Question 3: State the meaning of:
(a) Outstanding expenses
(b) Prepaid expenses
(c) Income received in advance
(d) Accrued income
Answer:
(a) Outstanding expenses are recorded in books of finance at the end of an accounting period to show the true numbers of a business. The outstanding expense is a personal account and is treated as a liability for the business. It is also shown on the liability side of a balance sheet.
(b) Prepaid expenses represent goods or services paid for upfront where the company expects to use the benefit within 12 months. It is a future expense that a company has paid for in advance. A prepaid expense is only recognized in the income statement when the company consumes the product or service.
(c) Income that is received in advance is a liability because the company that received the money has not yet earned it and it has an obligation (a liability) to deliver the related goods or services in the future.
(d) Accrued income is earnings from investments that have not yet been received by the investing entity, and to which the investing entity is entitled. This concept is used under the accrual basis of accounting, where income can be earned even when the related cash has not yet been received. Under the accrual basis, the investing entity should accrue its best estimate of the income in the accounting period in which it earns the income. It may not be necessary to generate this accrual if the amount is immaterial, since the resulting accrual would have no demonstrable impact on the financial statements.
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