Accruals, Prepayments, Depreciation and Provisions
What the exam tests
This domain tests year-end adjustments: accruals, prepayments, depreciation and provisions, and their effect on profit and financial position.
Core rules
- Accrued expense: expense incurred but not paid; credit liability. Prepaid expense: payment made for future period; debit asset.
- Accrued income: income earned but not received; debit asset. Income received in advance: credit liability.
- Depreciation allocates the depreciable amount systematically over useful life. Straight line = (cost - residual)/life; reducing balance = carrying amount x rate.
- A provision is a liability of uncertain timing or amount and is recognised when a present obligation exists, outflow is probable and the amount can be estimated reliably.
Worked example
Rent paid N480,000 covers 12 months to 31 March next year; year end is 31 December. Three months relate to the next year, so prepayment = 480,000 x 3/12 = N120,000 and expense = N360,000. A machine costs N2,400,000, residual N400,000, life five years. Straight-line depreciation = (2,400,000 - 400,000)/5 = N400,000. Receivables are N800,000; allowance for doubtful debts is 5%, N40,000. If the opening allowance was N30,000, the increase of N10,000 is charged to profit or loss.
Traps
Do not treat a prepayment as an expense in the current year. Do not depreciate below residual value. A provision is recognised; a contingent liability is only disclosed unless the outflow is remote or the recognition criteria are met. Depreciation is an allocation, not a cash payment.