### Financial Statements -II Adjustments - Revision Notes

CBSE Class 11 Accountancy

Revision Notes
Chapter 10 Financial Statements -II Adjustments

Adjustment in preparation of financial statements of Sole-proprietor

Meaning of Adjustment entries: Those entries which need to be passed at the end of the accounting year to show the accurate profit or loss and fair financial position of the business.

Need of Adjustment: There are number of transactions that may not find the place in the Trial Balance due to any reason such as Closing Stock (because it is valued at the end of the year), Manager’s Commission based on Net profits (because its calculation requires preparation of Income Statement first). These transactions can only be taken into account by passing Adjustment entries so that their impact on the profitability and financial position can be shown.

Closing Stock: the closing stock represents the cost of unsold goods lying in the stores at the end of the accounting period.

Outstanding Expenses: When expenses of an accounting period remain unpaid at the end of an accounting period, they are termed as outstanding expenses.
As they relate to the earning of revenue during the current accounting year, it is logical that they should be duly charged against the revenue for computation of the correct amount of profit or loss.

Prepaid Expenses: At the end of the accounting year, it is found that the benefits of some expenses have not yet been fully received; a portion of its benefit would be received in the next accounting year. This portion of expenses, is carried forward to the next year and is termed as prepaid expenses.

Accrued Income: It may sometime happen that certain items of income such as a interest on loan, commission, rent, etc. are earned during the current accounting year but have not been actually received by the end of the same year. Such incomes are known as accrued income. .

Income Received in Advance: Sometimes, a certain income is received but the whole amount of it does not belong to the current period. The portion of the income which belongs to the next accounting period is termed as income received in advance or an Unearned Income.

Depreciation: It is the decline in the value of assets on account of wear and tear and passage of time. It is treated as a business expense and is debited to profit and loss account.
This, in effect, amounts to writing-off a portion of the cost of an asset which has been used in the business for the purpose of earning profits.

 Closing Stock Closing Stock A/c Dr. (i) Credit side of Trading A/c. To Trading A/c (ii) Show on the assets side of BALANCE SHEET. Outstanding/Unpaid Expenses Expenses A/c Dr. (i) Add to the concerned item on the Debit side of Trading/Profit & Loss A/c. Outstanding Expenses A/c (ii) Shown on the liabilities side of BALANCE SHEET. Prepaid expenses/Unexpired expenses Prepaid Expenses A/c Dr. (i) Deduct from the concerned expenses on the debit side of Profit & Loss A/c To Expenses A/c (ii) Show on the assets side of BALANCE SHEET. Accrued income/ Income due but not received Accrued Income A/c Dr. (i) Add to the concerned income on Credit side of Profit and Loss A/c To Income A/c (ii) Show on the assets side of BALANCE SHEET. Unearned income/Income received in Advance Income A/c Dr. (i) Deduct from the concerned income on the credit side of Profit & Loss A/c To Unearned Income A/c (ii) Show on the liabilities side ofBalance Sheet. Depreciation Depreciation A/c Dr. (i) Show on the debit side of ProfitLoss A/c To Asset A/c (ii) Deduct from the concerned asset in the Balance Sheet.

Bad Debts : The debtors from whom amounts cannot be recovered are treated in the books of accounts as bad and are termed as bad debts.

Further Bad Debts : These Bad debts is a loss that occurred after reparation of Trial Balance. Further bad debts be added in the bad debts already appearing in the Profit and Loss Ae and Debtors would be reduced with the same amount.

Provision for Bad Debts : In the balance sheet, debtors appears on the assets side of the Balance Sheet, which is their estimated realisable value during next year. It is quite possible that the whole of the amount may not be realized in future. However it is not possible to accurately know the amount of such bad debts.
Hence, a reasonable estimate of such loss is provided in the book. Such provision is called provision for bad debts. Provision for doubtful debts is shown as a deduction from the debtors on the asset side of the balance sheet.
Note : The provision for doubtful debts brought forward from the previous year is called the opening provision or old provision. When such a provision already exists, the loss due to bad debts during the current year are adjusted against the same and while making provision for doubtful debts required at the end of the current year is called new provision. The balance of old provision as given in trial balance should also be taken into account.

Provision for discount on Debtors : Discount is allowed to customers to encourage them to make prompt payment. The discount likely to be allowed to customers in an accounting year can be estimated and provided for by creating a provision for Discount on debtors.
Provision for discount on debtors is made on good debtors which are arrived at by deducting further bad debts and provision for bad debts out of Debtors shown in the Balance sheet.

 To write off bad debts Bad Debts A/c Dr. (i) Debit side of P&L A/c. To Debtors (ii) Deduct from debtors on the as- sets side of Balance Sheet. Provision for bad and doubtful debts Provision for Doubtful Debts A/c Dr. (i) Debit side of P & L A/c. To Debtors A/c (ii) Deduct from debtors on the assets side of Balance Sheet. Provision for discount on debtors P & L A/c Dr. (i) Debit side of P & L A/c. To Provision for Discount on Debtors Debtors A/c (ii) Deduct from debtors on the assets side of Balance Sheet.

Manager’s Commission
The manager of the business is sometimes given the commission on the net profit of the company. The percentage of the commission is applied on the profit either before charging such commission or after charging such commission. In the absence of any such information, it is assumed that commission is allowed as a percentage of the net profit before charging such commission.

1. Commission on net profits before charging such commission
Commission $=\frac{\text{Net profit before commission}×\text{Rate of Commission}}{100}$

2. Commission on net profits after charging such commission
Commission

 Interest on Capital Interest on Capital A/c Dr. (i) Debit side of P & L A/c. To Capital A/c (ii) Add to capital on the liabilities side of Balance Sheet. Interest on drawings Capital/Drawings A/c Dr. (i) Credit side of P & L A/c. To Interest on Drawings A/c (ii) Deduct from capital on the liabilities side of Balance Sheet. Interest payable on loan (borrowed) Interest on Loan A/c Dr. (i) Debit side of P & L A/c. To Loan A/c (ii) Add to loan on the liabilities side of Balance Sheet. Commission payable to manager P& L A/c Dr. (i) Debit side of P & L A/c. To Comm. Payable to manager A/c (ii) Show on the liabilities side of Balance Sheet.

Abnormal Loss : Sometimes losses occur due to some abnormal circumstances such as accident, fire, flood, earhquakes etc. Such losses are called Abnormal losses. These may be divided into two categories :-
(A) Loss of Goods (B) Loss of fixed assets
Good taken for personal use {Drawings in goods) : When the goods are withdrawn by proprietor for personal use the cost of such goods deduct from purchases and the amount should be deduct from capital in Balance Sheet.
Goods distributed as free samples : Sometime goods are distributed as free sample by the businessman for the purpose of advertisement. The cost of free sample deduct from purchase and shown in Debit side of profit and loss account.

Abnormal loss of goods by fire, theft, accident, etc.

 Adjustment Treatment in Trading & P & L A/c Treatment in Balance Sheet 1) Loss of Goods (By accident, Fire, Theft) 1) Loss of ... A/c Dr. (i) Gross Loss: Deduct from Purchases or show on the credit side of Trading A/c. To Trading A/c(or) To Purchases A/c If goods were note insured 2) P & L A/c Dr. (ii) Net Loss: Debit side of P & L A/c. To Loss by ...... A/c If goods were insured and full claim accepted by insurance company 2) Insurance company A/c Dr. (iii) Insurance claim: Assets side of Balance Sheet. To Loss by ... A/c If full claim not accepted by Insurance Company 2) Insurance Company A/c Dr. Profit & Loss A/c Dr. To Loss By .... A/c 2) Goods taken by the proprietor for his personal use Drawings A/c Dr. (i) Deduct the amount of goods from the purchases in Trading A/c. To Purchases A/c (ii) Deduct the amount from the capital on the liabilities side of Balance Sheet. 3) Goods distributed as free samples Advertising A/c Dr. (i) Deduct the amount of goods from the purchases in Trading A/c. To Purchases A/c (ii) Show on the debit side of P & L A/c. 4) Goods given as charity Charity A/c (i) Deduct the amount from the purchases on the debit side of Trading A/c. To Purchases a/c (ii) Show on the debit side of P & L A/c.

Key Points:

1. If closing stock is shown in Trial Balance then it will be shown in balance sheet only. It is assumed that purchases amount already gets adjusted in trial balance.
2. Salary and wages will be shown in profit and loss A/c debit side (assuming that salary is prominent) while wages and salary will be shown in trading A/c debit side, (wages are prominent).
3. Freight, carriage, cartage will be shown in Dr. side of trading A/c. if inward word attached with these then it also debited to trading A/c, if outward word attached with these item then it will be debited to profit and loss account.
4. Any expenses related to factory are debited to trading account like factory lighting, factory rent if factory word is not given then lighting and rent will be debited to profit and loss account.
5. Trade expenses always debited to profit and loss A/c not as name indicate trading A/c.
6. Packaging material: cost of packaging material used in product are direct expenses as it refers to small containers which form part sold, it will debited to trading A/c.
7. Packing: the packing refers to the big containers that are used for transporting the goods and regarded as indirect expenses and debited to profit and loss account.
8. Adjusted purchases mean the amount of purchases is adjusted by way of adding opening stock and reduced by the amount of closing stock, e.g., purchases Rs. 1,00,000; opening stock Rs. 12,000, closing stock Rs. 8,000. Calculate adjusted purchases.
Adjusted purchases = purchases + opening stock - closing stock
= Rs. 1,00,000 + Rs. 12,000 - Rs. 8,000 = Rs. 1,04,000
When adjusted purchases is given in trail balance, then there is no need of debiting opening stock and crediting closing stock in trading A/c.
In this case closing stock will be shown in balance sheet only.

Remember
While preparing Final Accounts the items which are given inside the Trial Balance are written only once either in Income Statement or in the Balance Sheet. (Assuming that they have been already adjusted in the respective account). On the other hand, the items which are given outside the Trial Balance (known as adjustment) are to be written twice because the double entry in respect of all adjustments is to be completed in the final accounts itself.