Final Account Adjustments
"The finishing touches that make financial statements accurate."
Final accounts require adjustments to ensure they reflect the true financial position following the Accrual Concept and Matching Principle.
Types of Adjustments
1. Outstanding Expenses
Meaning: Expense incurred during the year but payment not made.
Example: December rent ₹10,000 will be paid in January.
Treatment:
- P&L Account: ADD to the respective expense
- Balance Sheet: Show as Current Liability
Adjusting Entry:
Rent A/c Dr. ₹10,000
To Outstanding Rent A/c ₹10,000
2. Prepaid Expenses
Meaning: Expense paid in advance (relates to next year).
Example: Annual insurance ₹12,000 paid on 1st Oct (covers Oct-Sep next year). Year ends 31st March → 6 months (Apr-Sep) are prepaid.
Prepaid Amount: ₹12,000 × (6/12) = ₹6,000
Treatment:
- P&L Account: DEDUCT from the respective expense
- Balance Sheet: Show as Current Asset
Adjusting Entry:
Prepaid Insurance A/c Dr. ₹6,000
To Insurance A/c ₹6,000
3. Accrued Income
Meaning: Income earned but not yet received.
Example: Interest on FD ₹5,000 earned but bank hasn't credited yet.
Treatment:
- P&L Account: ADD to the respective income
- Balance Sheet: Show as Current Asset
Adjusting Entry:
Accrued Interest A/c Dr. ₹5,000
To Interest Income A/c ₹5,000
4. Income Received in Advance (Unearned Income)
Meaning: Income received but not yet earned (relates to next year).
Example: Commission ₹8,000 received for next year's services.
Treatment:
- P&L Account: DEDUCT from the respective income
- Balance Sheet: Show as Current Liability
Adjusting Entry:
Commission Received A/c Dr. ₹8,000
To Unearned Commission A/c ₹8,000
5. Depreciation
Meaning: Systematic allocation of asset cost over its useful life.
Example: Machinery ₹1,00,000, depreciation @ 10%.
Treatment:
- P&L Account: Add Depreciation as expense (₹10,000)
- Balance Sheet: Reduce asset value OR show provision
Adjusting Entry:
Depreciation A/c Dr. ₹10,000
To Machinery A/c ₹10,000
6. Bad Debts and Provision
a) Bad Debts
Meaning: Debts that are irrecoverable.
Example: Customer owes ₹5,000 but went bankrupt.
Treatment:
- P&L Account: Add as Bad Debts expense
- Balance Sheet: Reduce Debtors
Adjusting Entry:
Bad Debts A/c Dr. ₹5,000
To Debtors A/c ₹5,000
b) Provision for Doubtful Debts
Meaning: Expected future bad debts (conservatism principle).
Example: Total debtors ₹1,00,000, create 5% provision.
Provision: ₹1,00,000 × 5% = ₹5,000
Treatment:
- P&L Account: Add Provision for Doubtful Debts
- Balance Sheet: Debtors less Provision
Adjusting Entry:
Provision for Doubtful Debts A/c Dr. ₹5,000
To Provision for Doubtful Debts A/c ₹5,000
Balance Sheet shows:
Debtors ₹1,00,000
Less: Provision (₹5,000)
Net Debtors ₹95,000
7. Closing Stock
Meaning: Inventory unsold at year-end.
Example: Goods worth ₹50,000 unsold.
Treatment:
- Trading Account: Credit side (₹50,000)
- Balance Sheet: Current Asset (₹50,000)
Note: Appears in BOTH places!
Adjusting Entry:
Closing Stock A/c Dr. ₹50,000
To Trading A/c ₹50,000
Adjustment Timeline for Year-End
⏳ Chronology of Events
Transactions Recorded
All business transactions recorded in books of original entry and ledgers.
Trial Balance Prepared
All ledger balances extracted and Trial Balance prepared.
Outstanding, Prepaid, Depreciation
All adjusting entries passed to reflect accrual basis and matching principle.
Trading, P&L, Balance Sheet
Adjusted figures used to prepare final accounts showing true financial position.
Summary Table of Adjustments
| Adjustment | P&L Treatment | Balance Sheet Treatment |
|---|---|---|
| Outstanding Expense | ADD to expense | Current Liability |
| Prepaid Expense | DEDUCT from expense | Current Asset |
| Accrued Income | ADD to income | Current Asset |
| Unearned Income | DEDUCT from income | Current Liability |
| Depreciation | ADD as expense | Reduce asset value |
| Bad Debts | ADD as expense | Reduce debtors |
| Provision for Doubtful Debts | ADD as expense | Deduct from debtors |
| Closing Stock | ADD (Cr. side Trading A/c) | Current Asset |
Important Points
Key Rules:
- Outstanding = Liability (we owe money)
- Prepaid = Asset (we'll get benefit in future)
- Accrued = Asset (others owe us)
- Unearned = Liability (we owe service/goods)
- Closing Stock appears TWICE (Trading & B/S)
- Depreciation ALWAYS reduces profit
- Bad Debts are actual losses; Provision is anticipated
Common Exam Question Pattern
Question: "Following adjustments are to be made: (a) Outstanding salaries ₹5,000, (b) Prepaid rent ₹3,000, (c) Depreciation on furniture @ 10% on ₹50,000. Show treatment in final accounts."
Answer:
P&L Account:
- Salaries: (Trial Balance amount + ₹5,000)
- Rent: (Trial Balance amount - ₹3,000)
- Depreciation: + ₹5,000
Balance Sheet:
- Liabilities: Outstanding Salaries ₹5,000
- Assets: Prepaid Rent ₹3,000, Furniture ₹45,000
Quiz: Final Account Adjustments
Test Your Knowledge
Question 1 of 5
1. Outstanding salary is shown in Balance Sheet as: