Other receivables and payables (end of period adjustments)

👋 Welcome to Other Receivables and Payables!

Hello future accountants! This chapter is incredibly important because it deals with ensuring your company’s financial reports show the true picture of performance for a specific time period. This process is often called making adjustments.

Don't worry if this seems tricky at first! We are just learning how to sort transactions into the correct "filing cabinets"—this year's vs. next year's.

SECTION CONTEXT: This topic is part of "Accounting for End of Period Adjustments." We adjust accounts on the last day of the financial year to follow the fundamental accounting principles.

Why do we need these adjustments? (The Matching Principle)

The core reason we study Other Receivables and Payables is the Matching Principle.

Definition: The Matching Principle requires that the income (revenue) earned in a period must be matched with the expenses incurred to earn that income, in the exact same period.

Analogy: Think of your school term. If you bought textbooks in December (Expense) to use for exams in January (Income/Result), you wouldn't count the cost of those books entirely in December, would you? You need to spread the cost to the period where the benefit is received.

---

SECTION 1: Other Receivables (Current Assets)

Receivables mean money that is owed to the business. If they are not standard trade debtors (customers who bought goods), they are classified as Other Receivables. These are always recorded as Current Assets.

1. Prepaid Expenses (Expenses Paid in Advance)

A Prepaid Expense occurs when the business pays for an expense before the goods or services are fully used up or received.

• This payment covers a period that extends into the next financial year.
• Because the business has a right to the service/benefit in the future, it is an Asset.

Understanding the Concept of Prepaid Expenses

Real-World Example: Insurance

On 1st December 20X1, a business pays \$1,200 for a 12-month insurance policy. The financial year ends on 31st December 20X1.

• Total paid: \$1,200
• Expense used in 20X1 (1 month): \$100
• Expense for 20X2 (11 months): \$1,100

When the \$1,200 was paid, the bookkeeper usually debits the full amount to the Insurance Expense Account. At the end of the year, this account is too high! We must reduce the expense by \$1,100 and create a Prepaid Asset.

Step-by-Step Adjustment Entry for Prepaid Expenses

Goal: Decrease the Expense Account (Credit) and Increase the Asset Account (Debit).

\( \begin{array}{|l|l|c|c|} \hline \text{Date} & \text{Details} & \text{Debit (\$)} & \text{Credit (\$)} \ \hline \text{31 Dec} & \text{Prepaid Insurance (Current Asset)} & 1,100 & \ & \text{Insurance Expense (P&L)} & & 1,100 \ \hline \end{array} \)

Key Takeaway for Prepayments: We take the payment out of the Expense account and move it into the Asset account.

2. Accrued Income (Income Earned but Not Received)

Accrued Income occurs when the business has earned revenue during the current financial year, but the money has not yet been received (or invoiced) by the end of the period.

• Since we have provided the service or the income relates to the current period, the Matching Principle demands we record it now.
• Since someone owes us this money, it is a Current Asset.

Understanding the Concept of Accrued Income

Real-World Example: Interest Income

A business has \$50 of interest income related to the month of December, but the bank will not credit this money to the account until January 5th.

The financial statements currently show \$0 interest income, which is incorrect. We must record the \$50 now.

Step-by-Step Adjustment Entry for Accrued Income

Goal: Increase the Income Account (Credit) and Increase the Asset Account (Debit).

\( \begin{array}{|l|l|c|c|} \hline \text{Date} & \text{Details} & \text{Debit (\$)} & \text{Credit (\$)} \ \hline \text{31 Dec} & \text{Accrued Income / Interest Receivable (Current Asset)} & 50 & \ & \text{Interest Income (P&L)} & & 50 \ \hline \end{array} \)

---

SECTION 2: Other Payables (Current Liabilities)

Payables mean money that the business owes to others. If they are not standard trade creditors (suppliers of goods), they are classified as Other Payables. These are always recorded as Current Liabilities.

3. Accrued Expenses (Expenses Incurred but Not Paid)

An Accrued Expense occurs when the business has used a service or incurred an expense during the current period, but the supplier has not yet issued the invoice or we have not yet paid the bill.

• The cost relates to the current financial year, so we must record the expense now (Matching Principle).
• Since we owe this money, it is a Current Liability.

Understanding the Concept of Accrued Expenses

Real-World Example: Utility Bills (Electricity)

The business used \$200 worth of electricity in December, but the electricity company only sends the bill in January.

If we don't record this, the profit for the year will be overstated, and the liability will be hidden. We must debit the expense and credit the liability.

Common Mistake Alert! Students often confuse Prepaid Expenses and Accrued Expenses.

Prepaid Expense (Asset): Paid now, used later. (We paid too much.)
Accrued Expense (Liability): Used now, paid later. (We owe the money.)

Step-by-Step Adjustment Entry for Accrued Expenses

Goal: Increase the Expense Account (Debit) and Increase the Liability Account (Credit).

\( \begin{array}{|l|l|c|c|} \hline \text{Date} & \text{Details} & \text{Debit (\$)} & \text{Credit (\$)} \ \hline \text{31 Dec} & \text{Electricity Expense (P&L)} & 200 & \ & \text{Accrued Expenses / Electricity Payable (Current Liability)} & & 200 \ \hline \end{array} \)

4. Prepaid Income (Income Received in Advance / Deferred Revenue)

Prepaid Income occurs when the business receives cash from a customer during the current period, but the service or delivery of goods will only happen in the next financial year.

• Although cash has been received, the income has not yet been earned.
• The business owes the customer goods or services in the future, so this is a Current Liability.

Understanding the Concept of Prepaid Income

Real-World Example: Magazine Subscriptions

A publisher receives \$600 in December for a magazine subscription that runs from January 1st to December 31st of the following year.

When the cash was received, the bookkeeper likely credited the full \$600 to Subscription Income. But since the service hasn't been provided yet, the income account is currently overstated by \$600.

Step-by-Step Adjustment Entry for Prepaid Income

Goal: Decrease the Income Account (Debit) and Increase the Liability Account (Credit).

\( \begin{array}{|l|l|c|c|} \hline \text{Date} & \text{Details} & \text{Debit (\$)} & \text{Credit (\$)} \ \hline \text{31 Dec} & \text{Subscription Income (P&L)} & 600 & \ & \text{Prepaid Income / Deferred Revenue (Current Liability)} & & 600 \ \hline \end{array} \)

Summary and Reporting

Effect on Final Accounts

Once these adjustments are made, they affect both the Statement of Profit or Loss and the Statement of Financial Position (Balance Sheet).

1. Statement of Profit or Loss (Income Statement):

The adjusted expense and income figures (e.g., Insurance Expense of \$100, Interest Income of \$50) are used here. This ensures profit is calculated correctly based on the Matching Principle.

2. Statement of Financial Position (Balance Sheet):

• Other Receivables (Prepaid Expenses, Accrued Income) are shown under Current Assets.
• Other Payables (Accrued Expenses, Prepaid Income) are shown under Current Liabilities.

You've mastered one of the trickiest parts of accounting! By understanding these four adjustments, you ensure that the financial statements are accurate and reliable. Well done!