Mastering Year-End Adjustment Entries: Prepaid Insurance and Accrued Interest#
The Importance of Accrual Accounting#
Under the accrual basis of accounting (which is mandatory for companies under the Companies Act), income and expenses must be recorded in the period they occur, regardless of when the cash actually changes hands.
If you just run a Trial Balance on March 31st without passing adjustment entries, your Profit & Loss statement will be fundamentally wrong. Here are the two most common adjustments.
1. Prepaid Expenses (e.g., Insurance)#
The Scenario: On October 1, 2025, your company pays an annual business insurance premium of ₹120,000. During the year, the accountant booked the entire amount to "Insurance Expense." If left unadjusted, the P&L for FY 25-26 will bear the burden of the full 12 months, drastically reducing your profit. However, by March 31, 2026, only 6 months of the insurance policy have actually been "used up" (Oct to March).
The Adjustment Calculation:
- Total Premium: ₹120,000 for 12 months.
- Unused portion (Prepaid): 6 months (April to Sept 2026) = ₹60,000.
The Year-End Journal Entry (March 31):
- Debit: Prepaid Insurance (Current Asset) - ₹60,000
- Credit: Insurance Expense - ₹60,000 (This reduces your expense for the current year, increasing your net profit to its correct value).
2. Accrued Income (e.g., Interest on FD)#
The Scenario: Your company has a Fixed Deposit of ₹10,00,000 earning 7% interest annually. The FD matures in June 2026, which is when the bank will actually credit the interest to your account. However, by March 31, 2026, the FD has been sitting in the bank for 9 months (July to March), earning interest "on paper." You must recognize this income in FY 25-26, even though you haven't received the cash yet.
The Adjustment Calculation:
- Total Annual Interest: ₹70,000.
- Interest earned for 9 months: ₹70,000 * (9/12) = ₹52,500.
The Year-End Journal Entry (March 31):
- Debit: Accrued Interest on FD (Current Asset) - ₹52,500
- Credit: Interest Income (Indirect Income) - ₹52,500 (This accurately inflates your income for the current year).
Mastering these entries ensures your balance sheet reflects a true and fair view of the company's financial health.