The Year-End Accrual That Changes the Profit
You are preparing the year-end accounts of Pemberton Trading Ltd for the year ended 31 December 20X4. During the audit you identify the following:
- A supplier invoice for £18,000 dated 28 December 20X4 for goods received on 30 December 20X4 was not recorded until January 20X5 (the invoice was in the 'post year-end' pile).
- A customer was invoiced £24,000 on 20 December 20X4 for goods dispatched on 5 January 20X5. The revenue was recognised in 20X4.
- The company pays an annual insurance premium of £36,000 on 1 October each year, covering the 12 months from that date. The full £36,000 was expensed on 1 October 20X4.
- A staff bonus of £15,000 for 20X4 performance was approved by the board on 15 February 20X5 and paid in March 20X5. No accrual was made.
The draft profit before tax is £420,000. The tax rate is 25%.
1. For each of the four items, state the correct accounting treatment and the adjustment to profit before tax.
Read the worked answer
Item 1 - Goods received not invoiced (£18,000). Under the accruals concept, the expense belongs to 20X4 because the goods were received before the year end. Accrue £18,000; reduce profit by £18,000.
Item 2 - Revenue recognised before dispatch (£24,000). Revenue should be recognised when control passes to the customer - on dispatch (5 Jan 20X5). The £24,000 is not 20X4 revenue; reverse it. Reduce profit by £24,000. (Also reverse any related cost of sales and reinstate inventory.)
Item 3 - Insurance prepayment (£36,000 paid 1 Oct 20X4 for 12 months). Only 3 months (Oct–Dec 20X4) relates to 20X4 = £9,000. The remaining 9 months = £27,000 is a prepayment (asset). Increase profit by £27,000.
Item 4 - Staff bonus (£15,000). The bonus relates to 20X4 performance and was approved before the accounts were finalised; under the accruals concept it is a 20X4 liability. Accrue £15,000; reduce profit by £15,000.
Net adjustment: −18,000 − 24,000 + 27,000 − 15,000 = −£30,000.
2. Calculate the adjusted profit before tax and the tax charge, and explain the principle that underlies your treatment of item 4.
Read the worked answer
Adjusted profit before tax: £420,000 − £30,000 = £390,000.
Tax charge: £390,000 × 25% = £97,500.
Principle behind item 4 (the bonus): The accruals (matching) concept requires expenses to be recognised in the period to which they relate, not when they are paid or approved. The bonus was earned by staff for 20X4 performance, so the obligation arose in 20X4 even though it was approved and paid in 20X5. Because the board approved it before the financial statements were authorised for issue, it provides evidence of a present obligation at the reporting date - so it is accrued. (Had the bonus been discretionary and unapproved at the reporting date, the treatment would need careful judgement.)
Summary of the corrected position:
| Item | Adjustment to PBT |
|---|---|
| Goods received not invoiced | −£18,000 |
| Revenue reversed | −£24,000 |
| Insurance prepayment | +£27,000 |
| Bonus accrual | −£15,000 |
| Net | −£30,000 |
Adjusted PBT £390,000; tax £97,500; adjusted profit after tax £292,500.