Accruals, Prepayments and Adjusting Entries
What the exam tests
This domain tests the accrual concept, matching of income and expenses to the period, and adjusting journals for accrued and prepaid items. Expect profit and statement of financial position effects.
Core rules
- Accrued expense: expense incurred but not yet paid; debit expense, credit accrual liability.
- Prepaid expense: expense paid in advance; debit prepayment asset, credit expense.
- Accrued income: income earned but not yet received; debit receivable, credit income.
- Deferred income: income received in advance; debit income, credit liability.
- Adjustments ensure the income statement shows the period's expense and income, not simply cash paid or received.
Worked example
Rent paid during the year is 4,800 for the 12 months to 31 March next year. The year end is 31 December, so 3 months relate to the next period. Prepaid rent = 4,800 x 3/12 = 1,200. Rent expense for the year = 3,600. Journal: Dr Prepayments 1,200; Cr Rent expense 1,200. The prepayment is a current asset; the expense in profit or loss is 3,600.
Traps
Do not charge the full cash paid to the current year's profit. Do not confuse an accrual with a prepayment: an accrual is a liability for an unpaid expense; a prepayment is an asset for an unused payment. Check the period covered by the payment rather than assuming it matches the accounting year. For deferred income, the liability is the unearned portion.
Key points
- Accruals add unpaid expenses; prepayments remove unused expense.
- Accrued income is a receivable; deferred income is a liability.
- Adjusting entries change both profit and the statement of financial position.
- Match the expense to the period benefited.