Business Accounts - Year-End Adjustments - Accruals and Pre-payments

Question 1

What does the accruals concept require?

Answer 1

That:
- Income and expenses are recognised in the accounting period to which they relate
- Current obligations are recognised as liabilities
- Assets are assessed for recovery through future profits

Question 2

What is an accrual?

Answer 2

An expense that relates to the current accounting period but has not yet been paid or invoiced by the year end

Question 3

Why is an accrual recorded?

Answer 3

To ensure the business’s profit is not overstated by failing to recognise an unpaid cost it has already benefited from

Question 4

Where does an accrual appear in the financial statements?

Answer 4

• As an expense in the profit and loss account
• As a current liability in the balance sheet.

Question 5

Example of an accrual?

Answer 5

A business uses legal services in the accounting year but receives the invoice after year end. The expected cost must still be included in that year’s legal expenses and shown as an accrual on the balance sheet.

Question 6

What is a pre-payment?

Answer 6

An expense that has been paid in advance, where the benefit will be received in the next accounting period

Question 7

Where does a prepayment appear in the financial statements?

Answer 7

• As a reduction in the relevant expense in the profit and loss account
• As a current asset in the balance sheet

Question 8

Give an example of a prepayment.

Answer 8

A business pays £30,000 rent in advance for a year on 1 October. If its accounting year ends 31 December, only £7,500 relates to the current year. The remaining £22,500 is a prepayment and appears as a current asset.

Question 9

How do accruals affect the profit figure?

Answer 9

They increase expenses, thereby reducing the reported profit for the current accounting period

Question 10

How do prepayments affect the profit figure?

Answer 10

They reduce expenses, thereby increasing the reported profit for the current accounting period

Question 11

What is the impact of not adjusting for an accrual?

Answer 11

The profit is overstated, because an expense the business has already incurred is missing.

Question 12

What is the impact of not adjusting for a prepayment?

Answer 12

The profit is understated, because an expense is recorded before the benefit is received.