topic 5 prepayments and accruals Flashcards
(21 cards)
what are balance day adjustments
- Entries made on the last day of an accounting period (often 30 June, but could be end of month if monthly reports are prepared for internal use).
- Recorded like other transactions (in journals, then posted to ledgers).
- essential part of accrual accounting.
why are balance day adjustments needed
they ensure:
- Correct profit/loss in Income Statement
- Accurate assets/liabilities in Balance Sheet
- Accrual accounting is followed
To ensure that the financial statements show appropriate amounts at the end of an accounting period when reports are prepared.
when do balance day adjustments arise
They often arise due to timing differences in relation to earning income (and receiving the cash) and incurring expenses (and the cash outflow).
adjusting income and expenses
By adjusting income and expenses, they ensure the appropriate amount of profit or loss (performance) is reported in the income statement.
adjusting assets and liabilities
By adjusting assets and liabilities, they ensure the appropriate financial position is presented in the balance sheet.
which accounts do BDAs affect?
- Always one income/expense and one asset/liability
- Never involves cash
2 types of balance day adjustments
- accruals
- prepayments
Accruals
- new info to record
- Income/Expense happened before cash flow
- Cash comes after
Accrued income
- Income that has been earned, but not yet received in cash and not yet recorded in the accounts.
(e.g. services provided, but customer hasn’t paid yet).
Asset (e.g. Accounts Receivable) ↑ Income ↑
Accrued expense
- incurred but not paid yet
Expense ↑
Liability (e.g. Wages Payable) ↑
Prepayments
- cash flow had already occurred and was recorded
- adjustment to existing information
- Cash flow happened before income/expense
Prepaid income
- cash received before it’s earned
Liability (Unearned Income) ↓
Income ↑
Prepaid expense
- cash paid before it’s used
Asset (Prepaid Expense) ↓
Expense ↑
Accruals relating to income
recording income for work that has been performed by the business but not invoiced
Accruals relating to expenses
recording an expense that was incurred in the accounting period but will not be paid until a future accounting period
accrued income also known as (3 more names)
Accrued Revenue, Income Receivable or Revenue Receivable
Prepaid income also known as (3 more names)
Prepaid Revenue, Unearned Income, Unearned Revenue
prepaid income - initially recorded as a liability
Prepaid income recorded as liability
→ Adjust for what’s earned
- adjusting entry reduces the liability to reflect portion of the prepaid income that has since been earned.
prepaid income - initially recorded as income
under accrual accounting:
- income should not be recorded as earned when cash received in advance.
- however if it is it increases the liability to reflect the portion of the prepaid income that has still not been earned.
prepaid expense - initially recorded as an asset
Prepaid expense recorded as asset
→ Adjust for what’s used
- the entry required reduces the asset to reflect the portion of the prepaid expense that has since been incurred or consumed.
Prepaid expense recorded as expense
Adjust for what’s not used
- If the business recognised an expense when the cash was paid, the entry required increases the asset to reflect the portion of the prepaid expense that has NOT been incurred or consumed.
