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Accruals and prepayments

Accruals and prepayments. hink Corner. uiz Corner. What’s Inside ?. Learning Objectives. Prepaid expenses. Accruals and prepayments. Learning Objectives. After reading this chapter, you will be able to:. . Briefly explain what accrual accounting is. .

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Accruals and prepayments

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  1. Accruals and prepayments

  2. hink Corner uiz Corner What’s Inside ? Learning Objectives Prepaid expenses Accruals and prepayments

  3. Learning Objectives After reading this chapter, you will be able to:  Briefly explain what accrual accounting is.  Explain the term ‘accrued expenses’ and adjust expenses accounts for accruals.  Explain the term ‘prepaid expenses’ and adjust expenses accounts for prepayments.  Explain the term ‘revenues in arrears’ and adjust revenues accounts for amounts in arrears.  Explain the term ‘revenues in advance’ and adjust revenues accounts for amounts in advance.  Disclose accruals, prepayments, revenues in arrears and revenues in advance in a balance sheet.  Become familiarised with the alternative method of recording.

  4. Accrual accounting Accrual accounting is based on the ____________. accrual concept Accrual concept states that:  Revenues are recognised in the profit and loss account for the period in which they have been earned, not when they are received.  Expenses are recognised in the profit and loss account for the period in which they have been incurred, not when they are paid. Therefore, when we draw up the profit and loss account at the year end, we need to make adjustments to _______ and _______ for any _______ and __________. revenues expenses accruals prepayments Learning Objectives

  5. Accrued expenses Accrued expense is the expense _______ in a period but which has not yet been _______ by the end of that period. incurred paid for Example 1: Longway Company paid electricity charges every three months. The following are the dates of payments: Expenses due Expenses paid Amount $ 31 March 20X7 3 April 20X7 1,500 30 June 20X7 5 July 20X7 1,800 30 September 20X7 2 October 20X7 2,000 31 December 20X7 4 January 20X8 1,600

  6. Electricity 20X7 $ Accrued expenses The total electricity charges for the year 20X7 should be ($1,500 + $1,800 + $2,000 + $1,600) = $6,900. And this is the amount needed to be transferred to the __________________ at the year end. profit and loss account However, at the year end, the electricity charges for the last three months were still outstanding. Apr 3 Bank 1,500 Jul 5 Bank 1,800 Oct 2 Bank 2,000

  7. Electricity 20X7 $ 20X7 $ Apr 3 Bank 1,500 Jul 5 Bank 1,800 The amount of electricity actually paid in the current year. Oct 2 Bank 2,000 The amount of electricity incurred but not yet paid in the current year. The amount of electricity incurred in the current year. 6,900 6,900 The balance to be carried forward to the next financial year. Accrued expenses This outstanding amount is called _____________ or ______ and is to be carried forward to the following year as a ______. accrued expense accrual liability Dec 31 Profit and loss 6,900 Dec 31 Accrued c/f 1,600 Learning Objectives

  8. Prepaid expenses Prepaid expense is an expense which has been ____ in a period but will not be incurred until the _______ period. paid following Example 2: Longway Company paid insurance every three months. The following are the dates of payments: Expenses due Expenses paid Amount $ 31 March 20X7 28 March 20X7 5,000 30 June 20X7 25 June 20X7 5,000 30 September 20X7 27 September 20X7 5,000 31 December 20X7 31 March 20X8 29 December 20X7 10,000

  9. Insurance 20X7 $ Prepaid expenses The total insurance for the year 20X7 should be ($5,000 x 4) = $20,000. And this is the amount needed to be transferred to the ____________ ______ at the year end. profit and loss account At the year end, the company had paid three months’ insurance in advance. Mar 28 Bank 5,000 Jun 25 Bank 5,000 Sep 27 Bank 5,000 Dec 29 Bank 10,000

  10. Insurance 20X7 $ 20X7 $ Mar 28 Bank 5,000 Jun 25 Bank 5,000 Sep 27 Bank 5,000 The amount of insurance incurred in the current year. Dec 29 Bank 10,000 The amount of insurance paid but which has not been incurred in the current year. 25,000 25,000 The balance to be carried forward to the next financial year. The amount of insurance actually paid in the current year. Prepaid expenses This excess amount is called _____________ or _________ and is to be carried forward to the following year as an _____. prepaid expense prepayment asset Dec 31 Profit and loss 20,000 “ 31 Prepaid c/f 5,000 hink Corner uiz Corner

  11. hink Corner nswer The amount paid for stationery is usually treated as an expense. For the stock of unused stationery at the end of a period, what is the accounting treatment? Stationery not entirely used up in the period in which it is bought should be treated as a prepayment. The balance of the stationery account should be carried forward to the following period as a debit balance. The stock of stationery is seldom added to the stock of unsold goods in the balance sheet; it is added to other prepayments. Learning Objectives

  12. Revenues in arrears accrued revenue Revenue in arrears (_____________) is other revenue (other than sales) earned but which has not yet been _______ in the period. received Example 3: Longway Company received a commission every three months. The following are the dates of receipts: Revenues due Revenues received Amount $ 31 March 20X7 4 April 20X7 10,000 30 June 20X7 2 July 20X7 8,000 30 September 20X7 5 October 20X7 12,000 31 December 20X7 6 January 20X8 9,000

  13. Commission Receivable 20X7 $ Revenues in arrears The total commission receivable for the year 20X7 should be ($10,000 + $8,000 + $12,000 + $9,000) = $39,000. And this is the amount needed to be transferred to the __________________ at the year end. profit and loss account At the year end, the company had not yet received the commission for the 3 months to 31 December 20X7. Apr 4 Bank 10,000 Jul 2 Bank 8,000 Oct 5 Bank 12,000

  14. Commission Receivable 20X7 $ 20X7 $ Apr 4 Bank 10,000 Jul 2 Bank 8,000 The amount of commission earned in the current year. Oct 5 Bank 12,000 The amount of commission actually received in the current year. 39,000 39,000 The amount of commission earned but not yet received in the current year. The balance to be carried forward to the next financial year. Revenues in arrears This outstanding amount is called _____________ and is to be carried forward to the following year as an _____. accrued revenue asset Dec 31 Profit and loss 39,000 Dec 31 In arrears c/f 9,000 Learning Objectives

  15. Revenues in advance Revenue in advance (_____________) is the other revenue which has been received in a period but will not be _____ until the following period. prepaid revenue earned Example 4: Longway Company received rent every three months. The following are the dates of receipts: Revenues due Revenues received Amount $ 31 March 20X7 24 March 20X7 10,000 30 June 20X7 27 June 20X7 10,000 30 September 20X7 25 September 20X7 10,000 31 December 20X7 31 March 20X8 26 December 20X7 20,000

  16. Rent Receivable 20X7 $ Revenues in advance The total rent receivable for the year 20X7 should be ($10,000 x 4) = $40,000. And this is the amount needed to be transferred to the __________________ at the year end. profit and loss account At the year end, the company has received the rent for the 3 months to 31 March 20X8 in advance. Mar 24 Bank 10,000 Jun 27 Bank 10,000 Sep 25 Bank 10,000 Dec 26 Bank 20,000

  17. Rent Receivable 20X7 $ 20X7 $ Mar 24 Bank 10,000 Jun 27 Bank 10,000 Sep 25 Bank 10,000 Dec 26 Bank 20,000 The amount of rent earned in the current year. The amount of rent received but not yet earned in the current year. The balance to be carried forward to the next financial year. 50,000 50,000 The amount of rent actually received in the current year. Revenues in advance This amount received in advance is called _____________ and is to be carried forward to the following year as a ______. prepaid revenue liability Dec 31 Profit and loss 40,000 “ 31 In advance c/f 10,000 Learning Objectives

  18. Disclosure in the balance sheet As we mentioned before, prepaid expenses and revenues in arrears are ______. assets Prepaid expenses represent the resources to be _______ in the near future. used up Revenues in arrears represent the monies to be _______ in the near future. received Therefore, both prepaid expenses and revenues in arrears should be shown under ____________ in the balance sheet. current assets

  19. Disclosure in the balance sheet As we mentioned before, accrued expenses and revenues in advance are ________. liabilities Accrued expenses represent the debts to be ______ in the near future. settled Revenues in advance represent the obligations to ______ services in the near future. provide Therefore, both accrued expenses and revenues in advance should be shown under ______________ in the balance sheet. current liabilities

  20. Longway Company Balance Sheet as at 31 December 20X7 (extract) Current Assets $ Current Liabilities $ Stock XXX Creditors XXX Debtors XXX Bank XXX Cash XXX Disclosure in the balance sheet Refer to Examples 1 – 4. They will be shown in Longway Company’s balance sheet as follows: Revenues in advance 10,000 Accrued expenses 1,600 Revenues in arrears 9,000 Prepaid expenses 5,000 Learning Objectives

  21. Alternative method Using this method, instead of carrying forward the accrued or prepaid balance in the expenses account, we now transfer the balance to an accruals account or a prepayments account. The double entry for recording an accrued expense is: Dr Expenses account Cr Accruals account The double entry for recording a prepaid expense is: Dr Prepayments account Cr Expenses account

  22. Electricity 20X7 $ 20X7 $ Apr 3 Bank 1,500 Jul 5 Bank 1,800 6,900 6,900 Oct 2 Bank 2,000 Accruals 20X7 $ 20X7 $ Alternative method Refer to Example 1. The double entries would be: Dec 31 Profit and loss 6,900 Dec 31 Accruals 1,600 Dec 31 Balance c/f 1,600 Dec 31 Electricity 1,600

  23. Insurance 20X7 $ 20X7 $ Mar 28 Bank 5,000 Jun 25 Bank 5,000 Sep 27 Bank 5,000 25,000 25,000 Dec 29 Bank 10,000 Prepayments 20X7 $ 20X7 $ Alternative method Refer to Example 2. The double entries would be: Dec 31 Profit and loss 20,000 “ 31 Prepayments 5,000 Dec 31 Insurance 5,000 Dec 31 Balance c/f 5,000

  24. Alternative method Likewise, a revenues in arrears account and a revenues in advance account are opened to record all accrued revenues and prepaid revenues, respectively. The double entry for recording an accrued revenue is: Dr Revenues in arrears account Cr Revenues account The double entry for recording a prepaid revenue is: Dr Revenues account Cr Revenues in advance account

  25. Commission Receivable 20X7 $ 20X7 $ Apr 4 Bank 10,000 Jul 2 Bank 8,000 Oct 5 Bank 12,000 39,000 39,000 Revenues In Arrears 20X7 $ 20X7 $ Alternative method Refer to Example 3. The double entries would be: Dec 31 Profit and loss 39,000 Dec 31 Revenues in arrears 9,000 Dec 31 Commission 9,000 receivable Dec 31 Balance c/f 9,000

  26. Rent Receivable 20X7 $ 20X7 $ Mar 24 Bank 10,000 Jun 27 Bank 10,000 Sep 25 Bank 10,000 50,000 50,000 Dec 26 Bank 20,000 Revenues In Advance 20X7 $ 20X7 $ Alternative method Refer to Example 4. The double entries would be: Dec 31 Profit and loss 40,000 “ 31 Revenues in advance 10,000 Dec 31 Balance c/f 10,000 Dec 31 Rent receivable 10,000

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