Financial Accounting

4ACCN008C-n
Semester 2, 2022/2023
Lecture 6:End of year adjustments: Accruals and
prepayments
 Learning Outcomes:

Upon successful completion of the session student will be able to:

1. Recognize how the matching concept applies to accruals and prepayments;

2.Prepare the journal entries and ledger entries for the creation of an accrual or
prepayment;
 Midterm assessment

Section A: 40 marks - 8 MCQs 5 marks each. Questions from TW1-5

materials

Section B: 60 marks - 1 open ended question (double- entry transactions,

balancing-off accounts(b b/d, b c/d), preparation of Trial Balance)

Date: October 24, 2023

Time: 10:00
Duration: 1 hour 15 minutes
 End of Year Adjustments

The Basics of How it effects the

RECAP Adjusting Entries Financial
Statements

• Fiscal and calendar • Adjusting entries for • Where to put the

years accruals items in the financial
• Periodicity concept • Adjusting entries for statements
• Applying revenue & prepayments
matching principle • Entries for bad debts and
provision for doubtful debts
• Summary of journalizing
and posting
Adjusting Entries
• Adjusting entries make it possible to report correct amounts on the
balance sheet and on the income statement.

• A company must make adjusting entries every time it prepares

financial statements.

• Revenues - recorded in the period in which they are earned.

earned
• Expenses - recognized in the period in which they are incurred.
incurred

Adjusting entries - needed to ensure that the revenue recognition and

matching principles are followed.
Accruals and prepayments
Important in accrual accounting
1.Accrue: To accumulate a receivable (asset) or payable (liability)
during a given period, even though no explicit transaction occurs, and
to record a corresponding revenue or expense
2.Accruals are not based on explicit transactions, hence not recorded
on a day-to-day basis
3.Affect both an income statement account and a balance sheet
account
4. Never affect cash
5.Help match revenues and expenses to appropriate accounting period
6.Ensure that balance sheet correctly states assets and liabilities
Accruals and prepayments
Arise from four types of implicit transactions:

Expiration or consumption of unexpired costs-Prepaid expenses

Earning of revenues received in advance-Prepaid (deferred) revenues

Accrual of unrecorded expenses -Accrued expenses

Accrual of unrecorded revenues-Accrued revenues

Prepaid expenses

Prepayment is a current asset representing amount paid in cash for a

service that will be provided in a subsequent period.
 Prepaid expenses
A company pays $6,000 rent in advance for the months of January,
February, and March
– Transaction initially recorded as an asset

(a) Prepaid rent 6,000

Cash 6,000

End of January, asset declines in value as rent for one month has
been consumed

(b) Rent expense 2,000

Prepaid rent 2,000
Prepaid revenue

Cash received from customers who pay in advance for goods or services to
be delivered at a future date
Also known as revenue received in advance or deferred revenue
Requires recording both the receipt of cash and the liability for future goods
or services
Prepaid revenue
A company receives $6,000 in cash for rent in advance for the months of January,
February, and March
Transaction initially recorded as a liability

(a) Cash 6,000

Unearned rent revenue 6,000

End of January, liability decreases as revenue for one month has been earned

(b) Unearned rent revenue 2,000

Rent revenue 2,000
Accrual of Unrecorded Expenses
Accrual of Unrecorded Expenses
A company makes routine entries for the explicit payment of $500,000 in
wages to employees during January

(a) Wages expense 500,000

Cash 500,000

Adjusting entry to accrue $75,000 in wages for the last three days wages
in January

(b) Wages expense 75,000

Accrued wages payable 75,000
Accruals of Unrecorded Revenues

An implicit transaction recognizes an asset and a revenue.

Subsequent explicit transaction records the receipt of cash and reduction

of previously recorded asset

Characteristics of unrecorded revenues

Accruals of Unrecorded Revenues
Suppose the bank made a $100,000 loan to a customer on December 31, 2012. The terms of
the loan require repayment of the loan amount of $100,000 plus 6% interest on December 31,
2013
Accruals of Unrecorded Revenues
As of January 31, 2013, the bank has earned interest for one month
The amount of interest earned is (1/12 x .06 x $100,000) = $500
Adjusting entry need to accrue $500 in interest revenue earned, but not yet
received, for the month of January

Accrued interest receivable 500

Interest revenue 500
Contingent Assets and Liabilities

A contingent asset is a possible asset that arises from past events and whose existence will be
confirmed only by the occurrence or non-occurrence of one or more uncertain future events not
wholly within the control of the entity.

A contingent liability is simply a disclosure note shown in the notes to the accounts. There is no double
entry recorded in respect of this. Instead, a description of the event should be given to the users with
an estimate of the potential financial effect. In addition to this, the expected timing of when the event
should be resolved should also be included.

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 Possible adjustments
List of adjusting journal entries List of the types of accruals: List of common prepaid
1. Accrued expenses 1. Deferred revenue Expenses:
2. Accrued revenues 2. Accrued revenue Prepaid rent
3. Prepaid expenses 3. Prepaid expenses Prepaid insurance
4. Unearned revenues 4. Accrued expenses Small business insurance
5. Depreciation expense 5. Accrued tax liabilities policies
6. Bad debt expense 6. Accrued interest earned or Equipment paid for before
7. Allowance for doubtful accounts payable use
8. Impairment of non-current assets 7. Future tax liabilities Salaries (unless you run
9. Deferred tax assets and liabilities 8. Future interest expenses payroll in arrears)
10. Accrued interest 9. Accounts receivable Estimated taxes
11. Accrued taxes 10. Accounts payable Some utility bills
12. Accrued salaries and wages Interest expenses
13. Accrued vacation time
14. Accrued sick leave
15. Accrued bonuses

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Lecture Roundup:
1.Accrued expenses (accruals) are expenses which relate to an accounting period but have not yet
been
paid for. They are shown in the statement of financial position as a liability.
2. Prepaid expenses (prepayments) are expenses which have already been paid but relate to a future
accounting period. They are shown in the statement of financial position as an asset
References:

1. Wood, F & Sangster, A (2001) Business Accounting 1, chapters 5, 6, 25, 26,

28

2. Dyson, J.R (2004) Accounting for Non-Accounting Students, chapter 5.

3. ACCA (2017) Approved Interactive Text. Foundations in Accountancy FFA

2017/2018. BPP Media Ltd.chapter 10,12