Accruals and prepayments

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    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.

    ACCRUED EXP

    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 :

    Rent

    Date Details Amount Date Details Amount
    1 october Cash 750 31 dec Profit and loss account 1000
    31 dec Accrued rent 250      
        1000     1000

    Accrued expenses are recorded as liabilities in the balance sheet.

    PREPAID EXP

    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 :

     

    Date Details Amount Date Details Amount
    1 october Cash 1200 31 dec Profit and loss account 1000
          31 dec Prepaid rent 200
        1200     1200

     

    Note: Prepayments are recorded in the current assets in balance sheet.