Chapter 9

Accruals and prepayments

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 Learning outcomes

- Record and account for transactions and events resulting in

income, expenses, assets, liabilities and equity in accordance
with the appropriate basic of accounting and the laws,
regulations and accounting standards applicable to the
financial statement.
- Identify the main components of a set of financial statements
and specify their purpose and interrelationship.
- Prepare and present the statement of financial position,
statement of profit or loss and statement of cash flows (or
extracts) from the accounting records and trial balance in a
format which satisfies the information requirements of the
entity.

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 Accruals and prepayments
Topic list

 The principle behind accruals and prepayments

 Accruals
 Prepayments
 Accounting for accruals and prepayments
 The accruals principle and income
 Accruals, prepayments, advances and arrears on the TB

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 Accruals and prepayments
The principle behind accruals and prepayments

 The accrual principle requires that we match expenses with the revenue
generated by them.
 Accruals (accrued expenses): Expenses which are charged against the
profit for a particular period, even though they have not yet been paid for.
 Prepayments (prepaid expenses): Expenses which have been paid in one
reporting period, but are not charged against profit until a later period,
because they relate to that later period.

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 Accruals and prepayments
Accruals
To set up an accrual
 DEBIT: Expense (statement of profit or loss) £X
 CREDIT: Accrual (liability on the statement of financial position) £X

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 Accruals and prepayments
Accruals - example
ABC LTD receives interest of $10,000 on bank deposit for the month of December
2010 on 3rd January 2011. ABC LTD has an accounting year end of 31st December
2010. ABC LTD will recognize interest income of $10,000 in the financial statements
of year 2010 even though it was received in the next accounting period as it relates to
the current period. Following accounting entry will need to be recorded to account for
the interest income accrued:
Debit Interest Income Receivable 10,000
Credit Interest on Bank Deposit (Income) 10,000

On the date of receipt of interest (i.e. 3rd January of the next year) following
accounting entry will need to be recorded in the subsequent year

Debit Bank 10,000

Credit Interest Income Receivable 10,000

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 Accruals and prepayments
Accruals - example

Horace Goodrunning, trading as Goodrunning Motor Spares,

ends his financial year on 28 February each year. His telephone
was installed on 1 April 20X6 and he receives his telephone
account quarterly at the end of each quarter. On the basis of the
following data, you are required to calculate the telephone
expense to be charged to the statement of profit or loss for the
year ended 28 February 20X7.
Goodrunning Motor Spares – telephone expense for the three
months ended:

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 Accruals and prepayments
Accruals - example

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 Accruals and prepayments
Prepayments
To set up a prepayment
DEBIT Prepayment (asset in the statement of financial position £X
CREDIT Expense (statement of profit or loss) £X

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 Accruals and prepayments
Prepayments – expense example
ABC LTD pays advance rent to its landowner of $10,000 on 31st December 2010 in
respect of office rent for the following year. ABC LTD has an accounting year end of 31st
December 2010.
ABC LTD will recognize an asset of $10,000 in the financial statements of year 2010 in
respect of the prepaid expense to recognize its right to use office space in the following
year. Following accounting entry will be recorded in the books of ABC LTD in the year
2010:
$ $
Debit Prepaid Rent 10,000
Credit Cash 10,000
The prepaid expense will be recognized as expense in the next accounting period to
which the rental expense relates. Following accounting entry will be recorded in the year
2011
$ $
Debit Rent Expense (Income Statement) 10,000
Credit Prepaid Rent 10,000

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 Accruals and prepayments
Prepayments & accrual
• Prepayments are included in current assets in the statement of
financial position.
• Accruals are included in current liabilities as they represent
liabilities which have been incurred but for which no invoice has
yet been received.

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 Accruals and prepayments
Reversing accruals and prepayments in new period
Transaction DR CR Description
Accrual (opening Reversing accrual of
Reverse
credit balance on Expense (new period) expense set up in
accrual
liability account) previous period
Prepayment (opening Reversing prepayment of
Reverse
Expense (new period) debit balance on asset expense set up in
prepayment
account) previous period

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 Accruals and prepayments
Practice question
The Batley Print Shop, which is not registered for VAT, rents a photocopying machine. It makes a
quarterly payment as follows:
(a) Three months rental in advance
(b) A charge of 2 pence per copy made during the quarter just ended
The rental agreement began on 1 August 20X4. The first six quarterly bills were as follows.
Bills dated Rental Cost of Total
copies taken
£ £ £
1 August 20X4 2,100 0 2,100
1 November 20X4 2,100 1,500 3,600
1 February 20X5 2,100 1,400 3,500
1 May 20X5 2,100 1,800 3,900
1 August 20X5 2,700 1,650 4,350
1 November 20X5 2,700 1,950 4,650
The bills are paid promptly, as soon as they are received.
Requirements
(a) Calculate the charge for photocopying expenses for the year to 31 August 20X4 and the amount
of prepayments and/or accrued charges as at that date.
(b) Calculate the charge for photocopying expenses for the following year to 31 August 20X5, and
the amount of prepayments and/or accrued charges as at that date.
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(a) Year to 31 August 20X4
£
One months' rental (1/3  £2,100) * 700
Accrued copying charges (1/3  £1,500) ** 500
Photocopying expense (Statement of profit or loss) 1,200

* From the quarterly bill dated 1 August 20X4

** From the quarterly bill dated 1 November 20X4
There is a prepayment for 2 months' rental (2/3 × £2,100 = £1,400) as at 31 August
20X4, and an accrual for copying charges of £1,500/3 = £500
(b) Year to 31 August 20X5
£ £
Rental from 1 September 20X4 – 31 July 20X5 (11 months at
£2,100 per quarter or £700 per month) 7,700
Rental from 1 August – 31 August 20X5 (1/3  £2,700) 900
Rental charge for the year 8,600
Copying charges:
1 September – 31 October 20X4 (2/3  £1,500) 1,000
1 November 20X4 – 31 January 20X5 1,400
1 February – 30 April 20X5 1,800
1 May – 31 July 20X5 1,650
Accrued charges for August 20X5 (1/3  £1,950) 650
6,500
Photocopying expense (statement 201109
21-Sep-23 of profit–or
Chapter
loss) 9: Accruals and prepayments 14
15,100
 There is a prepayment for 2 months' rental (2/3 × £2,700 = £1,800) as at 31
August 20X5, and an accrual for copying charges of £1,950/3 = £650.
Summary of reporting period 1 September 20X4 – 31 August 20X5
Rental Copying
charges costs
£ £
Prepayment as at 31.8.20X4 (2/3  £2,100) 1,400
Accrued charge as at 31.8.20X4 (500)
Bills paid during the reporting period
1 November 20X4 2,100 1,500
1 February 20X5 2,100 1,400
1 May 20X5 2,100 1,800
1 August 20X5 2,700 1,650
Prepayment as at 31.8.20X5 (2/3  £2,700) (1,800)
Accrued charge as at 31.8.20X5 650
Charge to the Statement of profit or loss for the reporting period 8,600 6,500
Items in the statement of financial position as at 31 August 20X5
Prepaid rental (current asset) 1,800
Accrued copying charge (current liability) 650

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 Accruals and prepayments
The accrual principle and income
The accrual principle also applies to income.
 Accrued income arises when receipt of income (such as rent or subscription) is in
arrears at the year end.
 Deferred income arises when income has been received in advance at the end of the
reporting period, so it needs to be carried forward and treated as income of the
following reporting period.
 Accounting for accrued income
DEBIT Accrued income (asset in the statement of financial position)
CREDIT Other income (statement of profit or loss)
 Accounting for deferred income:
DEBIT Revenue or other income (statement of profit or loss)
CREDIT Deferred income (liability in the statement of financial position)

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 Accruals and prepayments
Deferred income
ABC LTD receives advance rent from its tenant of $10,000 on 31st December 2010 in
respect of office rent for the following year. ABC LTD has an accounting year end of 31st
December 2010. ABC LTD will recognize a liability of $10,000 in the financial
statements of year 2010 in respect of the prepaid income to acknowledge its obligation to
make the office space available to the tenant in the following year. Following accounting
entry will be recorded in the books of ABC LTD in the year 2010:
Debit Cash 10,000
Credit Deferred income 10,000
The prepaid income will be recognized as income in the next accounting period to
which the rental income relates. Following accounting entry will be recorded in the year
2011:
Debit Prepaid Rent Income (Liability) 10,000
Credit Rent Income (Income Statement) 10,000

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 Accruals and prepayments
The accrual principle and income
Worked example: Deferred and accrued income
Sunrise Carpets sells floor coverings to the public. At the end of its 12 month
reporting period,
31 December 20X4, it has recorded as sales £1,200 received from customers as
deposits on carpets which are not due to be invoiced until February 20X5. In
January 20X5 it records a £500 refund from one of its main suppliers as a result
of exceeding the agreed level of custom during 20X4.
Requirement
Prepare journals:
(a) Recording these transactions in the ledger accounts for the reporting period
ended 31 December 20X4.
(b) Recording these transactions in the ledger accounts for the reporting period
ended 31 December 20X5.

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 Accruals and prepayments
The accrual principle and income
Solution
• The reversal of deferred income in 20X5 is not to a statement of profit or loss account but to trade
receivables. This is because we are dealing with credit transactions: the full amount of the sale will
be invoiced in February 20X5 (Debit Receivables, Credit Sales), so the deposit should be credited
to trade receivables in the new reporting period in anticipation
• The full amount of purchases was originally invoiced by the supplier in 20X4, so the refund is
treated as a deduction from what is owed to the supplier by being debited to trade payables in 20X5

£ £
1.1.X5 DEBIT Deferred income (liability) 1,200
CREDIT Trade receivables 1,200
Reversal of deferred income
1.1.X5 DEBIT Trade payables 500
CREDIT Accrued income (asset) 500
Reversal of accrued income

£ £
31.12.X4 DEBIT Sales 1,200
CREDIT Deferred income (liability) 1,200
Deposits from customers
31.12.X4 DEBIT Accrued income (asset) 500
21-Sep-23 CREDIT Purchases
201109 – Chapter 9: Accruals and prepayments 500
19
Refund from supplier
 Accruals and prepayments
Accruals, prepayments, advances and arrears on the ETB
• Calculate the amounts of the accrued and prepaid expenses, and the deferred
or accrued income, as usual.
• Prepare the period-end journals as usual.
• Enter these journals in the adjustments columns of the ETB, opening up lines
in the statement of financial position column for accruals, prepayments,
accrued income and deferred income as necessary.
• Include these adjustments in the ETB cross-cast to prepare the financial
statements.
• Enter the closing journals in the ledger accounts as usual.
• Prepare and enter the opening journals.

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 Accruals and prepayments
Accruals, prepayments, advances and arrears on the ETB
Worked example: Accruals and prepayments on the ETB
Jezebel makes and sells clothing to order. Her reporting period is the 12 months ended
31 December. She has extracted the following trial balance as at 31 December 20X1
Debit Credit
£ £

Cash at bank 6,541

Opening capital 15,000
Loan 8,000
Non-current assets 45,000
Trade payables 16,758
Expenses 10,877
Purchases 62,975
Sales 157,632
Other income 0
Trade receivables 22,854
Drawings 49,143
197,390 197,390
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 Accruals and prepayments
Accruals, prepayments, advances and arrears on the ETB
She needs to take account of the following matters:
(a) Her quarterly power bills are £822. The last bill she paid was in respect of the
quarter ending 31 October 20X1.
(b) Her annual rent bill of £2,970 was paid on 1 May 20X1 in respect of the year to 30
April 20X2.
(c) Sales include £350 received from cash customers in December in respect of items
of clothing that Jezebel will complete in January 20X2.
(d) A royalty of £58 is due from a fashion magazine which used Jezebel's products in
a fashion shoot. Jezebel wishes to account for this as other/accrued income rather
than trade receivables.
We need to complete Jezebel's ETB to calculate her net profit for the reporting period.

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 Solution
Ledger balance Trial balance Adjustments Statement of profit Statement of
or loss financial position
Debit Credit Debit Credit Debit Credit Debit Credit
£ £ £ £ £ £ £ £
Cash at bank 6,541 6,541
Opening capital 15,000 15,000
Loan 8,000 8,000
Non-current assets 45,000 45,000
Trade payables 16,758 16,758
Expenses (a),(b) 10,877 548 990 10,435
Purchases 62,975 62,975
Sales (c) 157,632 350 157,282
Other income (d) 58 58
Trade receivables 22,854 22,854
Drawings 49,143 49,143
Accruals
(822 x 2/3) (a) 548 548
Prepayments
(2,970 x 4/12) (b) 990 990
Accrued income (d) 58 58
Deferred income (c) 350 350
Net profit 83,930 83,930
21-Sep-23 197,390 201109 – Chapter
197,390 1,9469: Accruals
1,946 and157,340
prepayments157,340 124,586 124,586
23
 Accruals and prepayments
Practice question
A business has received telephone bills as follows:
Date received Amount of Date paid
bill
£
Quarter to 30 November 20X5 December 20X5 336.50 January 20X6
Quarter to 28 February 20X6 March 20X6 364.20 April 20X6
Quarter to 31 May 20X6 June 20X6 313.70 June 20X6
Quarter to 31 August 20X6 September 20X6 335.80 October 20X6
Quarter to 30 November 20X6 December 20X6 361.20 January 20X7
Quarter to 28 February 20X7 March 20X7 403.80 March 20X7

In the statement of profit or loss for the year ended 31 December 20X6 its charge
for telephone expense should be:
A £1,388.10
B £1,266.70
C £1,522.80
D £1,401.30 Answer: A (2/3  364.20) + 313.70 + 335.80 + 361.20 + (1/3
21-Sep-23 × 403.80)201109
= £1,388.10
– Chapter 9: Accruals and prepayments 24
 Accruals and prepayments
Practice question
An insurance prepayment of £1,050 was treated as an accrual in a sole trader’s
statement of profit or loss at the year end. As a result the profit was:
A Understated by £1,050
B Understated by £2,100
C Overstated by £2,100
D Overstated by £1,050

B £1,050 has been deducted from instead of added to profit. Therefore to cancel the
error, you have to add it back then to post the correct entry you have to add it on
again.

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 Accruals and prepayments
Practice question
At 31 December 20X6 a business has an insurance prepayment of £100. During
the year the business pays £600 in respect of various insurance contracts. The
closing accrual for insurance is £130.
The statement of profit or loss charge for insurance for the year ended 31
December 20X7 is:
A £830
B £630
C £600
D £570

A £600 + £100 + £130 = £830

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 Accruals and prepayments
Practice question
Whilst preparing the extended trial balance for a business it was determined that an accrual
for electricity was required for £400 and that there was a prepayment of insurance of £900.
What entries are required in the adjustments column of the extended trial balance?
(i) debit electricity £400
(ii) debit insurance £900
(iii) credit electricity £400
B Debit electricity
(iv) credit insurance £900
Credit insurance
(v) debit accruals £400 Credit accruals
(vi) credit accruals £400 Debit prepayments
(vii) debit prepayments £900
(viii)credit prepayments £900
A (ii), (iii), (v) and (viii)
B (i), (iv), (vi) and (vii)
C (i), (ii), (vi) and (viii)
D (iii), (iv), (v) and (vii)
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 Accruals and prepayments
Practice question
A business compiling its financial statements for the year to 31 October each
year pays rent quarterly in advance on 1 January, 1 April, 1 July and 1 October
each year. The annual rent was increased from £48,000 to £60,000 per year
from 1 March 20X4.
What figure should appear for rent in the statement of profit or loss for the
year ended 31 October 20X4 and in the statement of financial position at
that date?
Statement of profit or loss Statement of financial position
A £56,000 £10,000
B £52,000 £5,000
C £56,000 £5,000
D £55,000 £10,000

A Statement of profit or loss (8/12 × 60,000) + (4/12 × 48,000)

Statement of financial position (2/12 × 60,000)
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 Accruals and prepayments
Practice question
In the year ended 31 December 20X4 B Ltd received cash of £318,600 from subscribers
to its website.
Details of subscriptions in advance and in arrears at the beginning and end of 20X4 are
as follows:
31 December
20X4 20X3
£ £
Subscriptions received in advance 28,400 24,600
Subscriptions owing 18,300 16,900
All subscriptions owing were subsequently received.
What figure for subscriptions income should be included in the statement of
profit or loss of B Ltd for 20X4?
A £321,000 D
SUBSCRIPTION INCOME ACCOUNT
B £336,400
£ £
C £300,800 B/d arrears 16,900 B/d advances 24,600
Subscription income (bal 316,200 Cash received 318,600
D £316,200 fig)
C/d advances
201109 28,400
– Chapter 9: Accruals and C/d arrears
prepayments 18,300
21-Sep-23
361,500 29
361,500
 Accruals and prepayments
Practice question
During 20X4, B paid a total of £60,000 for rent, covering the period from
1 October 20X3 to 31 March 20X5.
What figures should appear in the financial statements for the year ended
31 December 20X4?
Statement of profit or loss Statement of financial position
A £40,000 £10,000 Prepayment
B £40,000 £15,000 Prepayment
C £50,000 £10,000 Accrual
D £50,000 £15,000 Accrual

A Statement of profit or loss = £60,000 × 12/18 = £40,000

Statement of financial position = £60,000 × 3/18 prepayment = £10,000

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 Accruals and prepayments
Practice question
A company pays rent quarterly in arrears on 1 January, 1 April, 1 July and 1
October each year. The rent was increased from £90,000 per year to £120,000
per year as from 1 October 20X2.
What rent expense and accrual should be included in the company's
financial statements for the year ended 31 January 20X3?
Rent expense (SPL) Accrual (SFP)
A £100,000 £20,000
B £100,000 £10,000
C £97,500 £10,000
D £97,500 £20,000

B Rent expense (SPL) (8/12 × 90,000) + (4/12 × 120,000) = 100,000

Accrual (SFP) 12,000/12 = 10,000

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 End of chapter 9

Study Manual - Read, read and read all chapter 9

(p. 224 - 248)
Question Bank – Complete all questions in
Chapter 9

21-Sep-23 201109 – Chapter 9: Accruals and prepayments 32