Other Payables and Other Receivables | O Level Accounting 7707 & IGCSE Accounting 0452 | Detailed Free Notes To Score An A Star (A*)

Importance of matching costs and revenue

• Accruals/ matching principle
  • Revenues of a period should be matched against the expenses that are incurred during that period to generate those revenues.
• Prudence Principle
  • We do not understate losses or overstate profits
  • Without matching, both can occur.
  • If we don’t match the expenses, we can overstate profits
  • If we don’t match the revenues, we can understate profits.
• Matching meaning
  • It does not matter when an expense was paid, or when an income was received.
  • Instead, it is important
    • When the benefit of that expense is taken
    • When the benefit of the income was given to the customer.
  • For example
    • If I pay 10,000 for electricity bill
    • However, I have only used electricity worth 8,000 in the current month, then I still have not derived the benefit of the remaining 2,000. So I have paid 2,000 in advance, it should not be considered an expense for the current period. This situation is called prepaid expense. It is a current asset.
    • Similarly, if you pay me rent of 10,000, but your this month’s rent was only 5,000, then you used the benefit of 5,000 only. The remaining 5,000 is unearned rent (unearned income), because I still haven’t provided you the benefit of the remaining 5,000. It is called unearned revenue. It is a short-term liability.
    • If I pay electricity bill of 10,000 but I have actually used electricity of 15,000 this month, the remaining 5,000 must be matched against the revenue of the current month because although it is not paid, it was still used in the current month to generate its revenue. It is called accrued expense and it is a short-term liability.
    • If you pay me rent of 5000 but your actual rent for the month for 7000, you have already used the remaining 2000 to generate the revenues of this month but have not paid for it. It is called accrued income or unpaid income, it is a current asset.
• Important To Note
  • The Expense Account and the Accrued Expense/ Prepaid Expense Account are NOT THE SAME
    • Expense account is an expense account.
      • At the end of the accounting period, its balance will be carried to the income statement.
      • Income statement will be debited as it is an operative expense. The expense account will be credited to bring the totals to an equal.
      • There is no CD or BD of an expense account at the end of the accounting period.
      • Recording an expense is simple
        • Debit the expense account
          • Credit the cash or bank account through which it is paid.
    • Prepaid Expense is an asset account
      • It will have a debit BD
      • It will have a credit side CD
      • It will NOT be transferred to income statement at the end of the period
      • It only closes when the prepaid expense is used up.
      • Recording a prepaid expense is simple
        • Prepaid Expense account debited
          • Cash or bank account used to pay the prepaid expense will be credited
        • Once the benefit has been used
          • Expense account will be debited
          • Prepaid expense account will be credited
    • Accrued Expense is a liability account
      • It will have a credit CD
      • It will have a debit side BD
      • It will not be transferred to income statement at the end of the period
      • It only closes when accrued expense has been paid.
      • Recording it is simple
        • Expense account will be debited
        • Accrued expense account will be credited
        • When an accrued expense occurs
      • When it is paid
        • Accrued expense account is debited
        • Cash or bank used to pay it will be credited
  • The Income account and the accrued income/ unearned income account are separate accounts.
    • Income account is an income account
      • At the end of the accounting period, its balance will be carried to the income statement
      • Income statement will be credit, as an income is a profit. The income account itself will be debited to bring the totals to an equal
      • There is no CD of BD of an income account at the end of the accounting period.
      • Simple Recording
        • Cash or bank account debit
          • Income Account credited
    • Accrued Income is an asset account
      • It will have a debit BD
      • It will have a credit side CD (still called a debit balance)
      • It will not be transferred to income statement at the end of the period
      • It only closes when the income has been received
      • When it occurs
        • Income receivable account is debited
        • Income account is credited
      • When the income is finally receiced
        • Cash or Bank account debited
        • Income receivable account credited
    • Unearned Income is a liability account.
      • It will have a credit CD
      • It will have a debit side BD (it will still be a credit balance – don’t forget the naming)
      • It will not be transferred to income statement at the end of the period
      • It only closes when the benefit for the unearned income has been provided to the customer.
      • When it occurs
        • Cash or bank account debited
        • Unearned Income account credited
      • When the benefit is provided to the customer
        • Unearned Income account is debited
        • Income account is credited