Chapter – 10

FINANCIAL STATEMENTS - II
Final accounts with adjustments – It is quite usual that some of the expenses paid or incomes received
during the accounting period may relate to the previous year or to the subsequent year. If these items
are not adjusted into the accounts, the summary presented in the form of final accounts will not give a
true picture. All items which need alteration or which are to be brought into records at the time of
preparation of final accounts are called adjustments.

1. Closing stock – The adjustments regarding closing stock are:

Closing Stock a/c Dr
a. It is credited to trading account. To Trading a/c
b. It is shown as an asset in the balance sheet.

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) E.g., Rs.1000 per month is paid salary to an employee, but altogether only Rs.11000
has been paid during this year, here one month salary Rs.1000 is due but not paid and is called
outstanding salary. In order to find the true profit for the year this outstanding amount is to be
brought into accounts. This is actually an expense for the year as well as a liability too.
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 – Those expenses which have been paid in advance, whose benefit will be
available in 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:

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 a. It will be deducted from the respective expense on the debit side of trading and profit and
loss account.
b. It is shown as an asset in the 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:
Accrued/Outstanding income a/c Dr

To Concerned income a/c

The effect of the above adjustment will be:

a. It will be shown on the credit side of the profit and loss a/c by way of addition to the income.
b. It will be shown on the asset side of the Balance Sheet as Accrued Income.
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:
Concerned Income a/c Dr
To Income received in advance a/c

The effect of the above adjustment will be:

a. It will be deducted from concerned income on the credit side of T&P/L a/c.
b. It is shown as a liability in the Balance Sheet.
6. Depreciation – 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 Concerned Asset a/c

The effect of the above adjustment will be:

a. Depreciation is shown on the debit side of profit and loss account.

b. It is shown on the assets side of the Balance Sheet by way of deduction from the concerned
asset.
7. Bad debts – Any irrecoverable portion of sundry debtors is terms 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
To Debtors A/c

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The effect of the above adjustment will be:

a. It should be shown on the debit side of the profit and loss account as it is a loss to the
business.
b. It should be deducted from Sundry debtors on the assets side of the Balance Sheet as it is
irrecoverable.

Note: If the bad debt is given in the trial balance, it means that it has already been adjusted
with the sundry debtors and hence, need not be deducted from sundry debtors again while preparing
the balance sheet, but it should be shown on the debit side of profit and loss account only.

8. Provision for bad and doubtful debts - When it is feared that some of the amounts owed by
customers are not likely to be collected, it is prudent to recognize the expected loss by reducing
the current year’s profit and placing the amount in a special account called “Provision for bad
and doubtful debts a/c”. This provision is created out of profit and hence, the Adjustment
entry will be:
Profit & Loss a/c Dr

To Provision for bad & doubtful debts a/c

The effect of the above adjustment will be:

a. It will be shown as an addition to Bad debt on the debit side of Profit and loss a/c.
b. It should be deducted from sundry debtors on the assets side of the Balance Sheet.

9. Provision for discount on debtors – Cash discount may be granted to customers to ensure
prompt payment of their dues. A provision for this purpose is created out of the profits and it
is calculated as certain percentage on good debtors. Therefore,

Good debtors = Sundry debtors – Further bad debt – provision for doubtful debts

Adjustment entries:
Profit and Loss a/c Dr
To Provision for discount of debtors a/c

The effect of the above adjustment will be:

a. The amount of provision for discount on debtors should be debited to profit and loss a/c.
b. It should be shown by way of deduction from sundry debtors in the balance sheet after
deducting further bad debt and new provision for debtors.

10. Manager’s commission – Sometimes the managers are paid a commission calculated as a
certain percentage on the profit. Such commission may be ‘before charging such commission’
or ‘after charging such commission’.

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 The procedure for calculation of commission before charging such commission:

a. Find out the difference between credit side and debit side of profit and loss a/c. This
represents the notional profit.
b. Multiply this amount by the given percentage. E.g., Notional profit is Rs.26000 and the
manager is to be given 5% commission of the profit before charging such commission, it
will work out as under: 26000 X 5/100 = 1300

The procedure for calculation of commission after charging such commission:

a. Find the notional profit.

b. Assume that the profit so arrived at is inclusive of commission (i.e., if profit is 100%, the
profit inclusive of commission will be 100+% of commission).
c. Calculate the commission by applying the following equation:

Notional profit X % of commission / 100+ % of commission

E.g., Notional profit is Rs.14700, manager’s commission is 5% after charging such commission,
the commission payable will be: 14700 X 5/105 = 700.

Adjustment entry: Profit and Loss a/c Dr

To Manager’s Commission a/c

The effect of the above entry will be:

a. Manager’s commission account will be closed by transfer to profit and loss account.
b. The Manager’s commission account will be shown on the liabilities side of the balance sheet
as it is outstanding.
11. Interest on capital – In case the interest on capital is paid to the proprietor, it is to be treated
as an expense to the business and hence debited to profit and loss account. This interest on
capital is shown on the liability side of the balance sheet by adding the same to capital account.
Adjustment entry:
Interest on capital a/c Dr
To Capital a/c

The effect of the above adjustment will be:

a. It will be debited to profit and loss account as a separate item.

b. It will be added to capital on the liability side of the balance sheet.

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Treatment for various types of adjustments:

Adjustment Adjustment Entry Treatment in Treatment in

Trading and Profit Balance
and Loss Account Sheet

1. Closing stock Closing stock A/c Dr. Shown on the credit Shown onthe
To Trading A/c assets side and profit assets side
and loss account

2. Outstanding Expense A/c Dr. Added to the Shown on the

expenses To outstanding respective expense liabilities side
expense A/c on the debit side

3. Prepaid/ Prepaid expense A/c Dr. Deducted from the Shown onthe
Unexpired To Expenses A/c respective expense on assets side
expenses the debit side

4. Incomeearned Accrued income A/c Dr. Added to the Shown onthe

butnotreceived To Income A/c respective income assets side
on the credit side

5. Incomereceived Income A/c Dr. Deducted from the Shown on the

in advance To Income received respective income liabilities
in advance A/c on the credit side sides

6. Depreciation Depreciation A/c Dr. Shown on the debit Deducted from

To Assets A/c side the value of
asset

7. Provision for Profit and Loss A/c Dr. Shown on the debit Shown as
bad and To Provision for side deduction
doubtful debts doubtful debts from debtors

8. Provision for Profit and Loss A/c Dr. Shown on the debit Shown as
discount on To Provision for side deduction
debtors discount debtors form debtors

9. Manager’s Manager’s Dr. Shown on the debit Shown on the

commission commission A/c side liabilities side
To outstanding
commission A/c
10. Interest on Interest on capital A/c Dr. Shown on the debit Shown as
capital To capital A/c side addition to
capital

11. Further bad Bad debts A/c Dr. Shown on the debit Deducted from
debts To Sundry Debtors A/c side debtors

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