Adjustments in Final Accounts: Concepts and Accounting Treatment
1. Why are Year-End Adjustments Necessary?
Under the Accrual Concept and the Matching Concept of accounting, the true net profit or loss of a financial year can only be calculated if:
- All revenues earned during that year are accounted for (whether received in cash or not), and
- All expenses incurred to generate those revenues are matched against them (whether paid in cash or not).
Often, when the Trial Balance is extracted on 31st March, certain financial facts have occurred that are not yet reflected in the ledger:
- Salaries for March are not yet paid to employees.
- Insurance premium paid in advance covers the next 6 months of the coming year.
- Unsold goods remain lying in the warehouse.
To incorporate these unrecorded facts, Adjustment Entries are passed at the end of the financial year.
The Golden Rule of Adjustments:
- Any item inside the Trial Balance has already completed its double entry → It appears ONLY ONCE in Final Accounts (either in Trading A/c, P&L A/c, OR Balance Sheet).
- Any adjustment given outside the Trial Balance (additional information) has NOT yet completed its double entry → It must appear AT LEAST TWICE (once in Trading/P&L Account AND once in the Balance Sheet)!
2. In-Depth Master Table of All Major Adjustments
For your BBA DAVV practical examination, here is the complete reference table of all standard year-end adjustments:
| Adjustment Item | Journal Entry | 1st Effect (Trading or P&L A/c) | 2nd Effect (Balance Sheet) |
|---|---|---|---|
| 1. Closing Stock | Closing Stock A/c .. DrTo Trading A/c |
Credited to the Trading Account. | Shown under Current Assets. |
| 2. Outstanding Expenses (Incurred but not yet paid) | Expense A/c ........ DrTo Outstanding Exp A/c |
Added to the respective expense on the Debit side of Trading or P&L A/c. | Shown under Current Liabilities. |
| 3. Prepaid Expenses (Paid in advance for next year) | Prepaid Expense A/c . DrTo Expense A/c |
Deducted from the respective expense on the Debit side of P&L A/c. | Shown under Current Assets. |
| 4. Accrued Income (Earned but not yet received) | Accrued Income A/c .. DrTo Income A/c |
Added to the respective income on the Credit side of P&L A/c. | Shown under Current Assets. |
| 5. Unearned Income (Received in advance for next year) | Income A/c ......... DrTo Unearned Income A/c |
Deducted from the respective income on the Credit side of P&L A/c. | Shown under Current Liabilities. |
| 6. Depreciation on Fixed Assets | Depreciation A/c ... DrTo Fixed Asset A/c |
Debited to the Profit & Loss Account as an operational expense. | Deducted from the respective asset on the Assets side. |
| 7. Interest on Capital | Interest on Cap A/c . DrTo Capital A/c |
Debited to the Profit & Loss Account. | Added to Capital on the Liabilities side. |
| 8. Interest on Drawings | Drawings / Cap A/c .. DrTo Interest on Draw A/c |
Credited to the Profit & Loss Account (income to firm). | Deducted from Capital on the Liabilities side. |
| 9. Further Bad Debts (Discovered after trial balance) | Bad Debts A/c ...... DrTo Sundry Debtors A/c |
Added to existing Bad Debts on the Debit side of P&L A/c. | Deducted from Sundry Debtors on the Assets side. |
| 10. Provision for Doubtful Debts | P&L A/c ............. DrTo Provision for D/D A/c |
Debited to P&L A/c (or adjusted against old provision). | Deducted from Sundry Debtors (after further bad debts) on Assets side. |
3. Detailed Walkthrough of Tricky Adjustments
A. Bad Debts and Provision for Doubtful Debts
This is the single most tested adjustment in college accounting exams. Follow this strict chronological sequence:
- Calculate Further Bad Debts: Deduct any new uncollectible debt mentioned in the adjustment from Sundry Debtors:
Remaining Good Debtors = Trial Balance Debtors - Further Bad Debts
- Calculate New Provision on Remaining Debtors:
New Provision = Remaining Good Debtors × (Required Percentage / 100)
- In the Profit & Loss Account (Debit Side):
To Bad Debts (from Trial Balance) ₹ xxxx Add: Further Bad Debts (Adjustment) ₹ xxxx Add: New Provision Required (Adjustment) ₹ xxxx ---------- ₹ xxxx Less: Old Provision (from Trial Balance) ₹ (xxxx) ---------- Net Amount extended to P&L Debit column: ₹ xxxx - In the Balance Sheet (Assets Side):
Sundry Debtors ₹ xxxx Less: Further Bad Debts (₹ xxxx) Less: New Provision for Doubtful Debts (₹ xxxx) ---------- Net Good Debtors extended to Assets: ₹ xxxx
B. Depreciation on Fixed Assets
- Example: Plant & Machinery inside Trial Balance = ₹1,00,000.
- Adjustment: Provide depreciation at 10% per annum on Plant & Machinery.
- Calculation: Depreciation = ₹1,00,000 × 10% = ₹10,000
- Effect 1 (P&L Debit): Write
To Depreciation on Plant & Machinery: ₹10,000. - Effect 2 (Balance Sheet Assets):
Plant & Machinery: ₹1,00,000 Less: Depreciation: (₹10,000) -> Net Asset value = ₹90,000
4. Comprehensive Final Accounts Numerical Example with Adjustments
Given Trial Balance as on 31st March, 2026
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Capital | 1,20,000 | |
| Drawings | 10,000 | |
| Opening Stock | 25,000 | |
| Purchases and Sales | 90,000 | 1,60,000 |
| Wages | 12,000 | |
| Salaries | 18,000 | |
| Office Rent | 6,000 | |
| Sundry Debtors and Creditors | 40,000 | 22,000 |
| Cash at Bank | 15,000 | |
| Plant & Machinery | 50,000 | |
| Furniture | 10,000 | |
| Insurance Premium | 3,000 | |
| Discount Received | 2,000 | |
| Bad Debts | 1,000 | |
| Provision for Doubtful Debts | 1,000 | |
| TOTAL | ₹2,85,000 | ₹2,85,000 |
Additional Adjustments:
- Closing Stock valued at cost ₹35,000 (Market value ₹38,000). (Take lower! ₹35,000)
- Outstanding Salaries ₹2,000; Prepaid Insurance ₹600.
- Write off further bad debts ₹1,000 and maintain a Provision for Doubtful Debts at 5% on debtors.
- Depreciate Plant & Machinery at 10% and Furniture at 5%.
Solution:
Step 1: Compute Debtors & Provision
- Total Debtors = ₹40,000
- Less: Further Bad Debts = ₹1,000 → Remaining Debtors = ₹39,000
- New Provision at 5% on ₹39,000 = ₹1,950
- P&L Debit: Old Bad Debts (₹1,000) + Further Bad Debts (₹1,000) + New Provision (₹1,950) - Old Provision (₹1,000) = ₹2,950
Step 2: Trading Account
- Net Sales = ₹1,60,000
- COGS = Opening Stock (₹25,000) + Purchases (₹90,000) + Wages (₹12,000) - Closing Stock (₹35,000) = ₹92,000
- Gross Profit = ₹1,60,000 - ₹92,000 = ₹68,000.
Step 3: Profit & Loss Account
- Gross Profit b/d = ₹68,000 + Discount Received ₹2,000 = Total Credit ₹70,000
- Expenses (Debit):
- Salaries: ₹18,000 + ₹2,000 (O/s) = ₹20,000
- Office Rent = ₹6,000
- Insurance: ₹3,000 - ₹600 (Prepaid) = ₹2,400
- Bad debts & provision = ₹2,950
- Depreciation: Machinery ₹5,000 + Furniture ₹500 = ₹5,500
- Total Indirect Expenses = ₹20,000 + ₹6,000 + ₹2,400 + ₹2,950 + ₹5,500 = ₹36,850
- Net Profit = ₹70,000 - ₹36,850 = ₹33,150.
Step 4: Balance Sheet Total
- Liabilities Side:
- Capital: ₹1,20,000 + Net Profit ₹33,150 - Drawings ₹10,000 = ₹1,43,150
- Creditors = ₹22,000
- Outstanding Salaries = ₹2,000
- Total Liabilities: ₹1,43,150 + ₹22,000 + ₹2,000 = ₹1,67,150
- Assets Side:
- Plant & Machinery: ₹50,000 - ₹5,000 = ₹45,000
- Furniture: ₹10,000 - ₹500 = ₹9,500
- Closing Stock = ₹35,000
- Debtors: ₹40,000 - ₹1,000 - ₹1,950 = ₹37,050
- Cash at Bank = ₹15,000
- Prepaid Insurance = ₹600
- Total Assets = ₹45,000 + ₹9,500 + ₹35,000 + ₹37,050 + ₹15,000 + ₹600 = ₹1,67,150.
₹1,67,150 = ₹1,67,150 (Matched Perfectly!)
5. Summary & Quick Revision Checklist
- Items inside Trial Balance appear once; adjustments outside Trial Balance appear twice.
- Outstanding Expenses: Add to expense in Trading/P&L, show as Current Liability.
- Prepaid Expenses: Deduct from expense in P&L, show as Current Asset.
- Accrued Income: Add to income in P&L, show as Current Asset.
- Closing Stock: Valued at Cost or Market Price, whichever is lower; credited to Trading A/c and shown under Current Assets.
- Depreciation: Debited to P&L, subtracted from fixed asset in Balance Sheet.
- Further Bad Debts & New Provision: Subtracted from Sundry Debtors in Balance Sheet and adjusted in P&L.