Accruals and prepayments

PRC -4 Introduction to Accounting Chapter 04:Accruals and Prepayments
Instructor: H. M. Umer 1
There are two methods of accounting.

1. Cash basis of accounting:
• In this method, income is recorded when received and expense is recorded when paid.
• Payments (in case of expenses) or receipt (in case of income) are recorded as an expense or
income.
• In cash basis of accounting, amount to be recognized as an expense (in P/L) is equal to the payment
made while income (in P/L) is equal to the receipt during the accounting period.
• If no payment is made during the period, then income/expense to be recognized in P/L is nil during
the accounting period.
• There is no concept of assets or liabilities in cash base accounting.
• Cash basis of accounting is not a popular method of accounting as its not provide true picture of
business (i.e. related to the income or business).
Relevant entries in case of expense and income
On Payment of expense during accounting period, On Receipt of income during accounting period
Expense account Debit Cash/Bank Debit
Cash / Bank Credit Income Account Credit
Example
Ronaldo acquired a shop on rent on 1st January 2021. The rent per month is Rs. 1500. A yearly payment of rent is to
be made in advance starting from 1st January 2021.
Required:
Prepare expense a/c for year ended December 31, 2021.
Rent Expense
01.01.2021 Cash (1,500 X 12) 18,000
P/L (Bal.) 18,000
Note: Expense to be recognized in P/L is Rs. 18,000 which is equal to the cash paid.
Example
Ronaldo acquired a shop on rent on 1st February 2021. The rent per month is Rs. 1500. A half yearly payment of rent
amounting to Rs. 9,000 is to be made in arrears starting from 1st February 2021.
Required:
Rent Expense
01.02.08 Cash 9,000
P/L (Bal.) 9,000
Note:
• Expense to be recognized in P/L is Rs. 9,000 which is equal to the cash paid.
• Arrears means payment to be made at the end of the accounting period.
Example
Messi acquired a shop on rent on 1st February 2021. The rent per month is Rs. 1500. A quarterly rent is to be paid in
advance starting from 1st February 2021.
Required:
Rent expense
01.02.08 Cash 4,500
01.05.08 Cash 4,500 P/L (Bal.) 18,000
01.08.08 Cash 4,500
01.11.08 Cash 4,500
2. Accrual basis of accounting:

• In this method of accounting, income is recorded when earned and expense is recorded when
incurred irrespective of the cash received or paid.
• Accountant record the transaction on cash basis and we need to adjust it (made period end
adjustment) as per expense incurred or income earned.
• The period-end adjustment of accruals and prepayments is important to calculate for matching
income and expenses of the same period to calculate correct profit. These adjustments result in
recognition of assets (income receivable or prepaid expenses) and liabilities (unearned income or
expenses payables).
• Financial Statements are prepared on the accrual basis.
• There are two system of accounting, single and double accounting system for recognition of
expense and
- Single account system w.r.t r expense: Under this system prepaid/accrued expense
(asset/liability) and expense account is presented in a single account. If in exams there
are both prepaid and accrued expenses then we will present all this in a single account.
- Single account system w.r.t r income: Under this system accrued/un-earned income
(asset/liability) and income account is presented in a single account. If in exams there are
both accrued and un-earned income then we will present all this in a single account.
(Discuss later in this chapter).
- Double account system: In this system all accounts are prepared separately i.e., Expense,
Income, asset or liability with its own name (Just like we did practice in Ledger chapter).
It can be explained later in this chapter.
Exam Tip
With perspective of this chapter, we will always solve question by using single account system.
Following are the different scenarios if payment/receipt is different than expense incurred or income earned.
I. If during the accounting period, Payment (Rs. 200) > expense incurred (Rs. 180), it is recorded prepaid
expense.
PREPAID EXPENSES
This is cash paid in advance for expenses to be incurred after the end of an accounting period.
The amount that relates to next accounting period is not an expense for this period and must be presented
as an asset (Prepayments).
Period end adjustment of prepaid expense: Reverse the expense and record asset (prepayment) with the
differential amount (Rs. 20).
Dr. Cr.
Prepaid expense (Asset) 20
Expense 20
Format of Prepaid expense Ledger (under single account system)
EXPENSES
Date Particulars Rs Date Particulars Rs

Bal. b/d (opening prepaid) XX
Cash paid XX Expense (balancing figure) XX
Bal. c/d (closing prepaid) XX
XX XX
Example
Williamson acquired a shop on rent on 1st February 2021. The rent per month is Rs. 1500. A quarterly payment of rent
is to be made in advance starting from 1st February 2021.
Required:
Solution
Rent Expense
01.02.21 Cash 4,500
01.05.21 Cash 4,500 P/L (Bal.) 16,500
01.08.21 Cash 4,500
01.11.21 Cash 4,500 Closing prepaid (4,500/3 x1) 1500
Impact if period end adjustment (Entry of prepaid expense) is not recorded in F/S:
Expense is overstated due to which profit is understated. Further, due to non-recognition of prepayment, asset is
understated.
Impact after incorporation of period end adjustment (Entry of prepaid expense) in F/S:
Expense will decrease due to which profit increase. Further, asset (prepaid expense) will also increase.
II. If during the accounting period, Payment (Rs. 180) < expense incurred (Rs. 200), then it is recorded accrued
expense.
ACCRUED EXPENSES
• These are expenses incurred but not paid by the end of an accounting period.
• The expense must be recorded, even if it has not been paid yet, as it relates to the period in which
it was incurred.
• The amount unpaid should be recorded as a liability (Expenses Payable).
Format of Accrued expense Ledger (under single account system)
EXPENSES
Date Particulars Rs Date Particulars Rs
Bal. b/d (opening payable) XX
Bal. c/d (Closing payable) XX
Period end adjustment/Treatment: Increase the expense and record liability (accrued expense) with the
Dr. Cr.
Expense 20
Accrued expense 20
Example:
Williamson acquired a shop on rent on 1st February 2021. The rent per month is Rs. 1500. A quarterly payment of rent
is to be made in arrears.
Required:
Solution
Rent Expense
30.04.21 Cash 4,500
30.07.21 Cash 4,500 P/L (Bal.) 16,500
30.10.21 Cash 4,500
31-12-21 Closing payable (4,500/3 x2) 3,000
Impact if period end adjustment (Entry of accrued expense) is not recorded in F/S:
Expense is understated due to which profit is overstated. Further, due to non-recognition of accrued expense,
liability is understated.
Impact after incorporation of period end adjustment (Entry of accrued expense) in F/S:
Expense will increase due to which profit decrease. Further, Liability (accrued expense) will also increase.
III. If during the accounting period, Receipt (Rs. 180) < than income (Rs.200), then it is recorded accrued
income.
Accrued Income
• These is income earned but not received by the end of an accounting period.
• The income must be recorded, even if it has not been received yet, as it relates to the period in
which it was earned and the amount to be received should be recorded as an asset (Income
Receivable).
Format of accrued income Ledger (under single account system)

INCOME
Date Particulars Rs. Date Particulars Rs.
Bal. b/d (opening receivable) XX
Income (balancing figure) XX Cash received XX
Bal. c/d (closing receivable) XX
XX XX
Period end adjustment/Treatment: Increase the income and record asset/receivable (accrued income) with the
Dr. Cr.
Receivable/Accrued Income 20
Income 20
Example
LALA Afridi has rented out a shop on rent on 1st April 2021. The rent for the year is Rs. 10,000. A six monthly
payment of rent is to be made by tenant in arrears.
Required:
Prepare income a/c for year ended December 31, 2021.
Solution
Rent Income
Bal. b/d (opening receivable)
Income (balancing figure) 7,500 30-9-21 Cash received 5,000
31-12-21 Bal. c/d (5,000/6*3) 2,500
Example
Mr. Anas has rented out his shop on 1 July 2020. Quarterly rent is received on the first day after the end of each
quarter. Quarterly rent is Rs. 15,000.
Required: Prepare rental income a/c for year ended June 30, 2021.
Solution
Rent Income
1-Jul-20 Opening receivable - 1-Jul-20 Opening unearned -
1-Oct-20 Cash 15,000
30-Jun-21 P/L (Balancing fig.) 60,000 1-Jan-20 Cash 15,000
1-Apr-21 Cash 15,000
30-Jun-21 Closing unearned - 30-Jun-21 Closing receivable 15,000
60,000 60,000
Exam Tip
Impact if period end adjustment (Entry of Accrued income) is not recorded in F/S:
Income is understated due to which profit is understated.
Further, due to non-recognition of accrued expense, asset/receivable (accrued income) is understated.
Impact after incorporation of period end adjustment (Entry of Accrued income) in F/S:
Income will increase due to which profit increase. Further, asset (accrued income) will also increase.
IV- If during the accounting period, receipts (Rs. 200) > than the income (Rs.180), then it is recorded as un-
earned liability.
Unearned Income
• This is cash received in advance for income yet to be earned at the end of an accounting period.
• The amount that relates to next accounting period is not an income for this period and must be
presented as a liability (unearned income / advance).
Period end adjustment/Treatment: Reverse the income and record liability (un-earned income) with the
Format of un-earned income Ledger (Under single account system)

Income
Bal. b/d (opening advance) XX
Bal. c/d (closing advance) XX
XX XX
Dr. Cr.
Income 20
Liability/Un-earned Income 20
Example:
LALA Afridi has rented out a shop on rent on 1st March 2021. The rent for the year is Rs. 10,000. A quarterly advance
payment is made by tenant.
Required:
Prepare rental income a/c for year ended December 31, 2021.
Rent Income
Bal. b/d (opening receivable) -
Income (balancing figure) 8,333 1-3-21 Cash received 2,500
1-6-21 Cash received 2,500
1-9-21 Cash Received 2,500

31-12-21 Bal. c/d (2,500/3x2) 1,667 1-12-21 Cash Received 2,500
Example
Bilal has rented out his shop on 1 August 2020. Rent per month is Rs.2,500. Tenant pays quarterly rent in advance
starting from 1 August 2020.
Required:
Prepare rental income a/c for year ended June 30, 2021.
Solution:
Rent Income
1-Jul-20 Opening receivable - 1-Jul-20 Opening unearned -
1-Aug-20 Cash 7,500
30-Jun-21 P/L (Balancing fig.) 27,500 1-Nov-20 Cash 7,500
1-Feb-21 Cash 7,500
1-May-21 Cash 7,500
30-Jun-21 Closing unearned (7,500/3x1) 2,500 30-Jun-21 Closing receivable
(7500 x 1/3)
30,000 30,000
Example
Talha has rented out 3 offices in his plaza for a monthly rent of 25,000 each on 3 March 2021. He receives quarterly
rent in advance starting from 5 March 2021.
Required: Prepare rental income a/c for year ended December 31, 2021.
Solution
Rental Income
Rs. Rs.
1-Jan-21 Opening receivable - 1-Jan-21 Opening unearned -
3-Mar-21 Cash (25,000 x3x3) 225,000
31-Dec-21 P/L (Balancing fig.) 750,000 3-Jun-21 Cash (25,000 x3x3) 225,000
3-Sep-21 Cash (25,000 x3x3) 225,000
3-Dec-21 Cash (25,000 x3x3) 225,000
31-Dec-21 Closing unearned 150,000 31-Dec-21 Closing receivable
(225,000  2/3) 900,000 900,000
Exam Tip
Impact if period end adjustment is not recorded:
Income is overstated due to which profit is overstated.
Further, due to non-recognition of liability (unearned income) is understated.
Impact after incorporation of period end adjustment (Entry of un-earned income) in F/S:
Income will decrease due to which profit decrease. Further, liability (un-earned income) will also increase.
Exam Tip
Cash basis of accounting don’t give a clear picture of the business in terms of profitability while the accrual basis of
accounting gives a better measurement of profitability than does the cash basis because accrual basis matches
revenue with expenses that an entity incurred to earn it.
Which type of questions examiner may ask from this chapter

- Examiner may ask impact on expenses, profit and impact on assets or liabilities.
- Calculate the expense or income to be recorded in P/L for the accounting period (In this case opening,
closing and cash paid/received data will be given and balancing would be the expense/income figure).
- Calculate the payment or receipt during the accounting period. (In this case expense/income and any
information/hint for opening/closing figures will be provided in the question).
- Calculate the closing prepaid/accrued expenses, and accrued/un-earned income of any accounting period
(In this case, we just think in our mind the number of short or extra paid/received months and its amount
w.r.t expense or income and this would be the closing figure (whether asset or liability).
- Calculate the opening balance (asset/liability in case of expense or income) then in this case cash
paid/receipt, and any hint relating to expense incurred/income earned and closing balance will be given in
the question.
• Following steps need to be followed to find out expense incurred/income earned, prepaid/accrued expense
or accrued income/un-earned liability.
Step #1
Identification of relevant/correct accounting period, its starting and ending date. Accounting period may be of 1
Month, 3 Month, 6 Month, 12 month or any other.
Example: Accounting period is of 12 months starting from 1-October-2021. It means starting date is 1-October-2021
and the ending date is 30-September-2022.
Step #2
Identification that how many months are relevant w.r.t accounting period as expense/income is recorded on this
basis.
Example: Mr. Anas is entered into a 12 months rental agreement starting from 1- Jan-2022. However, his year end
is 30-September-2022. Payment of Rs. 120,000 is made in advance.
Solution: However rental agreement is of 12 months starting from 1-Jan-2022 to 31-December-2022 but in this
scenario, 9 months are relevant w.r.t accounting period i.e. 1-Jan-2022 to September-2022 (as accounting period
has ending date of 30-September). 3 months (1-October-2022 to December-2022 is pertaining to next accounting
period).
Step # 3
Record cash paid (in case of expenses) and received (in case of income) into the relevant ledger. Cash paid will be
recorded on the debit side while cash received will be recorded on the credit side of relevant ledger.
Step # 4
Find out the required figure (Examiner may ask to find income/expense to be recognized in P/L or closing
receivable/liability). Find any of the one and balancing amount would be the missing figure.
Exam tip: Sometimes examiner may also require to calculate paid/receipt figure. However, in this case
opening/closing and P/L figure is given in the question.
Under single account system combine account of both prepaid and accrued expense can also be
prepared. So, in this system, one memorandum T account is prepared to present an asset, liability
and expenses.
Format of Combined account of prepaid and accrued expenses

EXPENSES
Bal. b/d (opening prepaid) XX Bal. b/d (opening payable) XX
Bal. c/d (closing payable) XX Bal. c/d (closing prepaid) XX
XX XX
Example:
At 31 March 2012 a company had oil in hand to be used for heating costing Rs. 8,200 and an unpaid heating oil bill
for Rs. 3,600. At 31 March 2013 the heating oil in hand was Rs. 9,300 and there was an outstanding heating oil bill
of Rs. 3,200. Payments made for heating oil during the year ended 31 March 2013 totalled Rs. 34,600.
Based on these figures, what amount should appear in the company's Statement of Profit or Loss for heating oil for
the year?
(a) Rs. 23,900 (b) Rs. 36,100
(c) Rs. 45,300 (d) Rs. 33,100
Solution
Heating expense
b/d oil in hand 8,200 b/d heating oil bill 3,600
Cash 34,600 P/L 33,100
c/d heating oil bill 3,200 c/d oil in hand 9,300
46,000 46,000
Example (Homework)
Adeel Engineering has two motor vehicles that are used within the business. The expenses of running these vehicles
and insuring these vehicles are recorded in the “Vehicle running expenses”. At May 1, 2003 there are repair bills
accrued of Rs. 4,780, petrol bills accrued of Rs. 12,000 and insurance that had been prepaid of Rs. 2,900.
During the year ended April 30, 2004 following transactions took place:
Date Description Rs.
30 June 2003 Paid repair bills to workshop 6,980
1 September 2003 Paid insurance for one of motor vehicles for the year to Aug 31, 2004 34,800
1 December 2003 Paid insurance for other motor vehicle for year to November 30, 2004 9,000
30 April 2004 Paid petrol bills 130,000
At April 30, 2004 there were repair bills unpaid totalling Rs. 3,560 and no petrol bill was outstanding.
Required:
Write up ledger accounts under two account system and single account system for the year ended April 30, 2004.
Solution
Vehicle running expenses (Memorandum account)
May 1 Bal b/d (Prepaid insurance) 2,900 May 1 Bal b/d (Expenses payable) 16,780
Jun 30 Bank 6,980
Sep 1 Bank 34,800 Apr 30 Expense in PL 166,110
Dec 1 Bank 39,000
Apr 30 Bank 130,000
Apr 30 Balance c/d (Expenses payable) 3,560 Apr 30 Bal c/d (Prepaid insurance) 34,350
217,240 217,240
W1 Calculation of closing prepaid insurance Rs.
01.09.03 Prepaid insurance of one of the motor vehicles (34,800/12x4) 11,600
01.12.03 Prepaid insurance for other motor vehicle (39,000/12x7) 22,750
34,350
Under single account system combine account of both accrued and un-earned income can also
be prepared. So, in this system, one memorandum T account is prepared to present an asset,
liability and expenses.
Format of combine Income Account
Income
Bal. b/d (opening receivable) XX Bal. b/d (opening advance) XX
Bal. c/d (closing advance) XX Bal. c/d (closing receivable) XX
XX XX
Example (Homework)
Bones owns various properties which he rents; some tenants pay in advance, some in arrears.
During 2013 rent collected was Rs. 229,500.
Rents receivable and paid in advance at the statement of financial position dates were as follows.
31 December
2012 2013
Rs. Rs.
Rents owed by tenants 34,200 40,500
Rents prepaid by tenants 20,700 15,300
Required:
Write up ledger accounts under single account system for the year ended December 31, 2013.
Solution
SINGLE ACCOUNT SYSTEM
Rent Income
1 Jan Bal b/d (Rent receivable) 34,200 1 Jan Bal b/d (Unearned rent) 20,700
31 Dec Profit or loss 241,200 Cash 229,500
31 Dec Balance c/d (Unearned rent) 15,300 31 Dec Bal c/d (Rent receivable) 40,500
290,700 290,700
Example: Zameen, a property company, received cash totalling Rs. 838,600 from tenants during the year ended 31
December 2016. Figures for rent in advance and in arrears at the beginning and at the end of year were:
31 December 2015 31 December 2016
Rs. Rs.
Rent received in advance 102,600 88,700
Rent in Arrears (all subsequently received) 42,300 48,400
Required:
What amount should appear in company’s Statement of P&L for the year ended 31 December 2016 for rental
income?
(a) Rs. 818,600 (b) Rs. 738,000
(c) Rs. 939,200 (d) Rs. 858,600

Rent income a/c
b/d 42,300 b/d 102,600
SPL 858,600 Cash 838,600
c/d 88,700 c/d 48,400
989,600 989,600
Exam Tip (In exam no need to prove or calculate, just remember these points and choose the correct option without
wasting time)
Prepaid expense (Asset): Always remember that if opening prepaid expense > closing prepaid
expense then during the accounting period expense incurred is always more than the payment
made during the accounting period and vice versa.
Accrued expense (Liability): If opening accrued expense > then closing accrued expense then
during the accounting period expense incurred is always less than the payment made and vice
versa.
Accrued income (asset): If opening accrued income > then closing accrued income then during
the accounting period income earned is less than the receipt and vice versa.
Un-earned income (Liability): If opening un-earned income > then closing un-earned income then
during the accounting period income earned is always more than cash receipt and vice versa.
Note: Solve all these scenarios by taking the opening and closing figures as Rs. 15,000 or Rs. 10,000. If opening is
higher then take it by Rs. 15,000 or closing as Rs.10,000 and vice versa. Further take cash paid/receipt amount by
Rs. 5,000.
Double account system: In this system all accounts are prepared separately i.e., Expense, Income, asset or liability
with its own name (Just like we did practice in Ledger chapter).
Expense/Income or asset/liability are presented in a separate account just in a simple way as we did in the ledger
chapter.
In asset/liability account we reverse the closing balance of previous accounting period at the start of each
accounting period.
Exam Tip
We always solve question by using single account system in the exams. Only described here so students can become
familiar to this system too.
ALTERNATE NAMES FOR DIFFERENT TERMINOLOGIES
Expenses Main name Other names

Liability Accrued expense Payable, Outstanding, Arrears, Due, Owing
Asset Prepaid expense Advance
Income
Asset Accrued income Receivable, Arrears, Due, Outstanding, Owing
Liability Unearned income Advance, Deferred

Accruals and prepayments

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Accruals and prepayments

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PRC -4 Introduction to Accounting Chapter 04:Accruals and Prepayments

There are two methods of accounting.

Prepare expense a/c for year ended December 31, 2021.

2. Accrual basis of accounting:

Format of Prepaid expense Ledger (under single account system)

Date Particulars Rs Date Particulars Rs

Format of Accrued expense Ledger (under single account system)

Format of accrued income Ledger (under single account system)

Format of un-earned income Ledger (Under single account system)

1-9-21 Cash Received 2,500

Which type of questions examiner may ask from this chapter

Format of Combined account of prepaid and accrued expenses

W1 Calculation of closing prepaid insurance Rs.

01.09.03 Prepaid insurance of one of the motor vehicles (34,800/12x4) 11,600

01.12.03 Prepaid insurance for other motor vehicle (39,000/12x7) 22,750

(c) Rs. 939,200 (d) Rs. 858,600

Expenses Main name Other names

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