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Accounting Topics

Ledger Entries & Adjustments
Accruals and Prepayments


What is the Accruals or Matching Concept?

The principle that final accounts should only include income and expenditure for a particular financial year

When we prepare double entry accounts we can do them in one of two ways:

1) Cash Basis

We record transactions in full when they occur. This is the most straightforward accounting method but is not the most accurate.

EXAMPLE

A business pays its annual (yearly) insurance bill now for three months of this financial year and nine months of the next financial year. It records the following entries:

DEBIT

Insurance (an expense)

 

£1200
CREDIT

Bank or Cash (reduction of an asset)

£1200

Whilst this transaction accurately shows the cash flow out of the business during this financial year, it does not accurately represent the expense incurred by the business for this accounting period (because £900 or 3/4 of the amount refers to the Insurance expense in the next accounting period, and only £300 or 1/4 refers to the expense for this period).

Accountants instead apply the Accruals or Matching Concept which enables businesses to more accurately calculate profits and losses for a given accounting period.

2) Accruals Basis

The above transaction would again be recorded in full but this time a note would be made, in this example to show that a proportion of the amount paid refers to the next period, namely £900. This note takes the form of a Balance being Carried Down to the next Accounting Period.

The cash flow is accurately recorded (as above) but this method also ensures that when Profit or Loss is calculated it is using only those expenses and revenues which relate to that period of time. The remainder of the expense or revenue is recorded, in this case, in the following period.

This does however mean that a balance will often be remaining in an expense or revenue account at the end of an acconting period. All balances on accounts are summarised in the Balance Sheet, being vategorised as assets or liabilities.


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