CHAPTER 19 – FINANCIAL STATEMENTS II (WITH
ADJUSTMENTS)
INTRODUCTION
Financial Statements = Trading & Profit and Loss A/c (Income Statement) + Balance Sheet
(Position Statement).
But → Trial Balance alone is not enough.
Many incomes/expenses belong to future periods or have accrued but not recorded.
To present a true and fair view, we need adjustments.
NEED FOR ADJUSTMENTS
Reasons:
1. Record outstanding expenses.
2. Adjust prepaid expenses.
3. Record accrued incomes.
4. Exclude unearned incomes.
5. Match expenses & incomes correctly.
6. Show assets/liabilities at true value.
7. Provide depreciation, provisions, etc.
Principle Applied:
👉 Accrual Basis – Expenses & incomes are recorded when incurred/earned, not when
paid/received.
Illustration 1: Goods sold ₹10,000 but payment not received. → Still recorded as income.
Illustration 2: Rent unpaid ₹20,000 for March. → Still recorded as expense.
CLOSING STOCK & OUTSTANDING EXPENSES
Closing Stock
Unsold stock at year-end.
Valued at Cost or Market Price, whichever lower.
Entries:
o Closing Stock Dr. → To Trading A/c.
Appears:
o Credit side of Trading A/c.
o Asset side of Balance Sheet.
Illustration 3:
Opening Stock ₹4,000, Purchases ₹10,000, Closing Stock ₹2,000.
Raw material used = 4,000 + 10,000 – 2,000 = ₹12,000.
Outstanding Expenses
Expenses due but not yet paid. (e.g., Rent, Salary).
Entry: Expense A/c Dr. → To Outstanding Expense A/c.
Shown:
o Debit side of P&L A/c.
o Liability in Balance Sheet.
Illustration 4: Salary = ₹15,000 unpaid for March.
Added to Salaries in P&L; shown as Current Liability.
PREPAID EXPENSES & ACCRUED INCOME
Prepaid Expenses
Expenses paid in advance.
Entry: Prepaid Expense A/c Dr. → To Expense A/c.
Shown: Deducted in P&L; Asset side in Balance Sheet.
Illustration 5: Annual Insurance = ₹5,000 paid on 1 July. Year ends 31 March.
9 months (₹3,750) = Expense; 3 months (₹1,250) = Prepaid.
Accrued Income
Income earned but not received.
Entry: Accrued Income A/c Dr. → To Income A/c.
Shown: Add to income in P&L; Asset in Balance Sheet.
Illustration 6: Debenture interest due ₹5,000 at year-end.
Add to Interest Income in P&L; show as Current Asset.
UNEARNED INCOME & DEPRECIATION
Unearned Income
Income received in advance.
Entry: Income A/c Dr. → To Income Received in Advance A/c.
Shown: Deducted from Income in P&L; Liability in Balance Sheet.
Illustration 7: Rent received ₹45,000 (includes ₹15,000 advance).
P&L = ₹30,000; Balance Sheet Liability = ₹15,000.
Depreciation
Reduction in asset value due to wear/tear.
Entries:
o Depreciation A/c Dr. → To Asset A/c.
o P&L A/c Dr. → To Depreciation A/c.
Shown:
o Expense in P&L.
o Deducted from Asset value in Balance Sheet.
Illustration 8: Machinery ₹3,00,000, Depreciation @12% = ₹36,000.
P&L Expense = ₹36,000; Machinery = ₹2,64,000.
INTEREST, COMMISSION & BAD DEBTS
Interest on Capital
Entry: Interest on Capital A/c Dr. → To Capital A/c.
Shown: Expense in P&L; Added to Capital in Balance Sheet.
Interest on Drawings
Entry: Capital A/c Dr. → To Interest on Drawings A/c.
Shown: Income in P&L; Deducted from Capital in Balance Sheet.
Manager’s Commission
1. On Profit before Commission:
Commission = NP × Rate /100.
2. On Profit after Commission:
Commission = NP × Rate /(100+Rate).
Illustration 9: Net Profit before commission = ₹22,000, rate 10%.
Before commission = ₹2,200; After commission = ₹2,000.
Bad Debts & Provisions
Bad Debts: Actual irrecoverable → Expense in P&L, deducted from Debtors.
Provision for Bad Debts: Anticipated future losses.
Provision for Discount on Debtors: Expected discount allowed.
Provision for Discount on Creditors: Expected benefit (income).
Illustration 10–12 included in chapter (Bad debts ₹4,500, provision adjustments, etc.).
ABNORMAL LOSS & FREE SAMPLES
Abnormal Loss (e.g., fire, theft)
Loss A/c Dr. → To Trading A/c.
If insured: Claim receivable shown as Asset.
If uninsured: Entire loss in P&L.
Illustration 14: Stock lost ₹3,00,000, claim admitted ₹2,00,000.
👉 Insurance Co. A/c Dr. 2,00,000, P&L Dr. 1,00,000 → To Loss A/c 3,00,000.
Free Samples / Personal Use
Treated as Advertisement/Drawings.
Entry: Advertisement A/c / Drawings A/c Dr. → To Purchases A/c.
Illustration 15: Goods worth ₹38,000 withdrawn – Free samples (₹23,000), Personal use
(₹3,000), Staff distribution (₹12,000).
👉 Deducted from Purchases; shown in P&L/Capital.
FULL-SCALE ILLUSTRATION
Illustration 16 & 13 from chapter:
Preparation of Trading A/c, Profit & Loss A/c, Balance Sheet with multiple adjustments (Closing
Stock, Depreciation, Bad Debts, Manager’s Commission, Fire Loss, Prepaid Expenses).
Shows complete process of incorporating all adjustments into Final Accounts.
PAGE 9 – SUMMARY POINTS
Adjustments needed for true & fair financial results.
Closing stock = lower of cost/market.
Outstanding = Expense + Liability.
Prepaid = Deduct from Expense + Asset.
Accrued Income = Add to Income + Asset.
Unearned Income = Deduct from Income + Liability.
Depreciation = Expense + Reduction in Asset.
Provisions = Conservative estimates.
Abnormal Loss = Shown separately; Insurance claim adjusted.
Free Samples = Advertisement / Drawings.
PRACTICE QUESTIONS
1. What are Adjustment Entries? Why needed?
2. Explain treatment of Outstanding & Prepaid expenses.
3. Differentiate Accrued Income vs Unearned Income.
4. Journalise:
o Rent paid in advance ₹15,000.
o Depreciation on Machinery ₹25,000.
o Outstanding Salary ₹10,000.
o Rent received in advance ₹25,000.
5. Solve Full Illustration: Prepare Final Accounts from a Trial Balance (given in your PDF).
