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Chapter 11
Accruals, Prepayments, Accrued and Deferred Income

© ACCA

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Chapter 11 Accruals, Prepayments, Accrued and Deferred

Income

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Accrual and Matching Concepts

Accrual Basis

The accrual basis of accounting (“accrual accounting”) concerns the

timing of the recognition of transactions. Under the accrual basis, the
statement of profit or loss must include all income and expenses related
to the period, regardless of the timing of cash receipts or payments.

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Accrual and Matching Concepts

Accrual Basis

The mismatches between the timing of transactions and their cash flow
give rise to the following in the statement of financial position:

ACCRUAL ACCOUNTING

EXPENSE PAID IN EXPENSE INCURRED INCOME EARNED BUT

INCOME RECEIVED
ADVANCE BUT NOT NOT
INVOICED/PAID IN ADVANCE
PRE-PAID EXPENSE INVOICED/PAID
(= PREPAYMENT) ACCRUED INCOME DEFERRED INCOME
ACCRUED EXPENSE

trả trc xài sau nhan tien nhung chua cung

phát sinh chi phí kiếm đc thu nhập chưacap dich vu
xuất invoice chưa
xài trc trả sau thu tiền © ACCA 5

Key Point

Key point

Under the accrual basis, revenue and costs are both:

• accrued (recognised as earned or incurred) and
• recorded in the financial statements of the period they
relate.

dthu sẽ được ghi nhận trong kì

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Accrual and Matching Concepts

khái niệm phù hợp/ ngtac phu hợp
Accrual Basis
đòi hỏi chi phí phải phù hợp với doanh thu, vd để ra 5 dt thì bỏ ra bnh chi phí
The matching concept requires expenses incurred in generating revenue
to be matched against the revenue in determining profit or loss for the
period.

• When revenue is recognised because it has been earned, the costs

incurred in generating such revenue are also recognised (matched).

• However, a future sale cannot be recognised merely because it can be

matched with costs incurred. This would be contrary to the accrual
basis and the concept of prudence (which calls for the exercise of
caution so that, for example, income is not overstated).
là một khoảng bán hàng trong tương lai, ko thể ghi nhận được vì trong tl mới bán
- concept of prudence: tính thận trọng
xem xét trong một bối cảnh, liệu nó phải là DT trong kì này hay ko? -> kì sau thì k đc phép ghi nhận -> tránh thu
nhập bị khai khống © ACCA 7

Accrual and Matching Concepts

Accrual Basis

The accruals concept is applied to:

• Receivables and Payables

When goods are sold or bought on credit, the sale or the purchase is
recorded immediately, and receivables and payables are created. As a
result, the income (Sales) and expense (Purchases) is recognised
even though there has been no actual payment.

• Business Expenses and Income

The same logic used for credit sales and purchase transactions is
applied to other expenses or income of the business, such as rental,
electricity and insurance fees.

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Example 1
Desmond owns a business that makes made-to-measure wooden window
frames, doors and furniture. The business is known as DPQ Joinery, and
all the wooden furniture is made at a single workshop premise that the
business owns. Any painting required is done at a separate workshop
space, which the business rents. DN đang thuê workshop-> psinh expense

The office where all the accounting and administrative functions are
carried out is attached to the business's workshop premises.

DPQ Joinery would most likely incur numerous expenses to operate his
business, such as wages, electricity, repairs, maintenance, telephone,
insurance, rental of the painting workshop, advertising and stationery.

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Example 1
Broadly, expenses can be split into two categories:

• Those related to a specific transaction on a particular date, for

example, stationery. các loại chi phí liên quan đến thời điểm cụ thể

• Those related to an ongoing service received over time, for example,

electricity, rent or telephone service.chi phí kéo dài qua một khoảng thời kì

For example, DPQ Joinery uses electricity daily, incurring an expense.

However, the electricity supplier may only invoice DPQ Joinery each
quarter for the electricity used over the past three months.
chi phí thời điểm
chi phí thời kì
- cách xuất hóa đơn: trả từng quý, trả cho 3 tháng vừa rồi -> dùng rồi mới trả=> accrued expense

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Example 1
At DPQ Joinery's year-end, the business will owe the electricity supplier
for electricity used but not yet invoiced. This used but unpaid electricity
will need to be accrued to ensure that the total cost of the electricity used
in the year is reflected in the profit figure within the statement of profit or
loss.

The business expense reflected in the final accounts should be based on

the electricity use rather than how much has been invoiced or paid.

Electricity was used as an example, but the same logic applies to other
business expenses with ongoing use – such as telephone service, rent or
insurance.

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Accruals Concept on Accruals, Prepayments, Accrued

Income and Deferred Income
Payment received from income and made for expenses may be made in
arrears (received/paid later) or in advance (received/paid earlier).

This chapter discusses accruals, prepayments, accrued income and

deferred income.
may be made in arrears:
arrears: trả sau- dùng rồi mới trả, nhận tiền sau/ trả sau
# in advanced: trả trước, nhận tiền trc/ trả trc

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Accruals Concept on Accruals, Prepayments, Accrued

Income and Deferred Income

Category Explanation Asset Liability Double Entry

Accruals Expenses incurred DR Expenses
chi phí dùng rồi trả before payment CR Accruals
sau-> payables made
Prepayments Payment made DR Prepayments
chi phí trả rồi dùng before expenses CR Expenses
sau -> receivable incurred
Accrued Income Income earned DR Accrued Income
kiếm đc DT nhưng before payment CR Income
chưa thu-> assets received
Deferred Payment received DR Deferred
Income before income Income
nhận rồi ;;mới phát earned CR Income
sinh DT

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Accruals Concept on Accruals, Prepayments, Accrued

Income and Deferred Income
A business may incur expenses with payments made in arrears or in
advance:

• Accruals are expenses paid in arrears. For example, electricity

incurred from January to March is paid only at the end of March.
Accruals are reported as a liability in the statement of financial
position.

• Prepayments are expenses paid in advance. For example, yearly

business insurance is paid once at the start of the year. Prepayments
are reported as an asset in the statement of financial position.

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Accruals Concept on Accruals, Prepayments, Accrued

Income and Deferred Income
A business may generate income with payments received in arrears or in
advance:

• Accrued Income is income generated for payments received in

arrears. For example, a business may rent out additional space in an
office and collect rental income at the end of the month. Accrued
income is reported as a liability in the statement of financial position.
assets
• Deferred Income is income generated with payments received
in advance. For example, a business may collect rental income only
at the end of the month. Deferred income is reported as an asset in
the statement of financial position. liability

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Key Point
Adjustment:bút toán điều chỉnh- chỉ xuất hiện tại thời điểm cuối kì
có khoảng nào chưa được ghi nhận hay ko
có expense incurred nhưng chưa paid/ invoice

Key point

An accrual is recognised when an expense incurred has

not been paid or invoiced for by the end of the financial
period.

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Accruals

Usually, a business recognises an expense when it receives a purchase

invoice (credit purchase) or makes a payment (cash purchase); the
double entry would be DR Expenses, CR Payables/Bank.

However, certain ongoing expenses may only be paid after the services
have been incurred. This is known as a payment in arrears. The
expense that has yet to be paid at year-end is recognised as an accrual.
chi phí thời kì, chi phí dịch vụ-> in arrears -> trả sau

in arrears: thanh toán chậm

đến cuối năm tài chính mà khoản này không được trả thì gọi là dồn tích(accrual)

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Example 2
DPQ Joinery's electricity supplier sends its invoice every quarter (three
months).

The quarterly invoice will be for the electricity used in the previous
quarter (three months). This means that the electricity supplier will
invoice DPQ Joinery after it has used the electricity. This is known as
invoicing in arrears.

At the year-end, DPQ Joinery will owe the electricity supplier for
electricity used since the last invoice date. A liability, therefore, needs to
be recorded in the statement of financial position to reflect the amount
owed.

This liability is an accrual, which will also be recorded in the electricity

expense account.
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Accounting for Accruals

Once the accrual amount is established, the amount is recognised as an

expense and a liability.

At year-end, the business will adjust for accruals creation for

expenses incurred before receiving the invoice/making payment.
Trong kỳ kế toán tiếp theo, khi nhận được hóa đơn và thanh toán, doanh nghiệp sẽ đảo ngược khoản
dồn tích (reverse the accruals) và ghi nhận khoản thanh toán chi phí (expense payment)
In the subsequent accounting period, where the business receives the
invoice and makes the payment, it will reverse the accruals and
account for the expense payment. The accruals creation and the
reversal of accruals are posted to the relevant ledgers using journals.
reverse the accruals: ghi đảo lại
thanh toán cho ngày cung cấp rồi-> ghi đảo cho accrual (cho kì trc)
bút toán điều chỉnh nên ghi vào journals do nó là unusual transaction

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Accounting for Accruals

The double entry for creating accruals at year-end to recognise the

expense incurred that has not been paid is:

Individual Account Category Explanation

DR Individual Expense Expense Expenses increased

CR Accruals Liability Accruals (Liability) increased

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Accounting for Accruals

The adjustment for accruals creation will have an impact on the

business’s profits and net assets as follows:

• Profits – The double entry to create accruals is to debit the expenses

account. Expenses increases, which will lead to a reduced profit
figure. accrual là chi phí tăng-> profit giảm

• Net Assets – The corresponding entry is to credit the Accruals liability

account. Net assets or capital is the assets less liabilities of a
business. Since liability has increased, the net assets of the business
will decrease.equity= A-L
ghi nhận liability tăng nên net asset giảm

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Accounting for Accruals

In the next accounting period, the supplier will invoice the business for
the expense, and the business will make payment. As a result, double
entries are made for:

• the accruals reversal

• the expense payment

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Accounting for Accruals

The double entry to reverse the accruals adjustment is: ghi ngược kì trc
-> kì trc ghi tăng bnh
Individual Account Category Explanation -> kì sau ghi giảm đúng bấy nhiêu

DR Accruals Liability Accruals (Liability) decreased

CR Individual Expense Expense Expense decreased

The double entry for the expense payment is:

ghi nhận khoảng chi phí khi nhận được invoice
Individual Account Category Explanation

DR Individual Expense Expense Expense is recorded (increased)

CR Bank/ Payables Asset Bank (Asset) decreased

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Example 3
During the year ended 31 December 20X2, the electricity supplier sent
the following invoices to DPQ Joinery, which were paid immediately:

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Example 3

DPQ Joinery paid a total of $21,880 for electricity during the year.
However, this relates only to the electricity used by the business from 1
January to 31 October. An additional two months of electricity use (1
November to 31 December) have not been invoiced and paid.

At year-end 31st December 20X2, DPQ Joinery needs to adjust for Accrual
creation.

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Example 3

There are two options to calculate the value of the Accrual:

1. Calculate the accrual amount based on the invoice for the same period
last year (This will reflect consumption at the same time of year).

2. Calculate the accrual amount based on the last invoice received.

Note: Since there is no information on the last year's invoice for the same
period, DPQ Joinery will use the previous invoice received.

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Example 3

The last invoice received was $7,230 and relates to electricity use for
August to October. However, we only need to make an accrual for two
months (November and December) of electricity use.

From the last invoice,

The average cost for one month: $7,230 ÷ 3 months = $2,410

Therefore, two months' worth of electricity: $2,410 x 2 months = $4,820

So, the estimated value of the accrual required to be created at year-

end: $4,820
DR Electricity Expense $4,820

CR Accruals $4,820

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Example 3

The debit to the expense account increases the expense for the year. As
a result, this accrual adjustment will reduce profits during the year.

The impact of the Accruals creation adjustment to the general ledger

accounts for the year is as follows (assuming no opening balance in the
Accruals account):

DR Accruals (Liability) CR

31-Dec-X2 Electricity Expense $4,820

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Example 3

DR Electricity Expense (Expense) CR

Statement of
02-May-X2 Bank $8,460 31/12/X2 $26,700
Profit or Loss
02-Aug-X2 Bank $6,190
02-Nov-X2 Bank $7,230
31-Dec-X2 Accruals $4,820

$26,700 $26,700

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Example 3
In this example, we assumed there is no opening accrual on 1 January
20X2 for electricity expenses, meaning there is no accrual balance at 31
December 20X1.
This is slightly unrealistic because electricity expense is paid in arrears,
and there should be an accrual balance at the end of each accounting
period.

In this scenario, the closing accruals balance of $4,820 is the following

period’s opening accruals balance.

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Example 4 (with opening balance)

DPQ Joinery’s employees are paid on an hourly basis. The employees
are paid once a week in arrears for hours worked in the previous week.
The year-end is 31 December 20X2. At the end of the year, DPQ Joinery
owes its employees a week's worth of wages for the hours that they
have worked.

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Example 4 (with opening balance)

During the year-ended 20X2, DPQ Joinery has the following information:

1. At the end of 20X1, DPQ Joinery owed its employees $1,560 for
wages.

On 31 Dec 20X1, the double entry is made to create an accrual.

DR Wages Expense $1,560

CR Accruals $1,560

The accrual balance of $1,560 is brought forward in 20X2 as an opening

balance. The expense is transferred to the profit or loss for the year and
not brought forward to the following period.

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Example 4 (with opening balance)

- The payment of expenses is recorded:

DR Wages Expense $1,560

CR Bank $1,560

3. In weeks 2 to 52 of 20X2, a further $84,934 of wages was paid to

the employees.

The payment of expenses is recorded as follows:

DR Wages Expense $84,934

CR Bank $84,934

© ACCA 33

Example 4 (with opening balance)

4. At the end of 20X2, the business owes its employees $1,790 for
wages.

At the end of 20X2, DPQ Joinery creates an accrual for the balance
owed to its employees who have not been paid.

DR Wages Expense $1,790

CR Accruals $1,790

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Example 4 (with opening balance)

The impact of the accruals adjustment to the general ledger accounts is
as follows:

DR Accruals (Liability) CR
Wages
Week 1 $1,560 01-Jan-X2 Balance b/d (1) $1,560
Expense (2)
31-Dec-X2 Balance c/d $1,790 31-Dec-X2 Wages Expense (4) $1,790
$3,350 $3,350
01-Jan-X3 Balance b/d $1,790

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Example 4 (with opening balance)

DR Wages Expense Account (Expense) CR

Week 1 Bank (2) $1,560 Week 1 Accruals (2) $1,560
Statement of Profit
Week 2-25 Bank (3) $84,934 31-Dec-X2 $86,724
or Loss
Accruals
31-Dec-X2 $1,790
(4)
$88,284 $88,284

DR Bank Account (Asset) CR

Week 1 Wages Expense (2) $1,560

Week 2-25 Wages Expense (3) $84,934

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Example 5
Anne owns a business with an accounting year-end of 30 September
20X5. A lease on office premises is taken on 1 January 20X5. Rent for
the year to 31 December 20X5 is $2,400. On 1 January 20X5, $1,000
was paid regarding rent due.

For the year-ended 30 Sept 20X5 (Year 1):

The Year 1 financial period is from 1 October 20X4 to 30 Sept 20X5,

while the lease rental period is from 1 Jan X5 to 31 Dec X5.

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Example 5
1. On 1 Jan X5, Anne paid rent of $1,000. The double entry to record
the expense payment is:

DR Rent Expense $1,000

CR Bank $1,000

2. At year-end 30 Sept X5, the portion of rental expense used but not
paid is recognised as an accrual. The lease on office premises was
taken from 1 Jan X5 to 31 Dec X5. On 30 Sept X5, Anne incurred 9
months of expense ($2,400 x 9/12 months) = $1,800.

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Example 5

Anne paid $1,000 at the start of the lease period; the total expense
incurred but not paid is $800 ($1,800 – $1,000). The double entry
to create the accrual is:

DR Rent Expense $800

CR Accruals $800

The ledger account during the financial year-end 30 Sept 20X5 will
show the following after the double entries have been recorded.

© ACCA 39

Example 5

DR Accruals (Liability) CR

30-Sep-X5 Balance c/d $800 30-Sep-X5 Rental Expense (2) $800

$800 $800
01-Oct-X5 Balance b/d $800

DR Rental (Expense) CR

01-Jan-X5 Bank (1) $1,000

30-Sep-X5 Accruals (2) $800 30-Sep-X5 Profit or Loss $1,800

$1,800 $1,800

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Example 5

DR Bank (Asset) CR

01-Jan-X5 Rental Expense (1) $1,000

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Example 5

For the year-ended 30 Sept 20X6 (Year 2):

The Year 2 financial period is from 1 October 20X5 to 30 Sept 20X6,

while the rental lease period is from 1 Jan X6 to 31 Dec X6.

1. Anne pays rent on the office building lease of $1,400 on 31 Dec 20X5.

The double entry to record the lease payment on 31 Dec X5 is:

DR Rent Expense $1,400

CR Bank $1,400

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Example 5

2. The rental for the lease for the first year would have been paid in
total ($1,000 + $1,400) = $2,400. On 31 December 20X5, the
accruals made of $800 in the previous year would have been
incurred. The accruals adjustment will be reversed:

DR Accruals $800

CR Rent Expense $800

Anne has identified that the rent for the year to 31 December 20X6 is
$2,800. On 15 June 20X6, she pays rent of $1,400.

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Example 5

3. The double entry to account for the rental payment of $1,400 on 15

June X6 is:

DR Rent Expense $1,400

CR Bank $1,400

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Example 5

4. At the year-end of 30 Sept X6, Anne will adjust for accruals for rental
expenses incurred but not paid. The expense incurred for the year is
$2,800 x 9/12 months = $2,100. Only $1,400 has been paid in
respect of this expense. Therefore $700 ($2,100 – $1,400). The
double entry is:

DR Rent Expense $700

CR Accruals $700

The ledger accounts during the financial year-end 30 Sept 20X6 will
show the following after the double entries have been recorded.

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Example 5
DR Accruals (Liability) CR
Balance c/d
31-Dec-X5 Accrual Reversal (2) $800 01-Oct-X5 $800
(opening)
30-Sep-X6 Balance b/d $700 30-Sep-X6 Accruals (4) $700
$1,500 $1,500
01-Oct-X6 Balance c/d $700

DR Rental (Expense) CR

31-Dec-X5 Bank (1) $1,400 31-Dec-X5 Accrual Reversal (2) $800

15-June-X6 Bank (3) $1,400 30-Sep-X6 Profit or Loss $2,700
30-Sep-X6 Accruals (4) $700
$3,500 $3,500

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Example 5

DR Bank (Asset) CR

31-Dec-X5 Rental Expense (1) $1,400

15-June-X6 Rental Expense (3) $1,400

© ACCA 47

Activity 1
The accounting year end is 31 December 20X6. A gas bill for $300
arrives on 2 February 20X7 for the quarter to 31 January 20X7.

Show the 31 December 20X6 ledger entries for the accrued

expense.

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Key Point

Key point

A Prepayment is recognised when a business pays in the

current financial period for an expense that relates to the
next financial period.

© ACCA 49

Prepayments
A business recognises an expense when it receives an invoice and makes
payment. However, certain expenses may be invoiced and paid before
they are incurred. This is known as a payment in advance. The
amount paid for expenses not yet incurred is recognised as a
prepayment.

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Example 6

DPQ Joinery rents a workshop and pays rent quarterly in advance. This
means payment must be made on the first day of each rental period.
This payment is for the rental expense for the next three months.

The business started renting this workshop on 1 June 20X2. So far, the
following invoices for rent have been received and paid:

© ACCA 51

Example 6

In 20X2, a total of $3,600 is paid for rent covering the period from 1
June 20X2 to 28 February 20X3. Some of this payment relates to 20X3,
so if the total amount of $3,600 were included as the rent expense for
20X2, then it would be overstated.

In this situation, you need to reduce the expense. This reduction to the
expense is known as a prepayment.

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Example 7

The accounting year-end is 30 June. Insurance on the business property

runs from 1 October to 30 September and is paid annually in advance.

Paid:
1 October 20X5 $1,200
1 October 20X6 $1,800

What is the insurance expense for the year ended 30 June 20X7?

© ACCA 53

Example 7

Consider the timeline:

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Example 7

The expense for the accounting period under consideration must include
all the amounts which accrue to (belong in) the year to 30 June 20X7:

July X6 to September X6 (3/12 × $1,200) $300

October X6 to June X7 (9/12 × $1,800) $1,350

Expense in profit or loss $1,650

Note: Because $1,800 was paid in advance, there will be a prepayment

of $450 on 30 June 20X7. This is recognised as a current asset,
increasing net assets/capital in the statement of financial position and
profit (by reducing the expense).
© ACCA 55

Accounting for Prepayments

During the year, the business makes payments for expenses not yet
incurred and records expense payments. At year-end, the business
identifies which payments were made for expenses not yet incurred.
Since expenses are not incurred in the year, an adjustment for
prepayment creation is made (credit/reduces expenses).

When the business continues using the expenses in the next accounting
period, it will adjust for prepayment reversal.

In a financial year, a supplier sends invoices to the business, and the

business makes payments for the expenses. However, at year-end, it is
identified that the amount paid does not relate to expenses incurred
during the year. Therefore, a prepayment is recognised to reduce the
expense charge for the year.

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Accounting for Prepayments

During the year, two entries occur for payments of expenses not yet
incurred:

• the Expense Payment

• the Prepayment Creation

© ACCA 57

Accounting for Prepayments

The double entry for the expense payment is:

Individual Account Category Explanation

DR Individual Expense Expense Expense increased

CR Bank Asset Bank decreased

The above double entry reflects the business paying the expense in cash
to the supplier.

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Accounting for Prepayments

The double entry for prepayment creation is:

Individual Account Category Explanation

DR Prepayment Asset Prepayment

(Asset) increased
CR Individual Expense Expense Expense is
reduced

Since expenses have been recognised earlier, although they have not
yet been incurred (only incurred in the next accounting period), a
prepayment is created to reduce the expense charge during the year.

© ACCA 59

Accounting for Prepayments

The adjustment for prepayment creation will have an impact on the
business’s profits and net assets as follows:

• Profits – The double entry to create prepayment is to credit the

expenses account. Expenses decrease, which will lead to an
increased profit figure.

• Net Assets – The corresponding entry is to debit the Prepayment

asset account. Net Assets or Capital is the Assets less Liabilities of
a business. Since assets have increased, the business’s net assets
will also increase.

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Accounting for Prepayments

In the next accounting period, the business incurs expenses as the
period progresses. Therefore, the business records the reversal of
prepayment adjustment made in the previous period. Thus, the
Prepayment account is reversed, and the expense is recorded.

The double entry for the Reversal of Prepayment is:

Individual Account Category Explanation

DR Individual Expense Liability Expenses have increased

CR Prepayment Asset Prepayment (Asset) decreased

© ACCA 61

Example 8

DPQ Joinery pays rent for one of its shops quarterly in advance. This
means payment is made on the first day of each rental period. DPQ
Joinery has a current year-end of 31st December 20X2.

DPQ Joinery started renting on 1 June 20X2. So far, the business has
received and paid the following invoices in respect of rent:

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Example 8

In 20X2, DPQ Joinery paid $3,600 for rent covering the period 1 June
20X2 to 28 February 20X3. Some of this payment relates to the financial
period 20X3 and should not be included as the rent expense for 20X2 to
avoid overstatement.

DPQ Joinery will adjust for prepayment creation on 31 December 20X2

for the two months’ rent advanced payment relating to 20X3 (January
and February). The last invoice received and paid of $1,200 relates to
three months' rent for December, January and February. Therefore, the
rent for January and February is prepaid.

© ACCA 63

Example 8

The average cost per month for the last invoice: $1,200 ÷ 3 months =
$400
Therefore, two months’ worth of rental: $400 × 2 months = $800
The value of the prepayment required at the end of the year is $800

1. The supplier invoices the business for the expense not yet incurred,
and the business makes a payment of $1,200 on 1 December 20X2.
The double entry for the expense payment is as follows:

DR Rent Expense Account $1,200

CR Bank Account $1,200

© ACCA 64

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Example 8

2. At the year-end, the business has identified that only $400

relates to expenses during the year. It will reduce the expense
charge and recognise it as an asset under prepayments. The
double entry to create the prepayment is:

DR Prepayment Account $800

CR Rent Expense Account $800

The prepayment (asset) creation reduces the expense amount.

Thus, it increases profit for the year by reducing losses.

© ACCA 65

Example 8

The impact of the prepayment creation adjustment to the General

Ledger Accounts should look like this (assume no opening balance in the
Prepayment Account):

DR Prepayment Account (Assets) CR

31-Dec-X2 Electricity Expense (2) $800

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Example 8

DR Rent Expense Account (Expense) CR

01-June-X2 Bank (during year) $1,200 31-Dec-X2 Prepayment (2) $800

01-Sept-X2 Bank (during year) $1,200 31-Dec-X2 Profit or Loss $2,800

01-Dec-X2 Bank (1) $1,200

$3,600 $3,600

The expense in the statement of profit or loss is correct. The monthly

rent is $400, and DPQ Joinery has rented the shop for seven months
(from June to December). Therefore, the correct rent expense is $400 ×
7 = $2,800.

© ACCA 67

Example 9 (with opening balance)

DPQ Joinery pays insurance for his business once a year on 1

September. The payment on that date provides insurance coverage from
1 September until 31 August the following year. On 1st September 20X2,
DPQ Joinery paid $4,875 for insurance. DPQ Joinery has a current year-
end of 31st December 20X2.

The prepayment at the start of the year was $2,880. This is based on
the 20X1 payment of $4,320 for insurance, for which DPQ Joinery has
prepaid eight months out of the twelve (8 × $4,320) ÷ 12 = $2,880

© ACCA 68

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Example 9 (with opening balance)

The double entry for each transaction is:

1. At the end of 20X1 (the previous year), DPQ Joinery prepaid

insurance expenses of $2,880. A double entry was made to create a
prepayment adjustment. The prepayment balance of $2,880 is
brought forward in 20X2 as an opening balance.

DR Prepayment $2,880

CR Insurance Expense $2,880

© ACCA 69

Example 9 (with opening balance)

2. By the end of August 20X2, DPQ Joinery would have incurred the
prepaid expenses of $2,880.

Since DPQ Joinery has incurred the prepaid expenses of $2,880 by

August 20X2, the opening prepaid balance from 20X1 is reversed,
and expenses are finally recognised.

DR Insurance Expense $2,880

CR Prepayment $2,880

© ACCA 70

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Example 9 (with opening balance)

3. On 1st September 20X2, DPQ Joinery pays $4,875 for insurance

expenses covering 1 September X2 to 31 August X3. The payment of
expenses is recorded as follows:

DR Insurance Expense $4,875

CR Bank $4,875

© ACCA 71

Example 9 (with opening balance)

4. At the end of 20X2, DPQ Joinery notes that not all $4,875 relates to
the financial period 20X2. A prepayment is created for the payment
made for expenses not yet incurred.

$4,875 was paid for insurance cover from 1st Sept 20X2 to 31st
August 20X3. Out of the 12 months, 8 months (January 20X3 to
August 20X3) have not been incurred at the end of the financial
period 31 Dec 20X2.

Therefore, $4,875 x 8/12 months = $3,250 is recognised as

prepayment.
DR Prepayment $3,250

CR Insurance Expense $3,250

© ACCA 72

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Example 9 (with opening balance)

The impact of the prepayment creation on the general ledger accounts is

as follows:

DR Prepayment (Assets) CR

Insurance
01-Jan-X2 Balance b/d (1) $2,880 31-Aug-X2 $2,880
Expense (2)
31-Dec-X2 Insurance Expense (4) $3,250 31-Dec-X2 Balance c/d $3,250
$6,130 $6,130
01-Jan-X3 Balance b/d $3,250

© ACCA 73

Example 9 (with opening balance)

DR Insurance (Expense) CR
Prepayment
31-Aug-X2 Prepayment (2) $2,880 31-Dec-X2 $3,250
(4)
Statement
01-Sept-X2 Bank (3) $4,875 31-Dec-X2 of Profit or $4,505
Loss
$7,755 $7,755

DR Bank (Assets) CR

01-Sept-X2 Insurance Expense (3) $4,875

© ACCA 74

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Activity 2
1. During the year ended 30 June 20X5, a business pays $5,905 for
electricity to cover the opening accrual of $590 and the invoices
received during the year. The last invoice was $1,860 and covered the
period from 1 March 20X5 until 31 May 20X5.

What should the expense be in the statement of profit or loss

for the year ended 30 June 20X5?

2. During the year ended 30 September 20X7, a business paid $10,200

for insurance to cover the period from 1 July 20X7 to 30 June 20X8.
The opening prepayment for insurance expenses was $6,850.

What should the expense be in the statement of profit or loss

for the year ended 30 September 20X7?

© ACCA 75

Key Point

Key point

Accrued income is recognised when a business receives its

income in arrears after earning it. At year-end, the business
has earned income that has not been received.
Deferred income is recognised when a business receives its
income before earning it. At year-end, the business received a
payment related to the following year.

© ACCA 76

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Accrued and Deferred Income

Accruals and prepayments are liabilities and assets recognised during
year-end due to payment of expenses in arrears or in advance.

Accrued and deferred (prepaid) incomes are assets and liabilities

recognised during year-end due to income receipts in arrears or in
advance.

© ACCA 77

Accrued and Deferred Income

Category Explanation Asset Liability Double Entry

Accruals Expenses incurred DR Expenses
before payment CR Accruals
made
Prepayments Payment made DR Prepayments
before Expenses CR Expenses
incurred
Accrued Income Income earned DR Accrued
before payment Income
received CR Income
Deferred Payment received DR Deferred
Income before Income Income
earned CR Income

© ACCA 78

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Accrued and Deferred Income

• Accrued income is recognised as an asset to reflect the

income owed to the business since revenue has been
provided but payment has not yet been received. (receipt in
arrears).

• Deferred income is recognised as a liability as payment

has been received for revenue not yet provided. (receipt in
advance)

© ACCA 79

Accounting for Accrued Income

At year-end, the business will adjust for accrued income creation for
income generated for payments in arrears.

The double entry for the accrued income is:

Individual Account Category Explanation

DR Accrued Income Asset Accrued Income (Asset) increased
CR Individual Income Income Income has increased

© ACCA 80

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Accounting for Accrued Income

The income calculated for the current financial year where payment has
not been received is recognised as an asset (accrued income).

In the next financial period where payment has been received, the
business will reverse the accrued income adjustment made in the
previous period and record the income receipt.
Reversal of accrued income:

Individual Account Category Explanation

DR Individual Income Account Income Income has decreased
CR Accrued Income Account Asset Accrued Income (Asset) decreased

© ACCA 81

Accounting for Accrued Income

Record of Income Receipt:

Individual Account Category Explanation

DR Bank Account Asset Bank (Asset) increased

CR Individual Income Account Income Income has increased

© ACCA 82

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Accounting for Deferred Income

At year-end, the business will adjust for deferred/prepaid income for

income generated for payments in advance.

Payment has been received in the current financial period for income
generated in the following financial period. The business records the
income receipt during the year, then calculates and creates the
deferred income amount adjustment.

Record of income receipt:

Individual Account Category Explanation
DR Bank Account Asset Bank (Asset) increased
CR Individual Income Income Income has increased

© ACCA 83

Accounting for Deferred Income

The double entry for deferred income creation is:

Individual Account Category Explanation

DR Individual Income Income Income has decreased
CR Deferred Income Liability Deferred Income
(Liability) increased

As the months progress, the business will generate income in the

following accounting period. Accordingly, it will record deferred income
reversal.

© ACCA 84

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Accounting for Deferred Income

The double entry for the reversal of deferred income is:

Individual Account Category Explanation

DR Deferred Income Liability Deferred Income
(Liability) decreased
CR Individual Income Income Income has increased

© ACCA 85

Example 10

DAHS Co rents out two properties that it owns. Its year-end is 30 June
20X6. Payment for both properties is made every three months (every
quarter).

For property 1, the rent is received in advance. The rent is $5,400 per
quarter, and the last receipt was for the three months of 1 May to 31
July 20X6.

For property 2, the rent received is in arrears. The rent is $3,600 per
quarter, and the last receipt was for the three months of 1 February to
30 April 2006.

© ACCA 86

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Example 10
Property 1 Property 2
Rent Receipt: In advanced In arrears
Rental per quarter: $5,400 $3,600
Period where payment 1 May 20X6 to 1 Feb 20X6 to
already received: 31 July 20X6 30 April 20X6
1 month payment (July X6) 2 months income (May &
relates to the following June) has not received
period payment
Recognition: Deferred Income (Liability) Accrued Income (Asset)
$5,400 x 1/3 = $1,800 $3,600 x 2/3 = $2,400
Double Entry in 20X6
DR Bank Account $5,400
Income receipt: No receipt in 20X6
CR Rent Income $5,400
Deferred/ Accrued DR Rent Income $1,800 DR Accrued Income $2,400
Income: CR Deferred Income $1,800 CR Rent Income $2,400

© ACCA 87

Example 10
Property 1 Property 2
Double Entry in 20X7
Reversal of Accrued/ DR Deferred Income $1,800 DR Rent Income $2,400
Deferred Income: CR Rent Income $1,800 CR Accrued Income $2,400
DR Bank Account $3,600
Income Receipt: Already received in 20X6
CR Rent Income $3,600
Deferred Income reduces Accrued Income increases
income and, therefore, income in the year and,
reduces profits in the year. therefore, increases
Effect on 20X6
In addition, since deferred profits. Accrued Income is
Financial Statement:
income is recorded as a recorded as an asset. This
liability, the capital amount causes the capital amount
is reduced. to increase.

© ACCA 88

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Summary

The effects of making adjustments for reporting on an accrual basis can be

summarised as follows:

© ACCA 89

Summary

*Remember that an increase in an asset that increases net assets (i.e. total
assets less total liabilities) arises when there is an increase in profit (either
through a decrease in expense or increase in income) or capital contribution.
An increase in a liability that decreases net assets arises when there is a
reduction in profit (either through an increase in expense or decrease in
income) or capital distribution (e.g. payment of a dividend).
A credit balance on a deferred income account will only be a real "liability" if
there is an obligation to repay.

© ACCA 90

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