topic 8 adjustments for accruals + prepayments

• The income statement is prepared using income and expenditure
• Rule for accrued expenses:

  • add accrued expenses to the trial balance figure when preparing the income statement, show the total amount of the amount paid + accrued
  • include accrued expenses as a current liability in the SOFP, just the amount accrued!
• Rules for prepaid expenses:

  • minus prepaid expenses from the trial balance figure when preparing the income statement, show the total amount paid - prepaid
  • include prepaid expenses as a current asset in the SOFP, just the amount prepaid!
• Interest payable is an expense in the income statement and as with all other expenses the accrual concept applies, namely if it is the amount of interest due for the accounting year which must be included in the income statement, not the amount actually paid. To calculate the interest due for the year, the amount of loan is multiplied by the rate of interest chargeable on the loan
• Rules for accrued income:

  • add accrued income to the trial balance figure when preparing the income statement
  • include accrued income as a current asset in the SOFP, just the amount accrued!, show the total of the amount of the amount received + accrued
• Rules for prepaid income:

  • minus prepaid income from the trial balance figure when preparing the income statement
  • include prepaid income as current liability in the SOFP just the amount accrued!, show the total of the amount received + accrued
• SOFP entries: Accrued expense is a current liability and is expense owing. Prepaid expense is a current asset and is when an expense has been paid in advance. Accrued income is a current asset and is income owing. Prepaid income is a current liability and is when income has been received in advance
• Drawings - the trial balance figures may also need to be amended if there are unrecorded drawings, if the owner has taken goods from the business for personal use or puts personal expenses through the business accounts. The double entry to correct this would be:

  DR Drawings CR Purchases/expense
• When completing financial statements from a trial balance:

  • minus the goods use from purchases (to calculate gross profit)
  • minus the personal items from the expense (to calculate profit for the year)
  • add to the trial balance figure for drawings in the SOFP
• Accrued expenses - When a business owes expenses, the expense owing is added in the IS. This is shown in the expense account by the expenses owing being the balance cd on the DR side and balance bd on the CR side because accrued expenses are a current liability
• Prepaid expenses - When a business pays expenses in advance, the amount prepaid is subtracted in the IS. This is shown in the expense account by the expenses prepaid being the balance cd on the CR side and balance bd on the DR side because prepaid expenses are a current asset
• Balances accrued/prepaid at the start of the year: Calculating the amount to go in the IS is more complicated if expenses are accrued/prepaid at both the beginning of the year and the end of the year
• PAPA:

  DR side: Bal bd (prepaid) / Bal cd (accrued)

  CR side: Bal bd (accrued) / Bal cd (prepaid)
• Ledger accounts accrued/prepaid income: DR Bank (or cash) CR Income account. In the ledger accounts for income (APAP) the items appear on the completely opposite sides to the ledger accounts for expenses (PAPA)