Uptill now, you have studied that we deduct all the expenses from the gross profit to find the net profit of the time period. But what if, the expenses belong to some other time period – that is that they are accrued(pending to be paid) or prepaid for the future time period.
Some adjustments are to be made in order to record such data.
Assume the following examples.
Business A takes 2 buildings on rent both at $4000 per annum each. It pays $7000 as rent. That means that $1000 rent is pending for this year.. in other words, accrued expense : $1000
On the other hand, if business A pays $9000 as rent, $8000 for the current tear and $1000 in advance then prepaid expense would be $1000.
Accured expenses are carried down in the account of that particular expense and recorded as liability for the business for the current time period.
For example a building is taken on rent for $1000 per annum. $750 are paid till the end of the year. The account of “Rent” would be as follows :
|1 october||Cash||750||31 dec||Profit and loss account||1000|
|31 dec||Accrued rent||250|
Accrued expenses are recorded as liabilities in the balance sheet.
On the other hand prepaid expenses are recorded as follows
Lets say the rent is still $1000, business A paid $1200. This means that not only did it pay the rent for this year, but it also paid $200 as advance for the next year. The prepayment would be recorded as :
|1 october||Cash||1200||31 dec||Profit and loss account||1000|
|31 dec||Prepaid rent||200|
Note: Prepayments are recorded in the current assets in balance sheet.