This post has been re -updated on 7th June 2013.
This topic is easy if you understand what is accounting period and accrual concept.
Accrual concept is the consideration of income and expenses (also called charges) relating to the accounting period. You then need to know what is an accounting period. Accounting period is the time set by a company itself on its period of accounting, reporting date and year end closing. Most companies have an accounting period of one year and they usually ends at 31st December 20XX so you could expect most companies and exam questions’ accounting period starts at 1st January 20XX – 31st December 20XX.
Accrual means owing and prepayment means advanced payment. If you start a business on 15th August 2012 and you decide to rent a vacant lot for your business. So you will expect payment to be made in advance, say 3 months in advance worth of $3,000 (well, the tenant needed to ensure that you really wanted to rent the lot and perhaps also for security reason). So you made the following payments on 15th August 2012 and 15th November 2012. I have further explained the points below:Right now, you will need to know how to open up a Rent account (an expense account). The reason I emphasized on an expense account is the fact that you will need to apply the nature of transaction for an expenses – which is the debit side. You will also need to know how to post the rental account items to its relevant account and the overall format of how the adjusted accounts will look like. The above example uses rental account, which is an expense item, in this case, you will need to follow the general format for an expense account as proposed above. You will not see this in any textbook, you are expected to know where to put accrued and prepaid opening and closing entries, which is indeed confusing during the examination. In any case, you should also be able to tell whether it is an expense or an income. Remember that if you pay then it is an expense while if you receive then it is an income. Then use the relevant format to solve for the Profit and Loss amount.
In order to score well, you will need to know:
1) How to charge expense/income to the profit and loss account, for which you will need to refer back to the format above to solve.
(The trick that I used!) In order to remember,
- I denote Expenses as [E], Revenues as [R], Accrual as [A], Bank as [B], Profit and Loss as [P] and Prepaid as [P].
- For an Expense Account, the debit side will be PBA and the credit side will be APP.
- So memorize only “E – PBA APP”
- For an Income Account, the debit side will be APP and the credit side will be PBA.
- So memorize only “R – APP PBA”
You can stick with any other method you like to as long as you can remember them.
2) How to post closing entry to the balance sheet.
- Accrued at closing balance of Expenses = Current Liabilities
- Prepaid at closing balance of Expenses = Current Assets
- Accrued at closing balance of Revenues = Current Assets
- Prepaid at closing balance of Revenues = Current Liabilities