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Its accrual world. A guide to accrued and prepaid expenses
14th January 2013
An accrual is an amount used in an accounting period which will not be paid for until the next accounting period. In final accounts accrued expenses are: - added to the expense (from trial balance) before listing in the Income Statementshown as a current liability in the balance sheet This ensures the Income Statement records costs incurred for the year instead of amounts paid. The expense is adjusted to relate to the period covered by the Income Statement. The balance sheet shows a liability for the amount due but unpaid.
Worked example
Alesha’s trial balance shows a debit balance for
electricity and gas of £3,000. An
electricity bill for £250 is received 1 January 2013. As this bill is for electricity used in 2012,
an adjustment needs to be made.
- In the Income Statement account, the total cost of
£3,250 (i.e. £3,000 from the Trial Balance. plus £250 accrued) will be recorded
as expenses.
- In the balance sheet £250 will be shown as a current liability'.
The effect on profit
Adjusting an accrued expense reduces previously reported net profit as the expense increases. Thus the profit for the year of Alesha reduces by £250
Prepayment of expenses
A prepayment is a payment made in this accounting period but will be used in the next accounting period. It is the opposite of an accrual part of the expense has been paid in advance. In the final accounts prepaid expenses are:
- deducted from the expense amount of the trial balance before listing it in the Income Statement
- shown as a current asset in the year end balance sheet
This ensures the Income Statement account record costs incurred not amounts paid.
- The Income Statement account expense relates to the time covered by the Income Statement.
- The year-end balance sheet shows an asset for the amount prepaid.
Worked example
The owner of Alesha tells you the trial balance figure for rent and rates of £2000 includes £100 of rent paid in advance for Jan 2013. An adjustment needs to be made.
- In the Income Statement account, the cost of £1,900 (i.e. £2.000 from the trial balance, less the £ 100 prepaid) will be recorded as an expense.
- In the balance sheet £100 will be shown as a current asset “prepayment”
The effect on profit
Prepayment of an expense has the effect of reducing
expenses so profit for the year is greater by £100.
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