Year-End Adjustments: Accruals and Prepayments Flashcards
(8 cards)
What is the main reason for making an accrual adjustment in the accounts at year-end?
A. To record future income
B. To delay recognition of income
C. To reflect income earned in prior years
D. To match expenses incurred with the correct accounting period
D. To match expenses incurred with the correct accounting period
Explanation: Accruals make sure expenses are included in the correct financial year, even if the payment is made after the year ends.
Devon Limited pays twenty-four thousand pounds for twelve months of insurance on the first of November. The year ends on thirty-first December. How should this be treated in the accounts?
A. Twenty-four thousand pounds as an expense, no further adjustment
B. Four thousand pounds as an expense, twenty thousand pounds as a prepayment
C. Twenty thousand pounds as an expense, four thousand pounds as a prepayment
D. Four thousand pounds as an expense, twenty thousand pounds as a prepayment
D. Four thousand pounds as an expense, twenty thousand pounds as a prepayment
Explanation: Only two months fall into the current year, so only two-twelfths of the payment is an expense. The rest is prepaid.
How is a prepayment shown in the financial statements?
A. As a non-current asset
B. As a deduction from sales
C. As a current asset on the balance sheet
D. As a long-term liability
C. As a current asset on the balance sheet
Explanation: Prepayments represent expenses paid in advance. They are recorded as current assets because they relate to future benefit in the next year.
At year-end, a business has received telephone services worth six hundred pounds in December but has not yet been invoiced. What adjustment is needed?
A. No adjustment required
B. Six hundred pounds as an accrual and added to the telephone expense
C. Six hundred pounds as a prepayment
D. Six hundred pounds as a capital expense
B. Six hundred pounds as an accrual and added to the telephone expense
Explanation: Since the business has already used the service, it must be recorded as an expense. It is also a liability because it has not yet been paid.
Which of the following statements is correct regarding the effect of failing to include an accrual in the accounts?
A. The business will understate its liabilities and overstate its expenses
B. The business will overstate its liabilities and understate its profit
C. The business will understate its liabilities and overstate its profit
D. The business will correctly match income to the period
C. The business will understate its liabilities and overstate its profit
Explanation: If an accrual is missed, the expense is not shown, which means the business will appear more profitable than it really is, and the liability will be missing.
Which entry best represents a prepayment adjustment in double-entry terms?
A. Debit expense, credit current liability
B. Debit current liability, credit expense
C. Debit expense, credit prepayment
D. Debit prepayment, credit expense
D. Debit prepayment, credit expense
Explanation: This removes the part of the expense that does not relate to the current year and records it as a current asset on the balance sheet.
Watson Engineering paid £12,000 on 1 July for a 12-month insurance policy. Its accounting year ends on 31 December. What figures should be included in the financial statements?
A. Profit and Loss: £6,000 expense, Balance Sheet: £6,000 prepayment
B. Profit and Loss: £12,000 expense, Balance Sheet: £0 prepayment
C. Profit and Loss: £3,000 expense, Balance Sheet: £9,000 prepayment
D. Profit and Loss: £0 expense, Balance Sheet: £12,000 prepayment
A. Profit and Loss: £6,000 expense, Balance Sheet: £6,000 prepayment
Explanation:
Only 6 months (July–December) of the insurance cost relates to the current financial year (£12,000 × 6/12 = £6,000). The remaining £6,000 relates to the following year and should be recognised as a prepayment (current asset).
Maya Ltd receives an invoice of £4,800 in January for utility services covering October to December of the previous year. The accountant failed to accrue this at year-end. What is the financial impact if the accounts are not adjusted?
A. Current liabilities understated, net profit overstated
B. Current assets overstated, net profit understated
C. Current liabilities overstated, net profit overstated
D. No impact as the invoice was received after year-end
A. Current liabilities understated, net profit overstated
Explanation:
The expense relates to the previous accounting period but was not recorded. This means expenses are understated, which leads to overstated profit. Since the liability was not included, current liabilities are understated.
