Cash Management - Green Light

Kelly7

Hi all
I started my level 3 at college in September with the subjects Indirect Tax and Cash Management. Last Monday my cash management tutor said we have one lesson when we get back to finish everything off then we have revision lessons so to try the green lights but I just have and have got all the questions involving accruals and pre-payments wrong and still can't understand after reading the answers. Wondered if anyone else could explain this. Here is the question and answer...


DG Ltd has prepared its income statement and statement of financial position for the year ended 31 December 20X1. One of its expenses is for insurance, and the income statement shows a figure of £5,300. At 1 January 20X1 there was an opening accrual of £550 for insurance, whilst at 31 December 20X1 the statement of financial position includes in other receivables a prepayment for insurance of £740. From the data given, calculate the actual payment for insurance during the year ended 31 December 20x1.
4,010
6,590
5,110
Incorrect 5,300

Explanation of the correct answer:
The answer is £6,590. Start with the insurance in the income statement of £5,300, then add the opening accrual of £550 as this would only have been paid in cash during the year. The closing prepayment of £740 is also added, because although it relates to next year's insurance expense the cash amount would have been paid this year.

To me, I would have taken away the £550 as as far as I'm aware an accrual is when you have accounted for something that you are due to pay and it says receivables pre-payment, to me this doesn't relate to same thing as receivables is money coming in and we're talking about payments.

Really starting to wonder if I'm actually able to complete my level 3, did anyone else feel like this? My work has received the invoice but we haven't paid yet, not sure whether I should leave the course and save them the money...:001_unsure:

liveprincess

Hi Kelly

First of all, try not to panic, you will get this.

It says receivables because prepayment is your asset, the same as debtors, so sometimes they will be grouped together and called receivables or other receivables.

Start with what the income statement says: a figure paid of £5300. This was paid this period.

as as far as I'm aware an accrual is when you have accounted for something that you are due to pay

yes you're right. But it says that there is an opening accrual so it's from the previous period so it will have to be paid in this period. For your cash flow it means an outflow so you have to add this to the 5300.

When you have a closing prepayment, although it's for the cost incurred in the next period it has also been pre-paid in this period so you also have to add this to 5300+550=740=6590

Hope that helps, just ask here if you have any more doubts.
Good luck

Kelly7

Hiya
Sorry, I did try and reply a couple of days ago but it wouldn't let me post. Thank you for always trying to help, you're great to have on here, appreciate your time.

Not quite sure how a prepayment is an asset buy I will just take it in the exam that if it mentions the same type of payment / income
to treat them as the same thing. I can only see that the accrual would be paid at earliest Jan, or Feb, why would we go back? Not sure if I'm making sense and I don't expect you to try to explain again but just to say why I don't get it. Its frustrating when everyone else must be getting it apart from me.

Thanks again.

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liveprincess

Ok looks as your college got the order in which you do the units wrong. If you did the Accounts Preparation 1 you wouldn't have a problem with understanding prepayments and accruals. If your college decides on this order of units they should explain to you more clearly accruals and prepayments as this knowledge is vital to answer this question.

Kelly7

I have just ordered the Cash Management book and the book which covers both AP1 and 2 so I will have a read though the other book too and see if that has any useful info for this topic.
Thanks again.
xx

billdoor

Im just doing Cash Management now so I'll have a go too.

Remember that you're dealing only with cash that has actually gone out of the business or come into the business during the period.

So £5300 expenses for insurance in the period.
An opening accrual of £550 for insurance means that it wasn't paid in the last period, so it must have been paid in this one - so add £550.
A prepayment for insurance for £740 means that it has been paid in this period.
So 5300 + 550 + 740 = 6590

Again, the key thing to remember is when the cash is paid - if you have an opening accrual then you will pay that amount in this period, so you add it. If you have a closing accrual then you haven't paid that amount in this period, so you subtract it.

If you have an opening prepayment then you haven't paid that amount in this period, so you subtract it. If you have a closing prepayment then you have paid that amount in this period, so you add it.


With regards to you later post - a prepayment is an asset because you've already paid for something that you haven't yet used, i.e. you've paid insurance for the next six months. And an accrual is a liability because you owe money for something that you have already used, i.e. electricity.

I agree with liveprincess that it would have been better if your college had done AP1 and AP2 first as they cover prepayments and accruals, so don't beat yourself up if you don't understand it. Once you read the sections about them I'm sure you'll be fine.:001_smile:

ademoore

First thing is to be clear on exactly what an accrual and prepayment is.

An accrual is an expense which relates to the current year, however you havent received the bill for it yet - for example, a phone bill, where you might receive the bill on the 5th of the following month. Since the bill relates to the financial year i am looking at, then in order to show a true reflection on costs, i must make an allowance for that bill, ie my accrual.

A prepayment is the opposite, an expense which relates to next year, however i have incurred the expense this year. For example i may have had to pay up my rent upfront, therefore to include it in this year wouldn't be a true reflection of my costs this year, so i need to credit my expenses to reduce them and take the other entry as a debit to my prepayments in my balance sheet.

Once you can get your mind around this, then you need to look purely at the cash timing of these - for cash management subject.

Think again, what is an accrual - an expense relating to this year, but not yet accounted for, therefore cash will not have been transacted yet.
An example, if electricity is expensed in the accounts at £1500, and we are told it includes an accrual of £300 at the end of the year, then from what we know of an accrual, we know that the £300 would not have been actually cash transacted (as relates to current yr but not paid) therefore to find cash position we can deduct the £300.

Similarly, for a prepayment, remind yourself the rule, an expense relating to next yr, but paid in this year. If insurance is expensed in accounts at £5000 and we are told it includes a prepayment at start of the year of £1000, then we know prepayments at the start of the year relate to money 'out' last year, so therefore to find cash position of insurance this year, we can deduct the £1000 as it didnt physically leave our bank this year. If there is a prepayment at the end of the year, then we need to add that cash expense on, as the cash would have physically left the bank, for example a closing prepayment of £1250. In summary, 5000 + 1250 - 1000 = 5250

Hope that helps.

Kelly7

Thank you all for your help and from what you're saying I'm agreeing with in my head but still after re-reading the question about 50 times I still can't see why it is saying what it is.

If it is saying at the end of December the insurance figure is £5,300, then in January there is an opening accrual of £500 - I am taking from this the opening accrual is going to be paid in thiser next quarter?!?

I am not getting from anywhere that an accrual payment goes backwards so why would we be adding it to the actual payments in December?

Thank you for your replies, really appreciate all your time.

btw. AP1 is one of my next topics.

ademoore

If there is an opening accrual of £500 this FY, then you can safely assume in this exam that the £500 will leave your bank this FY. The prepayment at the end of the year will also have left your bank account, because it's a prepayment, therefore you add both amounts to your income statement balance because this will then tell you the full amount that has physically come out of your bank, paying for insurance.

liveprincess

Kelly, get your tutor to draw you like a timeline where he can explain to you when the expense was incurred and when it was actually paid for. It's impossible on here to explain this properly. I think you are just getting your financial years mixed up as of what gets paid when.

Kelly7

Hi all
Bit embarrassed to say this but I asked my teacher this yesterday and after still not getting it for about 5 minutes, she said something to make me realize the Jan and Dec in the question are in the same year, I was taking it as the Jan was after the Dec.
Thanks for all the replies.
Xx