NEED FOR ADJUSTMENTS
Reason: Accrual basis of accounting – revenue recorded when earned, expenses when incurred, regardless of cash flow. Adjustments ensure true profit/loss and correct financial position.
Two-fold effect: Each adjustment affects both the Income Statement (P&L A/c) and the Balance Sheet.
CLOSING STOCK
Meaning: Unsold goods at year-end. Given as adjustment outside Trial Balance.
Entry: Closing Stock A/c Dr.; To Trading A/c.
Treatment: Credited to Trading A/c; shown as Current Asset in Balance Sheet.
OUTSTANDING EXPENSES
Meaning: Expenses incurred but not yet paid.
Entry: Concerned Expense A/c Dr.; To Outstanding Expense A/c.
Treatment: Added to expense in P&L A/c (debit side); shown as Current Liability in Balance Sheet.
PREPAID EXPENSES
Meaning: Expenses paid in advance, benefit in next period.
Entry: Prepaid Expense A/c Dr.; To Concerned Expense A/c.
Treatment: Deducted from expense in P&L A/c; shown as Current Asset in Balance Sheet.
ACCRUED INCOME
Meaning: Income earned but not yet received.
Entry: Accrued Income A/c Dr.; To Concerned Income A/c.
Treatment: Added to income in P&L A/c (credit side); shown as Current Asset in Balance Sheet.
INCOME RECEIVED IN ADVANCE
Meaning: Income received that relates to next period.
Entry: Concerned Income A/c Dr.; To Income Received in Advance A/c.
Treatment: Deducted from income in P&L A/c; shown as Current Liability in Balance Sheet.
DEPRECIATION
Meaning: Non-cash expense for wear & tear of fixed assets.
Entry: Depreciation A/c Dr.; To Asset A/c (or Provision for Depreciation A/c).
Treatment: Debited to P&L A/c; asset shown at cost less depreciation in Balance Sheet.
BAD DEBTS & FURTHER BAD DEBTS
Further Bad Debts: Additional irrecoverable amounts discovered at year-end.
Entry: Bad Debts A/c Dr.; To Sundry Debtors A/c.
Treatment: Total bad debts (including further) debited to P&L A/c; debtors reduced in Balance Sheet.
PROVISION FOR DOUBTFUL DEBTS
Meaning: Estimated loss from debtors who may not pay. Created as % of debtors (after further bad debts).
Steps: Write off further bad debts → Calculate new provision → Compare with old provision (from Trial Balance).
If new > old: P&L A/c Dr. (difference); To Provision for Doubtful Debts A/c.
If new < old: Provision for Doubtful Debts A/c Dr.; To P&L A/c.
Treatment: Net amount (Bad debts + New provision – Old provision) debited to P&L; provision deducted from debtors in Balance Sheet.
PROVISION FOR DISCOUNT ON DEBTORS
Meaning: Estimated discount to be allowed for prompt payment. Calculated on "good debtors" (debtors after further bad debts & provision for doubtful debts).
Entry: P&L A/c Dr.; To Provision for Discount on Debtors A/c.
Treatment: Debited to P&L; deducted from debtors in Balance Sheet (after deducting bad debts & provision for doubtful debts).
MANAGER'S COMMISSION
Meaning: Commission to manager based on net profit. May be calculated before or after charging commission.
If before charge: Commission = Net Profit × Rate/100.
If after charge: Commission = Net Profit × Rate/(100+Rate).
Entry: P&L A/c Dr.; To Manager's Commission Outstanding A/c.
Treatment: Debited to P&L; shown as liability in Balance Sheet.
INTEREST ON CAPITAL
Meaning: Interest allowed to proprietor on capital (if provided).
Entry: Interest on Capital A/c Dr.; To Capital A/c.
Treatment: Debited to P&L; added to capital in Balance Sheet.
SUMMARY TABLE OF ADJUSTMENTS
| Adjustment | Effect in P&L A/c | Effect in Balance Sheet |
|---|---|---|
| Closing Stock | Credited to Trading A/c | Asset (Current) |
| Outstanding Expenses | Added to expense (Debit) | Liability (Current) |
| Prepaid Expenses | Deducted from expense (Debit) | Asset (Current) |
| Accrued Income | Added to income (Credit) | Asset (Current) |
| Income Received in Advance | Deducted from income (Credit) | Liability (Current) |
| Depreciation | Debited (expense) | Deducted from asset |
| Further Bad Debts | Added to bad debts (Debit) | Deducted from debtors |
| Provision for Doubtful Debts | Debited (net of old provision) | Deducted from debtors |
| Provision for Discount on Debtors | Debited | Deducted from debtors |
| Manager's Commission | Debited | Liability |
| Interest on Capital | Debited | Added to capital |
IMPORTANT EXAM QUESTIONS
1. Explain need for adjustments in final accounts.
2. Pass adjustment entries and show treatment for: Outstanding expenses, Prepaid expenses, Accrued income, Income received in advance.
3. Calculate new provision for doubtful debts and pass entry given old provision and debtors.
4. Calculate manager's commission when rate is given on profit before/after charge.
5. Prepare Trading and P&L A/c and Balance Sheet with given adjustments (common 8-mark problem).
6. Differentiate between Provision for Doubtful Debts and Provision for Discount on Debtors.