Accrual Concept Of Accounting- Accrued income, deferred income, prepaid expenses, Outstanding expenses.

 Accrual Concept

 

The Accrual Concept is one of the Most Important Methods for Adjusting the Year-End Entry. It is the standard method for entering Transaction revenue and expenses incurred or earned.

The Accrual Concept Split as four method ,

1. outstanding expenses

2. Prepaid expenses

3. Accrued income

4. Deferred income

            Before we know about the above concepts we should know about the open transaction and closing transaction to understand the accrual concept. Let us see the open transaction and closing transaction with examples,

An open transaction is a transaction that is not completed within the financial year that transaction is called an open transaction. for example, a P2P (PROCURE TO PAY) transaction or an o2c (ORDER TO CASH) Transaction not completed in the one financial year, the sales completed but the amount not received in the financial year, or the purchase completed. Still, the payment not paid in the financial year is an open transaction.

The closing transaction is all the entry transactions P2P or O2C completed in one financial year that is called a closing transaction.

Now we enter into the accrual concept,

1. Outstanding Expenses 

                      The Outstanding expenses are when we or the firm avail the Sources or benefits from the supplier but we or the firm are not yet to pay the amount belonging to the sources or benefits until the end of the year. The Current Liability of the Payable, Credit Balance is Outstanding Expenses.

Example,

March 2022’s warehouse Rent has to be paid by the landlord MR Ravin ₹ 15000.

But the rent amount is usually paid every month 5th. So the March rent was also paid on 5th April 2022. But the expenses have to occur in the financial year 2021-22. So the outstanding entry has to be made on 31-03-2022 and the reversal entry has to be made on 01-04-2022.

The journal entry is

Date

Particular

Debit

credit

31-03-2022

By Rent A\C

15000

 

 

      To Outstanding Expenses A\C

 

15000

 

 

 

 

 The rent expenses were added to the P&L for 2021-2022. We have to make a reversal entry for Nil and open the new financial yearbook.

The reversal entry is

 

Date

Particular

Debit

credit

01-04-2022

By outstanding expenses, A\C

15000

 

 

      To Rent A\C

 

15000

 

 

 

 

 

 The entry makes zero balance for opening the new book for the new financial year. That ₹15000 negative balance will Adjusted to the rent paid on 05-04-2022. The amount does not affect the P&L  in the financial year 2022-23. The entries continue every financial year.

It is not only applicable for Rent, but also applicable to EB Charge, Interest Payable, Water charges, Wages, Salary Etc.,

 

2. Prepaid Expenses 

            The Prepaid Expenses are when we made the prepayment to the supplier before the avail of services or products. In that case, the payment and purchase have been completed at the end of the financial year we never make any adjusting entries for the transaction, possibly the transaction incurred over the financial year the adjusting entry should made.

For example, 

Amount paid to Cholamandalam Insurance Ltd ₹ 120000 for the period of 01-01-2023 to 31-12-2024.

 

The Payment Entry is,

           

Date

Particular

Debit

credit

01-01-2023

By prepaid insurance A\C

120000

 

 

      To Cholamandalam Insurance LTD A\C

 

120000

 

Advance insurance amount paid for Raw materials. The insurance covered from 01-01-2023 to 31-12-2023.

 

 

01-01-2023

By Cholamandalam Insurance LTD A\C

120000

 

 

      To Bank A\C

 

120000

 

Amount Paid  to Cholamandalam Insurance

 

 

 

Here the Financial Year is 2022-23 and 2023-24. Now the end of the financial 2022-23 has to make adjustment entries for Expenses.

The 120000 should be dividing in monthly wise ₹120000/12= ₹10000 per month

Jan-2023 to MArch-2023 is 3 month total of ₹30000, so the adjustment entry is,

Date

Particular

Debit

credit

31-03-2023

By insurance A/C

30000

 

 

      To Prepaid Insurance A\C

 

30000

 

NOTE: The Expenses are added to the P&L and also the Current assets are Reduced.

 

 

 

Here no need to make the reversal entry cause the expenses are transferred from prepayments.

In case the expenses are made directly in the insurance account we should make the adjusting entry, For Example

First reversal entry is, that we just leave the actual expenses incurred in the financial year 2022-23, rest of the amount should transfer to prepaid insurance

Date

Particular

Debit

credit

31-03-2023

By prepaid insurance A/C

90000

 

 

      To Insurance A\C

 

90000

 

 

 

 

 

The Actual Expenses occur in the P&L balance amount transfer to Current Asset for utilising next financial year.

 

3. Accrued income

      The Accrued income is income earned but the amount not received in the same financial year. The simple concept is we earn the amount that amount also we should show in the P&L if isn’t received.

For Example, the construction firm built a villa for the LLC worth ₹5000000. The project end date is 31-08-2023. The project starts on 01-08-2022. The advance amount received ₹ 1000000 only. The actual project value for 6 months is ₹ 2500000, but we received only a small amount. So, the rest of the amount is earned but not recorded. So, we consider it income to show the P&L as accrued income at the end of the financial year.

Date

Particular

Debit

credit

31-03-2023

By Accrued income A/C

1500000

 

 

      To construction services income A\C

 

1500000

 

NOTE: Here is the income shown in the P&L Account, as well as the current asset increase.

 

 

 

 

And also made the reversal entry for the next financial year's book Opening DT: 01-04-2023

Date

Particular

Debit

credit

31-03-2023

By construction services income A/C

1500000

 

 

      To Accrued income A\C

 

1500000

 

NOTE: Here is the income shown in the P&L Account, as well as the current asset increase.

 

 

 

That is Accrued Income.

4. Deferred income

            Deferred income is income received in advance that amount is called deferred income or unearned income. The revenue was received before we supply services or goods. In this Adjusting entry is only applicable to the transaction that is open transaction in the end of the financial year.

            For example,

We received the advance amount from Mr Rahim against the sale ₹500000 on the date of 15-03-2023.

Date

Particular

Debit

credit

15-03-2023

Bank A\C

500000

 

 

      To Rahim A\C

 

500000

 

The advance amount received from MR Rahim

 

 

 

We made the sales entry on 31.03.2023 worth ₹ 300000, and the balance amount was transferred to Deferred income.

Date

Particular

Debit

credit

31-03-2023

Mr Rahime  A\C

300000

 

 

      To Sales A\C

 

300000

 

The advance amount received from MR Rahim

 

 

 

The balance ₹200000 amount was transferred to deferred income cause that amount was not our revenue in the particular financial year. So we consider that as a current liability.

 

Date

Particular

Debit

credit

31-03-2023

Mr Rahime  A\C

200000

 

 

      To Deferred income A\C

 

200000

 

The advance amount received from MR Rahim

 

 

 

Then we made the reversal entry for the next financial year 01-04-2023.

 

Date

Particular

Debit

credit

01-04-2023

Deferred income A\C

200000

 

 

     To  Mr Rahime A\C

 

200000

 

The advance amount received from MR Rahim

 

 

 







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