01 Accruals and Prepayments Test

1
Chapter 1 Accruals and Prepayments

Notes to teachers
1 Start with Chapter 4 of Frank Woods Introduction to Accounting and briefly explain to students how to
record expenses and other revenues in the cash book and post entries to the general ledger.
2 Refer to Chapter 10 of Frank Woods Introduction to Accounting and briefly explain to students the
accrual concept.
3 Explain the meaning of accrued expenses, prepaid expenses, accrued revenues and unearned revenues
with the aid of real-life examples, and why they are treated as current assets or current liabilities.
4 Students should know the alternative names of the above items.
5 Most students have difficulty understanding why accrued revenues and unearned revenues are treated as
current assets and current liabilities, respectively. Teachers should clarify the meaning of current assets
and current liabilities by doing Try This Activity A3 and A7 with students.
6 If the entries in the accounts of expenses and other revenues are posted from the cash book, they are said
to be made on a cash basis. Students should know that the accrual concept is one of the fundamental
principles underlying financial reporting. To correspond with the accrual concept, adjustments are
required in the accounts of expenses and other revenues at the end of an accounting period. As a result,
financial statements can then be prepared on an accrual basis.
7 Two methods are used to adjust for accruals and prepayments. Students should master both methods.
8 Timing is very important in deciding whether an item and how much of an item is accrued or prepaid.
Teachers always need to remind students to note the financial years closing date.
Q1 According to the accrual concept, a firm should only record revenues generated by goods sold or services
rendered during a period, rather than the amounts actually received during that period. Similarly, a firm
should only record expenses which have been incurred in generating those revenues during the same
period, rather than the amounts actually paid during that period.
Q2 Under cash accounting, revenues are recognised when received and expenses are recognised when paid.
Under accrual accounting, revenues are recognised when earned and expenses are recognised when
incurred.
Q3 Accruals refer to expenses that have been incurred during a period but have not been paid by the end of
that period. Accruals can also refer to revenues that have been earned during a period but have not been
received by the end of that period.
Notes to teachers
M01_FWFA_TB_HKG_9646_C01_6.indd 1 2009/11/4 3:46:67 PM
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Q4 Prepayments refer to expenses that have been paid during a period but have not been incurred by the
end of that period. Prepayments can also refer to revenues that have been received during a period but
have not been earned by the end of that period.
Q5 Accrued expenses are liabilities of the firm and therefore the accrued expense account should be
classified as a real account.
Q6 Accrued revenues are assets of the firm and therefore the accrued revenue account should be classified as
a real account.
Q7 Accrued Water Charges
2010 $ 2010 $
Jan 1 Water charges 1,240 Jan 1 Balance b/f 1,240
Water Charges
2010 $
Jan 1 Accrued water charges 1,240
Accrued Interest Revenue
2010 $ 2010 $
Jan 1 Balance b/f 1,600 Jan 1 Interest revenue 1,600
Interest Revenue
2010 $
Jan 1 Accrued interest revenue 1,600
A1 This is because accrued expenses are liabilities that are expected to be repaid within one year.
A2 Total expenses for the period will be understated and the net profit for the period will be overstated.
A3 This is because accrued revenues are assets that are expected to be converted into cash within one year.
A4 Total revenues for the period will be understated and the net profit for the period will also be
understated.
A5 This is because prepaid expenses represent goods or services that are expected to be consumed within
one year.
A6 Total expenses for the period will be overstated and the net profit for the period will be understated.
A7 This is because unearned revenues represent goods or services that a business has to provide to its
customers within one year.
A8 Total revenues for the period will be overstated and the net profit for the period will also be overstated.
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A9 K Hui
Income Statement for the year ended 31 March 2010 (extract)
$
Other revenues:
Rent revenue 80,000
Commission revenue 2,680
Expenses:
Rent expense 100,000
Telephone expense 1,140
A10 Insurance
2009 $ 2009 $
Feb 26 Bank 1,800 Dec 31 Profit and loss 3,000
Aug 24 Bank 1,800 " 31 Prepaid insurance 600
3,600 3,600
2010
Jan 1 Prepaid insurance 600
Prepaid Insurance
2009 $ 2009 $
Dec 31 Insurance 600 Dec 31 Balance c/f 600
2010 2010
Jan 1 Balance b/f 600 Jan 1 Insurance 600
Rent Revenue
2009 $ 2009 $
Dec 31 Profit and loss 30,000 Sept 24 Bank 10,000
" 31 Unearned rent revenue 10,000 Oct 25 Bank 10,000
Nov 26 Bank 10,000
Dec 28 Bank 10,000
40,000 40,000
2010
Jan 1 Unearned rent revenue 10,000
Unearned Rent Revenue
2009 $ 2009 $
Dec 31 Balance c/f 10,000 Dec 31 Rent revenue 10,000
2010 2010
Jan 1 Rent revenue 10,000 Jan 1 Balance b/f 10,000
A11 In the income statement:

Net profit for the year would be total revenues received minus total expenses paid during the year.

Sales would be the amount actually received from sales during the year. Discounts allowed would
not be separately shown.

Purchases would be the amount actually paid for purchases during the year. Discounts received
would not be separately shown.

The matching concept (which will be explained in Chapter 17 of Frank Woods Financial
Accounting 2) would no longer apply. Therefore, no adjustments for opening/closing inventory
would be required.

Rent received in advance would be recognised as revenue for the year.

Interest revenue would not be recognised as revenue for the year because it had not been received
by the year end.

No adjustments for accrued wages and prepaid telephone charges would be required.
4
In the balance sheet:

The items inventory, accounts receivable, accrued revenues and prepaid expenses would not
appear in current assets.

The items accounts payable, accrued expenses and unearned revenues would not appear in
current liabilities.
A13 Accrual accounting can more accurately measure the financial performance (i.e., profitability and
liquidity) of an entity.
Under cash accounting, revenues represent the amounts received during an accounting period, whether
they have been earned or not. The amounts earned but not yet received would not be recorded as
revenues while the amounts received but not yet earned would not be excluded and not treated as
revenues.
Under accrual accounting, revenues represent the amounts earned during an accounting period, whether
they have been received or not. The amounts earned but not yet received or received but not yet earned
would be shown as current assets and liabilities, respectively, in the balance sheet.
Likewise, under cash accounting, expenses represent the amounts paid during an accounting period,
whether they have been incurred or not. The amounts incurred but not yet paid would not be recorded
as expenses while the amounts paid but not yet incurred would not be excluded and not treated as
expenses for the period.
Under accrual accounting, expenses represent the amounts incurred during an accounting period,
whether they have been paid or not. The amounts paid but not yet incurred or incurred but not yet paid
would be shown as current assets and liabilities, respectively, in the balance sheet.
ASSESSMENT
Short Questions Short Questions
1 (i) Rent
2008 $ 2008 $
Dec 31 Bank 16,000 Dec 31 Profit and loss 20,000
" 31 Accrued c/f 4,000
20,000 20,000
(ii) Insurance
2008 $ 2008 $
Dec 31 Bank 900 Dec 31 Profit and loss 635
" 31 Prepaid c/f 265
900 900
(iii) Rates
2008 $ 2008 $
Jan 1 Bank 750 Dec 31 Profit and loss 1,500
Jul 1 Bank 1,125 " 31 Prepaid c/f ($1,125 ) 375
1,875 1,875
3
9
3
9
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(iv) Rent Revenue
2008 $ 2008 $
Dec 31 Profit and loss ($4,000 12) 48,000 Apr 15 Bank 20,000
" 31 In advance c/f 16,000 Dec 15 Bank 44,000
64,000 64,000
2X (i) General Expenses
2009 $ 2009 $
Mar 31 Bank 6,150 Mar 31 Profit and loss 5,590
" 31 Prepaid c/f 560
6,150 6,150
(ii) Commission Revenue
2009 $ 2009 $
Mar 31 Profit and loss 3,231 Mar 31 Bank 3,056
" 31 Accrued c/f 175
3,231 3,231
(iii) Carriage Outwards
2009 $ 2009 $
Mar 31 Bank 666 Mar 31 Profit and loss 788
788 788
(iv) Insurance
2008 $ 2009 $
Apr 1 Bank 1,080 Mar 31 Profit and loss 1,440
2009 " 31 Prepaid c/f ($1,080
6
9
) 720
Jan 1 Bank 1,080
2,160 2,160
3 (i) Rent Accrued Rent
2008 $ 2008 $ 2008 $ 2008 $
Dec 31 Bank 16,000 Dec 31 Profit and Dec 31 Balance c/f 4,000 Dec 31 Rent 4,000
" 31 Accrued loss 20,000
rent 4,000
20,000 20,000
The Journal
Date Details Dr Cr
2008
Dec 31 Rent
Accrued rent
$
4,000
$
4,000
(ii) Insurance Prepaid Insurance
2008 $ 2008 $ 2008 $ 2008 $
Dec 31 Bank 900 Dec 31 Profit and Dec 31 Insurance 265 Dec 31 Balance c/f 265
loss 635
" 31 Prepaid
insurance 265
900 900
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The Journal
Date Details Dr Cr
2008
Dec 31 Prepaid insurance
Insurance
$
265
$
265
(iii) Rates Prepaid Rates
2008 $ 2008 $ 2008 $ 2008 $
Jan 1 Bank 750 Dec 31 Profit and Dec 31 Rates 375 Dec 31 Balance c/f 375
Jul 1 Bank 1,125 loss 1,500
" 31 Prepaid
rates 375
1,875 1,875
The Journal
Date Details Dr Cr
2008
Dec 31 Prepaid rates
Rates
$
375
$
375
(iv) Rent Revenue Unearned Rent Revenue
2008 $ 2008 $ 2008 $ 2008 $
Dec 31 Profit and Apr 15 Bank 20,000 Dec 31 Balance c/f Dec 31 Rent revenue
loss 48,000 Dec 15 Bank 44,000 16,000 16,000
" 31 Unearned rent
revenue 16,000
64,000 64,000
The Journal
Date Details Dr Cr
2008
Dec 31 Rent revenue
Unearned rent revenue
$
16,000
$
16,000
4X (i) General Expenses Prepaid General Expenses
2009 $ 2009 $ 2009 $ 2009 $
Mar 31 Bank 6,150 Mar 31 Profit and Mar 31 General Mar 31 Balance c/f
loss 5,590 expenses 560 560
" 31 Prepaid general
expenses 560
6,150 6,150

The Journal
Date Details Dr Cr
2009
Mar 31 Prepaid general expenses
General expenses
$
560
$
560
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(ii) Commission Revenue Accrued Commission Revenue
2009 $ 2009 $ 2009 $ 2009 $
Mar 31 Profit and Mar 31 Bank 3,056 Mar 31 Commission Mar 31 Balance c/f
loss 3,231 " 31 Accrued revenue 175 175
commission
revenue 175
3,231 3,231
The Journal
Date Details Dr Cr
2009
Mar 31 Accrued commission revenue
Commission revenue
$
175
$
175
(iii) Carriage Outwards Accrued Carriage Outwards
2009 $ 2009 $ 2009 $ 2009 $
Mar 31 Bank 666 Mar 31 Profit and Mar 31 Balance c/f Mar 31 Carriage
" 31 Accrued carriage loss 788 122 outwards 122
outwards 122
788 788
The Journal
Date Details Dr Cr
2009
Mar 31 Carriage outwards
Accrued carriage outwards
$
122
$
122
(iv) Insurance Prepaid Insurance
2008 $ 2009 $ 2009 $ 2009 $
Apr 1 Bank 1,080 Mar 31 Profit and Mar 31 Insurance 720 Mar 31 Balance c/f 720
2009 loss 1,440
Jan 1 Bank 1,080 " 31 Prepaid
insurance 720
2,160 2,160
The Journal
Date Details Dr Cr
2009
Mar 31 Prepaid insurance
Insurance
$
720
$
720
8
5 C Chan
Income Statement for the year ended 31 December 2008
$ $
Sales 92,950
Less Cost of goods sold:
Opening inventory 10,250
Add Purchases 55,850
66,100
Less Closing inventory (19,550) (46,550)
Gross profit 46,400
Less Expenses:
Rent ($6,400 $1,600) 4,800
Wages and salaries ($21,400 + $2,900) 24,300
Insurance ($590 $190) 400
Telephone ($300 + $110) 410
General expenses 1,800 (31,710)
Net profit 14,690
6X K Chu
Income Statement for the year ended 31 March 2009
$ $
Sales 108,380
Less Returns inwards (2,000) 106,380
69,740
Gross profit 48,760
Less Expenses:
Motor expenses 2,120
Rent and rates ($12,000 $800) 11,200
Discounts allowed 290
Lighting expenses ($580 + $170) 750
Computer operating expenses ($1,210 $280) 930
General expenses 3,600 (44,710)
Net profit 4,050
7 Happy Wong
$ $
Hairdressing revenue 100,400
Less Expenses:
Advertising 2,300
Car expenses ($4,800 ) 3,200
Rates ($1,400 $300) 1,100
Telephone 1,100
Sundry expenses 1,200
Cleaning 150 (9,050)
Net profit 91,350
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2
3
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Happy Wong
Balance Sheet as at 31 December 2008
$ $
Non-current assets
Shop premises 60,000
Equipment 7,200
Car 26,400
93,600
Current assets
Prepaid expenses 300
Bank 5,400
Cash 400
6,100
Less Current liabilities
Accrued expenses (150)
Net current assets 5,950
99,550
Financed by:
Capital as at 1 January 2008 14,300
Add Net profit for the year 91,350
105,650
Less Drawings [$4,500 + ($4,800 )] (6,100)
99,550
8X L Tang
$ $ $
Sales 120,320
Less Returns inwards (1,384) 118,936
Less Returns outwards (810) 83,480
Add Carriage inwards 309
114,605
Gross profit 40,751
Add Other revenues:
Discounts received 506
Rent revenue 2,500 3,006
43,757
Less Expenses:
Discounts allowed 410
Carriage outwards 218
Motor expenses ($4,917 + $330) 5,247
Repairs to premises 1,383
Salaries and wages 16,184
Sundry expenses ($807 + $162) 969
Rates and insurance ($2,896 $332) 2,564
Loan interest 4,000 (30,975)
Net profit 12,782
1
3
1
3
10
9 (a) T Lee
Income Statement for the year ended 30 June 2009
$ $
Fees charged 108,600
Less Expenses:
Postage and stationery ($2,140 + $220) 2,360
Telephone 1,250
Computer operating expenses 2,190
Travel expenses ($1,620 90%) 1,458
Insurance ($890 $170) 720
Rent ($23,000 $600) 22,400
Sundry expenses 520 (65,178)
Net profit 43,422
T Lee
Balance Sheet as at 30 June 2009
$ $
Non-current assets
Office furniture 10,800
Equipment 25,400
36,200
Current assets
Accounts receivable 11,100
Prepaid expenses ($600 + $170) 770
Bank 8,090
Cash 120
20,080
Less Current liabilities
Accrued expenses ($220 + $2,320) (2,540)
Net current assets 17,540
53,740
Financed by:
Capital as at 1 July 2008 19,680
Add Net profit for the year 43,422
63,102
Less Drawings [$9,200 + ($1,620 10%)] (9,362)
53,740
(b) No, both types of firms treat revenues and expenses in the same manner if they adopt accrual-basis
accounting. For trading firms, revenues are recognised when goods are sold. For service firms,
revenues are recognised when services are provided. As for expenses, they are recognised by both
types of firms when they are incurred.
11
Application Problems
10X
The Journal
Date Details Dr Cr
2009 $ $
Mar 31

" 31

" 31

" 31
Bank
Rent revenue
Rent revenue
Profit and loss ($340,000 + $24,000 $65,000 $38,000 + $42,000)
Insurance
Bank
Profit and loss
Insurance [$18,000 + ($12,000 ) ($18,000 )]
340,000
303,000

18,000
16,500
340,000
303,000
18,000
16,500
11X Salaries
2007 $ 2007 $
Mar 31 Balance b/f 9,880 Mar 31 Profit and loss 12,180
" 31 Accrued c/f 2,300
12,180 12,180
Electricity
2007 $ 2007 $
6,500 6,500
Rental Income
2007 $ 2007 $
Mar 31 Profit and loss 150,000 Mar 31 Balance b/f 162,500
" 31 Prepaid c/f 12,500
162,500 162,500
12 (a) One of the main differences between cash accounting and accrual accounting lies in the treatment of
accruals and prepayments of revenues and expenses.
Under cash accounting, revenues are recorded when cash is received and expenses are recorded
when cash is paid. This means that revenues are recognised when received and expenses are
recognised when paid.
Under accrual accounting, a firm should only record revenues generated by goods sold or services
rendered during a period and the expenses which have been incurred in generating those revenues
during the same period, rather than the amounts actually received or paid during that period. This
means that revenues are recognised when earned and expenses are recognised when incurred.
(b) Cash accounting often leads to misleading results as a firm may have earned certain revenues during
a period but those revenues have not been recognised because they have not been received by the
end of that period. Likewise, it may have incurred certain expenses during a period but those
expenses have not been recognised as they have not been paid by the end of that period. Owing to
its inadequacy, cash accounting is not commonly used by businesses.
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13 (a) Jimmy Chan
$ $
Sales 182,480
Less Purchases (97,200)
Gross profit 85,280
Less Expenses:
Administrative expenses 42,570
Selling and distribution expenses 21,230 (63,800)
Net profit 21,480
(b) Jimmy Chan
$ $
Sales ($182,480 + $12,130) 194,610
Purchases ($97,200 + $7,790) 104,990
Gross profit 104,320
Add Interest revenue ($50,000 6% ) 1,000
105,320
Less Expenses:
Administrative expenses ($42,570 + $6,000) 48,570
Selling and distribution expenses [$21,230 ($2,400 )] 19,430 (68,000)
Net profit 37,320
(c)
In (a), sales were recognised when cash was received. In (b), sales were recognised when sales
were made, thus including trade receivables which arose during the year.

In (a), purchases were recognised when cash was paid. In (b), purchases were recognised when
goods were obtained, thus including trade payables which arose during the year.

In (a), the gross profit was calculated by deducting purchases paid during the year from sales
receipts for the year. In (b), the gross profit was calculated by deducting the cost of goods sold
for the year from sales for the year. The cost of goods sold equalled the purchases made during
the year less the value of unsold goods at the year end.

In (a), interest revenue was not recognised because it had not been received by the year end. In (b),
interest revenue was recognised because it had been earned during the year.

In (a), expenses were recognised when paid. In (b), expenses were recognised when incurred,
thus including the amounts accrued and deducting the amounts prepaid.

As a result, the net profits calculated in (a) and (b) were different.
14X (a) (i) Advertising and Promotions
2008 $ 2008 $
Jul 28 Bank 7,500 Apr 1 Accrued b/f 2,220
Oct 15 Bank 12,600 2009
Mar 31 Profit and loss 14,400
" 31 Prepaid c/f 3,480
20,100 20,100
4
12
4
12
9
12
9
12
13
(ii) Printing and Stationery
2008 $ 2009 $
Apr 1 Stationery b/f 20,400 Mar 31 Profit and loss 13,110
Sept 14 Bank Stationery 5,100 " 31 Stationery c/f 18,600
2009
Feb 12 Bank Printing 2,520
Mar 31 Accrued printing c/f 3,690
31,710 31,710
(iii) Rental Income
2009 $ 2008 $
Mar 31 Profit and loss (12 months) 15,780 Apr 1 In advance b/f (3 months) 3,780
" 31 In advance c/f (3 months: $8,880
1
2
) 4,440 Jul 1 Bank (6 months) 7,560
Oct 1 Bank (6 months) 8,880
20,220 20,220
(iv) Rates
2008 $ 2009 $
Apr 1 Prepaid b/f (3 months) 4,680 Mar 31 Profit and loss (12 months) 19,800
Jul 1 Bank (6 months) 10,080 " 31 Prepaid c/f (3 months: $10,080
1
2
) 5,040
Oct 1 Bank (6 months) 10,080
24,840 24,840
(b) Financial Services
Balance Sheet as at 31 March 2009 (extract)
Current assets $ Current liabilities $
Stationery inventory 18,600 Accrued expenses 3,690
Prepayments ($3,480 + $5,040) 8,520 Unearned revenues 4,440
Past Exam Questions Past Exam Questions
15 Insurance Account
2006 $ 2006 $
" 31 Prepayment c/f ($2,780 ) 695
8,100 8,100
Electricity Account
2006 $ 2006 $
" 31 Accrual c/f 1,560
8,040 8,040
Commission Income Account
2006 $ 2006 $
" 31 Prepaid income c/f 12,000
200,000 200,000
Rental Income Account
2006 $ 2006 $
" 31 Accrued income c/f 20,000
140,000 140,000
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Chapter 1 Accruals and Prepayments

Rent received in advance would be recognised as revenue for the year.

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