Accruals and Prepayments

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Prepayments and accruals are likely to be small relative to receivables and payables, but they can nevertheless be material and need to be audited.

• Compare to last year. One of the first steps normally carried out is to compare this year’s accruals and prepayments with last year’s. Many accruals and prepayments arise because of periodic payments whose pattern doesn’t change very much from one year to the next. For example, if at the end of last December two months of rent have been paid in advance, probably that is going to be the case this year because the rent will be payable at particular times of the year. Similarly if there was an accrual for wages in last year’s financial statements because the workforce is normally paid a week in arrears, almost certainly you would expect to find a similar accrual in this year’s financial statements.
  

• Scrutinise payments made shortly after/shortly before year end. To identify accruals it is going to be very important to look at payments made just after year end and to see whether or not any of those relate to the period covered by the financial statements. Similarly, with respect to prepayments, looking at invoices paid in the last few months of the year may identify some which partially relate to services which are not going to be provided until after the year end.
  

• Analytical procedures. The overall level of expenses can also be important. If an expense varies widely from one year to another, one potential explanation is that there has simply been a difference in payment date and that an accrual or prepayment is needed to ensure that the financial statements are drawn up using the accruals or matching principle.
  

• 'Goods received - not invoiced' accrual. As mentioned in the previous chapter, there may be timing differences between suppliers' statement balances and payables' balances. Since goods received before the year end will be included in physical inventory, the corresponding purchase/liability must be recorded. If the invoice has not yet been received, it must be accrued.
  

• Letter of representation. We will cover this in more detail later. Suffice to say at the moment that it is a letter from the directors to the auditors making certain representations, for example, that all liabilities have been accounted for in the financial statements.