Accruals and Prepayments Flashcards

Accruals

• Accrual definition: Income or expenses that have occurred during the period but are unpaid at the end of the year.
  • Example: Electricity bill for January to December accounting period.
    • By the end of September, nine months' worth of electricity has been paid.
    • Three months (October, November, December) need to be accrued.

Accounting for Accruals

• Since it's an expense owed at the year-end, it's shown as a liability.
  • Debit the expense account.
  • Credit accrued expenses in the liabilities section of the Statement of Financial Position.
• Accrued Income: Income included in the period and considered an asset at the end of the year.
  • Debit accrued income.
  • Credit the income account.

Prepayments

• Prepayment definition: Income or expenses that are paid for in advance of the period they relate to.
  • Example: Rent paid for fifteen months (up to March of the next year) when the accounting period is January to December.
    • The three months (January, February, March) are prepayments and need to be removed from the current year's expenses.

Accounting for Prepayments

• These have been paid in advance, so they're not included in your expenses as they do not relate to your year. So you need to remove them from expenses.
  • Credit the expense account to reduce it.
  • Debit the prepayment account, which is a current asset.
    • Prepaid rent means you're owed the use of the property for those months.
• Deferred or Prepaid Income: Income received in advance but related to the next year.
  • Remove it from current year's income.
    • Debit the income account.
    • Credit deferred income, which is a liability on the Statement of Financial Position.
      • Represents a service owed to someone who has paid in advance.

Key Takeaways

• Definitions: Understand the definitions of accruals and prepayments.
• Timelines: Draw timelines to visualize the periods involved, especially when confused about whether to accrue or prepay.