Accrued & Prepaid Expenses

Transferring expenses to the income statement

Transferring expenses to the income statement

How do I record expenses in the income statement?

• The accounting principle of matching states that expenses should be recorded for the financial period in which they are incurred

• The value posted to the income statement for an expense should be the actual amount invoiced for that period

• Entries are made in the expense account:

  • During the financial period when payments are made

  • At the end of the financial period

How do I calculate the amount to charge to the income statement for an expense?

• In an exam, you will likely be given information about an invoice for an expense for a period that does not fully align with the financial period

  • For example, the financial period might be from March 2023 to February 2024 but an invoice for an expense might be for August 2023 to July 2024

    • Only the amount for August 2023 to February 2024 should be posted to the income statement

• STEP 1
  Find the amount due per month

  • Divide the total amount by the number of months in the invoice period

• STEP 2
  Find the amount of the invoice that is due in that financial period

  • Multiply the amount per month by the number of months that are also in the financial period

• There might be multiple invoices which cover the financial period

  • Find the amount of each which is due in the financial statement

  • Add these amounts together to get the total amount due

Accrued expenses

Accrued expenses

What is an accrued expense?

• An accrued expense is an expense that is still owed at the end of a financial period

  • This is also called an accrual

  • The expense is in arrears

• Accrued expenses can occur at the end of a financial period when a business pays less than the amount due in that period

  • This usually happens when the invoice period of an expense does not align with the financial period of the business

  • The business might pay at the end of the invoice period

    • However, this might be after the end of current financial period

• An accrued expense is a liability to the business

  • The business owes money

How do I record accrued expenses?

• The expense account will have a credit balance if there is an accrual at the end of the financial period

  • This indicates that it is a liability, as the business still owes money for that period

• The full amount that is due for the period is stated on the income statement

• The amount that is accrued appears on the statement of financial position as a current liability

  • It is included in the amount for other payables

Prepaid expenses

Prepaid expenses

What is a prepaid expense?

• A prepaid expense is an expense for the next financial period that is paid in advance during the current financial period

  • This is also called a prepayment

• Prepaid expenses can occur at the end of a financial period when a business pays more than the amount due in that period

  • This commonly happens when the invoice period of an expense does not align with the financial period of the business

  • The business might pay an expense in full as soon as they receive an invoice

    • However, this invoice might also cover part of the next financial period

• A prepaid expense is an asset to the business

  • The business has paid too much to the supplier for that period

  • Technically, the business is owed money by the supplier 

How do I record prepaid expenses?

• The expense account will have a debit balance if there is a prepayment at the end of the financial period

  • This indicates that it is an asset, as the business has already made payments that relate to the next financial period

• The full amount that is due for the period is stated on the income statement

• The amount that is prepaid appears on the statement of financial position as a current asset

  • It is included in the amount for other receivables

Expense accounts with accruals & prepayments

Expense accounts with accruals & prepayments

How do I calculate the value to transfer to the income statement?

• You could be asked to find the find value to transfer to the income statement

  • This is the amount that is due for that financial period

• STEP 1
  Start with the amount that has been paid during the current financial period

• STEP 2
  Deal with any amounts carried over from the previous financial period

  • Subtract the amount if it is an accrual

    • Because this amount was not due in the current period

    • It was due in the previous period

  • Add the amount if it is a prepayment

    • Because this amount is due in the current period

• STEP 3
  Deal with any amounts that will be carried over to the next financial period

  • Add the amount if it is an accrual

    • Because this amount is due in the current period

  • Subtract the amount if it is a prepayment

    • Because this amount is not due in the current period

    • It will be due in the next period

How do I calculate the amount paid for an expense within a financial period?

• You could be asked to find the amount paid within a financial period

  • This might be different to the amount that is due for that period

• The method is the opposite of the previous method

• STEP 1
  Start with the amount that is due for the current financial period

• STEP 2
  Deal with any amounts carried over from the previous financial period

  • Add the amount if it is an accrual

    • Because this should have been paid in the current period

  • Subtract the amount if it is a prepayment

    • Because this was not paid in the current period

    • It was paid in the previous period

• STEP 3
  Deal with any amounts that will be carried over to the next financial period

  • Subtract the amount if it is an accrual

    • Because this has not been paid during the current period

    • It will be paid in the next period

  • Add the amount if it is a prepayment

    • Because this was also paid during the current period

How do I calculate a missing value in an expense account?

• You can use a ledger account to find any missing value

  • Fill in the amounts that you know on the correct sides

  • Find the missing value which balances the account

• You can use this method to find the amount paid for an expense as an alternative to the previous method