Expense In The Current Year's Accounts example essay topic

Before the final accounts of a business are prepared it is often necessary to make ADJUSTMENTS to the trial balance. This may be because some transactions have not yet been taken into account. This might be that a rent payment near the end of the trading year might relate partly to the current year and partly to the next year. If this was to happen, we should calculate the fraction that relates to the current year.

The main adjustments that are made to the trail balance are: . Accrued expenses owed by the business; . Accrued receipts owed to the business; . Prepayments; .

Provision for bad and doubtful debts; . Provision for discounts; . Depreciation of certain assets; . Drawings; The purpose of making adjustments is to produce a set of accounts that provide 'a true and fair view' of the firm's financial circumstances. Details of adjustments are entered in the journal and might also be included as footnotes to the trial balance. We will now focus on two of these adjustments, accruals and prepayments.

What are accruals? An accrual is an estimate of money that is owed, but which is not supported by an invoice at the time the trial balance is prepared. Accrued expenses: Sometimes a business may use a resource during the current trading year and still owe money for it at the end of the year. For example, they may hire a van near the end of the year, and not receive the invoice until the following year. This is an accrued expense.

It is important to include this expense in the current year's accounts even though payment has not been made. Another example is when bills are received that partly relate to the previous year. This could be a quarterly gas bill for lb 600 relating to December, January and February. Therefore lb 200 of this bill relates to December's gas usage so should be included in that years accounts. Accrued revenue: This is money owed to a business at the end of the trading year, but where no invoice has been issued.

Examples include interest receivable from banks, rent that is due and commission owed from selling another firm's goods. Such revenues tend to be quite small in comparison with the sales revenue that a business receives. Adjustments for accruals do not include money owed for credit sales and credit purchases as, although this money is still owed at the end of a trading period, it is already accounted for in the sales and purchases ledger. Accounting for accruals The accruals concept states that revenue and costs should be recognised when they are earned or incurred, not when the money is received or paid. So any money that is owed by a business in the current year must be added to expenses. Similarly, any money owed to the business must be added to revenue.

Consider the example of Ben McDonald who runs a restaurant called Caf'e Noir in Nottingham. Above the restaurant is a flat which is rented out for lb 1000 per quarter. The rent is classed as part of the business's income. At the end of the financial year, 30 December 2000, the trial balance indicated that: . The amount paid for gas was lb 980.

This did not include the bill for the last quarter's gas usage which had not yet been paid. The bill was lb 330, all of which related to the trading period ended on 31 December 2000... The amount of rent received for the year was lb 3,000. Ben's tenant still owed lb 1,000 for the period up to 31 December 2000. Caf'e Noir Trial Balance extract as at 31.12. 00 Dr Cr lb lb Gas 980 Rent receivable 3,000 Accounting for the accrued expense: The accrued expense is the unpaid gas bill of lb 330 for the current year's consumption of gas.

Copy the example from the board of dealing with the accrued expense: Accounting for accrued revenue: The accrued revenue is for the rent owed of lb 1,000 but not yet received. Copy the example from the board of dealing with the accrued revenue: Adjusting the trial balance: The adjustments for accrued income and accrued expenses can be included in an adjusted trial balance. Caf'e Noir Trial Balance as at 31.12. 00 Dr Cr lb lb Gas 1,310 Gas accrued 330 Rent receivable 4,000 Rent accrued 1,000 The debit balance on the gas account has increased to lb 1,310 to show the effect of the accrued expense. A new balance for lb 330 is listed for gas accrued, showing that Caf'e Noir still owed lb 330 for gas, it is a current liability.

The credit balance on the rent received account has increased to lb 4000 to show the effect of the accrued revenue. A new balance for lb 1000 is listed for rent accrued, showing lb 1000 is still owed to Caf'e Noir, it is a current asset. What are prepayments? A prepayment is a payment made in advance of the accounting period to which it refers.

This could be an annual insurance premium paid in advance of receiving the cover. Sometimes a business receives a prepayment in advance of a transaction. This could be a builder receiving a deposit or advance payment before work begins. If a prepayment is made an adjustment to the trial balance is required.

We must firstly calculate how much of the prepayment relates to the current trading period. For example if a firm paid lb 500 on July 1st for motor insurance, only 6 months of the premium would relate to the current trading period. Therefore, half the premium, lb 250, must be subtracted from the insurance expenses for that year in order to give a 'true and fair view' of the firm's financial circumstances. Accounting for prepayments: Copy the example of Hornchurch Metal Products. The trial balance at 31 December 2000 showed lb 1,200 spent on insurance expenses.

However, the premium was paid on 1 February 2000 for one year's cover. Therefore, one month of the total premium was for the next trading period. Therefore had been a prepayment of lb 100.