Year-End Adjustments (Grade 10 NSC Matric Accounting): Revision Notes

Year-End Adjustments

Introduction to year-end adjustments

At the end of every financial year, businesses need to make adjustments to their accounting records. These adjustments ensure that the financial statements accurately reflect the business's financial position and performance for that specific period.

Year-end adjustments are essential because they ensure that only income earned during the period and expenses incurred during the same period are included in the profit calculation. This principle is called the matching principle, which is a key part of Generally Accepted Accounting Practice (GAAP).

Adjustments are recorded in the General Journal and then posted to the General Ledger accounts. Once these adjustments are complete, businesses can prepare their final accounts and financial statements.

Steps in doing year-end adjustments

When preparing year-end adjustments, follow these steps in order:

1. Prepare journal entries for all the adjustments needed
2. Journalise all closing transfers (transferring balances to final accounts)
3. Post to the ledger (update all affected accounts in the General Ledger)
4. Prepare final accounts (Income Statement and Balance Sheet)
5. Prepare financial statements (complete set of financial reports)

Types of year-end adjustments

Additional bad debts written off

Sometimes a business discovers that certain debtors will not be able to pay their debts. These amounts are considered bad debts and must be written off as an expense. This adjustment reduces both the debtors' control account and increases expenses.

Journal entry for bad debts:

• Debit: Bad debts (expense account)
• Credit: Debtors control (asset account)
• Credit: Individual debtor's account in the debtors ledger

Depreciation

Depreciation refers to the decrease in value of fixed assets (like vehicles and equipment) over time. Fixed assets are purchased to use in the business, not for resale. While land and buildings can increase in value if well-maintained, according to GAAP's historical cost principle, these assets must always be recorded at their original purchase price in the financial statements, not at revalued amounts.

Why assets depreciate

Assets lose value due to several factors:

• Usage - what the fixed assets are used for in the business
• Technological changes - newer, better equipment becomes available
• Wear and tear (ageing) - physical deterioration over time

The matching principle requires businesses to depreciate assets because the cost of using these assets should be matched to the periods in which they generate income.

Understanding depreciation vs accumulated depreciation

Journal entry for depreciation:

• Debit: Depreciation (expense account)
• Credit: Accumulated depreciation on vehicles/equipment (negative asset account)

Methods of calculating depreciation

There are two main methods for calculating depreciation:

1. Fixed amount method (also called straight-line method):

• A fixed amount of depreciation is written off every year
• The depreciation amount stays the same each year
• Calculated as a percentage of the original cost price

2. Diminishing balance method (also called declining method or book value method):

• The depreciation amount decreases each year
• Calculated as a percentage of the carrying value (not the original cost)
• Results in higher depreciation in early years and lower depreciation in later years

Carrying value formula:

$\text{Carrying value} = \text{Cost price} - \text{Accumulated depreciation}$

The choice of depreciation method depends on how the asset is used and its expected lifespan. Once a business chooses a method for a particular asset, it must continue using that same method consistently and cannot change it every year.

Asset register

An asset register is a detailed record maintained by the business for all tangible (physical) assets. It provides complete information about each asset individually.

For example, if a business owns four vehicles, the asset register will have separate entries for each vehicle showing its purchase date, cost, depreciation, and carrying value. However, in the General Ledger, only one vehicles account is maintained showing the total value of all four vehicles.

The asset register shows:

• Date of purchase
• Cost of each asset
• Annual depreciation for each year
• Accumulated depreciation (total depreciation to date)
• Carrying value (cost minus accumulated depreciation)

Accrued income (income receivable)

Accrued income is income that the business has earned and should receive, but has not yet received by the end of the accounting period. This follows the matching principle of GAAP - income must be recorded in the period it was earned, not when the cash is received.

Two elements of accrued income

Accrued income affects two accounts:

• Asset element - Accrued income (Balance Sheet section) - represents money owed to the business
• Income element - Income account (Nominal section) - increases the income for the period

Effect on the accounting equation: Assets increase, Equity increases

Important information needed

To process accrued income adjustments, you need:

• The date of the financial year-end
• The balance of the income account in the pre-adjustment trial balance

Accrued expenses

Accrued expenses are expenses that have been incurred (used up) during the accounting period but have not yet been paid by the end of the period. Like accrued income, this adjustment follows the matching principle of GAAP.

Two elements of accrued expenses

Accrued expenses affect two accounts:

• Liability element - Accrued expenses (Balance Sheet section) - represents money the business owes
• Expense element - Expense account (Nominal section) - increases the expense for the period

Effect on the accounting equation: Liabilities increase, Equity decreases

Important information needed

To process accrued expenses adjustments, you need:

• The date of the financial year-end
• The balance of the expense account in the pre-adjustment trial balance

The reversal:

On the first day of the next accounting period, the accrued expense must be reversed:

• Debit: Accrued expenses - R1,240
• Credit: Telephone - R1,240

Prepaid expenses

Prepaid expenses are expenses that have been paid in the current accounting period, but the benefit will only be received in the next accounting period. These are expenses paid in advance. The matching principle requires that these amounts be recorded as an asset rather than as an expense for the current period.

Two elements of prepaid expenses

Prepaid expenses affect two accounts:

• Asset element - Prepaid expenses (Balance Sheet section) - represents a benefit owed to the business
• Expense element - Expense account (Nominal section) - reduces the expense for the period

Effect on the accounting equation: Assets increase, Equity increases (because expenses decrease)

Important information needed

To process prepaid expenses adjustments, you need:

• The date of the financial year-end
• The balance of the expense account in the pre-adjustment trial balance

The reversal:

On the first day of the next accounting period, the prepaid expense must be reversed:

• Debit: Insurance - R1,200
• Credit: Prepaid expenses - R1,200

Income received in advance (deferred income)

Income received in advance (also called deferred income) occurs when the business receives income in the current accounting period that relates to the next accounting period. Since the service has not yet been provided or the income has not yet been earned, it must be recorded as a liability rather than as income.

Two elements of income received in advance

Income received in advance affects two accounts:

• Liability element - Income received in advance (Balance Sheet section) - represents an obligation to provide services
• Income element - Income account (Nominal section) - reduces the income for the period

Effect on the accounting equation: Liabilities increase, Equity decreases (because income decreases)

Important information needed

To process this adjustment, you need:

• The date of the financial year-end
• The balance of the income account in the pre-adjustment trial balance

The reversal:

On the first day of the next accounting period, the income received in advance must be reversed:

• Debit: Income received in advance - R5,000
• Credit: Rent income - R5,000

Consumable stores on hand

Businesses purchase various consumable items that are used in daily operations, such as:

• Stationery
• Cleaning material
• Fuel
• Packing material

When these items are purchased, they are initially recorded as expenses. However, at year-end, there may be unused items remaining. These unused items cannot be treated as expenses (since they haven't been used yet) and should instead be recorded as a temporary asset.

Two elements of consumable stores on hand

This adjustment affects two accounts:

• Asset element - Consumable stores on hand (Balance Sheet section)
• Expense element - Expense accounts (Nominal section) - reduces the expenses

Effect on the accounting equation: Assets increase, Equity increases (because expenses decrease)

The reversal:

On the first day of the next accounting period, the consumable stores must be reversed:

• Debit: Packing material - R1,400
• Debit: Stationery - R2,300
• Credit: Consumable stores on hand - R3,700

Trading stock deficit

Under the continuous (or perpetual) inventory system, businesses maintain ongoing records of stock. At year-end, a physical stock count is performed to verify the actual stock on hand. This count may reveal:

• Deficit - less stock than shown in the records
• Surplus - more stock than shown in the records

When a deficit occurs, an adjustment entry is necessary to ensure the trading stock account reflects the correct value of stock actually on hand.

Two elements of trading stock deficit

This adjustment affects two accounts:

• Expense element - Trading stock deficit (expense account)
• Asset element - Trading stock (asset account)

Effect on the accounting equation: Equity decreases, Assets decrease

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