IGCSE Accounting 0452 - 5.1 Sole Traders

This section focuses on adjusting entries for accrued and prepaid expenses and income, which are essential for accurately reflecting a sole trader's financial position at the end of the accounting period.

Understanding Accrued Expenses

Accrued expenses are expenses that have been incurred during the accounting period but have not yet been paid. They represent a liability to the business.

Example: A sole trader uses electricity in December but doesn't receive the bill until January. The electricity expense is accrued in December.

Why are adjustments needed? Accrued expenses are not initially recorded because the cash hasn't changed hands. At the end of the accounting period, an adjustment is made to recognize the expense and the corresponding liability.

Adjusting for Accrued Expenses

1. Identify expenses incurred during the accounting period but not yet paid.
2. Calculate the amount of the expense.
3. Create an income statement adjustment to recognize the expense and debit the relevant expense account.
4. Create a balance sheet adjustment to recognize the liability (accrued expense) and credit the corresponding liability account (e.g., Accrued Expenses).

Journal Entry Format:

Date	Account Debited	Account Credited	Amount
<Date of Adjustment>	<Expense Account (e.g., Electricity Expense)>	<Accrued Expenses>	<Amount of Expense>
<Date of Adjustment>	<Accrued Expenses>	<Liability Account (e.g., Payable to Supplier)>	<Amount of Expense>

Understanding Prepaid Expenses

Prepaid expenses are expenses that have been paid for in advance but have not yet been used up. They represent an asset to the business.

Example: A sole trader pays for insurance in December, covering the period up to the end of February. The insurance premium is prepaid in December.

Why are adjustments needed? Prepaid expenses are initially recorded as an asset (prepaid expense). As the expense is consumed over time, adjustments are made to recognize the expense and reduce the prepaid expense balance.

Adjusting for Prepaid Expenses

1. Identify expenses paid for in advance but not yet used.
2. Calculate the portion of the prepaid expense that has been used during the accounting period.
3. Create an income statement adjustment to recognize the expense and debit the relevant expense account.
4. Create a balance sheet adjustment to reduce the prepaid expense account and credit the relevant expense account.

Journal Entry Format:

Date	Account Debited	Account Credited	Amount
<Date of Adjustment>	<Expense Account (e.g., Insurance Expense)>	<Prepaid Insurance>	<Amount of Expense>
<Date of Adjustment>	<Prepaid Insurance>	<Insurance Expense>	<Amount of Expense>

Example Calculation

Accrued Expense Example: Electricity bill of $200 incurred in December, paid in January.

Adjustment: Debit Electricity Expense $200, Credit Accrued Expenses $200

Prepaid Expense Example: Insurance premium of $1200 paid in December, covering the period up to the end of February.

Monthly expense: $1200 / 3 = $400

Adjustment: Debit Insurance Expense $400, Credit Prepaid Insurance $400

Table Summary:

Adjustment Type	Income Statement Impact	Balance Sheet Impact
Accrued Expense	Increases Expense	Increases Liability (Accrued Expenses)
Prepaid Expense	Decreases Prepaid Expense (Increases Expense)	Decreases Asset (Prepaid Expense)

These adjustments ensure that the financial statements accurately reflect the sole trader's financial position and performance during the accounting period.