Accruals and Prepayments PDF

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Accruals and Prepayments...

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Financial Accounting Accruals and Prepayments

Accruals and Prepayments The need for an accruals approach • Ideally we want to MATCH revenue and costs in our income statement on both a o Time Basis

o Volume Basis

Accrued Expenses • Expenses we have incurred but not paid for at the yearend. • We need to add the cost of the goods not yet consumed to our total expense for the year. • The double entry is o Dr o Cr • In the financial statements for the FOLLOWING year the accrual brought forward at the start of the year is deducted from the expense for that year.

Financial Accounting Accruals and Prepayments • Example: Jones starts in business on 1 May 20X1, and has a 31 December year end. He pays for electricity on a quarterly basis in arrears. His first three bills are o Quarter ended 31July 20X1 $800 o Quarter ended 31 October 20X1 $1,100 o Quarter ended 31 January 20X2 $1,200 o Quarter ended 30 April 20X2 $1,300 o Quarter ended 31 July 20X2 $900 o Quarter ended 31 October 20X2 $1,400 o Quarter ended 31 January 20X3 $1,500 • Requirement: Calculate the electricity cost for the period to 31 December 20X1 and 20X2?

Financial Accounting Accruals and Prepayments Prepaid expenses • Here we pay for a service in advance of receiving it. • At the year end it could be that we have paid for part of the service for the following year. • We need to DEDUCT the amount that relates to the following year from our expense this year. • The double entry is o Dr o Cr • The prepayment is ADDED to the cost of the service in the income statement in the following year. • Example: Scooby starts in business on 1 May 20X4. He pays insurance for 12 months to 30 April 20X5 of $1,800. He then pays insurance for the 12 months to 30 April 20X6 of $2,100. Scooby’s year end is 31 December. Requirement: Calculate the insurance cost and prepayment in the financial statements for years ending 31 December 20X4 and 20X5.

Financial Accounting Accruals and Prepayments Deferred Income • This arises when we receive income from a customer BEFORE we have delivered them a service. • We should DELAY showing this as part of sales/revenue until delivery takes place. • The deferred element of the income is therefore treated as a LIABILITY, because in theory the customer could be given their money back if we fail to provide the product to them. • The double entry is: o Dr o Cr

Financial Accounting Accruals and Prepayments • Example: Smita started in business on 1 October 20X1 selling a monthly magazine. Smita has a 31 December year end. Customers pay for a 12 month subscription to the magazine for $60 a year. o In October 20X1 25 customers subscribe for the magazine. o In November 20X1 30 new customers subscribe for the magazine. o In December 20X1 40 new customers subscribe for the magazine. • Requirement: Show Smita’s sales income for the year and the deferred income in the statement of financial position for the year ended 31 December 20X1.

Financial Accounting Accruals and Prepayments Cost of Sales • The aim is to match the volume/number of goods sold with the cost of producing/buying the same number of goods (ignoring wastage). • This is achieved by calculating a cost of sales figure as follows OPENING inventories

x

PLUS purchases/produced

x

LESS CLOSING inventories

(x)

Total cost of sales

x

• Example Uhuru sells 500 iPhones during the month for £400 each. At the start of the month she has 120 in inventories, she buys 650 during the month, all of which cost her £300 each. What is the gross profit made by Uhuru during the month?

Financial Accounting Accruals and Prepayments Supertutorial Question: Bones starts in business on 1 March 20X3: His year end is 31 December. He has the following transactions: Gas, paid in arrears Quarterly invoice to 31 May 20X3 $500 Quarterly invoice to 31 August 20X3 $700 Quarterly invoice to 30 November 20X3 $1,000 Quarterly invoice to 28 February 20X4 $1,800 Quarterly invoice to 31 May 20X4 $640 Quarterly invoice to 31 August 20X4 $780 Quarterly invoice to 31 November 20X4 $940 Quarterly invoice to 28 February 20X5 $1,320

Local business taxes paid in ADVANCE Six months to 31 August 20X3 $1,200 Six months to 28 February 20X4 $1,200 Six months to 31 August 20X4 $1,500 Six months to 28 February 20X5 $1,500 Requirement: Show how the above transactions are included in the financial statements for the years ended 31 December 20X3 and 20X4

Financial Accounting Accruals and Prepayments Tutorial Question 1: Spock starts in business on 1 March 20X3: His year end is 31 December. He has the following transactions: paid in arrears Quarterly invoice to 31 May 20X3 $600 Quarterly invoice to 31 August 20X3 $900 Quarterly invoice to 30 November 20X3 $1,400 Quarterly invoice to 28 February 20X4 $2,100 Quarterly invoice to 31 May 20X4 $540 Quarterly invoice to 31 August 20X4 $780 Quarterly invoice to 31 November 20X4 $1,080 Quarterly invoice to 31 February 20X5 $1,500

Local business taxes paid in ADVANCE Six months to 31 August 20X3 $1,500 Six months to 28 February 20X4 $1,500 Six months to 31 August 20X4 $1,800 Six months to 28 February 20X5 $1,800 Requirement: Show how the above transactions are included in the financial statements for the years ended 31 December 20X3 and 20X4

Financial Accounting Accruals and Prepayments 2: Kirk is a retailer of televisions. On 1 January he has 30 in inventories, at a cost of £450 each. During January he buys 600 televisions for £450 each and sells 480 at £600 each. Requirement: Calculate Kirk’s gross profit for January...