Final Accounts With Adjustments

Final Accounts
This is the last stage of accounting cycle process.
Through this tool the financial position and level of profit or loss
can be estimated or calculated.
Trading account always represent gross profit or gross loss, on
the other hand profit and loss account represents net profit or net
loss.
Trading account shows the difference between the direct income
or direct expenses.
All indirect income and expense come under Profit and loss
account.
2

Final account continues

Balance sheet shows the financial position of any business.
It consists into two parts. Left side known for Liabilities
and Right side shows Assets.
The total of both side of balance sheet must be equal, other
wise it will show some accounting errors.

Trading Account
Debit side
1. Opening stock
2. Purchase
3. Wages
4. Carriage in ward
5. All direct expenses

Credit Side

1.Sales
2.Closing stock

The difference at Debit side will be Gross profit

The difference at Credit side will be Gross loss
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Profit and Loss Account

Debit Side

Credit Side

1.Salary
2.Rent paid
3.Interest paid
4.Bad debts
5.All other indirect expenses

1. All other indirect income

The difference at Debit side will be Net Profit

The difference at Credit side will be Net Loss

Balance Sheet
Liabilities

Assets

1.Share Capital
2.Reserve and surplus
3.Long term liabilities
4.Current liabilities

1.Fixed assets
2.Investment
3.Goodwill
4.Current assets
5.Fictitious assets

Total of Both sides will be equal or same

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What are Adjustments?

The transactions which have not yet been journalised, appended to the trial
balance are what we call adjustments. Thus we can say that Adjustments are
transactions relating to the business which have not been journalised by the
end of the accounting period.
Since adjustments are also transactions relating to the business, we need to
bring them into the accounting books by journalising them. The trial balance
is used for final accounting for making up final accounts, posting them into
respective ledger accounts, balancing of ledger accounts effected by these
transactions.
Therefore even for the purpose of bringing the transactions represented by
the adjustments into books a method has been designed which would not
require us to record these transaction, post them and balance the ledger
accounts affected. This method incorporates the effect of the transactions
into the final accounts without having to go through the regular process of
recording, posting, balancing etc.
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Types of Adjustment
1. Closing Stock
2. Outstanding expenses
3. Prepaid expenses
4. Accrued income
5. Uneread income
6. Depreciation
7. Provision for bad debts
8. Provision for discount on debtor
9. Provision for discount on creditor
10. Interest on capital
11. Interest on drawings
12. Loss by accident or fire
13. Manager commission
14. Sales on approval

Illustration
Particulars
Opening Stock
Purchases
Salaries
Wages
Carriage Inwards
Trading Charges
Carriage Outwards
Rent received
Cash
Capital
Bank (Overdraft)
Commission
Creditors
Sales
Debtors
Machinery
Total

L.F.

Debit Amount
86,000
11,36,000
1,53,000
18,000
26,900
64,000
52,500
62,500
42,780
2,56,000
4,80,000
23,77,680

Credit Amount

1,78,300
3,44,700
37,980
2,68,000
15,48,700

23,77,680

Adjustments
A Machine purchased on credit from M/s Ramsay Machine Tools for Rs. 2,00,000 is not yet
recorded in the books.
Wages to the extent of Rs. 43,000 are incorrectly recorded as Salaries.
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Closing Stock
In a business the remaining stock at the end of an accounting
period
is
known
as
closing
stock.
It includes finished products, raw
materials,
or work
in
progress and is deducted from the period's costs in the balance
sheet.
Closing Stock =
Opening Stock + Purchases + Direct Expenses + Gross Profit
Sales
It represents the unsold stock at the end of the year.

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 Closing stock will be written in the credit side of trading account.

It will be shown as an asset in the assets side of balance sheet.

Dr.

Tradng a/c

Cr.

By closing stock

Liabilities
Assets

Balance sheet
Closing stock
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Outstanding Expenses
Certain expenses relating to a particular period may not have been paid in that
accounting period known as outstanding. All such expenses which are due for
payment in one accounting year but actually paid in future accounting years or
payment of which is postponed are all outstanding or unpaid expenses.
All such expenses must be accounted for in that accounting year in which they
are incurred, irrespective of the fact whether they are paid or not, with a view to
ascertain true trading results.
Example if salaries for the last month are not paid, no entry will appear in books
of accounts unless these are paid. So profit and loss account in respect of
salaries will thus be under charged than the actual expenditure, therefore the
profit will be more.

12

Effects of Outstanding expense

Outstanding expenses will be added in expenses ~
If it is direct in nature it will go to trading accounts debit side , if it is indirect
nature then it will go to the debit side of profit and loss account
It will be the current liability so it will be shown in the liabilities side of
balance sheet

Adjustment entry :
Respective Expenses a/c

Dr

To Outstanding Expenses a/c

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Dr.
Cr.

Trading a/c

To Wages outstanding a/c

Dr.
Cr.

Profit & loss a/c

To Salary outstanding a/c

Liabilities
Assets

Balance sheet

Wages outstanding
Salary outstanding

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Prepaid Expenses
The, benefit of some of the expenses already spent will be available in the next
accounting year also, Such a portion of the expense is called pre-paid expense;
since such expenses are already paid, they are also recorded in the books of
accounts of that period to which they do not relate.
The result shown by the final accounts of a particular period will not be correct
because such expenses relate to future periods. Therefore, such prepaid
expenses must be adjusted in the books of accounts to arrive at true profit.
Generally insurance, taxes, telephone subscriptions, rent etc. are paid in
advance, thus requiring adjustment e.g. Rent paid by X for one year on 1.7.07
when his accounting year is calendar year; thus rent for 6 months will remain
unexhausted and will be c/f to the next year.

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Effects of Prepaid expenses

It will deduct from respective expenses paid .

It will be the current asset so it reflect in the assets side of

the balance sheet
Adjustment entry :
Prepaid Expenses a/c Dr
To Respective Expenses a/c

16

Dr.

Profit & loss a/c

Cr.

To prepaid expenses a/c ( Example :

rent prepaid )

Liabilities

Balance sheet

Assets

Rent Prepaid

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Accrued Income
There may be certain incomes which have been earned during the year but not
yet received till the end of the year.
Income like interest on investments, rent and commission etc. are normally
earned by merchant during a particular accounting period but actually not
received during that period. Such income items need adjustments before the
preparation of final accounts.
Such incomes should be credited to that particular income account. At the same
time the income so -earned but not received is an asset because the amount is
still to be received.
Adjustment entry :
Accrued Income a/c
to Respective Income a/c
18

Effects of Accrued income

It will add in the income and go to credit side of
profit and loss account.
It will be shown as an asset in the assets side of
balance sheet.

19

Dr.

Profit and Loss a/c

Cr.
Interest on Investment

Liabilities

Balance Sheet

Assets
Interest on Investment

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Income Received in Advance

Sometimes, traders receive certain amounts during a
particular trading period which are to be earned by them in
future periods. Such incomes though actually received and
therefore, recorded i.e. not yet earned.
Such incomes should be credited to the profit and loss
account of the year in which these are earned. Therefore,
such income though received is not the income but a liability
of that period
Example : Rent received in advance.

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Effects of Advance income

It

will be deducted from the income

received at credit side of Profit and loss
account.

It

will be shown as a liability in the

liabilities side of balance sheet.

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Depreciation
The value of fixed assets diminishes gradually with their use for business purposes. Although this
decrease in the value happens every day but its accounting is done only at the end of accounting
period with the help of following entry :Depreciation account To Particulars asset

Adjustment entry :
Depreciation a/c
to Unearned Income a/c

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Effects of Depreciation

It will go to the debit side of profit and loss

account.

It will be deducted from fixed asset from the

assets side of Balance sheet, as it tends to
decrease the value of the asset.

24

Dr.

Profit and Loss a/c

Cr.

Depreciation
Liabilities

Balance Sheet

Assets
Fixed Assets - Depreciation

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Interest on Capital
The proprietor may wish to ascertain his profit after considering the
interest which he losses by investing his money in the firm. Interest to
be charged is an expense for the business on one hand and income to
the proprietor on the other hand.
Following adjusting entry is recorded at the end of accounting period:
Interest on capital a/c To Capital a/c Interest on capital being an
expense is debited to profit and loss account and same amount of
interest on capital is added to capital.
Adjustment entry :
Interest on Capital a/c
to Capital a/c
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Effects of Interest on Capital

It will be shown on the debit side of Profit and

Loss Account.

It will be added to the capital on the liabilities

side of the Balance Sheet.

27

Dr.

Profit and Loss a/c

Cr.

Interest on Capital

Liabilities

Balance Sheet

Assets

Capital + Interest on Capital

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Interest on Drawings
As business allows interest on capital it also charges interest on
drawings made by the proprietor. Interest so charged is an income for
the business on one hand and expense for the proprietor on the other
hand.
Following adjusting entry is passed at the end. of accounting period:
Capital a/c Dr. To Interest on drawings a/c. The interest on drawings
being an income is credited to profit and loss account is shown as a
deduction from the capital.
Adjustment entry :
Capital a/c
to Interest on Drawings a/c
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Effects of Interest of Drawings

It will be shown on the credit side of Profit and

Loss Account.

It will be deducted from capital on the

liabilities side of Balance Sheet.

30

Dr.

Profit and Loss a/c

Cr.
Interest on Drawings

Liabilities

Balance Sheet

Assets

Capital Interest on drawings

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Bad Debts
Bad debts are irrecoverable debts from customers, during
the course of the financial year. It results in the reduction of
customers debit balance and addition to the loss i.e. Bad
Debts. Such bad debts must be recorded with the given
adjusting entry.

Adjustment entry :
Bad Debts a/c
to Sundry Debtors a/c
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Effects of Bad Debts

It will be shown on the debit side of Profit and

Loss Account.

Asset side of Balance Sheet : Sundry Debtors

Bad debts

33

Dr.

Profit and Loss a/c

Cr.

Bad Debts

Liabilities

Balance Sheet

Assets

Sundry Debtors Bad Debts

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Provision for Bad Debts

At the end of the year, after writing off the bad debts about whom we
were sure of becoming irrecoverable, there may still be some customer
balances from whom it is doubtful to collect the entire amount. However,
it cant be written off as bad because non-recovery of such amount is not
certain. But at the same time the balance in sundry debtors account
should be brought down to its net realizable figure so that balance sheet
may not exhibit the debtors at more than their actual realizable value.
Therefore, to show the approximately correct value of the sundry
debtors in the balance sheet a provision or reserve is created for
possible bad debts. Such an adjustment entry is recorded at the end of
accounting year.
Provision for bad debts is an attempt to anticipate possible losses due
to bad debts and to keep aside an amount out of profit to meet the loss
estimated in the following years.
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Effects of PBD
It will be written on debit side of Profit and Loss
Account.
Asset side of Balance Sheet : Sundry Debtors
provision for bad debts

Adjustment entry :
Profit and Loss a/c
to Provision for Bad Debts a/c
36

Dr.

Profit and Loss a/c

Cr.

Bad Debts

Liabilities

Balance Sheet

Assets

Sundry Debtors Provision for Bad Debts

37

Discount on Debtors
It is normal practice in trade to allow discount to customers
for prompt payment and it constitutes a substantial sum.
Sometimes the goods are sold on credit to customers in
one accounting period where as the payment of the same is
made by them in the next accounting period and so
discount is to be allowed.
It is a prudent policy to charge this expenditure to the period
in which sales have been made, so a provision is created in
the same manner, as in case of provision for doubtful debts.

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It will be shown on the debit side of Profit and Loss Account.

Assets side of Balance Sheet : Sundry Debtors Provision
for discount on debtors.

Adjustment entry :
Profit and Loss a/c
To Provision for Discount on Debtors a/c

39

Dr.

Profit and Loss a/c

Cr.

Discount on Debtors

Liabilities

Balance Sheet

Assets

Sundry Debtors Provision for

Discount on Debtors

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Discount on Creditors
Prompt payment, if made, enables a businessman to receive discount.
The question arises whether this discount should be treated as income
of the period in which purchases were made or of the period when the
payment is made, if both events are in different accounting years, it has
been well decided by accountants that it should be treated as income of
the period in which purchases are made.
So on last date of accounting period if some amount is still payable to
creditors, a provision should be created for such probable income and
amount should be credited to the profit and loss account of that year in
which purchases are made. Following adjusting entry is passed for it
:Provision for discount on creditors a/c Dr. To Profit and loss account

41

Effects of Discount on Creditors

It will be shown on the credit side of Profit and Loss

Account.

Liabilities side of Balance Sheet : Creditors

provision for discount on creditors.

42

Dr.

Profit and Loss a/c

Cr.
Discount on Creditors

Liabilities

Balance Sheet

Assets

Sundry Creditors Provision for

Discount on Creditors

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Loss by Accident/Fire/Theft
Sometimes a business suffers certain losses not because of trading but
because of certain accidents. These may destroy some fixed assets of the
merchant. In such a case the asset account is credited and the profit and loss
account is debited.
If full claim of the goods destroyed is received :
It will be shown in credit side of trading account.
It will be shown on the assets side in the balance sheet.
If full claim of the goods destroyed is not received :
It will shown in the debit side of Profit and Loss a/c and also in the credit side of
Trading a/c.
It will also be shown on the assets side in the balance sheet
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If the destroyed goods are uninsured :

It will be shown only in the debit side of Profit and Loss a/c.

It will be shown on the assets side in the balance sheet.

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Manager Commissions
Sometimes the manager is entitled to a commission on profits. Such
commission may be :
(a) Fixed percentage on net profits before charging such commission.
(b) Fixed percentage on net profits- after charging such commission.
Such commissions being an expense are debited to commissions
account. However, as it has not yet been paid, so commission payable
account is given the credit and finally it is shown in the balance sheet as
a liability.
Calculation of Commission First of all trading account should be
prepared in usual manner and after transferring the gross profit or loss
all expenses and incomes should be debited or credited except the
commission which is still to be calculated.
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It will be shown in the debit side of Profit and Loss Account

as O/S commission to manager.
It will be shown as a liability in the liabilities side of the
Balance Sheet.
Dr.

Profit and Loss a/c

Cr.

O/S Commission to Manager

Liabilities

Balance Sheet

Assets

O/S Commission to Manager

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Sale or Approval Basis

Generally, goods supplied on approval are recorded as
sales. But this cannot be treated as sales until the express
or implied consent of the buyer is obtained.
It will be shown in the credit side of Trading a/c by way of deduction
from Sales.

It will be shown on the assets side of Balance Sheet by way of

deduction from Debtors.

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