Financial Statements with Adjustments — II

The trial balance shows only what was actually paid or received. But the matching and accrual concepts demand that each year carry its own expenses and incomes. So before final accounts are finished, we pass adjustments. The golden rule: every adjustment has a double effect — it appears in two places (one in the Trading/P&L Account, one in the Balance Sheet).

The logic is always the same. An outstanding expense (say rent owed) belongs to this year, so we add it to the expense to find true profit, and we still owe it, so it is a liability. A prepaid expense (insurance paid for next year) does not belong to this year, so we remove it from the expense, and it is a benefit receivable, so it is an asset. Accrued income (commission earned but not yet received) is added to income and shown as an asset; income received in advance is removed from income and shown as a liability. Master this four-way table and adjustments stop being scary.

Several more adjustments appear in almost every final-accounts question.

• Closing stock (when given outside the trial balance) has a double effect: shown on the credit side of the Trading Account and as a current asset in the balance sheet.
• Depreciation: charged as an expense in the P&L Account (debit) and deducted from the asset in the balance sheet.
• Bad debts (further/new bad debts given in adjustment): added to bad debts in the P&L (debit) and deducted from debtors in the balance sheet.
• Provision for doubtful debts: created on the debtors that remain after writing off bad debts. It is charged to the P&L (debit) and deducted from debtors in the balance sheet.
• Provision for discount on debtors: a further (smaller) provision, created on debtors after deducting the provision for doubtful debts; treated the same way (P&L debit; deducted from debtors).

The order for debtors is important and often tested: start with debtors, less further bad debts, less new provision for doubtful debts, less provision for discount — the final figure is the net debtors shown in the balance sheet. For example, debtors Rs 1,00,000; further bad debts Rs 5,000; provision for doubtful debts 10%. Net debtors = 1,00,000 − 5,000 = 95,000; provision = 10% of 95,000 = 9,500; debtors in the balance sheet = 95,000 − 9,500 = Rs 85,500, and Rs 5,000 + Rs 9,500 = Rs 14,500 is charged to the P&L (adjusted for any old provision).

A full question gives a trial balance plus several adjustments, and asks for the Trading and P&L Account and Balance Sheet. The reliable procedure:

1. Read each adjustment and note its two effects (use the tables from the previous topics).
2. Prepare the Trading Account — opening stock, purchases (net), direct expenses (add outstanding, remove prepaid), and sales (net) with closing stock on the credit side → gross profit.
3. Prepare the P&L Account — gross profit b/d, indirect expenses (adjusted), depreciation, bad debts and provisions on the debit, and incomes (adjusted) on the credit → net profit.
4. Prepare the Balance Sheet — capital (+ net profit − drawings), liabilities (including outstanding expenses and income received in advance), and assets (fixed assets less depreciation, net debtors, closing stock, prepaid expenses, accrued income, cash).

Two habits prevent most errors: (i) tick off each trial-balance item and each adjustment as you use it — a trial-balance item is used once, an adjustment item twice; and (ii) check that the balance sheet totals agree — if not, an adjustment has been used only once or on the wrong side.

For example, if rent of Rs 12,000 appears in the trial balance and the adjustment says "rent outstanding Rs 2,000," then the P&L shows rent Rs 14,000 and the balance sheet shows outstanding rent Rs 2,000 — the item from the trial balance used once, the adjustment used twice. Working methodically like this, even a long question becomes routine. With adjustments mastered, you can prepare the complete, true final accounts of any sole proprietor — the capstone skill of Class 11 Accountancy.