ACCRUALS AND PREPAYMENTS
FIRST TERM E-LEARNING NOTE
SUBJECT: FINANCIAL ACCOUNTING
CLASS: SS 2
WEEK FOUR AND FIVE
FINAL ACCOUNTS – ACCRUALS AND PREPAYMENTS
ACCRUALS
The accrual concept states that revenue and expenditure of a period should be matched together – whether or not such revenue or expenditure had actually been received or paid for.
This means that items of expenditure or income shown in the final account should be for sums actually related to the period covered by the financial statements prepared in the final account. Therefore, statements such as the Trading and Profit and Loss Account should be prepared on the accruals, or matching basis so that expenses are matched to the revenue earned: that is, expenses are shown in the Profit and Loss Account as they have been incurred rather than as they have been paid. Similarly, incomes are shown in the Profit and Loss Account as they have been earned rather than as they have been received.
Accrual can be divided into
(a) Accrued expenses
(b) Accrued income (i.e income received in arrears)
ACCRUED EXPENSES: These are expenses which accrued but have not been paid for or
discharged. They are also referred to as expenses owing or creditors for expenses e.g.
Accrued electricity.
Ilustration:
Supposing rent for 9 months (says N18,000) had actually been paid, that of the remaining 3
months (say N6,000) not yet paid must also be charged to Profit and Loss Account making the
total rent N24,000 (i.e. N18,000 + N6,000) for the 12 months accounting period for which the
Profit and Loss Account is prepared.
The Rent Account will appear as follows:
Rent
N N
July 2 Cash 18,000 Dec. 31 Profit and Loss 24,000
Dec. 31 Accrued Rent c/d 6,000
24,000 24,000
Jan. 1 Accrued Rent b/d 6,000
The credit balance of N6,000 on the Rent Account is an accrued expenses and is shown as a current liability in the Balance Sheet as at 31st December …….
ACCRUED INCOME: These are incomes which are due in respect of the current trading period but such income have not been received at the close of final account preparation. It is also refered to as income receivable e.g. interest receivable, rent receivable, commission receivable.
Illustration
In the year ended 31st December, 2005,Modupe had received interest of N4000 on her fixed
deposit account with First Bank Nig. Plc. At that date, interest for the half year to 31st
December, 2005 was due from the bank. The entries in the Interest Receivable account of
Modupe at 31st December, 2005 are as follows:
Interest Receivable
2005 N 2005 N
Dec. 31 Profit and Loss 8,000 Sept. 15 Bank 4,000
Dec. 31 Interest accrued c/d 4,000
8,000 8,000
2006
Jan 1 Balance b/d 4,000
The balance of N4,000 on the Interest Receivable Account is shown as a current asset in the
Balance Sheet as at 31st December, 2005.
EVALUATION
- List six uses of the General Journal.
- State two similarities and two differences between the Trading Account and the Profit and Loss Account.
PREPAYMENTS
Prepayments are payments made in advance of the benefits to be derived from them. It
represents amount paid in current period for services to be received in a subsequent period.
Prepayment can be divided into
(a) Prepaid expenses
(b) Income received in advance
PREPAID EXPENSES: These are expenses like rent, insurance etc. which are paid in advance for subsequent period. Only the expenses for the period must be charged to the Profit and Loss Account. Therefore expenses paid in advance are deducted from total payments in line with the requirements of the matching concept.
Illustration:
Supposing N15,000 is paid for electricity and it is for 15 months, the amount to be charged to the Profit and Loss Account at the end of the year is not N15,000 but N12,000
i.e. N15,000 x 12 months
15
while the N3,000 balance is regarded as prepayment or payment in advance.
The Electricity (or Lighting and Heating)Account will appear as follows:
Electricity
20×5 N 20×5 N
Jan. 23 Cash 15,000 Dec. 31 Profit and Loss 12,000
“ “ Prepaid Electricity c/d3,000
15,000 15,000
20×6
Jan. 1 Prepaid Elect. b/d 3,000
The debit balance of N3,000 on the Electricity Account is a prepaid expense and is shown as a current asset in the Balance Sheet as at 31st December, 20×5.
INCOME RECEIVED IN ADVANCE: These are income received by the organization duringthe current period but which relate to the next (or subsequent) trading period e.g. rent received in advance.
Illustration:In the year ended 31st December, 2007, Elizabeth had received N30,000 for rent from a tenant. At that date rent for the half year has been prepaid by the tenant. Show the Rent Receivable Account in the books of Elizabeth.
Rent Receivable
2007 N 2007 N
Dec. 31 Profit and Loss 20,000 Jul. 8 Bank 30,000
Dec. 31 Balance c/d 10,000
30,000 30,000
2008
Jan 1. Balance b/d 10,000
The credit balance of N10,000 on the Rent Receivable Account is an income received in advance and is shown as a current liability in the Balance Sheet of Elizabeth as at 31st December, 2007.
EVALUATION
- Why is it necessary to make adjustments in the final accounts for accruals and prepayments?
- How will you account for the following when preparing the final accounts.
(i) Accrued Expenses
(ii) Prepayments
(iii) Rent Receivable Outstanding
- What accounting concepts underly your treatment of these items.
GENERAL EVALUATION
- Explain the following : (a) bank loan (b) bank overdraft (c) standing order (d) credit transfer
- List five source documents used in preparing the Cash Book.
- List four accounts found in each of the following (a) nominal ledger (b) private ledger(c) general ledger
- Describe three features of each of the following financial statements: (a) Trading Account (b) Profit and Loss Account (c) Balance Sheet
- State seven reasons for preparing a bank reconciliation statement.
READING ASSIGNMENT
Simplified and Amplified Financial Accounting, Page 185-202
WEEKEND ASSIGNMENT
- Prepayment is treated in the balance sheet of a firm as a ________
(a) fixed asset (b) long-term liability (c) current asset (d) current liability
- Rent prepaid as at 1st January, 2002 was N10,000. Annual rent payable is N80,000 and rent accrued as at 31st December, 2002 was N15,000. How much was paid for rent in 2002
(a) N80,000 (b) N75,000 (c) N55,000 (d) N35,000
- Resources consumed but to be paid for within the next accounting period are classified in the balance sheet as ________
(a) current liabilities (b) current assets (c) long-term liabilities (d) capital
Use the following information to answer questions 4 and 5
Rent receivable accrued 1/01/2005 D3,000
Rent received during the year 2005 D5,000
Rent receivable accrued 31/12/2005 D2,500
- The entry for rent received in the profit and loss account for the year ended 31st December, 2005 is __________
(a) Credit profit and loss account with D4,500 (b) Credit profit and loss account with D2,500 (c) debit profit and loss account with D2,500 (d) debit profit and loss account with D4,500
- The balance in the rent receivable account as at 31/12/2005 is shown in the balance sheet as (a) fixed asset (b) current asset (c) current liability (d) long term liability
THEORY
Write up the ledger accounts of Adesua. Enterprises for the year ended 31st December, 2007.
(a) Motor Expenses:
Paid for the year to 31st December 2007 N80,000; Owing at 1st January, 2007 N4000; Prepaid at 31st December, 2007 N5,000
(b) Rates:
Paid in the year to 30th June 2005 N4,500; Rates prepaid as at 30th June 2004 N1000
Rates owing at 30th June 2005 N2,500