Hello IGCSE Accountants! Understanding Other Payables and Receivables

Welcome to a crucial section of your accounting journey! This chapter, Other Payables and Other Receivables, deals with adjustments that ensure our financial statements show the true picture of our business’s performance, regardless of when cash changed hands.

Don't worry if this sounds complicated. We are simply adjusting for timing differences. Think of it as making sure that the income statement shows *exactly* the income earned and the expenses incurred for the year, and not just the cash that was paid or received during that time.

This process is fundamental to the accuracy of your financial statements!

Section 1: The Foundation – The Matching Principle

Why Adjustments are Essential

The entire concept of 'Other Payables' and 'Other Receivables' relies on one core accounting principle: the Matching Principle (also known as the Accruals concept).

What is the Matching Principle?
  • It states that expenses incurred during a specific accounting period must be matched against the revenue earned during that same period.
  • It ensures that we calculate the true profit for the year.
  • Example: If you earned $1,000 in revenue in December, but only paid $100 of the related utility bill in December (the remaining $50 is due in January), you must include the full $150 utility cost in December's expenses to calculate the correct profit.

Quick Takeaway: We ignore when cash is paid or received; we focus on when the service/benefit was incurred or earned.

Section 2: Adjusting Expenses (Accruals and Prepayments)

When dealing with expenses (like rent, wages, or insurance), we need to check if the amount paid relates perfectly to the current accounting period.

4.3.1 Accrued Expenses (Other Payables)

Accrued expenses are expenses that the business has incurred (used the service or benefit) but has not yet paid for by the end of the accounting period.

Definition and Impact
  • Definition: Expenses due but unpaid.
  • Analogy: You used your phone in December, but the bill only arrives and is paid in January. The December cost is an accrued expense.
  • Effect on Profit: Increases the expense figure in the Income Statement (reducing profit).
  • Effect on SFP: Creates a Current Liability (it is an amount the business owes). This is classified as an Other Payable.
Step-by-Step Double Entry

We need to increase the expense (Debit) and create a liability (Credit).

Let's say Rent owed for the year is $10,000, but only $9,500 has been paid. The accrued expense is $500.

1. Journal Entry:

Debit: Rent Account (Expense) $500

Credit: Accrued Expenses Account (Liability) $500

2. Ledger Accounts:

  • The Rent Account balance transferred to the Income Statement will now show $10,000 (the full expense).
  • The Accrued Expenses Account ($500) will be shown as a Current Liability in the Statement of Financial Position (SFP).

❗ Common Mistake to Avoid

Do not mix up Accrued Expenses with Trade Payables (Creditors). Trade Payables are amounts owed for buying goods for resale. Accrued Expenses are amounts owed for services or general overheads (like salaries, rent, or utilities).

4.3.2 Prepaid Expenses (Other Receivables)

Prepaid expenses are expenses that the business has paid for, but the service or benefit extends into the next accounting period.

Definition and Impact
  • Definition: Expenses paid in advance.
  • Analogy: You pay $1,200 for 12 months of insurance on 1st October. By 31st December, only 3 months ($300) have expired. The remaining 9 months ($900) are prepaid.
  • Effect on Profit: Decreases the expense figure in the Income Statement (increasing profit). We remove the portion that belongs to next year.
  • Effect on SFP: Creates a Current Asset (the business has paid for future benefit). This is classified as an Other Receivable.
Step-by-Step Double Entry

We need to reduce the expense (Credit) and create an asset (Debit).

Using the insurance example above, the prepaid amount is $900.

1. Journal Entry:

Debit: Prepaid Expenses Account (Asset) $900

Credit: Insurance Account (Expense) $900

2. Ledger Accounts:

  • The Insurance Account balance transferred to the Income Statement will now show only the $300 that relates to the current year.
  • The Prepaid Expenses Account ($900) will be shown as a Current Asset in the SFP.

Memory Aid (Expenses):
If the expense is too high (paid too much or included next year’s amount), you make a Prepayment (Asset).
If the expense is too low (not yet paid), you make an Accrual (Liability).

Section 3: Adjusting Income (Accruals and Prepayments)

The same matching principle applies to income (like rent received, commission, or interest). We must ensure the Income Statement only records income earned in the current period.

4.3.3 Accrued Income (Other Receivables)

Accrued income is income that the business has earned (provided the service or benefit) but has not yet received the cash payment by the end of the accounting period.

Definition and Impact
  • Definition: Income earned but unreceived.
  • Analogy: You rented out a piece of machinery in March, but the tenant won't pay the rent until April. The March rent is accrued income.
  • Effect on Profit: Increases the income figure in the Income Statement (increasing profit).
  • Effect on SFP: Creates a Current Asset (an amount owed to the business). This is classified as an Other Receivable.
Step-by-Step Double Entry

We need to increase the income (Credit) and create an asset (Debit).

Assume the business earned $400 in commission but has only received $350. The accrued income is $50.

1. Journal Entry:

Debit: Accrued Income Account (Asset) $50

Credit: Commission Received Account (Income) $50

2. Ledger Accounts:

  • The Commission Received Account balance transferred to the Income Statement will now show the full $400 earned.
  • The Accrued Income Account ($50) will be shown as a Current Asset in the SFP.

4.3.4 Prepaid Income (Other Payables)

Prepaid income (often called Unearned Revenue) is cash that the business has received, but the service or benefit is still due to the customer in the next accounting period.

Definition and Impact
  • Definition: Income received in advance.
  • Analogy: A magazine business receives $240 for a 12-month subscription starting December. By the end of the year, only 1 month ($20) has been earned. The remaining $220 is prepaid income.
  • Effect on Profit: Decreases the income figure in the Income Statement (reducing profit). We remove the portion that hasn't been earned yet.
  • Effect on SFP: Creates a Current Liability (the business owes the service or refund). This is classified as an Other Payable.
Step-by-Step Double Entry

We need to reduce the income (Debit) and create a liability (Credit).

Using the magazine subscription example, the unearned income is $220.

1. Journal Entry:

Debit: Subscription Income Account (Income) $220

Credit: Prepaid Income Account (Liability) $220

2. Ledger Accounts:

  • The Subscription Income Account balance transferred to the Income Statement will now show only the $20 that was actually earned this year.
  • The Prepaid Income Account ($220) will be shown as a Current Liability in the SFP.

Quick Review: Summary of Adjustments

The classification in the Statement of Financial Position (SFP) is key:

Adjustment Type Cash Flow vs. Benefit SFP Classification
Accrued Expense Benefit used, cash NOT paid. Other Payable (Current Liability)
Prepaid Expense Cash paid, benefit NOT used. Other Receivable (Current Asset)
Accrued Income Benefit given, cash NOT received. Other Receivable (Current Asset)
Prepaid Income (Unearned Revenue) Cash received, benefit NOT given. Other Payable (Current Liability)

Did you know? These adjustments are often referred to collectively as "Year-End Adjustments" because they are typically calculated and recorded only when preparing the final financial statements.