Interactive Worksheet: Accruals and Prepayments

by Ken Delaney-Moore, Sheffield Hallam University

Aims:

This worksheet deals with:

1. The accruals 'concept'
2. The effect of prepayments on expense accounts.
3. The effect of accruals on expense accounts.

After having completed the worksheet you should be able to explain both of these points. When you are done, please fill-in the on-line evaluation form in order for us to monitor the quality of the materials we provide for you. Tell us what we're doing right and wrong. It takes very little time, and your opinions are valued - thank you.

The accruals concept

This is a rule, like the 'business entity concept' and 'dual aspect concept'. It means that when we calculate the profit for (say) 'Year 1', we should deduct expenses that relate to that period and only to that period. So, if during year 1 we had paid expenses for 'Year 2' or 'Year 0', we would not include these when calculating the profit for Year 1. This rule is the principle behind both prepayments and accruals.

For starters ...

Q1. Work your way through the following exercise. (Type your answer) Q1. Crosspool bicycles pays £300 (by cheque) for rent to cover the period 1st January to 31st March. Complete the following: The account to be debited is . The account to be credited is . The amount is £ .

If you didn't score 3/3, you might benefit by first having a look at the work-sheet on double - entry for assets and liabilities, revenues and expenses.

An example of a prepayment

A prepayment is a payment in advance of the period to which it pertains. Let's take the above example a stage further. At the 1st of April the rent for the period 1st April to 30th June becomes due and this is paid (£300 again), exactly on time. This is only a prepayment because Jim Sayers, the business owner, has decided that he wants the firms' financial year to run from 1st June to 31st May each year. So, at midnight on 31st May, he has paid one months rent in advance for next year (this being the rent for June). A look at the diagram below might help:

Date	1 Jan 31	1 Feb 28	1 Mar 31	1 Apr 30	1 May 31	1 Jun 30
Payments	1st: £300			1st : £300		Prepayment
Period covered by payment	Whole period			Whole period
Financial year	This financial year					Next financial year

At the end of the year, the 'profit and loss account' is drawn-up, and after all of this the rent account will look as follows:

RENT
	Debits	£		Credits	£
1 1	Bank	300
1 4	Bank	300	31 5	balance c/d	600
		600			600
31 5	balance b/d	600	31 5	to profit and loss a/c	500
		___	31 5	balance c/d	100
		600			600
1 6	balance b/d	100

Q2. Have a good look at this account and try to describe what's happened by completing the paragraph below: (Type your answer) 600 - balanced off - £100 - 300 - trial balance - credit - debit - debit - 500 - five - 100 - profit and loss account - asset - 300 The amount debited to the rent account on 1st January is £ . The amount debited to the rent account on 1st April is also £ . On 31st May the account is The balance is £ . A is drawn-up at this stage. The next stage is a transfer to the . To do this you the rent account and the profit and loss account with the amount of rent that has been incurred (used -up) for this financial period (1st Jan to 31st May). This will be months' rent at per month, a total of £ . The next stage is a second balancing-off, the balance this time being £ on the side. This represents a pre-payment and will appear in the balance sheet as an , since (on the 31st May) the landlord owes us something of value.

The sequence of events can be summarised as follows:

1. Enter the amounts paid (and any refunds) as debits.
2. Balance-off the account (the trial balance is drawn-up at this stage).
3. Enter the expenditure incurred (the value of expense actually used during the period) as a credit with the description "profit and loss account"
4. Balance-off for the second time. This balance will appear in the balance sheet.

Some further practice in prepayments

Morgan & co. started business on 1st July 19-6 and decided to draw up its first set of 'final accounts' for the six months ending 31st Dec 19-6. The full rates charge for the year to 31st march 19-7 would have been £2400. Morgan paid for its first three months rates on 8th July, and for the next 6 months on 5th October. Both payments were by cheque.

First of all, try to visualise what has happened by using a time-chart:

Date	1 Jul 31	1 Aug 31	1 Sep 30	1 Oct 31	1 Nov 30	1 Dec 31
Payments	8th: £600			5th : £1200
Period covered by payment	Whole period			Whole period and until 31st March next year
Financial year	This financial period: total amount of rates incurred = 6 months at £2400 per annum = 1200

Q3. Using the above information relating to Morgan & Co., try to fill-in the gaps in the following: (Type your answer) 1200 - December - balanced off - incurred - debit - debit - March - 1200 - 1800 - 600 - trial balance - credit - asset - 600 The amount debited to the rates account on 8th July is £ . The amount debited on 5th October is £ . On 31st the account is The balance is £ . A drawn-up at this stage. Next, we transfer the value of rates that has been to the profit and loss account. To do this you the rates account and the profit and loss account with six months worth of rates, i.e. £ . The next stage is a second balancing-off, the balance this time being £ on the side. This represents a pre-payment and will appear in the balance sheet as an , because (on the 31st Dec) the local authority owes Morgan something of value. They owe Morgan three months' worth of rates covering the period up to the end of of next year.

An example of an accrual ('accrued expense').

An accrual is quite simply an unpaid bill at the end of a financial period. Look at the following example:

Martin Sicey started a welders business on 1st April 2001, and used 31st March 2002 as his financial year-end. The electricity bills for his first year had been paid as follows (all payments were by cheque):

	date paid	amount	covering the period
2001	18th July	£52	1st April to 30th June 2001
2001	16th Oct	£86	1st July to 30th Sept 2001
2002	20th Jan	£75	1st Oct to 31st Dec 2001
unpaid		£94	1st Jan to 31st Mar 2002

At the end of the year (after the profit and loss account is drawn-up), the electricity account would look as follows:

ELECTRICITY
Date	Debits	£	Date	Credits	£
18.07.01	bank	52
16.10.01	bank	86
20.01.02	bank	75	31.03.02	balance c/d	213
		213			213
31.03.02	balance b/d	213	31.03.02	to profit and loss	307
31.03.02	balance c/d	94			___
		307			307
			01.04.02	balance b/d	94

Q4. Using this account, try the exercise below. (Type your answer) trial balance - incurred - accrued - liability - 307 - 94 - credit - payments - 213 The entries of £52, £86 and £75 are . The total payments made amounts to £ . We then balance-off. A is drawn-up at this stage. The next stage is a transfer £ to the profit and loss account. This represents the electricity expenses for this financial period. The next stage is a second balancing-off, the balance this time being a one of £ . This represents an expense, and will appear in the balance sheet as a , since (on the 31st March) Sicey owes £94 to his electricity supplier.

Some further practice in prepayments

Winnie Welbeck's cafe had its financial year from Jan to Dec. The rent payable was £30 per week. At the start of 2001 she owed five weeks rent for the last weeks of 2000. Her payments during 2001 were as follows:

amount	date paid	payment method
£500	29th Jan	cheque
£180	3rd April	cash
£300	14th June	cheque
£150	11th August	cash
£ 60	5th Nov	cash
£430	12th Dec	cheque

Note that in this question there is already an accrual at the start of the year. She owes five weeks rent (5 X £30 = £150) from last year, so this shows-up as an opening credit balance (being a liability).

This is the 'almost-finished' rent account; you will notice that a few figures are deliberately missing.

RENT
Date	Debits	£	Date	Credits	£
29.01.01	bank	500	01.01.01	balance c/d	150
03.04.01	cash	180
14.06.01	bank	300
11.08.01	cash	150
05.11.01	cash	60
12.12.01	bank	430	31.12.01	balance c/d	?A
		1620			1620
31.12.01	balance b/d	?A	31.12.01	to profit and loss	?B
31.12.01	balance c/d	?C			____
		?B			?B
			01.01.02	balance b/d	?C

Now try to answer the following questions:

Q5. a. The figure at '?A' is the trial balance figure. What should it be? [Don't enter a £ sign here]. (Type your answer) 1470" type="hidden">

Q6. b. The figure at '?B' is the amount transferred (charged) to the profit and loss account. What should it be? [Remember, no £ sign]. (Type your answer) 1560" type="hidden">

Q7. c. The figure at '?C' is the final balance figure, which will feature in the balance sheet. What should it be? [No £ sign]. (Type your answer) 90" type="hidden">

Now please fill-in the on-line evaluation form in order for us to monitor the quality of the materials we provide for you. Tell us what we're doing right and wrong. It takes very little time, and your opinions are valued - thank you.

Source:
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