Need for Adjustment, Closing Stock and Outstanding Expenses: Concepts

When the final accounts of a firm are being finalized, necessary adjustment entries need to be incorporated at the close of the year, in order to prepare correct accounts. Without passing such adjustment entries, the correct value of the profit and loss for the year cannot be correctly determined. Hence, adjustment entries play a pivotal role while preparing the balance sheet at the end of the year. Let us understand more about closing stock and outstanding expenses.

Adjustment of Closing Stock in the Final Accounts

The closing stock implies inventory held at the end of the year. Thus, to derive information relating to closing stock we maintain a real account by name Closing Stock. It provides data relating to the value of stock unsold at the end of the accounting period. The value of closing stock is ascertained by physical verification of stock and its valuation at cost or market price whichever is lower.

Usually, the closing stock does not appear in the Trial Balance when the accounts are being finalized as the closing stock is ascertained by physical verification, which takes time in bringing up the value. Thus it appears as part of adjustment entry, which has to be passed before the preparation of Final Accounts.

If the closing stock is shown in the trial balance it means the adjustment for the closing stock has already been done and it will be shown as a current asset on the right side of the balance sheet. From the accounting point of view, aspects covered while preparing the accounts are:

Closing Stocks as shown on the Credit Side of Trading Account
Closing Stocks as shown on the Asset Side of Balance Sheet

However, if the value of the adjusted purchase(the cost of goods sold) is given then, the trial balance will show figures of both adjusted purchases account and Closing Stock Account.

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Adjustment Entries for Outstanding Expenses

Need for Adjustment, Closing Stock and Outstanding Expenses

There are certain expenses which are incurred but not actually paid. They are called outstanding expenses. Expenses like salaries, rents and more, of each month, are paid in the following months. Such expenses, which are due for payment in a given accounting year but the payment will be made in the future accounting year, that is, the payment of such items is postponed, are Outstanding expenses.

In order to bring a true view of the accounts, it is necessary to account the expenses in that year in which they occur, irrespective of the fact whether they are paid or not. That is, all such outstanding expenses which are in nature of a liability account must be recorded in the accounting period if they relate to that accounting year. The accounting effect of this entry is as follows:

An outstanding expense is a liability and shown in Balance Sheet as a liability.
An outstanding expense is added to the respective expense in profit and loss account.

Solved Example for You

Question: Pass journal entries for the following events:

Trial Balance shows Salary of Rs 15,000 but the salary of Rs 1,000 for the month of December 2004 has not been paid till 31.12.2004.
The value of the closing stocks is Rs 10,000

Answer: