0452 · 4.3Other payables and other receivables

Matching costs and revenues

0:00Nadia’s Florist uses electricity in December but pays the bill in January. It also pays for insurance before the cover begins. Payment dates alone cannot tell us which year should include these costs. This video covers matching costs and revenues, accruals and prepayments, and the journal entries and ledger accounts for expenses and incomes. Revenue is the income a business earns from its main activity, such as selling goods or providing services.

0:24Nadia’s Florist earns its revenue from flower sales. Expenses are the costs used up in running the business and earning revenue during a period. Electricity and insurance are two of the florist’s expenses. Profit for the year is the amount by which revenue exceeds expenses over one financial year. The matching or accruals concept means income and expenses are recorded in the period to which they relate, not when cash is received or paid.

0:49December’s electricity belongs with December’s business activity. Insurance covering next year belongs with next year’s activity. Matching costs and revenues is important because each year’s revenue is then compared with the expenses used up in earning it. Without the adjustment, a late electricity bill would make this year’s profit too high and next year’s profit too low. Financial statements are summaries that show a business’s profit or loss for a period and what it owns and owes at a date.

1:13The statement of profit or loss is the financial statement that shows the revenue, expenses and profit or loss for a period. Adjusted expenses and incomes belong in this statement. The bank payment itself is still recorded in the cash book on the day the money moves.

Classifying adjustments and double entry

1:28Assets are resources owned or controlled by a business that bring future benefit, while liabilities are amounts the business owes to others. A statement of financial position shows assets, liabilities and owner’s equity at a particular date. Owner’s equity, also called capital, is the owner’s investment in the business, or the amount the business owes the owner. Current assets are assets expected to be turned into cash or used up within twelve months, while current liabilities are amounts due for payment within twelve months.

1:56The year-end adjustments in this video appear under two headings in the statement of financial position. Other receivables are current assets, such as amounts due to the business and payments for benefits not yet used. Unpaid expenses and money received before it is earned are grouped as other payables, which are current liabilities. Double entry means every transaction is recorded as a debit in one account and a credit of the same amount in another.

2:20An expense or an asset increases on the debit side, while income or a liability increases on the credit side. The reason for each entry comes from what has been used, earned, paid or owed. An accrued expense is a cost of the current year that is still unpaid at the year end. Nadia’s Florist has already received the service, so we add the accrued amount to this year’s expense.

2:41The unpaid amount is also a current liability under other payables. A prepaid expense is a cost paid in advance that belongs to a future period. The unused part of the payment is a current asset under other receivables. It gives Nadia’s Florist a future benefit, such as insurance cover or the right to occupy premises. We deduct that unused part from the current year’s expense. This deduction changes the expense reported, rather than reversing the actual payment.

Worked example: accrued rent

3:09Nadia’s premises rent is three hundred dollars per month. At the start of the year, a prepayment of three hundred dollars covers January. Payments during the year are two thousand seven hundred dollars and cover February to October. At the year end, six hundred dollars remains unpaid for November and December. The opening prepayment becomes this year’s expense because January’s occupation uses the benefit purchased last year. Three hundred plus the two thousand seven hundred dollars paid during this year gives three thousand dollars.

3:37Adding the closing accrual of six hundred dollars produces a rent expense of three thousand six hundred dollars. Check the result against the months of occupation. January contributes one month, the payments cover nine months from February to October, and the accrual covers November and December. One plus nine plus two gives twelve. Twelve multiplied by three hundred dollars confirms the expense of three thousand six hundred dollars. A journal entry records the year-end adjustment before it is posted to the ledger.

4:07Debit premises rent with six hundred dollars because this occupation belongs to the year, and credit other payables because the amount owed rises. Total debits and total credits both equal six hundred dollars. In the ledger, the premises rent account holds the accrual itself as a balance carried down. Its credit balance brought down is the other payable shown in the statement of financial position. The journal entry and this account record the same six hundred dollars, so the amount is never posted twice.

4:36Use the layout that the question asks for. The opening prepayment appears as a debit balance brought down of three hundred dollars. For the bank payments, debit premises rent because the cost of occupying the premises rises, and credit bank because money held there falls. Enter two thousand seven hundred dollars on the debit side with Bank as the details. The details column names the other account involved, so each record points towards its matching entry.

5:01Place the closing accrual of six hundred dollars on the debit side as balance carried down. Three hundred plus two thousand seven hundred plus six hundred equals three thousand six hundred dollars. Transfer that expense by debiting the statement of profit or loss and crediting premises rent. Both account totals equal three thousand six hundred dollars, and next year begins with a credit balance brought down of six hundred dollars.

Worked example: prepaid insurance

5:25For insurance, Nadia’s Florist pays two thousand dollars, but five hundred dollars covers next year. Debit other receivables because the right to future cover is an asset, and credit insurance because this year’s cost falls by five hundred dollars. The journal totals agree at five hundred dollars on each side. The original payment debits insurance because the recorded cost rises and credits bank because money leaves the business. Two thousand dollars minus five hundred dollars gives this year’s insurance expense of fifteen hundred dollars.

5:55Debit the statement of profit or loss and credit insurance to transfer that expense. The remaining five hundred dollars appears on the credit side as balance carried down. Fifteen hundred plus five hundred equals two thousand dollars, so both sides total two thousand dollars. Next year’s balance brought down is five hundred dollars on the debit side. That debit balance represents a current asset, because next year’s insurance cover has already been purchased.

6:20The side of the balance brought down identifies its nature.

Accrued and prepaid income

6:24Other income is income from activities other than the main one, such as rent received or discount received. Nadia’s Florist lets a spare room and receives rent as other income. Accrued income is an amount earned in the current year but not yet received at the year end. The amount due is a current asset under other receivables, because the business has already earned the payment. Prepaid income is an amount received in advance for a period after the year end.

6:49Nadia’s Florist may receive rent before the tenant occupies the room. That amount is a current liability under other payables because the business still owes the tenant the future use of the room. Receiving money does not automatically make it this year’s income. The tenant pays rent of four hundred dollars per month. On the first of January, four hundred dollars was still owed for the previous December. Nadia’s Florist receives six thousand dollars during this year.

7:13Those receipts include last December’s rent and eight hundred dollars for January and February of next year. Start with six thousand dollars received and subtract the opening accrued income of four hundred dollars. That leaves five thousand six hundred dollars. Subtract the closing prepaid income of eight hundred dollars to obtain four thousand eight hundred dollars earned this year. The opening amount belongs to last year, while the closing advance belongs to next year.

7:37A monthly check confirms the result. At four hundred dollars per month, six thousand dollars received covers fifteen months. One of those months belongs to last year and two belong to next year. Fifteen minus one minus two leaves twelve months, and twelve multiplied by four hundred dollars is four thousand eight hundred dollars. Debit rent income because eight hundred dollars leaves this year’s income, and credit other payables because the duty to provide future occupation rises.

8:03The adjustment leaves the bank receipt unchanged. Both journal totals equal eight hundred dollars. In the rent income account, the opening accrued income is a debit balance brought down of four hundred dollars. Record receipts by debiting bank because money held there rises and crediting rent income because income from the tenant rises. The credit side therefore shows Bank with six thousand dollars. Transfer the earned amount by debiting rent income and crediting the statement of profit or loss with four thousand eight hundred dollars.

8:32The closing advance appears on the debit side as balance carried down of eight hundred dollars. Four hundred plus four thousand eight hundred plus eight hundred equals six thousand dollars. Both sides total six thousand dollars. Next year begins with a credit balance brought down of eight hundred dollars, which represents income received before it is earned. Nadia’s Florist also earns commission for arranging flower deliveries for another business. It receives two thousand one hundred dollars, while seven hundred dollars earned remains unpaid.

9:02Debit other receivables because seven hundred dollars is due to the business, and credit commission income because that amount has been earned. Both journal totals equal seven hundred dollars. For the receipts, debit bank because money held there rises and credit commission income because the commission earned rises. Two thousand one hundred plus seven hundred equals two thousand eight hundred dollars earned. Transfer that amount by debiting commission income and crediting the statement of profit or loss.

9:28The accrued amount appears as balance carried down on the credit side. Both account totals are two thousand eight hundred dollars. Next year’s debit balance brought down is seven hundred dollars. This represents a current asset because the commission has already been earned. An income account can therefore begin with a debit balance when money remains receivable.

Adjustment rules and exam effects

9:48The correct adjustment depends on the period, rather than whether cash moved. When calculating this year’s expense, add closing accrued expenses and deduct closing prepaid expenses. Income follows the same pattern, with closing accrued income added and closing prepaid income deducted. Opening balances work the other way, so an opening accrued expense is deducted from the payments and an opening prepaid expense is added. Distinguish balance carried down from balance brought down when reading a ledger.

10:18An accrued expense becomes a credit balance brought down, while a prepaid expense becomes a debit balance brought down. For income, an amount earned but outstanding becomes a debit balance brought down. Income received in advance becomes a credit balance brought down because future service remains owed. Paper One contains forty multiple-choice questions, and Paper Two contains five compulsory structured questions. Questions can test calculations, journal entries, ledger accounts and classifications.

10:46Calculate means work out from given figures, while prepare means present information in a suitable format. Explain means give reasons why and how, supported by evidence. Consider an exam question that asks you to explain the effect of omitting Nadia’s closing accrued premises rent. Expenses would be understated by six hundred dollars because this year’s unpaid occupation cost would be left out. As a result, the profit for the year would be overstated by the same amount.

11:13In the statement of financial position, other payables and current liabilities would also be six hundred dollars too low. Matching costs and revenues places expenses and incomes in the periods they relate to. Accruals record amounts already used or earned but not yet paid or received. Prepayments separate amounts paid or received for future periods. Journal entries record both effects, while balanced ledger accounts show the current period’s amount and the balance carried into the next year.