IGC-L17: Accruals & Prepayments
Adjusting income and expenses to ensure accurate profit calculation
Learning Objectives
- Define accruals and prepayments
- Apply the accruals principle
- Adjust expenses and income correctly
- Prepare journal entries for adjustments
- Understand impact on financial statements
Concept Framework
The Accruals Principle
Income and expenses must be recorded in the accounting period to which they relate, regardless of when cash is received or paid.
This is also known as the matching principle.
Accrued Expenses
Expenses incurred but not yet paid.
Example: Wages owing at year end.
Treatment:
Added to the expense in the Income Statement.
Shown as a current liability in the Statement of Financial Position.
Prepaid Expenses
Expenses paid in advance.
Example: Insurance paid covering next year.
Treatment:
Deducted from the expense in the Income Statement.
Shown as a current asset in the Statement of Financial Position.
Accrued Income
Income earned but not yet received.
Shown as a current asset.
Income Received in Advance
Income received before it is earned.
Shown as a current liability.
Worked Examples
Example 1 — Accrued Expense
Wages expense £12,000
Wages owing £2,000
Adjusted expense = £14,000
Income Statement: £14,000
Statement of Financial Position: Current liability £2,000
Example 2 — Prepaid Expense
Insurance £6,000 paid
£1,500 relates to next year
Adjusted expense = £4,500
Income Statement: £4,500
Statement of Financial Position: Current asset £1,500
📌 Additional adjustment-based examination questions are available in the 🎯 Question Papers + YouTube Explanation section.
Structured Practice
Level 1 – Concept Check
Define accrual.
Define prepayment.
State where an accrued expense appears.
Level 2 – Application Practice
Rent paid £10,000.
£2,000 relates to next period.
Calculate adjusted rent expense and show treatment.
Level 3 – Examination Style Question
Explain why accruals and prepayments are necessary when preparing financial statements. (6 marks)
📌 Additional structured adjustment questions are available in the 🎯 Question Papers + YouTube Explanation section.
∗ Additional structured Errors and Suspense Account questions are available in the Question Papers and YouTube Explanation section. Students should practise journal corrections and Suspense Account preparation regularly and review video explanations for procedural clarity.
Enrolled students may submit questions from recognised textbooks, past examination papers or other genuine academic material for expert clarification through the Student Doubt Support facility.
Proficiency Check
If you believe you have already mastered this topic, attempt the following without referring to notes.
If you are unable to answer confidently, revisit the lesson before proceeding.
Electricity expense £5,000; £800 unpaid. Calculate adjusted expense and show classification.
Income received £12,000; £3,000 relates to next period. Show adjustment.
Explain how failure to adjust prepayments affects net profit.
Why does the accruals principle improve reliability of financial statements?
Detailed Activity Solutions
Solution to Structured Practice
Adjusted rent expense:
10,000 – 2,000 = £8,000
Prepaid rent £2,000 shown as current asset.
Solutions to Proficiency Check
Solutions to Proficiency Check
Adjusted expense = £5,800
Accrued £800 shown as current liability.
Income for period = £9,000
£3,000 shown as current liability.
Failure to adjust overstates expenses and understates profit.
It ensures income and expenses are matched to correct period.
Marking Logic
2 marks – Correct calculation
2 marks – Logical explanation
2 marks – Evaluation
How This Topic Appears in the Examination
This topic is commonly assessed in:
• Paper 2 adjustment questions
• Financial statement preparation
• Theory questions on accruals principle
Examiners frequently assess:
Correct adjustment
Proper classification
Impact on profit
Students should practise adjustment questions regularly and review video explanations for clarity.
Enrolled students may submit questions from recognised textbooks, past examination papers or other genuine academic material for expert clarification through the Student Doubt Support facility.
Self-Assessment Checklist
- I understand the accruals principle
- I can adjust expenses correctly
- I can adjust income correctly
- I can classify accruals and prepayments
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