Accrued & Prepaid Expenses (Cambridge (CIE) O Level Accounting)
Revision Note
Written by: Dan Finlay
Reviewed by: Lucy Kirkham
Transferring Expenses to the Income Statement
How do I record expenses in the income statement?
The accounting principle of matching states that expenses should be recorded for the financial period in which they are incurred
The value posted to the income statement for an expense should be the actual amount invoiced for that period
Entries are made in the expense account:
During the financial period when payments are made
At the end of the financial period
Payments made during the financial period | At the end of the financial period | |
|---|---|---|
Account to debit | Expense account | Income statement |
Account to credit | Cash or bank account | Expense account |
Amount to record | The amount paid | The amount due to suppliers for the financial period |
How do I calculate the amount to charge to the income statement for an expense?
In an exam, you will likely be given information about an invoice for an expense for a period that does not fully align with the financial period
For example, the financial period might be from March 2023 to February 2024 but an invoice for an expense might be for August 2023 to July 2024
Only the amount for August 2023 to February 2024 should be posted to the income statement
STEP 1
Find the amount due per monthDivide the total amount by the number of months in the invoice period
STEP 2
Find the amount of the invoice due in that financial periodMultiply the amount per month by the number of months that are also in the financial period
There might be multiple invoices which cover the financial period
Find the amount of each which is due in the financial statement
Add these amounts together to get the total amount due
Examiner Tips and Tricks
It can help to write out the months involved and identify which ones belong in the financial period.
Worked Example
Soraia is a trader. Soraia pays her rent on 1 February each year for the following 12 months.
On 1 February 2023, she pays $6 420 for rent and on 1 February 2024 she pays $8 040 for rent.
How much should Soraia include for rent in her income statement for the year ended 30 April 2024?
Answer
The invoice period is from February 2023 to January 2024.
The financial period is from May 2023 to April 2024.
$6 420 is for the 12 months from February 2023 to January 2024.
Current financial period | |||||||||||||||||||||||
F | M | A | M | J | J | A | S | O | N | D | J | F | M | A | M | J | J | A | S | O | N | D | J |
$6 420 rent for the year | $8 040 rent for the year | ||||||||||||||||||||||
Only amounts due between May 2023 and January 2024 are included in the financial period.
STEP 1: Divide by 12 to find the monthly expense
$6 420 ÷ 12 = $535
STEP 2: Find the part of this payment to be included in the income statement
9 months (M-J-J-A-S-O-N-D-J)
$535 ✕ 9 = $4 815
$8 040 is for the 12 months from February 2024 to January 2025.
Only amounts due between February 2024 and April 2024 are included in the financial period.
STEP 1: Divide by 12 to find the monthly expense
$8 040 ÷ 12 = $670
STEP 2: Find the part of this payment to be included in the income statement
3 months (F-M-A)
$670 ✕ 3 = $2 010
Add the two values together to find the amount for the income statement.
$4 815 + $2 010 = $6 825
Accrued Expenses
What is an accrued expense?
An accrued expense is an expense that is still owed at the end of a financial period
This is also called an accrual
The expense is in arrears
Accrued expenses can occur at the end of a financial period when a business pays less than the amount due in that period
This usually happens when the invoice period of an expense does not align with the financial period of the business
The business might pay at the end of the invoice period
However, this might be after the end of current financial period
An accrued expense is a liability to the business
The business owes money
How do I record accrued expenses?
The expense account will have a credit balance if there is an accrual at the end of the financial period
This indicates that it is a liability, as the business still owes money for that period
The full amount that is due for the period is stated on the income statement
The amount that is accrued appears on the statement of financial position as a current liability
It is included in the amount for other payables
Prepaid Expenses
What is a prepaid expense?
A prepaid expense is an expense for the next financial period that is paid in advance during the current financial period
This is also called a prepayment
Prepaid expenses can occur at the end of a financial period when a business pays more than the amount due in that period
This commonly happens when the invoice period of an expense does not align with the financial period of the business
The business might pay an expense in full as soon as they receive an invoice
However, this invoice might also cover part of the next financial period
A prepaid expense is an asset to the business
The business has paid too much to the supplier for that period
Technically, the business is owed money by the supplier
How do I record prepaid expenses?
The expense account will have a debit balance if there is a prepayment at the end of the financial period
This indicates that it is an asset, as the business has already made payments that relate to the next financial period
The full amount that is due for the period is stated on the income statement
The amount that is prepaid appears on the statement of financial position as a current asset
It is included in the amount for other receivables
Expense Accounts with Accruals & Prepayments
How do I calculate the value to transfer to the income statement?
You could be asked to find the find value to transfer to the income statement
This is the amount that is due for that financial period
STEP 1
Start with the amount that has been paid during the current financial periodSTEP 2
Deal with any amounts carried over from the previous financial periodSubtract the amount if it is an accrual
Because this amount was not due in the current period
It was due in the previous period
Add the amount if it is a prepayment
Because this amount is due in the current period
STEP 3
Deal with any amounts that will be carried over to the next financial periodAdd the amount if it is an accrual
Because this amount is due in the current period
Subtract the amount if it is a prepayment
Because this amount is not due in the current period
It will be due in the next period
How do I calculate the amount paid for an expense within a financial period?
You could be asked to find the amount paid within a financial period
This might be different to the amount that is due for that period
The method is the opposite of the previous method
STEP 1
Start with the amount that is due for the current financial periodSTEP 2
Deal with any amounts carried over from the previous financial periodAdd the amount if it is an accrual
Because this should have been paid in the current period
Subtract the amount if it is a prepayment
Because this was not paid in the current period
It was paid in the previous period
STEP 3
Deal with any amounts that will be carried over to the next financial periodSubtract the amount if it is an accrual
Because this has not been paid during the current period
It will be paid in the next period
Add the amount if it is a prepayment
Because this was also paid during the current period
Examiner Tips and Tricks
Try to understand the logic behind the two methods above rather than memorising them.
If you need to find the amount to include on the income statement, then consider which amounts are due in the current financial period.
If you need to find the amount that has been paid, then consider which amounts were paid during the current financial period.
How do I calculate a missing value in an expense account?
You can use a ledger account to find any missing value
Fill in the amounts that you know on the correct sides
Find the missing value which balances the account
You can use this method to find the amount paid for an expense as an alternative to the previous method
Worked Example
Garry is charged $4 200 each year for commission. At the start of the financial year, Garry was in arrears of $700 for commission. At the end of the financial year, Garry owed three months’ commission.
How much did Garry pay for commission during the financial year?
Answer
Find the accrual at the end of the year.
STEP 1: Divide the yearly charge by 12 to get the monthly charge
$4 200 ÷ 12 = $350
STEP 2: Multiply it by 3 to find the accrual at the end of the year
$350 ✕ 3 = $1 050
Deal with the accruals at the start and end of the year.
Garry started the year with an accrual
so he also needed to pay that amount during the year
add this to the yearly charge
Garry ended the year with an accrual
so he had not paid that during the year
subtract this from the yearly charge
$4 200 + $700 - $1 050 = $3 850
Examiner Tips and Tricks
You might be asked to complete an expense account which deals with two expenses together. You would complete this using the same method. You can combine the balances if they appear on the same side. If you combine them, it is good practice to show both values separately as well as the combined total. You can combine the entries for the income statement in a similar way as shown in the following worked example.
Worked Example
Yuzra combines rent and rates into one single ledger account.
On 1 January 2023
$500 was owed for rent
$800 was owed for rates
On 1 January 2024
$400 was owed for rent
$200 was prepaid for rates
During the year (2023)
$4 900 was paid for rent by cheque
$2 300 was paid for rates by cheque
Prepare the rent and rates account in the ledger for Yuzra for the financial year ended 31 December 2023. Balance the account and bring down the balances on 1 January 2024. Clearly show the amount that is transferred to the income statement
Answer
Identify which side each amount needs to be posted to:
On 1 January 2023, both amounts were owed by Yuzra
Therefore they represent liabilities
The opening balances will appear on the credit side
On 1 January 2024, Yuzra owed rent
The opening balance for January 2024 will be on the credit side
Therefore the closing balance for December 2023 will be on the debit side
On 1 January 2024, Yuzra had prepaid rates which represents an asset
The opening balance for January 2024 will be on the debit side
Therefore the closing balance for December 2023 will be on the credit side
Deal with the payments during the year:
The payments for rent and rates will be on the debit side
Because they would appear on the credit side in the cash book
Calculate the amount that should be transferred to the income statement for rent and rates. You can either do this by balancing the account for rent and rates separately or by calculating how much should have been paid for the financial year.
Rent: $4 900 (amount paid)
- $500 (amount owed from last year)
+ $400 (amount owed at end of this year)
= $4 800
Rates: $2 300 (amount paid)
- $800 (amount owed from last year)
- $200 (amount prepaid for next year)
= $1 300
Yuzra
Rent and Rates Account
Date | Details | $ | Date | Details | $ |
2023 Dec 31 |
Bank Rent 4 900 Rate 2 300 |
| 2023 Jan 1 | Balance b/d Rent 500 Rates 800 |
1 300 |
Dec 31 | Balance c/d (rent) | 400 | Dec 31 | Income statement Rent 4 800 Rates 1 300 |
6 100 |
| Dec 31 | Balance c/d (rates) | 200 | ||
7 600 | 7 600 | ||||
2024 Jan 1 | Balance b/d (rates) | 200 | 2024 Jan 1 | Balance b/d (rent) | 400 |
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