Accruals: cash has a timetable, work has another
Introduced| English | Meaning |
|---|---|
| accrual basis | Recognising revenue and expense when work happens, not cash. |
| matching principle | Expenses belong to the period of the revenue they earn. |
| prepayment | Cash paid before the expense; the unused part is an asset. |
| accrual | Expense incurred before the cash is paid; a liability. |
| depreciation/dɪˌpriːʃɪˈeɪʃn/ | A reduction in the value of an asset over time, often modelled as a percentage decrease. |
£12,000 of rent leaves the bank on 1 October
- Nimbus pays a whole year's shop rent in one payment on 1 October. Its financial year ends on 31 December.
- If the full £12,000 counts as this year's cost, this year looks poor and next year looks far too good. This lesson shows how accountants move costs to the months they belong to.
Count the work, not the payment
- The accrual basis 权责发生制 records income when it is earned and an expense when the benefit is used, whatever day the cash moves.
- The matching principle 匹配原则 puts each expense in the same period as the work it supports. Year-end adjustments move entries from the cash timeline to the work timeline.
Under the accrual basis, an expense is recorded in the month the cash is paid.
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The accrual basis records an expense when the benefit is used. The payment date only decides when cash moves.
Cash first, cost later: a prepayment
- A prepayment 预付款 is cash paid before the benefit is used. The unused part is an asset, because Nimbus has bought a right it has not yet used.
- Rent of £12,000 from 1 October covers 12 months. By 31 December three months are used: $12\,000 \times \dfrac{3}{12} = 3\,000$ is this year's expense, and $12\,000 \times \dfrac{9}{12} = 9\,000$ is a prepayment asset.
Rent of £12,000 is paid on 1 October for one year, and the year ends on 31 December. What does this year's account show?
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Three months are used: $12\,000 \times \dfrac{3}{12} = 3\,000$ of expense. The other nine months stand as a prepayment asset.
Nimbus pays £2,400 on 1 September for 12 months of insurance. The year ends on 31 December. What is the prepayment at the year end, in £?
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September to December uses four months, leaving eight: $2\,400 \times \dfrac{8}{12} = 1\,600$. This year's expense is £800.
Cost first, cash later: an accrual
- An accrual 应计 is an expense already used but not yet paid, so it is a liability. The bank loan's interest, $15\,000 \times 6\% = 900$, is owed for the year but paid on 1 January.
- The same idea runs the other way for income: if Nimbus delivers to a café that will pay next month, the money it is owed is an asset, a receivable.
Prepayment, accrual or already matched?
Sort each item at Nimbus's 31 December year end. Paid before the benefit is used means a prepayment; used before it is paid means an accrual; paid and used in the same year needs no adjustment.
Match each year-end item to where it goes.
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Paying early creates an asset; owing for work already used creates a liability. Money owed to Nimbus is an asset.
Depreciation spreads the oven's cost
- Depreciation 折旧 spreads the cost of a long-lived asset over the years it is used. Straight-line: $\dfrac{\text{cost} - \text{residual value}}{\text{years of use}}$.
- The oven cost £6,000 and will be worth £600 after five years: $\dfrac{6\,000 - 600}{5} = 1\,080$ a year, or £90 a month. After one year its carrying amount is $6\,000 - 1\,080 = 4\,920$.
The oven cost £6,000, will be worth £600 after five years, and is depreciated straight-line. What are year 1's depreciation and the carrying amount?
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$\dfrac{6\,000 - 600}{5} = 1\,080$ a year, and $6\,000 - 1\,080 = 4\,920$. Option 2 forgets the residual value.
A delivery van costs £18,000 and will sell for £3,000 after five years. What is the straight-line depreciation each year, in £?
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$\dfrac{18\,000 - 3\,000}{5} = 3\,000$ a year.
Year 1's profit, with every adjustment
- Each line uses the cost of the year's work, not the year's payments. The rent is £3,000, not £12,000; the oven costs £1,080, not £6,000.
| Year 1 | £ |
|---|---|
| Sales | 156,000 |
| Cost of sales (66,000 bought − 3,600 left) | −62,400 |
| Wages (incl. 400 unpaid) | −52,000 |
| Rent (3 months) | −3,000 |
| Other running costs | −8,000 |
| Depreciation | −1,080 |
| Electricity (accrued) | −250 |
| Interest (accrued) | −900 |
| Profit | 28,370 |
A student counts the whole £12,000 of rent as year 1's expense and makes no other change. What profit do they report, in £?
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They add the £9,000 prepayment to the expenses: $28\,370 - 9\,000 = 19\,370$. Profit is understated by the unused nine months.
Three year-end slips
- Counting an accrual twice. "Wages expense £52,000, of which £400 unpaid" already includes the £400. Adding it again understates profit by £400.
- Depreciating to zero. Spread cost minus residual value, not the whole cost.
- Calling a prepayment an expense because the cash has gone. Cash timing does not decide the expense; the work does.
Wages expense is stated as £52,000, of which £400 is unpaid. Which wages figure goes into profit?
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The stated expense already includes the unpaid part, which only affects cash. Adding the £400 again counts it twice.
Recap
- Expenses follow the work, not the payment.
- Prepayment: paid early, an asset. Accrual: paid late, a liability.
- Depreciation spreads (cost − residual value) over the years of use.