Accruals and prepayments

Interactive Worksheet: Accruals and Prepayments

by Ken Delaney-Moore, Sheffield Hallam University

Aims:

This worksheet deals with:

  1. The accruals 'concept'
  2. The effect of prepayments on expense accounts.
  3. The effect of accruals on expense accounts.

The accruals concept

This is a rule, like the 'business entity concept' and 'dual aspect concept'. It means that when we calculate the profit for (say) 'Year 1', we should deduct expenses that relate to that period and only to that period. So, if during year 1 we had paid expenses for 'Year 2' or 'Year 0', we would not include these when calculating the profit for Year 1. This rule is the principle behind both prepayments and accruals.


For starters ...

Q1. Work your way through the following exercise.


(Type your answer)





If you didn't score 3/3, you might benefit by first having a look at the work-sheet on double - entry for assets and liabilities, revenues and expenses.


An example of a prepayment

A prepayment is a payment in advance of the period to which it pertains. Let's take the above example a stage further. At the 1st of April the rent for the period 1st April to 30th June becomes due and this is paid (£300 again), exactly on time. This is only a prepayment because Jim Sayers, the business owner, has decided that he wants the firms' financial year to run from 1st June to 31st May each year. So, at midnight on 31st May, he has paid one months rent in advance for next year (this being the rent for June). A look at the diagram below might help:

Date 1 Jan 31 1 Feb 28 1 Mar 31 1 Apr 30 1 May 31 1 Jun 30
Payments 1st: £300     1st : £300   Prepayment
Period covered by payment Whole period Whole period
Financial year This financial year Next financial year

At the end of the year, the 'profit and loss account' is drawn-up, and after all of this the rent account will look as follows:

RENT
  Debits £   Credits £
1 1 Bank 300      
1 4 Bank 300 31 5 balance c/d 600
    600     600
31 5 balance b/d 600 31 5 to profit and loss a/c 500
    ___ 31 5 balance c/d 100
    600     600
1 6 balance b/d 100      
Q2. Have a good look at this account and try to describe what's happened by completing the paragraph below:


(Type your answer)





The sequence of events can be summarised as follows:

  1. Enter the amounts paid (and any refunds) as debits.
  2. Balance-off the account (the trial balance is drawn-up at this stage).
  3. Enter the expenditure incurred (the value of expense actually used during the period) as a credit with the description "profit and loss account"
  4. Balance-off for the second time. This balance will appear in the balance sheet.

Some further practice in prepayments

Morgan & co. started business on 1st July 19-6 and decided to draw up its first set of 'final accounts' for the six months ending 31st Dec 19-6. The full rates charge for the year to 31st march 19-7 would have been £2400. Morgan paid for its first three months rates on 8th July, and for the next 6 months on 5th October. Both payments were by cheque.

First of all, try to visualise what has happened by using a time-chart:

Date 1 Jul 31 1 Aug 31 1 Sep 30 1 Oct 31 1 Nov 30 1 Dec 31
Payments 8th: £600     5th : £1200    
Period covered by payment Whole period Whole period and until 31st March next year
Financial year This financial period: total amount of rates incurred = 6 months at £2400 per annum = 1200
Q3. Using the above information relating to Morgan & Co., try to fill-in the gaps in the following:


(Type your answer)






An example of an accrual ('accrued expense').

An accrual is quite simply an unpaid bill at the end of a financial period. Look at the following example:

Martin Sicey started a welders business on 1st April 2001, and used 31st March 2002 as his financial year-end. The electricity bills for his first year had been paid as follows (all payments were by cheque):

date paid amount covering the period
2001 18th July £52 1st April to 30th June 2001
2001 16th Oct £86 1st July to 30th Sept 2001
2002 20th Jan £75 1st Oct to 31st Dec 2001
unpaid £94 1st Jan to 31st Mar 2002

At the end of the year (after the profit and loss account is drawn-up), the electricity account would look as follows:

ELECTRICITY
Date Debits £ Date Credits £
18.07.01 bank 52      
16.10.01 bank 86      
20.01.02 bank 75 31.03.02 balance c/d 213
    213     213
31.03.02 balance b/d 213 31.03.02 to profit and loss 307
31.03.02 balance c/d 94     ___
    307     307
      01.04.02 balance b/d 94
Q4. Using this account, try the exercise below.


(Type your answer)






Some further practice in prepayments

Winnie Welbeck's cafe had its financial year from Jan to Dec. The rent payable was £30 per week. At the start of 2001 she owed five weeks rent for the last weeks of 2000. Her payments during 2001 were as follows:

amount date paid payment method
£500 29th Jan cheque
£180 3rd April cash
£300 14th June cheque
£150 11th August cash
£ 60 5th Nov cash
£430 12th Dec cheque

Note that in this question there is already an accrual at the start of the year. She owes five weeks rent (5 X £30 = £150) from last year, so this shows-up as an opening credit balance (being a liability).

This is the 'almost-finished' rent account; you will notice that a few figures are deliberately missing.

RENT
Date Debits £ Date Credits £
29.01.01 bank 500 01.01.01 balance c/d 150
03.04.01 cash 180      
14.06.01 bank 300      
11.08.01 cash 150      
05.11.01 cash 60      
12.12.01 bank 430 31.12.01 balance c/d ?A
    1620     1620
31.12.01 balance b/d ?A 31.12.01 to profit and loss ?B
31.12.01 balance c/d ?C     ____
    ?B     ?B
      01.01.02 balance b/d ?C

Now try to answer the following questions:

Q5. a. The figure at '?A' is the trial balance figure. What should it be? [Don't enter a £ sign here].

(Type your answer)





Q6. b. The figure at '?B' is the amount transferred (charged) to the profit and loss account. What should it be? [Remember, no £ sign].

(Type your answer)





Q7. c. The figure at '?C' is the final balance figure, which will feature in the balance sheet. What should it be? [No £ sign].

(Type your answer)