END OF YEAR ADJUSTMENTS

1. 1.      The need for end-of-year adjustments
   
   
   Start of a financial year
   At the start of a financial year the asset, liability and capital accounts in the general ledger contain the balances brought forward at the end of the last year as set out in last year’s statement of financial position.
   The income and expense accounts in the general ledger are empty as they will have been transferred to the income and expense account for the calculation of profit.
   
   
   
   
   During the financial year
   During the year the business records transactions to appropriate accounts in the general ledger.
   The balances on the asset and liability accounts at any one time reflect the position at the start of the year and the effect of transactions relevant to those accounts that have occurred during the period.
   The balances on the income and expense accounts reflect the activity during the period.
   
   
   End of a financial year
   Balances on the accounts in the general ledger are extracted to produce a trial balance. The trial balance is the net effect of all of the transactions in the year and forms the basis for the preparation of the financial statements.
   However, certain adjustments must be made to income, expenses, assets and liabilities before the financial statements can be finalised to take account of items not captured as regular accounting transactions.
   Adjustments are needed for:
   • •  opening and closing inventory
   • •  accrued expenses and prepaid expenses
   • •  bad and doubtful debts
   • •  non-current assets and depreciation.
   Having made the adjustments, a business can then prepare its financial statements, calculating the profit or loss it has made for the year and adding the resultant figure to capital.
   A general ledger exercise is then carried out:
   • •  Balances on income and expense accounts are transferred to a profit or loss account. The balance on this account is the profit or loss for the year and should agree with the profit or loss shown in the statement of comprehensive income.
   • •  The profit for the year is added to capital, or the loss is subtracted from
   capital.
   
   
   2.      Check list of end-of-year adjustments
   A check list showing the end-of-year adjustments required to prepare financial statements is shown below.
   These are explained in subsequent Posts.
    
   Non-current assets and depreciation
   A depreciation charge for non-current assets is calculated, and included in the statement of comprehensive income.
   The carrying amount of non-current assets in the statement of financial position is reduced by accumulated depreciation on those assets.
   
   
   Bad debts and doubtful debts
   Establish the amount of bad debts to be written off and the change in an allowance for doubtful debts. These items are included in the statement of comprehensive income.
   In the statement of financial position, total receivables are reduced by bad debts written off. In addition, the allowance for doubtful debts is set off against the figure for total receivables.
   
   
   Accruals and prepayments
   Establish the amount of accrued expenses or prepaid expenses at the end of the financial year.
   Opening and closing accrued expenses or prepaid expenses are needed to calculate the amount to include in the statement of comprehensive income for certain expense items.
   Accruals and prepayments also appear in the statement of financial position.
   
   
   Opening and closing inventory
   Establish the value of closing inventory.
   Use the values for opening and closing inventory to calculate the cost of sales and gross profit for the statement of comprehensive income.
   
   Read also: ACCOUNTING FOR CASH