Other payables and other receivables Revision Notes

In accounting, the matching principle requires that expenses be recorded in the same accounting period as the revenues they help to generate. This alignment ensures that financial statements accurately reflect a business's performance and profitability during a specific period.

For example, if a business incurs electricity costs in December but pays the bill in January, the expense should be recorded in December to match the revenue earned in that month. Failing to do so would distort profit figures for both months.

This principle prevents misleading financial results by avoiding the overstatement or understatement of profits in any period. It is fundamental to accrual accounting, which recognises economic events when they occur, not when cash changes hands.

• Matching expenses with related revenues ensures accurate profit measurement.
• Accrual accounting recognises expenses and incomes when incurred or earned, not just when paid or received.
• Ignoring the matching principle can misstate financial performance.

Expenses can be categorised based on timing of payment and recognition:

Accrued expenses are costs that have been incurred during the accounting period but have not yet been paid by the end of that period.

Prepaid expenses are payments made in advance for goods or services to be received in future periods, so part or all of the payment relates to future accounting periods rather than the current one.

• Accrued expenses create liabilities because the business owes money.
• Prepaid expenses are assets because they represent future economic benefits.
• Correctly classifying these ensures expenses are matched to the correct period.

Similarly, incomes can be accrued or prepaid: - Accrued income is revenue earned during the accounting period but not yet received in cash or recorded.

Prepaid income (also called unearned income) is cash received before the service or goods are delivered, so the income relates to future periods.

Accrued income is recorded as an asset because the business has a right to receive payment. Prepaid income is recorded as a liability because the business owes goods or services to the customer.

• Accrued income increases assets until cash is received.
• Prepaid income increases liabilities until the income is earned.
• Proper recognition ensures revenues are matched to the period they are earned.

To record accrued expenses, the expense account is debited to recognise the cost, and a liability account (such as Accrued Expenses or Accrued Liabilities) is credited to show the amount owed.

Example: A company owes £500 for electricity used in December but will pay in January. The journal entry on 31 December is:

Debit Electricity Expense £500 (to recognise the expense) Credit Accrued Expenses £500 (to record the liability) When the payment is made in January: Debit Accrued Expenses £500 Credit Cash £500 For prepaid expenses, the payment is made in advance and initially recorded as an asset. The journal entry when payment is made: Debit Prepaid Expense (asset) Credit Cash As the expense is incurred over time, the prepaid asset is reduced and the expense recognised: Debit Expense Account Credit Prepaid Expense Example: Paying £1,200 for a 12-month insurance policy on 1 January. Initially: Debit Prepaid Insurance £1,200 Credit Cash £1,200 Each month, recognise £100 insurance expense: Debit Insurance Expense £100 Credit Prepaid Insurance £100

• Accrued expenses increase expenses and liabilities before payment.
• Prepaid expenses initially increase assets and decrease cash.
• Expense recognition reduces prepaid assets over time.

Accrued income is recorded by debiting an asset account (such as Accrued Income or Accounts Receivable) and crediting the income account to recognise revenue earned but not yet received.

Example: A business earned £800 consulting fees in December but will receive payment in January. The journal entry on 31 December is: Debit Accrued Income £800 Credit Consulting Fees Income £800 When payment is received: Debit Cash £800 Credit Accrued Income £800 Prepaid income is recorded by debiting cash and crediting a liability account (such as Unearned Income) when cash is received before earning the income. As the income is earned over time, the liability is reduced and income recognised.

Example: A customer pays £1,200 in advance on 1 January for a 12-month service contract. Initially: Debit Cash £1,200 Credit Unearned Income £1,200 Each month, recognise £100 income: Debit Unearned Income £100 Credit Service Income £100

• Accrued income increases assets and income before cash receipt.
• Prepaid income increases cash and liabilities before earning.
• Income recognition reduces liabilities and increases income over time.

Ledger accounts track the balances of expenses, incomes, assets, and liabilities related to accrued and prepaid items.

For accrued expenses, the Accrued Expenses ledger shows the liability balance until payment. The related Expense ledger shows the expense recognised.

For prepaid expenses, the Prepaid Expense ledger shows the asset balance, which decreases as the expense is recognised in the Expense ledger over time. Similarly, accrued income is tracked in an Accrued Income ledger (asset), and prepaid income in an Unearned Income ledger (liability). Maintaining these ledgers ensures accurate financial statements and facilitates adjustments at period end.

• Ledger accounts reflect the timing differences between cash flows and expense/income recognition.
• Accrued and prepaid ledgers help in preparing adjusting entries.
• They ensure the trial balance includes correct balances for financial statements.