Adjustments of Final Accounts

To ensure that the final accounts disclose the true trading results, it is necessary to lake into account the whole of the expenses incurred, whether paid or not, and whole of the losses sustained. Likewise the incomes and gains earned, whether actually received or not, during the period covered by the trading and profit and loss account under consideration must also be recorded.

In mercantile system of accounting, it is essential to adjust different accounts before the preparation of final accounts. It is quite common to adjust expenses paid in advance, incomes received in advance, income accrued but not received, bad debts, provision for bad debts depreciation on assets and soon. Journal entries are passed to effect the required adjustments; these entries are known as adjusting entries.

Usual Adjustments

Outstanding Expenses:

Certain expenses relating to a particular period may not have been paid in that accounting period. 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. In other words, all paid and also unpaid expenses must be recorded in an accounting year if they relate to that accounting year only with a view to ascertain true trading results e.g. 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.

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 1.7.79 when his accounting year is calendar year; thus rent for 6 months will remain unexhausted and will be c/f to the next year.

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.

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

Closing Stock

It represents the unsold stock at the end of the year. Closing stock is valued and following entry is passed at the end of the year: Closing Stock account To Trading Account Closing stock at the end appears in the balance sheet and is carried forward to the next year. At the end of the next year it appears in the trial balance as opening stock and from there it is taken to debit side of trading account and thus closed.

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

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/e 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.

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 ale Dr. To Interest on drawings a/e The interest on drawings being an income is credited to profit and loss account is shown as a deduction from the capital.

Bad Debt to be written off

Bad debts are irrecoverable debts from customers, during the course of the financial year. These are recorded as follows: Bad debts a/c To Sundry Debtors a/c It results in the reduction of customers debit balance and addition to the loss i.e. Bad Debts. At the end of the year when the trial balance is drawn, these two accounts show debit balances. The balance on sundry debtors account, thus arrived, is the net balance, after deduction of any bad debts recorded during the year. But after the trial balance is prepared and before the final accounts are drawn trader may find that there are additional bad debts. Such bad debts must be recorded with the same adjusting entry and giving it following effect in ledger and final accounts.

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. When the provision for bad debts is created, following entry is recorded:

Profit and Loss A/c Dr. To Provision for bad debts A/c

Some important considerations while creating provision for bad debts

(i) Sundry debtors account should not be credited with the amount of provision for doubtful debts because the loss has not actually been incurred.

(ii) Treatment of bad debts or provision for bad debts appearing inside the trial balance. If some balance (credit) is already appearing in provision for doubtful debts account inside the trial balance, it is the previous years unutilized balance of this account. If some bad debts are also appearing on the debit side of the trial balance, these should be transferred to provision for bad debts account, with the help of following entry: Provision for bad debts a/e To Bad debts a/e. It is important to note that, as these items appear inside the trial balance, so these are to appear only in profit and loss account as debtors have already been reduced during the year.

(iii) When bad debts and provision for bad debts appear in trial balance, new provision is to be created and further bad debts are to be written off. If already bad debts and provision for bad debts are appearing in trial balance, these should be adjusted and only difference should be taken to profit and loss account.

If bad debts written off plus bad debts to be written off plus new provision for bad debts is more than the credit balance of old provision appearing in the trial balance, the difference should be debited to profit and loss account.

Provision for 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

An important point to note is that no discount win be allowed on debts that become bad. Therefore, the provision required for discount will be in respect of the other debts only. So the amount of provision for discount be calculated after deducting the provision for bad debts from sundry debtors.

Provision for 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

Losses by Accidents

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 goods (stock-in-trade) are lost by accident the value of closing stock win be lower than otherwise. This will reduce the amount of gross profit. So the cost of goods lost by accident is credited to the trading account and debited to the profit and loss account. The increase -in gross profit will be neutralized by the debit to the profit and loss account and thus the net profit will not be effected. The entries to the passed are as follows: Loss by accident a/c To Goods lost by accident a/c

Commission to manager payable on profits

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 commission being an expense is debited to commission 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.

Goods used in business

Sometimes goods purchased for the purpose of resale are used in business as giving them away for charitable purpose or distributing them as free samples. In these conditions purchases account should be credited with an amount equal to the cost of goods used in business and same amount is debited to charity or advertisement expenses account, as the case may be.

Author:.

Proprietor of HiTech Computer Services, Anil Kumar Gupta, Bachelor of Engineering (Hons.) in Electrical and Electronics Engineering from Birla Institute of Technology and Science, Pilani, India, Year of passing : May, 1985, is born on January 7, 1964 , Age : 40+, and is Indian national. Services Offered by HiTech Computer Services : Standard software for various business segments, Customized Software Development, Websites and web based ASP applications development, Financial Accounting and...

Go Deeper | Website

Have a question for Anil?

Gravatar
jessica
11th May 2014 3:58am
how is vat recorded on final accounts and patents

Gravatar
Adnan tahir
13th May 2014 11:11pm
i want to ask why adjusting entries have two affects in final account while preparing final account?

Gravatar
risha
26th May 2014 8:46am
what is accrued interest on investment and where is it suppose to be placed
Gravatar
abdulrahuf
1st June 2014 1:40am
to treat such accrued interest you have to post it to expenses side and also post it to short term liabilities.

Gravatar
Prakash
5th June 2014 10:57pm
sir please explain what is the major difference between Accounts Manager and Finance Manager
Gravatar
Reshma
24th January 2015 3:55am
Sir plz explain the other adjustments

Gravatar
giselle
22nd September 2014 11:06am
Hi, would like to know how to clear or remove the past years balance of sundry debtors. the customers paid already but it still showing balances from the last year. pls help

Gravatar
KANNAN SUNDARAM IYER
22nd September 2014 9:25pm
STATIONERY PURCHASED DURING THE YEAR - PUT TO USE IN NEXT FINANCIAL YEAR . VAT PART WE ARE UTILISING IN THIS YEAR. CAN WE CAPITALISE ONLY STATIONERY EXPENSES TO NEXT FINANCIAL YEAR OR TAX ALSO HAS TO BE CAPITALISED

Gravatar
Vijay
24th September 2014 7:29am
Where i can enter the record of Debenture at so and so company in final account.

Gravatar
Shihab
3rd November 2014 5:19am
Sir, how can be done all adjustments related with provisions in final accounts

Gravatar
sachin dahal
10th November 2014 9:58am
sir, please keep some challenging questions. so that i can challenge my self

Gravatar
Bikram
10th November 2014 10:44pm
where credit sale suppose to be placed in final account???

Gravatar
francis
19th November 2014 9:22am
how to record stock of stationery??

Gravatar
toshika
11th January 2015 5:31am
where will bad debts reserve which is to be maintained (adjustment) go ???

Gravatar
Lahari
16th January 2015 7:04pm
Why is stock of stationary outstanding written on credit side of profit and loss account?(its a type writing institute)

Gravatar
kuldeep gogoi
17th January 2015 1:54am
sir what is the reason that deferred revenue expenditures are excluded from the Revised Schedule 6 format of company's balance sheet which was notified by the Ministry of Corporate affairs on 28 th february 2011 and come into force from the financial year commencing on or after 1-4-2011?

Gravatar
D.jaya prabhu
21st January 2015 6:12am
we have received the some of amount from sundry debtors from bank no 1 but the same amount refund to the guest to another bank - how to pass the entry

Gravatar
sakthi
23rd January 2015 2:16am
Sir, pls clarifiy the debtors statement and crs statement with journal entries

Gravatar
sridhar
6th February 2015 8:10am
Interest received in which side of final a/c's

Gravatar
bela
6th February 2015 11:57am
why are adjustments considered while preparing final accounts?

Gravatar
kritika sharma
15th February 2015 6:20am
sir, can you explain the adjustment of provision for depreciation ?

Gravatar
preet kothari
18th February 2015 5:35am
If suppose purchase of goods is made on
the 28th of march and is included in closing stock but the bill is not received sir then what to do

Gravatar
Parul
25th February 2015 1:05am
pls tell me the treatment of accumulated depreciation in final accounts...

Gravatar
nafisha
2nd March 2015 2:48pm
what would be the effect of adjustment that outstanding expense is recorded in expense account but not recorded in outstanding expense account in final accounts

Gravatar
maurine
5th March 2015 6:09am
how does interest earned be treated in the income and expenditure accounts

Gravatar
sahista
7th March 2015 4:39pm
What is the entry of 8%debentures purchased on 1.10.2009??

Gravatar
Subeesh
13th March 2015 9:05am
I made the salary payable for the month of Jan Rs 450,000
but the actual salary paid on Feb is Rs 400,000.
I need to write off the balance Rs 50,000
How can I made the adjustment entry kindly revert

Gravatar
shebi
18th March 2015 12:44am
How to calculate new provision ?

Gravatar
Debopriya Pandey
29th March 2015 10:53pm
if depreciation appears in trial balance then what should be its effect in profit and loss account and balance sheet.

Gravatar
Lario
4th April 2015 3:15pm
HI , can you please help me.
my question:

the trial balance as at 28 Feb 2010 show the following balances:

provisions for bad and doubtful debts 1st march 2009 - credit balance 270 000
bad debts written off - debit balance 810 000

additional information:
increase the provision for bad and doubtful debts by 60 000

how will this entry look in the income statement and balance sheet ?

can you please help me

thank you

Lario

Gravatar
yash
12th April 2015 3:27am
Where does this adjustment be placed in final accounts:-
1. Leasehold property is to be run for 10 years w.e.f 1/10/2008.??

Gravatar
Md Azhar Farooq
13th April 2015 1:55pm
why made payable entry for ending year please this give me answer full reason?

what is the mean of trial balance in errors pls give me answer full reason?

thanks.

Gravatar
Debojit
18th April 2015 10:48am
If opening stock is under valued in trial balance and when it appear in trading a/c then it will be in cost....
sir please tell me adjustment entry for this ...

Gravatar
JOY AICH
28th April 2015 2:26am
If an expenditure is booked for Rs100 in the year end on estimated basis pending submission of bill. Next the actual bills comes for Rs110. How to account for the balance Rs 10 which was not provided in last years account. Whether it should booked as prior period or it should be debited to the current year expenditure.

Gravatar
Firoz Ahmad
29th April 2015 4:24am
How to record first year 2015 rent received from various tenant. Because the rent period is 15.10.2014 to 14.10.2015. there is no book written last year. Accounting entry start for this year (Jan.'2015 to Dec. '2015

Gravatar
ATANU MISHRA
5th May 2015 1:34pm
i have advance to my other company but that company was closed so i have not recd.any money from that partnership firm.how to adjustment the amount in balance sheet?

Gravatar
lakshmi
11th May 2015 10:03am
would you plz give me the answer to adjust the subscriptions in the accounts?

Gravatar
Sam
15th May 2015 7:43am
how to do the adjustment rebate on creditors

Gravatar
abdul ur raouf
19th May 2015 11:37am
"store expenses" are direct or indirect??
please tell me about these expenses

Gravatar
Nisha Kahyap
6th June 2015 6:15am
hello Sir,
Purchase amount AP Enterprises 600000
Payment given 590000
Remain Discount Adjust
sir plzzzzz explain this question

Gravatar
Aarti duseja
2nd September 2015 3:52pm
My question is bills receivable are dishonoured with some amount. But 50% is fully irrecoverable. Help me out with this adjustment with effects.

Gravatar
navneet
27th October 2015 1:51pm
how to treat discount received by creditors if it is given in adjustment??

Gravatar
Rey
26th December 2015 9:50pm
I do enjoy this very informative article, thank you for sharing :)

Gravatar
Umer Farooq
29th June 2016 6:00am
Sir Please Explain.
I Want to know, How i can adjust final account for the next year. I don't know adjustment entries to close expenses balances for next year.

Gravatar
Anuj Kothari
18th July 2016 7:54am
Where is income tax...already included in trial balance...shown in final accounts?

Load More Comments

* Required information
Name:
Email Address:
(never displayed)

Your question or comment:
Human? What is the opposite word of weak?
 
Enter answer:
 
Tell me when Anil responds to me.
 
Remember my form inputs on this computer.
 
 
New Graphic
Subscriber Counter