Accounting 2.4

Expenses

Prepaid Expense

An item that has been paid in advance but not yet consumed.

Current asset

Payment for Prepaid Expense Double-entry

When payment is made, but asset has not been consumed.

Dr	Prepaid [Expense]
Cr	Bank

Prepaid Expense Balance Day Adjustment Double-entry

When asset has been consumed/incurred.

Dr	[Expense]
Cr	Prepaid [Expense]

Effect on Accounting Equation - Prepaid Expense (BDA)

Assets	Decrease
Liabilities	No effect
Owner’s Equity	Decrease

Accrued Expense

An expense that has been incurred/consumed but has yet to be paid.

Current liability

Accrued Expense Double-entry

Dr	[Expense]
Cr	Accrued [Expense]

Effect on Accounting Equation - Accrued Expense

Assets	No effect
Liabilities	Increase
Owner’s Equity	Decrease

Payment of Accrued Expense in Following Period Entries

Dr	Accrued [Expense]
Dr	[Expense]
Cr	Bank

Effect on Accounting Equation - Payment of Accrued Expense in Following Period

Assets	Decrease	Full amount paid
Liabilities	Decrease	Accrued [Expense] amount
Owner’s Equity	Decrease	Balancing Figure (expense for next period)

The Going Concern Assumption

The business will continue to operate in the future, and its records are kept on that basis.

• Requires the business to report prepaid expenses that are yet to be consumed to be reported as a current asset as they provide economic benefits expected to be consumed in the future.

• Requires expenses that have been consumed but not yet paid to be reported as a current liability as they are expected to be settled in the future.

The Accrual Basis Assumption

Revenue is recognized in the period in which it is earned and expenses are recognized in the period in which they are incurred.

• Expenses must be recognized in the period it is incurred regardless of when the cash is paid. This will ensure all expenses incurred are compared with revenues earned in the same period to calculate an accurate profit.

• Prepaid Expenses not recorded - expense overstated, profit understated

• Accrued Expenses not recorded - expense understated, profit overstated

The Period Assumption

Reports are prepared for a specified period of time (reporting period), such as a month or a year, in order to obtain comparability of results.

• Only the actual expense incurred/consumed in the period should be used in the calculation of profit for the current period.

• Any expenses that are outside the current Period should NOT be included.

Relevance

Financial information must be capable of influencing decisions made by users to help them make predictions and/or confirm or change their previous evaluations.

• Only expenses incurred within the current period will be compared with revenues earned in the same period in order to calculate an accurate profit.

• Prepaid Expenses not recorded - expense overstated, profit understated

• Accrued Expenses not recorded - expense understated, profit overstated

• BAD ensure that the financial reports contain all information that can influence decision-making about the performance of the business.

Faithful Representation

Financial information should be a truthful representation of the real-world economic event and must be complete, free from material errors, and without bias.

• Prepaid Expenses are assets and should be reported in the Balance Sheet as current assets, as that provides a truthful representation of future benefits.

• Accrued Expenses should be reported in the Balance Sheet as current liabilities until they are paid for, as that provides a truthful representation of present obligations.

• The Income Statement will be more complete as all expenses incurred in the period are reported as they include what has occurred.