Adjusting for Accruals

and Prepayments
Introduction
At Level 1 you made year-end adjustments for accruals and prepayments
in the profit and loss account and th e balance sheet. At Level 2, however,
you will be required to calculate accruals and prepayments and make
adjustments in the ledger accounts and then transfer the adjustments to
the profit and loss account and the balance sheet.

Learning targets
By the end of this chapter you should be able to:
explain the significance of expense prepayments and accruals and
income prepayments and accruals
calculate and make end-of-period adjustments in expense accounts for
prepayments and accruals
calculate and make end-of-period adjustments in income accounts for
both accrued and prepaid income
record two areas of expense within one expense account
make adjustments in the trading account and balance sheet for
end-of-period 'outstanding' purchases, i.e . goods received but invoices
still awaited
make end-of-period adjustments in the profit and loss account and
balance sheet for both accrued and prepaid income and accrued and
prepaid expenses.

2.1 Calculating accruals and prepayments

When preparing the profit and loss account, it is important to match
income and expenses in the correct accounting period. This is known as the
matching concept and is carried out using accruals and prepayments.
An accrual is a provision for income or expenses that relate to the

accounting period, but that have not yet been invoiced.

A prepayment is an adjustment for income that has been received, or
expenses that have been invoiced, in advance of any service or goods
being provided.
The key point for calculating accruals and prepayme nts is the time period.

Pearson LCCI Book-keeping and Accounts: Level 2

The following situations relating to Mr Yew's business show how to calculate

accruals and prepayments correctly and how to post them into the ledger
accounts . This workbook uses separate accounts for recording accruals and
prepayments because the balances on these accounts are used in preparing the
balance sheet.
Expense prepayments

Yew prepares accounts annually to 30 June each year.

On 1 April 20X7, he pays an insurance invoice for 2 ,400 that covers
the period 1 April 20X7 to 31 March 20X8. Calculate the prepayment at
30 June 20X7.
The first step is to calculate the correct time period for the prepayment.
This can be shown using a time-line.
01/07;X6

Time

Ol/04/X7

Invoice

30/06;X7

Pl

r. "" I I

31/03/X8

3/12

The cu rrent accounting period for Yew falls in the period between Ol/07/X6
and 30/06/X7, while the invoice payment covers the period Ol!04/20X7 to
31/03/20X8.
The timeline shows that the proportion of the payment relating to the
current accounting period is only three months (April, May and June); the
rest of the payment is for 9 months of the next accounting period. Therefore,
as he has paid for insurance 9 months in advance, this is a prepayment. The
prepayment can then be calculated as 9 -:- 12 X 2,400 = 1 ,800.
The journal entry to process this expense prepayment is:
Dr

Prepayments
Insurance

Cr

1,800
1,800

The effect of this journal entry on the ledger accounts is shown below.

20X7
April 1 Bank/Cash

20X7
June 30 Insurance

Think about it
Why is an expense
prepayment an asset
on the balance sheet?

Insurance
20X7

2,400
June 30 Prepayment
June 30 Profit and Loss Account
2,400

1,800
600
2,400

Prepayments

20X7
1,800
June 30 Balance c/d
1,800

1,800
1,800

The balance on the prepayment account is an asset on the balance sheet and
re resents a reductiQn in the expense on the profit and loss account. The
balancing figure on the insurance account is transferred to the profit and loss
account as an expense for the year.

C hapter 2: Adj ustin g for Accrua ls an d Prepay ments

Expense accruals

On 31 July 20X7, Mr Yew receives an invoice fo r telepho ne charges of 450

covering the pe riod 1 May 20X7 to 31 July 20X7. Calculate the accru al at
30 June 20X7.
01/07/X6

Time

01/05/X7

Invoice

30/06/X7 31/07/X7

31/03/XS

11-- -2/-3--tl- -1/-3----;1

Again, you are interested in th e portio n of the charges relating to the

current accounting period Ol/07/20X6 to 30/06/20X7. The invoice received is
fo r the period Ol/05/20X7 to 31/07/20X7, which is three mo nths (May, June
and July). Two of these three mo nths fall in the year ending 30/06/20X7; as the
telephone charges for these m o nths was unpaid at the e nd of the accounting
pe riod , this is an accrual. The accrual am o unt can then be calculated as
2/3 X 450 = 300.
The jo urnal entry and the ledger accounts to record this accrual are shown
below:
Dr

300

Tele pho ne
Accruals

Cr

300

Telephone

20X7
June 30 Accruals

300
---300

300
300

20X7
June 30 Profit and Loss Account

Accruals

20X7
June 30 Balance c/d

Think about it
Why is an expense
accrua l a liabi lity on
the balance sheet?

300
300

20X7
June 30 Telepho ne

300
300

The balance o n the accruals account is a current liability o n the balance sheet
and it represents an increase in the expe nse o n the p rofit and loss account.
The balancing fig ure o n the tele pho ne account is transferred to the p rofit and
loss account as an expe nse for the year.
Accrued income

So far you have looked at expe nses, but the incom e of a business also needs
to be allocated to the correct period. Accrued incom e is include d in the ledger
acco unt for prepayments and this account is often known as pre p ayment s
and accrued income.
At 30 June 20X7, Mr Yew had sup p lied_good~ to Beech but had no t yet raised
th e invoice for 1,900. This needs to be included as sales in the acco unts fo r
the year to 30 June 20X7 because the goods have been supplied during this
period.
Again , the relevant jo urnal and the ledger accounts are shown below:

Prepayme nts and accrued income

Sales

Dr

Cr

1,900
1,900

ID

Pearson LCCI Book-keep ing and A ccounts: Level 2

Sales

20X7
June 30 Profit and Loss Account

1,900
1,900

20X7
June 30 Accrued income

1,900
1,900

Prepayments and Accrued Income

20X7
June 30 Insurance
June 30 Sales

1,800
1,900
3,700

20X7
June 30 Balance c/d

3,700
3,700

Prepaid income
It is also possible for a business to raise a sales invoice in advance of supplying
any goods or services. This is prepaid income and needs to be adjusted for at
the accounting year-end. Prepaid income is included in the ledger account for
accruals and this account is ofte n known as accruals and deferred income .
On 15 June 20X7, Yew raised a sales invoice for 850 but_Lhe goods were
not supplied until 8 July 20X7. This sales invoice belongs in the accounting
year ended 30 June 20X8 and therefo re needs to be removed from the sales
for the year e nded 30 June 20X7.
The relevant jo urnal and ledger accounts are shown below:
Dr

Sales
Accruals and Deferred Income

Cr

850
850

Sales

20X7
June 30 Deferred income
June 30 Profit and Loss Account

850
1,050
1,900

20X7
June 30 Accrued income

1,900
1,900

Accruals and Deferred Income

20X7
June 30 Balance c/d

1,150

20X7
June 30 Sales
June 30 Telepho ne

1,150

850
300
1,150

2.2 Recording two areas of expense in one

expense account
Businesses sometimes group similar expenses together into one ledger
acco unt. Examples might include rent, rates and insurance being posted to
one ledger account, or postage and stationery costs being posted to another
ledger account. This means that there may be accruals and prepayments o n
the same ledger account. You should keep these entries separate and not net
off accruals and prepayme nts.

Chapter 2: Adjusting for Accruals and Prepayments

Exercise 2.1

Ash prepares his accounts annually to 31 December and maintains a single

expense account for rent, rates and insurance.
On 1 January 20X6, the opening accruals and prepayments on this
ledger account were a rent accrual of 500, a rates prepayment of 400
and an insurance prepayment of 250. The following transactions occurred
during the year to 31 December 20X6.

1 Rent of 500 was paid on 15 January 20X6; 650 on 1 March 20X6,

1 June 20X6 and 1 September 20X6. The amount of 650 due on
1 December 20X6 was not paid until 10 January 20X7.
2 Insurance totalling 550 was paid on 30 June 20X6 for the year to
30 June 20X7.

3 Rates of 1,700 were paid on 1 April 20X6 for the year to 31 March 20X7.
Required
(a) Prepare the rent, rates and insurance account for the year ended

31 December 20X6, clearly showing the charge to the profit and loss
account.
(b) Prepare a balance sheet extract at 31 December 20X6 to show the
accruals and prepayments.
Solution

Rent, Rates and Insurance

20X6
]an 1
Jan 1
Jan 15
March 1
April 1
June 1
June 30
Sept 1
Dec 31
20X7
Jan 1
Jan 1

Balance b/d - Rates

Balance b/d - Insurance
Bank- Rent
Bank - Reo t
Bank - Rates
Bank- Rent
Bank- Insurance
Bank - Rent
Balance c/d - Rent

Balance b/d - Rates

Balance b/d- Insurance

400
250
500
650
1,700
650
550
650
650
6,000
425
275

20X6
Jan 1
Dec 31
Dec 31
Dec 31

Balance b/d - Rent

Profit and Loss Account (3)
Balance c/d- Rates (1)
Balance c/d - Insurance (2)

6,000
20X7
Jan 1

Balance b/d- Rent

Notes
1. 3/12 X 1,700 = 425
2. 6/12 X 550 = 275
3. The balancing figure is the transfer to the profit and loss account

Ash- Balance Sheet (extract) at 31 December 20X6

Current assets

Prepayments

- Rates
- Insuran ce

425
275
700

Current liabilities

Accruals

-Rent

500
4,800
425
275

650

650

Pearson LCCI Book-keeping and Accounts: Level 2

2.3 Adjusting for outstanding purchases

It is possible that, at the end of an accounting period, a business has received
goods from a supplier but has not yet received the invoice. This means that
the cost will not be included in the accounting records and must be accrued.
This is done by increasing (debiting) the purchases account and crediting
accruals.

Example 1
Ash received goods from Oak on 30 April 20X7, the final day of his accounting
period. The invoice for these goods, totalling 3,400 did not arrive until
15 May 20X7. This invoice needs to be accrued.

Purchases
20X7
12,500
June 30 Profit and Loss Account
3,400
15 ,900

20X7
April 30 Purchases
April 30 Accruals

15,900
15,900

Accruals
20X7

April 30 Purchases
3,400
3,400

20X7
April 30 Balance c/d

3,400
3,400

2.4 Adjusting the profit and loss account and

balance sheet for accruals and prepayments
It is not always necessary to prepare ledger accounts to adjust the profit
and loss account or balance sheet figures for accruals and prepayments.
Adjustments can be made directly in the final accounts, as shown in
Exercise 2.2.

g
R

Exercise 2.2

El m's trading and p rofit and loss account for the year ended 31 March
20X7 and balance sheet at 31 March 20X7 are as fol lows:
c

Elm - Trading and Profit and Loss Account

for the year e nde d 3 1 March 20X7

Sales
Cost of sales
Opening stock
Purchases
Less Closing stock

Gro ss profit

65,000
AI

2,300
29,100
31,400
2,150
29,250
35,750

Chapter 2: Adjust in g for Accrua ls and Prepayments

Less Expenses

Wages
Rent, rates and insurance
Heat and light
Stationery and postage
Depreciation

8,400
3,500
2,950
955
2,250
18,055
17,695

Net profit

Elm - Balance Sheet at 31 March 20X7

Fixed assets

Fixtures and fittings at cost

Less Accumulated depreciation

9,000
4,500
4, 500

Current assets

Stock
Debtors
Bank

2,150
4,200
1,265
7,615

Curre nt liabilities

Creditors

1,880

Ne t current assets
Ne t assets

5,73 5
10,235

Capital account

Improve your
grade
Remem ber t hat :
accrued inco m e
increases t he
sales figure w hil e
prepai d incom e
reduces it
accruals increase
expenses wh il e
prepayme nts
reduce exp enses.
Always sh ow you r
wo rkin gs in an
examinatio n.

Balance b/d
Add Net profit

7,540
17,695
25 ,235
15,000
10,235

Less Drawings

Required
Prepare an amended t rading and profit and loss account for t he year
ended 31 March 20X7 a nd ba lance sheet at 31 March 20X7, afte r providing
for the fol lowing accrua ls and prepayme nts .

Wages
Rent, rates and insurance
Purchases
Heat and light
Statio ne ry and postage

Accruals

Pre paytnents

600
200
375

750
165

80

Pearson LCCI Book-keeping and Acco unts: Level 2

Solution

Elm - Trading and Profit and Loss Account

for the year ended 31 March 20X7

65,000

Sales
Cost of sales
Opening stock
Purchases (29 100 + 375)
Less Closing stock

2,300
29 ,475
31,775
2,150
29,625
35,375

Gross profit
Less Expenses

Wages (8,400 + 600)

Re nt, rates and insurance (3,500 + 200 - 750)
Heat and light (2,950- 165)
Statio ne ty and postage (955 + 80)
Depreciatio n

9,000
2,950
2,785
1,035
2,250

Notice how the expenS{

are adjusted to account
for th e accruals and
prepayments. Accruals
are added ( +) and
prepayments are
subtracted(-).

18,020
17,355

Net profit
Elm - Balance Sheet at 31 March 20X7
Fixed assets
Fixtures and fittings : cost
Less Acc umulated de preciation

Accruals and
prepayme nts
are to talled
separately and
shown in the
balance sheet.
Prepayments
shoul d always
be entered after
debto rs and
accruals after
cred ito rs .

Current assets
Stock
Debtors
Pre payments (750
Bank

+ 165)

Current liabilities
Credito rs
Accruals (600 + 200
Net current assets
Net assets
Capital account
Balance b/d
Add Net profit
Less Drawings

+ 375 + 80)

9,000
4,500
4,500
2, 150
4,200
915
1,265
8,530

1,880
1,255
5,395
9,895
7,540
17,3 55
24,895
15,000
9,895

Chapter 2: Adjusting for Accrua ls and Prepayments

Chapter summary
Important points to remember from this chapter:
1 Income and expenses need to be matched to the correct accounting

period.
2 Accruals and prepayments are used to match income and expenses.

3 An accrual is a provision for income or expenses that relate to the

current period.
4 Accruals are included in current liabilities on the balance sheet.

5 A prepayment is an adj ustment to transfer income or expenses into the

next accounting period.
6 Prepayments are included in current assets on the balance sheet.

1\SeS

mt

7 Accrued income increases the sales figure, wh ile deferred income

reduces it.

ls

8 Accruals increase expenses, while prepayments reduce expenses.

Target practice
1

Complete the correct journal entry to process:

(a) A prepayment for electricity of 330 .

330

)'

330
(b) Accrued motor expenses of 927.

927
927

(c) Sales of 2,500 invoiced in advance.

Or

Cr

( )o (~

"

2,500

IT

')

r,r, 1tl

""'r'-!)'!1

''

2,500

(d) Rent receivable but not yet collected of 700 .

Or

Cr

'""' 1.;

r
"

,~I

~-

)1; y-'
)

.n

: ; t';'

,-r

I,

I, rl

700
700

Pearson LCCI Boo k-keepin g and Acco unts: Level 2

Calculate the following accruals and prepayments at 30 June 20Xl:

(a) An invoice for telephone costs totalling 900 was received on
31 August 20X1 and related to the period 1 June 20X1 to
31 August 20Xl.
(b) Motor insurance of 420 was paid on 1 February 20X1 for the year to

31 January 20X2.
(c) An invoice for electricity of 840 was received on 15 August 20X1 and
related to the quarter ended 31 July 20Xl.
(d) Rent of 8,000 for the six months to 30 September 20X1 was paid on

1 April 20Xl.
3

Enter the figures calculated in Question 2 into the relevant ledger

accounts, including accounts for accruals and prepayments. Balance off all
the accounts, clearly showing the transfer to the profit and loss account or
- the balance c/d .

4 Cedar maintains a single ledger account for premises expenses, which

includes costs for rent, rates, electricity and gas.
At 1 October 20X6, the balances on this account consisted of
prepayments for rent of 780 and rates of 1 ,500, and accruals of 275 for
electricity and 130 for gas.
During the year, Cedar paid 12 instalments of 800 for rent. The
payment made in September 20X7 related to October 20X7. Rates for
the year to 31 March 20X8 were paid in April 20X7 and totalled 1,700 .
Total payments during the year amounted to 3,000 for electricity and
1,900 for gas.
In October 20X7, Cedar received an invoice for electricity charges for
the period ended 30 September 20X7 totalling 245. An invoice for 324 in
respect of gas charges for the three months to 30 November 20X7 arrived
in early December.
Required

Write up the ledger account for premises expenses for the year ended
30 September 20X7 showing the balances c/d and the transfer to the profit
and loss account.

5 Amend Birch's trading and profit and loss account for the year ended
31 December 20X3 and balance sheet at 31 December 20X3 to account for
the following listed accruals and prepayments.
Accruals

Motor expenses
Rent, rates and insurance
Purchases
Heat and light
Telephone and stationery

300
350
665
136

Prepayments

442
1,312
210
95

Chapter 2: Adjusting for Accru a ls and Prepayments

Birch - Trading and Profit and Loss Account

for the year ended 31 December 20X3

Sales

113 750

Cost of sales
Opening stock
Purchases
Less Closing stock

4,025
50,925
54,950
3,765
51,185
62,565

Gross profit
Less Expenses

Wages
Rent, rates and insurance
Heat and light
Motor expenses
Telephone and stationery
Depreciation

23,500
6,125
5,525
3,489
1,672
3,938
44,249
18,316

Net profit

Birch - Balance She et at 3 1 December 20X3

Fixed assets

Motor vehicles: cost

Less Accumulated depreciation

15,750
5,907
9,843

Current assets

Stock
Debtors
Bank

3,765
3,553
195
7,513

Current liabilities

Creditors
Ne t curre nt assets
Ne t assets

3,290
4,223
14,066

Capital account

Balance b/d
Add Net profit
Less Drawings

13,250
18,316
31,566
17,500
14,066