CH#10: Accruals and

Prepayments
 Accruals Concept

▪ Accruals: Incomes are recognized in the financial statements as they

are earned, not when the cash is received.
▪ For example, your business’s accounting year ends on 31st December,
2020.
▪ You have made a credit sale of $400 on 10th December, 2020 but the
customer has not made payment by 31st December, 2020.
▪ The sale will still be included in the statement of profit and loss
prepared on 31st December, 2020 regardless of the fact that payment
has not been received yet.
 Accruals Concept

▪ Accruals: Similarly, expenses are recognized in the financial

statements as they are incurred, not when the cash is paid.
▪ For example, your business’s accounting year ends on 31st December,
2020.
▪ Your rent for the months of November and December is due but has
not been paid by the end of the year.
▪ The rent of these two months will still be included in rental expense
in the financial statements on 31st December, 2020 even though the
payment has not been made yet.
 Amount Payment terms

Statement of Profit and Loss for Amount:

the year ended 31 December, 20x1 • $5000 per quarter
• Quarter= 3 months
$ $ • Quarters in an year= 4
Gross profit 80,000 • Amount per year= $5000 x 4
less: Expenses • Annual Amount= $20,000
Rent 20,000
 Amount paid during year Amount that relates to
year but not paid yet
Statement of Profit and Loss Amount:
$ $ • January-September: $1000
Gross profit 60,000 • Bill for Oct-Dec: $300
less: Expenses • Total bills for 20x1: $1300
Rent 20,000
Electricity 1,300
 Amount paid during year Amount that relates to year but
not paid yet
Statement of Profit and Loss
$ $ Amount:
Gross profit 60,000 • January-November: $820
• Bill for the following quarter: $240
less: Expenses • Bill for Dec-Feb: $240
Rent 20,000 • Bill for December: $240/3=$80
Electricity 1,300 • Total bills for 20x1: $900
Telephone 900
 Payment terms

Statement of Profit and Loss

$ $ Amounts
Gross profit 60,000
less: Expenses
Rent 20,000
Electricity 1,300
Telephone 900
Insurance
 1st January, 31st December,
2011 2011

31st 31st
1st April, $3000 1st April, $4200 March,
March,
2010 2011 2012
2011
 Payment terms

Statement of Profit and Loss

$ $ Amounts
Gross profit 60,000
less: Expenses Amount:
January-March:
Rent 20,000 • $3000/12 months= $250 per month
Electricity 1,300 • 3 months= $250 x 3 = $750
Telephone 900 April-December
• $4200/12months= $350
Insurance 3,900 (26,100) • 9 months= $350 x 9 = $3150
33,900 Jan-Dec= 750 + 3150 = $3900
Net profit Annual Amount-= $3900
Amount:
July 2015-March 2016:
• $10,800/12 months= $900 per month
• 9 months= $900 x 9 = $8100
April 2016-June 2016
• $12000/12months= $1000
• 3 months= $1000 x 3 = $3000
July 2015-June 2016= 8100 + 3000 = $11,100
Annual Amount= $11,100
 Accrued Expense
Accrued expense is expense which has been:
▪ incurred(good or service has been received) but
▪ not paid yet.
When making Financial Statements:
Any amount of expense which has been incurred during the accounting
year but is still unpaid is known as accrued expense
 Example

A. Electricity bill for the month of June is unpaid.

Amount of accrual= bill of June.
Bill of June: $900/3 months= $300

B. Water bill relating to the months of May and June are unpaid.
Amount of accrual= bills of May and June
Bills of May and June: $780/3= $260 x 2 = $520
 Prepaid Expense
Prepaid expense is expense which has been:
▪ paid in advance, before
▪ the expense has been incurred(before the good or service has been
received).
When making Financial Statements:
Any amount of expense which has been paid for but will be incurred in
the next accounting year is known as prepaid expense.
 Example

A. Insurance for the months of July 2018-Februaury 2019 has been paid in advance.
Amount of prepayment= Insurance of July 2018-Februaury 2019.
Prepayment: $2136/12 months x 8 months = $1424

B. Rent of July 2018 has been paid in advance.

Prepayment: $7800/3 months x 1 month = $2600
 After receiving the
good/service

Amount:
• $5000 per quarter
• Quarters in an year= 4
• Amount per year= $5000 x 4
• Annual Amount= $20,000

• Rent expense to included in the statement of profit and loss for the year ended 31st
December, 20x1= $20,000
• Accrued Rent expense to be included in the statement of financial position at
31st December, 20x1= $5000
 Accrued Expense in Accounts

▪ Credit entry is made in the expense account to transfer that expense

to the statement of profit and loss
▪ Closing balance on the debit side in an expense account represents a
closing accrual
▪ Opening accrual will come on the credit side in an expense account
 Factory rent account
2011 $ 2011 $
31 Mar Cash 5000 31 Dec Transfer to SOPL 20,000
29 Jun Cash 5000
Opening
Closing Accrual 2 Oct Cash 5000 Accrual comes
comes on Debit 31 Dec Bal c/d 5000 on Credit side
side
20,000 20,000
2012
Jan,1 Balance b/d 5000
 Factory rent account
2012 $ 2012 $
4 Jan Cash 5000 Jan,1 Balance b/d 5000
28 Mar Cash 5000 31 Dec Transfer to SOPL 20,000
28 Jun Cash 5000
4 Oct Cash 5000
No closing 23 Dec Cash 5000
accrual as
account has 25,000 25,000
balanced
 Prepaid Expense in Accounts

▪ Credit entry is made in the expense account to transfer that expense

to the statement of profit and loss
▪ Closing balance on the credit side in an expense account represents a
closing prepayment
▪ Opening prepayment will come on the debit side in an expense
account
Insurance of months from January 2011 to December 2011 will be included as insurance
expense in the statement of profit and loss for the year ended 31 December, 2011.

Insurance for the months of January 2011 to March 2011: $800

Insurance for the months of April 2011 to September 2011: $1800

Insurance for the months of October 2011 to December 2011:

6 months insurance=$1800
Insurance of 3 months=$1800/6months x 3months= $900
Insurance relating to Accounting year= $800 + $1800 + $900 = $3500
 Insurance account Closing
2011 $ 2011 $ Prepayment
Opening 1 Jan Cash 800 31 Dec Transfer to SOPL 3500 comes on
Prepayment 28 Mar Cash 1800 31,Dec Balance c/d 900 Credit side
comes on Debit 2 Oct Cash 1800
side
4400 4400
2012
Jan,1 Bal b/d 900
 Closing Accrual
Electricity account
2015 $ 2015 $
Feb,6 Cash 2800 Jan,1 Balance b/d 2000
May,8 Cash 3000 31 Dec Transfer to SOPL ?
11,450
Aug,5 Cash 2750
Nov,10 Cash 3100
Dec,31 Bal c/d 1800
Closing Accrual 13,450 13,450
comes on Debit side
 Formula Method

Amount transferred to SOPL:

= Payments + Closing Accrual – Opening Accrual – Closing prepayment + Opening Prepayment
 Opening Accrual

Closing Accrual

• Payments + Closing Accrual – Opening Accrual = Charge to SOPL

• 2800+3000+2750+3100 + 1800 – 2000 = Charge to SOPL

• Charge to SOPL = 11,450
 Accruals and Prepayments in Statement of
Financial Position
• Accrued expenses are considered to be liabilities.
• Prepaid expenses are considered to be assets.
• Accrued incomes are considered to be assets.
• Prepaid incomes are considered to be liabilities.
 Accrued Income and Prepaid Income
Accrued income is income which has been:
▪ earned(good or service has been delivered) but
▪ payment has not been received yet.
Prepaid income is income for which:
▪ payment has been received in advance, before
▪ the income has been earned(before the good or service has been delivered).
When making Financial Statements:
Any amount of income which has been earned during the accounting year but is
still not received is known as accrued income.
Any amount of income for which payment has been received but will be earned
in the next accounting year is known as prepaid income.