Hi,

Looking through the past F3 examiners’ reports in the June 2008 one I found the following phrase:

An accrual is an additional expense and hence will reduce profit, whereas a prepayment is an expense paid in advance so when adjusted will increase profit.

Can someone please explain how this is so?  As I understand it, when dealing with expenses, the figure shown in the income statement will be the charge for the period.  So assuming I have an accrued expense from the previous accounting period, the figure shown in the income statement for this period will be the charge for the period, not the actual charge plus the accrual from the last period, therefore net profit would be the same either way.

What am I doing wrong?

Thank you.

Welcome to the forums i_lose_flips

You’re a step ahead there!

You are correct in that the charge in the income statement has already taken account of the accruals and prepayments.  What the examiner has said that to arrive at that charge you need to deal with accruals and prepayments which will affect the profit as he has stated.

Does that make sense?

Does that make sense?

Nope.

Let’s say a sole trader pays rent of £1,000 pa.  In year 1 he makes £2,000 gross profit, £1,000 net profit after paying the rent expense.  Assuming he only paid £800 towards rent, he carries forward an accrued expense of £200.  In year 2, he again makes £2,000 gross profit, £1,000 net profit after the rent charge for the year.  However, according to the examiner, he would have made £800 net profit in year 2.  This is where it doesn’t make sense to me.

In your example the £200 accrual was included in year 1, therefore that’s where the expense was included and how you got a £1,000 rent charge (800+200).

In year 2 you don’t include the expense again, your accrual has been brought forward and will remain in accruals until the £200 is paid.
When the £200 is paid you don’t include that as an expense, you reduce the accrual by that payment amount, ie. the accrual would become nil.

The examiner is looking at the expense before you make the year 2 accrual.