TREATMENT OF ALBJUS'IL'MENTS IN FINAL ACCOUNTS

 8.3 TREATMENT OF ALBJUS'IL'MENTS IN FINAL ACCOUNTS

There are several items whida need adjustment at tlie tirne of preparing the final accounts. Some of the important and cornmoil adjustment  are listed below:

1 Closing Stock 

2 Outstanding or Accrued Expense

3 Prepaid or Unexpired Expense

4 Outstanding or Accured Incomes 

5 incomes Received in Advance (Unearned Income) 

6 Depreciation 

7 interest on Capital 

8 Interest on Drawings 

9 Interest on Loan 

10 Bad Debts 

11 Provision for Bad Debts 

12 Provision fur  Discount on Debtors 

13 Provision fur  Discount on Creditors 

14 Manager's Comxnission 

15 Abnormal Loss 

16 Drawing of Goods by the Proprietor 

Let us now discuss tlie nature of cach item of adjustment and its treatment in the final accounts. ln this connection you must remember that the general prirlciple of double ' entry has to be fully followed. Hence, for bringing any item into the books of account or adjusting the amount of any expense or income, you have to ensure that the amount is debited to one account and credited ,to another; and while showing it in the final accounts the item should appear at two places, one representing the debit and the other representing the credit, otherwise the Balance Sheet will not tally. Usually, each adjustment will  first appear in the Trading and Profit and Loss Account and then in the Balance Sheet. 

8.3.1 Closing Stock 

You know that all goods purchased or produced during the year are not completely sold-aut by the end of the year. Some goods always remain unsold as at the end of the year which are called 'Closing Stock'. The Closing Stock does not usually appear in the Trial Balance. It is mostly given in the form of additional information. Since Gross ProfitlGrbss Loss cannot be worked out without accounting for the closing stock it is brought into books by means of the following adjustment entry. 

Closing Stock A/c            Dr.

To Trading A/c  

The closing stock is treated in the final accounts as follows: 

i) On the credit side of Trading Account: shown as a separate item, and

ii) On the assets side of the Balance Sheet: shown as a separate item under Current Assets.

Adjusted Purchases and Closing Stock: Sometimes the closing stock may be given in the Trial Balance itself. This would mean that both the opening and the closing stocks have been adjusted in the purchases. In such a situation, the opening stock will not appear in the Trial Balance. The Trial Balance will show only the figures of adjusted purchases and the closing stock. The adjusted purchases are in fact the cost of goods sold. They have been worked out by adding the opening stock to purchases and subtracting the closing stock therefrom. Hence, the adjusted Purchases are shown on the debit side of the Trading Account. In such a situation there is no need to show closing stock in the Trading Account qs it already stands adjusted in purchases. It will be shown only on the asset side of the Balance Sheet.

8.3.2 Outstanding Expenses

Outstanding expenses are those expenses which have been incurred during the current accounting year but have not been paid till the end of the year. They are also called 'expenses accrued'. The common examples of such expenses are the salaries, wages and rent for the last month of the accounting year paid in the first month of the next year. Since they remained unpaid as at the end of accounting year, no entry might have been passed in the books of account. So, they must be taken into account while preparing the Trading and Profit and Loss Account otherwise it will not reveal the correct amount of profit or loss. The following adjustment entry is passed in respect of outstanding expenses.

Concerned Expense A/c Dr.

To Outstanding Expenses A/c

The outstanding expenses will be treated in final accounts as follows: i) Added to the concerned expenses in the Trading and Profit and Loss Account, and

ii) Shown on the liabilities side of the Balance Sheet as a separate item under Current Liabilities.

8.3.3 Prepaid Expenses

Sometimes, the bedefit of some expenses will be available not only in the current accounting year but also during the next year. That portion of expense the benefit of which is yet to.be received is called 'prepaid expense'. It is also called 'unexpired expense'. Examples of such expenses are unexpired insurance,'interest paid in advance, etc. In such situations it is necessary to find out the unexpired portion and . adjust it in the concerned'expense. The following adjustment entry is passed in respect of the prepaid expenses:

Prepaid Expenses A/c          Dr

To Conpmed Expense A/c

  The Prepaid expenses will be treated in finai accounts as follows: 

 i) Subtracted from the concerned expense in the Trading and Profit and Loss Account, and 

 ii) Shown on the assets side of the BaIiznce Sheet as a separate itern under Current Assets.

8.3.4 Accrued Income

Accrued Incomcs are those incomes whicll have been earned during the current accounting year but have not heen received till the end of the year. They are also called 'outstanding incomes' or 'incomes earned but not yct received'. Exarnples of such incomes are commission receivable, income on investments due but not yet received, etc. The following adjustment entry is passed in respect of accrued income. 

Accrued Income A/c                Dr.

To Concerned Income A/c

The Accrued income is treated in final accounts as Follows: 

 i) Added to the concernd income in the: Profit and  Loss Accnunt, and 

 ii) Shocvn on the asset side sf the Balancc Sheet as a separate item under Current Assets. 

8.3.5 Income Received in Advance 

Any income which belongs to the next accounting year but has been received during the current accounting year is called income received in advance' or 'unearned income'. It is the income in respect of which the service is yet to be provided. Examples of such incomes arc rent received in advance, interest received in advance, etc. In such a situation, the unearned portion of the income will have to be adjusted while preparing the final accounts. The following adjusting entry is passed in respect of the unearned income.

Coccerned Income A/c Dr. 

 To Income Received in Advance A/c

The unearned income is treated in final accounts as foilows: 

 i) Deducted from the concerned income in the Profit and Loss Account, and 

 ii) Shown on the liabilities side of the Balance Sheet as a separate item under Current Liabilities. 

Look at Illustration 1 and see how adjustments are made in the final accounts in respect of outstanding expenses, prepaid expenses, outstanding incomes and incomes received in advance.

Illustration 1

Show how you will record the following items in the Profit and Loss Account and the Balance Sheet. The Trial Balance showed the following balances as on Dccernbcr 31,1987:  

Balance Sheet. It is possible that the adjustments given outside the Trial Balance already include this item. But, if they do not even then you have to account for it. This is called an implied adjustment.

 Question Peper_8