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189
The rent account as at 31 December 20X6 will record only two rental payments (on 31 July and
31 October). There will be two months' accrued rental expenses for November and December 20X6
($2,000), since the next rental payment is not due until 31 January 20X7.
The charge to the statement of profit or loss for the period to 31 December 20X6 will be for eight
months' rent (May–December inclusive) and so it follows that the total rental cost should be $8,000.
So far, the rent account appears as follows.
RENT ACCOUNT
$
$
20X6
20X6
31 Jul
Cash
3,000
31 Oct
Cash
3,000 31 Dec Statement of profit
or loss
8,000
To complete the picture, the accrual of $2,000 has to be put in, to bring the balance on the account up
to the full charge for the year. At the beginning of the next year the accrual is reversed.
RENT ACCOUNT
$
$
20X6
20X6
31 Jul
Cash *
3,000
31 Oct
Cash *
3,000
31 Dec
Balance c/d (accruals)
2,000
31 Dec Statement of profit or
loss
8,000
8,000
8,000
20X7
1 Jan Balance b/d
(accrual reversed)
2,000
* The corresponding credit entry would be cash if rent is paid without the need for an invoice – eg with
payment by standing order or direct debit at the bank. If there is always an invoice where rent becomes
payable, the double entry would be:
DEBIT Rent
account
$2,000
CREDIT Payables
$2,000
Then when the rent is paid, the ledger entries would be:
DEBIT Payables
$2,000
CREDIT Bank
$2,000
The rent account for the next year to 31 December 20X7, assuming no increase in rent in that year,
would be as follows.
RENT ACCOUNT
$
$
20X7
20X7
31 Jan
Cash
3,000 1 Jan
Balance b/d
30 Apr
Cash
3,000
(accrual reversed)
2,000
31 Jul
Cash
3,000
31 Oct
Cash
3,000
31 Dec
Balance c/d (accruals)
2,000 31 Dec Statement of profit or
loss
12,000
14,000
14,000
20X8
1 Jan
Balance b/d
(accrual reversed)
2,000
A full 12 months' rental charges are taken as an expense to the statement of profit or loss.
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PART D: RECORDING TRANSACTIONS AND EVENTS
190
1.8 Further example: prepayments of income (also referred to as deferred
or unearned income)
Income can be prepaid, for example rent paid in advance and subscriptions to a trade association as in
the following example). This is income the recipient has not yet earned and could be repayable.
Therefore the treatment is to exclude the prepaid income from the statement of profit or loss.
Terry Trunk commences business as a landscape gardener on 1 September 20X5. He immediately
decides to join his local trade association, the Confederation of Luton Gardeners, for which the annual
membership subscription is $180, payable annually in advance. He paid this amount on 1 September.
The Confederation makes up its accounts to 30 June each year.
In the first period to 30 June 20X6, Terry has paid a full year's membership, but only 10/12 of the
subscription should be charged to the period (ie
10/12
$180 = $150). There is a prepayment of two
months' membership subscription (ie
2/12
$180 = $30).
The prepayment is recognised in the Confederation's ledger account for subscriptions. For simplicity,
only Terry's subscription is shown. This is done in much the same way as accounting for accruals, by
using the balance carried down / brought down technique.
DEBIT
Subscriptions account with prepayment as a balance c/d
$30
CREDIT
Subscriptions account with the same balance b/d
$30
Remember that the prepaid subscription is a liability because, theoretically, this amount could be repaid
to Terry.
The remaining expenses in the subscriptions account should then be taken to the statement of profit or
loss. The balance on the account will appear as a current liability (prepaid subscriptions) in the
statement of financial position as at 30 June 20X6.
SUBSCRIPTIONS ACCOUNT
$
$
20X6
20X5
30 Jun Statement of profit or loss 150
1 Sep
Cash
180
30 Jun Balance c/d
(prepayment)
30
180
180
20X6
1 Jul
Balance b/d
(prepayment reversed)
30
The subscription account for the next year, assuming no increase in the annual charge, will be:
SUBSCRIPTIONS ACCOUNT
$
$
20X7
20X6
30 Jun Statement of profit or loss
180
1 Jul
Balance b/d
30
30 Jun Balance c/d
1 Sep
Cash
180
(prepayment)
30
210
210
20X7
1 Jul
Balance b/d
(prepayment reversed)
30
Again, the charge to the statement of profit or loss is for a full year's subscription. Remember that the
prepaid subscription b/d is, theoretically, repayable if Terry ceases to be a member. Therefore it is a
liability.
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CHAPTER 10
//
ACCRUALS AND PREPAYMENTS
191
1.9 Effect on profit and net assets
You may find the following table a useful summary of the effects of accruals and prepayments.
Effect on income/expenses
Effect on profit
Effect on assets/liabilities
Accruals
Increases expenses
Reduces profit
Increases liabilities
Prepayments
Reduces expenses
Increases profit
Increases assets
Prepayments
of income
Reduces income
Reduces profit
Increases liabilities
QUESTION
Statement of profit or loss and statement of financial position
The Umbrella Shop has the following trial balance as at 30 September 20X8.
$
$
Sales
156,000
Purchases
65,000
Land and buildings – carrying value at 30.9.X8
125,000
Plant and machinery – carrying value at 30.9.X8
75,000
Inventory at 1.10.X7
10,000
Cash at bank
12,000
Trade accounts receivable
54,000
Trade accounts payable
40,000
Selling expenses
10,000
Cash in hand
2,000
Administration expenses
15,000
Finance expenses
5,000
Carriage inwards
1,000
Carriage outwards
2,000
Capital account at 1.10.X7
180,000
376,000 376,000
The following information is available.
(a)
Closing inventory at 30.9.X8 is $13,000, after writing off damaged goods of $2,000.
(b)
Included in administration expenses is machinery rental of $6,000 covering the year to
31 December 20X8.
(c)
A late invoice for $12,000 covering rent for the year ended 30 June 20X9 has not been included
in the trial balance.
Required
Prepare a statement of profit or loss and statement of financial position for the year ended
30 September 20X8.
EXAM FOCUS POINT
You will almost certainly have to deal with accruals and/or prepayments in the exam. Make sure you
understand the logic, then you will be able to do whatever question comes up.
The January to June 2017 examining team's report provides an example of a type of question relating
to the heat and light account expense. This question is designed to test whether candidates understand
prepayments and accruals.
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