Prepayments of Expenses

Prepayments of expenses
What is a prepayment of an expense?
A prepayment is an amount that has been paid during a
period but which relates to a future accounting period
(when the benefit will be received)

Examples (financial year ends 31st December 2019):

a) A warehouse has been rented and the rental period

is 1st January 2020 for one year. The full year’s rent
has been paid in advance, on 14th December 2019
b) A van has been insured for one year starting on 15th
January 2020. The insurance premium of £800 was
paid on 20th December 2019
In the financial statements…
The expense has NOT YET been incurred [this means that
(using the previous examples) the benefit of renting the
warehouse has not yet been received, and similarly, the
benefit of having an insured van has not yet been
received]
so the accruals (or matching) concept tells us that we
should show the expense in the financial statements that
cover that period (ie the NEXT financial year).

This means we MATCH the expense in the income

statement to the period of time when the benefit was
received
What does this mean?
In the financial statements…
In the Income Statement, we DEDUCT the amount of
the prepayment to the expense that has already
been recorded (this ensures it is shown in the
following financial year instead)

The prepayment is an amount paid out but with no

benefit having yet been received, therefore it is
shown as a current asset in the SOFP

Let’s look at an example…

Example of an accrual in the
financial statements
The trial balance shows that £8,400 of rent has been
paid out during the year. The business pays rent in
advance, and £1,200 of the amount paid relates to
next year’s rent.
How will this be reflected in the financial
statements?
 Example of an accrual in the
financial statements
The trial balance shows that £8,400 of rent has been paid
out during the year. The business pays rent in advance, and
£1,200 of the amount paid relates to next year’s rent.

Income Statement:
The rent expense will be shown as: £8,400 - £1,200 = £7,200
The SOFP:
The prepayment of £1,200 will be shown as a current asset
Calculating Prepayments
Often, in exam questions, the prepayment covers a
period of time that is partly before the end of the
financial year, and partly after the end of the
financial year:
End of the financial year

Bills paid for

this period of
time
Calculating Prepayments
Often, in exam questions, the prepayment covers a
period of time that is partly before the end of the
financial year, and partly after the end of the
financial year:
End of the financial year

Bills paid for

this period of This is the period of time
time that the prepayment relates
to: because it is in the next
financial year
Calculating Prepayments
Often, in exam questions, the prepayment covers a
period of time that is partly before the end of the
financial year, and partly after the end of the
financial year:
End of the financial year

Bills paid for

this period of This is the period of time
time that the prepayment relates
to: because it is in the next
financial year
Calculating Prepayments
Often, in exam questions, the prepayment covers a
period of time that is partly before the end of the
financial year, and partly after the end of the
financial year:
End of the financial year

£2,400 paid that covers
12 months: 7 months in
this financial year; 5
months in next
5 months
This is the period of time
that the prepayment relates
to: because it is in the next
financial year
Calculating Prepayments
Often, in exam questions, the prepayment covers a
period of time that is partly before the end of the
financial year, and partly after the end of the
financial year:
End of the financial year

£2,400 paid that covers
12 months: 7 months in
this financial year; 5
months in next
5 months
This is the period of time Prepayment =
that the prepayment relates 5/12 x £2,400 =
to: because it is in the next £1,000
financial year
 What is the impact of this in the financial
statements?

In the Income Statement:

Expense = 2,400 – 1,000 = £1,400

In the SOFP:
Prepayment = “Other Receivables” = Current Asset = £1,000
Preparing the T Account
Sometimes exam questions ask you to prepare a T
Account where the expense has prepayments at the
start and end of the year.

Here’s an example:
Prepayment at the start of the financial year £2,140
Bills paid during the year (£1,500 relates to next year) £8,600
Prepayment at the end of the financial year £1,500
The financial year ran from 1st January 2019 to 31st December
2019
 Prepayment at the
start of the year
Expense
1st Jan ‘19 Balance b/f 2,140

---------- ---------

--------- ---------

Remember that Prepayments are

a Current Asset, so the Balance
b/f (the prepayment) will always
be shown on the DEBIT side of the
account
 Always put in the full
amount paid during the year:
disregard the information
about the £1,500 that relates
Prepayment at the
to next year)
start of the year
Expense
1st Jan ‘19 Balance b/f 2,140

2019 Bank 8,600

---------- ---------

--------- ---------

Remember that Prepayments are

a Current Asset, so the Balance
b/f (the prepayment) will always
be shown on the DEBIT side of the
account
 Always put in the full
amount paid during the year:
disregard the information
about the £1,500 that relates
Prepayment at the
to next year)
start of the year
Expense
1st Jan ‘19 Balance b/f 2,140

2019 Bank 8,600 31st Dec ’19 Balance c/f 1,500

---------- ---------

--------- ---------
1st Jan ’20 Balance b/f 1,500

Remember that Prepayments are

a Current Asset, so the Balance Prepayment at the
b/f (the prepayment) will always end of the year
be shown on the DEBIT side of the
account
 Always put in the full
amount paid during the year:
disregard the information
about the £1,500 that relates
Prepayment at the
to next year)
start of the year
Expense
1st Jan ‘19 Balance b/f 2,140 31st Dec ‘19 Income 9,240
Statement
2019 Bank 8,600 31st Dec ’19 Balance c/f 1,500
---------- ---------
10,740 10,740
--------- ---------
1st Jan ’20 Balance b/f 1,500

Remember that Prepayments are

a Current Asset, so the Balance Prepayment at the
b/f (the prepayment) will always end of the year
be shown on the DEBIT side of the
account
A T-Account that has both
accruals and prepayments…
Usually exam questions will introduce as much
complexity as they can think of!

So here is an example that involves two expenses

within one T-Account (both Rent and Rates), and
includes both accruals and prepayments…
 A T-Account that has both
accruals and prepayments…
The financial year runs from 1st January 2019 to 31st December 2019.
At the start of the year:
Rent paid in advance £3,000
Rates owed £1,100
Paid during the year:
On 6th June 2019 – Rent £7,000
On 3rd February – Rates £2,500
On 4th August – Rates £2,700
At the end of the year:
Rent paid in advance £3,500
Rates owed £1,300
Prepare the Rent and Rates T-Account for the financial year
 Rent and Rates
1/1/19 Balance b/f (Rent) 3,000 1/1/19 Balance b/f (Rates) 1,100
3/2/19 Bank (Rates paid) 2,500
6/6/19 Bank (Rent paid) 7,000
4/8/19 Bank (Rates paid) 2,700 31/12/19 Income Statement 11,900
31/12/19 Balance c/f (Rates) 1,300 31/12/19 Balance c/f (Rent) 3,500
-------- ---------
16,500 16,500
--------- ----------
1/1/20 Balance b/f (Rent) 3,500 1/1/20 Balance b/f (Rates) 1,300
What’s Next?
Before we are ready to do practise questions, we
need to cover the other sections of this topic.

Therefore, next please watch the revision lessons for:

1) Depreciation
2) Writing off an irrecoverable debt and Provision
for Doubtful Debts