Accrual Of Expenses
An accrual is an
amount used in one accounting period that that will not be paid until the next
accounting period.
In the final accounts
accrued expenses are: -
- added to the expense from the trial balance
before listing in the Income Statement account
- shown as a current liability in the balance sheet
This is to ensure the
Income Statement account records the cost incurred for the year instead
of simply the amount paid. The expense is adjusted to relate to the time
period covered by the Income Statement account. The balance sheet shows a
liability for the amount that is due but unpaid.
Worked Example
Satis Plc has a trial
balance showing a debit balance for electricity and gas of £3,000. Before
preparing final accounts an electricity bill for £250 is received on 1 January 2013,
i.e. on the 1st day of new financial year As this bill is clearly for electricity
used in 2013, an adjustment needs to be made to record this accrued expense for
2013.
In the Income
Statement account, the total cost of £3,250 (I.e. £3,000 from the T B. plus
£250 accrued) will be recorded as expenses. In the balance sheet £250 will be
shown current liability of 'accruals'.
Accruals –
Putting them into the accounts
In the accounts,
accruals must be shown as an amount owing at the end of the financial year. The
electricity and gas account in Satis PLC records will appear as follows:
Dr
Electricity and Gas Account Cr
2013 £ £
31 Dec Balance b/d 3000 31
Dec Income Statement 3250
31 Dec Balance
c/d
250
_____
3250
3,250
1 Jan Balance
b/d
250
Later on for example
on 5 January the electricity bill is paid by cheque and the account for 2014
now appears as:
Dr
Electricity and Gas Account Cr
2014 £ £
5th
Jan Bank 250
1 Jan Balance b/d 250
The effect of the
payment on 5 January is that the account has a 'nil' balance and the bill
received on 1 January will not be recorded as an expense in the Income
Statement account at the end of 2014.
The effect on profit
Taking note of the
accrual of an expense has the effect of reducing a previously reported net
profit As the expenses have been increased net profit is less (but there is no
effect on gross profit). Thus, the net profit of Satis Plc reduces by £250.
Prepayment of expenses
A prepayment is
a payment made in this accounting period but which will not be used until the
next accounting period.
A prepayment is the
opposite of an accrual: some part of the expense has been paid in advance. In the final accounts prepaid expenses are: -
- deducted from the expense amount of the trial
balance before listing it in the Income Statement account
- shown as a current asset in the year end balance
sheet
As with accruals, the
reason for this is to ensure that the Income Statement account records the cost
incurred
The owner of Satis
Plc tells you the trial balance figure for rent and rates of £2000 includes
£100 of rent paid in advance for Jan 2014. An adjustment needs to be made for 2013
to record this.
In the Income
Statement account, the cost of £1,900 (i.e. £2.000 from the trial balance, less
the 100 prepaid) will be recorded as an expense. In the balance sheet
£100 will be shown as a current asset of “prepayments”
Prepayments - the book-keeping records
In the double entry
records, prepayments must be shown as an asset at the financial year end. Thus
the account for rent and rates in the records of Satis Plc will appear as
follows:
Cr
Rent
and Rates
Account Dr
2013 £ £
31
Dec Balance b/d 2,000 31 Dec Income Statement 1900
____ 31
Dec Bal c/d 100
2000
2000
2014 1 Jan Balance b/d 100
What effect does this have on profit ?
Prepayment of an
expense has the effect of reducing expenses so net profit is greater.
Accruals And Prepayments Of Income
Just as expenses can
be accrued or prepaid at the financial year end so can income amounts.
Accrual of income
Here, income of a
business is due but unpaid at the financial year. For example, commission
receivable might have been earned, but the payment is received after the
financial year end, accrual of income is:
- added to the income amount from the trial balance
before listing it in the Income Statement account
- shown as a current asset (e.g. commission
receivable) in the year end balance sheet
Prepayment of income
Here, the income of a
business is paid in advance. For example, rent receivable account could include
an advance payment received from tenants. This is:
- deducted from the income from the trial balance
before listing it in the Income Statement account
- shown as a current liability (e.g. rent
receivable prepaid) in the year end balance sheet
The objective of
taking note of accruals and prepayments of income is to ensure that the amount
stated in the Income Statement account relates to the period covered by the
account.
Opening Balances
On Expense Or Income Accounts
There are likely to
be 4 separate figures making up the expense or income:
- amount owing or prepaid at the beginning of the
year (opening balance)
- amount paid (or received, if an income account)
during the course of the year
- amount to be transferred to Income Statement
account at the end of the financial year
- amount owing or prepaid at the end of the year
(closing balance)
If any three of these
are known, the fourth can be calculated, For example, we are given the
following information about expenses account for 2013
- owing at beginning of year £35
- amount paid in year £350
- owing at end of year £55
The 'missing' figure here, is the amount transferable to Income Statement
account (£370) at year-end, calculated as follows
Dr Vehicle
Expenses Account
Cr
2013 £ 2013 £
Bank 350 1 Jan Balance
b/d 35
31 Dec Balance
c/d 55 31 Dec Income
Statement
370
405
405
1 Jan Bal
b/d 55
Applying these
techniques will help you to solve quite complex expenses and income problems
set as part of the exam. For example, where an expense account deals with two
expenses, such as electricity and gas account, and one expense is prepaid at
the year start while the other is accrued!!
PRIVATE EXPENSES AND GOODS FOR OWN USE
Adjustments also have
to be made in the final accounts for the amount of any business are used by the
owner for private purposes These adjustments are for private expenses and goods
for own use,
Private expenses
Sometimes business
owners use business facilities for private purposes, e.g. telephone, or car.
The owner will agree that part of the expense shall be charged to him or her as
drawings, while the other part represents business expense,
Goods for own
use
When the owner of a
business takes some goods in which the business trades for his/her own use, the
double-entry book-keeping is:
debit drawings
account
credit purchases account
When working from a
trial balance to produce the final accounts, goods for own use should be
deducted from purchases and added to drawings.
