CHAPTER 13
ACRUALS AND PREPAYMENTS
- LEARNING OBJECTIVES
The accruals basis of accounting consists of recording revenue in the period in which it is earned and recording expenses in the period in which they are incurred. The receipt or disbursement of cash in the same period may or may not be involved. Revenue is generally recognized when services are performed or goods are provided, and is considered to be earned when in exchange for something of value is received or legal claim is made.
Expenses should be recognized when goods or services are consumed. The accruals basis of accounting involves the period – by – period matching of revenue with expenses that caused or aided in producing that revenue. In keeping business records, accountants must think in terms of time intervals and must be sure that the revenues and expenses are accounted for in the proper accounting period.
- PREPAID EXPENSES
A prepaid expense is an item that was purchased and considered to be an asset when acquired but which will be consumed or used up in the near future and thus become an expense.
Purchase of various sorts of supplies and payments for utilities and insurance are good examples of prepaid expenses. At the end of the period, the portions of such assets that have expired or have been consumed must be determined and entries made by debiting the proper expense accounts and crediting the proper prepaid expense accounts.
ACRUED INCOME
The accrued basis concept of accounting states that revenue is recognized in the accounting period in which it is earned and expenses are recognized in the accounting period in which they are incurred. Accrued income is income earned but not received during an accounting period i.e. amount owed or where a business receives income other than sales revenue it may have earned some income.
For Example
Accrued interest may be interest payable or interest receivable. Accrued rent may be rent payable or rent receivable. One is an expense the other is revenue.
13.3 OTHER CONSIDERATIONS
The combined effect of the realization and matching concepts plus the accruals basis concept provide some assurance that income is accurately measured.
Under the accruals basis concept
- Expenses may be paid for in advance (prepayments) or in arrears
(accrued).
- Similarly revenue may be received in advance or be accrued.
- Debit closing balances in an expense account represent an outstanding balance of a prepayment. It is an asset shown as a current asset in the balance sheet.
- Credit closing balance, in an expense account; represent outstanding balance in amount owing. It is a liability and appears as a current liability in the balance sheet.
SUMMARY OF THE CHAPTER
The chapter introduced periodic adjustments to accounts in the forms of accruals and prepayments. This introduction was supported through the use of the principles contained in the accruals concept after which respective nature and purpose of the adjustments were illustrated. The treatment of revenue owing at the end of a period was also provided followed by presentation of the items in financial statements.