Year-End Adjustments — Accruals, Prepayments, Bad Debts & Impairment Provisions
The accrual concept and the four timing adjustments (accrued and prepaid expenses, income receivable and income in advance), bad debts, and the provision for impairment of receivables (new, increased and decreased), with their effects on the P&L and the SFP.
1The accrual concept
Under the accrual concept, each item of income or expense is recorded when it is earned or incurred, regardless of when cash is received or paid.
The trial balance shows what was paid or received. Year-end adjustments correct it to what belongs to this period.
| Not yet paid/received (arrears) | Paid/received in advance | |
|---|---|---|
| Expense | Accrued expense → current liability | Prepaid expense → current asset |
| Income | Income receivable (accrued income) → current asset | Income received in advance → current liability |
P&L figure = amount for this period's months, not the cash figure.
- Expenses: P&L = paid + accrued − prepaid.
- Income: P&L = received + receivable − in advance.
2Accrued & prepaid expenses
Accrued expense
An expense incurred but not yet paid (e.g. electricity for March, paid in April). It must be recognised in the period it's incurred, not the period it's paid.
- P&L: add to the expense.
- SFP: current liability.
Prepaid expense
An expense paid in advance but not yet incurred (e.g. insurance paid for next year). It's an asset until the service is received.
- P&L: deduct from the expense.
- SFP: current asset.
3Income receivable & income received in advance
Income receivable (accrued income)
Income earned but not yet received (e.g. March rent from a tenant, received in April). Recognise it when earned.
- P&L: add to income.
- SFP: current asset.
Income received in advance (prepaid income)
Revenue received but not yet earned (e.g. next year's rent received early). It's a liability until the service is performed.
- P&L: deduct from income.
- SFP: current liability.
Rent expense paid Rs 110,000; rent is Rs 10,000 a month and the year has 12 months, so the charge should be 120,000. - Accrued rent = 10,000: Dr Rent / Cr Accrued rent. - P&L rent 120,000; SFP current liability 10,000.
Insurance paid Rs 36,000 for 18 months starting at the beginning of the year. Only 12 months belong to this year. - Prepaid = 36,000 × 6/18 = 12,000. - P&L insurance 24,000; SFP current asset 12,000.
4Bad debts (irrecoverable debts)
Some receivables can't be recovered. These are bad debts (irrecoverable debts).
Causes:
- the debtor's bankruptcy
- the debtor's death
- the debtor's absence from the country
- lunacy (mental incapacity)
- P&L: a bad debts expense.
- SFP: reduces receivables.
5Provision for impairment of receivables
Some receivables are doubtful: not definitely irrecoverable, but they might not be paid. Prudence requires an allowance (provision) for the potential loss.
- First write off bad debts from receivables.
- Then calculate the provision on the remaining receivables (often a %).
- Only the change in the provision goes to the P&L.
| Situation | Entry | P&L effect |
|---|---|---|
| New provision (no opening balance) | Dr Impairment loss on trade receivables / Cr Provision for impairment | Expense = the full provision |
| Under-provision: the required provision increases | Dr Impairment loss / Cr Provision, for the increase only | Expense = increase |
| Over-provision: the required provision decreases | Dr Provision / Cr Impairment loss (income / reduction), for the decrease only | Income (or a reduced expense) = decrease |
SFP: Trade receivables − provision for impairment = net receivables (a current asset).
Final-accounts questions always include several of these adjustments. For each one:
- Journal entry
- P&L effect (add or deduct)
- SFP effect (current asset or liability)
Classic traps:
- The provision is calculated after writing off bad debts.
- Only the movement in the provision hits the P&L.
- Prepayments are assets and income in advance is a liability.
6Practice questions (course paper)
Accruals and prepayments
| Expense | Paid | Correct expense for the year | Adjustment |
|---|---|---|---|
| Insurance | 60,000 | 70,000 | Accrued 10,000 (current liability) |
| Electricity | 100,000 | 10,000 × 12 = 120,000 | Accrued 20,000 |
| Rent | 150,000 (10 months) | 15,000 × 12 = 180,000 | Accrued 30,000 |
Journal: Dr Insurance 10,000 · Dr Electricity 20,000 · Dr Rent 30,000 / Cr Accrued expenses 60,000.
| Expense | Paid | Expense for the year | Adjustment |
|---|---|---|---|
| Rent | 250,000 | 225,000 | Prepaid 25,000 (current asset) |
| Electricity | 75,000 | 5,000 × 12 = 60,000 | Prepaid 15,000 |
| Rates | 80,000 (16 months) | 5,000 × 12 = 60,000 | Prepaid 20,000 |
| Income | Received | Income for the year | Adjustment |
|---|---|---|---|
| Commission | 80,000 | 120,000 | Accrued income 40,000 (current asset) |
| Rent | 600,000 (8 months) | 75,000 × 12 = 900,000 | Accrued income 300,000 |
| Income | Received | Income for 2018 | Deferred (current liability) |
|---|---|---|---|
| Discount received | 150,000 | 120,000 | 30,000 |
| Rent (15 months) | 375,000 | 25,000 × 12 = 300,000 | 75,000 |
| Commission | 60,000 | 54,000 | 6,000 (10%) |
Bad debts and the provision for impairment
| Q | Write-offs | Provision needed | Change in provision | P/L charge | Receivables in SOFP |
|---|---|---|---|---|---|
| 5 | Kumara 50,000 + Sisira 80,000 = 130,000 | — | — | 130,000 | 60,000 |
| 6 | Naleen 40,000 | 50,000 × 5% = 2,500 | +2,500 (new) | 42,500 | 50,000 − 2,500 = 47,500 |
| 7 | — | 150,000 × 10% = 15,000 | +15,000 (new) | 15,000 | 135,000 |
| 8 | 10,000 | 230,000 × 10% = 23,000 | 23,000 − 15,000 = +8,000 | 18,000 | 230,000 − 23,000 = 207,000 |
| 9 | — | 500,000 × 10% = 50,000 | 50,000 − 60,000 = −10,000 | income 10,000 | 450,000 |
- Increase in provision: Dr Impairment expense / Cr Provision.
- Decrease in provision: Dr Provision / Cr Income statement.
Full statements with adjustments
| Rs. | |
|---|---|
| Net sales: 127,245 − 3,486 | 123,759 |
| Cost of sales: 7,940 + 61,420 − 1,356 − 6,805 | (61,199) |
| Gross profit | 62,560 |
| Add discount received | 62 |
| Discount allowed | (2,480) |
| Carriage out | (3,210) |
| Rent & insurance: 8,870 − 600 prepaid | (8,270) |
| Wages: 39,200 + 3,500 accrued | (42,700) |
| Office: 319 + 16 owing | (335) |
| Net profit | 5,627 |
SOFP: fixtures 1,900 + vehicle 5,600 = 7,500 · inventory 6,805 + receivables 12,418 + prepaid 600 + cash 140 = 19,963 · total 27,463
Capital 25,200 + 5,627 − 21,400 = 9,427 · payables 12,030 + overdraft 2,490 + accruals 3,516 = 18,036 · total 27,463 ✓
The trial balance columns are jumbled in the PDF. Read back, the credits are: sales 357,165, capital 613,400, discounts received 1,160, payables 4,495 and provision 805. Dr = Cr = 977,025 ✓
| Rs. | |
|---|---|
| Sales | 357,165 |
| Cost of sales: 4,120 + 192,800 − 4,500 | (192,420) |
| Gross profit | 164,745 |
| Add discount received | 1,160 |
| Electricity: 4,400 − 330 | (4,070) |
| Wages: 31,400 + 1,340 | (32,740) |
| Discount allowed | (1,820) |
| Van running costs | (1,745) |
| Depreciation 10%: building 20,000 + vehicle 20,300 + furniture 290 (not land) | (40,590) |
| Bad debts | (5,000) |
| Provision: (12,316 − 5,000) × 10% = 731.60; was 805, so a decrease | +73.40 |
| Net profit | 80,013.40 |
SOFP: land 300,000 + building 180,000 + vehicle 182,700 + furniture 2,610 = 665,310 · inventory 4,500 + receivables 6,584.40 + prepaid 330 + bank 4,100 + cash 1,324 = 16,838.40 · total 682,148.40
Capital 613,400 + 80,013.40 − 17,100 = 676,313.40 + payables 4,495 + accrued wages 1,340 = 682,148.40 ✓
7Quick revision sheet
| Adjustment | Journal | P&L | SFP |
|---|---|---|---|
| Accrued expense | Dr Expense / Cr Accrued expense | + expense | Current liability |
| Prepaid expense | Dr Prepaid / Cr Expense | − expense | Current asset |
| Income receivable | Dr Income receivable / Cr Income | + income | Current asset |
| Income in advance | Dr Income / Cr Income in advance | − income | Current liability |
| Bad debts | Dr Bad debts / Cr Receivables | Expense | − receivables |
| New provision | Dr Impairment loss / Cr Provision | Expense (full) | − from receivables |
| Increase | Dr Impairment loss / Cr Provision | Expense (increase) | − |
| Decrease | Dr Provision / Cr Impairment loss | Income (decrease) | − |
| Accrual concept | Record when earned or incurred, not when cash moves |
?Self-check quiz
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