Accruals and Prepayments Flashcards

Accruals and Prepayments

• Accruals concept: Accounting for transactions when they occur, not when payment is received or paid.

• Accruals: Expenses incurred but not yet paid.

• Prepayments: Payments made in a year that relate to a following accounting year.

• Accrued expenses are interchangeable with accruals.

• Prepaid expenses are interchangeable with prepayments.

• Key accounting adjustments: accrued income and deferred income.

• Exam questions may include calculating figures for financial statements (statement of financial position, statement of profit or loss) or journal entries.

• Accruals and prepayments relate to both income and expenses.

• Accruals: Expenses related to the current accounting period that need to be added in.

• Prepayments: Payments relating to the next year that need to be removed.

Calculations and Adjustments

• May need to calculate accruals or prepayments when part of an invoice relates to a different accounting period.

• Time apportionment might be necessary.

• Need to know the debit and credit for the creation and subsequent reversal of accruals or prepayments.

IAS 1 and Accruals Basis

• IAS 1 requires accounts to be prepared on an accruals basis.

• Closing inventory adjustments and depreciation are applications of accruals concepts.

• Transactions and events are recognized when they occur, not necessarily when cash changes hands.

• Focus is on income and expense items that are not sales to customers or purchases of goods for resale.

• Gross profit is calculated by matching sales against the cost of sales.

• Other items of profit should be calculated by charging expenses that relate to that accounting period.

Accruals Explained

• An expense charged against profit, even though it has not yet been paid for.

• If some services were used during the accounting period, but haven't been invoiced yet, there's an obligation to pay.

• An obligation to pay a bill is a liability, typically shown as a current liability.

• Accruals and trade payables are separate balances included within liabilities.

• Accruals are generally liabilities to pay for services.

• Trade payables are liabilities to pay for goods.

• If an invoice hasn't been received yet, but you know you're going to get one, create an accrual.

• The supplier doesn't have to be a third party; it could be staff (e.g., profit-related pay).

• Accrue bonus in the accounting period where the work was done and the profit earned.

• Accrual: No invoice received.

• Trade payable: Invoice received but not yet paid.

Prepayments Explained

• An expense that is paid in advance.

• Payments made in one accounting period, but the economic benefit is seen in a later period.

• An expense paid in advance is an asset.

• Definition of an asset: A present economic resource controlled by the entity as a result of past events.

Accounting Entries

• Accruals and prepayments happen once a year (at year-end).

• Journal entries for accruals and prepayments need to be prepared.

• For an accrual: Debit expense and credit accruals.

• For a prepayment: Debit prepayments and credit the expense.

Creating an Accrual

• Increase the expense (debit the expense).

• Create a current liability called accruals on your statement of financial position.

Creating a Prepayment

• Debit prepayments (record the asset on the statement of financial position).

• Reduce the appropriate expense.

• Make sure to learn those general entries and identify the correct general entry, which the examiner expects you to do.

Financial Statement Presentation

• Accruals are shown under current liabilities.

• Prepayments are shown under current assets.

• To create accrual: Debit expense, credit liability.

• To create prepayment: Debit prepayment, reduce the expense.

Reversing Accruals and Prepayments for Ongoing Businesses

• Need to deal with accruals and prepayments brought forward from earlier accounting periods.

Double Entry for Reversing

• To reverse an opening prepayment, remove the asset and charge the rent to the correct accounting period.

• To reverse an opening accrual, remove the liability and credit the electricity expense account.

Four-Step Approach for Ongoing Businesses

• Reverse opening accruals or prepayments.

• Post the cash that was actually paid during the year.

• Record the journal entries for closing accruals and prepayments.

• Balance off the accounts.

Accrued Income and Deferred Income

• Income may be received in arrears or in advance.

• Accrued income: Income earned but not yet invoiced or received (shown as an asset).

• Deferred income: Income received, but it doesn't entirely relate to this accounting period (shown as a liability).

Objective Test Questions

• Identify it's about an income, but follow the exact same approach as the accrued and prepared expenses.

• Reverse the opening balances, post the cash received, post the closing figures, and then balance off the accounts.