Asok Nadhani-Accountancy-Adjustment Entries

Adjustment Entries for Final Accounts
By Asok Kandhani

16.7 Adjustment Entries relating to Preparation of Final Accounts

16.7.1 Bad Debts

Goods are often sold to known customers on credit. Some of these customers may fail to pay their debts due to insolvency. The unrecoverable debts are called Bad Debts. It is a loss to the business.

To account for the loss for Bad Debts, entry will be:

Bad Debts A/c	Dr.	(To be shown in the Profit and Loss Account)
To Sundry Debtors A/c		(In the Balance Sheet, Sundry Debtors is shown after deducting this bad debt)

No adjustment is required for any bad debt which is already appearing in the Trial Balance. The bad debt which is appearing in the Trial Balance is to be debited to Profit and Loss Account of the period.

[Hanif, Pg- 17.20]

16.7.2 Provision for Bad Debts

Credit sales are recognized as income at the time of the sale without knowing the exact time of collection. In course of time, loss may result from non-realization of some amount due from the customers. Every organization crates a provision for this anticipated loss, from the reported income of the credit sales in the current period. There are different methods of creating provision for bad debts.

The accounting entry will be:

(a)   When Provision for Bad Debts Not Appearing in the Trial Balance

Profit and Loss A/c	Dr.
To Provision for Bad debts A/c		(To be shown in the Balance Sheet as a deduction from Debtors)

(b)   When Provision for bad Debts Appearing in the Trial Balance

At first, calculate the amount of provision to be created at the end of the period. Now compare it with the provision already appearing in the Trial Balance.

Ø  If the required provision is more than the provision appearing in the Trial Balance

Profit and Loss A/c	Dr.
To Provision for Bad Debts A/c		(Required Provision – Existing Provision)

Ø  If the required provision is less than the provision appearing in the Trial Balance

Provision for Bad Debts A/c	Dr.
To Profit and Loss A/c		(Existing Provision – Required Provision)

The required position is then shown in the Balance Sheet as deduction from Sundry Debtors.

 [Hanif, Pg- 17.20 – 17.21]

16.7.3 Provision for Discount on Debtors

Most traders give a cash discount to debtors who make prompt payment (i.e. within a specified time). So, the real worth of debtors will be the gross figure of debtors - (minus) the cash discount that they would take.

Usually, discount is allowed at a percentage (%) who repays their obligation within time. Therefore, the estimated amount of bad debt should be deducted from the total of debtors; and provision for discount on debtors should be made only on the balance.

The accounting entry will be:

Profit and Loss A/c	Dr.
To Provision for Discount on Debtors A/c		(To be shown in the Balance Sheet by way of deduction from Sundry Debtors)

[Hanif, Pg- 17.22]

16.7.4 Discount received from Creditors

If goods are purchased on credit and paid to creditors in time, creditors allow cash discount. It is an income of the business. For this, following entries are passed:

(i)	Creditors A/c	Dr.
	To Bank A/c
	To Discount Received A/c
(ii)	Discount Received A/c	Dr.
	To Profit and Loss A/c

Out of the creditors, at the end of the accounting year, we may expect certain discount but such discount will be received in the next year though it actually related to current period.

[Hanif, Pg- 17.22]

16.7.5 Depreciation

Depreciation is the process of allocating the cost of a tangible fixed asset over its estimated life, in a rational and systematic manner. Depreciation is generally charged to assets like Plant and Machinery, Building, Furniture, Equipment, etc. Initially the cost of the assets including installation cost is debited to the particular asset account.

The Accounting Entry will be:

(a)   When asset account is maintained at written down value:

(i)	Depreciation A/c	Dr.
	To Asset A/c
	(Being depreciation charged)
(ii)	Profit and Loss A/c	Dr.
	To Depreciation A/c
	(Being depreciation transferred to Profit and Loss Account)

(b)   When asset account is maintained at cost price:

(i)	Depreciation A/c	Dr.
	To Provision for Depreciation A/c
	(Being depreciation charged)
(ii)	Profit and Loss A/c	Dr.
	To Depreciation A/c
	(Being depreciation transferred to Profit and Loss Account)

Total accumulated Depreciation Provision is shown in the Balance Sheet liabilities side. Alternatively, it can be shown by way of deduction from the original cost of asset in the assets side.

[Hanif, Pg- 17.23]

16.7.6 Goods Distributed as Free Samples

This is a kind of advertisement. When goods are distributed to the prospective customers as free samples, an expense is incurred (advertisement expense) and there is reduction from the stock of goods.

The following entry is passed:

Advertisement (Sample) A/c	Dr.
To Purchases or Trading (Sample) A/c		(For a trader of a manufacturer)

 At the end, Advertisement Account is closed by transferring to the Profit and Loss Account:

Profit and Loss A/c	Dr.
To Advertisement  (Sample) A/c

[Hanif, Pg- 17.23]

16.7.7 Income Tax or Advance Tax

Income Tax or Advance Tax are not an expense to earn revenue. It is tax on profit earned after considering all expenses. So, while ascertaining the profit of a concern, income tax is not treated as an expense to be deducted from the profit. For a sole proprietor, income tax or advance tax both are payable by the owner and not by the business. Therefore, if income tax or advance tax appears in the Trial Balance of a partnership firm, it should be treated as drawings and should be deducted from capital.

The following are the entries to be passed:

(a)	Income Tax or Advance Tax A/c	Dr.	(When paid)
	To Cash or Bank A/c
(b)	Drawings A/c	Dr.
	To Income Tax or Advance Tax A/c

[Hanif, Pg- 17.24]

16.7.8 Interest on Advance Tax

In case of partnership firm, if any interest is received on advance tax; it is not the income of the business. It is the income of the proprietor. Therefore, if the interest on advance tax appears in the Trial Balance it should be added with the capital.

The following are the entries to be passed:

(a)	Bank A/c	Dr.
	To Interest on Advance Tax A/c
(b)	Interest on Advance Tax A/c	Dr.
	To Capital A/c

[Hanif, Pg- 17.24]

16.7.9 Drawings (Made by the Proprietor)

Drawings made by the proprietor(s) may be in cash or in kinds.

Ø  Drawings made in cash:- When money is withdrawn in cash or from bank, following entries are passed-

(a)	Drawings A/c	Dr.
	To Cash or Bank A/c
(b)	Capital A/c	Dr.
	To Drawings A/c

Ø  Drawings made in kinds:- When some of the stocks withdrawn from the business, the following entry should be passed- 

(a)	Drawings A/c	Dr.
	To Purchases A/c
(b)	Capital A/c	Dr.
	To Drawings A/c

If the drawings made by the owner are included in sales, create a reserve entry to cancel the original entry. For the drawings, the above two entries are to be passed.

  [Hanif, Pg- 17.24 – 17.25]

16.7.10 Dishonour of Cheques or Bill of Debtors

When a cheque previously received from a debtor, is dishonoured, the debtors is increased and the bank balance is decreased.

The following entry should be passed-

Sundry Debtor A/c	Dr.
To Bank A/c

When a bill, previously drawn on a debtor, is dishonoured, Debtor Account is debited and the person who is holding the bill is credited. The sundry debtors is increased and one of the following is credited, depending on the manner in which it has been previously dealt with.

The following entry should be passed-

Sundry Debtor A/c	Dr.	(Dishonoured of Bill)
To Bill Receivable A/c		(When the Bill is Retained)
To Bill for Collection A/c		(When the Bill is sent to Bank for Collection)
To Bank A/c		(When the Bill is Discounted with Banker)
To Endorsee A/c		(When the Bill is Endorsed)

If the provision for doubtful debts is to be made, it should be on the value of the Sundry Debtors after making the above adjustments.

  [Hanif, Pg- 17.25]

16.7.11 Set-off between Debtors & Creditors

Sometimes, a Debtor may also be a Creditor for the business (some Finished Goods Sold to Mr. X and some Raw Materials Purchased from). The name of Mr. X will appear both in the Debtors and Creditors list. Instead of receiving payment for sale Mr. X and making payment for purchase, these two results may be mutually set-off. The following entry is passed (the amount will be the smaller of the two figures):

Sundry Creditors A/c	Dr.
To Sundry Debtors A/c

  [Hanif, Pg- 17.25]

16.7.12 Abnormal Loss of stock by Accident i.e. by Fire

If a portion of the Stock is lost, the value of such loss is first to be ascertained. Thereafter, the following should be passed-

Abnormal Loss  A/c	Dr.
To Trading A/c

And Abnormal Loss Account is closed by transferring to the Profit and Loss Account, i.e.

Profit and Loss A/c	Dr.
To Abnormal Loss A/c

If insurance claim is lodged, the following entry should be passed-

Insurance Claim or Insurance Company A/c	Dr.
To Abnormal Loss A/c

When the claim is received, then the following entry should passed-

Bank A/c	Dr.
To Insurance Claim A/c

If the goods are partially insured, the portion not covered by insurance, is to be charged to Profit and Loss Account.

Example:

Goods costing Rs.6,000 were loss on fire. Goods were partially insured. So as Insurance Claim of Rs.5,000 was made. Insurance company settled the claim at Rs.4,500. Make the entries.

Solution:

On Loss of goods on fire:

Goods lost by fire A/c	Dr.	6,000
To Trading A/c			6,000

On raising insurance claim:

Insurance claim A/c	Dr.	5,000
Profit & Loss A/c	Dr.	1,000
To Goods lost by fire A/c			6,000

On receiving claim:

Bank A/c	Dr.	4,500
Profit & Loss A/c	Dr.	500
To Goods lost by fire A/c			5,000

  [Hanif, Pg- 17.25]

16.7.13 Goods sent on Approval Basis

When goods are sold to the customers on sale or return or on approval basis, it is not considered as sale till the time it is not approved by the customers or on expiry of specified period. When goods are sold initially to a customer on approval basis, entry for sales is passed. At the year end, if the goods are still lying with the customers awaiting approval, the following entries are to be passed:-

To cancel previous entry:

Sales A/c	Dr.	(Sales value)
To Sundry Debtors A/c

To add the value of the closing stock:

Stock with Customers A/c	Dr.
To Trading A/c

Consequently, sundry debtors will be recorded by sales price and the closing stock will be increased by the cost of sales.

  [Hanif, Pg- 17.26]

16.7.14 Interest on Loan taken (Fully/ Partly Paid or Not yet Paid)

In the Trial Balance, the amount of the loan appears in the credit column and interest paid appears in the debit column. If a portion of the interest is still outstanding at the year end, pass the following entry for the balance amount:

Interest on Loan A/c	Dr.
To Loan A/c

If nothing has been paid as interest, compute the amount of interest and pass the above entry. The total amount of unpaid interest will appear in the Balance Sheet as a liability.

  [Hanif, Pg- 17.26]

16.7.15 Interest on Capital  

Sometimes, it may have to be for interest on the capital contributed by the proprietor or the partners. Such interest is not a charge against profit but an appropriation of profit. In this connection, the following two entries have to be passed:

(a)	Profit and Loss Appropriation A/c	Dr.
	To Interest on Capital A/c
	(Interest on capital payable)
(b)	Interest on Capital A/c	Dr.
	To Capital or Current A/c
	(Interest on capital transferred to Capital or Current Account)

  [Hanif, Pg- 17.26 – 17.27]

16.7.16 Interest on Drawings

Sometimes, interest may be charged on drawings by the partners. Such interest is not to be treated as income of firm. However, it increases the divisible profit. The following two entries have to be passed.

(a)	Interest on Drawings A/c	Dr.
	To Profit and Loss Appropriation A/c
(b)	Capital or Current A/c	Dr.
	To Interest on Drawings A/c
	(Interest on drawings transferred to Capital or Current Account)

  [Hanif, Pg- 17.27]

16.7.17 Sales Tax

When goods are sold to customers either in cash or credit, sales tax (or VAT) is collected from him along with the price of the goods sold. Periodically, this sales tax is paid to the Government through the bank. Generally, in the Sales Day Book, a separate column is provided for sales tax. When goods are sold, sales tax is entered in separate column from sales (value of goods).

When these are posted in the ledger, the following entry is passed:

Sundry Debtors A/c	Dr.
To Sales A/c
To Sales Tax A/c

When goods are sold for cash the entry will be:

Cash A/c	Dr.
To Sales A/c
To Sales Tax A/c

When sales tax is paid to the Government, the following entry is passed:

Sales Tax A/c	Dr.
To Bank A/c

Any balance is the Sales Tax Account represents amount unpaid and it is to be shown in the Balance Sheet as a liability. Sometimes, sales tax is not recorded separately but it is added with the sales. In this case, an adjustment entry is to be passed debiting Sales Account and Crediting Sales Tax Account. Unpaid amount of sales tax is to be shown in the Balance Sheet as a liability.

  [Hanif, Pg- 17.27]

16.7.18 Closing Stock

It is shown following two ways-

i)      If Closing Stock is not appearing in Trial Balance, Closing Stock will be credited in Trading Account and shown as a current asset in the Balance Sheet.

ii)     If Closing Stock is appearing in the Trial Balance it is to be shown in the Balance Sheet only.

“Closing Stock is to be valued at cost or market price, whichever is lower”.

Closing Stock  A/c	Dr.
To Trading  A/c

   [Hanif, Pg- 17.28]

16.7.19 Outstanding Expenses

At the end of the accounting year some of the expenses may remain outstanding. Following entry is required at the end of the year for necessary adjustments.

Relevant Expenses A/c	Dr.
To Outstanding Expenses A/c

Outstanding Expenses A/c would appear in the Balance Sheet under Liabilities side.

   [Taxman Book, Pg- 1.49]

16.7.20 Prepaid Expenses

Like Outstanding Expenses, if any expenses of the subsequent year have been paid in advance the following adjustment entry is required.

Prepaid Expenses A/c	Dr.
To Relevant Expenses A/c

Prepaid Expenses Account will appear in the Balance Sheet under Asset side.

   [Taxman Book, Pg- 1.49]

16.7.21 Accrued Income

Accrued income is income earned but not due (e.g. interest accrued but not due). The following adjustment entry is made for this of adjustment-

Accrued Income A/c	Dr.
To Relevant Income A/c

Accrued Income will appear on Assets side of the Balance Sheet.

   [Taxman Book, Pg- 1.50]

16.7.22 Income received in Advance

If Income of subsequent Accounting Period has been received in the Current Accounting Period, the following adjustment will be required:-

Relevant Income A/c	Dr.
To Income Received in Advance A/c

Income Received in Advance A/c will appear in the Balance Sheet under Liability side.

   [Taxman Book, Pg- 1.50]

16.7.23 Provision for doubtful debts

Apart from making provision for Bad Debts, sometimes it is felt that still there may be some Debtors who may not make payments. Accordingly a Provision for such eventuality is made on principle of conservatism. In such case the following entry would be passed:

Profit and Loss A/c	Dr.
To Provision for Doubtful Debts A/c

Such Provision is required to be shown on the Debit Side of Profit and Loss Account. New Provision is added to the existing Provision, Bad Debts incurred are deduced from the total Provision and the Net Amount is shown on Debit Side of Profit and Loss Account. If the Old Provision is more than the new Provision required for Bad Debts, the Net Amount is shown on the Credit Side of Profit and Loss Account.

   [Taxman Book, Pg- 1.50]

16.7.24 Managerial Commission

Sometimes, the manager of a concern is given a percentage (%) of the net profit as commission. It is treated an expense (like salaries). So, the entry will be:

Profit and Loss A/c	Dr.
To Commission A/c

If the amount is not paid within the accounting period, it will be shown in the liability side of the Balance Sheet. Commission may be computed in 2 ways:

16.7.24.1 Case – 1: When Commission paid at a Percentage (%) of Net Profit before charging such Commission

In such case, Commission = Net Profit before Commission x Rate of commission.

Example

The Manager is entitled to a Commission of 10% on Net Profit before charging such Commission. Net Profit before charging such Commission is Rs.1,10,000.

Commission = Rs.1,10,000 x 10% = Rs.11,000

16.7.24.2 Case – 2: When Commission is paid at a Fixed Percentage (%) of Net Profit after charging such Commission

In such case, Commission = Net Profit before such Commission	x	Rate of Commission
		100 + Rate of commission

Example

The Manager is entitled to a Commission of 10% on Net Profit after charging such Commission. Net Profit before charging such Commission is Rs.1,10,000.

Commission = Net Profit before such Commission	x	Rate of Commission
		100 + Rate of commission
	=	Rs.1,10,000  x	10	=	Rs.10,000
			110