Bea 10 of Recon car iA (the nae Calwhen a payment i lat, itis said to bei rev accounting year but has pre-paid Prepayments (prepaid expenses) — for exampic rent, because it usually has tobe paid in notyotheen paid 10. Accruals and prepayments (the matching concept) AS Level 1.5, A matter of ing? Some business owners do not have a good Understanding of accounting and believe thet only those bills shat they have actualy paid wll count as expenses in their accounts. They might see their reverve increasing but their expenses increasing at a fa.to-rate. So they might wonder whether delaying she payment of some oftheir bills untl after the | year end will make thei accounts look better. When they present their records to thee accountant fo the yearend accounts to be produced, they could bein fora shock! nis, Discuss ina pair or a group: se Figure 10.1: Some businesses might wonder whether + Will not paying the bills unti next year improve delaying bill payments util after the year end will make their this years profit gure? celaying Pill peymes ‘+ Ifa business owner hes paid for a fll year's EC insurance, three months before the end of the year, would the fact that they have nine months left increase their expenses for the year and reduce their profit? ‘+ Which accounting concept is an accountant likely 1o refer to wien judging whether the business owner’ plan to delay paying some of the bill is actually good oF not? 10.1 What are accruals and prepayments? postpaid Accruals (acerued expenses) ~ for example, an unpai electricity bill is an accrued expense; the electricity has been consumed (the cost has been incurred), but not paid for. Sometimes ‘accrual: an expen: that's due win the advance, Insurance is another example us the insurance premium for the year may have 10 be paid in advance prepayment: a payment made by a business in advance senelis to be derived from @ 10.2 How to treat accrued expenses in an account (end of year) An accrued expense is one where we have had the benefit of that expense but have not yet paid for it. We owe somebody money and, as we are almost certainly going to have them within 12 months, that means we have a eufrent liability Liabilities have year of a business ended on 31 December 2019. During the year, payments fom the bank totaling $960 for heat and ight had been made. At MI December 2019 there was an il for $3 How much expense should be shown in the statement of profit or loss? Step 1 Enter the nk payments into te heating and lighting account Copyright Material - Review Only ~ Not for RedistributionCAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSESOOK Step? Enter the closing bulance bd fi below your sub-total figures — this isa liability so wil bea credit entry ‘Step 3 Enter the closing balance eld figure above your sub-total figures but on the other (debit side. Step ‘Add up the total ofthe entries on each side of the acount and use the larger igure as your sub-total Steps Find the missing figure onthe smaller (credit side — this is your expense figure that will appear in the statement of profit or loss Verious Bank’? 960 | 31 Dec Statement of pcitorloss (6) 1280 31Dec Brlancec/d (8) 320 (4) 1280 () 1280 Jan Balance b/d (2) 320 [Note: even though only $960 has actually been paid, he amount of expense incurred is $1280, ‘Te $320 owing atthe end ofthe period will appear in the urgent liabilities section of the stateiient of financial position, Sa | acme tenieceeeen en — Se 10.3 Opening and closing accrued expenses in an account ‘The situation becomes complicated when there are unpaid bills at both ends of he accounting yeat. Suppose someone receives a bill for an expense covering the period 1 January to 31 December 2018 and pays for it on 15 January 2019. Therefore, there is aliability: When they get the bill for 2019, they will ikely pay for it in Janaary 2020, so there is another tinbilty. This might make it difficult to calculate how much expense has been incurred. Fortunately, the use of ledgers can help us to calculate the correct figure and we will now Took at an adapted version of the previous example to show how. Copyright Material - Review Only ~ Not for Redistribution10. Accruals and prepayments (the matching concept) AS Level 1.5, ‘The accounting year of a business ended on 31 December 2019, At Ifanuary/2019, there had Remember that accrued ppenses are labilties ‘and therefore any bealance b/d figure will bbe on the credit side been am unpaid bit During the year, payments from the bank tot: $960 for heat and light had besn made. At 31 December 2019 there was an unpaid bill fr S320, Te approach is identical to Worked example I, except thatthe qpeping accrual eds to be entered on the credit side (referred to as step 0) Hest and tah agg | $ $ Various Bank) 960/10 Balance bid) 250 31Dec Balance c/d (3) | 31 Dec_ Statement of profit orloss (5) 1030 (4) 3280 (@) 1280 1 Jan Balance b/d (2) 20 Note: even though only $960 hos actually been paid, the amount of expense incu dropped to $1,030 because $250 of that has been used to pay for 2018 expense= ‘The $320 owed at the ead ofthe period will still appear in the current labices section of the statement of finacal position because that i till the amount of money that we owe So Kumarhas a business whose accounting year ended an 31 March 2020, During | ever ayments rom the ak totaling S200 for ren hos Bas ng $1200 frente eet ad ‘At LApil 2019 there was an unpaid bill fr $5430 and at 3T March 2020, there None fe, 4] Pere sity vor an ail of 2168 —_ =o |wlonc c/a 7) Stele & Ising a rent account, show the amount of rent for the year that will appear in the | —| — eee =| of 10.4 How to treat a prepaid expense in an account Th enon ashe as ead in anes ve es may because they fpr Nh example is insurance where 1 year's cover has been paid for and the insurance company ows us a year's protection, As timengases, the amo ill duce as the amount of protection that the busing (is ls The business has an asset that is represented on the expense acount by a debit balance carried down, * [As with the acerued expenses, the amount of expcase incured is calculated using a ledger account, We shall also considera situation where there are closing prepaid expenses and one where ther isa prepayment atthe beginning and end of the accounting year. a, 0 a 113 > Copyright Material - Review Only ~ Not for RedistributionCAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSESOOK Nes euad During 2019, Yutt wade bank payments rating to adertising costs oeting $5200, 8 AC31_December 2019, heeled that he had pad $740 relating to adver ‘wo net appEsr ot 2020, » ination o HET Tentoned in a Yous wats’ ths been prepaid adverng expenses of [6p ck espe: sould beso in te ate oft or lot 9p 1 anvary 2019, there had —— ‘The steps involved are very similar to those for accrued expenses, except that we are dealing with an asset. step 1 Enter the bank payments into the advertising account ‘Step? Enter the closing balance bd figure below your sub-total figures this is an asset so vill be a debit entry ‘Step3 Enter the closing bslance cfd figure above your sub-Cotal figures but on the ovher (cre side, Step 4 ‘Add up the total ofthe entries on each side of the uecount and use the larger figure as your sub-total Step 5 Pind the missing figure onthe smaller (credit side thsi your expense figure that will appear In the statement of profit of loss ses Various Bank (1) 5200|31 Dec Statement of profit orlors 1450 @ 31.Dec. Balance c/d (3) 740 (4) 5200 (@) 5200 Jan Balance b/d (2) 740 Note: even though $5200 has actually been paid, the amount of expense incurred is only ‘$4490 Fecause the $740 paid at the end of the year relates 1o next year's expenses. The $740 owing atthe end ofthe period will appear in the current assets section of the tatement of financial position ‘The approach when faced with an opening prepaid expense i exactly the same a for the ‘acerued expenses except that you fist have 10 put the opening balance on the debit side to rflet the fact that we ae dealing wih a asset a the start of the year. Copyright Material - Review Only ~ Not for Redistribution10. Accruals and prepayments (the matching concept) AS Level 1.5, Remember that prepaic ‘expenses are assets and ee therefore any balance bod figure willbe on the Jan Balance b/d (0) 410|31Dec Statament ofprofitor -4870—‘| debit side. loss) Various Bank (1) 5200|31 Dec. Balance c/d (3) 740 14 5610! (4) 5610 Jan Balance b/d (2) 70 Note: the expense figure has inereaced because the business has also incurred S410 of advertising expenses, which were actually paid for in 2018 The $740 owing atthe end ofthe period wil sill appear in the current assets section of the statement of financial postion 10.5 Mixed balances Sometimes, che business will have an expense where there is a prepayment atthe start of the period and an accrual at the end of the period, It could also be tte other way around. This is nota problem as long as you remember that prepayments are assets and have debit balance bid figures, while accruals are liabilities and have credit balance bid figures. During 2019, Keira made bank payments fer office expenses that totalled $15280, On rauary 2019 there had been an unpaia hil of S895 and at 31 December 2019 2035 had bees paid in advance. What office expenses would appear in the statement of profit or loss? ‘The order in which the entris were made is shown in brackets, Jan Balance bie (0) 895 Various Bank (1) 18280 | 31 Dec Staterveni of profit or loss (5) 12350 31Dec Relance cd (3) 2035 (@) 15280 (ay) 15280 ‘Jan Balance b/d (2) 2035 Note: do not be alarmed that there are thre2 entries on the credit side of the aecount und only ‘one on the debit side. Had there been an opening prepayment and a closing accrual, then there would have been three entries on the debit side and only one on the credit side 115 > Copyright Material - Review Only ~ Not for RedistributionCAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK During 2019, Benji made bank payments for motor expenses that totalled $7605. On 1 January 2019, $1 180 had been paid in advance and at 31 December 2019, there had been an urspaid bill of $755, \What was the motor expenses that would appear in the statement of profit or loss? 10.6 Groupings of expenses It is possible that a business might put several expenses under one category, eg. rent, rates and insurance, which makes it possible that there might be more than two adjustments. AS Tong as you apply the previous concepts, applying your double-entry concepts in a ledger account will enable you to identify the sinount of expense that will appear in the statement of profit or loss Pip isa sole trader who repairs computers. During the year ended 31 December 2049, he made bank payments for ren, rates and insurance of $19620, "The amount of 2:ered and prepaid expenses at 1 January 2019 and 31 December 2019 were: Insurance '$750 prepaid $520 prepaid Rent $1100 accrued $2340 accrued ‘What was the ret, rites and insurance expense that would appear inthe statement of profit o loss? ae eee $ s 1iJan Balance b/d ~insurancs: (9) 780] 1Jan Balance by ~ et (0) 1100 Various Bank (1) 19680 31 Dec Statersen: of profit or loss 20850 31Dec Balance eld rent (3) 2340|31 Dec Balance c/d —insurance (3) _820 (@ 2270 (@ 270 Tan Balance bud ~ insurance 2) 820 1Jan Balance b/d ~ rent (2) 2340 10.7 Calculation of accruals and prepayments So far, the value of the acerued or prepaid expense has been given to you. However itis possible that @ payment may cover a period of time rather than a definite expense and in some eases, that period of time might span parts of two accounting years. Let us consider a variety of situations and use them to establish the steps needed. to identity + whether we need to adjust for an accrual or prepayment and + the size of that adjustment In every case, the business has a year end of 31 December 2019, 18> Copyright Material - Review Only - Not for Redistribution10. Accruals and prepayments (the matching concept) AS Level 1.5 tion Payment of $2760 is made-oa 13 January 2020 covering the three months, October to December 2019. This is straightforward. The payment has been made after the year end, so tis is an accrued expense. All thrse months relate to 2019 so the value of the accrual iste whole $2760, Situation 2: Payment of $1440 is made on 21 November 2019 covering the ‘Manzi 2020. ‘This is straightforward. The payment has been made before the year end, so this isa prepaid expense. All three months relate to 2020 so the value of the prepayment is the whole $1 40, Situation 31] Payment of $1890 is made on 22 February to January 2020, This isnot so straightforward. The payment has been made after the year end, so this i an accrued expense. However, only two out of the three months covered by the payment relate to 2019 (November and December), so we must calculate the acsraal on & proportional basis: three months, January 10 120 covering the three months, November 2019 2x sis =si20 ixs 40] Payment of $3210 is made on 11 December 2019 covering th ‘November 2019 to January 2020. ‘This is not so straightforward. The payment has been made before the year end, so this is a _propatd expense. However, only one out of the three mouths covered by the payment relate {0 2020 January), so we must calculate the prepayment on a proportional basis e months, Lsiai=sion Notes: [1] Situation 3 had the payment been made before 31 December 2019, then one month \would have been paid earlv and this would have been a prepayment of $630. soonths >] Situation 4: had the poyment been made after 31 December 2019, then b ‘would have been paid lave and this would have been an accrual of $2 140. “The adjustment is casried out in exactly the same way as in the ealier examples, Caleulate the value of the accrual or prepayment in the following situations. In every ‘ease, the accounting year ended on 31 December 201°: ‘Situation 1: Payment of $720 is made on 1 Noveminer 2019 covering the three ‘months, December 2019 to February 2020, ‘Situation 2: Payment of $1 140 is made on 3 January 2020 covering the three months, December 2019 to February 2020, Situation 3: Payment of $2730 is made on 27 October 2019 covering the six months, | August 2019 to January 2020. 17> Copyright Material - Review Only ~ Not for RedistributionCAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK 10.8 How to record inventory of consumables on expense accounts Some expense accounts represent inventories of consumables, for example stationery and Fuel for motor veicles, Inventories of consumable stores may be unused atthe year end. According io the matching concept, these inventories should noi be charged against the profit forthe year ~ they are an asset and not an expense a tive year end. Carry them down as.a debit balance on the account. This may result in an eapense account having debit and sit balances atthe year end, Jn the statement of financial position, the inven‘ovies of unused consumable stores will appear under current assets. They should be shov'n under their own headings and not be included with the closing trading inventory tothe statement of profit or los, or inventory sil position, ‘of goods for resale in the statement of fi ler hal pi $1525 for stationery. Inventory of uous year ened 31 Devers 2019, AU31 December 2019, he owed $420 for stalonery and had Stationery, which had cost $280, eee $ s Vatous Bank 1525 |31 Dec Smiementofproftorloss 1665 Bbee Salone td @ 420 |31ex balan fd “280 @ is i985 ‘an ance bid @) “280 | Jar Bane Bid “a0 Note: in the statement of financial positioa et 31 December 2019, the inventory of unused stationery, $280, will be shown under euirent assets as inventory of stationery. The amount ‘owing of $420 will be shown as ‘other payables’ under current liabilities “The closing balances in 2019 will bs the opening balances in 20, 10.9 How to adjust income for accruals and prepayments Some incl ome sch mvs nea xine eran pay noe to bo word forincome received in advance or in areara Tus asa trader might pay for an expense early or lati is posible tht peopl wll pay sin the same Wo The Way fo del with acral an prepayments for diferent sources of come it secogise whether we ae dealing with asset or habits, Prepaid incomes ae labities— because we have be Jet provided. We one somebody that someting “Accrued incomes ae ase = because wea owed money for something we have provided, paid for something that we have not Copyright Material - Review Only ~ Not for Redistribution [eae rental income: the income earned from allowing someone to se your premises. interest earned: the income earned from monies that have been invested or lent.10. Accruals and prepayments (the matching concept) AS Level 1.5 Income ad $720 for Interest ona Toan, ‘The amounts prepaid and acerued at the beginning av ns of the year mere as follows: re oa Rent received $1100 prepaid $570 prepaid Irvcrest on loan $60 accrued $75 accrued 31 Mar_ Statement of profit orloss ©) 7330| 1 Ape Balance b/d) 1100 31 Mar Balance c/d (8) 570|31 Mar Bank 2) 6900 (6) 7900 (6) 7300 Apr Balance b/d (@) 570 1 Apr bance b/d (1) 60 | 31 Mar 720 31 Mar_ Statement of profit orloss (6) 735] 31 Mar Salancee/d (4 7s ©) 735 © 75 | ape Balance bye (2) 75! Note: all of the entries are on the opposite sie to those made for expenses. The double-entry relating to the money coming into the business is Debit. Bank Credit Income aevount (rental income, interest received and so on) (or loss willbe a credit because it isan income that is The entry in the statement of 0 increasing profit 4 aaa Inthe year ended 20 ure 202, Rajesh had received $8260 rental income and commision received $5120 er commission recsves, The amounts prepaid and scones st he beginning form of ncome that is often eamed as a result of seling Tc SR || cc on cha of ‘and end of the year were as follows: Rent received '$840 prepaid $1725 prepaid somebody else. Commission received | $315 accrued $360 accrued Required t Prepare the rent received and con:mission received, showing the amount of each income that wauld appear in the statement of profit or loss a 7 19> Copyright Material - Review Only ~ Not for RedistributionCAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK 10.10 How to ad} and prepayments just a trial balance for accruai You will come across tral balances where you need (0 adjust expens:s and incomes to refleet both wcerals and prepayments. The ways in which the various items shoul be treated are 2s follows: fea = other payables: the ‘Accrued expense | Add to figure shown in the wal Show as other current libily (money (youare paying | Balance ~ this wll ncrease the payables under ‘wed by the business) vemcoec ice [expense to show the total amount of | current labites, arising fom late expense incurred, payment of expenses or Prepaid expense | Deduct from amount in the trial ‘Show as other sary receipt of balance ~ vhs wll duce the receivables uncer (you are paying ‘ Sheard eng) [pense show the total amount of J eurentasets ther recat expense incur current asset (money $ ‘owed to the business) ‘Accrued income | Add to figure shown in the trial Show as other arising from early balance ~ this will increase the income to. | receivables under (someone is payment of expenses ying you Tate) _| show the total amount of income earned, nt assets, Slate receipt of Prepaid income | Deduct from amount in the tral Show as other payables ancoa tl balance = this wll increase the income to | under current labile, show the total amount of income earned. payino you early) “The terms ‘other receivables’ and ‘other payables are used to describe money owed to the ‘business oF money owed by the business that is vot che result of the buying and selling of the main product ~ they relate to day-to-day expenses and other income such as rental income or interest received. All items appearing as other receivable should be combined and presented as one figure tnd the same should be done for the other payables, ‘Money measurement: Why is it important to only include items inthe finencial statements that con (definitely) be expressed in terms of money? 120) Copyright Material - Review Only ~ Not for Redistribution10. Accruals and prepayments (the matching concept) AS Level 1.5 {rial balance from his books after he hed prspared the trading account setiow of his statement of profit or los forthe year ened 31 March 2020: 8 s Bank 6724 Capical at 1 Api! 2019 236698 ‘Conmiission received 1230 Drawings 34560 Gross profit 93777 Insurance 3760 Inventory at 31 Mar 2020, 2a921 Motor expenses 11044 Non-current assets 181600 Office expenses 16277 Rent received 3820 Stationery costs 1329 ‘Trade payables 19762 Trade receivacies 32150 Wages and salaries 42918 355283 355283, ‘ditional information 1 The inventory figure shown is closing inventory 2 The fllowing amounts were owing at 24 March 2020: commission earned S384 and motor expenses $863, 3° The following amounts had be and insurance $12: 4 The inventory of unused stationery on hand at 31 March was valued at its cost of $310, were stil owed $325, pid in advance at 31 March 2020: rental income $550 but suppliers of that sation ent of profit or Toss forthe year ended 31 Marts 2920. b Prepare the statement of financial positon at 31 March 2020, The treatments of the accruals and prepayments is as follows: Z a cee ‘Commission received 1230 +354 1584354 | tesance 3760 =1255 -=2505 1255 Motor expenses 11044 6263 = 11907 863, Rental income 380-550 = 3270 550 Stationery costs 1328 =5104325=1146 510325, 219 17% a, 0 a 121> Copyright Material - Review Only ~ Not for RedistributionCAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSESOOK Gross prof 93777 Commission received 1584 Ron received 3270 98631 Less: Expenses Insurance 2505 Motor expenses 11907 Office expenses 16277 Stationery 1148 Wages and salaries 42918 Total expenses 7475 Profit forthe year 23880 1 postion at 31 $ Non-curent assets 181600 ‘Comat assets inventory 24921 Trade receivables 32150 ther receivables (354 +1255 + 510) ang Bank 6724 65914 Total assets Capital and lilies Capital at 1 April 2019 236698 ‘Add: Profit forthe yesr Less: Drawings 226014 Current Habit ies Trade paysoles 19762 Other payables (863 + 550 + 325) 1738 21500 ‘oa capital and liabilities 247514 Copyright Material - Review Only ~ Not for Redistributionfrees Accruals and prepayments ‘Accountants make adjustments for accruals ‘and prepayments in order to ensure that the statemen: of profit o loss reflects the amount of income earned and expenses incurted. It also ensures that, 2s far as possible, the matching concept is being oEserved. Apart from not following the | matching principle, what problems might arise if a business puts some ofthis years ‘expenses into next years accounts? Figure 10.2: Adjustments for accruals 10. Accruals and prepayments (the matching concept) AS Level 1.5, and prepayments help to make sure the | statement of profit orloss reflects the | income and expenses of a business. Gemecuen o you think that making adjustments for accruals and prepayments makes the financial statements more or less useful? Why/why not? Discuss your views with ‘another lena. EXAM-STYLE QUESTIONS ES 1. A trader prepares her aocounts annv's}y to 31 March 2020, On 13 April 2020 she made a payment of $1500 relating to rent and rates, which covered the three months ending 30 April 2020. ‘Which of the following should bs included in the statement of financial position for the year ended 31 March 2020? A 8 c > $500 acerual in the eu $3500 prepayment liabilities $1000 prepayment 1 2 Atrader con.menced business on 1 June 2019, During the year suded 31 May 2020, he made bank payments of $1510 for cat and light. These payments included one for $470 that covered the three months, April to June 2020. Whicir nount for heat and light should be shown in the statement of profit or loss forthe year ended 31 May 2020? 8 c > 1 123) Copyright Material - Review Only ~ Not for Redistribution