Adjustments in Financial Accounting

The ultimate aim of the Trading and Profit and Loss Account is to know the real Profit or Loss of
the concern during a given period. The purpose of the Balance sheet is to know the financial
position at a given period. True profit can be arrived at after adjusting all pending bills and
outstanding expenses and incomes through entries. These entries which are passed at the end of
the accounting period are called adjustment entries. The following important adjustments which
are to be made at the end of the year are as follows.

Important Adjustments

1. Closing stock

2. Outstanding expenses

3. Prepaid or unexpired expenses

4. Income earned but not received or Accrued income

5. Income received in advance

6. Depreciation

7. Interest on capital

8. Interest on drawings

9. Interest on loan

10. Bad debts

11. Provision for bad and doubtful debts

12. · Provision for discount on debtors

13. Provision for discount on creditors

14. Goods distributed as free of sample

15. Loss of stock by fire 

In the actual sense all the above adjustments are given outside the Trial Balance. While preparing
the Final accounts all the adjustments are to be considered. Normally all the adjustments will
appear at two places in the final accounts i.e., either i) Trading Account and Balance Sheet or 
(ii) Profit & Loss Account and Balance Sheet 

Adjustment and their Treatment

1. Closing Stock

Trading Account                                 –           Credit side

Balance Sheet                                     –           Asset side. 

2. Outstanding Expenses

Trading or Profit & Loss Ale              –           Debit side

Balance Sheet                                     –           Liability side 

3. Prepaid Expenses

Profit & Loss Account                        –           Credit side

(subtract from respective expenses)

Balance Sheet                                     –           Asset side 

4. Income Due but not Received

Profit & Loss Account                        –           Credit side

(Add with respective incomes)

Balance Sheet                                                 –           Asset side 

5. Income Received in Advance

Profit and Loss Account                     –           Credit side

(Subtract from respective incomes)

Balance sheet                                      –           Liability side 

6. Depreciation Profit and Loss Account                     –           Debit side

Balance Sheet                                     –           (Subtract from respective Assets)

 
 

7. Interest on Capital

Profit and Loss                                   –            Account Debit side

Balance Sheet                                     –             liability side (Add the capital)

8. Interest on Drawings

Profit and Loss Account                     –           Credit side

Balance sheet                                      –           Liability side (Subtract from capital)

9. Interest on Loan

Profit and Loss Account                    –             Debit side

Balance Sheet                                     –             Liability side

(Add with the respective loan) 

10. Bad Debts New

Profit and Loss Account                     –              Debit side

Balance Sheet                                     –              Asset side

(Subtract from the sundry debtors) 

11. Provision for Bad and Doubtful Debts

Regarding the Bad debts and provision for Bad and doubtful debts we have to apply the
following formula.

BD + NR- OR 

BD : It refers to the bad debts. It should be given either Trial Balance or Adjustments or both.
The value of bad debts is transferred to formula for calculation. The calculated value should be
transferred either to debit side or credit side of the P.L & A/c.
Bad Debts (Adjustment)

Treatment: 

(i) BIS Asset side [Subtract from Debtors], (ii) Transfer to formula [P.L & A/c) NR : It refers to
New Reserve. Normally it should be give in the adjustment, in the name of provision for
doubtful debts or reserves on debtors and so on.

Treatment: 

(i) Transfer to formula, (ii) Balance Sheet : Asset side (Subtract from the Debtors)

OR : It represents old reserve. Normally, bad debts provision i.e., old reserve is given in the
Trial Balance. The treatment is that it should be transferred to the formula for calculating new
bad debts provision.

After finding the value, to apply the formula it should be transferred to P.L & Ale either debit
side or credit side.

12. Provision for Discount on Debtors

– Profit & Loss Accounts Debit Side

– Balance Sheet Asset side [Deduct from sundry debtors]

13. Provision for Discount on Creditors

– Profit & Loss Accounts Credit Side

– Balance Sheet Liability side [Deduct from sundry creditors]

14. Goods Distributed as free of samples

– Trading Accounts Debit Side [Deduct Purchases]

– Profit & Loss Accounts Debit Side (treated as advertisement expenditure).

15. Loss of Stock by fire 

(a) If Insurance Company admitted the full claim

Trading Account credit side (Total stock value destroyed by fire)

Balance Sheet Asset side (Insurance Company Accounts)

(b) If Insurance Company admitted the part of the claim : (for example 60%)

Trading Account credit side (Total stock value Destroyed by fire) (100%)

Profit and Loss Account Debit side (Loss by fire) (40%)

Balance Sheet Asset side (Insurance Company Account) (60%)

16. Managers Commission

In an organization earn higher amount of profit it may give at certain percentage of commission
on the net profit to their manager. It may calculate as follows:

Commission Payable = (% of commission/ 100+ rate of commission)* residual profit