Cambridge Syllabus Notes

5.1 Sole Traders: Adjustments for Accrued and Prepaid Items

What are Accruals and Prepayments?

Imagine you’re running a lemonade stand. You buy lemons on Monday but don’t sell any lemonade until Wednesday. The cost of the lemons is an accrued expense that should be recorded on Monday’s books, even though you’ll pay the supplier later.

Now, suppose you pay for a whole month’s rent on the first day of the month. That money is a prepaid expense because the benefit (the right to use the space) will be enjoyed over the next month, not all at once.

Accrued Expenses

Accrued expenses are costs that have been incurred but not yet paid or recorded. They must be recognised in the period they are incurred to keep the financial statements accurate.

Utility bills received after the period end.
Wages earned by employees but paid in the next month.
Interest on a loan that accrues monthly.

Prepaid Expenses

Prepaid expenses are payments made in advance for services or goods that will be consumed over future periods. The expense is recognised gradually as the benefit is received.

Rent paid for the next three months.
Insurance premiums paid yearly.
Subscriptions or memberships that cover future months.

Accrued Income

Accrued income is revenue earned but not yet received or recorded. It ensures that income is matched with the period in which it was earned.

Interest earned on a savings account.
Services rendered in December but invoiced in January.
Rent received in advance for the next month.

Prepaid Income

Prepaid income is money received before the service or product is delivered. The income is recognised over the period when the service is performed.

Advance payment for a future course.
Rent received for the next six months.
Subscription fees paid yearly.

Sample Adjustment Entries

Date	Account Debited	Account Credited	Amount	Explanation
31/12/2023	Utilities Expense	Accounts Payable	$120	Accrued utility bill for December.
01/01/2024	Prepaid Rent	Cash	$1,200	Rent paid for Jan‑Mar 2024.
31/12/2023	Interest Receivable	Interest Income	$25	Accrued interest earned on savings.

Exam Tip: Remember the Matching Principle

Accruals link expenses or income to the period they belong to, not when cash moves.
Use the formula: $$\text{Adjusted Income} = \text{Recorded Income} + \text{Accrued Income} - \text{Prepaid Income}$$ $$\text{Adjusted Expense} = \text{Recorded Expense} + \text{Accrued Expense} - \text{Prepaid Expense}$$ This keeps the income statement balanced for the period.

Quick Check‑List

Have you identified all expenses incurred but unpaid?
Did you recognise any payments made for future periods?
Are there any services performed but not yet invoiced?
Have you recorded any advance payments received?

🎓 Remember: Accurate adjustments give a true picture of your business’s financial health. Keep your books tidy, and the examiners will thank you! 🚀

make adjustments for accrued and prepaid expenses and accrued and prepaid income