A year’s profit should contain the expenses that belong to the year, whether or not they have been invoiced or paid, and the income earned in the year, whether or not it has been received. Accrued expenses and accrued income are the adjustments that achieve this at the year end.
This topic explains the accruals concept, how to account for an accrued expense using the two-account and the one-account methods, how to reverse the accrual, how to calculate the expense for the year, and how the same ideas apply to income earned but not yet received.
Accruals and prepayments are tested in Section A in most diets and sit inside many final accounts questions, with a full rental income account question in two diets reviewed. Read the topic on accounting concepts first. The next topic covers expenses paid in advance and income received in advance.
In 30 seconds
Under the Accruals concept expenses are recognised as they arise and income as it is earned, not when cash moves. An Accrued expense is an expense incurred but not yet invoiced or paid. It is charged to profit or loss and shown as a Current liability: Dr Expense, Cr Accruals. Accrued income is income earned but not yet received.
It is credited to profit or loss and shown as a Current asset: Dr Accrued income, Cr Income. With two accounts the entry is Reversed at the start of the next year. With one account the balance stays on the expense or income account. Expense for the year = payments + closing accrual − opening accrual.
The accruals concept
Financial statements are prepared on the accruals basis and not the cash basis. Sales are recognised in the same period as the cost of making them. Income is recognised in the period of the transaction that gave rise to it, not necessarily when cash is paid. Expenses are recognised as they arise and not as they are paid.
For example, rent on an office is spread over the period it relates to. If rent is paid each 1 June, ₦240,000 in 2018 and ₦300,000 in 2019, and the year end is 30 September, the expense for the year to 30 September 2019 is 8/12 × 240,000 (October to May) + 4/12 × 300,000 (June to September) = 160,000 + 100,000 = ₦260,000.
An accrual arises when a business incurs an expense before the year end but the invoice arrives after it. The business must estimate the expense and recognise it as an expense and a liability. The business is said to be accruing for the expense. A prepayment is the opposite, and the next topic covers it. Both can be recorded by two methods: using two accounts, or using one.
Accrued expenses
A business may incur an expense in the period without an invoice by the year end. Since nothing has been paid or invoiced, there is no ledger entry yet. To apply the accruals basis the expense must still be charged to the period. This is done by creating an accrued expense, an estimate of the cost incurred in the period.
It is included in expenses in the statement of profit or loss and recognised as a liability, the accrual, in the statement of financial position. Accruals are common when expenses are paid in arrears, at the end of the period of expense.
Method 1: two accounts
This is the easier method and the one computerised systems use. The accrual is recorded in a separate accruals account.
Dr Expense account, Cr Accruals account. The credit balance on the accruals account is a current liability.
There is a complication. When the next invoice arrives, the usual entry Dr Expense and Cr Payables would count the accrued part twice, once in the old year and again in the new year. To prevent that, the accrual is Reversed at the start of the next year: Dr Accruals, Cr Expense. This clears the accrual and reduces the expense account to the amount not yet expensed for that invoice.
Method 2: one account
The accrual is recognised on the expense account itself. Calculate the closing accrual and the charge to profit or loss, and take the other as the balancing figure. It is usually easier to calculate the accrual first. The accrual stays on the expense account as the closing balance, a credit, and becomes the opening balance of the next year, so there is no reversal.
Calculating the expense
Expense for the year = invoices or payments for the year + closing accrual − opening accrual
This is the figure charged to profit or loss. It makes sense when you build the year from first principles: the first invoice of the year includes months already expensed in the previous year, so those months are deducted, and the months at the end of the year not yet invoiced are added back as the closing accrual.
Accrued income
Accrued income is income earned in the period but not yet received. An example is rent from a tenant who pays in arrears. All of the income that relates to the period must be recognised in profit or loss. The amount the tenant owes at the year end is recognised as an Asset. The calculation has the same form as for expenses, in reverse:
Income for the year = cash received + closing accrued income − opening accrued income
- Two accounts. Dr Accrued income (an asset), Cr Income. At the start of the next period reverse it: Dr Income, Cr Accrued income.
- One account. The accrued income is brought down as an asset, a debit balance, on the income account. Either calculate the income and take the accrued income as the balancing figure, or calculate the accrued income and take the transfer to profit or loss as the balancing figure.
The accrued income is a current asset in the statement of financial position, and the income in the statement of profit or loss is the amount that relates to the period.
The ideas in more depth
Why reverse. The invoice that arrives next year covers months already charged, so the reversal removes the double count. No reversal in method 2 because the opening balance on the expense account already offsets the next invoice. The effect on profit. An accrual reduces profit this year and increases it next year relative to cash accounting. Accrued income does the opposite.
Estimates. The accrual is an estimate of what has been incurred, often a share of the next invoice. Classification. An accrued expense is a current liability and accrued income a current asset. Neither is a trade payable or trade receivable.
Worked example: Warri Foods
Scenario. Warri Foods starts on 1 January Year 1 with a 31 December year end. Electricity is invoiced quarterly in arrears. Year 1 invoices were paid on 30 April (₦36,000), 31 July (₦42,000) and 31 October (₦48,000). The next invoice, at the end of January, covers three months and is expected to be ₦60,000. In Year 2 the January invoice was ₦61,500, and later invoices were ₦54,000, ₦57,000 and ₦63,000. The next invoice is expected to be ₦66,000.
A part of the premises is rented out. Quarterly rent in arrears of ₦120,000 was received in each quarter of Year 2, though the rent rose from 1 November Year 2 to ₦45,000 a month from ₦40,000. Required: the expense, the accrued income and the entries.
- Year 1 accrual.
November and December are 2/3 of the three months in the January invoice: 2/3 × 60,000 = 40,000. - Year 1 expense.
Payments 36,000 + 42,000 + 48,000 = 126,000, plus the closing accrual 40,000, less opening accrual nil = ₦166,000.
Dr Electricity 40,000, Cr Accruals 40,000. - Start of Year 2. Reverse: Dr Accruals 40,000, Cr Electricity 40,000.
- Year 2 accrual.
2/3 × 66,000 = 44,000. - Year 2 expense.
Payments 61,500 + 54,000 + 57,000 + 63,000 = 235,500.
Expense = 235,500 + 44,000 − 40,000 = ₦239,500. - Check from first principles.
January invoice 61,500 less the 40,000 already expensed = 21,500, plus 54,000 + 57,000 + 63,000, plus the accrual 44,000: 21,500 + 54,000 + 57,000 + 63,000 + 44,000 = 239,500.
It agrees. - Accrued income.
At the start of Year 2 the accrued income was two months at 40,000 = 80,000.
At the end it is two months at 45,000 = 90,000.
Cash received in Year 2 was 4 × 120,000 = 480,000.
Income = 480,000 + 90,000 − 80,000 = ₦490,000.
Check: 10/12 × 480,000 + 2/12 × 540,000 = 400,000 + 90,000 = 490,000. - Statement of financial position. Accrued electricity of ₦44,000 is a current liability and accrued rent of ₦90,000 a current asset.
Common mistakes in the exam
- Adding the opening accrual instead of deducting it. The opening accrual was already charged last year.
- Forgetting the reversal when using two accounts.
- Reversing in the one-account method, where no reversal is needed.
- Taking the whole next invoice as the accrual instead of only the months that belong to this year.
- Showing accrued income as a liability, or an accrued expense as an asset.
- Using the cash received as the income for the year.
Quick revision
- Accrued expense: Dr Expense, Cr Accruals. Current liability.
- Accrued income: Dr Accrued income, Cr Income. Current asset.
- Two accounts: reverse at the start of the year. One account: no reversal.
- Expense = payments + closing accrual − opening accrual. Income = receipts + closing accrued − opening accrued.
Practice questions
These are original questions in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one first.
Section A style: multiple choice
Question 1. An accrued expense is shown in the statement of financial position as a:
- Current asset
- Current liability
- Non-current asset
- Reduction in capital
Show the answer
B. An accrued expense is owed at the year end, so it is a current liability.
Question 2. The entry to create an accrual is:
- Dr Expense, Cr Accruals
- Dr Accruals, Cr Expense
- Dr Bank, Cr Accruals
- Dr Expense, Cr Bank
Show the answer
A. An accrual adds the expense that is owed but not yet paid: Dr Expense, Cr Accruals.
Question 3. Wages paid were ₦118,000. Accrued wages were ₦6,000 at the start and ₦9,500 at the end. The wages expense is:
- ₦114,500
- ₦118,000
- ₦121,500
- ₦133,500
Show the answer
C. 118,000 + 9,500 − 6,000 = 121,500.
Question 4. The wages expense is ₦98,000. Accrued wages were ₦5,000 at the start and ₦8,000 at the end. Cash paid was:
- ₦95,000
- ₦98,000
- ₦101,000
- ₦111,000
Show the answer
A. 98,000 − 8,000 + 5,000 = 95,000.
Question 5. At the start of the next year, with two accounts, the accrual is:
- Left alone
- Reversed: Dr Expense, Cr Accruals
- Written off
- Reversed: Dr Accruals, Cr Expense
Show the answer
D. At the start of the next year the accrual is reversed (Dr Accruals, Cr Expense), so the payment is matched to the right period.
Question 6. Accrued income is recorded as:
- Dr Income, Cr Accrued income
- Dr Accrued income, Cr Income
- Dr Bank, Cr Income
- Dr Accruals, Cr Income
Show the answer
B. Income earned but not yet received: Dr Accrued income, Cr Income.
Question 7. Cash received was ₦52,000, opening accrued income ₦6,000 and closing accrued income ₦9,000. Income is:
- ₦49,000
- ₦52,000
- ₦55,000
- ₦67,000
Show the answer
C. 52,000 + 9,000 − 6,000 = 55,000.
Question 8. Adjusting for accruals complies with the concept of:
- Going concern
- Accruals (matching)
- Materiality
- Business entity
Show the answer
B. Adjusting for accruals matches expenses to the period they relate to, which is the accruals concept.
Question 9. In the one-account method the accrual is:
- A separate account
- Reversed on the first day
- The closing balance on the expense account
- Ignored
Show the answer
C. With one account, the accrual is the closing balance carried down on the expense account.
Question 10. Accrued income in the statement of financial position is a:
- Current liability
- Reserve
- Expense
- Current asset
Show the answer
D. Accrued income is owed to the business, so it is a current asset.
Section B style: written questions
Question 11 (10 marks). (a) Define an accrual and accrued income. (4 marks) (b) State the formula for the expense and for the income when there are accruals. (4 marks) (c) State where each appears in the statement of financial position. (2 marks)
Question 12 (20 marks). Ikot Enterprises paid wages of ₦1,860,000 in the year. Accrued wages were ₦150,000 at 1 January and ₦210,000 at 31 December. Commission received was ₦340,000, with commission accrued of ₦25,000 at 1 January and ₦38,000 at 31 December.
(a) Prepare the wages account and the accruals account by the two-account method, including the reversal. (8 marks) (b) Show the wages account by the one-account method. (4 marks) (c) Prepare the commission income account by the two-account method. (5 marks) (d) Show the statement of financial position extracts. (3 marks)
A further written question
Question 13 (10 marks). Electricity invoices received in the year total ₦186,000. The last invoice covered up to 30 November and December is estimated at ₦22,000. The opening accrual was ₦19,500. (a) Calculate the expense. (4 marks) (b) Give the journal for the accrual and for the reversal. (4 marks) (c) State the amount and class of the closing accrual. (2 marks)
Model answers
Show the model answer to Question 11
(a) An accrual is an estimate of an expense incurred in the period but not yet invoiced or paid, charged to profit or loss and held as a liability. Accrued income is income earned but not yet received. (b) Expense = payments + closing accrual − opening accrual. Income = receipts + closing accrued income − opening accrued income. (c) An accrual is a current liability and accrued income a current asset.
Show the model answer to Question 12
(a)
- Wages expense.
1,860,000 + 210,000 − 150,000 = 1,920,000. - Wages account: Dr Bank 1,860,000, Dr Accruals 210,000 (closing), Cr Accruals 150,000 (reversal at the start), Cr Statement of profit or loss 1,920,000.
- Accruals account: Cr Wages 210,000 at the year end, with the 150,000 opening balance Dr cleared by the reversal.
(b) One account: Dr Bank 1,860,000, Cr Opening balance 150,000, Cr Statement of profit or loss 1,920,000, Dr Closing balance c/d 210,000.
(c) Commission = 340,000 + 38,000 − 25,000 = 353,000.
Dr Accrued income (reversal) 25,000, Cr Bank 340,000 in the account, Cr Accrued income 38,000, Cr Statement of profit or loss 353,000. (d) Accrued wages ₦210,000 in current liabilities. Accrued commission ₦38,000 in current assets.
Show the model answer to Question 13
(a) 186,000 + 22,000 − 19,500 = ₦188,500. (b) Accrual: Dr Electricity 22,000, Cr Accruals 22,000. Reversal at the start of the next year: Dr Accruals 22,000, Cr Electricity 22,000. (c) ₦22,000, a current liability.
Pathfinder on Accrued expenses and accrued income
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
From the previous syllabus. Asks you to prepare a rental income account from accrued rent and prepaid rent at both year ends, rent received, uncollectable rent written off and an agreement fee, to find the rent recognised in profit or loss.
Revise first: Accrued income
From the previous syllabus. A property owner’s summary of rent: accrued and prepaid at two dates, rent received, rent to be written off and an agreement fee. Asks for a rental income account.
Revise first: Accrued income
Asks for the cash paid for wages and salaries from accrued wages at the start and end and the wages expense.
Revise first: Accrued expenses
Asks which statement correctly describes the accruals concept.
Revise first: The accruals concept
From the previous syllabus for the first three. Each asks which fundamental accounting concept is complied with when adjustments are made for prepaid and accrued expenses. The answer is the accruals concept.
Revise first: The accruals concept
An item most diets asks for the expense or cash paid from accruals, the accounts affected, or the concept behind the adjustment. Check Section A of every diet you practise.
Revise first: Accrued expenses
Source: ICAN Pathfinder, Financial Accounting. Diets covered: November Diet, 2015, November Diet, 2018, November Diet, 2021, November Diet, 2022, May Diet, 2023, November Diet, 2023 and May Diet, 2024 (the first six are previous syllabus). Diets before November 2014, and November Diet, 2024 onwards, are not covered here.
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