Adjustments in Preparation of Financial Statements
[Link] stock – The adjustments regarding closing stock are: Closing Stock a/c D
a. It is credited to trading account. To Trading r
b. It is shown as an asset in the balance sheet. a/c
Adjusted Purchase and Closing Stock – Sometimes the closing stock may be
included in the Trial Balance itself. That means the opening and closing stock have
been adjusted in the purchases. Here the opening stock will not appear in the Trial
balance. The trial balance will show only the figures of adjusted purchases and closing
stock.
Adjusted Purchases = Purchases + Opening Stock – Closing stock
Hence, only the adjusted purchases are shown on the debit side of the trading
account and closing stock will appear only on the asset side of the balance sheet.
2. Outstanding expenses – Expenses which have been incurred and are due for
payment, but have not yet been paid during the accounting period is called
outstanding expenses. (Due but not paid)
Adjustment entry regarding this item is as follows:
Concerned expenses a/c (Salary a/c) Dr
To Outstanding expenses a/c (O/s salary a/c)
The effect of the above adjustment will be:
a. Outstanding expenses will be debited to trading and profit and loss a/c by way
of addition to the concerned expense.
b. Outstanding expenses will be shown on the liability side of the Balance Sheet.
3. Prepaid expenses / Unexpired expenses – Those expenses which have been
paid in advance, whose benefit will be available in the future are called unexpired or
prepaid expenses. (Paid but not due). E.g., Prepaid insurance, Prepaid rent etc.
Adjustment entry: Prepaid expense a/c Dr
To Concerned expense a/c
The effect of the above adjustment will be:
a. Deduct from the respective expense on the debit side
b. Shown on the Asset side of Balance sheet
4. Accrued Income or outstanding income – Income which have become due
during the accounting period but the same has not been received are called
accrued income. (Income due but not received). E.g., Accrued Interest on bank
deposit, Accrued commission etc.
Adjustment entry: Accured income A/c Dr
To Income A/C The
effect of the above adjustment will be :
a. Added to the respective Income on the credit side
b. Shown on the Asset side.
5. Income received in advance – A portion of the income received during the
current year may relate to the future period is called Unearned income or income
received in advance.(Received but not due). E.g., Rent received in advance,
commission received in advance.
Adjustment entry: Income A/c Dr
To Income Received in Advance A/C The
effect of the above adjustment will be :
a. Deducted from the concerned income on credit side
b. Shown on the liability side
[Link] – Depreciation is the decrease in the value of an asset due to wear and
tear, passage of time etc. This is an operating expense to the business. And to arrive at
the correct profit or loss made by the business, it should be charged (debited) to profit
and loss a/c.
Adjustment entry: Depreciation A/c Dr
To Asset A/c The
effect of the above adjustment will be
c. Shown on the Debit side of Profit and Loss a/c
d. Deducted from the value of Asset in the balance sheet.
[Link] debts – Any irrecoverable portion of sundry debtors is termed as bad debts.
If bad debt is given outside the trial balance (given as adjustment), it is termed as
further bad debt. It may so happen that a debt becomes bad after the preparation of
Trial Balance.
Adjustment entry: Bad Debt a/c Dr
Debtors
The effect of the above adjustment will be
e. Shown on the debit side of Profit and Loss a/c
f. Deducted from Debtors in the Balance Sheet.
Bad debts recovered
Amount already written off as bad debts is recovered fully or partially. The entries will
be
(i) Cash or Bank A/c Dr
To Bad Debts Recovered A/c
(ii) Bad Debts recovered a/c Dr
To Profit & Loss A/c
8. Provision for Doubtful Debts
The provision for doubtful debts is an estimated amount of bad debts that are likely to
arise from the accounts receivable that have been given but not yet collected from the
debtor.
The following journal entry is recorded in this context:
Profit and Loss A/c Dr.
To Provision for doubtful debts A/c
Provision for doubtful debts is also shown as a deduction from the debtors on the asset
side of the balance sheet. The provision created for doubtful debts at the end of a
particular year will be carried forward to the next year and it will be used for meeting the
loss due to bad debts incurred during the next year.
The entry passed will be:
Provision for doubtful debts A/c Dr
To Bad Debts A/c
9. Provision for Discount on Debtors
A business enterprise allows discount to its debtors to encourage prompt payments.
Discount likely to be allowed to customers in an accounting year can be estimated and
provided for by creating a provision for discount on debtors.
The following journal entry is recorded to create provision for discount on debtors:
Profit and loss A/c Dr.
To Provision for discount on debtors A/c
Shown in the Debit side of Profit and loss Account.
Deducted from Sundry Debtors in the assets side of the Balance Sheet.
10. Manager’s Commission
The manager of the business is sometimes given the commission on the net profit of the
company. The percentage of the commission is applied on the profit either before
charging such commission or after charging such [Link] the absence of any such
information, it is assumed that commission is allowed as a percentage of the net profit
before charging such commission.
The manager’s commission will be adjusted in the books of account by recording the
following entry:
Managers Commission A/c Dr
To Managers Commission Payable A/c
(Providing manager’s commission)
Profit and loss A/c Dr.
To Manager’s commission A/c
(Transferring managers commission to profit and Loss A/c
• Shown as an expense in the debit side of Profit and Loss a/c.
• Commission Payable as current liability in the Balance Sheet.
Alternative cases to calculate Manager’s Commission
CASE 1: If manager is allowed commission on profit before charging such
commission:
Commission= Profit before charging such commission X % of commission/100
CASE 2: If manager is allowed commission on profit after charging such
commission:
Commission =Profit before charging such commission X % of commission/100+ %
of commission
11. Interest on Capital
Sometimes, the proprietor may like to know the profit made by the business after
providing for interest on capital. In such a situation, interest is calculated at a given rate
of interest on capital as at the beginning of the
accounting year.
Such interest is treated as expense for the business and the following journal entry is
recorded in the books of account:
Interest on capital A/c Dr
To Capital A/c
(Adjusting entry for interest on capital)
Profit and Loss a/c Dr
To Interest on Capital a/c
(Closing entry for interest on capital)
12. Goods taken by the proprietor for personal use
If the proprietor takes goods from the business for his personal use:
Drawing A/c Dr
To Purchases A/c
Shown in the debit side by way of deduction from Purchases.
Shown in the liabilities side by way of deduction from Capital.
13. Goods distributed among staff for staff welfare
Staff welfare expenses A/c Dr
To Purchases A/c
Shown in the credit side of trading A/c or deducted from the Purchases.
Shown in the debit side of the Profit and Loss A/c.
14. Goods distributed as samples
Advertisement or samples A/c Dr
To Purcahses A/c
Shown in the credit side of trading A/c or deducted from the Purchases.
Shown in the debit side of the Profit and Loss A/c as advertisement or
samples A/c.
15. Abnormal losses
Abnormal losses occur because of fire, accidents or earthquakes, which damage goods of
the [Link] of stock is transferred to the credit of Trading a/c or Deducted from
Purchase.
When goods are not insured
Profit and Loss A/c. Dr
To Loss of Stock A/c or Loss of Stock by fire A/c
When goods were fully or partially insured
(i) Loss of Stock A/c or Loss of Stock by fire A/c
To Purchase A/c
(ii) For insurance claim lodged
Insurance Claim or Insurance Co. a/c. Dr
To Loss of Stock A/c or Loss of Stock by fire A/c
(iii) Receipt of Insurance Claim
Bank. a/c. Dr
Profit and Loss a/c. Dr
To Insurance Claim or Insurance Co
It is to be noted that in all cases, Purchase Account is credited by the amount
of abnormal loss whether recoverable or not. Amount that is not recoverable
from insurance company is a loss and is transferred to the debit of Profit and
Loss Account. The amount of claim receivable from the insurance company
is shown in the Asset side of Balance Sheet.