Adjustments and their Accounting Treatment

Adjusting entries are made before making the organization’s financial statement and after the preparation of trial balance. Adjusting entries are accounting journal entries in which we adjust the expenses and the company’s revenue and finance. At the end of the accounting period, ledger requires some alterations and adjustments which is done by adjsuting journal entries. Types of Adjusting Entries are Outstanding Expenses, Prepaid Expenses, Accrued Income, Unearned Income, Inventory. In this article, we will learn about adjusting entries, types of adjusting entries, and accounting treatment.

Adjusting Entries and Accounting Treatment

There should be a two-fold impact in case of any adjustment entry. Debit profit and loss account and credit the expense account. Credit profit and loss account and debit the income account.

Rectification of Errors and Transfers

We need to rectify errors such as the wrong amount/account by passing correct adjustment entry. Also, record transfer from profit and loss appropriation accounts such as Partner’s salary or Interest on capital by debiting Profit and Loss account and crediting to the parties concerned.

Understand the concept of Journal Entries here in detail.

Types of Adjusting Entries

• Outstanding Expenses
• Prepaid Expenses
• Accrued Income
• Unearned Income
• Inventory

Adjusting Entries Related to Income and Expense

Type	Particulars		Amount (Dr)	Amount (Cr)
1. Outstanding Expense	Expense A/c	Dr
	To Outstanding Expense A/c
	(Adjustment entry of expense incurred but not paid)
2. Accrued Income	Accrued Income A/c	Dr
	To Income A/c
	(Being income accrued but not received is recorded)
3. Prepaid Expense	Prepaid Expense A/c	Dr
	Expense A/c
	(Being expense paid in advance is adjusted over the respective period by adjustment entry)
4. Unearned Income	Fees\Income A/c	Dr
	To Unearned Fees/Income A/c
	(Being fees or income received but not earned of is recorded)
5. Inventory of material in hand	Inventory of materials in hand A/c	Dr
	To Appropriate expenses account A/c
	(Being respective cost incurred on the inventory of materials in hand adjusted)

Other Adjustment Entries

1. Provision for bad and doubtful debts	Profit and Loss A/c	Dr
	To Provision for Bad and Doubtful Debts A/c
	(Provision is created for doubtful debtors)
2. A Provision for discount	Profit and Loss A/c	Dr
	To Provision for Discount A/c
	(Being Provision for discount created)
3. Provision for depreciation	Profit and Loss A/c	Dr
	To Provision for Depreciation A/c
	(Being Provision for depreciation created)
4. Abnormal Loss of inventory	Loss by Fire A/c	Dr
	To Inventory A/c
	(Being loss by fire)
5. Goods sent on the approval basis
a.	Sales A/c	Dr
	To Trade Receivable Account A/c
	(Being goods treated as sales but not approved, now reversed)
b.	Stock on Approval A/c	Dr
	To Trading A/c
	(Being goods sent on approval basis recorded as closing stock)
6. Goods used other than sale	Drawings/ Donation/Free Samples/Repairs/Fixed Assets A/c	Dr
	To Purchases A/c
	(Adjustment entry for goods used other than purchase)
7. Commission based on profit
a.	Commission A/c	Dr
	To Commission Payable A/c
	(Being commission payable due)
b.	Profit and Loss A/c	Dr
	To Commission A/c
	(Being entry passed for commission payable to the manager on net profit)

Note: 

1. Reverse the Entries no. 1 to 5 at the beginning of the next year.

2. Whenever we expect that an expense/loss can incur in the near future and amount is uncertain then we create a provision for the same in books with an estimated amount.

3. We create Provision for discount on debtors on good debtors i.e., debtors after deduction of provision for doubtful debts.

Solved Example For You

The Balance Sheet of XYZ Limited as of March 31, 2018

Particulars	Rs.	Particulars	Rs.
Trade Payables	10,00,000	Furniture and Fixtures	5,00,000
Capital	15,00,000	Trade Receivables	7,00,000
		Cash at Bank	7,00,000
		Inventories	5,00,000
Total	25,00,000	Total	25,00,000

Net Profit as on March 31, 2018, was Rs. 14,50,000.

Adjustments:1) Outstanding salary of Rs. 5,40,000 2) Prepaid Insurance of Rs. 3,20,000. Charge Depreciation on Furniture @10%. Create a Provision for doubtful debts @5%.

Prepare closing entries for the above items. Also, prepare revised Trading and Profit and Loss Account and Balance Sheet.

Ans.

Journal Entries

Date	Particulars		Amount (Dr)	Amount (Cr)
31 Mar	Salary A/c	Dr	5,40,000
	To Outstanding Salary A/c			5,40,000
	(Being outstanding salary recorded)
31 Mar	Prepaid Insurance A/c	Dr	3,20,000
	To Insurance A/c			3,20,000
	(Being prepaid Insurance recorded)
31 Mar	Profit and Loss A/c	Dr	50,000
	To Depreciation A/c			50,000
	(Being depreciation charged @10%)
31 Mar	Profit and Loss A/c	Dr	35,000
	To Provision for Doubtful Debt A/c			35,000
	(Being provision for doubtful debts created @5%)

 Revised Profit and Loss A/c

Particulars	Rs.	Particulars	Rs.
To Outstanding Salary	5,40,000	By balance b/d	14,50,000
To Depreciation	50,000	By Prepaid Insurance	3,20,000
To Provision for Doubtful Debt	35,000
To Net Profit	11,45,000
Total	17,70,000		17,70,000

 Revised Balance Sheet as of March 31, 2018

Liabilities		Rs.	Assets		Rs.
Trade Payables		10,00,000	Furniture and Fixtures	5,00,000
Capital	15,00,000		Less- Depreciation	50,000	4,50,000
Less- Net Loss	3,05,000	11,95,000	Trade Receivables	7,00,000
Outstanding Liabilities		5,40,000	Less- Provision for Bad and Doubtful Debts	35,000	6,65,000
			Cash at Bank		7,00,000
			Inventories		5,00,000
			Prepaid Insurance		3,20,000
Total		27,35,000	Total		27,35,000