ACCRUALS AND PREPAYMENTS

1.0 INTRODUCTION

There are transactions which take place after the books of accounts have been closed and trial balance prepared. In order to give the actual results of the year’s operations and to ensure that the balance sheet gives a true and fair view of the financial position, these transactions need to be adjustably incorporated into the final accounts for them to give a correct picture of the financial position of the reporting entity, as at the period ended. This Unit shall discuss these adjustments to be made, why and how.

2.0 OBJECTIVES

At the end of this unit, you should be able to:

1. prepaid and accrued expenses 
2. income received in advance and Income due to accrue 
3. other relevant issues. 

3.0 MAN CONTENT

3.1 Accruals and Prepayments

3.2 Expenses

These are amounts incurred for the purpose of earning an income. Expenses are written off to the income statement in line with the principles of cause and effect. However, there are times when such expenses are either not paid in full or the amount paid for exceeds the current accounting period of the receiving business. These instances are discussed below:

3.2.1 Prepaid Expenses

These are payments made in respect of a period beyond the date of account. It is in the nature of an asset; that is, the benefit of the expenditure is still to be derived. The portion which relates to the current period is transferred to the profit and loss and the balance which relates to the future period is shown under the current asset in the balance sheet.

 Accrued Expenses

This occurs where an expense has been incurred but not brought into the account as a result of it not being paid for. The amount of expenses shown in the ledger must be increased to allow for the expenses due but not yet entered. The accrued expenses are shown in the balance sheet under current liabilities at the end of the period.

SELF ASSESSMENT EXERCISE 1

1.  Why is prepaid expense an asset item? 
2. How is an accrued expense treated in the balance sheet? 

 Incomes

These are proceeds realized from transacting business. Incomes are the primary aim of being in business without which survival becomes difficult. Some incomes are often received in advance such as rental income while some are paid after being due. The adjustments required in either of the scenario mentioned are discussed below:

 Income in Advance

This is where sums have been received during a period in respect of future services. Only part of such sums which relates to the current period is transferred to the profit and loss account as earned income, while the portion relating to future period is shown in the balance sheet under current liabilities.

Income Due

These are incomes which are due but not yet received at the trial balance date. The amount of income shown in the ledger must be increased to allow for income due but not yet entered. The income accrued is shown in the balance sheet under current asset at the end of the period.

4.0 CONCLUSION

We have discussed accruals and prepayments adjustments that may arise in the course of preparation of final accounts for any form of business. We have also discussed various methods that may be applicable in the treatment of an item of expense and income in the final accounts. The Unit compliments other Units that are about adjustments to final accounts.

5.0 SUMMARY

In this Unit, we have explained the accounting treatments of prepaid and accrued expenses, income received in advance and income due. The Unit demonstrates how these issues are incorporated in the final accounts of any form of business.