Chapter 8 - Prepayments and Accural

 Lets start on prepayment & accrual:)  Prepayment & Accruals is an important topic, it will definitely come out as part of the income statement adjustment and/or a question on its own. 

💥Why do we need all these accruals & prepayments? 

 If you can recall in earlier topics, when we prepare the income statement & Balance sheet, it was prepared based on an earned/incurred basis in the financial period. 

For income/expenses which are Outside of the period or which are not earned/incurred, we will therefore have to exclude them. This is to satisfy the accrual accounting concept as well as the Matching accounting concept.

💨FYI, matching accounting concept refers to matching the income earned with the expenses incurred for the financial period. 

Expenses first, there are 2 types of expenses namely: (i) Accrued Expenses & (ii) Prepaid Expenses 

(i) Accrued expenses refer to an expense that is incurred in the current financial period which will be paid in the next accounting period. No invoice for this expenses has been received yet however the business has incurred this expenses in the current financial period.

☝Question-  A business financial year end is from 1 Jan 20X1 to 31 Dec 20x1 however the electricity bills is received half yearly from 1st April 20X1 to 30 Sept 20X1. How about the Electricity expenses from 1st Oct 20X1 to 31 Dec 20X1? 

Ans: Accrue the Electricity for this period 

Using the electricity bill from  1st April 20X1 to 30 Sept 20X1 as a proxy for e.g. $600 for 6 mths and accrue them:

Accrue Elect from 1st Oct 20X1 to 31 Dec 20X1: 3/6 mths X $600 = $300

Therefore , we  Dr Electricity Expenses $300 & Cr Accrued Electricity Exp $300 

The electricity expenses will lower the profit and accrued electricity will increase liability in the balance sheet. 

(ii)Prepaid Expenses refers to expenses whereby we paid for the expenses which we have not yet incurred in the financial period. 

☝Question- Company ABC whose financial year is between 1 Jan 20X1 to 31 Dec 20X1 paid for 15 months club membership from Jan X1 to Mar X2 in Jan X1 for $1,500. 

Since from Jan X2 to Mar X2 are considered outside of the financial period, the 3 months payment are therefore prepaid club membership expenses.

Therefore, to record the payment of the club Membership 

Jan X1 : Dr Club Membership Exp $1,500 Cr Cash at Bank $1,50

To remove Jan X2 to Mar X2 expenses 

Dec X1: Dr Prepaid Membership $300 Cr Club Membership Exp $300

The total club membership expenses would be $1,200 while prepaid club membership would be $300. 

Now lets go on to Income, there are 2 types of namely: (iii) Income Receivables & (iv) Income Received in advance

(iii) Income Receivables refers to income which has been earned in the current financial period but will only be received in the next financial period. This could be due to invoicing not done to customer yet which result in the late collection. The revenue for the current financial period should still be recorded. 

☝Question - ABC Ltd earns $100/mth for the rental of tables and chairs to Bebe Restaurant. For the year ended 31 Dec 20X1, the rental income of Nov X1 and Dec X2 had not been received . ABC Ltd has not billed Bebe Restaurant and no records exist.

(iv) Income Received in advance refers to income which has not been earned but received in advance. 

☝Question- ABC Ltd earns $100/mth for the rental of tables and chairs to Bebe Restaurant. For the year ended 31 Dec 20X1, ABC Ltd received 13 months of rental income from Jan X1. 

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