An accounting adjustment is a regularization that the company has to do, usually at the end of the year, to correctly allocate income, expenses, assets and liabilities to their corresponding fiscal years.
They are necessary accounting corrections to obtain the accounting result correctly. Although the accounting adjustments affect both assets and liabilities and income and expenses, the most important are those that affect the latter, since they will modify the accounting result.
During the year, the company accounts for numerous income and expense operations. But sometimes, at the end of the fiscal year (which is usually December 31) there may be income and expenses accounted for, which belong to other years; or income and expenses that are not accounted for and belong to the current year. To obtain the accounting result correctly, depending on the accrual criteria, the accounting adjustments are made.
It is important to distinguish the accounting adjustments from the extra- accounting adjustments, which are those that are made outside of accounting to adjust the expenses and income of a company to the expenses and tax revenues.
Types of accounting adjustments
There is no closed list of accounting adjustments, but the most common are the following:
- Adjustment for depreciation of fixed assets.The fixed assets of a company can lose value by use, by the passage of time or by exceptional circumstances. When they lose value for use and for the passage of time (which will be in any case) adjustments are made by amortization. Applying a depreciation coefficient to the valuation of fixed assets, the depreciation fee is obtained, which is accounted for as an expense and, therefore, reduces the accounting result. This adjustment is made at the end of the fiscal year or at the time of sale of a fixed asset.
- Impairment adjustment.Sometimes, the assets of a company lose value due to exceptional circumstances. The impairments affect all the assets of the company, not only the fixed assets. For example, when a customer owes us an amount of money and enters bankruptcy proceedings, that client’s credit loses value. Or when we have some goods in the warehouse and a flood occurs, those goods lose value. When these circumstances occur, an impairment adjustment must be made. This impairment is accounted for as an expense and, therefore, reduces the accounting result. It can be done at the end of the fiscal year or at the moment when the deterioration is detected.
- Stock regularization.At December 31, the valuation of the final stocks that are in the warehouse is made. The difference is calculated with respect to the initial stocks of the warehouse as of January 1 (the so-called inventory change entry). If stocks increase, they are accounted for as income, while if they decrease, they are accounted for as an expense.
- Periodification of expenses and income: expenses and anticipated income.This adjustment allows us to allocate income and expenses to the corresponding fiscal year. These are income and expenses that we have accounted for in the current year, but that really belong to future years. Hence the denomination of “anticipated expenses or income”. Below is an example of anticipated expenses:Example anticipated expenses. Imagine that on December 1 of year X we hired an insurance of 100 monetary units for 4 months. As of December 31, we realize that we have accounted for an insurance expense of 100 monetary units, but in year X, only 1 month of the 4 duration of insurance should be charged. That is, the year X should be charged 25 um (1/4 of 100) and the year X + 1 should be charged 75 um (3/4 of 100). Therefore, at December 31, an adjustment would be made for anticipated expenses to allocate only CU25 and not CU100 that were accounted for on December 1.
The accrual will always be done on the closing date of the fiscal year (December 31).
- Adjustments for revaluation of assets and liabilitiesOccasionally, there is a legal obligation to account for the revaluation of assets and liabilities. If so, an adjustment must be made for revaluation of assets or liabilities at the end of the fiscal year. This adjustment is only made if the legislator has established it. Below is an example of asset revaluation:Example asset revaluation. As of June 1, we have acquired 100 shares of a company listed for 10 CU / share. The General Accounting Plan establishes that as of December 31, a revaluation of the shares must be carried out at their contribution value. As of December 31, these shares are trading at CU15 / share. Then we have to make a revaluation adjustment of CU500 (100 shares x (CU15 – CU10)). These 500 um are an income.
- Long-term reclassificationFinally, there are debts and collection rights that as of December 31 are accounted for in the long term but after the following year they are short term and thus should be accounted for. When this occurs, we must reclassify the long to the short term. With an example it will be better understood:Reclassification of a long-term and short-term debt. On April 1 of year X we incur a debt that we have to pay back in 15 months, that is, on July 1 of year X + 1. As of April 1 of year X, we count it as long-term debt (because it is more than 12 months). However, when December 31 of year X arrives, there are only 6 months left before we have to repay that debt. Therefore, we will have to reclassify that debt in the short term (because it is less than 12 months).