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Prepayments - a difference of opinion

Prepayments - a difference of opinion

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An accountant friend and I have a long-running disagreement on what classifies as prepayment, or more specifically when you recognise a prepayment, particularly at year end.

I think if an invoice is received for services for a number of months ahead of the current accounting period, the invoice is treated as a prepayment at the point it is recorded to the ledgers and the expense realised. My friend thinks a prepayment can only be recognised if the invoice is paid and settled to the supplier.

Example: A company has a January to December business year. The company receives a £30,000 (+ VAT) invoice in December 2012 for 6 months support services fees to 30 May 2013. The invoice remains outstanding at 31 December 2012 and is fully settled on 15 January 2013.

My opinion is that the fees for January to May 2013 (i.e. £25,000) are treated as a prepayment in the 2012 accounts because the expense relates to future accounting periods.

My friend says that since the invoice was unpaid at 31st December it cannot be classified as a prepayment (asset) because under IFRS the £25,000 cannot be deemed an asset to the business.

I argued that their thinking would lead to the expense account being overstated in December 2012. However they countered that the invoice should be recorded to the January 2013 ledgers and the £5,000 fee amount for December be accrued in December.

Could some please help clarify the situation? We have been having the same disagreement for some years now and it would be great to know who is right or wrong.

Thanks in advance.

 

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By 2156806
16th Jan 2013 08:12

Your Correct
The company should recognise the amount due for services as a liability because there was an obligation to pay at the balance sheet date and also the prepayment for the expense of 5 months.

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16th Jan 2013 08:12

Get new clever friends ...

and then you can avoid that feeling of frustration every time you talk to them!

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By BKD
16th Jan 2013 08:18

Agreed

.

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By GW
16th Jan 2013 09:44

Depends on contract terms

The issue here would depend on the obligation to pay:

In the example the P&L charge should be for the December portion £5,000 which would be shown as an accrual if the invoice hadn't been raised. If there is an obligation to pay the full £30,000 even if the contract is cancelled part way through then the accounts should show £30,000 creditor and £25,000 prepayment.

If there is no obligation to pay the full £30,000 then the £25,000 debit should be put against the creditor leaving a net credit of £5,000 so you are showing the same position as if it was an accrual.

Thanks (2)
16th Jan 2013 10:28

Can you ask your friend...

... whether or not they think the VAT on the full £30K is recoverable?

EDIT: Just seen GW's post, with which I concur.  The point in the definition of asset that your friend is overlooking is "past event", which also features in the definition of liability.  If before the balance sheet there is an obligating event (like signing a contract, agreeing to particular terms) then a liability is recognised and to the extent that that event gives rise to future economic benefits there's also an asset.

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16th Jan 2013 10:34

Blimey

I discuss football with my friends!

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By Yoyo29
20th Jan 2013 21:39

Thanks everyone, particularly GW and George Attazder for highlighting the obligation to pay issue. 

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21st Jan 2013 01:51

VAT goes (in most cases) solely on the tax date

The VAT will be assessed, provided the tax date is in December, on your VAT period ending December or later if next quarterly VAT period end is later.  Similarly, also because the tax date is in December, your supplier will have to pay the VAT based on his December VAT period end (or later if he/she accounts for it quarterly etc.).

This supplier/customer matching of VAT payments/receipts is essential to HMRC and the only real thing they can go on is the headline tax date.

Note that there are a whole raft of issues in relation to the tax date but the majority relate to the supplier and the customer basically uses the same date/VAT value as the supplier on the basis that if the date is incorrect, then the VAT payment/receipt will be consistently wrong and cancel out.

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12th Feb 2018 12:47

your friend is right - and it's not a joke

This is because if an invoice for a future expense is received, you should NOT record any transaction until a payment is made or the expense is incurred. This is because only a receipt of an invoice is not an event that creates a liability in accounting terms (i.e. an obligating event).

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By Ruddles
to JohnWoch
12th Feb 2018 16:43

Any particular reason for resurrecting a 5 year-old thread?

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to JohnWoch
04th Jul 2018 10:41

Under IFRS the purchase invoice should be recognised when there is an unconditional or firm commitment to exchange economic resources.

There is a firm commitment if the invoice is approved and entered on the purchase ledger.

Therefore, you should recognise the purchase invoice and an asset in other receivables.

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