Chapter 5

PREPARATION OF POST
ADJUSTED FINANCIAL
STATEMENTS
(Accruals and Prepayments)

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 Learning Objectives
• To distinguish between the cash basis and accrual
basis of accounting
• To explain why the adjusting entries are needed
• To record adjusting entries for accruals and
prepayments
• To prepare the financial statements after the
adjustments were considered

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 ADJUSTING ENTRIES
• The financial statements that had been dealt
with so far have not taken into account year
end adjustments that must be made by the
business.

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 ADJUSTING ENTRIES
• Those adjustments include:

a) Accruals and Prepayments of expenses and revenues

b) Depreciation of Non-current asset or fixed assets

c) Bad debts, Bad debts recovered, Doubtful debts and

Allowance for doubtful debts.

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 Prepayments and Accruals
• Revenues and expenditures are categorized as
NOMINAL account.

• Nominal accounts are those accounts that are kept

temporarily in a business’s ledgers.

• At the end of the accounting period ALL nominal

accounts (expenditure and revenue accounts) shall
be closed and transferred to the income statement.

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• In preparing the financial statement there
are some generally accepted accounting
concepts that must be applied.

• In the treatment of expenses and revenues,

the concepts of Periodicity, Matching and
Accrual must be understood and applied.

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 Periodicity Concept
• The most important task in accounting is the
provision of information on a firm’s profitability
through the preparation of financial statements.

• In order to do this, the life of the business is divided

into periods of time to ease reporting.

• This period is normally referred to as ‘the

accounting period”.

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 Actg. period Actg. period

1 June 2015 31. May 2016

1. Jan. 2014 31. Dec. 2014

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• Accounting period is normally made up of 12
months.

• The period may start at any day in a calendar year.

• For example: an accounting period that starts on

1st of January 2014 will end on the 31st of
December 2014.

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 Matching Concept
• In an accounting period, the Profit or loss is
determined by comparing or matching total
revenues earned against expenditures
incurred for a particular accounting year.

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 Accrual Concept
Revenues earned
Revenues is said to have been earned when the
business transaction has taken place regardless of
whether cash has been received.

Expenses incurred
Expenses is said to have been incurred when the
business transaction has taken place regardless of
whether cash has been paid.

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• Requirement of the three accounting concepts raises a
number of issues relating to reporting & recording of
revenues and expenses.

• Those issues are:

– Prepaid expenses/Expenses paid in advance
– Prepaid revenues/ Revenues received in advance
– Accrued expenses/Expenses in arrears/Unpaid expense
– Accrued revenues/Revenues in arrears/Revenue not yet
received

➢ These items need to be adjusted before the financial

statements are release to users.
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 ADJUSTING ENTRIES

Prepayments Accruals

Prepaid Prepaid Accrued Accrued

Expenses Revenue Expenses Revenue

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 Prepaid Expenses
• Prepaid expenses are those expenses which belong
to the subsequent accounting period but somehow
is paid in advance in the current period.

• Since it does not belong to the current accounting

period, adjustment needs to be made in the
expense account by eliminating it so that it will
not be taken into account in the current accounting
period as an expense.
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 Current Actg. Subsequent
period Actg. period

1. Jan. 2019 31. Dec. 2019

1. Jan. 2020 31. Dec. 2020

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 Journal entries for prepaid
expenses

DR Prepaid Expense account

CR Expense account

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 Illustration 1
The accounting year end of Megan
Enterprise is on every 31 December. On 1
April 2010, the firm purchased an insurance
policy for a year and the coverage took
effect on the same day. The insurance
premium that Megan Enterprise paid was
RM1,000.

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 Current Actg. Subsequent
period Actg. period

1. Jan. 2010 31. Dec. 2010

1. Jan. 2011 31. Dec. 2011

1. Apr 2010 31 March 2011

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 Current Actg. period

1. Jan. 2010 31. Dec. 2010

1 April 2010 31 March 2011

RM1,000

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 Solution
From accounting point of view, the
Insurance expense that Megan Enterprise
should report for the year ended 31
December 2010 is:

RM1,000 x 9 months = RM750

12 months

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 Insurance Expense

1 April 10 Cash 1,000 31 Dec. 10 Prepaid insurance 250

31 Dec. 10 SOPL 750

===== ====

Prepaid Insurance expense account

31 Dec. 10 Prepaid insurance 250 31 Dec. 10 c/d 250

==== ====

1 Jan 2011 bal b/d 250

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 Prepaid Expenses
• NOTICE that the Insurance Expense account does
not have a balance on 31 December 2010.

• However, the Prepaid Insurance Expense account

has a DEBIT balance and it is treated as the
business asset.

• Prepaid Insurance Expense account is shown in

the Statement of Financial Position of Megan
Enterprise as at 31 December 2010 under
CURRENT ASSET.
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 Prepaid Revenues
• Prepaid revenues are those revenues which belong
to the subsequent accounting period but somehow
it is received in advance in the current period.

• Since it does not belong to the current accounting

period, adjustment needs to be made in the
revenue account by eliminating it so that it will
not be taken into account in the current accounting
period a revenue.
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 Journal entries for prepaid
revenues

DR Revenue account
CR Prepaid Revenue account

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 Illustration 2
The accounting year end of Megan
Enterprise is on every 31 December. On 1
April 2012, the firm rented out part on its
building for RM100 per month. On the
same day the tenant paid a sum of RM1,200
for a one-year rental.

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 Solution
From accounting point of view, the Rent
Revenue that Megan Enterprise should
report for the year ended 31 December 2012
is:

RM100 x 9 months = RM900

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 Rent Revenue

31 Dec. 12 Prepaid Rent 300 1 April 12 Cash 1,200

31 Dec. 12 SOPL 900
===== ====

Prepaid Rent Revenue account

31 Dec. 12 c/d 300 31 Dec. 12 Rent Revenue 300

==== ====
1 Jan 2013 bal b/d 300
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 Prepaid Revenues
• NOTICE that the Rent Revenue account does not have
a balance on 31 December 2012.

• However, the Prepaid Rent Revenue account has a

CREDIT balance and it is treated as the business
liability.

• The Prepaid Rent Revenue account is shown in the

SOFP of Megan Enterprise as at 31 December 2012
under CURRENT LIABILITY.

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 Accrued Expenses
• Accrued expenses are those expenses incurred in
the current accounting period but has not been
paid yet.

• Although it is not yet paid, it must be taken into

account in the current accounting period as
expenses.

• Thus, adjustment needs to be made in the expense

account by adding it to recognize the expense.

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 Journal entries for accrued
expenses

DR Expense account
CR Accrued Expense account

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 Illustration 3
The accounting year end of Megan
Enterprise is on every 31 December. On 1
April 2011, the firm rented a building for
RM200 per month. For the period up to 31
December 2011, Megan Enterprise had only
paid rent for April to November only.

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 Solution
From accounting point of view, the Rent
Expense that Megan Enterprise should
report for the year ended 31 December 2011
is:

RM200 x 9 months = RM1,800

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 Rent Expense

1 April 11 Cash 1,600 31 Dec. 11 Profit and Loss 1,800

31 Dec. 11 Accrued Rent 200

===== ====

Accrued Rent Expense account

31 Dec. 11 c/d 200 31 Dec. 11 Rent Expense 200

==== ====
1 Jan 2012 b/d 200
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 Accrued Expenses
• NOTICE that the Accrued Rent Expense account does
not have a balance on 31 December 2011.

• However, the Accrued Rent Expense account has a

CREDIT balance and it is treated as the business
liability.

• The Accrued Rent Expense account is shown in the

SOFP of Megan Enterprise as at 31 December 2011
under CURRENT LIABILITY.

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 Accrued Revenues
• Accrued revenues are those revenues incurred in the
current accounting period but have not been received
yet.

• Although it is not yet received, it must be taken into

account in the current accounting period as revenues.

• Thus, adjustment needs to be made in the revenues

account by adding it to recognize the revenue.

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 Journal entries for accrued
revenues

DR Accrued Revenue account

CR Revenue account

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 Illustration 4
The accounting year end of Megan
Enterprise is on every 31 December. On 1
April 2011, the firm rented a building for
RM200 per month. For the period up to 31
December 2011, Megan Enterprise had only
received rent for April to November only.

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 Rent Revenue

1 April 11 Cash 1,600

31 Dec. 11 Profit and Loss 1,800 31 Dec. 11 Accrued Rent 200

===== ====

Accrued Rent Revenue account

31 Dec. 11 Rent Expense 200 31 Dec. 11 c/d 200

==== ====

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 Accrued Revenues
• NOTICE that the Accrued Rent Revenue account does
not have a balance on 31 December 2011.

• However, the Accrued Rent Revenue account has a

DEBIT balance and it is treated as the business asset.

• The Accrued Rent Revenue account is shown in the

balance sheet of Megan Enterprise as at 31 December
2011 under CURRENT ASSETS.

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