PRC 4: INTRODUCTION TO ACCOUNTING
Chapter 4
ACCRUAL CONCEPT
Accrual concept requires recording income when they are earned and not when they are received
in cash, and recording expenses when they are incurred and not when they are paid.
Cash basis vs. Accrual basis
Under the cash basis of accounting, income and expenses are reported in financial statements
when the cash is received or paid.
Under the accrual basis of accounting, expenses are matched with the related income and are
reported when the expense is incurred, not when the cash is paid.
The accrual basis of accounting gives a better measurement of profitability than does the cash
basis because accrual basis matches revenue with expenses that an entity incurred to earn it.
ACCRUED EXPENSES
These are expenses incurred but not paid by the end of an accounting period. The expense must
be recorded, even if it has not been paid yet, as it relates to the period in which it was incurred
and the amount unpaid should be recorded as a liability.
The related journal entries (two account system) are as follows:
On payment of expense during accounting period
Debit Expense account
Credit Cash / Bank
Period end adjustment for expenses incurred but not yet paid
Debit Expense account
Credit Accrued expenses
At start of next accounting period, reversal of period end adjustment is needed
Debit Accrued expenses
Credit Expense account
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PRC 4: INTRODUCTION TO ACCOUNTING
PREPAID EXPENSES
This is cash paid in advance for expenses to be incurred after the end of an accounting period.
The amount that relates to next accounting period is not an expense for this period and must be
presented as an asset.
The related journal entries are as follows:
On payment of expense during accounting period
Debit Expense account
Credit Cash / Bank
Period end adjustment for expenses not yet incurred and paid in advance
Debit Prepaid expenses
Credit Expense account
At start of next accounting period, reversal of period end adjustment is needed
Debit Expense account
Credit Prepaid expenses
ACCRUED INCOME
These is income earned but not received by the end of an accounting period. The income must
be recorded, even if it has not been received yet, as it relates to the period in which it was earned
and the amount to be received should be recorded as an asset.
The related journal entries are as follows:
On receipt of income during accounting period
Debit Cash / Bank
Credit Income account
Period end adjustment for income not yet received
Debit Accrued income
Credit Income account
At start of next accounting period, reversal of period end adjustment is needed
Debit Income account
Credit Accrued income
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PRC 4: INTRODUCTION TO ACCOUNTING
UNEARNED INCOME
This is cash received in advance for income yet to be earned at the end of an accounting period.
The amount that relates to next accounting period is not an income for this period and must be
presented as a liability.
The related journal entries are as follows:
On receipt of income during accounting period
Debit Cash / Bank
Credit Income account
Period end adjustment for income not yet earned and received in advance
Debit Income account
Credit Unearned income
At start of next accounting period, reversal of period end adjustment is needed
Debit Unearned income
Credit Income account
Example: 1
i. A revenue not yet recognized; collected in advance.
ii. Office supplies on hand that will be used in the next period.
iii. Subscription revenue collected; not yet recognized.
iv. Rent not yet collected; already recognized.
v. An expense incurred; not yet paid.
vi. A revenue recognized; not yet collected.
vii. An expense not yet incurred; paid in advance.
viii. Interest expense incurred; not yet paid.
Required:
Identify the statements above with the appropriate terms from the following:
Prepaid Expenses
Unearned Revenues
Accrued Revenues
Accrued Expenses
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PRC 4: INTRODUCTION TO ACCOUNTING
Example: 2
Ujala Limited has provided the following information for the year ended 31 st December 2020:
On 1st July 2020, A building is hired and annual Rent is paid in advance amounting to Rs.
240,000.
On 1st September 2020, Insurance contract is made and annual insurance will be paid in
arrears amounting to Rs. 300,000.
On 1st October 2020, Fee from customers is received in advance Rs. 120,000 for the next
6 months.
On 1st March 2020, A deposit is made with the bank amounting to Rs. 480,000 and 10%
interest income will be received annually in arears.
Required:
Identify “Accrual & Prepayment” and “Income & Expense” in the above information.
Example: 3
Ali & Co. has prepaid insurance amounting to Rs. 50,000 as at 1st July 2018. Insurance expense
for the year was amounting to Rs. 400,000 while payments made during the year were as follow:
• 1st July 2018 Rs. 100,000
• 1st November 2018 Rs. 150,000
• 1st April 2019 Rs. 70,000
Required:
Calculate accrual or prepayment of insurance as at 30th June 2019.
Example: 4
Shahzeb started a business on 1 July 2020 and accounting year ended 30 June 2020:
On 1st October 2020, Shahzeb received Electricity Bill demand for Rs. 80,000 for the 12 months
to 30th September 2021. Payment was made, in full, on 1 st October 2020.
The Electricity bill demand for the next 12 months to 30 th September 2022 was Rs. 96,000.
Shahzeb paid the full amount on 30th September 2022.
Required:
Write up the Electricity expense ledger account for 2020 and for 2021.
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PRC 4: INTRODUCTION TO ACCOUNTING
Example: 5
Professional Institute of Training is providing training services to IT & accounts professionals. Fee
for training was charged to customers at the rate of Rs. 1,000 per month which was increased
from January 2020 by Rs. 500. Fee from each customer is received quarterly in advance on the
following dates;
• 1st August
• 1st November
• 1st February
• 1st May
Company has 100 customers throughout the year.
Required:
Calculate fee income for the year and unearned fee income as at 30th June 2020.
Example: 6
Jimmy Co prepares its financial statements for the year to 30th June each year. The company
pays for its insurance quarterly in advance on 1st March, 1st June, 1st September and 1st
December each year. The annual insurance premium was Rs. 24,000 until 31st August 2020, after
that date it increased to Rs. 30,000 per year.
Required:
What insurance expense and end of year prepayment should be included in the financial
statements for the year ended 30th June 2021?
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