At year-end, the ledger balances as recorded don’t always reflect reality. Some expenses have been paid for periods beyond year-end. Some income has been earned but not yet received. Some assets have worn out. Adjustments correct all of this — they make sure every rand lands in the right period.
Accounting follows the accrual principle: income and expenses must be recognised in the period they are earned or incurred — not necessarily when cash moves. But throughout the year, transactions are recorded as they happen. By year-end, some of those records need to be corrected to match the actual period they belong to.
Adjustments are journal entries made at year-end that do not originate from source documents. Their purpose is to ensure the financial statements give a true and fair picture of the period.
The golden rule of adjustments: One leg of every adjustment entry always affects a nominal account (income or expense — which goes to the income statement). The other leg always affects a statement of financial position account (asset or liability). Every adjustment touches both statements.
2. The five-step adjustment process
1
Identify the accounts that need to be adjusted.
2
Determine how the accounts should be affected and what the correct balances should be.
3
Calculate the amount involved in the adjustment.
4
Record the adjustment in the general journal and post to the ledger.
5
Verify that the new balances on the affected accounts are now correct.
3. Short-term adjustments at a glance
Short-term adjustments deal with the apportionment of income and expenses between consecutive periods. There are six types:
Short-term · Expense
Prepaid Expense
→ Current Asset
Expense paid this period but relating partly to next period. The future portion is an asset.
Short-term · Expense
Accrued Expense
→ Current Liability
Expense incurred this period but not yet paid. The unpaid portion is a liability.
Short-term · Expense
Consumable Inventory
→ Current Asset
Consumables purchased but still on hand at year-end. The unused portion is an asset.
Short-term · Income
Income Received in Advance
→ Current Liability
Income received this period but relating to next period. The future portion is a liability.
Short-term · Income
Accrued Income
→ Current Asset
Income earned this period but not yet received. The uncollected portion is an asset.
Short-term · Loss
Credit Losses (Bad Debts)
→ Expense / Loss
A debtor whose account is irrecoverable. Written off as an expense and removed from assets.
4. Prepaid expenses
An expense paid during the current period, where part of it relates to a future period. The future portion is an asset (Prepaid expenses) — it represents value that will be consumed next year.
1
Prepaid expenses
Short-term
Xa-Xa Dealers paid an annual insurance premium of R2 400 on 2 January 20.1. Their financial year ends 28 February 20.1. Only 2 months of the 12-month policy fall in this year (January & February).
Actual expense this year (2 months)
R2 400 ÷ 12 × 2 = R400
Prepaid — relates to next year (10 months)
R2 400 ÷ 12 × 10 = R2 000
Adjustment entry — 28 February 20.1
Prepaid expenses2 000
Insurance2 000
Adjustment of insurance account — 10 months prepaid
SFP: Current assets — Prepayments R2 000
To reduce an expense account, credit it. The prepaid amount (future asset) is debited to Prepaid expenses. Insurance expense in the income statement = R400 only.
5. Accrued expenses
An expense that relates to the current period but has not yet been paid by year-end. The unpaid portion is a liability (Accrued expenses) — the entity owes this amount.
2
Accrued expenses
Short-term
At 28 February 20.1, Xa-Xa Dealers’ water and electricity account shows R2 880 recorded. However, February’s bill of R360 has not yet been received or paid.
Actual expense this year (full year)
R2 880 + R360 = R3 240
Still owed — accrued liability
R360
Adjustment entry — 28 February 20.1
Water and electricity360
Accrued expenses360
Adjustment of water and electricity account — February bill outstanding
SFP: Current liabilities — Accrued expenses R360
To increase an expense account, debit it. The accrued amount (liability owed) is credited to Accrued expenses. Water and electricity expense in the income statement = R3 240.
6. Consumable inventory adjustments
Consumables (stationery, packaging, etc.) purchased during the year are initially debited to the expense account. At year-end, any unused stock still on hand is not an expense — it is a current asset.
3
Consumable inventory
Short-term
Xa-Xa Dealers purchased R500 of stationery during the year. At year-end, a count reveals R150 of stationery is still on hand.
Actual stationery expense (used)
R500 − R150 = R350
Still on hand — asset
R150
Adjustment entry — 28 February 20.1
Inventory: Stationery150
Stationery150
Adjustment of stationery account — stationery on hand at year-end
SFP: Current assets — Inventories: Stationery R150
7. Income received in advance
Income received during the current period that relates to a future period. The entity owes that future service — so the advance portion is a liability.
4
Income received in advance
Short-term
Xa-Xa Dealers rents out part of their building at R800 per month. At 28 February 20.1 the rental income account shows R10 400. On investigation, the March rent has already been received.
Actual income this year (12 months)
R10 400 − R800 = R9 600
Received in advance — liability
R800 (March not yet earned)
Adjustment entry — 28 February 20.1
Rental income800
Income received in advance800
Adjustment of rental income — March rent received in advance
SFP: Current liabilities — Income received in advance R800
To reduce an income account, debit it. The advance (owed to the tenant) is credited to Income received in advance. Rental income in the income statement = R9 600.
8. Accrued income
Income that has been earned during the current period but has not yet been received. The uncollected amount is a current asset.
5
Accrued income
Short-term
At 28 February 20.1, Xa-Xa Dealers’ commission income account shows R2 200. An additional R200 commission has been earned but not yet received.
Actual income earned this year
R2 200 + R200 = R2 400
Still to be received — asset
R200
Adjustment entry — 28 February 20.1
Accrued income200
Commission income200
Adjustment of commission income — R200 earned but not yet received
SFP: Current assets — Trade and other receivables: Accrued income R200
To increase an income account, credit it. The amount still to be received (asset) is debited to Accrued income. Commission income in the income statement = R2 400.
9. Credit losses (bad debts)
When a debtor is unable to pay and their account is declared irrecoverable, the amount must be written off. It becomes an expense (Credit losses) and the asset (Debtors) is reduced.
6
Credit losses (bad debts)
Short-term
On 25 January 20.1, Xa-Xa Dealers learn that debtor A Boeka is insolvent and still owes R230. The account is irrecoverable.
General journal entry — 25 January 20.1
Credit losses (Bad debts)230
A Boeka / Debtors control230
A Boeka’s balance written off as irrecoverable
Two postings required: The Cr entry must be posted to both the Debtors control account in the general ledger AND to A Boeka’s individual account in the debtors ledger. Both must be reduced.
10. Long-term adjustments: Depreciation
Non-current assets (property, plant and equipment) lose value as they are used. This decline is called depreciation and is charged as an expense each year over the asset’s useful life. Instead of reducing the asset account directly, depreciation is credited to a special asset contra account — the Accumulated depreciation account.
Why an asset contra account? Using a separate Accumulated depreciation account allows the SFP to show both the original cost AND the total depreciation separately, so users can see how much the asset has worn down. The net figure (Cost − Accumulated depreciation) is called the carrying amount.
7
Depreciation
Long-term
Xa-Xa Dealers bought machinery for R80 000 during the year. At 28 February 20.1, depreciation of R12 000 must be provided for.
Adjustment entry — 28 February 20.1
Depreciation12 000
Accumulated depreciation: Machinery12 000
Depreciation on machinery for the year
SFP: Non-current assets — Property, plant and equipment
The asset is presented in the SFP notes as follows:
Property, plant and equipment
Machinery (R)
Cost
80 000
Accumulated depreciation
(12 000)
Carrying amount (net book value)
68 000
Carrying amount = Cost − Accumulated depreciation. This is the amount shown on the face of the SFP. The full breakdown (cost and accumulated depreciation) appears in the notes. Depreciation is an expense in the income statement.
11. The three trial balances
At year-end, up to three different trial balances are prepared at different stages of the closing process:
1
Pre-adjustment trial balance
Prepared after posting all journal entries for the period, but before any year-end adjustments. Tests whether double-entry has been applied correctly.
2
Post-adjustment trial balance
Prepared after all year-end adjustments have been journalised and posted. This is used to prepare the financial statements.
3
Post-closing trial balance
Prepared after all nominal (income and expense) accounts have been closed to the profit or loss account and transferred to capital. Only real accounts (assets, liabilities, equity) remain — these become the opening balances for next year.
Quick guide — what appears where:
Adjustments create accounts like Prepaid expenses, Accrued expenses, Income received in advance, Accrued income, Accumulated depreciation. Here is where each ends up:
▸ Prepaid expenses → SFP: Current assets (Prepayments)
▸ Accrued expenses → SFP: Current liabilities (Trade and other payables)
▸ Consumable inventory on hand → SFP: Current assets (Inventories)
▸ Income received in advance → SFP: Current liabilities
▸ Accrued income → SFP: Current assets (Trade and other receivables)
▸ Accumulated depreciation → SFP: Deducted from the cost of the asset (non-current assets note)
12. Worked exercises
Year-end adjustment questions in the FAC1502 exam style.
Identify the correct adjustment
Scenario 1 of 6
13. Quick quiz
Twelve questions on adjustments. No notes — identify the gaps first.