WITH ADJUSTMENT

FINALACCOUNT

INTRODUCTION

Final accounts are prepared to achieve the objectives of accountancy. A businessman isInterested to know the final result of the business– Whether he has earned profit or sufferred loss in that particular amounting period.The businessman prepares certain financial statements at the end of accounting period. In order to know profit or loss

An earned by a firm income statement or trading and profit and loss account is prepared. Balance sheet orposition statement will portray the financial condition of a firm on particular date. These two statements i.e. trading and profit and loss Account and balance sheet are preparedto give final results of the business, that is why both these are collectively called Final Accounts.

COMPOSITIONOF FINAL ACCOUNTS

Manufacturing

account Trading

account Profit &

loss account

Balance sheet

MEANING OF ADJUSTMENTThose transactions which relate to the accounting periodFor which financial statements are being prepared but arenot included in the trail balance because these transactionhave not yet been recorded in the books of accounts arecalled “ADJUSTMENTS”.

In addition to it, those transactions which have been recoded in the books of accounts but they don't relate to the accounting period for which accounts are being prepared are also called “ADJUSTMENTS”.

LIST OF IMPORTANT ADJUSTMENTS :

(I) Outstanding Expenses(II) Prepaid Expenses(III) Accrued Income(IV) Income received in advance(V) Closing Stock(VI) Depreciation(VII) Interest on Capital(VIII) Interest on Drawings(IX) Bad Debts to be written off(X) Provision for Bad Debts(XI) Provision for discount on Debtors(XII) Goods withdrawn for domestic use(XIII) Opening Stock(XIV) Goods used in Business (free samples, charity

or Gifts)

IMPORTANT ADJUSTMENTS(I).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 postponed are all outstanding or unpaid expenses. All such expenses must be accounted for in that year in which they are incurred, irrespective of the fact whether they are paid or not.

Example :The adjustment entry required will be as follow : Salaries a/c Dr To Outstanding salaries a/c

TREATMENT OF ENTRY : Salaries outstanding A/c Salary A/c To Bal c/d By Salary 200 To Cash 2200 By profit200 (for 1 month) (for 11 month)

&loss To Salary 200

A/c 2400 (for 1 month) 2400

2400 Balance sheet Profit and loss A/cSalary 200 To Salary

2400Outstanding (+)O/S salary 200

(II) PRE – PAID EXPENSES

The benefits of some of the expenses already spent will be available in the next accounting year also. Such a portion of the expenses is called pre-paid expenses; since such expenses are already paid, they are also recorded in the books of accounts of a particular period to which they do not relate. The result shown by the final accounts of a particular period will not 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. Like insurance, taxes , telephone, rent paid in advance, thus requiring adjustment.- EXAMPLE Rent paid by x for one year on 1.7.09 when his accounting year is calendar year ; thus rent for 6 months will remain unexhausted and will be carried to the next year.

THE ADJUSTING ENTRY AND TREATMENT :

P & L A/C Balance sheet

To rent 400(-)prepaid 100

Liabilities Assets prepaid rent 100

(III) ACCRUED INCOMEThere may be certain incomes which have been earned during there the year but not yet received till the year end. Income like interest on investment, 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 adjustment before the preparation of final accounts. Such income should be credited to that income account. At the same time, the income so earned but not received is an asset because the amount is still to be received. The adjusting entry will be under :

The adjusting entry will be under :

P & L A/C Balance Sheet By commission 500 Liabilities Assets (+)Accrued com.100 Accrued 100 commission

At the beginning of next year , the above adjusting entry will be reserved as under : commission a/c Dr. To Accrued commission (it will close the accrued commission a/c)

(IV) INCOME RECEIVED IN ADVANCE

Sometimes, traders receive certain amounts during aParticular 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.(1)Such income should be credited to profit

and loss account of the year in which they earned.

(2)Therefore, such income though is not the income but a liability of that period.

EXAMPLE :In the trail balance of Ram the amount of

commissionCredit side is 500.ADJUSTMENT : Commission received in

advance 100

(Dr.) P & L A/C (cr.) Balance Sheet By commission 500 Liabilities Assets (-)commission 100 commission received received in in advance -> 100 advance

500 100

At the commencement of next year, the above adjusting entry will be reversed by debiting commission received in advance a/c and crediting rent a/c. This will close the rent received in advance account.

INCOME RECEIVED IN ADVANCE

(V) CLOSING STOCK

Its represent the unsold stock at the year end. Generally, closing stock does not appear inside the trail balance. It that case, it is shown on the credit side of trading account. But sometimes it appears inside the trail balance, it is not to be shown on the credit side of trading account but appears only in the balance sheet as an asset. Closing stock should be valued at cost or market price, which ever is least.(FOLLOWING ENTRY IS PASSED ON THE YEAR END) : Closing stock a/c Dr. To Trading a/c

EXAMPLE :Following balance appear in the trail balance of Mr.NitinFor the year ending 31 march, 2006. Particulars Dr. Cr. Closing Stock 5400 ------ Purchases 1200 ------ Sales ------- 20,000

ADJUSTMENT : Closing stock at the end of year was Rs.3,500. Adjustment entry : Dr. Cr. closing stock a/c Dr. 3500 To Trading a/c 3500

To opening stock 5,400 Rs By Sales 20,000 RsTo Purchases 12,000Rs By Closing stock 3500 RsTo Gross profit c/d 6100 Rs

23,500Rs 23,500 Rs

Balance Sheet

Liabilities Amount Assets Amount Closing Stock 3500 Rs

Dr. Trading Account Cr.

(VI) DEPRECIATION

The value of fixed assets diminishes gradually with their use for business purposes . Although thisDiminishes in the value happens everyday but its accounting is done only at the end of accounting period with the help of the following entry :

Depreciation a/c Dr. To Particular assets a/c Profit & loss A/c Balance Sheet Liabilities Assets

To Dep. 200Furniture 2000(-) Dep. 200

The entry may have been passed before preparation of trial balance. In that case the depreciation account will appear in the trail balance itself ; also the concerned asset will appear at its reduced value since the amount of depreciation would have been credited to it. In that case no further adjustment would be necessary.The depreciation will debited to profit & loss account likeOther expenses.

NOTE : When it is desired that fixed assets are to be shown at their Original cost.

(a)When depreciation is provided for on fixed, adjustment entry would be ::

Depreciation a/c Dr. To Provision for Depreciation

(b) When depreciation account is closed , the adjustment entry would be : Profit and Loss a/c Dr. To depreciation a/c

(VII) INTEREST ON CAPITAL

The proprietor may wish to ascertain his profit after considering the interest which he loses by investing his money in the firm. Interest to be charge is an expense for the business on one hand and income to the proprietor on the other hand. Following adjustment entry is recorded at the end of accountingPeriod. Interest on capital a/c Dr. To capital a/c

Interest on capital being an expense is debited to profit & loss a/c and same amount of interest on capital is added to Capital.

The adjustment entry is explained given below :

(Dr) Profit & loss A/C (Cr) Balance Sheet Liabilities Assets To interest 500 Capital 10,000 on Capital (+)Interest on 500 Capital 10500

(VIII) INTEREST ON DRAWING

As business allow interest on capital, it also chargesInterest on drawings made by the proprietor. InterestSo charged is the income of the business on one hand and expense for the proprietor on the other hand. Following 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 & loss a/c and is shown as a deduction from the capital.

The treatment of interest on drawings in the final accounts will be as follow : (Dr) Profit & loss A/C (Cr) Balance Sheet Interest on 500 Liabilities Assets drawings Capital 10,000 (-)Interest 500 on drawings 9500

(IX) BAD DEDTS TO BE WRITTEN OF

Bad debts are irrecoverable debts from the customers, during the course of the financial year. These are recorded as : Bed debts a/c Dr. To customer (particular) a/cIt result in the reduction of customer’s debit balance and addition to the loss i.e. bad debts. At the end of the year, when the trail 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 trail 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 adjustment entry and giving its following effect in the final accounts.(Dr) Profit & loss A/C (Cr) Balance SheetTo bad debts 600 Liabilities Assets a/c debtors 1000 (-)bad 600 debts 400NOTE: If bad debts are appearing inside the trail balance these should not be deducted from debtors in the balance sheet. In this case, bad debts are only to be shown on the debit side of profit & loss a/c.

(X) PROVISION FOR BAD DEBTS

At the year end, after writing off the bad debts about whom we sure of becoming irrecoverable, there may still be some customer balances from whom it is doubtful to collect the entire amount. However, it can’t 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 realisable figure so that balance sheet may not exhibit the debtors at more than there actualRealisable value. Therefore, to show the approximately correct value of the sundry debtors in the balance sheet, a provision is created for possible bad debts. This adjustment is recorded at the end year

Provision for bad debts is an attempt to anticipate possible losses due to bad debts and to keep aside an amount against the profit to meet the loss estimated in the following year. Entry for the provision for bad debts : Profit & loss a/c Dr. To provision for bad debts a/c (Dr) Profit & loss A/C (Cr) Balance Sheet To provision 500 Liabilities AssetsFor doubtful debtors 10000Debts (-)provision 500

(XI) 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 customer in one accounting period, whereas the payment is made by them in the next accounting period and discount is to be allowed to them. It is 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 doubtful debts i.e.. Profit and loss a/c Dr. To provision for discount on debtors

(XII) GOODS WITHDRAWN FOR DOMESTIC USE

Sometimes, proprietor withdraw goods, in which he is dealing for his domestic use. At the end year, one adjustment entry is passed for the total goods withdrawn during the year. The adjustment entry is passed with the total cost of goods withdrawn. Drawing or capital a/c Dr. To purchases a/cTREATMENT :(1)The value of goods withdrawn should be

deducted from purchases on debit side of trading account.

(2)Same amount is deducted from capital in the liabilities side of balance sheet.

The above entry will be treated in accounts as follow: Trading account Balance

SheetTo purchases 5000 Liabilities Assets(-)drawings 300 capital 80000 On goods (-)drawings 300 on goods

(XIII) OPENING STOCK

In case opening stock is appear outside the trail balance,It is simply an information and should not be taken as an adjustment. It means that value of opening stock has already been adjusted in purchases account. So, it should Not be taken as an adjustment. Sometimes, traders in order to suppress their profits undervalue the stock, in that case following adjustment should be made.The amount suppressed should be added to opening stock in the debit side of trading account and same amount should be added to the capital the liabilities side of the balance sheet. To give effect to above, following adjustment entry is

Passed, which will bring back stock at its real value. Opening stock a/c Dr. (with amount

To capital a/c suppressed)EXAMPLE : Ram values his stock at 20% below cost. While preparing theFinal accounts he has decided to show it at its original a/c.Opening Stock : 4000 Capital : 6000 Trading account Balance SheetTo Opening 4000 Liabilities AssetsStock Capital 6000(+)Addition20% (+)profit 1000 1000 on revaluation of opening stock

(XIV) GOODS USED IN BUSINESS It is a kind of advertisement, when goods in which a trader deals are distributed among valued customers as free samples as publicity of the product. This resultIn reduction of stock of trader. For giving effect to it,Following adjustment entry is passed at the year end. ADJUSTMENT ENTRY :

Advertisement a/c Dr. Or Charity a/c Dr. Or Gift a/c Dr. To Purchases a/c

( Being goods distributed as free samples/ Gifts )

TREATMENT :(i) The cost of free samples/gifts is deducted

from purchases in trading a/c debit side.(ii) Same amount is also shown on debit side

of profit & loss account.

Trading account Profit & loss a/cTo Purchases To Charity a/c& To Adv. (-)goods used in business