Accruals Basis of Accounting

This resource is part of our OTR Part 3 guidance: Keeping records, producing accounts and making a claim. It looks at how to keep accrual accounts for your concert production company for the purposes of claiming OTR. 

Organisations claiming Orchestra Tax Relief (OTR) (i.e. the concert production companies) have to prepare their financial statements under the Accruals Basis of accounting which requires that income and expense must be recognized in the accounting periods to which they relate rather than on a cash basis.

This means that income and expenditure is recorded when a service or product is delivered or received rather than when the money is actually exchanged. In other words accrual accounts recognize economic events in certain periods regardless of when actual payments are made or received.

Under accruals basis of accounting, an entity must account for the following types of transactions:

Accrued income

Accrued income is income which has been earned but not yet received.

Income must be recorded in the accounting period in which it is earned. Therefore, accrued income must be recognized in the accounting period in which the activity takes place rather than in the subsequent period when the payment is actually received.

As income will be credited to record the accrued income, a corresponding income receivable entry must be created to account for the debit side of the transaction. The accounting entry to record accrued income will therefore be as follows:

Debit Income Receivable (Balance Sheet)
Credit Income (Income Statement)

Example

XML Concert Production Ltd is a fully owned subsidiary of XLM Music Group. On 3rd January 2018 XLM Concert Production Ltd receives a commissioning fee of £1,000 (from the parent organisation) for the concert produced and performed in December 2017. XLM Concert Production Ltd has an accounting year end of 31st December 2017.

XLM Concert Production Ltd will recognize income of £1,000 in the 2017 financial statements even though it was received in the next accounting period, as the commissioning fee relates to an activity in 2017. The following accounting entry will need to be recorded to account for the commissioning fee accrued:

Debit Income Receivable £1,000
Credit Commissioning Fee (Income) £1,000

On the date of receipt of the commissioning fee (i.e. 3rd January of the next year) the following accounting entry will need to be recorded in the subsequent year:

Debit Bank £1,000
Credit Income Receivable £1,000

Accrued Expense

Accrued expense is expense which has been incurred but not yet paid.

The expense must be recorded in the accounting period in which it is incurred. Therefore, an accrued expense must be recognized in the accounting period in which the activity takes place rather than in the following period when the payment is actually made.

As expense will be debited to record the accrued expense, a corresponding expenses payable entry must be created to account for the credit side of the transaction. The accounting entry to record accrued expense will therefore be as follows:

Debit Expenses (Income Statement)
Credit Expenses Payable (Balance Sheet)

Example

On 15th January 2018 XLM Concert Production Ltd pays £1,500 to its Music Director (MD) for the work done in November and December 2017. XLM Concert Production Ltd has an accounting year end of 31st December 2017.

XLM Concert production Ltd will recognize expenses of £1,500 in the 2017 financial statements, even though it was actually paid in the next accounting period as it relates to services delivered by the MD in 2017. The following accounting entry will need to be recorded to account for the MD expenses accrued:

Debit Music Director Expenses £1,500
Credit Expenses Payable £1,500

On the date of payment of the expenses (i.e. 15th January of the next year) the following accounting entry will need to be recorded in the subsequent year:

Debit  Expenses Payable £1,500
Credit Bank £1,500

Prepaid Income

Prepaid income is revenue received in advance but which is not yet earned.

Income must be recorded in the accounting period in which it is earned. Therefore, prepaid income must not be shown as income in the accounting period in which it is received but instead it must be shown in the subsequent accounting period in which the services are delivered.

The production company should therefore recognize a liability in respect of income it has received in advance until the services are delivered. The following accounting entry is required to account for the prepaid income:

Debit Cash/Bank
Credit Prepaid Income (Liability)

Example

A production company set-up to claim OTR will not receive this type of income. Indeed, the whole point of setting up a separate production company is that the only income it will receive is the concert commissioning fee and the OTR payment. Any other income (e.g. ticket sales) will go to the main music group.  However, the following example illustrates how to handle the transaction entry for pre-paid income.

In December 2017 XML Concert Production Ltd received £1,000 for advanced ticket sales for a concert to be performed in February 2018. XLM Concert Production Company has an accounting year end of 31st December 2017.

XLM Concert Production Ltd will recognize a liability of £1,000 in the 2017 financial statements for the prepaid ticket income to acknowledge its obligation to allow the ticket holders attend the concert the following year. The following accounting entry will be recorded in the books of XLM Concert Productions Ltd in the year 2017:

Debit Cash/Bank £1,000
Credit Prepaid Ticket Income (Liability) £1,000

The prepaid income will be recognized as income in the next accounting period to which the ticket sales income relates (i.e. the date the concert actually takes place). The following accounting entry will be recorded in the year 2018:

Debit Prepaid Ticket Income (Liability)   £1,000
Credit Ticket Income (Income Statement) £1,000

Prepaid Expense

Prepaid expense is expense paid in advance but which has not yet been incurred.

This expense must be recorded in the accounting period in which it is incurred. Therefore, a prepaid expense must be not be shown as an expense in the accounting period in which it is paid but instead it must be shown in the subsequent accounting period in which the goods/services are received.

The production company should therefore recognize an asset in respect of expense it has paid in advance until the services that are due have been delivered by the suppliers/contractors. The following accounting entry is required to account for the prepaid expense:

Debit Prepaid Expense (Asset)
Credit Cash/Bank

Example

XLM Concert Production Ltd pays a deposit to a local theatre of £1,000 on 21st December 2017 for venue hire in the following year. XLM Concert Production Ltd has an accounting year end of 31st December 2017.

XLM Concert Production Ltd will recognize an asset of £1,000 in the 2017 financial statements for the prepaid expense to recognize its right to use the venue in the following financial year. The following accounting entry will be recorded in the books of XLM Concert Production Ltd in the year 2017:

Debit Prepayment (Venue Hire)  £1,000
Credit Cash/Bank £1,000

The prepaid expense will be recognized as an expense in the next accounting period to which the venue hire expense relates (i.e. the date the venue is actually used). The following accounting entry will be recorded in the year 2018:

Debit Venue Hire Expense (Income Statement)  £1,000
Credit Prepayment (Venue Hire) £1,000

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