Theory question 102
Accruals and Prepayments2. (a) Differentiate between adjustments and closing entries. (b) Explain how the following items are treated in the final accounts: (i) provision for doubtful debts; (ii) prepaid expenses; (iii) accrued income; (iv) depreciation on fixed assets.
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(a) Adjustments are entries made at the end of a period to bring the accounts up to date (accruals, prepayments, depreciation, provisions) so that income and expenses belong to the right period. Closing entries are the transfers made at the end of the period to close the income and expense accounts into the trading and profit and loss account.
(b)(i) Provision for doubtful debts: the provision (or the increase in it) is debited to profit and loss; in the balance sheet it is deducted from debtors.
(ii) Prepaid expenses: deducted from the expense in profit and loss; shown as a current asset in the balance sheet.
(iii) Accrued income: added to the income in profit and loss; shown as a current asset (amount receivable) in the balance sheet.
(iv) Depreciation: charged as an expense in profit and loss (or manufacturing account); the accumulated depreciation is deducted from the cost of the asset in the balance sheet to give net book value.
Each adjustment has two effects: one in the profit and loss account and one in the balance sheet.