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Accruals and prepayments

ACCA Accounting Basics

Accruals and prepayments

Introduction:
So today am going to discuss with you people all about “ACCRUALS” and “PREPAYMENT”.
First of all you have a bit idea about Accruals concept :

The Accruals Concept says that income and expenses should be included in the Statement of Profit or Loss account of the period in which they are earned or incurred, not when cash is paid or received.

Basically accrual is a current liability.

Throughout the year, when an invoice for an expense incurred is paid, this is accounted for by: Similarly, when income is received, this is accounted for by:
• Dr Cash
• Cr Income,

ACCRUED EXPENSE (liability) :
An accrual arises where expenses of the business, relating to the year, have been incurred but not yet paid by the year end. In this case, it is necessary to record the extra expense relevant to the year and create a corresponding statement of financial position liability. If no invoice has been received, the amount must be estimated: (called an accrual):

Dr Expense account X (SPL)
Cr Accrual X (SOFP)

The credit entry creates a current liability in the statement of financial position – an accrual.
The debit entry ensures that the Statement of P&L includes the expense relating to the whole year, thus reducing profit in the Statement of Profit or Loss.
In ACCRUED expense “expense incurred but not yet paid”.

PRE-PAID EXPENSE (asset):
Expense which has not been incurred but has been paid in advance. A prepayment arises where some of the following year’s expenses have been paid in the current year. In this case, it is necessary to remove that part of the expense which is not relevant to this year and create a corresponding statement of
financial position asset (called a prepayment):

Dr Prepayment X
Cr Expense account X

The debit entry creates a current asset in the statement of financial position – a prepayment.
The credit entry removes the expense relating to the following year from the current year’s Statement of Profit or Loss, thus increasing the profit for the year.

ACCRUED INCOME (asset):
Accrued income arises where income has been earned in the accounting period but has not yet been received. In this case, it is necessary to record the extra income in the Statement of Profit or Loss and create a corresponding asset in the statement of financial position (called accrued income):

Dr Accrued income (SOFP)
Cr Income (SPL) X

Accrued income is a current asset in the statement of financial position.

PRE-RECEIVED INCOME (liability):
Pre-received income (also known as Deferred Income) arises where income has been received in the accounting period but which relates to the next accounting period (not earned yet). In this case, it is necessary to remove the income not relating to the year from the Statement of Profit or Loss and create
a corresponding liability in the statement of financial position (called pre-received income):

Dr Income (SPL) X
Cr Pre-received Income (SOFP) X

Pre-received income is a liability in the statement of financial position.

Now I’m going to discuss about errors in recording:
Case 1
Accrual not treated as accrual (omission).
Expense understated Profit Overstated
Current Liability Understated

The correct double entry has to be passed:
Dr expense (X)
Cr accrued expense (x)

Case 2
Prepayment not treated as prepayment (omission)
Expense overstated Profit understated
Current Assets Understated

The correct double entry has to be passed:
Dr pre paid expense (x)
Cr expense (x)

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