December 2023
Nat Hammond explains what you need to know about accruals and prepayments â a topic that often trips students up.
At each level of AAT, there are topics that have a reputation as areas of increased difficulty and challenge for students, and as a tutor this observation is somewhat true.
At level 3 accruals and prepayments is arguably the most common example of this phenomenon, but is the reputation justified? Or can we break through the noise and build the skills to consistently solve such questions with little issue?
Deciphering accruals and prepayments
We can break down dealing with such questions into two distinct elements:
- Calculating the correct amounts.
- Posting the correct double entry.
Depending on your own knowledge you may wish to focus on one element more than the other, but letâs start with calculations.
Calculating the correct amount
In truth, this is normally the area students are more comfortable with, regardless there are still some pitfalls to be wary of. In your questions you will always be required to pro-rata the income or expenditure into the relevant periods, making sure you select the correct amount of months based on the information given is critically important, for example:
01/01/X3 to 31/03/X3 = 3 months
31/01/X3 to 31/03/X3 = 2 months
It is a natural response to just count the months in your head, but the devil is in the detail here â notice how we are not including all three months in the second example as this is from the end of January (the AAT always show dates in such questions at either the start or end of a month so be on the lookout). As mentioned, students are normally okay when is comes to the calculation-based work in these task, but double checking your working is always a good idea.
Double entry
Arguably the âmeatâ of these tasks is in correctly recording your entries and at face value it is easy to lose track of all the entries needed.
However, there are some handy techniques you can use to really nail these questions.
Firstly, letâs just recap the key concept of double-entry bookkeeping. There must be a debit and credit entry for each transaction.
A simple concept that we can use to our advantage here; in theory you do not need to remember where all the debits/credits fall into place. Instead, if you can say with 100% certainty you know where one side of the double entry sits, by the laws of double entry you also know where the other entry is. A reasonable assumption, but how can we now apply this?
Accruals and prepayments focus on two things, income and expenditure, which will be increasing or decreasing depending on the type of accrual or prepayment. These are our anchor points. At this stage of your studies you have already posted entries into these types of accounts numerous times, here is no different!
If you can understand what is happening in the income/expense account, you can identify the debit/credit entry needed, meaning you also know where the opposite entry sits. Here is this logic in action.
For example, letâs say we have an accrued expense, and I know that accrued expenses increase my total expenditure for the year.
How do I increase the amount in an expense account? I place a debit entry in there (the mnemonic DEAD CLIC can be used here and should be something you are familiar with from previous studies). If my debit entry sits in the expense account, the credit entry has to be in the accrued expenses account.
Letâs take the same logic and look at prepaid income. I know this reduces the amount of income for the period, so how do I reduce the amount in an income account? I debit it (donât forget to use DEAD CLIC for help!). If the debit entry sits in the income account, the credit entry must be in the prepaid income account.
By focusing on the income/expense account you are able to recall simple double entry you have done numerous times already, this is a superb way of cutting to the chase. The final consideration is for reversals.
Reversals
This is as complicated as the topic gets, but again we can take the logic above of âwhat is the effect in the income/expense accountâ and make a simple adjustment; we work in the opposite direction! Take our example above of the accrued expense which has the following entry:
Debit: Expense account (increased the amount present)
Credit: Accrued expense
To post the reversal I simply need to remind myself the original impact in the expense account, and work backwards. So I know originally the accrued expense increased the amount in my expense account, if I am now reversing this effect I am essentially asking myself how to reduce the amount in an expense account.
Debit: Accrued expense
Credit: Expense account (reversing the original effect)
Again the basic law of double entry shows me clearly where my other entry must go!
Summary
This method may seem a little over-zealous at first, but once you begin to piece things into place you are guaranteed to nail these questions each time they appear. Have a go yourself at applying the logic above to the two other types of accruals and prepayments we did not mention here (prepaid expense, accrued income).
- Nathaniel Hammond, is an AAT distance learning tutor, First Intuition
