Year-end & Adjustments
Now that all four quarters have been processed, the book-keeper now has to close the year and 'balance forward'.
Before this can be done, as was noted earlier, some adjustments need to be made to give a 'true and fair view' of the year.
Adjustments
In the simulations provided are two schedules of adjustments; one shows the calculations and workings to arrive at the adjustment values, the other shows the journals that need to be entered. Follow through the workings to understand them, and then enter the journals as shown.
Although many book-keepers like to do their own adjustments, just as many leave these tasks to the accountant at the end of the year, especially depreciation.
Adjustments should not just be limited to the year-end but used to correct whenever reports are created that would otherwise be distorted.
The £172 cost of the insurance is mostly prepaid. The year-long policy starts 1 March which means one twelfth of the cost is in the current year and the other eleven twelfths in the next year. To be 'true and fair' therefore, this portion needs to be 'deferred'.
Accruals
The last mobile phone bill doesn't go up to the end of the month and therefore this unbilled portion needs to be accrued. Using the last month as a guide (accruals are often an estimate) a calculation is made of how much should be accrued.
Alex is also advised that the book-keeper will charge £100 for his work and he should accrue an additional £100 for accountancy work. These two pieces of information are listed on the schedule.
Enter the three journals from the schedule.
Depreciation
Follow through the calculations on the schedule and enter the journal.
Taxation
There is no need to make any adjustments for taxation because Alex is a sole trader. However, personally he will be liable to pay:
- Income tax on the profit the business makes (regardless of whether he has withdrawn the profit as drawings). The amount he pays will depend on his allowances and any other income he may receive outside the business.Basic Rate Income Tax is 20%; higher rate 40% (over £35,000pa) and 50% (over £150,000)
- Class 2 National Insurance (a flat rate of £2.50 per week if earning over £5,315 per annum);
- Class 4 National Insurance at 9% if his profit goes over £7,225, up to £42475, and then 2% thereafter.
Income tax and Class 4 National Insurance will be declared on a Self Assessment form.
Payment of all these taxes is from him personally rather than business. Were he to pay income tax or national insurance using his business funds, these would have to be booked to Drawings.
Reporting
Now the adjustments have been entered the key Profit & Loss and Balance sheet reports can be run again. These show the true position at the end of the year.
Closedown
The total profit, shown at the foot of the Profit & Loss report can also be seen in the Capital & Reserves section of the Balance Sheet. As with all Balance sheet balances, this will be carried forward to the new year.
However, the Profit and Loss accounts will all be returned to zero for the beginning of the new year. A journal is entered in which every income and expenditure account has a value entered that brings it to zero, so for example if the balance on the stationery account is£49.59 debit, then a credit of £49.59 will be entered on this account. The overall journal will end up with a balance which is equal to the profit (or loss) for the year, and this will be entered into the 'Retained Profit' account on the Balance Sheet.
Different software handles this process in different ways; some will generate an auto-journal, but only when told to do so; others calculate the adjustment with reference to the date range and automatically include it.