Adjustments to Final Accounts
Why adjustments are needed
The accruals (matching) concept requires income and expenses to be matched to the period. Adjustments include accruals, prepayments, depreciation, bad and doubtful debts, and provision for doubtful debts.
Accruals and prepayments
An accrual is an expense incurred but not yet paid - add it to the expense and show it as a current liability. A prepayment is paid but not yet used - deduct it from the expense and show it as a current asset. Accrued income is a current asset; income received in advance is a current liability.
Bad and doubtful debts
A bad debt is written off: debit bad debts, credit the debtor. A provision for doubtful debts is an estimate of debts that may not be collected, usually a percentage of remaining debtors. Only the change in the provision goes to the profit and loss account.
Traps to watch
Do not add an accrual to the statement of financial position without also adjusting the expense. When a provision increases, the increase is an expense; a decrease is income. Calculate the provision on debtors after writing off bad debts. Prepayments reduce the expense, not increase it.
Rule of thumb
"Expense first, then the statement of financial position." Adjust the expense in the profit and loss account, then show the accrual or prepayment as a liability or asset.
Worked example
Rent paid $4,000; rent owing $500. Charge $4,500 to the profit and loss account and show $500 as a current liability.