Accruals basis of accounting 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 ID: 633571
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Slide1
Accruals and Prepayments Slide2
Accruals basis of accounting
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 XSlide3
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.
Slide4
Illustration 1
A
business’
electricity charges amount to
Rs.12,000
pa. In the year to 31 December 20X5,
Rs.9,000
has been paid. The electricity for the final quarter is paid in January 20X6.
What year-end accrual is required and what is the electricity expense for the year?Slide5
John
Simnel’s
business has an accounting year end of 31 December 20X1. He rents factory space at a rental cost of
Rs.5,000
per quarter, payable in arrears.
During the year to 31 December 20X1 his cash payments of rent have been as follows:
31 March (for the quarter to 31 March 20X1)
Rs.5,000
29 June (for the quarter to 30 June 20X1)
Rs.5,000
2 October (for the quarter to 30 September 20X1)
Rs.5,000
The final payment due on 31 December 20X1 for the quarter to that date was not paid until 4 January 20X2.
Show the ledger accounts required to record the above transactions.Slide6
Prepaid expenditure
A prepayment arises where some of the following
yearâ
€™s 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.Slide7
Illustration 2
The annual insurance charge for a business is
Rs.24,000
pa.
Rs.30,000
was paid on 1 January 20X5 in respect of future insurance charges.
What is the year-end prepayment and what is the insurance expense for the year?Slide8
Tubby
Wadlow
pays the rental expense on his market stall in advance. He starts business on 1 January 20X5 and on that date pays
Rs.1,200
in respect of the first
quarter’s
rent. During his first year of trade he also pays the following amounts:
3 March (in respect of the quarter ended 30 June)
Rs.1,200
14 June (in respect of the quarter ended 30 September)
Rs.1,200
25 September (in respect of the quarter
Rs.1,400
ended 31 December)
13 December (in respect of the first quarter of 20X6)
Rs.1,400
Show these transactions in the rental expense account.Slide9
On 1 January 20X5, Willy
Mossop
owed
Rs.2,000
in respect of the previous
year’s
electricity. Willy made the following payments during the year ended 31 December 20X5:
6 February
Rs.2,800
8 May
Rs.3,000
5 August
Rs.2,750
10 November
Rs.3,100
At 31 December 20X5, Willy calculated that he owed
Rs.1,800
in respect of electricity for the last part of the year.
What is the electricity charge to the income statement?Slide10
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.Slide11
Illustration 3
A business earns bank interest income of
Rs.300
per month.
Rs.3,000
bank interest income has been received in the year to 31 December 20X5.
What is the year-end asset and what is the bank interest income for the year?Slide12
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 XSlide13
A business rents out a property at an income of
Rs.4,000
per month.
Rs.64,000
has been received in the year ended 31 December 20X5.
What is the year-end liability and what is the rental income for the year?