Talltree Telecom bills its customers three months in arrears. A trader with a 30 June year end receives the bill covering April, May and June on 12 July, an...

This item tests the accruals concept: an expense belongs to the year in which the service was used, not the year in which the invoice arrives or the money leaves the bank.

The telephone service covering April, May and June was consumed entirely before 30 June, so the whole charge is a cost of the year ended 30 June and must be included in that year's income statement. Because nothing has been paid by the year end, the business owes the amount at that date. The correct treatment is therefore to charge it in the year to 30 June and to show the unpaid amount as an other payable within current liabilities.

Charging it in the following year when the bill is settled would be cash accounting: three months of telephone use would be reported in a year in which none of it happened, understating expenses and overstating profit for the year to 30 June. Treating it as an other receivable reverses the position, because an other receivable is an expense already paid that relates to a later period, and here nothing has been paid. Omitting it from both years would leave the cost recorded nowhere at all, which breaks the matching of expenses against the revenue they helped to earn.

Exam reminder: a supplier who bills in arrears normally produces an accrual at the year end, so expect an other payable rather than an other receivable.