayment is created to reduce the expense charge during the year.
The adjustment for prepayment creation will have an impact on the business’s profits and net assets as follows:
• Profits – The double entry to create prepayment is to credit the expenses account. Expenses decrease, which will lead to an
increased profit figure.
• Net Assets – The corresponding entry is to debit the Prepayment asset account. Net Assets or Capital is the Assets less
Liabilities of a business. Since assets have increased, the business’s net assets will also increase.
In the next accounting period, the business incurs expenses as the period progresses. Therefore, the business records
the reversal of prepayment adjustment made in the previous period. Thus, the Prepayment account is reversed, and the
expense is recorded.
The double entry for the Reversal of Prepayment is:
Individual Account Category Explanation
DR Individual Expense Expense Expenses have increased
CR Prepayment Asset Prepayment (Asset) decreased
Example 8
DPQ Joinery pays rent for one of its shops quarterly in advance. This means payment is made on the first day of each rental
period. DPQ Joinery has a current year-end of 31 December 20X2.
st

DPQ Joinery started renting on 1 June 20X2. So far, the business has received and paid the following invoices in respect of
rent:
Date Period invoice relates to $
1 June 1 June 20X2 to 31 August 20X2 1,200
1 Sept 1 September 20X2 to 30 November 20X2 1,200
1 Dec 1 December 20X2 to 28 February 20X3 1,200
3,600
In 20X2, DPQ Joinery paid $3,600 for rent covering the period 1 June 20X2 to 28 February 20X3. Some of this payment relates
to the financial period 20X3 and should not be included as the rent expense for 20X2 to avoid overstatement.
DPQ Joinery will adjust for prepayment creation on 31 December 20X2 for the two months’ rent advanced payment relating to
20X3 (January and February). The last invoice received and paid of $1,200 relates to three months' rent for December, January
and February. Therefore, the rent for January and February is prepaid.
The average cost per month for the last invoice: $1,200 ÷ 3 months = $400
Therefore, two months’ worth of rental: $400 × 2 months = $800
The value of the prepayment required at the end of the year is $800
1. The supplier invoices the business for the expense not yet incurred, and the business makes a payment of $1,200 on 1
December 20X2. The double entry for the expense payment is as follows:
DR Rent Expense Account $1,200
CR Bank Account $1,200
2. At the year-end, the business has identified that only $400 relates to expenses during the year. It will reduce the expense
charge and recognise it as an asset under prepayments. The double entry to create the prepayment is:
DR Prepayment Account $800
CR Rent Expense Account $800
3. The prepayment (asset) creation reduces the expense amount. Thus, it increases profit for the year by reducing
losses.
The impact of the prepayment creation adjustment to the General Ledger Accounts should look like this (assume no opening
balance in the Prepayment Account):
DR Prepayment Account (Assets) CR

31-Dec-X2 Rent Expense (2) $800

DR Rent Expense Account (Expense) CR

01-June-X2 Bank (during year) $1,200 31-Dec-X2 Prepayment (2) $800

01-Sept-X2 Bank (during year) $1,200 31-Dec-X2 Profit or Loss $2,800

01-Dec-X2 Bank (1) $1,200

$3,600 $3,600

The expense in the statement of profit or loss is correct. The monthly rent is $400, and DPQ Joinery has rented the shop for
seven months (from June to December). Therefore, the correct rent expense is $400 × 7 = $2,800.
Example 9 (with opening balance)
DPQ Joinery pays insurance for his business once a year on 1 September. The payment on that date provides insurance
coverage from 1 September until 31 August the following year. On 1 September 20X2, DPQ Joinery paid $4,875 for insurance.
st

DPQ Joinery has a current year-end of 31 December 20X2.

st

The prepayment at the start of the year was $2,880. This is based on the 20X1 payment of $4,320 for insurance, for which DPQ
Joinery has prepaid eight months out of the twelve (8 × $4,320) ÷ 12 = $2,880
The double entry for each transaction is:
1. At the end of 20X1 (the previous year), DPQ Joinery prepaid insurance expenses of $2,880. A double entry was made to create
a prepayment adjustment. The prepayment balance of $2,880 is brought forward in 20X2 as an opening balance.
DR Prepayment $2,880
CR Insurance Expense $2,880
2. By the end of August 20X2, DPQ Joinery would have incurred the prepaid expenses of $2,880.
Since DPQ Joinery has incurred the prepaid expenses of $2,880 by August 20X2, the opening prepaid balance
from 20X1 is reversed, and expenses are finally recognised.
DR Insurance Expense $2,880
CR Prepayment $2,880
3. On 1st September 20X2, DPQ Joinery pays $4,875 for insurance expenses covering 1 September X2 to 31 August X3. The payment
of expenses is recorded as follows:
DR Insurance Expense $4,875
CR Bank $4,875
4. At the end of 20X2, DPQ Joinery notes that not all $4,875 relates to the financial period 20X2. A prepayment is created for the
payment made for expenses not yet incurred.
$4,875 was paid for insurance cover from 1 Sept 20X2 to 31 August 20X3. Out of the 12 months, 8 months
st st

(January 20X3 to August 20X3) have not been incurred at the end of the financial period 31 Dec 20X2.
Therefore, $4,875 × 8/12 months = $3,250 is recognised as prepayment.

DR Prepayment $3,250

CR Insurance Expense $3,250

The impact of the prepayment creation on the general ledger accounts is as follows:
 DR Prepayment (Assets) CR

01-Jan-X2 Balance b/d (1) $2,880 31-Aug-X2 Insurance Expense (2) $2,880

31-Dec-X2 Insurance Expense (4) $3,250 31-Dec-X2 Balance c/d $3,250

$6,130 $6,130

01-Jan-X3 Balance b/d $3,250

DR Insurance (Expense) CR

31-Aug-X2 Prepayment (2) $2,880 31-Dec-X2 Prepayment (4) $3,250

01-Sept-X2 Bank (3) $4,875 31-Dec-X2 Statement of Profit or Loss $4,505

$7,755 $7,755

DR Bank (Assets) CR

01-Sept-X2 Insurance Expense (3) $4,875

Activity 2

1. During the year ended 30 June 20X5, a business pays $5,905 for electricity to cover the opening accrual of $590 and the
invoices received during the year. The last invoice was $1,860 and covered the period from 1 March 20X5 until 31 May 20X5.
What should the expense be in the statement of profit or loss for the year ended 30 June 20X5?
2. During the year ended 30 September 20X7, a business paid $10,200 for insurance to cover the period from 1 July 20X7 to 30
June 20X8. The opening prepayment for insurance expenses was $6,850.
What should the expense be in the statement of profit or loss for the year ended 30 September 20X7?

1. The business needs to accrue for one month's electricity (June), which is $620 ($1,860 ÷ 3).
Without drawing up the ledger T-account, the expense for the year can be found:
$
Paid 5,905
Minus: Opening accrual (590)
Add: Closing accrual 620
Expense 5,935
2. The business needs to recognise prepayment.
First, calculate the closing prepayment. Nine months have been prepaid (from 1 October 20X7 to 30 June 20X8).
The closing prepayment is, therefore, $7,650 (= $10,200 ÷ 12 × 9).
Without drawing up a T-account, the expense for the year can then be found:
$
Paid 10,200
Add: Opening prepayment 6,850
Minus: Closing prepayment (7,650)
Expense 9,400
The calculation of expenses in an accrual or prepayment is,
• Amount Paid − Opening Accrual + Closing Accrual = Expense
• Amount Paid + Opening Prepayment − Closing Prepayment = Expense

4.1 What is Accrued and Deferred Income?

Key Point

Accrued income is recognised when a business receives its income in arrears after earning it. At year-end, the business
has earned income that has not been received.
 Key Point

Deferred income is recognised when a business receives its income before earning it. At year-end, the business received a
payment related to the following year.
Accruals and prepayments are liabilities and assets recognised during year-end due to payment of expenses in arrears or in
advance.
Accrued and deferred (prepaid) incomes are assets and liabilities recognised during year-end due to income receipts in arrears
or in advance.
Category Explanation Asset Liability Double Entry
Accruals Expenses incurred before payment made ✓ DR Expenses
CR Accruals
Prepayments Payment made before Expenses incurred ✓ DR Prepayments
CR Expenses
Accrued Income Income earned before payment received ✓ DR Accrued Income
CR Income
Deferred Income Payment received before Income earned ✓ DR Income
CR Deferred Income
• Accrued income is recognised as an asset to reflect the income owed to the business since revenue has been
provided but payment has not yet been received. (receipt in arrears).
• Deferred income is recognised as a liability as payment has been received for revenue not yet provided. (receipt
in advance)

4.2 Accounting for Accrued Income

At year-end, the business will adjust for accrued income creation for income generated for payments in arrears.
The double entry for the accrued income is:
Individual Account Category Explanation
DR Accrued Income Asset Accrued Income (Asset) increased
CR Individual Income Income Income has increased
The income calculated for the current financial year where payment has not been received is recognised as an asset (accrued
income).
In the next financial period where payment has been received, the business will reverse the accrued income adjustment made
in the previous period and record the income receipt.
Reversal of accrued income:
Individual Account Category Explanation
DR Individual Income Account Income Income has decreased
CR Accrued Income Account Asset Accrued Income (Asset) decreased
Record of Income Receipt:
Individual Account Category Explanation
DR Bank Account Asset Bank (Asset) increased
CR Individual Income Account Income Income has increased

4.3 Accounting for Deferred Income

At year-end, the business will adjust for deferred/prepaid income for income generated for payments in advance.
Payment has been received in the current financial period for income generated in the following financial period. The business
records the income receipt during the year, then calculates and creates the deferred income amount adjustment.
Record of income receipt:
Individual Account Category Explanation
DR Bank Account Asset Bank (Asset) increased
CR Individual Income Income Income has increased
The double entry for deferred income creation is:
Individual Account Category Explanation
DR Individual Income Income Income has decreased
CR Deferred Income Liability Deferred Income (Liability) increased
As the months progress, the business will generate income in the following accounting period. Accordingly, it will record
deferred income reversal.
The double entry for the reversal of deferred income is:
Individual Account Category Explanation
DR Deferred Income Liability Deferred Income (Liability) decreased
CR Individual Income Income Income has increased
Example 5
DAHS Co rents out two properties that it owns. Its year-end is 30 June 20X6. Payment for both properties is made every three
months (every quarter).
For property 1, the rent is received in advance. The rent is $5,400 per quarter, and the last receipt was for the three months of 1
May to 31 July 20X6.
For property 2, the rent received is in arrears. The rent is $3,600 per quarter, and the last receipt was for the three months of 1
February to 30 April 2006.

Property 1 Property 2

Rent Receipt: In advance In arrears

Rental per quarter: $5,400 $3,600

Period where 1 May 20X6 to 31 July 20X6 1 Feb 20X6 to 30 April 20X6

payment already
received:

1 month payment (July X6) relates to the following 2 months income (May & June) has not received
period payment

Recognition: Deferred Income (Liability) Accrued Income (Asset)

$5,400 × 1/3 = $1,800 $3,600 × 2/3 = $2,400

Double Entry in
20X6

Income receipt: DR Bank Account $5,400 No receipt in 20X6

CR Rent Income $5,400

Deferred/ Accrued DR Rent Income $1,800 DR Accrued Income $2,400

CR Deferred Income $1,800 CR Rent Income $2,400
Income:

Double Entry in
20X7

Reversal of DR Deferred Income $1,800 DR Rent Income $2,400

CR Rent Income $1,800 CR Accrued Income $2,400
Accrued/ Deferred
Income:

Income Receipt: Already received in 20X6 DR Bank Account $3,600

CR Rent Income $3,600

Effect on 20X6 Deferred Income reduces income and, therefore, Accrued Income increases income in the year and,
Financial Statement: reduces profits in the year. In addition, since deferred therefore, increases profits. Accrued Income is
income is recorded as a liability, the capital amount is recorded as an asset. This causes the capital amount
reduced. to increase.