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Accruals and Prepayments

The document discusses accruals and prepayments and how they affect the financial statements. Accruals are estimates of expenses owed or income earned but not yet paid, while prepayments are payments made in advance. Accruals and accrued income increase expenses and income, reducing or increasing profit respectively. Prepaid expenses and income decrease expenses or income, increasing or decreasing profit. Adjustments via journal entries are made to accurately reflect the time period to which the income and expenses apply.

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Barry Patnett
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54 views7 pages

Accruals and Prepayments

The document discusses accruals and prepayments and how they affect the financial statements. Accruals are estimates of expenses owed or income earned but not yet paid, while prepayments are payments made in advance. Accruals and accrued income increase expenses and income, reducing or increasing profit respectively. Prepaid expenses and income decrease expenses or income, increasing or decreasing profit. Adjustments via journal entries are made to accurately reflect the time period to which the income and expenses apply.

Uploaded by

Barry Patnett
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Accruals and Prepayments

Accruals and prepayments

Before we prepare the final accounts of a business it is often necessary


to adjust the figures in the trial balance because:
 We may still owe money for items we have used in the financial year.

 We may have paid for some items in advance.

 We may be owed revenue.

 We may have paid revenue in advance.


Accruals basis of accounting
• An accrual is an estimate of money that is owed, but which has not
yet been paid.
• The accruals basis of accounting means that to calculate the profit for
the period, we must include all the income and expenditure relating
to the period, whether or not the cash has been received or paid or
an invoice received.
• Profit is therefore:
Income earned X
Expenditure incurred (X)
Profit X
Accrued expenditure
• An accrual arises where expenses of the business, relating to the year, have
not been paid by the year end.
• In this case, it is necessary to record the extra expense relevant to the year
and create a corresponding statement of financial position liability (called an
accrual):
Dr Expense account X
Cr Accrual X
• An accrual will therefore reduce profit in the income statement.
Prepaid expenditure
• A prepayment is a payment made in advance of the current period.
• A prepayment arises where some of the following years expenses
have been paid in the current year.
• In this case, it is necessary to remove that part of the expense which
is not relevant to this year and create a corresponding statement of
financial position asset (called a prepayment):
Dr Prepayment X
Cr Expense account X
• A prepayment will therefore increase profit in the income statement.
Accrued income
• Accrued income arises where income has been earned in the
accounting period but has not yet been received.
• In this case, it is necessary to record the extra income in the income
statement and create a corresponding asset in the statement of
financial position (called accrued income):
Dr Accrued income (SFP) X
Cr Income (IS) X
• Accrued income creates an additional current asset on our Statement
of financial position. It also creates additional income on our Income
statement, and hence this will increase overall profits.
Prepaid income
• Prepaid income arises where income has been received in the
accounting period but which relates to the next accounting period.
• In this case, it is necessary to remove the income not relating to the
year from the income statement and create a corresponding liability
in the statement of financial position (called prepaid income):
Dr Income X
Cr Prepaid Income X

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