Prepayments and Accruals

I will start off on a topic that is familiar to existing students and not touch on the basics too often. This topic on prepayments and accruals teaches us how to prepare the ledger accounts for Income and Expense item. For example, a typical business will have common expenses such as rent, insurance and utilities. Therefore, the very first step you need to do in exams is to be able to identify the type of topic the question is asking.

For example, if the question requires you to prepare an income/expense account, you will be able to identify that they are testing on your prepayments and accruals concepts.

How to tackle a question on prepayments and accruals?

Commonly, there can only be FOUR components in an expense account.

Expense a/c
Date	Particulars	DR(+)	CR(-)	Bal
First day	Prepaid expense/Accrued expense	PE	AE
Payment day	Cash at bank	CAB
Last day	Prepaid expense/Accrued expense	AE	PE
Last day	Profit and loss		P&L	-

1. On the first day of the accounting period, an expense can either be paid in advance(Asset) or it can still be owing(Liabilities).

For example, if your Utilities bill for the month of January amounts to $100 and you paid $130, we will then have a prepaid utilities of $30 on the first day of January. Likewise, if you had only paid $65, we will then start off with an accrued utilities of $35.

Essentially, PREPAID means TOO MUCH and ACCRUED means NOT ENOUGH.

2. Cash at bank component tells us how much has been paid for the expense. Therefore, it will be indicated in the question the amount that had been paid for the expense. Plug the figures and input into this account.

3. On the last day, we have to identify if the expense has been prepaid or accrued. Notice the numbers will be placed on the opposite side compared to the first day.

4. Profit and loss indicates how much expense we are SUPPOSE to pay. This is definitely different from the amount that you had paid because paying $100 for expenses does not mean that you are suppose to pay $100. You may be paying too much or inadequately.

Key pointers

1. There will only be 3 components given to you and you must be able to identify the last component. for example, they may provide information on component 1,2,3 and you need to find 4 yourself. Alternatively, they may provide 1,2,4 and you need to identify component 3.

2. The account must be zero-rised at the end of the year. (Indicated in the last row of the Balance column)

Practice question

Answer

Note:
This is a typical expense ledger and it will cost you approximately 4 marks. Want to know the preparation of an Income a/c? Call me at 91172152 to join my class!