Elements of accounting equation affected by prepaid income(reversal)

Sally_KSally_K Registered Posts: 4
Hi, I am about to sit Level 3 Advanced Bookkeeping assessment soon. I have a question about the sample assessment 2 in MyAAT study support.
Task 3(b) Answer the following regarding the prepaid income reversal of £2430 in the rental income account above. (I) How were the elements of the accounting equation affected by this transaction? Tick ONE box for each row.
The answer is No change on Assets, Decrease on Liabilities and Increase on Capital.
I think I have a pretty good understanding about accruals/prepaments. I've been doing all the tasks fine but I couldn't work this one out. It really makes my heart itchy!!!

Could anyone please enlighten me? Thanks in advance!

Best Answers

  • reastwoodreastwood Posts: 1
    Accepted Answer
    It appears that the £2430 Prepaid Income (reversal) is at the beginning of the year ended 31.3.x7. Therefore it is the reversal of the entry made at the end of the previous year, ending 31.3.x6.
    Lets think how the x6 entry occurred. In x6 maybe there were £25k receipts re. income, which of course were credited to this account. Although received in x6, £2430 was actually due, ie. earned, in x7. This is why we do a Prepaid income adjustment at the end of x6, when we debit the income account (reducing capital) and crediting a Prepaid Income a/c (increasing liabilities-remember Prepaid expenses are an asset).
    Fast forward to the start of x7, and we are told that according to policy this adjustment is now reversed, so as shown in the T a/c in the task we credited the income account (INCREASING CAPITAL), and by implication, debited the Prepaid Income a/c (REDUCING LIABILITIES). Thus the answer-what we did in x7 is the opposite of what we did in x6 !
    Hope that helps
    Sally_K
  • Sally_KSally_K Posts: 4
    Accepted Answer
    Reastwood, thank you very much for your reply! I think I can understand it better now with your explanation.
    But when we debit the income account, the income decreases. Why say the capital decreases as well? It's a Statement of Profit or Loss account. I can't work out how to link income account to capital. Or is it because income decrease, so does profit? And at last the capital decreases because profit is part of the final capital? ;)

    Another thing is, in BPP question bank, there are two very similar tasks but regarding accrued income (reversal). The answer is exactly the same as this question which is about prepaid income reversal! If we assume the answers on AAT website are correct, then the BPP ones must be wrong.

    I am self studying and don't have a tutor. It really got me. :'(
  • Sally_KSally_K Posts: 4
    Accepted Answer
    I just went to BPP website to check if there are new supplements for the studying materials and found one to correct the mistakes regarding the questions above. (I didn't know why I overlooked this supplement before though.)
    Reastwood, your explanation is absolutely correct and now it is crystal clear. I can finally relax for my assessment on the coming Monday. =)
    Thank you very much!

Answers

  • janakGjanakG Registered Posts: 9
    I just did this question and i still dont get why we increase capital, wouldn't we increase asset as we would be receving money from the reversal into the bank.
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