YEAR-END ADJUSTMENTS

Purpose: to ensure that income and expenses, and consequently the profit or loss, for the
relevant financial period are accurately reported.
This implies that only income and expenses with respect to the current financial period may be
recognised as income and expenses during the current financial period.
All the entries posted to the income and expense accounts in the general ledger are examined
at the end of each financial period to ensure that all amounts for the relevant financial period
are included in those ledger accounts and all other amounts for other financial periods are
transferred to either current asset accounts or current liability accounts.
Any adjustments are made by means of journal entries which are then posted to the general
ledger.
The following adjustments are made at the end of each financial period:
1. Income received in advance
2. Accrued income
3. Prepaid expenses
4. Accrued expenses
5. Closing inventory
6. Depreciation
7. Allowance for credit losses (provision for Bad debts)
8. Material consumed

Income received in advance

Income received in advance is the income for the following financial period that has already
been received during the current financial period. This income is not earned (meaning this
money is received before a sale is effected or a service rendered) and therefore cannot be
shown as an income for the current period.
Since the accrual principle requires that the transaction must still be recorded, this income will
be shown as income received in advance under CURRENT LIABILITIES in the statement of
financial position.
You will have to minus this income from the total income
Example 1: INCOME RECEIVED IN ADVANCE
SS Dealers rented office space to an accounting firm for the period from 1 January 2020 to 31
December 2020 (the end of the financial year) at R1 000 per month. Rent to the amount of
R13 000 was received during the current financial year and was credited to Rent received
account.
This adjustment will be calculated and recorded as follows:
The office space was rented for the full financial year, thus the income earned for the current
financial year amounts to R12 000 (R1 000 X 12 months). However, R13 000 was received.
R1 000 (R13 000 – R12 000) represents income received IN ADVANCE for 2021 (the following
financial year)
R1 000 must be deducted from the Rent received account and transferred to the Rent received
in advance account (CURRENT LIABILITY).
The journal entry is shown below:

FOL DR CR
2020
Dec 31 Rent received / rent income 1 000
Rent received in advance (LIABILITY) 1 000
(Rent for January 2021 received in advance)
Note: Rent received or Rent income a/c being an income account has a credit balance. To
deduct R1 000 received in advance, you need to DEBIT the income account.
The R1 000 rent received in advance is a liability.
Income statement 2020
Other Comprehensive incomes:
Rent Income (13 000 – 1 000) 12 000
Balance Sheet
Current liabilities:
Rent received in advance 1 000

Accrued income
Accrued income is the income that is earned in the current financial year but have not yet been
received. This income is earned (you sold goods or have rendered a service) and so it must be
shown as an income for the current financial period.
Accrued income will be shown as a CURRENT ASSET in the statement of financial position
Example 2:
SS Dealers received a commission of R960 during the year between January to November. A
commission of R240 for December 2020 that is earned has not been received yet.
This adjustment will be calculated and recorded as follows:
 Commission received 960
Commission earned but not received 240
Increase (TOTAL COMMISSION FOR 2020) 1 200

R240 represents the commission for December 2020 that is not received (Accrued income).
R240 must be added to the Commission received account and transferred to the Accrued
income account (CURRENT ASSET).

FOL DR CR
2020
Dec 31 Accrued commission income (ASSET) 240
Commission received 240
(Rent for January 2021 received in advance)

Commission received is an income account. Therefore, the 240 rand that you did not receive for
the current year must be added to commission income account.
To add to an income account, you need to credit the income account
Income statement
Other comprehensive incomes:
Commission received 960 + 240 1 200
Balance sheet
Current assets
Accrued income (commission) 240

Prepaid expenses
Prepaid expenses are the expenses for the following financial period that have already been
paid during the current financial period.
The portion of the expenses that has been paid in advance is shown as prepaid expenses under
CURRENT ASSETS in the statement of financial position.
Example 3: Read this again

Included in the insurance expense of R3 000 for the financial year ending 31 December 2020 is
an amount of R2 400 in respect of an insurance policy for the period from 1 October 2020 to 30
September 2021.
Year-end = 31 December 2020
New insurance for R2 400
Taken on 1 Oct 2020. Paid until 30 Sept 2021 (prepaid for 9 months)
The adjustment will be calculated and recorded as follows:
The insurance policy of R2 400 is for a period of 12 months, three of which fall within the
current financial period (1 October 2020 – 31 December 2020) and the other nine in the next
financial period (1 January 2021 – 30 September 2021).
The prepaid portion amounts to R1 800 (R2 400 ÷ 12 = R200 p.m. X 9 months).
R1 800 must be deducted from the insurance expense account and transferred to the prepaid
insurance account (CURRENT ASSET)

FOL DR CR
2020
Dec 31 Prepaid insurance (ASSET) 1 800
Insurance expense 1 800
(Rent for January 2021 received in advance)

ASSET / EXPENSE ACCOUNTS – DR MEANS TO ADD, AND CREDIT MEANS TO MINUS

LIABILITIES AND INCOME ACCOUNTS – CR MEANS TO ADD AND DR MEANS TO MINUS
Income statement (Statement of Comprehensive income)
Operating expenses:
Insurance (3 000 – 1 800 1 200
Balance sheet (Statement of financial position)
Current assets:
Pre-paid expense (Insurance) 1 800

Accrued expenses
Accrued expenses are expenses that have been incurred but have not been paid for by the
entity for the current financial period.
Accrued expenses are shown under CURRENT LIABILITIES in the statement of financial position.
Example 4:
The water and electricity account of R750 for December 2020 had not yet been received by the
end of the financial period (31 December 2020). The water and electricity account from January
to November amounted to R8 250.
This adjustment will be recorded as follows:
R750 owing for December 2020 will be added to the water and electricity expense
R750 will be shown as accrued expense under CURRENT LIABILITIES in the statement of
financial position

FOL DR CR
2020
Dec 31 Water and electricity 750
Accrued expense - water and electricity 750
(w&e for December 2020 not paid)

To add to an expense account means to DEBIT the account

Income statement
Operating expenses:
Water and electricity (8 250 + 750) 9 000
Balance sheet
Current Liabilities:
Accrued expenses (water and electricity) 750

Depreciation
A non-current asset is used over a long period and the initial cost is not written off as an
expense. The cost of the asset is written off annually at a certain percentage or fixed amount
over the expected useful life of the asset. This accounting entry is known as depreciation.
For the purposes of this course, we will study two depreciation methods, namely:
Straight-line method (fixed amount method)
As the name indicates, the cost of the asset is written off at a fixed amount or percentage per
annum. Keep in mind that there may be an expected residual value OR salvage value or scrap
value (residual value is the value of the asset at the end of its useful life).
To calculate depreciation, the residual value is first deducted from the cost and then divided by
the expected useful life.
Example 5:
A machine was purchased by SS Dealers on 2 January 2020 at a cost of R21 000. The machine
has a useful life 5 years and a scrap (residual) value of R1 000. Provision must be made for
depreciation according to the straight-line method. The financial year of SS Dealers ends on 31
December.
Depreciation will be calculated as follows:
Depreciation amount per year = (cost less residual value) ÷ Expected useful life; (Cost x the rate)
= (21 000 – 1 000) ÷5 (or x(20%)
= R4 000 p.a.

FOL DR CR
2020
Dec 31 Depreciation - Machinery (expense) 4 000
Accumulated depreciation: Machinery 4 000
(Negative asset)

Accumulated depreciation account has a CREDIT BALANCE, but it is NOT a liability account. You
call it a NEGATIVE ASSET ACCOUNT.
Income statement
Operating expenses:
Depreciation – Machinery 4 000

Balance sheet

Cost Accumulated Carrying

depreciation Amount
ASSETS
NON-CURRENT ASSETS:
Machinery 21 000 4 000 17 000

Reducing balance method

As the name indicates, depreciation is calculated on the reduced value (carrying value) of the
asset each year.
In year 1, depreciation is calculated on the cost of the asset by multiplying the cost with a fixed
percentage.
In year 2, depreciation for year 1 is deducted from the cost (this is known as the carrying value)
and depreciation is then calculated at the same fixed rate on the carrying value.
In year 3, the depreciation is calculated on the carrying value of year 2, and so on.
Example 6:
A vehicle with a useful life of 5 years, was purchased by SS Dealers on 2 January 2020 at a cost
of R20 000. Provision must be made for depreciation at 40% p.a. according to the reducing
balance method. The financial year of SS Dealers ends on 31 December.
Depreciation will be calculated as follows:

Year depreciation Carrying value

2020 20 000 X 40% 8 000 20 000 – 8 000 12 000
Dec 31
2021 12 000 X 40% 4 800 12 000 – 4 800 7 200
Dec 31
2022 7 200 X 40% 2 880 7 200 – 2 880 4 320
Dec 31
2023 4 320 X 40% 1 728 4 320 - 1 728 2 592

2024 2 592 2 592 – 2 592 0

Depreciation 8 000
Income statement
Operating expenses:
Depreciation – Vehicles 8 000

Balance sheet

Cost - Accumulated = Carrying

depreciation Amount
ASSETS
NON-CURRENT ASSETS:
Vehicles 2020 20 000 8 000 12 000
2021 8 000 + 4 800
 Vehicles 20 000 12 800 7 200
2022 12 800 + 2 880
Vehicles 20 000 15 680 4 320
2023 15 680 + 1 728
Vehicles 20 000 17 408 2 592

Pro rata depreciation

It is important to know that depreciation is written off only for the portion of the year that the
asset was available for use.
If the asset was purchased or sold during the year, depreciation is written off only for the
portion of the year that the asset was in use. We call this pro rata depreciation.
Calculation:
Pro rata depreciation = depreciation amount per year x n / 12
n = number of months in use
Example 7:
Furniture was purchased by SS Dealers on 30 September 2020 at a cost of R21 000. The
furniture has a useful life 5 years and a scrap (residual) value of R1 000 at the end of its useful
life. Provision must be made for depreciation according to the straight-line method. The
financial year of SS Dealers ends on 31 December.
Depreciation will be calculated as follows:
Depreciation amount per year = (Cost less residual value) ÷ Expected useful life
= (21 000 – 1 000) ÷ 5
= R4 000 p.a.
Year ending 31 December 2020 = 4 000 X 3/12 = R1 000
Year ending 31 December 2021 = R4 000
Year ending 31 December 2022 = R4 000
Year ending 31 December 2023 = R4 000
Year ending 31 December 2024 = R4 000
Year ending 31 December 2025 = R4 000 X 9/12 = 3 000

Provision for credit losses (earlier called ‘provision for doubtful debts’)
An entity should make provision for clients who may not settle their accounts. Entities create a
provision for credit losses as a percentage of outstanding debtors (Accounts receivable) at year-
end wherein provision for possible future losses is made.
Since the balance of outstanding debtors (accounts receivable) differs at the end of each
financial year, the provision for credit losses must be adjusted each year to conform to this
balance.
The amount of the provision is deducted from the outstanding debtors amount at year-end and
only the net amount of debtor is shown as a current asset in the statement of financial position.
Example 8:
On 31 December 2020, the last day of the financial year, the balance of the debtors control
account (accounts receivable) amounted to R151 000 and the balance of the provision for
credit losses amounted to R2 000. The following transactions must still be brought into account
on 31 December 2020:

• the account of a debtor who owes R1 000 must still be written off; and
• the provision for credit losses must be adjusted to 2% of outstanding debtors.
Step 1: Calculate the amount of the adjusted provision for credit losses

Current balance Debtors 151 000

Less: amount still to be written off (credit loss 1 000
/ Bad debt)
Outstanding debtors at year-end 150 000
X 2%
Provision for credit losses should be 3 000

Step 2: Balance of the provision for credit losses from previous year

Balance (existing) provision for credit losses 2 000

(given in the question)

Step 3: Calculate the increase or decrease in the provision for credit losses

Existing provision for credit losses 2 000

New balance should be 3 000
Increase 1 000

The transactions will be recorded in the accounting records as follows:

Step 1: Record the amount still to be written off

Bad debts / Credit losses 1 000

Debtors control (Accounts Receivable) 1 000

Step 2: Record the increase in the provision for credit losses

Provision for credit losses Adjustment 1 000

Provision for credit losses 1 000

Provision for credit losses / provision for doubtful debts is a negative asset account.
Income statement
Operating expenses
Provision for credit losses ADJUSTMENT 1 000
Balance sheet
Current assets
Accounts receivable (151 000 – 1 000 – 3 000) 147 000

NOTE: THE INCREASE IN PROVISION FOR CREDIT LOSS IS AN EXPENSE

Example 9:
On 31 December 2020, the last day of the financial year, the balance of the debtors control
account (accounts receivable) amounted to R151 000 and the balance of the allowance for
credit losses amounted to R4 000. The following transactions must still be brought into account
on 31 December 2020:

• the account of a debtor who owes R1 000 must still be written off; and
• the provision for credit losses must be adjusted to 2% of outstanding debtors.
Step 1: Calculate the amount of the adjusted provision for credit losses

Current balance of Debtors control 151 000

 Less: amount still to be written off (Bad debt) 1 000
Outstanding debtors at year-end 150 000
X 2%
Provision for credit losses should be 3 000

Step 2: Current balance of the provision for credit losses

Balance (existing) provision for credit losses 4 000

(given in the question)

Step 3: Calculate the increase or decrease in the provision for credit losses

Existing provision for credit losses 4 000

New balance should be 3 000
Decrease 1 000

The transactions will be recorded in the accounting records as follows:

Step 1: Record the amount still to be written off

Bad debts 1 000

Debtors control (Accounts Receivable) 1 000

Step 2: Record the increase in the provision for credit losses

Provision for credit losses 1 000

Provision for credit losses ADJUSTMENT 1 000

NOTE: THE DECREASE IN PROVISION FOR CREDIT LOSS IS AN INCOME

Income statement
Other incomes
Provision for credit losses ADJUSTMENT 1 000
Balance sheet
Current assets
Accounts receivable (151 000 – 1 000 – 3 000) 147 000

Material consumed
Consumable stores, stationery etc consumed during the year will be treated as an EXPENSE
(stationery expense in this example) and the balance remaining on year-end will be shown as a
CURRENT ASSET (stationery asset in this example)
Example 10
SS Dealers
1 January 2020 Stationery on hand 12 500
15 June 2020 Purchased stationery for cash 5 000
31 December 2020 Closing balance of stationery 8 500
(31 December is year-end)
Step 1: Calculate stationery consumed – stationery expense
Formula = (opening stock + purchases) – closing stock
i.e (12 500 + 5 000) – 8 500 = 9 000
Journal entry

Stationery expense 9 000

Stationery asset 9 000

Closing inventory
The value of closing stock (the balance of stock on year-end) will be shown under CURRENT
ASSETS in the statement of financial position. The value of the closing inventory is calculated by
a physical stock count.
Example 11
SS Dealers had the following inventory on hand at year-end:
Trading inventory 31 December 2020 R5 000
The transactions will be recorded in the accounting records as follows:
The inventory of R5 000 will be shown under CURRENT ASSETS in the statement of financial
position.