Adjustments of Final

Accounts

To ensure that the final accounts disclose the true

trading results, it is necessary to take into account the
whole of the expenses incurred, whether paid or not,
and whole of the losses sustained. Likewise the
incomes and gains earned, whether actually received
or not, during the period covered by the trading and
profit and loss account under consideration must also
be recorded.
In mercantile system of accounting, it is essential to
adjust different accounts before the preparation of
final accounts. It is quite common to adjust expenses
paid in advance, incomes received in advance, income
accrued but not received, bad debts, provision for bad
debts depreciation on assets and soon. Journal entries
are passed to effect the required adjustments, these
entries are known as adjusting entries
Outstanding Expenses
 Certain expenses relating to a particular period may not
have been paid in that accounting period. All such expenses
which are due for payment in one accounting year but
actually paid in future accounting years or payment of which
is postponed are all outstanding or unpaid expenses. All
such expenses must be accounted for in that accounting
year in which they are incurred, irrespective of the fact
whether they are paid or not.
 In other words, all paid and also unpaid expenses must be
recorded in an accounting year if they relate to that
accounting year only with a view to ascertain true trading
results
 e.g. if salaries for the last month are not paid, no entry will
appear in books of accounts unless these are paid. So profit
and loss account in respect of salaries will thus be under
charged than the actual expenditure, therefore the profit
will be more.
continue
The entry would be
 Salaries a/c dr...
 To salary outstanding
a/c
The items will fig final statement as follow
Profit and loss a/c
balance sheet
Dr Cr liabilities
assets
To salaries salaries
outstanding
+outstanding
Prepaid Expenses

 The, benefit of some of the expenses already spent will be

available in the next accounting year also, Such a portion of the
expense is called pre-paid expense; since such expenses are
already paid, they are also recorded in the books of accounts of
that period to which they do not relate. The result shown by the
final accounts of a particular period will not be correct because
such expenses relate to future periods. Therefore, such prepaid
expenses must be adjusted in the books of accounts to arrive at
true profit.
 Generally insurance, taxes, telephone subscriptions, rent etc.
are paid in advance, thus requiring adjustment
 e.g. insurance premium of Rs 400 is paid on 1 July and the
account are to be closed on 31 march the benefit of the
insurance policy will accure up to 30th june next year in other
word insurance benefit for three month i.e 1 april to 30th june
will be drived in the next accounting year 1/4th of the premium
continue
The entry would be
 Insurance prepaid a/c dr
100
 To insurance premium
a/c 100
The items will fig final statement as follow
Profit and loss a/c
balance sheet
Dr Cr liabilities
assets
To insurance pre 400 prepaid
insurance 100
Accrued Income

There may be certain incomes which have been

earned during the year but not yet received till
the end of the year. Income like interest on
investments, rent and commission etc. are
normally earned by merchant during a particular
accounting period but actually not received during
that period.
Such income items need adjustments before the
preparation of final accounts. Such incomes
should be credited to that particular income
account. At the same time the income so -earned
but not received is an asset because the amount
is still to be received. Suppose rent for dec Rs 500
continue
 The entry would be
 Rent receivable a/c dr...
 To rent a/c
 The items will fig final statement as follow
 Profit and loss a/c balance
sheet
 Dr Cr liabilities
assets
 By rent 500
rent receivable
 +accrued
 
 
Income Received in
Advance

Sometimes, traders receive certain amounts

during a particular trading period which are to be
earned by them in future periods. Such incomes
though actually received and therefore, recorded
i.e. not yet earned.
Such incomes should be credited to the profit and
loss account of the year in which these are
earned. Therefore, such income though received
is not the income but a liability of that period
suppose rent received in advance by tenant of Rs
1800 for 2 month and close there a/c before
continue
 The entry would be
 Rent a/c dr 1200
 To rent received in advance a/c
1200
 The items will fig final statement as follow
 Profit and loss a/c balance
sheet
 Dr Cr liabilities
assets
 To rent 1800 rent received
in adva 1200
 -received in advance 1200
Closing Stock

It represents the unsold stock at the end of the

year. Closing stock is valued and following entry is
passed at the end of the year: Closing Stock
account To Trading Account Closing stock at the
end appears in the balance sheet and is carried
forward to the next year. At the end of the next
year it appears in the trial balance as opening
stock and from there it is taken to debit side of
trading account and thus closed.
Depreciation

The value of fixed assets diminishes

gradually with their use for business
purposes. Although this decrease in the
value happens every day but its
accounting is done only at the end of
accounting period with the help of
following entry:
 Depreciation account Dr
To Particulars
asset
continue
The items will fig final statement as follow
Profit and loss a/c
balance sheet
Dr Cr liabilities
assets
To dep on asset
asset cost

-Dep
 
Interest on Capital

The proprietor may wish to ascertain his profit

after considering the interest which he losses by
investing his money in the firm. Interest to be
charged is an expense for the business on one
hand and income to the proprietor on the other
hand.
 Following adjusting entry is recorded at the end
of accounting period: Interest on capital a/e To
Capital a/c Interest on capital being an expense is
debited to profit and loss account and same
amount of interest on capital is added to capital
and come to liability side of balance sheet
Interest on Drawings
As business allows interest on capital it also
charges interest on drawings made by the
proprietor. Interest so charged is an income for
the business on one hand and expense for the
proprietor on the other hand.
Following adjusting entry is passed at the end. of
accounting period: Capital ale Dr. To Interest on
drawings a/e The interest on drawings being an
income is credited to profit and loss account is
shown as a deduction from the capital. In liability
side of b/s