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IAI Actuarial Core Principles · Business Finance · Construction and features of company accounts and reports

Under the accruals (matching) concept in preparing company accounts, which treatment is correct for a year-end insurance premium of Rs 120,000 paid in advance covering the next year?

The premium should be shown as a prepayment in current assets and charged to profit or loss next year. The accruals concept matches expenses to the period in which the benefit arises, not to the date of cash payment.

  1. ACharge it fully to this year's profit or loss because cash was paid this year
  2. BRecognise it as a prepayment in current assets and charge it to profit or loss next yearCorrect
  3. CRecord it as a non-current liability until the cover starts
  4. DCharge half to this year's profit or loss and carry half forward
  5. Offset it against retained earnings in the statement of changes in equity

Explanation

Accruals requires costs to be recognised in the period to which they relate, not when cash is paid. A premium covering next year is an asset (prepayment) at the year end and is expensed next year. Charging it to this year because cash left would follow cash-basis accounting and overstate expenses.

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