ADJUSTMENT TO FINANACIAL STATEMENT

Financial statements should be generated in accordance with generally accepted accounting

concepts and principles. When producing financial statements there are balances that we can’t
extract as they are. There may be errors in ledger accounts. In order to correct them and update
ledger accounts before preparing financial statements accountants keep adjustment entries in
general journal. Some figures we can’t extract directly and we have to adjust them according to
the accounting period and relevant accounting principles/ policies.

We make adjustments to financial statements because of the reasons below.

 To prepare financial statements in accordance with accrual basis.
 To prepare financial statements in compliance with accounting concepts and principles.
 To show an accurate picture on financial position and performance to decision makers.

Our aim is to study the following adjustment entries in this chapter.

1. Closing inventory
2. Accrued and prepaid expenses
3. Accrued and prepaid income
4. Bad debts and provision for doubtful debts

01. CLOSING INVENTORY / STOCK

 It is obvious that total inventory purchased during the year or produced finished goods will not
convert to sales during the same year.
 When computing gross profit we consider the cost of goods sold against sales value.
 In other terms the closing stock is not contributed to generate revenue. To compute cost of
sales we remove the value of stock that is not sold within the accounting period and it is
termed as “Closing Stock”,
 Closing stock is considered as a current asset to the entity. Closing stock generates future sales
(Future Economic Benefits) and so we transferred them to the asset account.
 Entries for Closing Stock As Follows
Closing Stock A/C Debit
Trading Account A/C Credit

ADJUSTMENT TYPE
 Cost & Net Realize Value of Stock Given in an adjustment. The following steps to carried out
01. Enter the Cost Value in Trading A/C to Calculate Cost of Sale
02. Compare the Two Value s and if NRV < COST Enter the NRV Amount in Balance sheet
03. The Difference between Cost & NRV to be entered as Loss of the value of Stock under the other
Expenses in Income Statement.
 Stock on the way- Some time ordered stock in particular financial Year not reach the store
and not included in the stock verification. At this situation we must include the amount of
stock on the way into Closing Stock Calculation
 Sample Stock – Some time the org. receive the sample stock for testing Purpose so when
calculating closing stock to ignore the sample stock.

02. ACCRUED AND PREPAID EXPENSES

ACCRUED EXPENSES

The income statement has to include the expenses relating to the period, weather not they have
been paid. The figures in the trial balance will usually be the amounts paid in the period, and they
need adjusting for outstanding amounts to obtain the income statement charge. Unpaid
balances relating to the period should be include in the statement of financial position as current
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liabilities. The accrued amount relating to period,

Dr. Relevant Expense Account
Cr. Accrued Expense Account

Example 01. The following information has been extracted from Mr. Krishantha’s Business.

Debit (Rs.) Credit (Rs.)

Building Rent 20,000
Electricity 37,000
Bank Loan (10%) 400,000
Loan Interest Paid 31,000

Additional Information
I. Electricity bill of Rs.3, 500 for the month of March 2014 is no settled yet.
II. The office building is obtained under a rent agreement of Rs.2, 000 per month.
Last two month rent is due.
III. The bank loan is obtained on 01.04.2013,

Required
Show the relevant extract from Profit and Loss account for the year ended 31.03.2014. And
Statement of Financial Position as at 31.03.2014.

Extract from Profit Loss Account.

Rs. Rs.
ADMINISTATION EXPENCES
Electricity 37,000 + 3500 40500
Building Rent 20000 + 40000 24000

FINANCE & OTHER EXPENSES

Bank loan Interest 31000 + 9000 40000

Extract from State of Financial Position

Rs. Rs.
NON CURRENT LIABILITIES
Bank Loan 400,000

CURRENT LIABILITIES
Accrued Electricity 3500
Accrued Building Rent 4000
Accrued Loan Interest 9000

PREPAID EXPENSES
In carrying out business we identify situations that we have paid amount in excess to the relevant
amount for the accounting period. These excess amounts are relating to future periods. If the
expense has been paid in advance, the amount prepaid is included in the statement of financial
position as a current asset. The amount paid in advance
Dr. Prepaid Expense Account
Cr. Relevant Expense Account
Example 02 the following balances were extracted from Geeth’s Trading Co. as at 31.03.2014.
Debit (Rs.) Credit (Rs.)
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Building Rent 48,000

Insurance Fees 40,000
Additional Information
I. Geeth’s Trading Co. entered into a rent agreement on 01.10.2013 to pay Rs.3, 000 per
month for the office building.
II. Insurance fees include an amount of Rs.5, 000 which is relevant to the financial year of
2014/2015.
Required
Show the relevant extract from Profit and Loss account year ended 31.03.2014 and Statement of
Financial Position as at 31.03.2014.

Extract from Profit Loss Account.

Rs. Rs.
ADMINISTATION EXPENCES
Building Rent 48000- 30000 18000

Insurance ( 40000 -5000 35000

Extract from State of Financial Position

Current Assets Rs. Rs.
Prepaid Building Rent 30000

Prepaid Insurance 5000

3. ACCRUED AND PREPAID INCOME

Income relevant to the accounting period and which are not received until the end of the period
is called “accrued income”. These are categorized under current assets in statement of financial
position.
Dr. Accrued Income Account
Cr. Relevant Income Account

Income received in advance for the future accounting periods is called “prepaid income”. In
statement of financial position prepaid income identified as current liabilities.
Dr. Relevant Income Account
Cr. Prepaid Income Account

Example3 The following balances were extracted from books of Chanaka Trading Co. as at
31.03.2014.
Debit (Rs.) Credit (Rs.)
Rent Income 22,000
Commission Income 34,000
Additional Information

I. It is discovered that rent for March 2014, Rs.2, 000 has not received yet.
II. The above commission income includes an amount of Rs.10, 000 which is received in advance
for the next accounting year.
Required
Show the relevant extract from Profit and Loss account year ended 31,03,2014 and
Statement of Financial Position as at 31.03.2014
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Extract from Profit Loss Account.
Rs. Rs.
OTHER INCOME
Rent Income 22000 +2000 24000
Commission Income 34000 – 10000 24000 480000

Extract from State of Financial Position

Current Assets
Rs. Rs.
Accrued Rent Income 20000
Current Liabilities
Prepaid Commission Income 10000

4. BAD DEBTS AND PROVISION FOR DOUBTFUL DEBTS

4.1. BAD DEBTS
An amount owed by a debtor that is unlikely to be paid is termed as ”Bad debt” and these
uncollectible amounts should write off against profit in income statement. This amount should be
eliminate from the debtor account & consider as a expenses to the entity.
Dr. Bad Debts Account
Cr. Relevant Trade Debtor's Account

4.2. SUBSEQUENT RECOVERY OF BAD DEBTS

There are circumstances that Customers Pay their balance due day after write off them as Bad
Debtors. Under such condition we remove their balance from bad debts account.
Dr. Cash Book
Cr. Bad Debts Account

EXAMPLE 4 You Are Given Following Information From The Books Of Sahan’s Business.

Debit (Rs.) Credit (Rs.)

Trade Debtors 42,500
Bad Debts 7,500

Additional Information
The balance receivable from Mr. Arawinda Rs.2, 500 as at 31.03.2014 is written off as bad debts.

Required
Show the relevant extract from Profit and Loss account year ended 31.03.2014 and Statement of
Financial Position as at 31.03.2014.

Extract from Profit Loss Account.

Rs. Rs.
Selling and Distribution Expenses

Bad Debts [ 7500 +2500] 10,000

Extract from State of Financial Position

Current Assets
Rs. Rs.
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Trade Debtors [42500 -2500] 40,000

 4.3. PROVISION FOR DOUBTFUL DEBTS

 Recoverability of some amounts due may be doubtful although not definitely irrecoverable.
Such receivables are known as doubtful debts. Accountants make provision for such debts
from current year profits.
 The allowance for doubtful debts is created by forming a credit balance which is deducted
from the total receivable, balance in the statement of financial position. The allowance for
doubtful debts reduces the receivable balance to the amount that the entity prudently
estimates to recover in the future.
 According to matching concept current year expenses should be set off against current year
income. Generally, we identify bad debts relating current year sales in subsequent financial
years.

Provision for doubtful debts can be identified in two types.

I. General Provision - Organization can make a percentage provision from year end debtors
balance by reviewing the history of business.
Example: Provision for doubtful debts 5% from Trade debtors as at 31.03.2014.

II. Specific Provision - This is provision created in respect of specific receivables which are known
to be facing serious financial problems.

Accounting for Doubtful Debts

 When making provision for the first time.
Dr. Doubtful Debts Account
Cr. Provision for Doubtful Debts

Doubtful debts for the financial year should be debited to the profit and loss Account and
subtracted from trade debtors in statement of financial position

 Increase in provision for doubtful debts

When a provision for doubtful debt is raised, only the amount necessary to increase the old
provision to the new provision is relevant in the book keeping record. The difference between the
original and new provision is debited to profit loss account an credited to provision for doubtful
debts account.

 Reduction in provision for doubtful debts

Where a provision proves excessive, it should be decreased. The amount necessary to reduce the
old provision to the required provision is debited to provision for doubtful debts account and
credited to profit and loss account.

You can further understand the above content from the following account.

Provision for Doubtful Debts Account

EXCESSIVE PROVISION XX B/B/F (provision as at 1.4.2013) XXX

B/C/F (provision as at 31.3.2014) XXX PROVISION IN DEFICIT XX

XXX XXX
Balance B/F XXXX

 An organization can record both bad and doubtful debts in the same ledger account. such
instance double entry for Bad debt write off is as follows
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Dr. Provision for Bad and Doubtful Debts Account

Cr. Trade Debtors Account
 The following balances were extracted from the books of Dannie’s business.

Debit (Rs.) Credit (Rs.)

Trade Debtors 87,500
Bad Debts 6,000

Additional Information

I. A debtor balance of Rs.2, 500 which is included in above trade debtors is written off as bad
debts.
II. Provision for doubtful debts on the balance as at 31.03.2014 is 5%.

Required –
Show the relevant extract from Profit and Loss account year ended 31.03.2014 and statement of
Financial Position as at 31.03.2014.

Extract from Profit Loss Account.

Rs. Rs.
Selling and Distribution Expenses

Bad Debts [ 6000 +2500] 8500

Doubtful debt 85000 X 5% 4250

Extract from State of Financial Position

Current Assets
Rs. Rs.

Trade Debtors [87500 -2500]

85000
Less : Provision for Doubtful debt 80750
(4250)

Following balances were extracted from Arawinda’s Books on 31.03.2014

Debit (Rs.) Credit (Rs.)

Trade Debtors 121,000
Provision for Doubtful Debts (01.04.2013) 3,500
Bad Debts 7,000

Additional Information
I. Amount due from a customer Rs.1, 000, which is included in above trade debtors has been decided
to write off as Bad Debts.

II. tis decided to make a provision of doubtful debts for Rs.10, 000 receivable from Mr. Jeevan, and
make a general provision of 5% for doubtful debts for balance debtors.

Required
1. Show the provision for doubtful debtors account.

2. Show the relevant extract from Profit and Loss account year ended 31.03.2014 and Statement of
Financial Position as at 31.03.2014.
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WORKINGS

Trade Debtors 121,000

Less: Bad Debts (1,000) (1,000)
120,000
Less: Specific provision for doubtful debtors (10,000)
110,000
5,500
General Provision of 5% 110,000 x 5%
15500
Provision for doubtful debtors (31.03.2014) [10000 + 5500]

Provision for Doubtful Debts Account

Balance B/F 3500

Balance C/F 15500 PROVISION IN DEFICIT 12000

15500 15500
Balance B/F 15500

Extract from Profit Loss Account.

Rs. Rs.
Selling and Distribution Expenses

Bad Debts [ 7000 + 1000 ] 8000

Doubtful debt deficit 15500 -3500 12000

Extract from State of Financial Position

Current Assets
Rs. Rs.

Trade Debtors [121000 -1000 ]

120,000
Less : Provision for Doubtful debt 104,500
(15,500)

 Method 2 instead of provision of doubtful debt account. can record both bad and doubtful
debts in the same ledger account such instance double entry for Bad debt write off is as
follows

Provision for Bad & Doubtful Debts Account

Trade debtors (7000 + 1000) 8000 Balance B/F 3500

P/L BAD & DOUBTFUL DEBT 12000 +8000 20000

Balance B/F
Balance C/F
15500

23500 23500
15500
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