FINAL ACCOUNTS - Meaning and Adjustments

12th BOOK KEEPING BY AJAYSANTHOSH MOURYA

Meaning & Explanation

When a person starts a business he wishes to know the financial performance of his business. A convenient and universally accepted method of knowing this is to ascertain the profit or loss at yearly intervals (1st April to 31st March) and the financial position of the business on a given date. He can ascertain these by preparing the Final Accounts, which is prepared on the basis of the Trial Balance. The preparation of Final Accounts is the last step in the accounting cycle and that is why they are called Final Accounts.

Final Accounts include the preparation of
i) Trading and Profit and Loss Account ; and
ii) Balance sheet.
Final accounts are the means of conveying the profitability and financial position to management, owners and interested outsiders of the business. Final accounts have to be prepared every year, to make a continuous assessment of the business for a completed period. It must be kept in mind that expenses and incomes for the full accounting period are to be taken into account.
Suppose, the firm closes its books on 31st March and rent for the month of March has not been paid, this expense (rent) has been incurred and yet to be paid. Therefore, it would be proper to include the rent for the month (March) along with the rent of the year to know the true profit. In a firm there will be a number of items, both expenses and incomes, which have to be adjusted. If such items are not adjusted, the final accounts will not reveal the true and fair picture of the business performance. All such items which need to be brought into books of account at the time of preparing final accounts are called “adjustments”.
Journal entries passed to effect the required adjustments are known as adjusting entries.

1.1 Adjustments
Some important and common items, which need to be adjusted at the time of preparing the final accounts are discussed below.
1. Closing stock
2. Outstanding expenses
3. Prepaid Expenses
4. Accrued incomes
5. Incomes received in advance
6. Interest on capital
7. Interest on drawings
8. Interest on loan
9. Interest on investment
10. Depreciation
11. Bad Debts
12. Provision for bad and doubtful debts
13. Provision for discount on debtors
14. Provision for discount on creditors.
Note : All adjustments are given outside the trial balance.

1.1.1 Closing Stock
The unsold goods in stock at the end of the accounting period is called as closing stock. This is to be valued at cost or market price whichever is lower.

Example:
The value of closing stock shown outside the trial balance on 31.3.2004 is Rs.1,00,000.

 

Value of closing stock will appear
i) on the credit side of trading account and
ii) on the assets side of balance sheet.

1.1.2 Outstanding Expenses
Expenses which have been incurred but not yet paid during the accounting period for which the final accounts are being prepared are called as outstanding expenses.
Example: Trial balance shows salaries paid Rs.22,000.
Adjustment: Salary for March 2004, Rs.2,000 not yet paid.

 

Outstanding expenses will be shown
i) on the debit side of Profit and Loss account by way of additions to the particular expenses and
ii) on the liabilities side of the Balance Sheet. 

1.1.3 Prepaid Expenses
Expenses which have been paid in advance are called as prepaid (unexpired) expenses.
Example: Trial Balance for the period ending 31st March, 2004 shows Rs.15,000 as insurance premium. Adjustment: Prepaid Insurance premium Rs.7,500.

 

Prepaid expenses will be shown
i) on the debit side of the Profit and Loss account by way of deduction from the particular expenses and
ii) on the assets side of the Balance Sheet. 

1.1.4 Accrued Incomes or Outstanding Incomes
Income which has been earned but not received during the accounting period is called as accrued income.

Example: Credit side of Trial Balance (31.3.2004) shows commission received Rs.8,000. Adjustment: Commission accrued but not yet received Rs.2,000.

 

Accrued income will be shown
i) on the credit side of Profit and Loss account by way of addition to particular income and
ii) on the assets side of the Balance Sheet

1.1.5 Incomes Received in Advance
Income received during a particular accounting period for the work to be done in future period is called as income received in advance.
Example: Trial Balance for the period ending 31st March, 2004 shows Rent received Rs.25,000. Adjustment: Rent received in advance Rs.5,000.

 

 Incomes received in advance will be shown
i) on the credit side of the Profit and Loss account by way of deducting from the particular income and
ii) on the liabilities side of the Balance sheet.

1.1.6 Interest on Capital
In order to see whether the business is really earning profit or not, it is desirable to charge interest on capital at a certain rate.
Example: As per Trial Balance, capital as on 31.3.2004 is Rs.4,00,000. Adjustment: Provide 6% interest on capital.

To bring interest on capital to Profit and Loss account, the following transfer entry is required.

 

Interest on capital will be shown
i) on the debit side of Profit and Loss account and
ii) on the liabilities side of the Balance Sheet by way of addition to the capital.

 

1.1.7 Interest on Drawings
Amount withdrawn by the owner for his personal use is called as drawings. When interest on capital is allowed, then interest on drawings is charged from the owner. Interest on drawings is an income for the business and will reduce the capital of the owner.

Example: The trial balance shows the following:
                                                                   Rs.
Capital as on 31.3.2004                           4,00,000
Drawings as on 31.3.2004                          30,000
Adjustment : Charge interest on drawings @ 5%.

Interest on drawings will be shown
i) on the credit side of Profit and Loss account and
ii) on the liabilities side of the Balance Sheet by way of additionto the drawings which are ultimately deducted from the capital.

 

Lesson to be continued