Authorship
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 £600 relating to December, January and February. Therefore £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 [next page]