Accruals and deferrals: year-end adjustments

At the end of the financial year, the accounts rarely coincide with economic reality. Rent paid in January for a quarter straddling the year-end, an insurance premium settled in advance, interest earned but not yet collected: these are costs and revenues that belong to one period but are paid or recorded in another. Accruals and deferrals exist precisely to put every value back in the year to which it belongs. They are the substance of closing adjustments.

The principle: accrual, not cash

The Code of Obligations requires the income statement to reflect the costs and revenues belonging to the financial year, regardless of when payment takes place. This is the principle of time apportionment: what has accrued in the year weighs on the year, even if the money moves before or after.

There are four figures to distinguish, by crossing two questions: is the value a cost or a revenue? Has the cash movement already occurred, or is it still to occur?

The four figures

Accrued liability (cost accrued, not yet paid): a cost belonging to the year that will be settled the following year. Example: interest on a loan accrued in December but charged in January. A liability and a cost are recorded in the current year.
Accrued asset (revenue accrued, not yet collected): a revenue belonging to the year that will be collected later. Example: interest income accrued but not yet credited. A receivable and a revenue are recorded.
Prepaid expense (cost paid in advance): a cost already paid that partly belongs to the following year. Example: an annual insurance premium paid in October. The portion relating to the new year is deferred, reducing the current year’s cost.
Deferred income (revenue collected in advance): a revenue already collected that partly belongs to the following year. Example: a fee or subscription collected in advance. The portion belonging to the future is deferred, reducing the current year’s revenue.

The mnemonic rule: accruals concern values earned but not yet settled (payment comes later); deferrals concern values already settled but belonging to a future period (payment has already occurred).

A numerical example

The company pays an insurance premium of CHF 12,000 for twelve months on 1 October. At 31 December, three months have elapsed: CHF 3,000 belongs to the current year, CHF 9,000 to the following year.

A prepaid expense of CHF 9,000 is recorded.
The current year’s insurance cost remains at CHF 3,000.
At the opening of the new year, the prepaid expense is reversed and the CHF 9,000 returns to cost in the period to which it belongs.

The same reasoning, reversed, applies to a revenue collected in advance.

Where they most often arise

Typical closing adjustments concern:

rent and leasing straddling the year-end;
insurance premiums and fees paid in advance;
interest income and expense accrued;
utilities, maintenance and supplies received but not yet invoiced;
the 13th salary and staff components accrued in the year;
subscriptions and recurring revenues collected in advance.

Common mistakes

Recording everything on a cash basis and ignoring the accrual principle, distorting the result for the year.
Confusing accruals and deferrals: the direction of the payment (before or after) is the key.
Forgetting to reverse the adjustments at the opening of the following year, leading to double counting.
Not documenting the pro-rata calculation, making verification difficult.

In summary

Accruals and deferrals allocate costs and revenues to the period to which they belong.
Accruals: values earned, payment later. Deferrals: payment already made, future period.
Every adjustment must be reversed at the opening of the new year.
It is how the financial statements respect the accrual principle of the Code of Obligations.

How we help you

We handle year-end closings by calculating accruals and deferrals precisely, so that the financial statements reflect the real economic period and hold up to scrutiny. Let’s sort out your closing.