End of year Adjustments for Profit & Loss Account Components

The components of P&L account are also subjected to the matching principle. This components are the operating income and expenses respectively. In addition to matching concept, the accrual concept also applies. The Accrual Concept advocates that income should not only be recognized and recorded when actual cash is received, but also when it is earned. Similarly, the concept advocate that expenses should not only be recognized when cash is actually paid but even when it has been incurred. It should be noted that when cash transactions take place, owner’s equity is instantly affected for cash is either physically received or paid. On the other hand, credit transaction, creates a mere obligation towards or by the business to pay or receive cash in the future. According to these Generally Accepted Accounting Principles (GAAP) and concepts aforementioned, the aspect of accrual should be incorporated such that both incomes received and earned and expenses paid and incurred are considered when matching the total incomes and total expenses for a particular period of time. Therefore, the learner need to note the following two key points

1.Income earned is the amount of cash the business is expecting to receive (also referred to as income receivable) in a future date for services it had provided to the customer/client.

2.Expense incurred is the amount of cash the business is expected to pay (also referred to as payable) in a future date for services provided by the service provider/supplier.

To understand this concept better, interrogate the following scenarios.

1. Scenario one: Accounting Treatment of Operating Income

   • Case 1: Per Annum Operating Income

   • Case 2: Accrued Income 

   • Case 3: Income in Advance

2. Scenario two: Accounting Treatment of Operating Expenses

   • Case 1: Per Annum Operating Expense

   • Case 2: Accrued Expense 

   • Case 3: Prepaid Expense