CHAPTER 4
PREPAYMENTS AND ACCRUALS

 

Chapter 4 explains prepayments and accruals.

The income statement of a business measures the profit by considering revenues earned and expenses incurred in an accounting year.

 

 

Remember:

Sales,
less cost of sales,
equals Gross Profit.

 

 

ACCRUAL CONCEPT

  • The accruals concept states that income and expenses should be included in the income statement of the period in which they are earned or incurred and not paid or received.

 

An Example

  • A business rents a shop for K1,200 per annum (K100 per month). If at year end, the business has only paid K1000, a full years charge of K1,200 will be expensed in income statement. The K200 though not paid will be included because it relates to the same period.

 

  • While the business may owe others for expenses, the business may also be owed for other amounts apart from trade among others:

>        Rent receivables

>        Commission receivable

>        Unsettled claims for insurance etc.

 

 

PREPAYMENTS

  • Prepayments are amount paid in advance before a service/good is provided.
  • Other persons or organizations make payments in advance to the business for certain items e.g. for rent receivable and any other income.
  • Any amount receivable paid in advance would not be included in income statement in the year it is received.
  • It should be accounted for in the period the service will be provided.
  • In balance sheet it should be reflected under current liabilities as other payables.

 

CHAPTER SUMMARY

 

       i.            Accruals are amounts the business has not yet paid or received for services provided.

     ii.            Accruals can be by the business or to the business.

  iii.            Prepayments are amounts paid in advance by the business or to the business.

  iv.            The matching or matching concept requires that income and expenses whether paid or not as long as they relate to the accounting period under review, should be matched when computing profit for that period.

     v.            Accruals by the business are included as a charge in income statement, and shown under current liabilities in balance sheet (accrued expenses).

  vi.            Accruals to the business (income) are also included in income statement added to amount received, but stated as current asset in balance sheet (other receivables).

vii.            Prepayments by business are excluded in income statement from total amount paid and reflected as current asset in balance sheet (prepayments).

   ix.            Prepayments to the business are also deducted from total amount received in income statement but shown as current liability in balance sheet (other payables).