ExpertAccruals, Prepayments, Accrued Income, and Deferred Income
Learning outcomes
- Apply accrual accounting to accruals, prepayments, accrued income and deferred income
- Calculate the adjustments needed for these items
- Illustrate the process of adjusting for these items
- Prepare journal entries for the creation and reversal of these items
- Identify the impact on profit and net assets
- Report these items in the financial statements
Objective A: Applying Accrual Accounting
Accrual accounting requires that income and expenses are recognised in the period to which they relate, regardless of when cash is received or paid. This creates four types of year-end adjustments:
| Adjustment | Definition | SFP Classification |
|---|---|---|
| Accrued expense (accrual) | Expense incurred but not yet paid | Current liability |
| Prepaid expense (prepayment) | Expense paid but not yet incurred | Current asset |
| Accrued income | Income earned but not yet received | Current asset |
| Deferred income | Income received but not yet earned | Current liability |
Accrued Expenses
Example: Electricity consumed in December but the bill arrives in January. The expense belongs to December, so an accrual is created:
Dr Electricity Expense | Cr Accruals (liability)
Prepaid Expenses
Example: Insurance paid in advance for the next 12 months. Only the portion relating to the current period is an expense; the rest is a prepayment:
Dr Prepayments (asset) | Cr Insurance Expense
Accrued Income
Example: Rent earned in December but not received until January. The income belongs to December:
Dr Accrued Income (asset) | Cr Rent Income
Deferred Income
Example: A customer pays in advance for services to be delivered next year. The cash is received but the income is not yet earned:
Dr Cash | Cr Deferred Income (liability)
The Four Adjustments — Quick Reference
| Expense | Income | |
|---|---|---|
| Incurred/earned but not paid/received | Accrual (liability) | Accrued income (asset) |
| Paid/received but not incurred/earned | Prepayment (asset) | Deferred income (liability) |
A company pays £12,000 for insurance covering 1 October 20X4 to 30 September 20X5. The year-end is 31 December 20X4. What is the prepayment at 31 December 20X4?
A customer pays £5,000 in advance for services to be delivered next month. How should this be recorded?
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ACCA FA — Financial Accounting Practice Exam 1
A complete mock exam replication for ACCA Financial Accounting (FA). This exam mirrors live computer-based testing parameters, featuring 35 Objective Test Questions (Section A) and 2 Multi-Task Questions broken down into 30 independent sub-questions (Section B). Covers double-entry accounting, ledger adjustments, group consolidations, and financial statement production.