Adjustments to Final Accounts
Now the tax year 2012-2013 has ended, it’s time to start finalising those accounts for your tax returns. This
is what we term the end-of-year.
In addition to the general bookkeeping that you have done throughout the last year, it is essential that you
are able to deal with adjustments that are necessary to give you the true profit figure for your tax return.
Stock
This is applicable to all businesses that sell a product whether it’s cosmetics, food or electrical items.
Stock is an asset and as such will have a debit balance. As with a cash account, it cannot have a credit
balance because you cannot use what you do not have. The account that is used to record the value of
your stock should not be used to record the purchases, it is used purely at the end of each financial year to
record the amount of stock left in the business.
If you are at the end of your first years’ trading, there will be no opening stock figure. All subsequent years
there will be. You will need to carry out a stock-take to determine the value of the goods that remain
unsold. This is your closing stock figure and must be accounted for.
At the end of each year you will have two amounts for stock:
o
o
the opening stock figure – which will be the previous year’s closing stock
the closing stock figure – which will be the figure obtained after the stock take.
The opening and closing stock figures will appear twice in your end-of-year accounts; once in the trading,
profit & loss account, and again on the balance sheet.
Accruals
An accrual is an expense that has been incurred but not yet entered into the accounts at the year end, as
no invoice has been received. An example is accrued wages.
This amount must be allowed for in the accounts for tax purposes. Whilst it is earned in the last part of one
financial year, it is not physically paid until the start of the next. It will be added to the expense account
then taken through to the TP&L account. The amount that has accrued is now a liability and will be taken
through to the balance sheet on its own.
This will account for payments that are due in the current tax year but not paid for until the new one.
Prepayments
These are dealt with in a similar way to the accruals, although they are in the reverse.
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A prepayment, as the name suggests, is an amount that has been paid in advance as you may do with
quarterly bills. The amount is paid in the current tax year, but is not relevant until the new one.
This amount must also be disallowed for in the accounts for tax purposes. It will be deducted from the
relevant expense account and taken through to the TP&L account. This amount that is prepaid is now an
asset and will be taken through to the balance sheet on its own.This will account for all payments made in
advance that are pertinent to the following tax year.
Depreciation
This was explained in the last article on how to calculate the depreciation of a fixed asset. Whichever
method you use, the bookkeeping is the same at the end of the year.
You will need two accounts:
o
o
one to record the depreciation for the year, which will be an expense on the TP&L
one to record the on-going provision for depreciation which will remain in the fixed assets section of
the balance sheet and be used to calculate the net book value of the asset concerned.
Provision for Bad / Doubtful Debts
Unfortunately, if you deal in credit transactions, there is a chance that at some stage a customer will be
unable to pay their debts for whatever reason. When it is known that a debt will not be paid, an actual bad
debt has been incurred and the amount should be written off to the profit and loss accounts and the
debtors figure is reduced accordingly.
As an extension to this procedure for actual bad debts, if a business is selling on credit, it should make
some provision for the possibility that bad debts might occur.
Experience will suggest just what level of bad debs might occur. If for example, previous trading periods
show that 2% of debtors fail to pay, then a provision of 2% of current debtors should be made in the
current periods’ accounts.
This is done by creating a “provision for doubtful debts” account and crediting it with the estimated figure
for possible bad debts. This account will be included in the profit and loss account as an expense item. It
will also be recorded on the balance sheet as a deduction from the debtors figure under current assets.
This is an item that does not actually take money out of the business. The profit is reduced by making
provisions but they differ from the actual expense items in that they have not caused an outflow of money.
These are known as “non cash” items.
Scenario
Company X has just completed its first year of selling on credit. Currently, there are two debtors who have
outstanding debts that are unlikely to be received.
As a result, Company X decides to set up a provision for the possibility that 1% of those debtors might not
pay. The debtors figure at the period end was £469.
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A provision for bad debts is calculated at 1%, £5 (rounded to the nearest pound) – a small figure like this
would not normally be entered, this is just to show the concept. This will be added to the notes and
included in the final accounts.
Provision for bad debts will be entered as an expense in the profit & loss account, and deducted from the
debtors figure on the balance sheet.
This example is based on introducing a provision for bad debts for the first time. The balance on the
account will be based on the level of debtors that existed at the time and will be the figure that is carried
down to the start of the next period:
This provision was based on a debtors level of £469 – the figure for year 1.
Let’s assume that at the end of year 2, the debtors figure had increased to £2500.
Assuming the prevision remains the same at 1% of debtors, the amount required will now be £25.
The amount in the provision account must be increased to £25
The amount charged to the profit& loss account in year 2 is £25 less the original £5 = £20
The £20 will appear as an expense in the expenses section of the profit & loss account, whilst the balance
sheet for year 2 will show the total provision made.
It is a common mistake to add the current year’s provision to that already existing for previous years. If
this was done in the above example there would be £30 in the provision account – not what is required.
It is reasonable to assume that the debtors figure might well decrease rather than increase. Let’s assume
the at the end of year 3, the debtors figure is £1500
Assuming the provision remains the same at 1% of debtors, the amount required will now be £15
The total provision for bad debts at the start of year 3 is £25, which is £10 more than what is required. The
provision must therefore be reduced by £10
An amount of £10 is credited to the profit & loss account in year 3 – i.e. it will appear as an addition to the
gross profit.
Each year the amount of provision required will fluctuate in line with the figure for the debtors.
o Where the debtors figure increases, the provision increases
o Where the debtors figure decreases, the provision decreases
o Only in the unlikely event that the debtors remained exactly the same as the previous year would
the provision remain the same.
Once a provision has been made, if there is an actual bad debt in subsequent years, it must be written off
against the provision account – this is because this written off amount has already been charged to the
profit & loss account within the existing provision. It should not be charged again. Once the debt has been
written off, the provision is re-calculated based on the revised debtors’ figure.
Goods Taken for Own Use
Quite often, goods will be taken from the business by the owner for their own use or private use, but paid
for by the business. For example, the owner of a retail food outlet might take goods for their own
consumption.
There is no law against this but should be reflected in the accounts. It has been normal practice that where
goods are taken for own use they can be charged to the owner at the purchase price rather than the
selling price as the owner is not required to make a profit from themselves. HMRC have ruled though, that
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for the purpose of the self-assessment tax return, goods must be taken at the selling price. The difference
is in the accounting. Where you would sell an item you would credit the relevant ledger account and debit
the bank account, when used for yourself you would debit the drawings account instead.
Conclusion
So there you have it, how to do your year-end accounts and adjustments so that your tax liability is correct
when filling out your tax return. Using the information in this article you can now spend all those hours
with lots of paper, pencils, erasers and a calculator getting your figures accurate so that when the tax man
comes knocking on your door asking to look over your accounts, they will be relevant to the right tax year.
Alternatively, you could employ an accounting professional to do it for you. This will free up all those hours
to work on completing current projects and prospecting for new ones. The fee that would be charged for
this would be considerably less than if you calculated the amount of your time you have lost.
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