LECTURE NOTE: ACCRUALS & PREPAYMENTS

INTRODUCTION

Before it is possible to determine accurately the profit earned by the business for the financial
year, any adjustments to the expense and revenue accounts must be made. The common
adjustments are:

a. Accrued expenses: expenses incurred by the business but

not yet paid or recorded in the books.

b. Accrued revenue/income: income earned by the business

but not yet received or recorded in the books.

c. Prepaid expenses: expenses paid in advance which related wholly or partly to the
next financial year.

d. Unearned revenues/ revenue received in advance: revenue actually received but

which will not be earned, wholly or partly, until the next financial year.

MATCHING CONCEPT

All the expenses and revenues for a particular period must be properly match in order to
accurately determine the profit or loss.

The matching of expenses with revenue is known as accrual accounting as distinct from the cash
basis accounting. According to the accrual accounting, adjustments for the expenses and
revenues must be made in the Income Statement in order to show the true profit or loss for the
period. Similarly, BS must also show a true and fair view of the financial position of the company
at a particular date, it is essential that all liabilities of the business be brought to account and that
all assets be included at realizable value.

Accrued expenses

Eg: Consider the annual rent is RM12,000 per year. However, until the end of the year, RM3,000
of the rent was not paid.

The double entry for the accrued rent is :

Dr. Rent expense a/c 3,000

Cr. Accrued rent expense a/c 3,000

The closing entry for the expenses a/c:

Dr. Income Statement 12,000

Cr. Rent expenses 12,000

Prepaid expense

Eg: Consider the annual insurance is RM2,400. For the year ended, let say that RM400 is
belongs to the next year.

The double entry is:

Dr. Prepaid insurance a/c 400
Cr. Insurance a/c 400

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 The closing entry is;
Dr. Income Statement 2,400
Cr. Insurance a/c 2,400

Accrued revenue

Eg: Consider a company rents out its property for RM6,000 per year. For the year ended it only
received RM4,000 cash, whereby RM2,000 is considered accrued rents revenue.

The double entry is:

Dr. Accrued Rent Received 2,000
Cr. Rent Received 2,000

The closing entry is:

Dr. Rent received 6,000
Cr. Income Statement 6,000

Unearned revenue/revenue received in advanced

Eg: Consider a company received RM6,400 for the rental, whereby RM800 is for the next
accounting period.

The double entry is:

Dr. Rent received a/c 800
Cr. Rent received in advanced 800

The closing entry is:

Dr. Rent received a/c 6,400
Cr. Income Statement 6,400

THE IMPORTANT POINTS ARE:-

 ACCRUED EXPENSE IS A LIABILITY

 ACCRUED REVENUE IS AN ASSET
 PREPAID EXPENSE IS AN ASSET
 REVENUE RECEIVED IN ADVANCE IS A LIABILITY

EXPENSES REVENUES
ACCRUED PREPAID ACCRUED PREPAID
Profit and Loss + Total Expenses - Total Expenses + Total Revenues - Total Revenues
account
Balance Sheet Current Liabilities Current Assets Current Assets Current Liabilities

Tutorial

1) Afiq’s Trial Balance on 30th June 2006 shows:

Wages RM6,500
Water & light RM2,000
Interest received RM3,000

The following items are still outstanding:

Wages RM100
Interest received RM300
Water bill RM400

Show: 1) Journal entries for the above transactions

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 HOW TO SOLVE THE ACCRUALS AND PREPAYMENTS QUESTIONS?

IDENTIFY WHETHER THE ACCRUALS AND PREPAYMENTs HAVE OPENING BALANCES (Bal
b/d)

If YES if NO
Step 1:
- make a reversing entry to reverse the effects of the
previous transactions. (reversing entry ? – for prepaid expenses
( Dr expenses Cr. Prepaid expenses)

Step 2:
- make the adjusting entries for the accruals and prepayments
- REMEMBER! – the double entries to record the accruals and
prepayments (accrued expenses, accrued revenue,
prepaid revenue (unearned revenue) and prepaid expenses
Step 3:
- transfer the expenses and revenue for the year in the Income
Statement (closing entry)
- All the expenses and revenues are nominal a/cs. (need to be transferred into IS)
- Accruals and prepayments need to be transferred into the BS
as CA or CL. (all acs that need to be transferred into the BS must have balance c/d)

Step 1:
- make the adjusting entry for the accruals and prepayments
- REMEMBER! – the double entry to record the accruals and
prepayments (accrued expenses, accrued revenue,
prepaid revenue (unearned revenue) and prepaid expenses

Step 2:
- transfer the expenses and revenue for the year in the Income
Statement.
- Accruals and prepayment need to be transferred into the BS
as CA or CL.

REMBEMBER !!!! – all the expenses and revenues stated in the Trail Balance involved cash
outflow and inflow ( the payments for the expenses have already been made and for the
revenues have already been received).

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Question 1

The following information was extracted from the books of Shim as at 31 August 2006.

As at 1 September 2005:
Electricity expenses prepaid RM1,500
Telephone expenses accrued RM275

During the year ended 31 August 2006, Shim has issued the following cheques:

30.6.2006 RM1,200 Tenaga Nasional Bhd

31.7.2006 RM1,800 TM Bhd

As at 31 August 2006

Telephone expenses prepaid RM585

Electricity expenses accrued RM1,100

Required:

Prepare:
i) Telephone account
ii) Water and electricity account
iii) Balance sheet extract as at 31 August 2006.

Question 2

Azman accepted a part time bookkeeping position with Mutiara trading. On his first day of work,
Azman’s boss left him the following message:

Although our accounting system is accrual based, we are very concerned about our
receipts and payments of cash. Please review this information and answer the questions
that follow.

Expenses and income in the Profit and Loss Account for the year ended 31 December 2006
include:

Interest expense RM5,000

Commission received RM20,000

31.12.2006 31.12.2005
Accrued interest RM1,400 RM1,800
Prepaid commission RM3,000 RM2,000

Required:

a) Determine the actual cash paid out for interest in 2006.

b) Determine the actual cash received for commission in 2006.

Question 3

Ibrahim is a new accounts clerk of Bina Trading. He has been told that the previous accounts
clerk did not take into account the accruals and prepayments. His boss wanted him to review all
the documents regarding the above matters for the year ending 31 January 2007.
Ibrahim has been provided with the following information:

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Interest expense for a year RM2,400
Rent expense for a year RM12,000
Commission income for a year a year RM16,000

Balance Sheet (extract) of related items as at 31 January 2006

Accrued interest expense RM800

Prepaid rent expense RM3,000
Commission income received in advance RM2,000

Bank
Commission income 20,000 Interest expense 1,000
Rent expense 2,000

You are required:-

i) Interest expense account
ii) Rent expense account
iii) Commission income account
iv) Income Statement for the year 31 January 2007
v) Balance Sheet as at 31 January 2007

Question 4

The extract trial balance of Selasa Enterprise at 31 October 2006

Particular Debit Credit

Insurance 24,000
Wages & Salaries 15,890
Interest income 13,245
Rental 35,886 14,440
Commission received 4,578
Water & Lighting 16,900
General expenses 9,873
Stationery 3,250

Adjustments on the day of preparing the final accounts (financial statements) are:-

a. The insurance expense was paid for the period of 12 months (from December 2005 until
November 2006).

b. The following are accrued expenses as at 31 October 2006

Wages and salaries RM 3,500
Rental expense M4,350
Electricity RM2,360

c. Rental received in advance amounted RM850

Show:-
a) All the necessary adjustments in the ledger accounts
b) Extract Income Statement for the year ended 31 October 2006
c) Extract Balance Sheet

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