Accruals are expenses that have been incurred but not paid for. For example, an unpaid electricity bill is an accrual expense; the electricity has been consumed (the cost has been incurred), but not paid for.
Prepayments are payments made in advance of the benefits to be derived from them. Rent is an example because it usually has to be paid in advance.
How to treat an accrued expense in an account:
An accrued expense is an amount that is owed to somebody and that somebody is a creditor. The creditor must be represented in the expense account by a credit balance carried down on the account.
Example: the accounting year of a business ended on 31 December 2016. In the 11 months ended 30 November 2016, payments for electricity amounted to $900. At 31 December 2016 there was an unpaid electricity bill for $130. That amount is carried down on the account as a credit balance.
• Only $900 has been paid but the Profit and Loss Account has been debited with the full cost of electricity for the year, $1,030.
• A creditor for the amount owing for electricity has been created on the account by a credit balance carried down.
• The creditor will be shown in the Balance Sheet under current liabilities as an ‘accrued expense’ or as an ‘expense creditor’ to distinguish it from ‘trade creditors’.
How to treat a prepaid expense in an account:
The person to whom a payment has been made in advance is a debtor of the business. The debtor is represented on the expense account by a debit balance carried down.
Example: Yousif rents a premise at a rate of $2,000 per annum, the rent being payable in advance on 1 January, 1 April, 1 July and 1 October. In 2016, Yousif paid the rent on each of these dates, but on 31 December he paid the rent due on 1 January 2017. At 31 December, the landlord is a debtor for the amount of the prepayments.
• Payments during the year amount to $2,500, but the Profit and Loss Account has been debited with the rent for one year only.
• The debtor (the landlord) is represented by the debit balance on the account.
• The debit balance will be included in the Balance Sheet under current assets as a prepayment to distinguish it from trade debtors.
How to record stocks of stores on expense accounts:
Some expense accounts represent stocks of consumable stores. Examples are stationery, heating fuel and fuel for motor vehicles. Stock of consumable stores may be unused at the year-end. According to the matching principle, these stocks should not be charged against the profit for the year; they are an asset and not an expense at the year-end. Carry them down as a debit balance on the account. This may result in an expense account having debit and credit balances at the year-end.
How to adjust income for accruals and prepayments:
Some income accounts such as rents or interest receivables may need to be adjusted for income received in advance or in arrears. Income received in advance of its due date indicates the existence of a creditor and requires a credit balance equal to the prepayment to be carried down on the account. Income accrued at the date it is due indicates existence of a debtor and a debit balance equal to the amount should be carried down on the account.
Adjusting your income for accruals and prepayments can be slightly confusing if you don’t have sufficient knowledge and experience in accounting fields. To keep a tight grip on your economics, seek an accounting firm for bookkeeping services in Singapore.