Accounting adjustment

The accounting adjustment is a regularization that the company has to make, usually at the end of the fiscal year, to correctly allocate income, expenses, assets and liabilities to their corresponding fiscal years.

These adjustments are necessary to obtain the accounting result correctly, affecting assets and liabilities. Likewise, they also modify income and expenses, and the profit or loss for the year may vary.

During the year, the company records numerous income and expense transactions. But sometimes at the closing date of the fiscal year (which is usually December 31), there may be income and expenses recorded that belong to other fiscal years; or income and expenses that are unaccounted for and pertain to the current fiscal year. Then, to correctly obtain the accounting result, based on the accrual criterion, accounting adjustments are made.

It is important to distinguish accounting adjustments from off-the-books adjustments, which are those that are made outside of accounting to adjust the expenses and income of a company to tax expenses and income.

Types of accounting adjustments

There is no closed list of accounting adjustments, but the most common are the following:

1. Fixed asset amortization adjustment.

The fixed assets of a company can lose value due to use, the passage of time or exceptional circumstances. When they lose value due to use and the passage of time, amortization adjustments are made. Thus, by applying a depreciation coefficient to the valuation of fixed assets, the depreciation fee is obtained, which is accounted for as an expense and, therefore, the accounting result decreases. This adjustment is made on the year-end date or at the time of sale of an asset.

2. Adjustment for impairments.

Sometimes a company's assets lose value due to exceptional circumstances. Impairments affect all company assets, not just fixed assets. For example, when a client owes us an amount of money and enters bankruptcy, that client's credit loses value. Or when we have some goods in the warehouse and there is a flood, those goods lose value. When these circumstances occur, an impairment adjustment must be made. This impairment is recorded as an expense and, therefore, reduces the accounting result. It can be carried out on the closing date of the fiscal year or at the moment in which the impairment is detected.

3. Stock regularization.

As of December 31, the final inventory that is in the warehouse is assessed. The difference with respect to the initial stock of the warehouse as of January 1 is calculated (the so-called inventory variation entry). If inventories increase it is recorded as income, while if they decrease it is recorded as expense.

4. Accrual of expenses and income: anticipated expenses and income.

This adjustment allows us to allocate income and expenses to the corresponding year. They are income and expenses that we have recorded in the current year, but that really belong to future years. Hence the name "anticipated income or expenses." Here is an example of anticipated expenses:

Let's imagine that on December 1 of year X we take out insurance for 100 monetary units (CU) for 4 months. As of December 31, we realize that we have recorded an insurance expense of CU100, but year X should only be charged 1 month out of the 4 of the duration of the insurance. In other words, year X should be charged 25 CU (1/4 of 100) and year X + 1 should be allocated 75 CU (3/4 of 100). Therefore, at December 31, an advance expense adjustment would be made to only allocate CU25 and not the CU100 that was recorded on December 1.

The accrual will always be carried out on the closing date of the fiscal year (December 31).

5. Adjustments for revaluation of assets and liabilities

Sometimes there is a legal obligation to account for the revaluation of assets and liabilities. If so, an adjustment must be made for the revaluation of assets or liabilities at the year-end date. This adjustment is only made if the legislator has so established it. Here is an example of asset revaluation:

As of June 1, we have acquired 100 shares of a listed company for CU10 / share. The General Accounting Plan establishes that at December 31, a revaluation of the shares must be carried out at their listed value. As of December 31, these shares are trading at CU15 / share. So we have to make an appreciation adjustment of CU500 (100 shares x (CU15 -10 CU)). These CU500 are income.

6. Reclassification from long to short term

Finally, there are debts and collection rights that as of December 31 are recorded in the long term, but when they move to the following year they are short term and should be recorded in this way. When this happens we must reclassify from long to short term. With an example it will be better understood:

On April 1 of year X we contract a debt that we have to repay in 15 months, that is, on July 1 of year X + 1. As of April 1 of year X, we recorded it as long-term debt (because it is more than 12 months old). However, when December 31 of year X arrives, there are only 6 months left until we have to repay that debt. Therefore, we will have to reclassify that debt to the short term (because it is less than 12 months).