Limited companies have a statutory obligation to file annual reports of their financial performance at their year-end to HMRC and Companies House. A company’s financial year-end is dependent upon the date they incorporated – usually the last day of the month of the day they registered as a company with Companies House – but can be changed or extended if more time is needed to complete reporting (you can shorten your financial year-end date as many times as you want, but you can only extend by a maximum of 18 months and only once every 5 years). The reports that need to be submitted include the Statement of Financial Position (also known as the balance sheet which provides a snapshot summary), an Income Statement (which is the profit and loss report that shows earnings and expenses for the financial year), a director’s report (not usually required for micro-entities), and footnotes which contain additional information that may be necessary to explain the reports.
What are year-end adjustments?
Year-end adjustments are changes that need to be made to the balance sheet and profit and loss statement in order to ensure that the year-end reports are an accurate reflection of the company’s accounts. By completing year-end adjustments, a company can conclude the overall financial position of the business for their financial year, which is sometimes referred to as being able to “close the books”.
Adjustments are necessary as financial reporting throughout the year will be made on an accruals basis. The accruals basis is a method of accounting whereby transactions of revenue are recorded as they are earned, as are expenses when they have been incurred, irrespective of whether money, goods or services have been exchanged. For example, this would mean that revenue would be accounted for as soon as a customer was sent an invoice, rather than when payment has been received. The same can be applied to expenses where a company may receive an invoice for stock ordered but have yet to make payment, however a deduction would still be recorded in the reports.
The accruals basis also allows for a reserve to be considered for eventualities such as customer returns, bad debts or inventory obsolescence (a significant reduction in demand or use for an asset due to competitor alternatives in the marketplace or a change in consumer behaviour). As the total value of these possibilities is unknown until the year-end, adjustments are necessary to confirm the amount.
The need for adjustments may make using the accruals basis seem inconvenient, however it is considered to be accounting best practice. It is particularly useful as it allows for revenue to be matched up to expenses, can show current cashflow alongside future expected cashflow, and thereby provides a more comprehensive summary of business performance. The disadvantage to using the accruals basis is that, because revenue is recorded in advance of payment, it can mean that a company is due to pay more corporation tax at the end of the year before they receive the payment (and therefore profit) from customers. Hence, it is crucial for a company to allocate sufficient time to tie up loose ends, outstanding debts, and make year-end adjustments to the financial reports.
What are the different types of year-end adjustments I need to make?
There are 5 different types of adjustments which are commonly made to the financial reports:
- Accrued income: Revenue that has been earned, but payment has not yet been received. Companies should ensure that all outstanding invoices are issued before year-end, as well as chase up on overdue payments.
- Accrued expenses: Expenses have been incurred but payment has not yet been made for them. This occurs in various ways such as receipt of an invoice which has yet to be paid for, employees’ wages which are due to be paid at the end of the month or ongoing regular payments such as rent.
- Deferred income: Money which has been paid to the company in advance of goods being delivered or services being provided. This may be more common in certain industries than others, such as in the events industry where people may put a deposit down on venue hire.
- Deferred expenses: Money which has already been paid for a future expense. The goods or service will not be received until a date in the future. An example of this is paying for an exhibition stand at a conference later in the year.
- Depreciation: Depreciation generally applies to larger assets which you may have purchased through one single transaction such as equipment, machinery or vehicles. However, an allocation of a declining level of cost over future financial accounting periods is needed to take into consideration the decreasing value of those assets. Depreciation can be complicated to calculate but it is important to record it as the continual wear and tear of those assets are a legitimate expense and they will need to be replaced at the end of their productivity cycle. By making adjustments to include depreciation it is possible for shareholders, directors and potential new investors to see the real cost of carrying out the business and provide a more accurate valuation of the business.
What accounts do not need to be adjusted for year-end?
Cash accounts should never need to be adjusted because electronic banking will automatically record every transaction immediately. Due to cash being such a liquid asset, it is expected that it will be constantly moving in and out of accounts. It’s also therefore highly unlikely that there would ever be a reason or need to know the exact amount of cash in an account for a given fixed period.
The value of land owned by company does not need to be adjusted at each year-end. Unlike other assets, depreciation is not applied to land despite any fluctuation in market value. Only the original purchase price and costs associated with the acquisition of the land will be recorded, as well as purchase price if the land is sold. The difference in value will be recorded as a gain or loss on the profit and loss statement.
The equity account is one which records the amount of cash owners have invested into the company. It will include cash received from investors in exchange for shares in the company. The only transactions made through this type of account should be the amount of net profit made for a period and this is not considered as an adjustment.
What is the purpose of making year-end adjustments?
Completing year-end adjustments is a necessary procedure to ensuring accurate financial reports are produced for various reasons. Firstly, because it is a legal obligation to do so for all limited companies as explained above. Reports must be submitted to both HMRC and Companies House annually. Secondly, by doing so can help prevent a company from paying too much corporation tax (or too little). An accountant may be able to provide valuable advice on bringing payments forward or deferring them into the next accounting period in order to more efficiently distribute your tax bill. Finally, year-end adjustments are important for shareholders and directors as it will help them understand how business has performed. Maintaining accurate financial reports is key to being able to see areas of weakness which may need addressing for the next financial period, as well as opportunities which can be maximised upon for growth.
How to prepare for year-end adjustments:
In order to prepare for year-end adjustments, it is advised that you tie up as many loose ends as possible. Here are a few areas that you may want to stay on top of:
- Expenses: Every single legitimate business expense (those which are “wholly and exclusively” for the purpose of the business) will help cut your tax bill so make sure you get employees to hand in their expenses form in time to ensure it can be accounted for the particular financial period. If you’ve had a particularly profitable year, you may even want to consider areas you can invest in before your year-end.
- Invoices: Make sure you plan enough time to chase up on overdue invoices. You may be tempted to let payments fall into the next period to pay less corporation tax for the period just gone, however you need to be wary when doing this. As a consequence, your financial reports may show that the business is less profitable than it actually is which can be detrimental if you are looking to raise funding either through bank loans or investors.
- Paperwork: Staying organised on your paperwork throughout the year will save you a lot of time when it comes to year-end. You will need to collect all your receipts and bank statements as evidence for your financial reports should HMRC ever decide to investigate your tax affairs. It is also a legal responsibility for limited company directors to keep company records for at least six years from the end of the company accounting period that they relate to.
- Deadlines: Be aware of your tax deadline. As explained above, your year end is usually the last day of the month from the date you first incorporated your company with Companies House. You have 12 months from this date to submit your corporation tax return, otherwise you’ll receive an automatic penalty. However, it’s important to remember that you have a second deadline in which to pay for your corporation tax and that is only 9 months and a day after your accounting period. Missing this payment will result in interest being added on.
Accurate bookkeeping can take time, but also save you time when it comes to year-end preparations. For ongoing support throughout the year to ensure your accounts are in order you can find more information on our Bookkeeping service page.