ZIMSEC O Level Principles of Accounts Notes: Prepayments and the Financial statements

  • A prepayment is when an amount is paid before it is due
  • In accounting there are two types of prepayments:
  • Prepaid expenses and
  • Prepaid income

Prepaid expenses

  • This is when the business prepays an expense
  • Examples are:
    • When a business pays rent payable in advance or
    • When it pays insurance expenses in advance
  • Only the expense for the period in question must be recorded in the Income statement
  • The excess amount must be carried forward and expensed in the period to which it relates
  • For example the rent for the business’s premises is $10 000 per year
  • During the month of October 20×6 the business makes a payment of $7500
  • Another payment of $5000 is made on 22 December
  • The business’s trading period ends on 31 December
  • These transactions would be recorded in the books as follows:
General Ledger
DateDetailsAmount($)DateDetailsAmount($)
31 OctoberCash/Bank750031 DecemberProfit and Loss10000
22 DecemberCash/Bank500031 DecemberBalance c/d2500

12500

12500

1 JanuaryBalance b/d2500
  • In other books the narration Balance c/d and Balance b/d are replaced using Prepaid c/d and Prepaid b/d respectively
  • As shown below:
General Ledger
DateDetailsAmount($)DateDetailsAmount($)
31 OctoberCash/Bank750031 DecemberProfit and Loss10000
22 DecemberCash/Bank500031 DecemberPrepaid c/d2500

12500

12500

1 JanuaryPrepaid b/d2500
  • As clearly shown only the amount attributable for the period is transferred to the Income statement
  • If you not asked to prepare the expense account you can use the short cut method in the Income statement
  • Prepaid amounts are subtracted from the expense amount
  • Prepaid expenses are shown under current assets beneath debtors
  • The order of the current assets list becomes:
    • Stock
    • Debtors
    • Prepaid expenses
    • Bank
    • Cash

Prepaid Income

  • This is when the business receives income in advance
  • An example is when the business receives rent when it rents out extra space
  • If the business receives this income in advance it becomes prepaid income
  • Only the income pertaining to the current period is shown in the Income Statement
  • The excess amount is carried forward
  • For example:
  • The rent receivable for the business is $4000 per year
  • The business receives a payment of $5000 on 14 July 20×6
  • The entries to record this would be as follows:
General Ledger
DateDetailsAmount($)DateDetailsAmount($)
31 DecemberProfit and Loss400014 JulyCash/Bank5000
31 DecemberPrepaid c/d1000

5000

5000

1 JanuaryPrepaid b/d1000
  • Prepaid income is deducted from income paid each period
  • Prepaid income is shown under current liabilities since the prepaid monies involved belong to outsiders

To access more topics go to the Principles of Accounts Notes.

 

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