END-OF YEAR ADJUSTMENTS
1. Accrued expenses
2. Prepaid expenses
3. Accrued income
4.Income received in advance
YEAR-END ADJUSTMENTS
PRE-ADJUSTMENT TRIAL BALANCE OF BONTLE TRADERS AS AT 31
DECEMBER 2019.
DETAILS
Telephone
DEBIT
CREDIT
770
Insurance
1 800
15% fixed deposit
8 000
Interest income
Membership fees received
600
12 000
ADDITIONAL INFORMATION:
1.
The telephone account for December has not yet been received.
2.
Annual insurance policy was taken and paid for on 1 October 2019.
3.
R8 000 was invested in the fixed deposit account on 1 April 2019 and interest is payable half-yearly in arrears..
4.
On 1 May 2019, some members paid their full membership fees for the year, R12 000.
Let us use the above information to explain the following:
1. accrued expenses
2. prepaid expenses
3. accrued income
4. income received in advance
EXPLANATION OF ACCRUED EXPENSES:
Accrued expenses are expenses incurred but not yet paid at the end of the financial year. At times payment is
delayed (because of credit terms )- this will result in expenses being accrued. At the end of the financial year,
the aim is to ensure that all expenses incurred up to and including the last day of the financial year have been
recorded.
Let us use the time-line :
Beginning
Financial year is 12 months
1 January 2019
End
12 months
31 Dec 2020
1 Jan 2019
11 months
30 November
R770
1 month
R70
……31 December
• The telephone account for December has not yet been received, it implies that the given R770 represent 11
months.
• Determine the amount per month.(i.e) 770/11 months= R70 per month. Therefore, R70 for December was not
paid.(It is accrued/outstanding)
A liability is created for the amounts owing to Telkom on 31 December 2019.
• Thus R770 + R70 = 840 is telephone expenditure incurred during the whole year
General ledger accounts will be as follows:
(-)
Accrued expenses (liability account)
2019
Dec 31 Telephone
(+)
70
Telephone (expense account)
Balance
b/f
Accrued expense
770
* Profit or loss (expenditure)
840
70
840
840
• The accrued expense account serves only a temporary function and is cancelled out by reversing the entries in the next financial
year.
REVERSING ENTRIES AT THE BEGINNING OF THE NEXT FINANCIAL YEAR (2020) WILL BE AS FOLLOWS:
(- )
2020
Jan 1
Telephone
Expenses accrued (liability account)
70
2019
Dec 31
Telephone
(+ )
70
Telephone account
2020
Jan 1
Expenses accrued(2019)
70
2. PREPAID EXPENSES
At times expenses (e.g.) insurance are payable in advance- thus when the financial year ends, the amount
shown comprise a portion that is an expense for the period, as well as a portion that is an expense for the next
financial period.
• An adjustment must therefore be made to match only the expense relating to the current period against income for the period.
• Insurance expense of R1 800 is overstated, that is, the amount shown on expense are in excess of that actually relating to the
current year.
Let us use the time-line for insurance
R1 800 was paid on 1 October 2019
Beg 1 Jan 2019
1 October 2019
End 31 Dec 2019
30 September 2020
(3 months) R1 800 × 3/12) = R450 (9 months) 1800 × 9/12= R1 350
From the time lines, it is apparent that in terms of the actual expense to be matched against the year’s income,
insurance is overstated, that is ,the amount shown as an expense is in excess of that actually relating to the current
year.
Insurance cover is from 1 October 2019- 30 September 2020 =1 year. But the financial year ended 31 December
2019.
From the 1st of Oct 2019 to 31st Dec 2019 is 3 months. Therefore, R1 800 x 3/12= R450 is the actual insurance
expense for the current financial year (30 December 2019).
From 1 January 2020 – 30 September 2020= 9 months. It is R1 800 x 9/12= R1 350 or R1 800 – R450 = R1 350 was
paid in advance. It is an expense for the next financial year and will be used in the next year.
• General ledger accounts will appear as follows on 30 December 2019.
Insurance (expense account)
Balance b/f
1 800
Prepaid insurance
* Profit & loss*
1 350
450
1 800
Prepaid expense( an asset account)
Insurance
1 350
REVERSING ENTRY: Prepaid expense account serves only a temporary function and is cancelled out by
reversing the entry in the new financial year.
Prepaid expense
2019
Dec 31
Insurance
1 350
2020
Jan 1
Insurance
Insurance (expense account)
; 2020
Jan 1
Prepaid expense
1 350
1 350
3. ACCRUED INCOME
Accrued income is income due, that is income that has not been received and recorded by the end of the
financial year or it is income earned during a specific period but not yet received. Example- interest
income.
Time line to be used:
1
Jan 2019
1 April 2019
(9 months)
11111111jjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjjj
31 December 2019
Calculate interest to be received at the end of the financial year 31/12/2019.
• April 2019- 31 December 2019= R8 000 x 9/12 x 15%= R900.
•
According to the trial balance R600 had already been received.
• R900 –R600 =R300 is accrued(not yet received). At the end of the financial year on 31 December
2019 an amount of R300 has been earned, but not yet received nor recorded. The next interest
payment will be received at a later date – it is accrued.
General ledger
Accrued income( asset account)
2019
Dec 31 Interest income
300
2019
Dec 31* Profit & loss
Interest income
2019
900
Dec 31
Balance b/d
Accrued income
900
Balance
b/f
15% Fixed deposit
8 000
600
300
900
In conclusion, income accrued is an asset, it is created on the last day of the financial year (31 Dec
2020) to show the amount of interest (R300)owed to the business.
REVERSING ENTRY: Accrued income account serves only a temporary function and is cancelled
out by reversing the entries in the new financial year.
Accrued Income
2019
Dec 31
1 Jan
2020
Interest income
I
Accrued income
300
2020
Jan 1
Interest Income
300
Interest income
300
4. INCOME RECEIVED IN ADVANCE
•
This is income that has been received but not earned yet.
Time line:
1 Jan 2019
1May 2019
8 months
31 Dec 2019
4 months
31 April 2020
The R12 000 Membership fees was overstated.
1 May 2019 – 31 Dec 2019 = R12 000 x 8/12 = R8 000 is the actual income for the period under
review.
Therefore, from 1 Jan 2020 –31 April 2020 = 4/12 x R12 000 = R4 000 or
R12 000 – R8 000 = R4 000 received in advance
General ledgers:
Membership fees (income account)
Income received in advance
4 000
*Profit & loss*
8 000
Balance
b/f
12 000
12 000
Income received in advance (liability account)
Membership fees
4 000
Membership fee income which was overstated will now show a total of R8 000,the
actual income for the period under review. R4 000 is a liability account-it is for the next
financial year.
Reversing entry: Income received in advance only serves a temporary function and is
cancelled out by reversing the entries in the next financial year.
Membership fees received in advance
2020
Jan 1
Membership fees
4 000
2019
Dec 31
Membership fees
Membership Fees account
2020
Jan 1
Received in advance
4 000
4 000