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In today’s class, we will be talking about the final accounts – accruals and prepayments. Enjoy the class!
Final Accounts – Accruals and Prepayments
The accrual concept states that revenue and expenditure of a period should be matched together – whether or not such revenue or expenditure had actually been received or paid for.
This means that items of expenditure or income are shown in the final account should be for sums actually related to the period covered by the financial statements prepared in the final account. Therefore statements such as the Trading and Profit and Loss Account should be prepared on the accruals, or matching basis so that expenses are matched to the revenue earned: that is, expenses are shown in the Profit and Loss Account as they have been incurred rather than as they have been paid. Similarly, incomes are shown in the Profit and Loss Account as they have been earned rather than as they have been received.
Accrual can be divided into
(a) Accrued expenses
(b) Accrued income (i.e. income received in arrears)
These are expenses which accrued but have not been paid for or discharged. They are also referred to as expenses owing or creditors for expenses e.g. Accrued electricity.
Supposing rent for 9 months (says N18,000) had actually been paid, that of the remaining 3 months (say N6,000) not yet paid must also be charged to Profit and Loss Account making the total rent N24,000 (i.e. N18,000 + N6,000) for the 12 months accounting period for which the Profit and Loss Account is prepared.
The Rent Account will appear as follows:
July 2 Cash 18,000 Dec. 31 Profit and Loss 24,000
Dec. 31 Accrued Rent c/d 6,000
Jan. 1 Accrued Rent b/d 6,000
The credit balance of N6,000 on the Rent Account is an accrued expense and is shown as a current liability in the Balance Sheet as at 31st December …….
These are incomes which are due in respect of the current trading period but such income have not been received at the close of final account preparation. It is also referred to as income receivable e.g. interest receivable, rent receivable, commission receivable.
In the year ended 31st December 2005, Modupe had received interest of N4000 on her fixed deposit account with First Bank Nig. Plc. At that date, interest for the half-year to 31st December 2005 was due from the bank. The entries in the Interest Receivable account of Modupe on 31st December 2005 are as follows:
2005 N 2005 N
Dec. 31 Profit and Loss 8,000 Sept. 15 Bank 4,000
Dec. 31 Interest accrued c/d 4,000
Jan 1 Balance b/d 4,000
The balance of N4,000 on the Interest Receivable Account is shown as a current asset in the Balance Sheet as at 31st December 2005.
- List six uses of the General Journal.
- State two similarities and two differences between the Trading Account and the Profit and Loss Account.
Prepayments are payments made in advance of the benefits to be derived from them. It represents the amount paid in the current period for services to be received in a subsequent period.
Prepayment can be divided into
(a) Prepaid expenses
(b) Income received in advance
These are expenses like rent, insurance etc. which are paid in advance for the subsequent period. Only the expenses for the period must be charged to the Profit and Loss Account. Therefore expenses paid in advance are deducted from total payments in line with the requirements of the matching concept.
Supposing N15,000 is paid for electricity and it is for 15 months, the amount to be charged to the Profit and Loss Account at the end of the year is not N15,000 but N12,000
i.e. N15,000 x 12 months
while the N3,000 balance is regarded as prepayment or payment in advance.
The Electricity (or Lighting and Heating)Account will appear as follows:
20×5 N 20×5 N
Jan. 23 Cash 15,000 Dec. 31 Profit and Loss 12,000
“ “ Prepaid Electricity c/d3,000
Jan. 1 Prepaid Elect. b/d 3,000
The debit balance of N3,000 on the Electricity Account is a prepaid expense and is shown as a current asset in the Balance Sheet as at 31st December, 20×5.
INCOME RECEIVED IN ADVANCE:
These are income received by the organization during the current period but which relate to the next (or subsequent) trading period e.g. rent received in advance.
In the year ended 31st December 2007, Elizabeth had received N30,000 for rent from a tenant. At that date rent for the half-year has been prepaid by the tenant. Show the Rent Receivable Account in the books of Elizabeth.
2007 N 2007 N
Dec. 31 Profit and Loss 20,000 Jul. 8 Bank 30,000
Dec. 31 Balance c/d 10,000
Jan 1. Balance b/d 10,000
The credit balance of N10,000 on the Rent Receivable Account is an income received in advance and is shown as a current liability in the Balance Sheet of Elizabeth as at 31st December 2007.
- What accounting concepts underly your treatment of these items.
- Why is it necessary to make adjustments in the final accounts for accruals and prepayments?
- How will you account for the following when preparing the final accounts?
(i) Accrued Expenses
(iii) Rent Receivable Outstanding
In our next class, we will be talking about Depreciation of Fixed Assets. We hope you enjoyed the class.
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