End of Year Adjustments (Forms 2–4)

Arts 1–4

Foreign Languages 1–4

Adjustments for accruals, prepayments, depreciation, provisions for doubtful debts, and closing entries.

📘 Topic Summary

End of Year Adjustments (Forms 2–4) is a crucial concept in Principles of Accounting that requires a thorough understanding of accruals, prepayments, depreciation, provisions for doubtful debts, and closing entries to accurately record financial transactions.

📖 Glossary

Accrual: The process of recording revenues or expenses when they are earned or incurred, regardless of when the cash is received or paid.
Prepayment: A payment made in advance for goods or services that have not yet been received.
Depreciation: The process of allocating the cost of a tangible asset over its useful life, resulting in a decrease in value.
Provision for doubtful debts: A provision made to account for potential bad debts that may arise from outstanding receivables.

⭐ Key Points

Adjustments are necessary to accurately reflect the financial position of a business at the end of an accounting period.
Accruals and prepayments require adjustments to match revenues and expenses with the correct periods.
Depreciation is essential for matching the cost of assets with their economic benefits over time.
Provisions for doubtful debts help to account for potential losses from bad debts.
Closing entries are necessary to reset the accounting equation at the end of an accounting period.

🔍 Subtopics

Accruals

An accrual is an expense or revenue that has been incurred but not yet paid or received. For example, if a company provides services to customers in December, it may have earned revenue for those services even though the customer has not yet paid. The company would record this revenue as an accrual at the end of the year. Similarly, if a company pays its employees' salaries in advance, it would record the salary expense as an accrual. Accruals are used to match the expenses and revenues with the period in which they were incurred.

Prepayments

A prepayment is a payment made in advance of receiving goods or services. For example, if a company pays its insurance premium for the next year in December, it would record this as a prepayment. Prepayments are initially recorded as an asset on the balance sheet and then gradually expensed over the period to which they relate.

Depreciation

Depreciation is the process of allocating the cost of a tangible asset over its useful life. This is done to match the expense with the revenue generated by the asset. For example, if a company purchases a machine for $10,000 that has a useful life of 5 years, it would record depreciation expense of $2,000 per year (=$10,000 / 5). The total depreciation expense over the 5-year period would be equal to the original cost of the asset.

Provisions for doubtful debts

A provision for doubtful debts is an estimate of the amount of debt that may not be collectible. This is done to match the loss with the revenue generated by the sale of the goods or services. For example, if a company sells goods worth $100,000 but estimates that 5% of these sales will not be collectible, it would record a provision for doubtful debts of $5,000 (=$100,000 x 0.05). This provision is then gradually written off over the period to which it relates.

Closing entries

Closing entries are journal entries that transfer the net income or net loss from the income statement to the retained earnings account on the balance sheet. They also zero out all temporary accounts, such as revenue and expense accounts, in preparation for the next accounting period. For example, if a company has a net income of $10,000, it would record a closing entry debiting retained earnings by $10,000 and crediting the net income account by $10,000.

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