CLOSING ENTRIES:- The entries that have to be made in the journal for preparing the Trading and the Profit and Loss Account that is for transferring the various accounts to these two accounts are known as closing entries. We have already seen the entries required for preparing the Trading Account and for transferring the gross profit to the profit and Loss Account. Now to complete the Profit and Loss Account, the under mentioned three entries will be necessary.
(a) For items to be debited to the Profit and Loss Account this account will be debited and the various accounts concerned will be credited. For example,
(b) Items of income or gain such as interest received or miscellaneous income will be credited to Profit and Loss Account.
(c) At this stage, the Profit and Loss Account will show net profit or net loss. Both have to be transferred to the Capital Account. In case of net profit, i.e., when the credit side is bigger than the debit side, the entry is:
ILLUSTRATION 3:- Revenue, Expenses and Gross Profit Balances of M/s ABC Traders for the year ended on 31st March 2016 were as follows:
Gross Profit ₹4,20,000, Salaries ₹1,10,000, Discount (Cr.), ₹18,000, Discount (Dr.) ₹19,000, Bad Debts ₹17,000, Depreciation ₹65,000, Legal Charges ₹25,000, Consultancy Fees ₹32,000, Audit Fees ₹1,000, Electricity Charges ₹17,000, Telephone, Postage and Telegrams ₹12,000, Stationery ₹27,000, Interest paid on Loans ₹70,000.
Required:- Prepare Profit and Loss Account of M/s ABC Traders for the year ended on 31st March, 2016. Show necessary closing entries in the Journal Proper of M/s. ABC Traders also.
In the Books of M/s. ABC Traders Profit and Loss Account For the year ended 31st March, 2016
Journal Proper in the Books of M/s. ABC Traders:-
Adjustments:- The fundamental principle of accounting is that the period to which various items of income and expenditure pertain should be co-extensive with the period of account. As such before Final Accounts are drawn up. It must be ensured that the accounts, which require adjustment on this consideration, have been adjusted, both by providing for expense accrued and including income outstanding and excluding expenses the benefit of which extends beyond the year of account as well as the income received in advance. The entries that must be passed for adjusting various accounts of income and expenditure are shown below:
(1) Expenses accrued and accruing, e.g., Rent, Interest, Local Taxes, Wages etc.
For Example, if Rent Paid is ₹50,000 for a year and Outstanding Rent is ₹14,000. It will be treated as follows:-
(2) Income accrued and accruing, e.g., Interest on Government Loans, Discounts on Bill, Professional fees, Rents and Premiums on leases, etc.
Suppose interest received is ₹1,50,000 and accrued interest for the same period is ₹45,000. It will be treated as follow:-
(1) The term “accrued” signifies that an amount has been incurred as expense or earned as income, the due date of payment of which falls in the next financial period. If the due date of payment occurs in the current accounting period the term used should be “Outstanding” or “accrued and due”.
2) The expression ‘accrued and accruing’ signifies items which though not due for payment but pertain to the period of account, a provision for which has been made. Converse is the position so far as items of income are concerned.
(3) Carrying forward income received in advance e.g., Subscription in the case of a club or fees in case of professional person.
For Example Subscription Received in advance is ₹70,000 and total subscription received is ₹1,75,000.
(4) Carrying forward of payments made in advance e.g., Telephone, Rent, Insurance etc.,
Suppose out of the total Rent of ₹50,000. ₹14,000 pertains to the next year.
(5) Adjustment of Inventory of materials in hand, e.g., Stationery, Advertisement, Material, Manufacturing Stores, etc., the cost whereof already has been debited to expense account.
For Example if opening stock of stationery is ₹15,000 and direct expenses on it is ₹1,700. It is also given outside the Trial Balance. Closing stock of stationery is ₹5,000. The treatment is as follow:-
Note: Next year in the beginning entries No. (1) to (5) should be reversed.
(6) Provision for Bad and doubtful Debts: When it is feared that some of the amount due from customers will not be collected it is prudent to recognise the expected loss by reducing the current year’s profit and placing the amount to the credit of a special account called “Provision for Bad and Doubtful Debts Account”. The entry is;
Note: The accounts of the customers concerned are not affected until the amount is actually written off for which the entry is,
Bad Debts when written off are debited to the provision in this respect where such a provision exists or directly to the Profit and Loss Account the corresponding credit being given (ultimately) to the trade receivable’s account. If, on the other hand, a provision is required to be created, the amount of provision is also debited to the Profit and Loss Account. Where an examination problem requires that certain bad debts should be written off and a provision for doubtful debts made, the amount of bad debts to be written off should be first debited against the existing balance of the provision and the resulting balance in the account afterwards should be raised to the required figure. The method is illustrated below:
ILLUSTRATION 4:- On 1st Jan. 2017 provision for Doubtful Debts existed at ₹40,000. Trade receivables on 31.12.2017 were ₹15,00,000; bad debts totalled ₹1,00,000. It is required to write off the bad debts and create a provision equal to 5% of the Trade receivables’ balances.
Required:- Show how you would compute the amount debited to the Profit and Loss Account.
Provision for Doubtful Debts Account:-
(7) Provision for Discount: This provision is created in the same manner, discussed above but the amount of provision is required to be calculated after deducting the Provision for Bad Debts from the total trade receivables. This is because Provision for discount is created only on good debtors.
For Example if Trade Receivables is ₹5,20,000 and provision for doubtful debt is ₹1,20,000. You are required to create a 10% provision for discount on debtors.
(8) Provision for Depreciation: It is made either by debiting Depreciation Account and crediting the Provision for depreciation account concerned and afterwards closing of the Depreciation Account by transfer to the Profit and Loss Account or by directly debiting the profit and loss Account and crediting provision for depreciation account and explaining the nature of adjustment by recording a detailed narration in the Journal.
The amount of depreciation is deducted from the concerned asset and is then shown in the Balance sheet.
For Example if machinery Cost ₹15,00,000 and 10% depreciation is to be provided. The treatment is as follow:-
Depreciation is now charged to P&L a/c as:
(9) Other Provisions: Whenever it is expected that a loss, the amount of which is not certain will occur, the proper course is to create a provision for meeting the loss if and when it occur. This would be the case, for example, if compensation has to be paid for the late delivery of goods. The entry is to debit the Profit and Loss Account and credit an account suitably named.
All accounts showing provisions may appear in the Balance Sheet on the liability side but it should be noted that:
(i) The provision for Bad and Doubtful Debts and the Provision for Discount on Trade receivables are deducted from the total book debts; and
(ii) The provision for Depreciation is deducted from the cost of the assets concerned.
(10) Transfers, involving correction of errors, are made by debit or credit to the accounts affected, the corresponding effect being recorded either in a Suspense Account of some other account.
Transfers in respect of special charges to the Profit and Loss Account e.g., partner’s salaries, interest, etc., and in respect of appropriation of profits are recorded by debit to the Profit and Loss Account and credit to the parties concerned.
While making adjustments, it is important to remember that every entry has a two-fold aspect, debit and credit. For example, if an adjustment is required to be made on account of prepaid insurance charges, the Insurance Charges Account would be credited, and, to complete the double entry, Prepaid Expenses Account is debited with the same amount. The last mentioned balance would be included on the debit side of the Trial Balance.
Students should, as a matter of course, record on the rough working sheets, adjustments in respect of various items stated in a question and then give their effect in the Trial Balance, before proceeding to draw up the Final Accounts.
1.5 CERTAIN ADJUSTMENTS AND THEIR TREATMENTS :-
1. Abnormal loss of Inventory by accident or are : Sometimes loss of goods occurs due to are, theft, etc. If due to accident or are, a portion of Inventory is damaged, the value of loss is first to be ascertained. Thereafter, Abnormal Loss Account is to be debited and Purchase Account or Trading Account is to be credited.
Abnormal Loss Account is to be transferred to Profit & Loss Account. If amount of loss is recoverable from insurance company, then insurance company is to be debited instead of Profit & Loss Account. Till the money is not received from the insurance company, Insurance Company’s Account will be shown in the Assets side of the Balance Sheet. If any part of the loss is recoverable from the insurance company, then the portion not compensated by the insurance company should be debited to Profit & Loss Account. For example, if goods worth ₹6,000 are destroyed by fire and the insurance company admits the claim for ₹4,500, the Journal entries will be:-
In the Trading Account, Purchases will be reduced by 6,000.
2. Goods sent on Approval basis: Sometimes goods are sold to customers on sale or return basis or on approval basis. It should not be treated as actual sale till the time it is not approved by the customer. When goods were sold we have passed the entry for actual sales. Therefore, at the year end, if the goods are still lying with the customers for approval, following entries are to be passed:
For example -
Goods costing ₹10,000 sent to a customer on sale or return basis for ₹12,000. The entry for such unapproved sale shall be-
These goods should now be included in the amount of Closing Stock at their cost price.
3. Goods used other than for sale : Sometimes goods are used for some other purposes, such as distributed as free samples, used in construction of any assets or used by proprietor for personal use. In such cases the amount used for other purposes is subtracted from Purchases A/c and depending upon the specific use done, the suitable account head is debited.
When goods are used in business for construction of Building or the Machinery :-
4. Commission based on profit: Sometimes commission is payable to manager based on net profit; in such a case calculation is done as follows:
(Being commission payable to Mr ….. @ …..% on net profit after charging such commission, net profit before charging commission being ₹……..)
Commission will be debited in the Profit & Loss Account and Commission Payable Account will be shown in the Balance Sheet on liability side.
For Example if Net profit before Commission is ₹1,00,000 and Manager is entitled to a Commission of 10% of Net Profit before charging such commission. The amount of Commission is = ₹10,000 (10% of ₹1,00,000). It will be shown as follow:-
Now, let us assume that 10% commission is payable on Net Profit after charging such commission. The amount of commission now is = 9,090.90 or 9091 (approx) (₹1,00,000 x 10/110)