FINAL ACCOUNTS ADJUSTMENTS

ACCRUALS AND PREPAYMENTS

Revenue and Expenses /costs must be recognized as they are earned or incurred, not as money
is received or paid. They must be matched with one another so far as their relationship can be
established or justifiably assumed, and dealt with in the profit and loss account of the period to
which they relate. Therefore all incomes and expenses that relate to a particular financial period
will be matched together to determine the profit for the year.
1. ACCRUALS
Income: Accrued Income
This is income that relates to the current year but cash has not yet been received. An accrued
income should be reported in the profit & loss account and the same income will be shown in
the balance sheet as a current asset.
Expenses: Accrued Expenses/outstanding expenses
An accrued expense is an expense that is payable or due for payment but has not yet been paid
during that period.
An accrued expense should be charged in the P&L account and shown in the balance sheet as a
current liability.

2. PREPAYMENTS
Prepaid Income/income in advance
This is income that is not yet due but cash has been received for it. This happens where an
income is payable in advance e.g. Rent payable 3 months in advance.
A prepaid income should not be reported in the current financial period but should be carried
forward and reported in the period it relates to.
The accounting treatment will be to show it as a current liability.
Prepaid Expenses/expenses in advance
A prepaid expense is an expense that is not/due payable but cash has already been paid. A
prepaid expense should not be charged in the P&L a/c but should be carried forward to the
next financial period and should be shown in the balance sheet as a current asset.
The accruals and expenses items may also be adjusted in the relevant income and expense
accounts so that the correct amount of expense or income is reported in the profit and loss
account for the year.
Example 1
The financial year of H Seamers ended on 31 December 2002. Show the ledger accounts for the
following items including the balance transferred to the necessary part of the final accounts,
also the balances carried down to 2003:

a) Motor expenses: Paid in 2002 £7,440; Owing at 31 December 2002 £280

 b) Insurance: Paid in 2002 £4200; Prepaid as at 31 December 2002 £350.
c) Stationery: Paid during 2002 £18,000; Owing as at 31 December 2001 £2500; Owing as
at 31 December 2002 £4900.
d) Rates: Paid during 2002 £9500; Prepaid as at 31 December 2001 £2,200; Prepaid as at
31December 2002 £2,900.

e) Seamers sub-lets part of the premises. Receives £5,500 during the year ended 31
December 2002. Tenant owed Seamers £1,800 on 31 December 2001 and £2,100 on 31
December 2002
Suggested sol

Motor Expenses Rates Expenses

Cash book 7440 P/L 7720 Bal b/d 2200 P/L 8800
Bal c/d 280 Cash book 9500 Bal c/d 2900
7720 7720 11700 11700

Insurance Expenses Rent Income

Cash book 4200 P/L 3850 Bal b/d 1800 Cash book 5500
Bal c/d 350 P/L 5800 Bal c/d 2100
4200 4200 7600 7600

Stationery Expense
Cash book 18000 Bal b/d 2500
Bal c/d 4900 P/L 20400
22900 22900

3. Accounting For Bad & Doubtful Debts.

Sale---------Cash

Credit (Debtors) ------------Pay

Not Paid-----------Never Pay---Bad debts w/o
Likelihood of pay----Doubtful debts

Bad debts
When a debt becomes bad the following entries will be made:
i. Debit bad debts account
Credit debtors account with the amount owing.
ii. Debit Profit and Loss Account.
Credit bad – debts account to transfer the balance on the bad – debts account to the Profit and Loss
Account.

Doubtful Debts
A provision for doubtful debts can either be for a specific or a general provision. A specific
provision is where a debtor is known and chances of recovering the debt are low.
The general provision is where a provision is made on the balance of the total debtors i.e.
Debtors less Bad debts and specific provision.
The accounting treatment of provision for doubtful debts depends on the year of trading and the
st st
entries will be as follows. If it is the 1 year of trading (1 year of making provision):

i. Debit P&L a/c.

ii. Credit provision for doubtful debts (with total amount of the provision).

In the subsequent periods, it will depend on whether if it is an increase or decrease required on

the provision.
If it is an increase:

i. Debit P&L a/c.

ii. Credit provision for doubtful debts (with increase only).

If it is a decrease:
i. Debit provision for doubtful debts.
ii. Credit P&L a/c (with the decrease in provision only).

Example

Debtors x
Bad debts (x)
X
Specific Provision (x)
X
General Provision (x)
X

A firm started trading in the year 1999, the balance on the debtor‟s account was £400,000. Bad
debts amounting to £40,000 were written off from this balance, there was a specific provision of
£5,000 to be made to one of the debtors and a general provision of £5% was to be made on the
balance of the debtors. The ledger accounts of 1999 were as follows:

Debtors Provision for doubtful debts

1999 £ 1999 £ 1999 £ 1999 £

Bal B/d 400,000 Bad debts 40,000 31/12 Bal c/d 22,750 31/12 P&L 22,750
Bal c/d 360,000

400,000 400,000

Bad debts
1999 £ 1999 £
Debtors 40,000 31/12 P&L 40,000
 £
Debtors 400,000
Bad debts (40,000)
360,000
Specific Provision (5,000)
355,000
General Provision (5%) (17,750)
337,250

Profit & Loss A/C (Extract) for the year ended 31/12/99

£ £
Expenses:
Bad debts 40,000
Increase in provision for D/debts 22,750

Balance Sheet (Extract) as at 31/12/99

£ £
Current Assets
Stocks x
Debtors 360,000
Provision for D/debts (22,750) 337,250
337,250 337,250

In the year 2,000, the debtors balance goes up to £500,000 from which bad debts of £50,000 needs
to be written off there is no specific provision but the general provision is to be maintained at 5%.
The ledger accounts will be as follows:

Debtors 500,000
Bad debts (50,000)
450,000
General Provision (5%) 22,500
427,500

Debtors
2000 £ 2000 £
Bal b\d 500,000 Bad Debts 50,000
Bal c\d 450,000
500,000 500,000

Provision for Doubtful Debts

2000 £ 2000 £
P\L 250 1\1 Bal b\d 22,750
Bal c\d 22,500
22,750 22,750

Bad Debts
2000 £ 2000 £
Debtors 50,000 31\12 P& L 50,000

Profit And Loss Account (Extract) for year ended 31/12/2002.

£ £
Incomes
Decrease in provision for D/debts 250

Expenses
Bad debts 50,000

Balance Sheet (Extract) as at 31/12/2002

£ £
Current Assets
Debtors 450,000
Provision for bad debts (22,500)
427,500

In the year 2001 the debtors balance goes up to £600,000 from which bad debts of £50,000 need to
be written off, there is no specific provision but the general provision is to be maintained at 5% the
ledger accounts is as shown:
£
Debtors 600,000
Bad debts (50,000)
550,000
General provision % (27,500)
522,500

Debtors
2001 £ 2001 £
Bal b\ Bad Debts 50,000
600,000
Bal c\d 550,000
600,000 600,000

Provision for Doubtful Debts

2001 £ 2001 £

1\1 Bal b\d 22,500

Bal c\d 27,500 P& L 5,000
22,500 27,500

Bad Debts
2001 £ 2001 £
Debtors 50,000 31\12 P& L 50,000

Profit And Loss Account (Extract) for the year ended 31/12/2001
£ £
Expenses
Bad debts 50,000
Increase in provision 5,000

Balance Sheet (Extract) as at 31/12/2001

£ £
Current Assets
Debtors 550,000
Less: Provision for Doubtful Debts (27,500) 522,500

Example 2
In a new business during the year ended 31 December 2002 the following debts are found to be
bad, and are written off on the dates shown:

30April H Gordon £1,100

31August D Bellamy Ltd £640
31October J Alderton £120

On 31 December 2002 the schedule of remaining debtors, amounting in total to £68,500, is

examined, and it is decided to make a provision for doubtful debts of £2,200.

You are required to show:

a. The Bad Debts Account, and the Provision for Doubtful Debts Account.
b. The charge to the Profit and Loss Account.
c. The relevant extracts from the Balance Sheet as at 31 December 2002.

Suggested Solution
 Bad debts ac Prov For Doubtful /D ac
Bad debts 1860 Debtors 2200
P/L 1860 P/L 2200
22900 2200

Debtors ac
Bal 68500 Prov foB/D 2200
Bal c/d 66300
68500 68500

Profit & Loss Account (Extract)

£ £
Expenses
Bad debts 1,860
Increase in provision for Doubtful debts 2,200

Balance Sheet (Extract)

£ £
Current Assets
Debtor 68,500
Less: Provision for D/Debts (2,200)
66,300
Example 4.2
A business started trading on 1 January 2001. During the two years ended 31 December 2001
and 2002 the following debts were written off to the Bad Debts Account on the dates stated:

31 August 2001 W Best £850

30 September 2001 S Avon £1,400
28 February 2002 L J Friend £1,800
31 August 2002 N Kelly £600
30 November 2002 A Oliver £2,500

On 31 December 2001 there had been a total of debtors remaining of £405,000. It was decided to
make a provision for doubtful debts of £5,500.
On 31 December 2002 there had been a total of debtors remaining of £473,000. It was decided to
make a provision for doubtful debts of £6,000.

You are required to show:

i. The Bad Debts Account and the Provision for Doubtful Debts Account for each of the
two years.
 ii. The relevant extracts from the Balance Sheet as at 31 December 2001 and 2002.

Solutions
Bad debts = 2,250
405,000
Provision (5,500)
399,500

Bad Debts
2001 £ 2001 £
31\8 W.Best 850
30\9 S.Aron 1400 31\12 P&L 2250
2250 2250

Provision for D/Debts

2001 £ 2001 £
31\12 Bal c\d 550 31\12 P&L 550

2001 £ 2001 £
1\1 Bal b\d 550
1\1 Bal c\d 600 31\12 P&L 50
600
600

Bad Debts
2001 £ 2001 £
28/2 J. Friend 1,800
31/8 N. Kelly 600
30/11 A. Oliver 2,500 31/13 P&L 4,900
4,900 4,900

Profit & Loss Account (Extract)

19x6 £ £

Expenses
Bad debts 2,250
Provision for Doubtful Debts 5,000

19x7
Bad debts 4,900
Increase in provision for D/Debts 500
Balance Sheet as at 19x6
£ £

Current Assets
Debtors 405,000
Less provision (5,500) 399,500

19x7
Debtors 473,000
Less: provision (6,000) 467,000

Provision for Bad Debts

Credit sales are recognised as income at the time of the sale without knowing the exact time of
collection. In the course of time, loss may result from unsuccessful attempts to protect the dues
from the customers. Every organisation creates a provision for this anticipated loss, from the
reported income of the credit sales in the current period.
There are different methods of creating provision for bad debts. However, we will discuss only
one method here. Accounting entry will depend upon the situation as to whether provision for
bad debts is or is not appearing in the Trial Balance.
Situation 1: When provision for Bad Debts not appearing in the Trial Balance:
The accounting entry will be:
Profit & Loss Account Dr.
To Provision for Bad Debts Account Cr
(To be shown in the Balance Sheet as a deduction for Debtors)
Situation 2: When provision for Bad Debts appearing in the Trial Balance:
At first, calculate the amount of provision to be created at the end of the period in the same way
as above. Now compare the provision with the provision appearing in the Trial Balance. There
are two resultant options:
a) If the new provision exceeds the provision appearing in the Trial Balance, pass the
following entry:
Profit & Loss Account Dr
To provision for Bad Debts Cr
b) If the new provision is less than the provision appearing in the Trial Balance, pass the
following entry:
Provision for Bad Debts Dr
To Profit & Loss Account Cr
Here, it should be noted that only new provision should be shown in the statement of
financial position as a deduction from Sundry Debtors.
4. Discount allowed on Debtors
Many business organizations offer to give a cash discount to all those debtors who arrange to
make their payment on or before the due date. It is clear that the real worth of debtors will be
the gross figure of debtors minus the cash discount that they would be given.
The figure of debtors should be accordingly adjusted.
The difficulty, however, is that nobody knows how many debtors will entertain cash discount
and what the amount will be. Therefore, all that is possible is to make a rough estimate.
Usually, it is made at a percentage of outstanding debtors who actually repay their obligation.
Therefore, the estimate amount of bad debt should be deducted from the total of debtors and
provision for discount on debtors should be made only on the balance.
Dr. Income statement Account
Cr To Provision for discount on Debtors Account
(To be shown in the statement of financial position by way of deduction from Sundry debtors)
Example:
 Total Sundry Debtors as per Trial Balance shs. 40,600
 Bad Debts after Trial Balance sh. 60
 Provision for debt to be created @ 5% on Sundry Debtors
 Provision for Discount on Sundry Debtors to be created @ 2%

Calculate the amount of Provision for Discount on Sundry Debtors.

Provision for discount on Sundry Debtors will be: 2/100 x shs. 38,000= shs.

Provision for discount on Sundry Debtors will be: 2/100 x shs. 38,000= shs. 760
5. Depreciation
According to Pickles, "Depreciation is the permanent and continuing diminution in the quality,
quantity or value of an asset". It is a measure of wearing out, consumption or other loss of
values of depreciable asset arising from use and passage of time. It is generally charged to such
assets as Plant & Machinery, Building, Furniture, Equipment, etc.
Initially, the cost of the assets including installation cost is debited to the particular assets. In
each accounting period, a portion of the cost expires and it needs adjustment for showing"
correct profit of the period and correct value of the assets.
Adjustment entries are:
(a) When assets account is maintained at written down value:
 (i) Depreciation Account Dr.
To Assets Account Cr.
(Being depreciation charged)
(ii) Income statement Account Dr.
To Depreciation Account Cr.
(Being depreciation transferred to profit & Loss Account)
(b) When assets account is maintained at cost price:
(i) Depreciation Account Dr.
To Provision for Depreciation Account Cr
(Being depreciation Charged)
(ii) Profit & Loss Account Dr.
To Depreciation Account Cr
(Being depreciation transferred to profit & Loss Account)
Total accumulated depreciation is shown in the statement of financial position on the liabilities
side.
Alternatively, it can be shown by way of deduction from the original cost of assets side.
Here, it should be noted that no adjustment is required for depreciation that already appears in
the Trial Balance. Depreciation that already appears in the Trial Balance should only be debited
to income statement Account.
6. Goods Distributed as Free samples:
This is one kind of advertisement. When goods are distributed to the prospective customers as
free samples, an expense is incurred (known as advertisement expense) and there is a usual
reduction from the stock of goods.
The following entry is passed:
Advertisement Account Dr.
To Purchase Account (For a trader) Cr
Or
To income statement Account (For a manufacturer)
At the year-end, transferring the entry to the income statement Account closes the
Advertisement Account:
Income statement Account Dr
To Advertisement Account Cr.
6. Income Tax
Income tax is not an expense to earn revenue. Therefore, when the profit is calculated, we
cannot deduct income tax from the profit and treat it as an expenditure of the business. For a
sole proprietor, income tax is payable by the owner and not by the business. Therefore, if
income tax appears in the Trial Balance, it should be treated as drawing and should be
deducted from the capital. Following are the entries to be passed:
(a) Income Tax Account Dr. (When Paid)
To Cash/ Bank Account Cr
(b) Drawing Account Dr.
To Income Tax Account Cr
However, for a registered partnership firm, income tax is payable by the business itself and not
by the owners. It generally appears as an appropriation of the net profits. The following entry is
passed:
Profit and Loss Appropriation Account Dr.
To Income Tax Account Cr
7. Drawing Made by the Proprietors
Drawing made by the proprietor(s) may be in cash or in kind. Drawing relates to the resources
of the business and the capital of the owner(s).
Drawings made in Cash: In this case, following entries are passed:
(a) Drawings Account Dr.
To Cash/Bank Account Cr
(b) Capital Account Dr.
To Drawings Account Cr
Drawings made in kind: When some of the stocks are withdrawn from the business, the
following entries are passed:
(a) Drawings Account Dr.
To Purchases Account Cr.
(b) Capital Account Dr.
To Drawings Account Cr.
If the drawings made by the owner are incorporated in sales, we are to pass a reverse entry to
cancel the original entry. For the drawings, the above two entries are to be passed:

Illustration 1
The following trial balance was extracted from the books of Dr. Masinde, a sole trader as at 31
August 2019
Additional information
1. Inventory as at 31 August was valued at sh. 3,690,000.
2. Allowance for bad debts is to be adjusted at 10% of debts.
3. Bad debts of sh. 370,000 had been posted to the ledger.
4. Goods which had cost sh. 300,000 had erroneously been invoiced to a customer for sh.
400,000 and had been accounted for as sales.
5. Electricity accrued as at 31 August 2019 was sh.130,000 and prepaid rates amounted to
sh.210,000
6. Stock of stationery as at 31 August 2019 was sh. 230,000.
7. Depreciation is to be provided on pro rata basis as follows.
i. Assets Rate per annum
ii. Motor vehicle 20% on reducing balance method
iii. Plant and machinery25% on reducing balance method
8. A motor vehicle was sold on credit on 31 December 2018 for sh.458,000. The motor
vehicle had been bought on 1 June 2017 for sh. 1,000,000 the sale had not been recorded
to the ledger.
9. During the year Dr. Masinde took good worth 350,000 from the business for his own
use.
Required: Dr. Masinde’s Income statement for the year ended 31 August 2019
 Dr. Masinde’s
Income statement
For the year ended 31 Aug 2019
W7 Depreciations

i. Plant and machineries

25% (11,35(400 — 4,150;000)2 = 1,800,000

ii. Motor vehicle

20% (13,290,000 — (2,790, 000 -291,000) =1,958,200

LIMITATIONS OF FINANCIAL STATEMENTS

The income statement and the statement of financial position, it must have been gathered, are
full of information about the results of operations and the financial position of the firm
concerned.
In fact, it would be unthinkable to appraise the performance and standing of a firm without the
aid of these two statements. A firm proclaims its efficiency, profit-ability and standing through
them and it is because of this that accounting is said to be the language of business.
However, the message conveyed by the statements is not infallible and often, one should not
readily accept the conclusions indicated by the financial statements. This is because by their
very nature, the statements suffer from a number of limitations,
These are given below but here we shall discuss only the impact of accounting policies.
The limitations briefly are the following:-
1. In spite of the great emphasis nowadays on accounting standards, the latest effort in
respect of which is being made by the IAS and the institute of certified public
accountants of Kenya (ICPAK), the management has a choice out of a number of
accounting policies chiefly in regard to valuation of inventory, depreciation, provision of
gratuity, treatment of research and development expenditure e t c.
2. There are numerous parties which are interested in the financial statements. The
proprietors or shareholders, the workers, the investors, the creditors etc. are some of the
obvious parties which are interested in the firm and, therefore, in the financial
statements concerned. Financial analysts and academicians are also interested.
Unfortunately, the information which concerns these parties differs and it is difficult to
draw up one set of financial statements that will be equally useful to all the parties. As
matters stand, the statements concerning companies have to be drawn up in India in
accordance with Schedule VI of the Companies Act which is mostly from the point of
view of the shareholders. The statements as drawn up today merely perform the
custodial function, showing statements as drawn up today merely perform the custodial
function, showing whether or not the funds entrusted to the Management have been
faithfully managed. The statements are quite defective from the point of view of decision
making. Whether a shareholder will be wise to dispose off his holdings or to increase
them will be difficult to decide on the basis of the information contained in the financial
statements.
3. One of the important limitations from which financial statements suffer is the fact that
quantitative factors, translated in terms of money, are the only factors which can be
revealed in the statements. The quantitative content of financial statements in Kenya has
 increased beyond recognition, for example, quantities also must be given for sales,
purchases, and stocks. Even so, such information cannot throw adequate light on the
qualitative factors, namely, the attitudes of workers and consumers towards the
company, research and development effort, the quality and caliber of management etc.
these are vital for the continued success of the company.
4. Great deal of effort these days is being directed towards evaluation of human resources
at the disposal of undertakings. However, these efforts have not yet been crowned with
success and it is a long way before a meaningful figure about this most important asset
can be entered in the financial statements. Short of this, however, the directors' report
can certainly describe fully, unless it is harmful to disclose information to competitors,
the problems faced by the company, the plans of the company and the manner in which
company is preparing to meet the future.
5. Last, but not the least, financial statements have now begun to suffer from a very serious
limitation which arises from the great fall in the value of money, in other words,
inflation. Even if a company is five years old, the values of the assets stated in the
balance sheet will be completely out of tune with the prevailing values. This means that
profitability worked out on the basis of the balance sheet figures will be misleading.
Further, it is to be recognized that good deal of profit reported in the profit and loss
account of a company today is due to inflation and, therefore, illusory. This is proved by
the fact that a large number of mills in India today are sick because, even though they
reported good profits in the past, they could not build up enough funds to replace their
plant and machinery when it was worn out
ILLUSTRATION
David Dolgellau, a sole trader has prepared the following balance as at 31 March 2001

Sales 378,500.00
Discount Received 2,400.00
Rent Received 7,500.00
Returns outwards 7,700.00
Creditors 18,700.00
Bank Overdraft 30,000.00
Capital 287,500.00
Purchases 261,700.00
Salaries and Wages 45,700.00
Office expenses 8,400.00
Insurance premiums 3,100.00
Electricity 1,600.00
Stationery 6,200.00
Advertising 8,400.00
Telephone 2,100.00
Business Rates 7,500.00
Discounts allowed 600.00
Returns Inwards 4,100.00
Stocks as at 1 April 2000 120,600.00
Warehouse, shop and office 210,000.00
Fixtures and fittings 12,800.00
Debtors 13,000.00
Cash in till 500.00
Drawings 26,000.00

The following further information was obtained:

 Closing stock was £ 102,500.00

 Electricity charges accrued £ 700.00
 Advertising expenses accrued £ 500.00
 Insurance premiums paid in advance £ 900.00
 Business rates prepaid £ 1,500.00

Required:

88
 Prepare a trial balance, trading, profit and loss account for the year ended 31 March
2001 and balance sheet as at that date.

David Dolgellau
Trading Profit and Loss account
For the year ended 31 Dec 2019
Kshs. Kshs. Kshs.
Sales 378,500
Less Sales returns (4,100)
Net Sales 374,400

Opening Stock 120,600

Add Purchases 261,700
Less Purchases Returns (7,700) 254,000
COGS 374,600
Less Closing stock (102,500)
COS 272,100
Gross Profit 102,300
Add discount received 2,400
Add Rent received 7,500
112,200

Less Expenses
Salaries 45,700
Office expenses 8,400
Electricity - 1,600
Add accrued ele 700 2,300
Advertising expenses 8,400
Add accrued adv expenses 500 8,900
Insurance premium 3,100
Less Prepaid insurance (900) 2,200
Business Rates 7,500
Less Prepaid (1,500) 6,000
Depreciation
Fixtures 5%*12800 640
Warehouse 10%210000 21,000
Discount allowed 600
Telephone 2,100
stationery 6,200
Bad debts 10% 13000 1,300 105,340
Net Profit 6,860
 David Dolgellau
Balance Sheet
As at 31 Dec 2019
Kshs. Kshs. Kshs.
Non Current Assets Cost Dep NBV
Warehouse Shop and office- 210,000 21,000 189,000
Fixrures and fittings 12,800 640 12,160
201,160
Current Assets
Cash 500
Prepaid insurance 900
Prepaid business rates 1,500
Debtors- (13000-10%*13000) 11,700
Stock 102,500 117,100
Total Assets 318,260

Financed by
Capital 287,500
Add Net profit 6,860
Less Drawings (26,000) 268,360

Liabilities
Creditors 18,700
Bank overdraft 30,000
Acrrued Electricity 700
Acrcrued adv exp 500 49,900
318,260