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Chapter 1 Accruals and Prepayments
Notes to teachers
1 Start with Chapter 4 of Frank Wood’s Introduction to Accounting and briefly explain to students how to
record expenses and other revenues in the cash book and post entries to the general ledger.
2 Refer to Chapter 10 of Frank Wood’s Introduction to Accounting and briefly explain to students the
accrual concept.
3 Explain the meaning of accrued expenses, prepaid expenses, accrued revenues and unearned revenues
with the aid of real-life examples, and why they are treated as current assets or current liabilities.
4 Students should know the alternative names of the above items.
5 Most students have difficulty understanding why accrued revenues and unearned revenues are treated as
current assets and current liabilities, respectively. Teachers should clarify the meaning of ‘current assets’
and ‘current liabilities’ by doing Try This Activity A3 and A7 with students.
6 If the entries in the accounts of expenses and other revenues are posted from the cash book, they are said
to be made on a cash basis. Students should know that the accrual concept is one of the fundamental
principles underlying financial reporting. To correspond with the accrual concept, adjustments are
required in the accounts of expenses and other revenues at the end of an accounting period. As a result,
financial statements can then be prepared on an accrual basis.
7 Two methods are used to adjust for accruals and prepayments. Students should master both methods.
8 Timing is very important in deciding whether an item and how much of an item is accrued or prepaid.
Teachers always need to remind students to note the financial year’s closing date.
Q1 According to the accrual concept, a firm should only record revenues generated by goods sold or services
rendered during a period, rather than the amounts actually received during that period. Similarly, a firm
should only record expenses which have been incurred in generating those revenues during the same
period, rather than the amounts actually paid during that period.
Q2 Under cash accounting, revenues are recognised when received and expenses are recognised when paid.
Under accrual accounting, revenues are recognised when earned and expenses are recognised when
incurred.
Q3 Accruals refer to expenses that have been incurred during a period but have not been paid by the end of
that period. Accruals can also refer to revenues that have been earned during a period but have not been
received by the end of that period.
Notes to teachers
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Q4 Prepayments refer to expenses that have been paid during a period but have not been incurred by the
end of that period. Prepayments can also refer to revenues that have been received during a period but
have not been earned by the end of that period.
Q5 Accrued expenses are liabilities of the firm and therefore the accrued expense account should be
classified as a real account.
Q6 Accrued revenues are assets of the firm and therefore the accrued revenue account should be classified as
a real account.
Q7 Accrued Water Charges
2010 $ 2010 $
Jan 1 Water charges 1,240 Jan 1 Balance b/f 1,240
Water Charges
2010 $
Jan 1 Accrued water charges 1,240
Accrued Interest Revenue
2010 $ 2010 $
Jan 1 Balance b/f 1,600 Jan 1 Interest revenue 1,600
Interest Revenue
2010 $
Jan 1 Accrued interest revenue 1,600
A1 This is because accrued expenses are liabilities that are expected to be repaid within one year.
A2 Total expenses for the period will be understated and the net profit for the period will be overstated.
A3 This is because accrued revenues are assets that are expected to be converted into cash within one year.
A4 Total revenues for the period will be understated and the net profit for the period will also be
understated.
A5 This is because prepaid expenses represent goods or services that are expected to be consumed within
one year.
A6 Total expenses for the period will be overstated and the net profit for the period will be understated.
A7 This is because unearned revenues represent goods or services that a business has to provide to its
customers within one year.
A8 Total revenues for the period will be overstated and the net profit for the period will also be overstated.
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A9 K Hui
Income Statement for the year ended 31 March 2010 (extract)
$
Other revenues:
Rent revenue 80,000
Commission revenue 2,680
Expenses:
Rent expense 100,000
Telephone expense 1,140
A10 Insurance
2009 $ 2009 $
Feb 26 Bank 1,800 Dec 31 Profit and loss 3,000
Aug 24 Bank 1,800 " 31 Prepaid insurance 600
3,600 3,600
2010
Jan 1 Prepaid insurance 600
Prepaid Insurance
2009 $ 2009 $
Dec 31 Insurance 600 Dec 31 Balance c/f 600
2010 2010
Jan 1 Balance b/f 600 Jan 1 Insurance 600
Rent Revenue
2009 $ 2009 $
Dec 31 Profit and loss 30,000 Sept 24 Bank 10,000
" 31 Unearned rent revenue 10,000 Oct 25 Bank 10,000
Nov 26 Bank 10,000
Dec 28 Bank 10,000
40,000 40,000
2010
Jan 1 Unearned rent revenue 10,000
Unearned Rent Revenue
2009 $ 2009 $
Dec 31 Balance c/f 10,000 Dec 31 Rent revenue 10,000
2010 2010
Jan 1 Rent revenue 10,000 Jan 1 Balance b/f 10,000
A11 In the income statement:


‘Net profit’ for the year would be total revenues received minus total expenses paid during the year.


‘Sales’ would be the amount actually received from sales during the year. ‘Discounts allowed’ would
not be separately shown.


‘Purchases’ would be the amount actually paid for purchases during the year. ‘Discounts received’
would not be separately shown.


The matching concept (which will be explained in Chapter 17 of Frank Wood’s Financial
Accounting 2) would no longer apply. Therefore, no adjustments for opening/closing inventory
would be required.


‘Rent received in advance’ would be recognised as revenue for the year.


‘Interest revenue’ would not be recognised as revenue for the year because it had not been received
by the year end.


No adjustments for accrued wages and prepaid telephone charges would be required.
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In the balance sheet:


The items ‘inventory’, ‘accounts receivable’, ‘accrued revenues’ and ‘prepaid expenses’ would not
appear in current assets.


The items ‘accounts payable’, ‘accrued expenses’ and ‘unearned revenues’ would not appear in
current liabilities.
A13 Accrual accounting can more accurately measure the financial performance (i.e., profitability and
liquidity) of an entity.
Under cash accounting, revenues represent the amounts received during an accounting period, whether
they have been earned or not. The amounts earned but not yet received would not be recorded as
revenues while the amounts received but not yet earned would not be excluded and not treated as
revenues.
Under accrual accounting, revenues represent the amounts earned during an accounting period, whether
they have been received or not. The amounts earned but not yet received or received but not yet earned
would be shown as current assets and liabilities, respectively, in the balance sheet.
Likewise, under cash accounting, expenses represent the amounts paid during an accounting period,
whether they have been incurred or not. The amounts incurred but not yet paid would not be recorded
as expenses while the amounts paid but not yet incurred would not be excluded and not treated as
expenses for the period.
Under accrual accounting, expenses represent the amounts incurred during an accounting period,
whether they have been paid or not. The amounts paid but not yet incurred or incurred but not yet paid
would be shown as current assets and liabilities, respectively, in the balance sheet.
ASSESSMENT
Short Questions Short Questions
1 (i) Rent
2008 $ 2008 $
Dec 31 Bank 16,000 Dec 31 Profit and loss 20,000
" 31 Accrued c/f 4,000
20,000 20,000
(ii) Insurance
2008 $ 2008 $
Dec 31 Bank 900 Dec 31 Profit and loss 635
" 31 Prepaid c/f 265
900 900
(iii) Rates
2008 $ 2008 $
Jan 1 Bank 750 Dec 31 Profit and loss 1,500
Jul 1 Bank 1,125 " 31 Prepaid c/f ($1,125 × ) 375
1,875 1,875
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(iv) Rent Revenue
2008 $ 2008 $
Dec 31 Profit and loss ($4,000 × 12) 48,000 Apr 15 Bank 20,000
" 31 In advance c/f 16,000 Dec 15 Bank 44,000
64,000 64,000
2X (i) General Expenses
2009 $ 2009 $
Mar 31 Bank 6,150 Mar 31 Profit and loss 5,590
" 31 Prepaid c/f 560
6,150 6,150
(ii) Commission Revenue
2009 $ 2009 $
Mar 31 Profit and loss 3,231 Mar 31 Bank 3,056
" 31 Accrued c/f 175
3,231 3,231
(iii) Carriage Outwards
2009 $ 2009 $
Mar 31 Bank 666 Mar 31 Profit and loss 788
" 31 Accrued c/f 122
788 788
(iv) Insurance
2008 $ 2009 $
Apr 1 Bank 1,080 Mar 31 Profit and loss 1,440
2009 " 31 Prepaid c/f ($1,080 ×
6
9
) 720
Jan 1 Bank 1,080
2,160 2,160
3 (i) Rent Accrued Rent
2008 $ 2008 $ 2008 $ 2008 $
Dec 31 Bank 16,000 Dec 31 Profit and Dec 31 Balance c/f 4,000 Dec 31 Rent 4,000
" 31 Accrued loss 20,000
rent 4,000
20,000 20,000
The Journal
Date Details Dr Cr
2008
Dec 31 Rent
Accrued rent
$
4,000
$
4,000
(ii) Insurance Prepaid Insurance
2008 $ 2008 $ 2008 $ 2008 $
Dec 31 Bank 900 Dec 31 Profit and Dec 31 Insurance 265 Dec 31 Balance c/f 265
loss 635
" 31 Prepaid
insurance 265
900 900
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The Journal
Date Details Dr Cr
2008
Dec 31 Prepaid insurance
Insurance
$
265
$
265
(iii) Rates Prepaid Rates
2008 $ 2008 $ 2008 $ 2008 $
Jan 1 Bank 750 Dec 31 Profit and Dec 31 Rates 375 Dec 31 Balance c/f 375
Jul 1 Bank 1,125 loss 1,500
" 31 Prepaid
rates 375
1,875 1,875
The Journal
Date Details Dr Cr
2008
Dec 31 Prepaid rates
Rates
$
375
$
375
(iv) Rent Revenue Unearned Rent Revenue
2008 $ 2008 $ 2008 $ 2008 $
Dec 31 Profit and Apr 15 Bank 20,000 Dec 31 Balance c/f Dec 31 Rent revenue
loss 48,000 Dec 15 Bank 44,000 16,000 16,000
" 31 Unearned rent
revenue 16,000
64,000 64,000
The Journal
Date Details Dr Cr
2008
Dec 31 Rent revenue
Unearned rent revenue
$
16,000
$
16,000
4X (i) General Expenses Prepaid General Expenses
2009 $ 2009 $ 2009 $ 2009 $
Mar 31 Bank 6,150 Mar 31 Profit and Mar 31 General Mar 31 Balance c/f
loss 5,590 expenses 560 560
" 31 Prepaid general
expenses 560
6,150 6,150

The Journal
Date Details Dr Cr
2009
Mar 31 Prepaid general expenses
General expenses
$
560
$
560
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(ii) Commission Revenue Accrued Commission Revenue
2009 $ 2009 $ 2009 $ 2009 $
Mar 31 Profit and Mar 31 Bank 3,056 Mar 31 Commission Mar 31 Balance c/f
loss 3,231 " 31 Accrued revenue 175 175
commission
revenue 175
3,231 3,231
The Journal
Date Details Dr Cr
2009
Mar 31 Accrued commission revenue
Commission revenue
$
175
$
175
(iii) Carriage Outwards Accrued Carriage Outwards
2009 $ 2009 $ 2009 $ 2009 $
Mar 31 Bank 666 Mar 31 Profit and Mar 31 Balance c/f Mar 31 Carriage
" 31 Accrued carriage loss 788 122 outwards 122
outwards 122
788 788
The Journal
Date Details Dr Cr
2009
Mar 31 Carriage outwards
Accrued carriage outwards
$
122
$
122
(iv) Insurance Prepaid Insurance
2008 $ 2009 $ 2009 $ 2009 $
Apr 1 Bank 1,080 Mar 31 Profit and Mar 31 Insurance 720 Mar 31 Balance c/f 720
2009 loss 1,440
Jan 1 Bank 1,080 " 31 Prepaid
insurance 720
2,160 2,160
The Journal
Date Details Dr Cr
2009
Mar 31 Prepaid insurance
Insurance
$
720
$
720
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5 C Chan
Income Statement for the year ended 31 December 2008
$ $
Sales 92,950
Less Cost of goods sold:
Opening inventory 10,250
Add Purchases 55,850
66,100
Less Closing inventory (19,550) (46,550)
Gross profit 46,400
Less Expenses:
Rent ($6,400 – $1,600) 4,800
Wages and salaries ($21,400 + $2,900) 24,300
Insurance ($590 – $190) 400
Telephone ($300 + $110) 410
General expenses 1,800 (31,710)
Net profit 14,690
6X K Chu
Income Statement for the year ended 31 March 2009
$ $
Sales 108,380
Less Returns inwards (2,000) 106,380
Less Cost of goods sold:
Opening inventory 8,620
Add Purchases 61,120
69,740
Less Closing inventory (12,120) (57,620)
Gross profit 48,760
Less Expenses:
Wages and salaries ($24,800 + $1,020) 25,820
Motor expenses 2,120
Rent and rates ($12,000 – $800) 11,200
Discounts allowed 290
Lighting expenses ($580 + $170) 750
Computer operating expenses ($1,210 – $280) 930
General expenses 3,600 (44,710)
Net profit 4,050
7 Happy Wong
Income Statement for the year ended 31 December 2008
$ $
Hairdressing revenue 100,400
Less Expenses:
Advertising 2,300
Car expenses ($4,800 × ) 3,200
Rates ($1,400 – $300) 1,100
Telephone 1,100
Sundry expenses 1,200
Cleaning 150 (9,050)
Net profit 91,350
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Happy Wong
Balance Sheet as at 31 December 2008
$ $
Non-current assets
Shop premises 60,000
Equipment 7,200
Car 26,400
93,600
Current assets
Prepaid expenses 300
Bank 5,400
Cash 400
6,100
Less Current liabilities
Accrued expenses (150)
Net current assets 5,950
99,550
Financed by:
Capital as at 1 January 2008 14,300
Add Net profit for the year 91,350
105,650
Less Drawings [$4,500 + ($4,800 × )] (6,100)
99,550
8X L Tang
Income Statement for the year ended 31 December 2009
$ $ $
Sales 120,320
Less Returns inwards (1,384) 118,936
Less Cost of goods sold:
Opening inventory 30,816
Add Purchases 84,290
Less Returns outwards (810) 83,480
Add Carriage inwards 309
114,605
Less Closing inventory (36,420) (78,185)
Gross profit 40,751
Add Other revenues:
Discounts received 506
Rent revenue 2,500 3,006
43,757
Less Expenses:
Discounts allowed 410
Carriage outwards 218
Motor expenses ($4,917 + $330) 5,247
Repairs to premises 1,383
Salaries and wages 16,184
Sundry expenses ($807 + $162) 969
Rates and insurance ($2,896 – $332) 2,564
Loan interest 4,000 (30,975)
Net profit 12,782
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9 (a) T Lee
Income Statement for the year ended 30 June 2009
$ $
Fees charged 108,600
Less Expenses:
Wages and salaries ($31,960 + $2,320) 34,280
Postage and stationery ($2,140 + $220) 2,360
Telephone 1,250
Computer operating expenses 2,190
Travel expenses ($1,620 × 90%) 1,458
Insurance ($890 – $170) 720
Rent ($23,000 – $600) 22,400
Sundry expenses 520 (65,178)
Net profit 43,422
T Lee
Balance Sheet as at 30 June 2009
$ $
Non-current assets
Office furniture 10,800
Equipment 25,400
36,200
Current assets
Accounts receivable 11,100
Prepaid expenses ($600 + $170) 770
Bank 8,090
Cash 120
20,080
Less Current liabilities
Accrued expenses ($220 + $2,320) (2,540)
Net current assets 17,540
53,740
Financed by:
Capital as at 1 July 2008 19,680
Add Net profit for the year 43,422
63,102
Less Drawings [$9,200 + ($1,620 × 10%)] (9,362)
53,740
(b) No, both types of firms treat revenues and expenses in the same manner if they adopt accrual-basis
accounting. For trading firms, revenues are recognised when goods are sold. For service firms,
revenues are recognised when services are provided. As for expenses, they are recognised by both
types of firms when they are incurred.
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Application Problems
10X
The Journal
Date Details Dr Cr
2009 $ $
Mar 31

" 31

" 31

" 31
Bank
Rent revenue
Rent revenue
Profit and loss ($340,000 + $24,000 – $65,000 – $38,000 + $42,000)
Insurance
Bank
Profit and loss
Insurance [$18,000 + ($12,000 × ) – ($18,000 × )]
340,000
303,000

18,000
16,500
340,000
303,000
18,000
16,500
11X Salaries
2007 $ 2007 $
Mar 31 Balance b/f 9,880 Mar 31 Profit and loss 12,180
" 31 Accrued c/f 2,300
12,180 12,180
Electricity
2007 $ 2007 $
Mar 31 Balance b/f 5,875 Mar 31 Profit and loss 6,500
" 31 Accrued c/f 625
6,500 6,500
Rental Income
2007 $ 2007 $
Mar 31 Profit and loss 150,000 Mar 31 Balance b/f 162,500
" 31 Prepaid c/f 12,500
162,500 162,500
12 (a) One of the main differences between cash accounting and accrual accounting lies in the treatment of
accruals and prepayments of revenues and expenses.
Under cash accounting, revenues are recorded when cash is received and expenses are recorded
when cash is paid. This means that revenues are recognised when received and expenses are
recognised when paid.
Under accrual accounting, a firm should only record revenues generated by goods sold or services
rendered during a period and the expenses which have been incurred in generating those revenues
during the same period, rather than the amounts actually received or paid during that period. This
means that revenues are recognised when earned and expenses are recognised when incurred.
(b) Cash accounting often leads to misleading results as a firm may have earned certain revenues during
a period but those revenues have not been recognised because they have not been received by the
end of that period. Likewise, it may have incurred certain expenses during a period but those
expenses have not been recognised as they have not been paid by the end of that period. Owing to
its inadequacy, cash accounting is not commonly used by businesses.
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13 (a) Jimmy Chan
Income Statement for the year ended 31 March 2010
$ $
Sales 182,480
Less Purchases (97,200)
Gross profit 85,280
Less Expenses:
Administrative expenses 42,570
Selling and distribution expenses 21,230 (63,800)
Net profit 21,480
(b) Jimmy Chan
Income Statement for the year ended 31 March 2010
$ $
Sales ($182,480 + $12,130) 194,610
Less Cost of goods sold:
Purchases ($97,200 + $7,790) 104,990
Less Closing inventory (14,700) (90,290)
Gross profit 104,320
Add Interest revenue ($50,000 × 6% × ) 1,000
105,320
Less Expenses:
Administrative expenses ($42,570 + $6,000) 48,570
Selling and distribution expenses [$21,230 – ($2,400 × )] 19,430 (68,000)
Net profit 37,320
(c)

In (a), sales were recognised when cash was received. In (b), sales were recognised when sales
were made, thus including trade receivables which arose during the year.


In (a), purchases were recognised when cash was paid. In (b), purchases were recognised when
goods were obtained, thus including trade payables which arose during the year.


In (a), the gross profit was calculated by deducting purchases paid during the year from sales
receipts for the year. In (b), the gross profit was calculated by deducting the cost of goods sold
for the year from sales for the year. The cost of goods sold equalled the purchases made during
the year less the value of unsold goods at the year end.


In (a), interest revenue was not recognised because it had not been received by the year end. In (b),
interest revenue was recognised because it had been earned during the year.


In (a), expenses were recognised when paid. In (b), expenses were recognised when incurred,
thus including the amounts accrued and deducting the amounts prepaid.


As a result, the net profits calculated in (a) and (b) were different.
14X (a) (i) Advertising and Promotions
2008 $ 2008 $
Jul 28 Bank 7,500 Apr 1 Accrued b/f 2,220
Oct 15 Bank 12,600 2009
Mar 31 Profit and loss 14,400
" 31 Prepaid c/f 3,480
20,100 20,100
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(ii) Printing and Stationery
2008 $ 2009 $
Apr 1 Stationery b/f 20,400 Mar 31 Profit and loss 13,110
Sept 14 Bank — Stationery 5,100 " 31 Stationery c/f 18,600
2009
Feb 12 Bank — Printing 2,520
Mar 31 Accrued printing c/f 3,690
31,710 31,710
(iii) Rental Income
2009 $ 2008 $
Mar 31 Profit and loss (12 months) 15,780 Apr 1 In advance b/f (3 months) 3,780
" 31 In advance c/f (3 months: $8,880 ×
1
2
) 4,440 Jul 1 Bank (6 months) 7,560
Oct 1 Bank (6 months) 8,880
20,220 20,220
(iv) Rates
2008 $ 2009 $
Apr 1 Prepaid b/f (3 months) 4,680 Mar 31 Profit and loss (12 months) 19,800
Jul 1 Bank (6 months) 10,080 " 31 Prepaid c/f (3 months: $10,080 ×
1
2
) 5,040
Oct 1 Bank (6 months) 10,080
24,840 24,840
(b) Financial Services
Balance Sheet as at 31 March 2009 (extract)
Current assets $ Current liabilities $
Stationery inventory 18,600 Accrued expenses 3,690
Prepayments ($3,480 + $5,040) 8,520 Unearned revenues 4,440
Past Exam Questions Past Exam Questions
15 Insurance Account
2006 $ 2006 $
Mar 31 Balance b/f 8,100 Mar 31 Profit and loss 7,405
" 31 Prepayment c/f ($2,780 × ) 695
8,100 8,100
Electricity Account
2006 $ 2006 $
Mar 31 Balance b/f 6,480 Mar 31 Profit and loss 8,040
" 31 Accrual c/f 1,560
8,040 8,040
Commission Income Account
2006 $ 2006 $
Mar 31 Profit and loss 188,000 Mar 31 Balance b/f 200,000
" 31 Prepaid income c/f 12,000
200,000 200,000
Rental Income Account
2006 $ 2006 $
Mar 31 Profit and loss 140,000 Mar 31 Balance b/f 120,000
" 31 Accrued income c/f 20,000
140,000 140,000
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Accrued Water Charges 2010 Jan 1 Water charges $ 2010 1. Total expenses for the period will be overstated and the net profit for the period will be understated. Total revenues for the period will be overstated and the net profit for the period will also be overstated.240 Q5 Q6 Q7 Water Charges 2010 Jan 1 Accrued water charges $ 1.240 Accrued Interest Revenue 2010 Jan 1 Balance b/f $ 2010 1. Total revenues for the period will be understated and the net profit for the period will also be understated.600 Interest Revenue 2010 Jan 1 Accrued interest revenue $ 1. Accrued revenues are assets of the firm and therefore the accrued revenue account should be classified as a real account.600 Jan 1 Interest revenue $ 1. This is because unearned revenues represent goods or services that a business has to provide to its customers within one year. This is because accrued revenues are assets that are expected to be converted into cash within one year.240 Jan 1 Balance b/f $ 1. Accrued expenses are liabilities of the firm and therefore the accrued expense account should be classified as a real account. This is because prepaid expenses represent goods or services that are expected to be consumed within one year. Prepayments can also refer to revenues that have been received during a period but have not been earned by the end of that period.Q4 Prepayments refer to expenses that have been paid during a period but have not been incurred by the end of that period. Total expenses for the period will be understated and the net profit for the period will be overstated.600 A1 A2 A3 A4 A5 A6 A7 A8 This is because accrued expenses are liabilities that are expected to be repaid within one year. 2 .

• ‘Interest revenue’ would not be recognised as revenue for the year because it had not been received by the year end. Therefore.800 " 31 3.000 2. • ‘Purchases’ would be the amount actually paid for purchases during the year. The matching concept (which will be explained in Chapter 17 of Frank Wood’s Financial • Accounting 2) would no longer apply.000 10. no adjustments for opening/closing inventory would be required.000 2010 Jan 1 Unearned Rent Revenue 2009 Dec 31 2010 Jan 1 Balance c/f Rent revenue $ 2009 10.000 Oct 25 Nov 26 Dec 28 40. ‘Discounts received’ would not be separately shown.000 10.000 10.000 Bank Bank Bank Bank $ 10. • ‘Sales’ would be the amount actually received from sales during the year.600 600 Prepaid Insurance 2009 Dec 31 2010 Jan 1 Insurance Balance b/f $ 2009 600 Dec 31 2010 600 Jan 1 Rent Revenue 2009 Dec 31 " 31 Profit and loss Unearned rent revenue $ 2009 30.000 600 3.000 10.000 Sept 24 10.000 Jan 1 Rent revenue Balance b/f $ 10.800 Dec 31 1.000 1.000 Dec 31 2010 10.140 Insurance 2009 Feb 26 Aug 24 2010 Jan 1 Bank Bank $ 2009 1.000 Balance c/f Insurance $ 600 600 Profit and loss Prepaid insurance $ 3. 3 .000 40.A9 K Hui Income Statement for the year ended 31 March 2010 (extract) $ Other revenues: Rent revenue Commission revenue Expenses: Rent expense Telephone expense 80.000 10. • No adjustments for accrued wages and prepaid telephone charges would be required. • ‘Rent received in advance’ would be recognised as revenue for the year.600 A10 Prepaid insurance Unearned rent revenue A11 In the income statement: • ‘Net profit’ for the year would be total revenues received minus total expenses paid during the year.680 100. ‘Discounts allowed’ would not be separately shown.

whether they have been paid or not.500 375 1.875 Profit and loss Prepaid c/f ($1. under cash accounting. profitability and liquidity) of an entity. ‘accounts receivable’. Under accrual accounting. The amounts paid but not yet incurred or incurred but not yet paid would be shown as current assets and liabilities. respectively.000 20. in the balance sheet.000 Dec 31 4. ‘accrued expenses’ and ‘unearned revenues’ would not appear in • current liabilities.125 × 3 ) 9 $ 1.125 " 31 1. ‘accrued revenues’ and ‘prepaid expenses’ would not appear in current assets. A13 Accrual accounting can more accurately measure the financial performance (i. respectively.000 Profit and loss $ 20. expenses represent the amounts paid during an accounting period. The amounts earned but not yet received or received but not yet earned would be shown as current assets and liabilities. Under cash accounting. Likewise. The amounts incurred but not yet paid would not be recorded as expenses while the amounts paid but not yet incurred would not be excluded and not treated as expenses for the period. ASSESSMENT Short Questions 1 (i) 2008 Dec 31 " 31 Bank Accrued c/f Rent $ 2008 16. in the balance sheet. The items ‘accounts payable’. expenses represent the amounts incurred during an accounting period. revenues represent the amounts received during an accounting period. whether they have been received or not.000 20.In the balance sheet: • The items ‘inventory’.e.. The amounts earned but not yet received would not be recorded as revenues while the amounts received but not yet earned would not be excluded and not treated as revenues. whether they have been incurred or not.875 4 . Under accrual accounting. revenues represent the amounts earned during an accounting period.000 (ii) 2008 Dec 31 Bank Insurance $ 2008 900 Dec 31 " 31 900 Profit and loss Prepaid c/f $ 635 265 900 (iii) 2008 Jan 1 Jul 1 Bank Bank Rates $ 2008 750 Dec 31 1. whether they have been earned or not.

160 Profit and loss Prepaid c/f ($1.160 3 (i) 2008 Dec 31 Bank " 31 Accrued rent Rent $ 16.000 × 12) In advance c/f Rent Revenue $ 2008 48.000 Accrued Rent 2008 $ Dec 31 Balance c/f 4.150 Profit and loss Prepaid c/f $ 5.080 × 6 ) 9 $ 1.000 Dec 15 64.080 Mar 31 " 31 1.150 (ii) 2009 Mar 31 Profit and loss Commission Revenue $ 2009 3.000 2X (i) 2009 Mar 31 Bank General Expenses $ 2009 6.(iv) 2008 Dec 31 " 31 Profit and loss ($4.000 2008 $ Dec 31 Profit and loss 20.231 Mar 31 " 31 3.150 Mar 31 " 31 6.000 20.000 Bank Bank $ 20.000 (ii) 2008 Dec 31 Bank Insurance $ 900 2008 Dec 31 Profit and loss " 31 Prepaid insurance $ 635 265 900 2008 Dec 31 Insurance Prepaid Insurance $ 265 2008 Dec 31 Balance c/f $ 265 900 5 .000 20.000 44.056 175 3.440 720 2.590 560 6.080 2.000 The Journal Date 2008 Dec Details 31 Rent Accrued rent Dr $ 4.000 Cr $ 4.231 (iii) 2009 Mar 31 " 31 Bank Accrued c/f Carriage Outwards $ 2009 666 Mar 31 122 788 Profit and loss $ 788 788 (iv) 2008 Apr 1 2009 Jan 1 Bank Bank Insurance $ 2009 1.000 4.000 Apr 15 16.231 Bank Accrued c/f $ 3.000 64.000 2008 Dec 31 Rent $ 4.

The Journal Date 2008 Dec Details 31 Prepaid insurance Insurance Dr $ 265 Cr $ 265 (iii) 2008 Jan 1 Bank Jul 1 Bank Rates $ 750 1.125 2008 $ Dec 31 Profit and loss 1.000 4X (i) 2009 Mar 31 Bank General Expenses $ 6.150 The Journal Date 2009 Mar Details 31 Prepaid general expenses General expenses Dr $ 560 Cr $ 560 6 .500 " 31 Prepaid rates 375 1.590 " 31 Prepaid general expenses 560 6.875 The Journal Date 2008 Dec Details 31 Prepaid rates Rates Dr $ 375 Cr $ 375 (iv) Rent Revenue 2008 Apr 15 Bank Dec 15 Bank $ 20.000 Cr $ 16.000 44.875 2008 Dec 31 Rates Prepaid Rates $ 375 2008 Dec 31 Balance c/f $ 375 1.150 2009 $ Mar 31 Profit and loss 5.000 64.000 Unearned Rent Revenue 2008 Dec 31 Balance c/f $ 16.000 64.000 2008 $ Dec 31 Profit and loss 48.000 The Journal Date 2008 Dec Details 31 Rent revenue Unearned rent revenue Dr $ 16.000 " 31 Unearned rent revenue 16.150 Prepaid General Expenses 2009 Mar 31 General expenses $ 560 2009 Mar 31 Balance c/f $ 560 6.000 2008 $ Dec 31 Rent revenue 16.

080 1.160 2009 $ Mar 31 Profit and loss 1.440 " 31 Prepaid insurance 720 2.160 2009 Mar 31 Insurance Prepaid Insurance $ 720 2009 Mar 31 Balance c/f $ 720 The Journal Date 2009 Mar Details 31 Prepaid insurance Insurance Dr $ 720 Cr $ 720 7 .056 " 31 Accrued commission revenue 175 3.(ii) Commission Revenue $ 3.231 2009 $ Mar 31 Bank 3.231 The Journal Date 2009 Mar Details 31 Accrued commission revenue Commission revenue Dr $ 175 Cr $ 175 (iii) Carriage Outwards 2009 Mar 31 Profit and loss $ 788 788 Accrued Carriage Outwards 2009 Mar 31 Balance c/f $ 122 2009 Mar 31 Carriage outwards $ 122 2009 $ Mar 31 Bank 666 " 31 Accrued carriage outwards 122 788 The Journal Date 2009 Mar Details 31 Carriage outwards Accrued carriage outwards Dr $ 122 Cr $ 122 (iv) 2008 Apr 1 Bank 2009 Jan 1 Bank Insurance $ 1.231 Accrued Commission Revenue 2009 $ Mar 31 Commission revenue 175 2009 Mar 31 Balance c/f $ 175 2009 Mar 31 Profit and loss 3.080 2.

950 Less Closing inventory Gross profit Less Expenses: Rent ($6.210 – $280) General expenses Net profit (57.550) (46.120) $ 106.820 2.800 + $1.850 66.690 6X Sales Less Returns inwards Less Cost of goods sold: Opening inventory Add Purchases K Chu Income Statement for the year ended 31 March 2009 $ 108.800 24.400 – $1.100 (19.200 150 (9.050) 91.400 + $2.100 1.250 55.000 – $800) Discounts allowed Lighting expenses ($580 + $170) Computer operating expenses ($1.600) Wages and salaries ($21.600 (44.800 (31.400 2.050 7 Happy Wong Income Statement for the year ended 31 December 2008 $ Hairdressing revenue Less Expenses: Advertising Car expenses ($4.020) Motor expenses Rent and rates ($12.400 – $300) Telephone Sundry expenses Cleaning Net profit $ 100.5 Sales Less Cost of goods sold: Opening inventory Add Purchases C Chan Income Statement for the year ended 31 December 2008 $ $ 92.800 × 2 ) 3 Rates ($1.350 8 .200 290 750 930 3.710) 14.620 61.550) 46.760 25.300 3.300 400 410 1.620) 48.710) 4.380 (2.120 11.000) 8.200 1.400 4.900) Insurance ($590 – $190) Telephone ($300 + $110) General expenses Net profit 10.100 1.120 69.740 (12.380 Less Closing inventory Gross profit Less Expenses: Wages and salaries ($24.

320 (1.605 (36.950 99.917 + $330) Repairs to premises Salaries and wages Sundry expenses ($807 + $162) Rates and insurance ($2.100) 99.500 3.290 (810) 83.500 + ($4.896 – $332) Loan interest Net profit $ 120.600 300 5.000 7.000 (30.550 14.757 410 218 5.420) $ 118.384) 30.480 309 114.006 43.383 16.400 400 6.816 84.650 (6.200 26.Happy Wong Balance Sheet as at 31 December 2008 $ Non-current assets Shop premises Equipment Car Current assets Prepaid expenses Bank Cash Less Current liabilities Accrued expenses Net current assets Financed by: Capital as at 1 January 2008 Add Net profit for the year Less Drawings [$4.975) 12.550 8X L Tang Income Statement for the year ended 31 December 2009 $ Sales Less Returns inwards Less Cost of goods sold: Opening inventory Add Purchases Less Returns outwards Add Carriage inwards Less Closing inventory Gross profit Add Other revenues: Discounts received Rent revenue Less Expenses: Discounts allowed Carriage outwards Motor expenses ($4.184 969 2.300 91.564 4.100 (150) 5.800 × 1 )] 3 $ 60.782 9 .247 1.350 105.185) 40.751 506 2.936 (78.400 93.

both types of firms treat revenues and expenses in the same manner if they adopt accrual-basis accounting.422 63. As for expenses.250 2.320) Net current assets $ 10.080 (2.960 + $2.9 (a) T Lee Income Statement for the year ended 30 June 2009 $ $ 108.458 720 22.540) 17.362) 53.422 T Lee Balance Sheet as at 30 June 2009 $ Non-current assets Office furniture Equipment Current assets Accounts receivable Prepaid expenses ($600 + $170) Bank Cash Less Current liabilities Accrued expenses ($220 + $2.740 19.620 × 90%) Insurance ($890 – $170) Rent ($23.740 Financed by: Capital as at 1 July 2008 Add Net profit for the year Less Drawings [$9. revenues are recognised when services are provided.000 – $600) Sundry expenses Net profit 34.140 + $220) Telephone Computer operating expenses Travel expenses ($1.090 120 20.800 25.102 (9.320) Postage and stationery ($2. revenues are recognised when goods are sold.400 36.540 53. 10 .280 2.680 43.600 Fees charged Less Expenses: Wages and salaries ($31.360 1.620 × 10%)] (b) No.100 770 8.200 11.200 + ($1.190 1. For trading firms.178) 43. For service firms.400 520 (65. they are recognised by both types of firms when they are incurred.

500 Cr $ 340.000 303. 11 .180 Electricity 2007 Mar 31 " 31 Balance b/f Accrued c/f $ 2007 5.500 Balance b/f $ 162.000 × 12) – ($18.000 303. This means that revenues are recognised when earned and expenses are recognised when incurred. This means that revenues are recognised when received and expenses are recognised when paid. cash accounting is not commonly used by businesses. Likewise.000 Mar 31 12.875 Mar 31 625 6.180 Profit and loss $ 12. revenues are recorded when cash is received and expenses are recorded when cash is paid. Under accrual accounting. Owing to its inadequacy.500 6.000 + $42.000 + ($12.500 16. (b) Cash accounting often leads to misleading results as a firm may have earned certain revenues during a period but those revenues have not been recognised because they have not been received by the end of that period. rather than the amounts actually received or paid during that period.000 – $38.500 162. it may have incurred certain expenses during a period but those expenses have not been recognised as they have not been paid by the end of that period.000 + $24. Under cash accounting.500 162.000 18.880 Mar 31 2. a firm should only record revenues generated by goods sold or services rendered during a period and the expenses which have been incurred in generating those revenues during the same period.180 12.500 Profit and loss $ 6.000 11X 2007 Mar 31 " 31 Balance b/f Accrued c/f Salaries $ 2007 9.500 12 (a) One of the main differences between cash accounting and accrual accounting lies in the treatment of accruals and prepayments of revenues and expenses.000 16.000 18.000 – $65.500 Rental Income 2007 Mar 31 " 31 Profit and loss Prepaid c/f $ 2007 150.300 12.000) Insurance Bank Profit and loss 3 3 Insurance [$18.000 × 12)] The Journal Dr $ 340.Application Problems 10X Date 2009 Mar " " " 31 31 31 31 Details Bank Rent revenue Rent revenue Profit and loss ($340.

In (a).570 21.570 19. In (a).480 20. In (b).610 Sales ($182. thus including the amounts accrued and deducting the amounts prepaid.000) 37. Advertising and Promotions Bank Bank $ 2008 7. In (b).200 + $7.600 2009 Mar 31 " 31 20.200) 85.700) (90. the gross profit was calculated by deducting purchases paid during the year from sales receipts for the year. In (a). In (b).230 (63.790) Less Closing inventory Gross profit 4 Add Interest revenue ($50.320 48. purchases were recognised when goods were obtained.290) 104. expenses were recognised when paid. the gross profit was calculated by deducting the cost of goods sold for the year from sales for the year.130) Less Cost of goods sold: Purchases ($97.13 (a) Jimmy Chan Income Statement for the year ended 31 March 2010 $ $ 182.320 (c) • • • • • • 14X (a) (i) 2008 Jul 28 Oct 15 In (a). In (b). In (a).480 (97. sales were recognised when cash was received.800) 21. thus including trade receivables which arose during the year.000 × 6% × 12 ) Less Expenses: Administrative expenses ($42.000) 9 Selling and distribution expenses [$21.500 Apr 1 12.990 (14. interest revenue was recognised because it had been earned during the year. The cost of goods sold equalled the purchases made during the year less the value of unsold goods at the year end.480 + $12. expenses were recognised when incurred.230 – ($2. In (b).320 1.000 105. purchases were recognised when cash was paid. sales were recognised when sales were made.220 14. the net profits calculated in (a) and (b) were different.480 (b) Jimmy Chan Income Statement for the year ended 31 March 2010 $ $ 194.100 Accrued b/f Profit and loss Prepaid c/f $ 2.100 12 .400 × 12 )] Net profit 104.570 + $6.430 (68.400 3. As a result. interest revenue was not recognised because it had not been received by the year end.280 Sales Less Purchases Gross profit Less Expenses: Administrative expenses Selling and distribution expenses Net profit 42. thus including trade payables which arose during the year.

600 Accrued expenses 8.880 × 1 ) 2 Rental Income $ 2008 15.000 200.440 Past Exam Questions 15 2006 Mar 31 Balance b/f Insurance Account $ 2006 8.100 Electricity Account 2006 Mar 31 " 31 Balance b/f Accrual c/f $ 2006 6.405 695 8.080 " 31 10.680 Mar 31 10.080 × 1 ) 2 $ 19.000 Mar 31 " 31 140.220 In advance b/f (3 months) Bank (6 months) Bank (6 months) $ 3.040 Commission Income Account 2006 Mar 31 " 31 Profit and loss Prepaid income c/f $ 2006 188.840 Profit and loss (12 months) Prepaid c/f (3 months: $10.880 20.000 140.040 8.000 200.440 Jul 1 Oct 1 20.480 Mar 31 1.000 20.040) Financial Services Balance Sheet as at 31 March 2009 (extract) $ Current liabilities 18.040 Profit and loss $ 8.100 Profit and loss Prepayment c/f ($2.(ii) 2008 Apr 1 Sept 14 2009 Feb 12 Mar 31 Stationery b/f Bank — Stationery Bank — Printing Accrued printing c/f Printing and Stationery $ 2009 20.690 31.000 Mar 31 12.040 24.710 (iii) 2009 Mar 31 " 31 Profit and loss (12 months) In advance c/f (3 months: $8.000 13 .400 Mar 31 5.560 8.100 Mar 31 " 31 8.520 Unearned revenues $ 3.840 (b) Current assets Stationery inventory Prepayments ($3.480 + $5.780 7.110 18.100 " 31 2.000 Balance b/f $ 200.800 5.780 Apr 1 4.000 Balance b/f Accrued income c/f $ 120.000 Rental Income Account 2006 Mar 31 Profit and loss $ 2006 140.220 (iv) 2008 Apr 1 Jul 1 Oct 1 Prepaid b/f (3 months) Bank (6 months) Bank (6 months) Rates $ 2009 4.560 8.080 24.780 × 3 ) 12 $ 7.710 Profit and loss Stationery c/f $ 13.520 3.690 4.600 31.