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Final Accounts for Sole Proprietors - Non-manufacturing

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

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
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