Preparing final accounts (Financial statements) of sole trader with adjustments.

1. M. C. Sharma
Associate Professor
Department of Commerce
Shaheed Bhagat Singh Evening College
(University of Delhi)
Delhi
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2. Meaning and Need of
Adjustments to Final Accounts
 Objectives of Preparing Financial Statements – to
show true and fair results and financial position of the
business
 Relevant Accounting Principles:
 Accounting Period
 Matching
 Accrual
 Going Concern (Value of assets should be shown on
going concern basis)
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3. Adjustments to Final Accounts
 Some balances of revenues and expenses given in trial
balance do not show the correct amount for the full
accounting year.
 It becomes necessary that the correct amount of
revenues and expenses for the full accounting year
must be taken into account to find out true and fair
profit.
 The adjustments are necessary for correct matching of
revenues and expenses incurred to earn those
revenues.
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4. Adjustments to Final Accounts
 Adjustments are also required to record assets and
liabilities at their correct values by taking into account any
wrong treatment (errors of principles), non-cash expenses
(depreciation, interest on capital) and non-cash incomes
(interest on drawings)
 According to Prudence Principle, the anticipated losses
such as provision for bad debts and provision for discount
on debtors are also incorporated through adjustments.
 Thus, the corrections in the existing balances of
revenues and expenses given in trial balance are
called adjustments.
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5. Important Adjustments in Final Accounts
 Closing Stock
 Outstanding Expenses
 Prepaid or Unexpired Expenses
 Accrued Income
 Unearned Income or Income Received in Advance
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6. Important Adjustments in Final Accounts
 Bad Debts
 Provision for Bad and Doubtful Debts
 Provision for discount on debtors
 Provision for discount on creditors
 Depreciation
 Interest on Capital
 Interest on Drawings
 Interest on Loan
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7. Important Adjustments in Final Accounts
 Loss of goods
 Goods withdrawn
 Goods given as charity
 Goods distributed as free sample
 Goods sold on sale or return basis
 Goods used in construction of a fixed assets
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8. Important Adjustments in Final Accounts
 Commission payable to manager
 Loss of fixed assets
 To write off deferred revenue expenditure
 Errors and omissions
 Other adjustments
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9. Closing Stock
 Closing stock is the goods unsold at the end of the
year. Value of closing stock is usually given as an
additional information. It is valued at cost or market
price, whichever is lower.
 For example:
i. Cost of unsold goods at the end of the year is Rs.
12,000, having a market value of Rs. 15,000.
ii. Cost of unsold goods at the end of the year is Rs.
12,000, having a market value of Rs. 10,000.
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10. Closing Stock
 Adjustment entry :
Closing Stock A/c Dr.
To Trading A/c
(Being closing stock recorded)
 Treatment in final accounts:
i. On the credit side of the Trading Account,
ii. On the assets side of the Balance Sheet.
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11. Closing Stock
 Adjusted purchases and closing stock:
 If the amount of closing stock is appearing in the trial
balance, it means that opening and closing stock both
have been adjusted in the purchases. The adjusted
purchases stand for the purchase price of goods sold.
 If closing stock is given in the trial balance and it will
be shown on the assets side of the balance Sheet only.
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12. Outstanding Expenses or Unpaid Expenses
 Expenses due but not paid
 Adjustment entry :
Expenses A/c Dr.
To Outstanding Expenses A/c
(Being outstanding expenses recorded)
 Treatment in final accounts:
 On the debit side of Trading Account or Profit and Loss
Account, by adding to the respective expenses, and
 On the liabilities side of Balance Sheet.
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13. Outstanding Expenses
 Example:
 Balances extracted from trial Balance
Dr. Balance Cr. Balance
Wages 4,600 -
Salaries 22,000 -
Adjustments:
 Wages due but not paid are Rs. 900 and salaries
outstanding Rs. 2,000.
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14. Outstanding Expenses
Outstanding expenses appearing in trial balance:
 If outstanding expenses are given on the credit side of
the trial balance, it means that outstanding expenses
are already adjusted in the relevant expense account.
 In this case outstanding expenses will be shown only
on the liabilities side of Balance Sheet.
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15. Prepaid or Unexpired Expenses
For example:
 Insurance premium is paid by firm on 1st July, 2014 is
Rs. 1,000 for one year. The firm closes its account on
31st March, every year.
 The benefit of insurance premium will continue upto
30th June, 2015, thus as on 31st March, 2015 insurance
premium for three months, i.e., 1st April to 30th June,
2015 will be prepaid insurance or unexpired insurance
and the benefit shall be derived in the next accounting
year.
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16. Prepaid or Unexpired Expenses
Adjustment Entry:
Prepaid Expenses A/c Dr.
To Expenses A/c
(Being prepaid expenses adjusted)
Treatment in final accounts:
i. It is deducted from respective item of expense on the
debit side of Trading/Profit & Loss Account.
ii. It will appear on the assets side of Balance Sheet as a
separate item.
Note: If prepaid expenses are already appearing in the trial
balance then these will be shown only on the assets side of
Balance Sheet.
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17. Accrued Income
 The income which has become due but not yet
received is called accrued income. It is also called
outstanding income or income earned but not yet
received.
Examples:
1. Rent due but not received
2. Interest due but not received
3. Commission due but not received
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18. Accrued Income
Adjustment entry:
Accrued Income A/c Dr.
To Income A/c
(Being accrued income recorded)
Treatment in final account :
i. It is added to the concerned income on the credit side of
Profit and Loss Account or may be shown as a separate
item.
ii. It is shown on the assets side of the Balance Sheet as a
separate item.
Note: If accrued income is already appearing on the debit
side of the trial balance, then it will be shown on the assets
side of the Balance Sheet only.
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19. Accrued Income
Implied Adjustment
 For example, 12 % Government Bonds (Face Value - Rs.
10,000) have been purchased by a firm on 1st October,
2015 for Rs. 9,500. Interest on these bonds is payable
annually on 30th September, every year.
 While preparing final accounts for the year ending 31st
March, 2016, interest from 1st October 2015 to 31st
March, 2016 is accrued and adjustment should be
made for the same, even if not specified in the
question. Accrued interest shall be calculated for 6
months @12% on Rs. 10,000.
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20. Unearned Income or
Income received in advance
Income received but not due.
Examples:
1. Rent received in advance
2. Commission received in advance
3. Interest received in advance
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21. Depreciation
Adjustment Entry:
Depreciation A/c Dr.
To Asset A/c
(Being depreciation charged on ........... )
Treatment in the final accounts :
1. It is shown on the debit side of Profit and Loss Account. When
a manufacturing account is prepared depreciation on factory
building, plant & machinery is shown in Manufacturing
Account.
2. Depreciation is deducted from the respective asset on the
assets side of Balance Sheet.
Note: If depreciation is already appearing on the debit side of trial
balance it will be shown only in the Profit and Loss Account.
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22. Bad Debts
Adjustment Entry:
Bad Debts A/c Dr.
To Debtor’s A/c (Individually)
Treatment in final accounts:
1. Bad debts are shown on the debit side of Profit & Loss
Account.
2. These are deducted from debtors on the assets side of
Balance Sheet.
Note: If bad debts are already appearing in the trial balance,
then these should be shown only on the debit side of Profit
and Loss Account.
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23. Provision for Bad and Doubtful Debts
 Provision is made for a known liability, the amount of
which cannot be determined with substantial
accuracy.
 Provision for bad and doubtful debts is made, when it
is certain that some loss will occur on account of bad
debts, but the parties and the amount of bad debts can
not be identified accurately.
 On the basis of past experience, a provision for bad
debts is estimated.
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24. Provision for Bad and Doubtful Debts
Adjustment Entry:
Profit and Loss A/c Dr.
To Provision for Bad Debts A/c
Treatment in final accounts:
1. It is shown on the debit side of Profit and Loss
Account.
2. It is deducted from the debtors on the assets side of
Balance Sheet.
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25. Provision for Bad and Doubtful Debts
 Old Provision: Provision for bad debts already appearing in trial
balance.
 In this case bad debts, new provision for bad debts and old provision
will appear in Profit and Loss Account as follows:
Profit and Loss Account
For the year ended 31st March, 20xx
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Particulars Rs. Particulars Rs.
To Bad Debts (i) x x
Add: Further bad debts (ii) x x
New Provisions (iii) x x
x x
Less: Old Provision (iv) (x x) x x x

26. Provision for Bad and Doubtful Debts
 If old provision for bad debts is more than the sum of bad debts and
new provision, then these item will be shown on the credit side of
Profit and Loss Account as follows:
Profit and Loss Account
For the year ended 31st March, 20xx
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Particulars Rs. Particulars Rs.
By Old Prov. for Bad Debts xx
Less: Bad debts xx
Less: Further Bad Debts xx
Less: New Provision xxx xxx

27. Provision for Bad and Doubtful Debts
 Net amount debited to Profit and Loss Account can also be
calculated by following equation:
Bad debts (i) + Further Bad Debts (ii) + New Provision
(iii) - Old Provision (iv)
(i) Bad Debts given in trial balance.
(ii) Further bad debts given in adjustments.
(iii) New Provision given in adjustments.
(iv) Old Provision already appearing in trial balance.
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28. Provision for Discount on Debtors
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 Keeping in mind the prudence principle, a provision is
made for discount on debtors. Calculation of provision for
discount on debtors, depends upon our past experience.
 This amount is calculated on the amount left after
deducting provision for bad debts.
Adjustment Entry:
Profit and Loss A/c Dr.
To Provision for Discount on Debtors
Treatment in Final Accounts:
1. It is shown on the debit side of Profit and Loss Account.
2. It is deducted from debtors on the assets side of Balance
Sheet.

29. Provision for Discount on Debtors
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 When provision for discount account is maintained,
the discount allowed account is closed by transferring
its balance to provision for discount on debtors
account.
 Net amount debited to Profit and Loss Account may
also be calculated by following equation:
Discount allowed + Provision to be maintained -
Provision given in trial balance

30. Provision for Bad Debts and Discount on
Debtors
Important Notes:
 New provision for bad debts is calculated on debtors
left after deducting further bad debts and making any
other adjustment affecting debtors.
 New provision for discount is calculated on debtors
after deducting further bad debts and new provision
for bad debts.
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31. Example
 Trial Balance as on 31.3.2015
Dr. Balance Cr. Balance
Debtors 32,000
Bad Debts 1,000
Provision for B/D 800
Adjustments:
1. Write off further bad debts Rs. 2,000.
2. Make a provision for bad debts on debtors @5%.
3. Make a provision for discount on debtors @2%.
Answer:
1. New Provision for B/D – Rs. 1,500
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32. Example
Answer:
1. New Provision for B/D – Rs. 1,500 [5% of 30,000
(32,000 – 2,000)]
2. Provision for discount on debtors – Rs. 570 [2% of
28,500 (32,000 – 2,000 – 1,500)]
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33. Amount to be shown in Profit and Loss Account
Profit and Loss Account
For the year ended 31st March, 20xx
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Particulars Rs. Particulars Rs.
To Bad Debts 1,000
Add: Further bad debts 2,000
New Provisions for B/D 1,500
4,500
Less: Old Provision for B/D (800) 3,700
To Provision for Discount 570

34. Amount to be shown in Balance Sheet
Balance Sheet
As on 31st March, 20xx
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Liabilities Rs. Assets Rs.
Debtors 32,000
Less: Further B/D (2,000)
30,000
Less: Provision for B/D
(1,500)
28,500
Less: Provision for Discount
(570)
27,930