Final Accounts

Accounts | Grade 11
Concept and Meaning of Final
Accounts

The main goal of accounting is to inform business proprietors

about the financial performance and position of their ventures.
Final accounts are crucial for this purpose and are prepared at the
end of each accounting period, utilizing data from the trial
balance. These accounts, which include income, expenses, assets,
liabilities, capital, and drawings, provide insights into whether a
business is running at a profit or loss. While final accounts can be
produced more frequently, annual reporting is standard for
obligations to entities like the Inland Revenue, banks, and other
stakeholders. In Nepal, organizations must align their accounting
period with the fiscal year specified in the Income Tax Act to meet
legal requirements and informational needs.
Final accounts serve as conclusive financial statements that convey a
concise overview of a business's profitability and financial position. They are
the end products of the accounting process, summarizing information from
subsidiary books and the ledger. The Trading and Profit and Loss Account
determines profit or loss, while the Balance Sheet assesses the financial
standing. Together, they form the final accounts or financial statements.

Therefore, the process of preparing final accounts entails:

• Trading Account
• Profit and Loss Account
• Balance Sheet
Accounting Procedures and Users

Input Processing Output Users

Owners
Accounting Principles & Final Accounts
Transactions Customers
Procedures(Journal, Ledger, (Trading Account, Profit
and Events of a Lenders and Creditors
Subsidiary Book, Trial Balance) & Loss Account,
Firm Government
Balance Sheet)
Financial Analysis
Managers &
Accountants
General Public
Trading and profit and loss accounts, along with the balance
sheet, are crafted post the trial balance. Utilizing figures from
the trial balance, the trading and profit and loss accounts
function as double-entry bookkeeping records for income and
expenses. Conversely, the balance sheet, although not an
account, is a statement incorporating balances from assets,
liabilities, and capital.
Components of Final Accounts

Given are the main components of final accounts:

1. Trading Account
2. Profit and Loss Account
3. Balance Sheet
1. Trading Account - Trading involves the buying and
selling of goods. The trading account is crafted to
determine the outcome of these activities,
specifically the gross profit or loss incurred during a
particular accounting period.
Gross Profit and Gross Loss

Gross profit is the surplus from the core business activity, involving the buying or
manufacturing and selling of goods. It is calculated as the excess of net sales over the cost of
goods sold, representing the revenue generated beyond the cost of production or purchase.
This is explained as under:
Gross Profit = Net Sales – Cost of Goods Sold

Net Sales = Total Sales(Credit & Cash) – Sales return or returns inward

Net Purchase = Total Purchase (Credit & Cash) – Purchase returns or returns outward
Cost of Goods Sold = Opening stock + Net purchases + Expenses incurred in connection with
purchases and manufacture (Direct expenses) – Closing stock

If 'net sales' are surpassed by the 'cost of goods sold,' it will result in a gross loss.
Example 1: Suppose the following information is available from a trader to calculate the
'cost of goods sold' and 'gross profit of the business. These can be calculated as follows:
Solution:
Objectives of Trading Account

The trading account is created to consolidate direct income and expenses

and determine gross profit or losses. Its primary objectives include:
1) To determine gross profit or gross loss.

2) To offer protection against potential losses.

3) To provide insights into direct expenses.

4) To compare closing stock with the stock of the previous year.

5) To offer details on direct income and expenses.

Importance and Advantages of Trading Account

The primary significance and benefits of the trading account include:

I. Illustrates the connection between gross profit and sales, aiding
in assessing the business's profitability.

II. Facilitates the calculation of ratios between costs of goods sold

and gross profit.

III. Offers insights into the efficiency of trading activities.

IV. Provides information about closing stock, sales, and cost of goods
sold, including other direct expenses.
Preparation of Trading Account

The trading account, a nominal account with

debit and credit sides, functions like other
accounts. Direct expenses related to the
purchase or manufacturing of goods are
recorded on the debit side, while direct
incomes (net sales of merchandise goods) are
recorded on the credit side. It encompasses
all direct revenues and expenses for the
current year, regardless of cash transactions,
excluding items related to past or future
years.
Format of Trading Account:
A. Items Shown on the ‘Debit’ Side of Trading Account

a) Opening Stock – The opening stock of the current year is the

unsold goods from the previous year, specifically the closing
stock of the last year. It is the first entry on the debit side of
the trading account. Newly started businesses typically do not
have an opening stock.

b) Purchases – Purchases consist of goods bought for resale or

as raw materials for production. It encompasses both cash and
credit purchases. The purchase account carries a debit
balance, reflecting on the debit side of the trial balance and
trading account in the final accounts preparation.
c) Purchases Returns – Goods returned by the business result in
crediting the Returns Outward or Purchase Returns Account,
while the Supplier's Account is debited. Purchase Returns
Account, with a credit balance, is presented on the credit side of
the trial balance. In the trading account, it is deducted from the
'purchases' on the debit side.

d) Direct Expenses – For a trading concern, all expenses related

to the purchase, transportation, and preparation of goods for sale
are treated as direct expenses and debited to the trading
account. In a manufacturing concern, the cost of converting raw
materials into finished products constitutes direct expenses,
which are also debited to the trading account are:
• Wages – Wages for workers involved in carrying, loading, unloading,
and production of goods are debited to the trading account. In the
trading account, if "wages and salaries" is specified in the trial
balance, it is shown there. However, if "salaries and wages" is
indicated, it is recorded as indirect expenses in the profit and loss
account.

• Freight/freight inward/freight on purchase or

carriage/carriage inward/carriage on purchase – Terms
such as "carriage inward," "freight," and "transportation
expenses" signify costs incurred to bring purchased
goods or raw materials to the shop or factory. These
expenses should be debited to the trading account.
• Dock Charges – Dock charges, incurred on ships and cargo during
entry or exit from docks, are debited to the trading account when
paid for the import of goods.

• Import Duty or Custom Duty – Import duty and custom duty, when paid
on the purchase or import of goods, are considered direct expenses and
are debited to the trading account. If custom duty is incurred on the sale
or export of goods, it is treated as an indirect expense and charged to
the profit and loss account. In the absence of specific instructions, both
types of duties are debited to the trading account as direct expenses.
• Excise Duty – Excise duty, as a charge paid to the government on
manufactured goods, is treated as a direct expense and is debited
to the trading account.

• Octroi - Octroi, a charge imposed by the municipality when goods

enter the city, is debited to the trading account as it is directly
associated with purchases.
• Royalty – Royalty, when based on production, is debited to the
trading account as a direct expense, increasing the cost of
production. If royalty is tied to sales, it is treated as an indirect
expense and charged to the profit and loss account. In the absence
of specific instructions, royalty payments are debited to the trading
account.

• Packing Charges/Packing Expenses – Packing material expenses

incurred to make goods saleable or in a saleable condition are
direct expenses and debited to the trading account. If packing
expenses are associated with sales, they become selling expenses
and are debited to the profit and loss account as indirect expenses.
• Manufacturing Expenses – Manufacturing expenses, including costs
like coal, gas, fuel, water, power, factory rent, insurance, heating,
and lighting, are directly associated with the production of goods.
Therefore, they are considered direct expenses and are debited to
the trading account.

• Consumable Stores - The total cost of small consumable items such

as nuts, bolts, grease, oil, cotton waste cloth, etc., essential for
machine operation and production, is considered a direct expense.
This cost is debited to the trading account in the context of
manufacturing goods.
• Commission on Purchase - Commission
paid on the purchase of goods is treated as
a direct expense and is considered part of
the cost of goods purchased. It is debited
to the trading account.
B. Items Shown on the ‘Credit’ Side of the Trading Account

a. Sales – Sales account in the trial balance represents total sales

(cash and credit) with a credit balance. It is treated as revenue
and appears on the credit side of the trading account. If the sales
include fixed asset sales, this amount is deducted from total
sales.
b. Sales Return – When buyers return goods, the Returns
Inward or Sales Return Account is debited, and the buyer's
account is credited. Sales return account, reflecting the
returned goods, appears on the debit side of the trial balance.
In the trading account, it is deducted from total sales.
c. Closing Stock or Closing Inventory – Closing stock is the
unsold goods at the end of the year, valued at the lower of cost
price or market price. It comprises raw materials, semi-finished
goods, and finished goods.

Note: Closing stock should be valued at the lower of its cost or

market price and recorded accordingly. When both the cost price
and market price figures are available, the closing stock will be
presented in both the trading account and the balance sheet at the
lower of the two values.
Balancing of Trading Account

After recording items in the trading account, the balance is

calculated. If the credit side exceeds the debit side, it indicates gross
profit; if the debit side is greater, it signifies gross loss. Gross profit is
transferred to the credit side, and gross loss to the debit side of the
profit and loss account.
Example 2: From the following information, prepare the Trading Account for the year ended
on 31st Chaitra 2076:
Solution:
Closing Entries for Trading Account

In the preparation of the trading account, closing entries are made to

transfer balances of accounts that appear in it. These entries, known
as closing entries, aim to close revenue and expense accounts at the
end of the year. Accounts with debit balances are credited, and the
accounts they are transferred to are debited, and vice versa.
Entries:
Example 3: Consider the following trading account.

Required: Closing Entries

Solution:
2. Profit and Loss Account – The profit and loss
account is a financial statement used to determine
the net profit or loss of a business. It focuses on
indirect expenses and revenues and is prepared
after the trading account to calculate the net result.
The gross profit is initially obtained from the trading
account, and then indirect expenses are deducted to
arrive at the net profit. The profit and loss account
summarizes the financial performance of a business
over a specific period.
Objectives of Profit and Loss Account

Various objectives of profit and loss account are:

i. To ascertain the business results (profit or loss) during a
specific period.

ii. To obtain details on various indirect expenses incurred within a

particular timeframe.

iii. To gather information on diverse sources of income, excluding

sales.

iv. To aid in the formulation of the balance sheet.

Importance/Advantages of Profit and Loss Account

The primary significance of creating the profit and loss account lies in
determining the net profit or net loss resulting from business
operations. The key advantages of the profit and loss account include:
• It furnishes details on indirect expenses.
• It discloses the net profit or net loss incurred by the business within
an accounting year.
• It aids in establishing the ratio between net profit and operating
expenses.
• It facilitates the calculation of the ratio between net profit and sales.
• It supports the management in controlling indirect expenses to
enhance future profitability.
Preparation of Profit and Loss Account

The profit and loss account, a nominal account with debit

and credit sides, uses trial balance information. It
considers only current-year indirect expenses and
revenues. Starting from the trading account result (gross
profit or loss), it shows gross profit on the credit side and
gross loss on the debit side. Indirect expenses go on the
debit side, while indirect revenues go on the credit side. If
the credit side total exceeds the debit side, it's a net
profit; if the debit side total exceeds the credit side, it's a
net loss.
Format of Profit and Loss
Account:
I. Items that Appear on ‘Debit’ Side of Profit and Loss
Account

a) Gross Loss – The debit balance of the trading account is

reflected on the debit side of the profit and loss account.

b) Administrative Expenses – These are everyday operational

expenses related to official, administrative, and managerial
activities. They encompass various costs such as office
salaries, rent, printing, stationery, postage, insurance,
lighting, heating, legal charges, audit fees, director's fees, and
general telecommunication expenses.
Note: Trade expenses, typically categorized as general expenses, are treated as indirect and
recorded in the profit and loss account. If the trial balance includes both trade expenses and
general expenses, trade expenses are considered direct and are allocated to the trading
account, while general expenses go to the profit and loss account.
c) Selling and Distribution Expenses – These expenses are
related to the promotion, sales, and distribution of goods.
Examples include packing charges, godown rent, carriage
outward, freight outward, forwarding charges, sales tax,
export duty, sales agent commissions, travel expenses,
salaries and commissions for salesmen, showroom staff
salaries, advertising costs, distribution of free samples, gifts,
insurance, and bad debts.

d) Maintenance Expenses – These expenses are associated

with preserving the functionality of fixed assets. Examples
include repair and maintenance or repair and renewal costs.
e) Depreciation – It is also an entry displayed on the debit side
of this account.

Note: Loss on revaluation of asset is also shown on its debit

side.

f) Financial Expenses – These expenses are for obtaining

necessary funds to operate the business and include items
such as interest on loans, discounts on bills, cash discounts
allowed, and interest on capital.
g) Abnormal Losses - These are losses resulting from
managerial negligence, such as unrecovered stock losses
due to fire or losses incurred on the sale of assets.

Note: Expenses not to appear in P/L account are:

 Proprietor's domestic and household expenses.

 Drawings made by the proprietor in the form of cash or
goods.
 Personal income tax and life insurance premiums paid by
the firm on behalf of the proprietor.
II. Items that Appear on ‘Credit’ Side of Profit and Loss
Account

• Gross Profit – It constitutes the initial entry in the profit and

loss account, having been transferred from the trading
account.

• Other Incomes – In the course of business operations, aside

from revenue generated from the sale of goods, there may be
additional financial gains, such as received discounts or
commissions.
• Non-Trading Incomes – The business engages in
transactions with the bank, earning interest by the year-end,
classified as non-trading income in the profit and loss account.
Additionally, income from investments in shares or debentures
outside the business is also categorized as non-trading income
and handled similarly.

• Abnormal Gains - Capital gains may occur during the year,

such as profits from the sale or revaluation of fixed assets.
Example 4: From the following information, prepare a Profit and Loss Account of a Trader for
the year ended on 31st Chaitra 2076.
Solution:
Close Entries Relating to Profit and Loss Account

The preparation of the profit and loss account necessitates the transfer of balances for items
that are expected to appear in the account. The entries for this process are as follows:
Example 5: Consider the following profit and loss account:

Required: Closing Entries

Solution:
Differences between Gross Profit and Net Profit

Bases Gross Profit Net Profit

Result It is the business's trading outcome, It is the net outcome of the business,
indicating the difference between representing the variance between
sales and the cost of goods sold. gross profit and indirect expenses.
Balance It is the balancing figure of trading It is the balancing figure of profit and
account. loss account.
Determination It is determined by comparing sales It is calculated by contrasting gross
and cost of goods sold. profit, indirect income, and indirect
expenses.
Transfer Gross profit is transferred to profit and Net profit is transferred to capital
loss account. account.
Uses It is used to evaluate the trading It is used to evaluate the operating
efficiency of the business. efficiency of the business.
Differences between Trading Account and Profit and Loss Account

Bases Trading Account Profit and Loss Account

Objective It is prepared to know the trading It is prepared to know the net
results i.e. gross profit or gross profit or net loss.
loss.
Nature of Expenses It records the purchase and direct It records the indirect expenses.
expenses.
Nature of Incomes It records only the sale of goods. It records all the incomes of the
business except sales.
Result The result of trading account is The result of profit and loss
transferred to profit and loss account is transferred to capital
account. account
3. Balance Sheet – Accounting serves two main
purposes: evaluating profitability through the
trading and profit and loss account and determining
financial position with the balance sheet, also known
as the Statement of Financial Position. The balance
sheet, presented at the end of the accounting
period, displays assets, liabilities, and capital,
providing a snapshot of the business's financial
status.
Features of Balance Sheet

• The balance sheet, being a statement, does not have 'debit' or

'credit' sides, and no 'To' or 'By' words are prefixed to account
names.
• Prepared at the end of an accounting period, the balance sheet
reflects the financial position on a specific date, not for a
particular period.
• The balance sheet reveals the business's indebtedness to others
and the amounts owed to the business.
• The total of 'assets' and 'liabilities' sides always equals each other.
Objective of Balance Sheet

• To depict the financial standing of the business on a specific

date.

• To furnish details on trade debtors and creditors.

• To offer insights into capital and owner's equity.

• To convey information about the value and nature of assets.

• To facilitate the process of obtaining loans from external

sources.
Importance of Balance Sheet

 Assists in determining the financial position of the business on a

specific date.

 Aids in determining the necessary provisions or reserves for

addressing future contingencies.

 Facilitates the calculation of owners' equity as of the balance

sheet date.
Preparation of Balance Sheet

The balance sheet, the concluding step in final accounts, is prepared after establishing net
profit or loss from the profit and loss account. Unlike an account, it features assets and
liabilities sides, summarizing personal and real accounts with debit or credit balances and
excluding accounts with no balance or those closed by transfer to the trading and profit and
loss account.
 Balance Sheet

Assets Side
Liability Side

Fixed Assets Investments Current Assets Liabilities Capital

Tangible Short-term Long-term liability

Intangible Long-term Current liability

Debit balances of personal and real accounts appear on the
right-hand side (assets side), while credit balances are on the
left-hand side (liabilities side) of the balance sheet. The total
of both sides must always be equal, and any discrepancy
suggests an error. The balance sheet reveals the financial
position of a business at a specific point in time and for a
fixed period, emphasizing that even a single transaction can
alter assets and liabilities.
Format:
A. Items that Appear on the ‘Assets’ Side of Balance
Sheet

Assets and their Classification

Assets represent valuable resources owned by a business,

acquired at a measurable monetary cost. The following points
highlight the key aspects of the definition.
o The resource must possess value.
o It must be owned by a business enterprise.
o Acquisition should involve a measurable monetary cost.
Classification of Assets

• Currents Assets – Current assets are business resources

convertible to cash within twelve months, including items like
cash, bank balances, closing stock, bills receivable, accounts
receivable, marketable securities, prepaid expenses, and
income receivable.

• Fixed Assets – Assets acquired for long-term use (more than

one year) and not intended for sale are classified as fixed
assets, examples being land, building, furniture and fixtures,
plant and machinery, equipment, etc. Fixed assets are further
divided into two parts which are:
o Tangible Fixed Assets - Tangible fixed assets are physical
assets with a visible and touchable presence, including
items like buildings, machinery, furniture, and motor
vehicles.

o Intangible Fixed Assets - Intangible fixed assets lack

physical existence and cannot be seen or touched.
Examples include goodwill, copyright, patents, and
trademarks.

• Fictitious Assets - Assets that lack a tangible form, such as

preliminary expenses and debit balances of the profit and
loss account, are known as intangible assets.
B. Items that Appear on the ‘Capital and Liabilities’ Side of Balance Sheet
• Liabilities – Liability refers to the business's obligation to
pay a third party for goods or services related to its
activities, representing the claims of outsiders against the
business. Different categories includes:
o Long-term liabilities – Long-term liabilities, typically settled
over an extended period, encompass obligations such as
long-term loans or notes payable.
o Current liabilities - Current liabilities are obligations payable
within twelve months, including items like sundry creditors,
bills payable, bank overdraft, outstanding expenses, short-
term loans, income received in advance, and provisions for
tax.
o Contingent Liabilities - Contingent liabilities are potential
future obligations for a firm, dependent on uncertain events.
They become liabilities only if the anticipated event occurs;
otherwise, no obligation is incurred. For instance, a discounted
bill with a bank becomes a contingent liability if the acceptor
fails to meet the bill.

• Capital – Capital is the amount of money or money's worth

provided by the proprietor when initiating a business. Net
profit is added to capital, while net loss and any drawings
listed in the trial balance are deducted from it.
Example 6: Consider the following information:

Required: Balance Sheet on 31 Ashadh 2076

Solution:
Arrangement of Assets & Liabilities in Balance Sheet
(Marshalling of Assets & Liabilities)

Marshalling of assets and liabilities refers to

the specific order in which they are arranged
on a balance sheet. There are two common
orders which are:
1) In the Order of Liquidity
2) In the Order of Permanence
1) In the Order of Liquidity – Assets are
arranged by liquidity, starting with cash in
hand, followed by cash at bank and other
assets, with land and building at the bottom.
Liabilities are ordered by the sequence of
discharge, beginning with bills payable, trade
creditors, loans, outstanding expenses, and
ending with capital. This method provides a
snapshot of short-term financial health and the
order in which obligations are expected to be
settled.
Assets & Liabilities under this method:
2) In the Order of Permanence – In the order of
permanence, assets are listed on the balance sheet
starting with the most permanent, such as goodwill,
followed by other fixed assets. The most liquid asset,
cash in hand, is placed last. On the liabilities side, the
most permanent liability, capital, appears first,
followed by fixed and long-term liabilities. Current
liabilities, to be paid first, are listed last. This method
provides a snapshot of the company's long-term
financial position, emphasizing the permanent nature
of assets and liabilities.
Assets & Liabilities under this method:
Differences between Trading and Profit and Loss Account and Balance Sheet

Bases Trading and Profit and Loss Balance Sheet

Account
Objectives It is created to determine the outcome of It is compiled to assess the financial status
trading, specifically to ascertain whether of the business.
there is a gross profit or loss and to
calculate the net profit or loss.

Heads/Items It records purchases and direct expenses At the year-end, the accounting year is
on the debit side, along with the sale of revealed by preparing a balance sheet
goods on the credit side in the first part. categorized under assets and liabilities.
The second part includes indirect expenses
on the debit side and all incomes of the
business, excluding sales, on the credit
side.

Parties In the trading and profit and loss account, It is a statement without separate columns
the debit side represents all expenses, for debit and credit sides.
while the credit side represents all
incomes.

Result It displays the outcome for the entire It reflects the outcome at a specific
operational period of a business within a moment in time.
year.
Differences between Trial Balance and Balance Sheet

Bases Trial Balance Balance Sheet

Objectives It is prepared to check the It is prepared to know the
arithmetical accuracy of financial position of the business.
accounting record.
Time It may be prepared covering It is prepared at a point of time.
some period i.e. fortnightly or
monthly or yearly, etc.
Side It has debit and credit column. It has assets and liability side.
Need of It is not necessary through It is must be prepared at the end
Preparation desirable. of accounting year.
Order of It is prepared before the It is prepared after the
Preparation preparation of final accounts. preparation of trading and profit
and loss account.
Example 7: The following Trial Balance has been extracted from the books of Sakar Sharma
of 31 March, 2020. The stock-in-trade on that date was valued at Rs. 18,400. Prepare Trading
and Profit and Loss Account for the year ended 31, March, 2020 and a Balance Sheet as on
that date:
Solution:
Adjustment Entries and it’s Types
The realization principle in accounting requires
recognizing income when earned and expenses when
incurred, irrespective of cash transactions. Adjusting
entries at the end of the period ensure accurate
financial statements, reflecting true financial results
and positions. Omitting these adjustments can lead to
an inaccurate portrayal of an entity's financial status.
Two foundations guide the recognition and preparation
of adjusting entries, outlined as follows:
1. Deferral Expenses and Income
2. Accrual Expenses and Income
1. Deferral Expenses and Income

• Deferral deals with recognizing revenue or expenses paid in

advance, requiring adjusting entries to account for the portion
incurred during the accounting period.

• Deferred expenses, like prepaid insurance or rent, involve

recording upfront payments as assets and later recognizing
them as expenses when incurred.
• Deferred revenue is income received in advance, recorded
initially as a liability. It is recognized as income when
earned, as in cases of advance sales revenue, service
revenue, or commission.

• Adjusting entries involve transferring amounts from assets

and liabilities to expenses and revenue accounts.
Adjusting entries for deferrals can be categorized into the following
two types:
 Payment has been made, but the expense has not been incurred.
This category includes:
o Prepaid/deferred expenses.
o Depreciation.
o Stock of supplies/merchandise goods.

 Cash has been received, but income has not been earned. This
category encompasses:
o Unearned or advance revenue or deferred revenue.
2. Accrual Expenses and Income

• Accruals involve recognizing expenses incurred or revenue

earned, even if cash transactions haven't occurred. Accrual
expenses, like outstanding salaries, are recorded by debiting
the related expenses account.

• Accrual revenue, such as service fees receivable, is recorded

by debiting the accrued income account. This approach
ensures recognition based on actual occurrences, not just
cash movements.
Adjusting entries for accruals can be categorized into the
following two types.

o Expenses are incurred, but payment has not been made,

known as outstanding expenses or accrued expenses.

o Income is earned, but payment has not been received, termed

as accrued revenue or income receivable.
Treatment of Adjustments
When an adjusting entry is recorded, it impacts a minimum of two
accounts.
A. Trading and profit and loss account, or
B. Trading account and balance sheet, or,
C. Profit and loss account and balance sheet, or
D. Balance sheet and balance sheet,
E. Trading and profit and loss account and balance sheet (affect in
three accounts).
Adjusting entries for deferral and accrual bases, along with their
impact on financial statements, are discussed below with an
illustrative example.
Deferral Basis Adjusting Entries

I. Closing Stock – Closing stock refers to the unsold parts of goods remaining in the store
at the end of the accounting year. It is valued at the lower of cost price or market price.
The adjustment of closing stock is made accordingly.
Example 8: Closing stock as at 31-12-2076 Rs. 100,000 appears outside the trial balance.
Accounts are closed on 31st Chaitra. Pass adjusting entry and show how will appear in final
accounts.
Solution:
II. Prepaid Expenses and Its Expiration - Prepaid
expenses are payments made in advance before actual
expenses are incurred. They are initially recorded as
assets in a "prepaid expenses" account. When expenses
are incurred, the prepaid amount is transferred to the
relevant expense account. The expired portion of prepaid
expenses is shown as an expense in the profit and loss
account, while the unexpired portion remains as an asset
on the balance sheet.
Format:
Example 9: Consider the following extracted trial balance:

Additional Information:
i. Prepaid insurance expired to the extent of Rs. 1,500.
ii. Unexpired rent is still unexpired Rs. 2,800.

Required: Treatment of Adjustments

Solution:
III. Office Supplies Expenses – Office supplies are materials
used for administrative work, such as stationery. When
purchased, the cost is initially recorded as an asset since
the entire amount is not spent immediately. As supplies
are used over time, their cost is gradually recognized as
expenses at the end of the accounting period. The unused
portion of supplies is recorded as an asset on the balance
sheet.
Format:
Example 10: During the year 2076/77, purchased office supplies for Rs. 24,000. As on 31st
Ashadh 2077, the physical count of supplies found costing Rs. 8,000.

Required: Prepare necessary journal entries for the above transaction on the date of
purchase of supplies and supplies used at the end of year.
Solution:
IV. Advance Income or Unearned Income Earned –
Advance or unearned income is cash received in advance
for future goods or services. Initially recorded as a liability
in the "unearned income" account, it is later recognized in
the income account at the end of the accounting period. In
the final accounts, the earned portion of income is
credited in the profit and loss account, while the unearned
portion remains a liability on the balance sheet.
Format:
Example 11: On Baishakh 1, 2076, took an advance from a customer to provide goods for
coming 12 months amounting to Rs. 18,000. The accounts are closed on 31 Ashadh 2076.
Prepare the original entry as on Baishakh 1, 2076 and adjusting entry as on Ashadh 31, 2076
and also show how they appear in the financial statement.
Solution:
If the trial balance includes advance income with no additional adjustment information
provided, it should be reflected on the liabilities side of the balance sheet exclusively.
Example 12: Consider the following extracted trial balance:

Additional Information:
i. Advance commission earned to the extent of Rs. 1,200.
ii. Unearned rent is Rs. 2,500 earned.

Required: Treatment of Adjustments

Solution:
V. Depreciation – Depreciation, a non-cash expense reflecting
the decline in fixed asset value, is recorded on the debit side
of the profit and loss account. It appears on the asset side of
the balance sheet, deducted from related fixed assets.
Depreciation can be recorded directly in the asset account or
through an accumulated depreciation account.
Way of recording and presenting depreciation:
Example 13: On 1-7-2076, a machinery costing Rs. 10,000 and furniture costing Rs. 20,000
were purchased. Write off 5% p.a. depreciation on furniture and depreciate the machinery @
10% p.a. Accounting year is calendar year. Pass the adjustment entry and show how this will
appear in final accounts.
Solution:
VI. Appreciation in Fixed Assets – In cases of revaluation
where the book value of fixed assets like land or investments
increases, the appreciation is treated as income. During
adjustment entries, the increased value is credited on the
profit and loss account as income. Simultaneously, the fixed
assets account is debited, adding the appreciation to the
assets side of the balance sheet.
Format:
Example 14: Following is the extracted trial balance

Adjustment: Appreciation in the value of land by 10%.

Required: Treatment of Adjustment

Solution:
VII.Provision for Doubtful Debts – Uncollectible or
bad debt amounts are typically estimated using
various methods such as past experiences,
economic conditions, and current payment trends.
Sales figures can be a basis, calculated as a
percentage of total sales or credit sales.
Estimations may also be based on the classification
of debtors into outstanding age groups, assuming
that the longer a receivable is due, the higher the
likelihood of nonpayment.
There are typically two methods employed for
accounting for uncollectible or bad debt accounts.

 The Direct Write-Off Method – This method records

accounts receivable as bad debt when deemed
uncollectible, but it is not recommended as it may
not align with the matching principle. It suits
businesses with limited credit sales. The entry
involves debiting the bad debts account and
crediting the accounts receivable account.
Journal Entry Format:
Example 15: A firm writes-off Rs. 5,000 accounts receivable balance as uncollectible. Pass
journal entry if direct write-off method is adopted to write-off receivable.
Solution:

Note: If bad debt account is given in trial balance, it should be recorded into the debit side of
profit and loss account only.
 Allowance for Doubtful Debt Method/Provision for Doubtful Debt
Method
The allowance for doubtful debt method estimates
uncollectible amounts by adjusting entries that debit the
bad debts account and credit the allowance for doubtful
debt account. When a specific account is considered
uncollectible, the allowance account is debited, and the
accounts receivable account is credited. This method
ensures a timely recognition of bad debts in the period of
corresponding sales, reducing the value of receivables.
Its method:
o Recording estimated bad debts – To record
estimated uncollectible or bad debts, the
account is debited, and the provision for doubtful
debt account is credited. The provision for
doubtful debt account represents the estimated
amount of future uncollectible claims.
Businesses use this contra account instead of
directly crediting accounts receivable, as they
cannot predict which specific customer will not
pay.
Format:
o Recording of actual an uncollectible account/ actual bad
debts – When a business determines that the collection
of a receivable is impossible, it should be written off with
approval from authorized personnel to prevent
premature and unauthorized actions. The actual amount
of bad debts is then written off by debiting the allowance
for doubtful debt account and crediting the accounts
receivable account.
Format:
Example 16: A firm has provided the following information from the trial balance.

Additional Information:
i. Firm wrote off bad debt Rs. 10,000.
ii. Provision for doubtful debt is maintained at 10%.

Required: Journal entry to record the estimated uncollectible showing presentation in

financial statement.
Solution:
Example 17: At December 31, the following accounts balances before adjustment of a
company are given:

Actual bad debt written off Rs. 5,000.

Required: Determine the estimated bad debts and give adjustment entry at December 31,
assuming that bad debt amount is excepted to be 5% of accounts receivable/debtors.
Solution:
VIII.Provision on Discount on Debtors – Discounts are
given to debtors for early payment. After deducting bad
debts, a provision for discount on remaining "good
debtors" is created by debiting a percentage to the profit
and loss account, anticipating potential losses from
discounts claimed by prompt-paying debtors.
Format:
IX. Abnormal Loss of Goods – Losses resulting from abnormal events like accidents, fire,
floods, or theft are termed abnormal losses. The accounting treatment involves debiting
the abnormal loss account with the loss amount and crediting the purchase account for
the same amount. At the end of the accounting year, the abnormal loss amount is
transferred to the profit and loss account.
Format:
Example 18: A fire occurred in the godown of factory and stock worth Rs. 20,000 was
destroyed. Total purchases during the year were of Rs. 100,000. Insurance company admitted
an insurance claim for Rs. 14,000 only. Show the adjustments by passing necessary entries
and the treatment in final accounts.
Solution:
X. Amortization of Fictituous and Intangible
Assets – Fictitious assets like preliminary
expenses, underwriting commission, and
intangible assets such as goodwill are
recorded on the assets side of the balance
sheet. They should be amortized or written off
within a specified time period according to the
income tax act. The adjustment entry involves
recording the amortization or write-off in the
fixed accounts of fictitious assets.
Adjustment entries:
Example 19: Following information is given to you:

Adjustments: Write off goodwill by 10%.

Required: Treatment of intangible assets in final accounts.

Solution:
XI. Goods Distributed as Free Sample or Charity – Distributing
goods as free samples or for charity is treated as a selling or
advertising expense. The associated costs are debited to the
profit and loss account and deducted from purchases on the
trading account.
Format:
Cr
Example 20: Following is an extract of trial balance as on 31-12-2076.

Adjustment:
i. Goods worth Rs. 5,000 were distributed as free sample.
ii. Goods worth Rs. 1,000 were given away as charity.

Required: Show the adjustment entry and also show the treatment in final accounts.
Solution:
Accrual Basis Adjusting Entries

a) Outstanding Expenses – Outstanding

expenses are costs incurred in one accounting
year but paid in the following year or
postponed. They are recorded in the year they
are incurred. For instance, if a salary for July is
paid in August, it is considered outstanding as
of the end of July. Although these expenses
represent current period costs, they are
recorded in the next accounting period.
Outstanding expenses are both an expense in
the profit and loss account and a liability on the
balance sheet.
Format:
Example 21: Salary has been paid for 11 months from 1st Shrawan 2076 to 31st Jestha
2077 @ Rs. 100 p.m. and shown in trial balance. Salary for the month of Ashadh has not yet
been paid. Accounting year is Nepalese fiscal year. Pass adjustment entry and show this how
appears in final accounts.
Solution:
b) Accrued Income/Outstanding Income –
Accrued incomes are earnings in the current
accounting year not yet received, such as interest
on investments or rent from subletting. These are
recorded as assets on the balance sheet and
added to related income on the credit side of the
profit and loss account. Accrued incomes represent
amounts due but not yet received, serving as both
an asset and income for the business.
Format:
Example 22: On 1-1-2076 a loan of Rs. 10,000 was given to Hari at the rate of interest of
12% p.a. During the year interest was received for 11 months from Baishakh to Falgun.
Interest for the month for Chaitra has not yet been received. Accounting year is calendar
year, pass adjustment entry and show how this will appear in final accounts.

Solution:
c) Interest on Investment – Investments in
marketable securities or government bonds represent
amounts lent outside the business. The interest
received on these investments is treated as income
and is shown on the credit side of the profit and loss
account. If interest is earned but not yet received, it is
considered receivable, and the adjustment entry is
made accordingly.
Format:
Example 23: Following is an extract of trial balance as on 31-12-2076:

Adjustment: The investment was made on 1-1-2076.

Solution:
d) Interest on Loan – A loan represents the amount
borrowed by a business from banks or financial
institutions. The fixed interest payable on the loan is
treated as an expense and is shown on the debit side of
the profit and loss account. Unpaid interest is considered
outstanding interest on the loan, and adjustment entries
reflect this in accounting. Interest on a loan, when given
in adjustment, is typically treated as outstanding
interest.
Format:
Example 24: Following is an extract of trial balance as on 31-12-2076.

Adjustment:
i. Interest on capital is allowed @ 5% p.a.
ii. Interest on drawing is @ 10% p.a.

Required: Treatment of adjustment.

Solution:
e) Manager’s Commission Payable – Manager's
commission is a remuneration based on a percentage of
profit, which can be calculated before or after commission
charges. In the absence of specific information, it is
typically calculated as a percentage of net profit before
commission. The commission is debited in the profit and
loss account and shown as a liability on the balance sheet.
Format:
If manager's commission is payable @ x% of net profit before charging such Commission
=

If manager's commission is payable @ x% of net profit after charging such commission

=
Example 25: The net profit of the firm amount to Rs. 21,000 before charging commission.
The manager of the firm is entitled to a commission of 10% on net profit. Calculate
commission payable to the manager in each of the following cases.
a. If the manager is allowed commission on the net profit before charging such commission,
and
b. If the manager is allowed commission on the net profit after charging such commission.
Solution:
Special Adjusting Entries

1. Interest on Capital - Interest on capital is treated as a

business expense. Therefore, it is debited in the profit and
loss account and presented as a liability on the balance
sheet when additional capital is introduced.
Format:
2. Interest on Drawing – When an owner withdraws money for
personal use and pays interest on the drawing, it is considered
income for the business. This interest on drawing is shown on
the credit side of the profit and loss account and is added to the
liability side of the balance sheet, along with capital deductions
or withdrawals.
Format:
3. Goods Used by Proprietor – When a business
proprietor uses goods for personal use, this is reflected on
the debit side of the trading account by deducting the
value from purchases. Additionally, on the liability side of
the balance sheet, the same amount is deducted from the
capital.
Format:
Example 26: Following is an extract of trial balance as on 31-12-2076.

Adjustment: The proprietor had used goods worth Rs. 1000 for his personal use.

Required: Show the adjustment entry and also show the treatment in final accounts.
Solution:
4. Capitalized Expenses – Capital expenditures incurred
during the installation of capitalized assets are reflected
on the debit side of the trading and profit and loss
account by deducting them from related expenses.
Simultaneously, these expenses are shown on the assets
side of the balance sheet.
Format:
Example 27: Following is an extract of trial balance as on 31-12-2076.

Adjustment:
i. Material worth Rs. 10,000 out of purchase was used for making office furniture.
ii. Wages amounting to Rs. 400 were paid to a worker for making office furniture.

Required : Show the adjustment entry and also show the treatment in final accounts.
Solution:
Some Hidden Adjustments

Hidden adjustments refer to those not explicitly provided or separated in financial

statements. They become apparent through careful analysis of cases and situations. These
adjustments involve intangible aspects of transactions and are considered "hidden" until
identified. Identifying these aspects is crucial before determining the type of entries required
for accurate accounting. For Example:
In the absence of specified adjustments, interest at 18% on Rs.
10,000 is calculated. If the trial balance reflects less interest (e.g.,
Rs. 1,000), the shortfall (e.g., Rs. 800) is considered outstanding
expenses. If the entire interest is undisclosed, it is treated as
outstanding expenses (e.g., Rs. 1,800). Similarly, for office rent at
Rs. 1,000 per month (Rs. 12,000 p.a.), if the trial balance reports
only Rs. 8,000 in expenses, the difference (Rs. 4,000) is treated
as outstanding expenses and added.
For Example:

The plant is subject to a depreciation rate of 10%, while the interest on capital is set at 5%.
Explanations of above adjustments are shown below:
I. On the trial balance, plant purchase after six months. So depreciation should be charge
for the six months i.e. Rs 3,000 ) and posted on debit side of profit and loss account, and
deduct the same amount from plant on assets side of balance sheet.
II. When goodwill is presented in the trial balance, it undergoes an annual write-off. The
yearly amount is divided, and the allocated sum is written off and recorded on the debit
side of the profit and loss account. Simultaneously, this amount is subtracted from
goodwill on the assets side of the balance sheet each year.
III. Expenses incurred for a period exceeding one year in advance are termed deferred
revenue expenses. During financial statement preparation, a portion of these expenses is
charged to the profit and loss account by dividing the total cost by its expected lifespan.
The remaining proportion is recorded on the balance sheet.
IV. If monthly expenses are specified in adjustments, the annual total (e.g., 12 months) is
calculated and shown in the profit and loss account. If this amount is less than the trial
balance figure, the difference is treated as outstanding expenses. The outstanding
amount is then recorded on the liability side of the balance sheet. For example, if the
monthly salary is Rs. 5,000, the annual total is Rs. 60,000 (5,000 × 12).
V. For prepaid expenses given on a monthly basis and paid at the start of the year, the total
for 12 months is considered as an expense (prepaid expenses expired). The remaining
amount is treated as still prepaid and appears on the assets side of the balance sheet.
The expired prepaid expenses are included on the debit side of the profit and loss
account.
VI. For prepaid insurance paid for one year on 1-10-2076, with statements prepared on 31-
12-2076 (after 3 months), the portion representing 3 months is considered expired and
included on the debit side of the profit and loss account. The remaining value for 9
months is still unexpired and is recorded on the assets side of the balance sheet.
VII. Interest receivable for 6 months on a 5% government bond is Rs. 1,000. Of this, Rs. 600
has been received, and the remaining Rs. 400 represents accrued interest.
VIII.In a proprietorship firm, income tax is typically treated as a withdrawal
by the proprietor. Therefore, the payment of this amount is considered
as drawings.

IX. Since the life insurance premium for the proprietor is regarded as a
personal expense, it is categorized and treated as a drawing.

X. If capital is introduced within the year, interest on that capital for the
period should be calculated and added to the total interest on existing
capital. For example, 5% of Rs. 30,000 + 5% of Rs. 20,000 for 6
months equals Rs. 1,500 + Rs. 500, resulting in Rs. 2,000. This is
treated as an expense, recorded on the debit side of the profit and loss
account, and added to the capital on the liability side of the balance
sheet.
XI. If a loan is specified with a percentage, that given percentage is considered the interest
rate. For instance, a 10% interest is charged on a Rs. 30,000 loan for 6 months (i.e., Rs.
30,000 x 10÷100 x 6÷12 = Rs. 1,500). If Rs. 1,000 has been paid, the remaining Rs. 500
represents outstanding interest for the period.
Treatment of Items of Adjustments Appearing in the Trial Balance

If adjustments are included within the trial balance, they should be presented once in the
final accounts at an appropriate location. The handling of such items is outlined as follows:

Items given in Trial Treatment in Profit and Loss Treatment in Balance Sheet
Balance a/c or Other Account
Closing Stock - Shown on the assets side as a current
asset
Outstanding - Shown on the liabilities side as a
expenses/Accrued current liability
Expenses
Prepaid Expenses - Shown on the assets side as a current
asset
Accrued Income - Shown on the assets side as a current
asset
Items given in Trial Treatment in Profit and Loss Treatment in Balance Sheet
Balance a/c or Other Account
Unearned Income - Shown on the liabilities side as a
current liability
Depreciation Shown on the debit side of P and L a/c -
as a separate item
Bad Debts Shown on the debit side of P and L a/c -
as a separate item
Discount allowed Shown on the debit side of P and L a/c -
as a separate item.
Discount received Shown on the credit side of P and L -
a/c as a separate item.
Interest on Capital Shown on the debit side of P and L a/c -
as a separate item.
Interest on Drawings Shown on the credit side of P and L
a/c as a separate item.
Treatment of Items of Adjustments Appearing Outside the Trial Balance

Less from unearned income

on the liabilities side as a
current liability
Thank You