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Difficulty: MediumAdjustments for Accrued and Prepaid Expenses and Incomes

Match each accounting adjustment scenario at the end of the financial year with its correct treatment in the Profit and Loss Account and Balance Sheet of a sole trader.

  • Accrued Expense (Expense owing at year-end)Added to the relevant expense in the Profit and Loss Account and shown as a Current Liability in the Balance Sheet
  • Prepaid Expense (Expense paid in advance at year-end)Deducted from the relevant expense in the Profit and Loss Account and shown as a Current Asset in the Balance Sheet
  • Accrued Income (Income earned but not yet received at year-end)Added to the relevant income in the Profit and Loss Account and shown as a Current Asset in the Balance Sheet
  • Prepaid Income (Income received in advance at year-end)Deducted from the relevant income in the Profit and Loss Account and shown as a Current Liability in the Balance Sheet

Answer

Accrued Expense matches with 'Added to the relevant expense in the Profit and Loss Account and shown as a Current Liability in the Balance Sheet'. Prepaid Expense matches with 'Deducted from the relevant expense in the Profit and Loss Account and shown as a Current Asset in the Balance Sheet'. Accrued Income matches with 'Added to the relevant income in the Profit and Loss Account and shown as a Current Asset in the Balance Sheet'. Prepaid Income matches with 'Deducted from the relevant income in the Profit and Loss Account and shown as a Current Liability in the Balance Sheet'.
Each item is correctly classified by matching the P&L adjustment direction (adding for accruals, deducting for prepayments) with its proper position in the Balance Sheet (liability for expense accruals and income prepayments; asset for expense prepayments and income accruals).

Step-by-Step Solution

1
Apply the accrual accounting concept to expenses.
Expenses incurred during the period must be matched against revenues earned regardless of cash paid. Owing amounts (accruals) are added to expenses (increasing P&L charge) and recognized as current liabilities. Amounts paid in advance (prepayments) are deducted from expenses and recognized as current assets.
Accruals reflect obligations to pay; prepayments reflect future economic benefits.
2
Apply the accrual accounting concept to incomes.
Revenue earned but not yet received (accrued income) increases total income in P&L and is a receivable (current asset). Revenue received in advance (prepaid income) belongs to the subsequent period, so it is removed from current P&L income and treated as an obligation to deliver services/goods (current liability).
Revenue recognition depends on performance/earning, not cash collection timing.

Key Concept

Accounting Adjustments for Accruals and Prepayments under the Matching Principle
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Topics

Adjustments for Accrued and Prepaid Expenses and Incomes

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