Key Notes: Financial Statements - II | Accountancy Class 11 - Commerce PDF Download

Need for Adjustments

Accounting adjustments are required because we use the accrual basis of accounting while preparing final accounts. In the accrual basis of accounting, revenues are considered on an earned basis, not on a receipt basis. Similarly, expenses are to be considered on an incurred basis and not on a paid basis.
Because of this, many payments and receipts that are recorded in the current year may not actually be attributable to the current year’s financial accounts after considering the accrual basis of accounting. Thus, these elements must be adjusted so that the objectives of the financial statements can be achieved i.e, to describe the company’s faithful and fair financial performance. 

Adjustments are required in the following:

• Closing stock: This is the stock of goods left at the end of the accounting year. The adjustment for closing inventory is made by:
  crediting it to the trading and profit and loss account
  recording it as an asset on the balance sheet
• Outstanding Expenses: These are unpaid expenses that businesses have not paid in the current accounting period and are due. 

To unpaid A/c expenses – Unpaid expenses are added to a specific expense item in the operating and Profit and Loss account and appear as liabilities on the balance sheet.

• Prepaid Expenses: These are expenses paid in advance by the businesses. The benefits of these expenditures are not received in the current accounting year but in subsequent years. 

An Affected Loads A/c – Prepaid expenses are subtracted from the particular expense head in Trading and Profit and Loss A/c and are shown as assets on the balance sheet.

• Accrued Revenue: This is revenue that is accrued but not yet received. 

To the income concerned, A/c – Accrued income is added to the relevant income item in the operations and Profit and Loss Account and appears as an asset on the balance sheet.

• Income received in advance: This is income that is received in advance but not yet accrued. 

Income received in advance A/c – Income received in advance is deducted from the respective income item in the operating and Profit and Loss account. It appears as a liability on the balance sheet.

• Depreciation: Depreciation is the decline in the book value of the assets due to regular wear and tear and the passage of time. 

To Asset Concerned A/c – It is debited from the Profit and Loss Account, and on the Balance Sheet, the asset is presented at cost less depreciation.

• Bad Debts: This is the amount that cannot be recovered from the debtors. This is considered a loss.

To A/C debtors – It is debited to the operating and Profit and Loss Accounts, and on the balance sheet, debtors have presented at their book value less bad debts.

• Provision for bad debts: Sometimes, we make a provision for a certain amount of debtors who may/ may not be realized in the future, such provisions are called provisions for bad debts. 

To Allowance for Doubtful Accounts A/C – The provision for bad debts is Debited from the operating and income statement. The number of debtors has presented as book value less the provision for bad debts on the balance sheet.

• Allowance for Discount on Accounts Receivable: Sometimes, companies allow a discount on the amount receivable from accounts receivable. There is a provision for a discount on accounts receivable, which is an expense for the company. Provision for discount is always made on good debtors by deducting the bad debts from the book value.  

A Provision for discount on accounts receivable A/c – This provision is an expense debited from the operating and income statement. On the Balance Sheet, the amount of debtors is reduced by the amount of the requirement for a discount on debtors.

• Manager’s commission: This is the commission that the manager receives from the company’s net profit. Manager’s commission percentage can be in the form of a share before the invoicing of the Manager’s commission or after the invoicing of this commission. And in case of nothing is mentioned in the question, it is assumed that the commission is paid before charging such a commission.