Ch10 Accruals and Prepayments

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CHAPTER 15

EXPENSES: Accruals and


Prepayments
What are accruals?

An accrual is an estimate of money that is


owed, but which has not yet been paid.

What are prepayments?


A prepayment is a payment made in
advance of the current period.
Accrual and Cash Basis
Under the accrual basis of accounting, revenues are reported on the income
statement in the period in which a service has been performed or a product has been
delivered.
Cash may or may not be received from customers during this period.
The accrual basis of accounting also requires expenses to be recorded when they are
incurred, not necessarily when cash is paid.
Most individuals and small service businesses may use the cash basis of accounting.
For most large businesses, however, the cash basis will not provide accurate financial
statements for user needs.
Generally accepted accounting principles (GAAP) require the accrual basis of
accounting.
Revenue and Expense Recognition
Under the revenue recognition principle, revenues are recorded when
services have been performed or products have been delivered to
customers.
Revenue is normally measured as the assets received, such as cash or
accounts receivable.
The process of recognizing revenues is called revenue recognition.
Under the expense recognition principle, the expenses incurred in
generating revenue must be reported in the same period as the related
revenue.
This is also called the matching principle.
By matching revenues and expenses, net income or loss for the
period is properly reported on the income statement.
Adjusting entries are required to properly match revenues and
expenses.
Accounting Cycle
The Accounting Period

© McGraw-Hill Education.
3-6
Exh.
3.4

Framework for Adjustments

Transactions where cash is paid or


received before a related expense
or revenue is recognized.

Transactions where cash is paid or


received after a related expense
or revenue is recognized.
Exh.
3.4

Framework for Adjustments

Transaction where cash is paid


before a related expense is
recognized.
Prepaid Expenses
Adjusting Prepaid Expenses
Resources paid Here is the check
for my first
for prior to 6 months’ rent.
receiving the
actual benefits.

Asset Expense
Unadjusted Credit Debit
Balance Adjustment Adjustment
Adjusting Prepaid Expenses
•On December 1, 2001, Scott Company paid
$12,000 to cover rent for December 2001
through May 2002.
•Let’s look at the adjusting journal entry
needed on December 31, 2001.
Adjusting Prepaid Expenses
•After posting, the accounts involved look like
this:

Prepaid Rent Rent Expense


12/1 $12,000 12/31 $2,000 12/31 $2,000
Example of a prepaid expense

A business has an accounting year end of


31 December.
On 1 January 2019 insurance of RM300
had been paid in advance.
During 2019 the business has paid
RM2,000 for insurance.
However, this includes a pre-payment for
RM100 for the year beginning 1 January
2020.
prepaid expense
prepaid expense
prepaid expense
prepaid expense
Profit and loss account for the year ended
31 December 2019 (extract)
Less expenses
Insurance 2,200

Balance sheet as at 31 December 2019 (extract)


Current assets
Insurance prepaid 100
Exh.
3.4

Framework for Adjustments

Transaction where cash is paid


after a related expense is
recognized.
Adjusting for Accrued Expenses
We’re about one-half
Costs incurred in a done with this job and
period that are want to be paid!
both unpaid and
unrecorded.

Expense Liability
Debit Credit
Adjustment Adjustment
Adjusting for Accrued Expenses
Denton, Inc. pays its employees every Friday.
Year-end, 12/31/02, falls on a Wednesday. As of
12/31/02, the employees have earned salaries of
$47,250 for Monday through Wednesday of the
week ended 1/02/03.

Last pay Next pay


date date
12/26/02 1/2/03

12/1/02 12/31/02 Record adjusting


Year end journal entry.
Adjusting for Accrued Expenses
Denton, Inc. pays its employees every Friday.
Year-end, 12/31/02, falls on a Wednesday. As of
12/31/02, the employees have earned salaries of
$47,250 for Monday through Wednesday of the
week ended 1/02/03.
Adjusting for Accrued Expenses
•After posting, the accounts involved will
look like this . . .

Salaries Expense Salaries Payable


12/31 $47,250 12/31 $47,250
Example of an accrued expense
A business with an accounting year end
of 31 December.
On 1 January 2019 electricity owing
amounted to RM400.
The business paid electricity of RM3,000
during the year.
There is RM250 owing for electricity at
31 December 2019.
accrued expense
accrued expense
accrued expense
accrued expense
Profit and loss account for the year ended
31 December 2019 (extract)
Less expenses
Electricity 2,850

Balance sheet as at 31 December 2019 (extract)


Current liabilities
Electricity accrued 250
Example of accrued and prepaid
expense
A business has a financial year ending
31 December.
On 1 January 2019 stock of stationery amounted
to RM260.
During the year the business paid stationery of
RM2,650.
On 31 December 2019 there was an outstanding
invoice for stationery of RM150.
On 31 December 2019 the business also had a
stock of stationery of RM300.
accrued and prepaid expense
accrued and prepaid expense
accrued and prepaid expense
accrued and prepaid expense
Profit and loss account for the year ended
31 December 2006 (extract)

Less expenses
Stationery 2,760

Balance sheet as at 31 December 2006 (extract)

Current assets
Prepaid stationery 300
Current liabilities
Accrued stationery 150
Exh.
3.18

Summary of Adjustments and


Financial Statement Links
Before Adjusting Adjusting
Category
B/S I/S Entry
Dr. Expense
Prepaid Expense Asset Expense
Cr. Asset
Dr. Liability
Unearned Revenue Liability Revenue
Cr. Revenue
Dr. Expense
Accrued Expenses Liability Expense
Cr. Liability
Dr. Asset
Accrued Revenues Asset Revenue
Cr. Revenue

Overstated

Understated
REVENUES: Accruals
and
Prepayments
Exh.
3.4

Framework for Adjustments

Transactions where cash is paid or


received before a related expense
or revenue is recognized.

Transactions where cash is paid or


received after a related expense
or revenue is recognized.
Example of An Accrued Revenue

On 1 January 2019 commission receivable is


owing of RM400.
During the year the business receives
commission of RM6,500.
However, RM500 of commission is still owed to
the business as at 31 December 2019.
Accrued Revenue
Accrued Revenue
Accrued Revenue
Accrued Revenue
Profit and loss account for the year ended
31 December 2006 (extract)
Gross profit xxx
Add commission received 6,600

Balance sheet as at 31 December 2006 (extract)


Current assets
Accrued commission receivable 500
Exh.
3.4

Framework for Adjustments

Transaction where cash is


received after a related
revenue is recognized.
Adjusting for Accrued Revenues
Revenues earned Yes, you can pay me
for your tax return
in a period that
when I finish the work.
are both
unrecorded and
not yet received.

Asset Revenue
Debit Credit
Adjustment Adjustment
Adjusting for Accrued Revenues
Smith & Jones, CPAs, had $31,200 of work completed but
not yet billed to clients. Let’s make the adjusting entry
necessary on December 31, 2002, the end of the
company’s fiscal year.
Adjusting for Accrued Revenues
•After posting, the accounts involved will
look like this . . .

Accounts Receivable Service Revenue


12/31 $31,200 12/31 $31,200
Example of a Prepaid Revenue

A business has a financial year ending


31 December.
On 1 January 2019 rent receivable paid in
advance was RM350.
During the year the business’s rent
received was RM2,500.
However, this figure includes RM500 of
rent receivable pre-paid for the year
beginning 1 January 2020.
Prepaid Revenue
Prepaid Revenue
Prepaid Revenue
Prepaid Revenue
Profit and loss account for the year ended
31 December 2019 (extract)
Gross profit xxx
Add rent received 2,350

Balance sheet as at 31 December 2019 (extract)


Current liabilities
Prepaid rent receivable 500
Exh.
3.4

Framework For Adjustments

Transaction where cash is


received before a related
revenue is recognized.
Adjusting Unearned Revenue
Cash received in
advance of
Buy your season tickets for
providing all home basketball games NOW!
products or
services. “GO SEAWOLVES”

Liability Revenue
Debit Unadjusted Credit
Adjustment Balance Adjustment
Adjusting Unearned Revenue
On October 1, 2002, UAA sold 1,000 season tickets to
its 20 home basketball games for $100 each. UAA
makes the following entry:
Adjusting Unearned Revenue

On December 31, UAA has played 10 of its regular


home games, winning 8 and losing 2.

Prepare the appropriate Adjusting


Entry on December 31
Adjusting Unearned Revenue

On December 31, UAA has played 10 of its regular


home games, winning 8 and losing 2.
Adjusting Unearned Revenue
•After posting, the accounts involved look like
this

Unearned Basketball
Revenue Basketball Revenue
12/31 $50,000 10/1 $100,000 12/31 $50,000
Exh.
3.18

Summary of Adjustments and


Financial Statement Links
Before Adjusting Adjusting
Category
B/S I/S Entry
Dr. Expense
Prepaid Expense Asset Expense
Cr. Asset
Dr. Liability
Unearned Revenue Liability Revenue
Cr. Revenue
Dr. Expense
Accrued Expenses Liability Expense
Cr. Liability
Dr. Asset
Accrued Revenues Asset Revenue
Cr. Revenue

Overstated

Understated
Accrued Revenues

Prepaid Revenues
End of Chapter 10

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