Expenses Paid in Advance and in Arrears
You can deduct all expenses invoiced for the whole accounting period from sales. It will go towards reducing the tax liability calculated on taxable profit. If invoices have not been paid at the year end they will not be in the cashbook summary. Therefore, bring them into the accounts by making up a list of all unpaid invoices. Be careful of double counting invoices already included in trade creditors.
The accounting entry is:
- Dr Expenses (profit and loss account)
- Cr Accruals (balance sheet liability)
The total accrued expenses are included in the balance sheet under current liabilities and shown in a seperate line in a note to the accounts.
Net: income statement
(Net): balance sheet
When accounts are prepared, the accrued expenses included in the previous balance sheet are reversed by using an accounting entry (cr expenses, dr accruals). Alternatively, the payment of the invoice is recorded in the balance sheet to clear out the accruals during the following accounting period (dr accrual, cr cash).
Expenses such as rates are paid in advance. You can exclude the portion belonging to next year from the profit and loss account to show the real profit from year to year by placing it on the balance sheet and releasing it to the profit and loss account as the service is used up.
Say four months of next year's rates have already been paid by the year end, and the full amount of the rates for 12 months is £1,000. The amount to include as a prepayment will be £333.33 (£1,000 x 4/12). The accounting entry is:
- Dr Prepayment (balance sheet asset)
- Cr Expenses (Profit & Loss account)
Make a list of all prepaid expenses and record how next year's portion have been calculated, as you will need to be able to explain it to the accountant and possibly the tax authority. Prepayments included in the accounts increase profit and the tax liability for the year.
The prepaid portion of each expense is deducted directly from the total of that expense for the year in the profit and loss account. The total of the prepaid expenses is shown in the balance sheet under current assets and in a seperate line in the notes to the accounts. The balance sheet will balance because you have adjusted current assets and accumulated profit by the same amount.
(Net): income statement
Net: balance sheet