Year-end adjustments are journal entries made at the end of an accounting period to ensure the financial statements accurately reflect the company’s financial position and performance. Under accrual accounting, income and expenses must be recorded in the period to which they relate, regardless of when cash changes hands.
These adjustments transform the bookkeeping records maintained throughout the year into financial statements that comply with FRS 102 and give a true and fair view as required by the Companies Act 2006.
Why Year-End Adjustments Are Needed
During the year, most transactions are recorded when invoices are received or payments are made. At year end, several categories of income and expense need adjusting:
- Costs incurred but not yet invoiced
- Payments made in advance for future periods
- Assets that have lost value through use
- Debts that may not be collected
- Stock that needs to be revalued
- Tax liabilities that need to be provided for
Without these adjustments, the income statement would show only cash-based figures, potentially materially misstating the true profit or loss.
Accruals
An accrual recognises an expense that has been incurred but not yet invoiced or paid. It ensures the expense appears in the correct accounting period.
Common Accruals
| Expense | Reason for accrual |
|---|---|
| Utilities (gas, electricity, water) | Bill covers a period straddling the year end |
| Accountancy fees | Audit and accounts preparation work relates to the current year |
| Employee bonuses | Earned in the current year, paid after the year end |
| Rent | Accrued if rent-free period is being spread |
| Interest on loans | Interest accrued since the last payment date |
Journal Entry
Accruing £3,200 for electricity consumed but not yet billed:
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Electricity expense | 3,200 | |
| Accruals (current liabilities) | 3,200 |
The accrual is reversed at the start of the next period so that the actual invoice, when received, is recorded normally.
Prepayments
A prepayment arises when the business has paid for a service or benefit that extends beyond the year end. The portion relating to the next period is removed from the current year’s expenses and shown as a current asset.
Common Prepayments
| Expense | Reason for prepayment |
|---|---|
| Insurance | Annual premium paid in advance |
| Rent | Quarterly rent paid covering the next period |
| Software subscriptions | Annual licence covering future months |
| Professional memberships | Annual fees paid part-way through the year |
Journal Entry
Annual insurance of £6,000 was paid on 1 October. At 31 December, six months remain prepaid (£3,000):
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Prepayments (current assets) | 3,000 | |
| Insurance expense | 3,000 |
This reduces the insurance charge in the current year to £3,000 (the six months that relate to the current period).
Depreciation
Depreciation is charged annually to spread the cost of fixed assets over their useful lives. The year-end depreciation journal updates the accumulated depreciation and recognises the expense.
Journal Entry
Annual depreciation on computer equipment of £4,500:
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Depreciation expense | 4,500 | |
| Accumulated depreciation - computers | 4,500 |
Depreciation must be calculated for each class of asset in accordance with the company’s accounting policy. For assets acquired part-way through the year, a pro-rata charge is normally applied.
Bad Debt Provision
At year end, the company reviews its trade debtors and provides for debts that may not be collected.
Specific Provision
Where a particular customer is known to be in financial difficulty, a specific provision is made:
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Bad debt expense | 5,000 | |
| Provision for doubtful debts | 5,000 |
General Provision
A general provision applies a percentage to the aged debtor balances based on historical collection experience:
| Age bracket | Balance (£) | Provision % | Provision (£) |
|---|---|---|---|
| Current | 80,000 | 1% | 800 |
| 1-30 days overdue | 25,000 | 3% | 750 |
| 31-60 days overdue | 10,000 | 10% | 1,000 |
| Over 60 days | 5,000 | 25% | 1,250 |
| Total | 3,800 |
If the existing provision is £2,500, an additional £1,300 is needed:
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Bad debt expense | 1,300 | |
| Provision for doubtful debts | 1,300 |
Stock Adjustments
At year end, stock must be valued at the lower of cost and net realisable value (NRV). If the NRV of any stock falls below its cost, a write-down is required.
Stock Count Adjustment
After the physical stock count, the accounting records are adjusted to match:
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Cost of goods sold | 2,800 | |
| Stock | 2,800 |
This adjustment recognises stock losses from damage, theft or obsolescence identified during the count.
NRV Write-Down
If stock costing £8,000 has a net realisable value of £5,500:
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Cost of goods sold | 2,500 | |
| Stock | 2,500 |
Deferred and Accrued Income
Deferred Income
If the company received payment for services not yet delivered, the unearned portion is deferred:
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Revenue | 4,000 | |
| Deferred income (current liabilities) | 4,000 |
Accrued Income
If the company has delivered services but not yet invoiced:
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Accrued income (current assets) | 6,500 | |
| Revenue | 6,500 |
Corporation Tax Provision
A provision for corporation tax is recorded based on the estimated tax liability for the year:
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Corporation tax expense | 18,500 | |
| Corporation tax liability | 18,500 |
The exact amount is finalised when the tax computation is prepared, and any difference between the provision and the actual liability is adjusted in the following period.
Summary of Common Year-End Adjustments
| Adjustment | Effect on P&L | Balance sheet impact |
|---|---|---|
| Accruals | Increase expenses | Increase current liabilities |
| Prepayments | Decrease expenses | Increase current assets |
| Depreciation | Increase expenses | Reduce fixed asset carrying value |
| Bad debt provision | Increase expenses | Reduce debtors (net) |
| Stock write-down | Increase cost of sales | Reduce stock |
| Deferred income | Decrease revenue | Increase current liabilities |
| Accrued income | Increase revenue | Increase current assets |
| Corporation tax provision | Increase tax expense | Increase current liabilities |
The Year-End Process
Year-end adjustments are typically prepared as part of the year-end accounts process, which follows this sequence:
- Close the books for the period and complete the bank reconciliation
- Run the trial balance and review it for obvious errors
- Prepare year-end adjustment journals (the entries described above)
- Post the journals and run a revised trial balance
- Prepare the financial statements from the adjusted trial balance
- Review and approve the accounts
Each adjustment journal should be clearly documented with a description, supporting calculation and approval. This documentation is reviewed during the audit and supports the integrity of the financial statements.