Principles of Accounting

L5 | Accruals and Prepayments

 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Basis of Measuring Profits

Two methods of measuring profits:
• Cash basis
• Accrual basis

Cash basis
• Surplus = Cash receipts – Cash payments

Accrual basis
• Profit = Revenues earned – Expenses incurred

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Cash Basis vs Accrual Basis - example

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Cash Basis vs Accrual Basis

• Note:
• Under the cash basis of accounting, revenues and expenses are recognised when cash is
received or paid.
• Under the accrual basis of accounting, revenues and expenses are recognised when revenues
are earned and when expenses are incurred.

• Impact on profit
• Profit fluctuates under cash basis.
• Profit is more evenly distributed under accrual basis.

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Balance Day Adjustments

• Entries made in the books to adjust revenues and expenses are called adjusting
entries.
• These entries are made on balance day or the last day of the accounting period.
• Adjusting entries are also called balance day adjustments.
• Balance day adjustments can be classified into:
• Accrued expenses
• Prepaid expenses
• Other receivable
• Unearned revenue/Revenues received in advance

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Accrued Expenses/Unpaid Expenses/Expenses Owing

• Accrued expenses are expenses that have been incurred, i.e. the amounts have not
been paid.
• Adjustments on balance day for accrued expenses are necessary to ensure the
following:
• Expenses for the period are matched against the revenues for the period.
• A liability is recorded to represent the amount of expenses owing.

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments
Accrued
Expenses/Unpaid
Expenses/Expenses
Owing - example

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Accrued
Expenses/Unpaid
Expenses/Expense
s Owing – example
(A total rent of $4,000…)

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Accrued
Expenses/Unpaid
Expenses/Expenses
Owing – example (A
total rent of $4,000…)

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Example 1

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Example 1

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Prepaid Expenses/Payments in Advance

• Prepaid expenses are expenses that have not been incurred but the amounts have
been paid.

• Adjustments on balance day for prepaid expenses are necessary to ensure the
following:
• Only the expenses related to the current period are matched against the revenues earned for the
current period. Expense paid in advance are only to be treated as expenses in the coming
accounting year.
• Expenses that are paid in advance are to be treated as current assets on balance day

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Prepaid Expenses/Payments in Advance

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Prepaid Expenses/Payments in Advance (Insurance premium…)

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Prepaid Expenses/Payments in Advance (Insurance premium…)

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Example 2

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Example2

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Other receivables/ Accrued revenue

• Other receivables are revenues earned in the current accounting period for which the
amounts have not been received.
• Adjustments on balance day for revenues are necessary for the following reasons:
• To ensure revenues earned for the accounting year include those revenues earned but not yet
received so that the correct expenses are matched against the correct revenues when
determining the profit and loss for the accounting period.
• To record the accrued revenues as assets of the business.

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Other receivables/ Accrued revenue

• Example:

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Other receivables/ Accrued revenue

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Revenues Received in Advance/Unearned Revenues

• Revenues received in advance or unearned revenues are revenues not earned but
the amounts have been received in the current accounting year.

• Adjustments on the balance day for revenues received in advance are necessary for
the following reasons:
• The amounts received in advance are excluded from the revenues earned in the current
accounting period. Hence, the profit can be determined more accurately.
• A liability is recorded to represent the amount of revenues received in advance.

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Revenues Received in Advance/Unearned Revenues

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Revenues Received in Advance/Unearned Revenues

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Revenues Received in Advance/Unearned Revenues

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 PRINCIPLES OF ACCOUNTING
L5 | Accruals & Prepayments

Revenues Received in Advance/Unearned Revenues

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