Chapter 10 — Preparation of Final Accounts

Final accounts are prepared on the accrual basis and the matching principle: the revenue of a year must be set against the expenses incurred to earn it, whether or not cash has changed hands. The trial balance, however, is built from transactions that have actually been recorded, and it usually reflects the cash basis for expenses and incomes. Rent paid for eleven months appears as eleven months' rent; the twelfth month, though used, is missing. Insurance paid for a year starting in October includes six months belonging to next year. Machinery has worked all year but shows the same value as at the start. Some of the debtors listed will never pay. Unless these facts are brought in, profit and financial position are both wrong.

An adjustment is therefore an entry made at the end of the year, before the final accounts are drawn, to record an item that belongs to the year but is not yet in the books, or to remove an item that is in the books but belongs to another year. Adjustments are recorded by adjusting entries in the journal proper. In an examination problem, adjustments are given as notes below the trial balance, and the student is expected to apply them directly in the final accounts rather than writing the journal entries, unless the question asks for them.

The dual-effect rule. Because every adjusting entry has a debit and a credit, every adjustment given outside the trial balance appears in two places in the final accounts. Typically one effect is in the trading or profit and loss account and the other in the balance sheet. Closing stock is credited to the trading account and shown as an asset. Outstanding salaries are added to salaries in the profit and loss account and shown as a liability. Depreciation is debited to the profit and loss account and deducted from the asset. A student who shows an adjustment only once has broken the double entry, and the balance sheet will not tally by exactly that amount; this is in fact the most common reason why a balance sheet fails to agree.

Items already in the trial balance. The opposite rule holds for an item that appears inside the trial balance: it has already been recorded by double entry, so it appears in one place only in the final accounts. If 'Outstanding wages Rs 2,000' is listed in the trial balance as a credit balance, the entry has been passed, wages already include it, and the item goes only to the liabilities side. If 'Depreciation Rs 5,000' is in the trial balance as a debit, the asset has already been reduced, and depreciation goes only to the profit and loss account. Recognising which side of this line an item falls on is the first skill of this chapter.

The adjustments that follow are the standard set for the Intermediate course. Each is presented in the same pattern: meaning, adjusting entry, effect in the trading or profit and loss account, effect in the balance sheet, and any special case.

Closing stock is the value of goods remaining unsold on the last day of the accounting year. It is found by physical stock-taking and is valued at cost price or net realisable (market) value, whichever is lower, in accordance with the principle of conservatism: anticipated losses are provided for, anticipated profits are not.

Because stock-taking is done after the books are closed, closing stock is not in the ledger and does not appear in the trial balance. It is the first and most universal adjustment.

Adjusting entry: Closing Stock A/c Dr; To Trading A/c. (Being closing stock brought into account.)

Effect in the trading account: shown on the credit side as 'By Closing Stock'. The reasoning is that the debit side of the trading account carries the cost of all goods available for sale during the year; the unsold portion must be taken out so that only the cost of goods actually sold is matched against sales. Crediting the closing stock has the same effect as deducting it from purchases.

Effect in the balance sheet: shown on the assets side under current assets as 'Closing Stock' or 'Stock in Trade'.

Special case – closing stock inside the trial balance. Sometimes the trial balance itself contains Closing Stock as a debit balance. This means the entry has already been passed, usually against Purchases (Closing Stock A/c Dr, To Purchases A/c), and the purchases figure in the trial balance is already reduced; the trial balance may then say 'Adjusted Purchases' and will have no opening stock line. In that case closing stock is shown only in the balance sheet as an asset, and is not credited to the trading account, because crediting it again would count it twice and overstate gross profit.

Special case – valuation. If the problem gives both cost and market value, take the lower. If the problem says stock was valued at cost, use it. If stock includes goods lying with a consignee or goods sent on approval, those belong to the business and are included at cost; goods held on behalf of others are excluded.

Effect on profit. Closing stock increases gross profit rupee for rupee; overvaluing it inflates profit and overvaluing next year's opening stock will reduce next year's profit by the same amount. Auditors therefore examine stock valuation carefully, and the student should remember that the closing stock of one year is automatically the opening stock of the next.

Illustration. Trial balance: Opening stock 30,000; Purchases 1,20,000; Sales 1,95,000. Closing stock Rs 22,000 given as an adjustment. Trading account: debit 30,000 + 1,20,000 = 1,50,000; credit 1,95,000 + 22,000 = 2,17,000; gross profit 67,000. Balance sheet assets: Closing Stock 22,000. Had the trial balance instead shown Adjusted Purchases 1,28,000 and Closing Stock 22,000 (no opening stock), the trading account would show only Adjusted Purchases 1,28,000 against Sales 1,95,000, gross profit 67,000, and the closing stock would go only to the balance sheet.

Outstanding expenses (accrued expenses, expenses due but not paid) are expenses that relate to the current year but have not been paid by the year end: December wages paid in January, the last quarter's rent, interest on a loan for the final months. The trial balance shows only the amount paid, so the expense is understated and a liability is missing.

Adjusting entry: Expense A/c Dr; To Outstanding Expense A/c. (Being the expense outstanding for the year.)

Effect: add the outstanding amount to the expense on the debit side of the trading account (for direct expenses such as wages) or profit and loss account (for indirect expenses such as salaries, rent, interest), shown as 'To Salaries 24,000 Add: Outstanding 2,000 = 26,000'; and show 'Outstanding Salaries 2,000' on the liabilities side of the balance sheet under current liabilities.

Outstanding Expense account is a personal account (representative personal), representing the persons to whom the amount is due. At the start of the next year, when the amount is paid, the entry is Outstanding Expense A/c Dr, To Cash, so that next year's expense is not charged twice.

Prepaid expenses (unexpired expenses, expenses paid in advance) are expenses paid during the year but relating wholly or partly to the next year: insurance premium paid for twelve months from 1st October, of which six months belong to the next year; rent paid in advance. The trial balance shows the whole amount paid, so the expense is overstated and an asset is missing.

Adjusting entry: Prepaid Expense A/c Dr; To Expense A/c. (Being the portion of the expense paid in advance.)

Effect: deduct the prepaid amount from the expense in the profit and loss (or trading) account, shown as 'To Insurance 2,400 Less: Prepaid 1,200 = 1,200'; and show 'Prepaid Insurance 1,200' on the assets side of the balance sheet under current assets.

Prepaid Expense account is also a representative personal account, representing the party who has received the advance. Next year it is transferred to the expense account: Expense A/c Dr, To Prepaid Expense A/c.

Computing the amounts. Problems state the outstanding or prepaid figure directly, or give enough to compute it. 'Salaries are Rs 2,000 per month' with Rs 22,000 in the trial balance means one month, Rs 2,000, is outstanding. 'Insurance premium of Rs 2,400 was paid on 1st October for one year' means 6/12 × 2,400 = Rs 1,200 is prepaid at 31st March. 'Interest on the bank loan of Rs 40,000 at 12% per annum' with Rs 3,600 in the trial balance means annual interest is 4,800 and Rs 1,200 is outstanding.

Inside the trial balance. If Outstanding Wages or Prepaid Insurance appears in the trial balance, the adjustment has been recorded already: show the outstanding amount only as a liability, the prepaid amount only as an asset, and take the expense at the trial balance figure.

Incomes are adjusted on the same principle as expenses, in the opposite direction.

Accrued income (income earned but not received, outstanding income) is income that belongs to the current year but has not been received by the year end: interest on investments for the last quarter, commission earned in March and received in April, rent due from a tenant. The trial balance shows only what has been received, so income is understated and an asset is missing.

Adjusting entry: Accrued Income A/c Dr; To Income A/c. (Being income earned but not received.)

Effect: add the accrued amount to the income on the credit side of the profit and loss account, shown as 'By Interest Received 800 Add: Accrued 400 = 1,200'; and show 'Accrued Interest 400' on the assets side of the balance sheet under current assets.

Accrued Income account is a representative personal account for the party who owes the income. When received next year: Cash Dr, To Accrued Income A/c.

Income received in advance (unearned income, unexpired income) is income received during the year but relating to the next year: rent received for April in March, an apprenticeship premium or subscription received for a period running into the next year. The trial balance shows the whole amount received, so income is overstated and a liability is missing.

Adjusting entry: Income A/c Dr; To Income Received in Advance A/c. (Being income received relating to the next year.)

Effect: deduct the advance from the income in the profit and loss account, shown as 'By Rent Received 6,000 Less: Received in Advance 1,000 = 5,000'; and show 'Rent Received in Advance 1,000' on the liabilities side of the balance sheet under current liabilities.

Income Received in Advance is a representative personal account for the party who has paid in advance and to whom the business owes the service. Next year it is transferred to income: Income Received in Advance A/c Dr, To Income A/c.

Computing. 'Investments of Rs 20,000 at 10% per annum; interest received Rs 1,500' means annual interest is 2,000, so Rs 500 is accrued. 'Rent received Rs 6,500 includes Rs 500 for April 2026' means Rs 500 is received in advance. 'Commission accrued Rs 300' is stated directly.

Symmetry table. Outstanding expense: add to expense, liability. Prepaid expense: deduct from expense, asset. Accrued income: add to income, asset. Income received in advance: deduct from income, liability. A student who memorises this square will place all four correctly: anything that increases an expense or income goes with a balance sheet item on the opposite side of the arithmetic, and the two 'add' items and two 'deduct' items pair off across the balance sheet.

Depreciation is the gradual and permanent decrease in the value of a fixed asset due to use, passage of time, wear and tear or obsolescence. It is an expense of the year in which the asset was used, even though no cash is paid, and it must be charged against profit to satisfy the matching principle; otherwise profit is overstated and the asset is shown above its worth.

Adjusting entry: Depreciation A/c Dr; To Asset A/c. (Being depreciation on the asset for the year.) At the year end Depreciation is closed to the profit and loss account: Profit and Loss A/c Dr, To Depreciation A/c.

Effect: debit side of the profit and loss account as 'To Depreciation on Machinery'; and on the assets side of the balance sheet deducted from the asset, shown as 'Machinery 60,000 Less: Depreciation 6,000 = 54,000'.

Computing depreciation. In this course depreciation is usually given as a percentage on the value of the asset in the trial balance, under the straight line (fixed instalment) method or the written down value method; since only one year is being dealt with, both give the same figure, the given percentage of the trial balance value, unless the problem says otherwise. Watch for these variations:

• Time factor. If an asset was bought during the year, depreciation is charged for the months of use: machinery of Rs 24,000 bought on 1st October at 10% per annum bears 24,000 × 10% × 6/12 = 1,200 for the year ending 31st March.
• Additions. If the trial balance shows Machinery 60,000 and a note says Rs 20,000 of this was bought on 1st January, depreciation at 10% is 40,000 × 10% + 20,000 × 10% × 3/12 = 4,000 + 500 = 4,500.
• Different rates. Furniture at 5%, machinery at 10%, buildings at 2.5% and so on; compute each separately and show separately in the profit and loss account.
• Depreciation inside the trial balance. If 'Depreciation' appears as a debit balance, it has already been charged and the asset already reduced; show it only in the profit and loss account and take the asset at the trial balance figure.
• Provision for depreciation in the trial balance. If the business keeps a Provision for Depreciation account (credit balance), the asset is at cost and the accumulated provision is shown; the year's depreciation is debited to profit and loss and added to the provision, and in the balance sheet the asset appears at cost less the total provision.

Land is not depreciated, because it does not wear out. Goodwill and other intangible assets are written off gradually by amortisation, which is treated in the same way as depreciation in the final accounts.

Depreciation is a non-cash expense: it reduces profit without reducing cash, and the amount retained in the business by charging it is, in effect, the fund from which the asset is eventually replaced. This point is asked in theory questions and distinguishes depreciation from all other expenses in the profit and loss account.

A business that sells on credit will find that some customers do not pay. When a debt becomes definitely irrecoverable, because the debtor has died, become insolvent, disappeared or simply refused and legal action is hopeless, it is written off as a bad debt. A bad debt is a loss of the year and is charged to the profit and loss account; the debtor's account is closed.

Entry when a debt is written off during the year: Bad Debts A/c Dr; To Debtor's A/c. This has been done before the trial balance is drawn, so 'Bad Debts' appears in the trial balance as a debit balance and Sundry Debtors already exclude the amount written off. Such bad debts are shown only in the profit and loss account: 'To Bad Debts 1,300'.

Further bad debts (additional bad debts, bad debts given as an adjustment) are debts found to be irrecoverable at the year end, after the trial balance, and not yet written off. A note such as 'Write off further bad debts Rs 700' or 'A debtor for Rs 700 became insolvent and nothing could be recovered' calls for the adjusting entry: Bad Debts A/c Dr 700; To Sundry Debtors A/c 700.

Effect: add the further bad debts to the bad debts in the profit and loss account, 'To Bad Debts 1,300 Add: Further Bad Debts 700 = 2,000'; and deduct them from Sundry Debtors on the assets side, 'Sundry Debtors 42,000 Less: Further Bad Debts 700 = 41,300'.

Bad debts recovered. If a debt previously written off is later paid, the receipt is a gain of the year in which it is received. It is credited to Bad Debts Recovered account (Cash Dr, To Bad Debts Recovered) and appears on the credit side of the profit and loss account; it is never credited to the debtor's account, which was already closed, and it is never netted against the year's bad debts on the debit side.

Partial recovery. If a debtor owing Rs 5,000 pays Rs 3,000 in full settlement and the balance is written off, the entry is Cash Dr 3,000, Bad Debts Dr 2,000, To Debtor 5,000. Only the Rs 2,000 is the bad debt.

Order of deductions from debtors. When several adjustments touch debtors, they are applied in a fixed order: first deduct further bad debts, then compute and deduct the provision for doubtful debts on the remaining balance, then compute and deduct the provision for discount on debtors on the balance after that. The next two topics take these up. The reason for the order is logical: a debt that is definitely bad is removed before estimating how much of the rest is doubtful, and discount can only be allowed on debts that will actually be paid.

A distinction the examiner tests: bad debts are a loss that has happened; the provision for doubtful debts, which follows, is an estimate of a loss that may happen. Bad debts reduce debtors directly and are certain; provisions are shown as deductions but the debts themselves remain on the books until they are actually written off.

At the year end some debtors are doubtful: they have not become definitely bad, but experience says a part of the total will never be collected. Prudence requires that this expected loss be charged against the profit of the year in which the sales were made, not the later year in which the debts actually go bad. The business therefore creates a provision for doubtful debts (provision for bad and doubtful debts, reserve for doubtful debts), usually as a percentage of the closing debtors.

Adjusting entry (creating the provision): Profit and Loss A/c Dr; To Provision for Doubtful Debts A/c. (Being provision created at x% on debtors.)

Effect: debit side of the profit and loss account 'To Provision for Doubtful Debts'; and on the assets side deducted from debtors, 'Sundry Debtors 41,300 Less: Provision for Doubtful Debts 2,065 = 39,235'. The debtors are thus shown at their expected realisable value.

Computing. The percentage is applied to the debtors after deducting further bad debts. With debtors 42,000, further bad debts 700 and provision at 5%: provision = 5% of 41,300 = 2,065.

When an old provision exists. A business that created a provision last year carries it forward, and it appears in the trial balance as a credit balance, 'Provision for Doubtful Debts (old)'. The bad debts of the current year are set against this old provision, and only the amount needed to bring the provision to the new required figure is charged to profit and loss. The working, which should be shown in the profit and loss account or as a note, is:

If the result is negative, that is, if the old provision exceeds bad debts plus the new provision, the excess is a gain and is shown on the credit side of the profit and loss account as 'By Provision for Doubtful Debts (excess written back)'.

Illustration. Trial balance: Debtors 42,000; Bad Debts 1,300; Provision for Doubtful Debts 1,500 (Cr). Adjustments: further bad debts 700; provision 5%. New provision = 5% × (42,000 − 700) = 2,065. Charge to P&L = 1,300 + 700 + 2,065 − 1,500 = 2,565, shown on the debit side as 'To Bad Debts 2,000 Add: New Provision 2,065 = 4,065 Less: Old Provision 1,500 = 2,565'. Balance sheet: Debtors 42,000 − 700 − 2,065 = 39,235.

Alternative presentation. Some accountants show the old provision on the credit side of the profit and loss account and the bad debts and new provision on the debit side; the net profit is the same. The examination accepts either, but the single net figure on the debit side is neater.

The provision is a credit balance carried forward; in the balance sheet the new provision (not the old, not the charge) is what is deducted from debtors. Confusing the new provision with the amount charged to profit and loss is the commonest error in this adjustment.

A business that allows cash discount to customers who pay promptly can expect that some of the closing debtors will earn that discount when they pay next year. The discount is a cost of this year's sales, so a provision for discount on debtors is created at the year end, usually at a small percentage of the good debtors.

Adjusting entry: Profit and Loss A/c Dr; To Provision for Discount on Debtors A/c.

Effect: debit side of the profit and loss account 'To Provision for Discount on Debtors'; and on the assets side deducted from debtors, after the provision for doubtful debts.

Computing. Discount will be allowed only to debtors who pay, so the percentage is applied to debtors after deducting further bad debts and the provision for doubtful debts. With debtors 42,000, further bad debts 700, provision for doubtful debts 2,065 and discount provision 2%: base = 42,000 − 700 − 2,065 = 39,235; provision for discount = 2% × 39,235 = 784.70, say 785. Balance sheet: Debtors 42,000 less 700 less 2,065 less 785 = 38,450.

If an old provision for discount exists in the trial balance, the working is the same as for doubtful debts: Discount allowed (trial balance) + New provision − Old provision = charge to P&L, or a credit if negative.

Reserve for discount on creditors. By the same logic the business may expect to receive discount from its creditors when it pays them promptly next year. Some concerns create a reserve for discount on creditors as a percentage of closing creditors. It is an anticipated gain, and prudent accounting discourages anticipating gains, so this reserve is unusual and is treated only when a problem specifically asks for it.

Entry: Reserve for Discount on Creditors A/c Dr; To Profit and Loss A/c. Effect: credit side of the profit and loss account 'By Reserve for Discount on Creditors'; and on the liabilities side deducted from sundry creditors.

With creditors 28,000 and reserve 2%: reserve = 560; P&L credit 560; liabilities: Creditors 28,000 − 560 = 27,440.

Discount allowed and discount received in the trial balance are the discounts of the year already recorded and go straight to the profit and loss account, debit and credit respectively. The provisions of this topic concern the discounts of next year that relate to this year's debts.

A complete working for debtors, which a student should set out in the balance sheet whenever more than one adjustment touches them, reads: Sundry Debtors (trial balance) less further bad debts, less provision for doubtful debts at x% on the balance, less provision for discount at y% on the balance after that, equals net debtors. Showing the working in the margin of the balance sheet earns method marks even if an arithmetic slip creeps in.

A sole trader's capital, if lent to someone else or deposited in a bank, would earn interest. To measure the true profit of the business as distinct from the return on the owner's money, and for consistency with partnership accounting, some concerns charge interest on capital as an expense of the business and credit it to the owner.

Adjusting entry: Interest on Capital A/c Dr; To Capital A/c. Then: Profit and Loss A/c Dr; To Interest on Capital A/c.

Effect: debit side of the profit and loss account 'To Interest on Capital'; and on the liabilities side added to capital, 'Capital 1,00,000 Add: Interest on Capital 5,000'. Net profit is reduced by the interest and capital is increased by the same amount, so the closing capital is unchanged in total; only its composition differs. The purpose is to show the trading profit separately from the reward for capital.

Computing. Interest is charged on the opening capital, as given in the trial balance, at the stated rate for the year. If additional capital was introduced during the year, interest on it is charged from the date of introduction. Interest on capital of Rs 1,00,000 at 5% = 5,000; if Rs 20,000 more was introduced on 1st October, add 20,000 × 5% × 6/12 = 500.

Interest on drawings. By the same reasoning the owner who withdraws money during the year is sometimes charged interest on the amounts withdrawn, as an income of the business.

Adjusting entry: Capital A/c (or Drawings A/c) Dr; To Interest on Drawings A/c. Then: Interest on Drawings A/c Dr; To Profit and Loss A/c.

Effect: credit side of the profit and loss account 'By Interest on Drawings'; and on the liabilities side deducted from capital (or added to drawings, which are then deducted from capital). Net profit rises and capital falls by the same amount.

Computing. If the problem gives the amount, use it. If it gives a rate and drawings were made evenly through the year, interest is charged for an average of six months: drawings 8,000 at 6% per annum, evenly, gives 8,000 × 6% × 6/12 = 240. If drawings were made at a stated date, charge from that date to the year end. If no dates are given and the problem simply says 'charge interest on drawings at 6%', many examiners accept the full year's interest, 480, unless the question hints at timing; a student should state the assumption.

Presentation of capital in the balance sheet with these items: Capital (opening) xx; Add: Additional capital xx; Add: Interest on capital xx; Add: Net profit xx; Less: Drawings xx; Less: Interest on drawings xx; = Closing capital.

Neither interest on capital nor interest on drawings is a cash transaction; both are book entries between the business and the owner. That is why they cancel out in the total of capital and why some teachers describe them as 'notional'. Their effect on profit is real, however, and the examiner will check that interest on capital appears on the debit side and interest on drawings on the credit side of the profit and loss account.

A group of adjustments concern goods that leave the business other than by sale. In each case the goods were included in purchases, but since they were not sold their cost must be taken out of the trading account and charged where it belongs.

Goods withdrawn by the proprietor for personal use. Entry: Drawings A/c Dr; To Purchases A/c. Effect: deduct from purchases in the trading account; add to drawings, which are deducted from capital in the balance sheet. The goods are taken at cost, not at selling price, because no profit is made on them.

Goods distributed as free samples (advertising). Entry: Advertisement (Free Samples) A/c Dr; To Purchases A/c. Effect: deduct from purchases in the trading account; debit to the profit and loss account as advertisement or free samples expense. The cost of the goods moves from trading to selling expenses.

Goods given as charity or donation. Entry: Charity A/c Dr; To Purchases A/c. Effect: deduct from purchases in the trading account; debit to profit and loss as charity.

Goods used in the business, for example goods used to make furniture or for repairs: Furniture A/c (or Repairs A/c) Dr; To Purchases A/c. Effect: deduct from purchases; add to the asset (or debit repairs).

Abnormal loss of stock by fire, theft or accident. The cost of the goods lost is removed from the trading account so that gross profit reflects only normal trading, and the loss is then dealt with according to insurance. Entry: Loss by Fire A/c Dr; To Purchases A/c (or To Trading A/c). Effect in the trading account: deduct from purchases, or show on the credit side 'By Loss by Fire (goods destroyed)'.

• Not insured: the whole loss is debited to the profit and loss account 'To Loss by Fire'.
• Fully insured and claim admitted: Insurance Company A/c Dr; To Loss by Fire A/c. The claim is shown as an asset 'Insurance Claim Receivable' in the balance sheet; nothing goes to profit and loss.
• Partly insured: the admitted claim is an asset; the balance is debited to profit and loss. Goods costing 6,000 destroyed, claim admitted 4,000: Insurance Company Dr 4,000, Profit and Loss Dr 2,000, To Loss by Fire 6,000. Trading account: credit 6,000 (or purchases less 6,000); P&L: To Loss by Fire 2,000; Assets: Insurance Claim 4,000.

Why the deduction from purchases matters. If the goods lost were left inside purchases, the trading account would charge their cost against sales that never happened, gross profit would fall and the gross profit ratio would be distorted. Removing them keeps the gross profit comparable with other years and shows the abnormal loss as what it is, an extraordinary item below the gross profit line.

Normal loss, such as evaporation or breakage inherent in the trade, is not adjusted; it is simply absorbed in the cost of goods sold and reduces gross profit. Only abnormal, non-recurring losses receive the treatment above.

In every one of these adjustments the double entry is preserved: one effect reduces the trading account debit side (purchases), the other appears as drawings, an expense, an asset or a loss. Where the problem says the goods were already recorded (for instance 'Drawings include goods worth Rs 2,000'), the adjustment has been made and no further entry is required.

Manager's commission on profit. Some traders pay the manager a commission as a percentage of net profit. The commission is an expense of the year and, being unpaid at the year end, an outstanding liability. Two forms occur.

• Commission on net profit before charging such commission: Commission = Rate × Net profit before commission. If profit before commission is Rs 22,000 and the rate is 10%, commission = 2,200.
• Commission on net profit after charging such commission: Commission = Net profit before commission × Rate ÷ (100 + Rate). With the same profit and rate: 22,000 × 10 ÷ 110 = 2,000. Check: profit after commission = 20,000, and 10% of 20,000 = 2,000.

Effect: debit side of the profit and loss account 'To Manager's Commission'; liabilities side 'Outstanding Manager's Commission'. Because the commission depends on the profit, it is computed last, after every other adjustment, and the profit and loss account is then balanced.

Items inside the trial balance that look like adjustments. A trial balance may contain Outstanding Salaries (Cr), Prepaid Insurance (Dr), Accrued Interest (Dr), Rent Received in Advance (Cr), Provision for Doubtful Debts (Cr), Depreciation (Dr), Closing Stock (Dr), Loss by Fire (Dr), Interest on Capital (Dr), Interest on Drawings (Cr) or Bad Debts (Dr). Each has already been recorded by double entry. The rule is simple: an item in the trial balance goes to one place only. Outstanding and advance items go to the balance sheet; expenses, losses and incomes go to the profit and loss account; provisions carried forward are used in the provision working; closing stock goes to the balance sheet only.

Bills of exchange. Bills receivable and bills payable in the trial balance are simply an asset and a liability. A note that a bill receivable of Rs 2,000 was dishonoured after the trial balance date, or that a discounted bill is outstanding, creates a contingent liability, shown as a footnote to the balance sheet.

Loans and interest. A loan in the trial balance with a stated rate of interest usually carries an outstanding interest adjustment: compute annual interest, deduct interest already paid (in trial balance), and the balance is outstanding. Loan of Rs 40,000 at 12%, interest paid 3,600: outstanding 1,200; P&L To Interest 3,600 + 1,200 = 4,800; Liabilities: Outstanding Interest 1,200.

Income tax and life insurance premium of the proprietor paid from business funds are drawings, not expenses; if in the trial balance as expenses, move them to drawings.

Wages paid for installing an asset included in Wages: deduct from wages in the trading account and add to the asset.

Sales include goods sent on approval not yet accepted: deduct the selling price from sales and from debtors, and add the cost price to closing stock.

Purchases include a fixed asset: deduct from purchases, add to the asset, and depreciate if required.

These items are rarer than the standard adjustments, but a full-marks answer requires handling any one of them when it appears. The unifying idea is unchanged: identify the correct classification, keep the double entry, and show each adjustment outside the trial balance in exactly two places.

The following table gathers every adjustment of the chapter in one place. A student who can reproduce it from memory has the tools to solve any final accounts problem in the Intermediate examination. Each row gives the adjusting entry and the two places where the adjustment appears when it is given outside the trial balance.

Three rows in the table have both effects inside the income statement (samples, charity, uninsured loss); they still obey the double-entry rule because the deduction from purchases and the debit to profit and loss are the two sides.

A checklist for the examination. (1) Read every adjustment and write its two effects in the margin before starting. (2) Mark each trial balance item T, P or B. (3) Prepare the trading account, applying stock and purchase adjustments. (4) Prepare the profit and loss account, applying expense, income, depreciation, provision and interest adjustments; compute manager's commission last. (5) Prepare the balance sheet, showing workings for debtors, fixed assets and capital. (6) If the two sides differ, find the difference and match it against the adjustments: an unmatched adjustment amount points straight to the omission. (7) Head each statement correctly: 'for the year ended' for the accounts, 'as on' for the balance sheet.

Adjustments are where most marks in the final accounts problem are earned and lost. Each adjustment applied correctly in both places earns its marks independently, so partial credit is available even if the balance sheet does not tally; but a tallying balance sheet is the surest sign of a complete answer.

From the following trial balance of Sri Krishna Traders as on 31st March 2026 and the adjustments given, prepare the Trading and Profit and Loss Account for the year and the Balance Sheet as on that date.

Debit balances: Cash in hand 4,500; Cash at bank 26,000; Drawings 8,000; Purchases 1,20,000; Sales returns 4,000; Opening stock 30,000; Sundry debtors 42,000; Wages 15,000; Salaries 18,000; Rent 9,000; Carriage inwards 2,500; Carriage outwards 1,500; Discount allowed 1,000; Furniture 20,000; Machinery 60,000; Bad debts 1,300; Bills receivable 6,000; Insurance 2,400; Interest on bank loan 3,600; Advertising 3,000 — total 3,77,800.
Credit balances: Capital 1,00,000; Sales 1,95,000; Purchases returns 3,000; Sundry creditors 28,000; Discount received 800; Commission received 2,000; Bills payable 9,000; Bank loan (12%) 40,000 — total 3,77,800.

Adjustments: (1) Closing stock Rs 22,000. (2) Wages outstanding Rs 1,500. (3) Insurance prepaid Rs 600. (4) Depreciate machinery at 10% and furniture at 5%. (5) Write off further bad debts Rs 700 and create a provision for doubtful debts at 5% on debtors. (6) Interest on the bank loan is outstanding for three months. (7) Commission accrued but not received Rs 400. (8) Goods worth Rs 2,000 were withdrawn by the proprietor for personal use, not recorded.

Step 1 – mark the adjustments. Before writing anything, note the two effects of each: (1) trading credit + asset; (2) add to wages + liability; (3) deduct from insurance + asset; (4) P&L debit + deduct from assets; (5) add to bad debts, P&L debit for provision + deduct both from debtors; (6) add to interest + liability; (7) add to commission + asset; (8) deduct from purchases + add to drawings.

Trading Account for the year ended 31st March 2026. Debit: Opening stock 30,000; Purchases 1,20,000 less returns 3,000 less goods withdrawn 2,000 = 1,15,000; Wages 15,000 add outstanding 1,500 = 16,500; Carriage inwards 2,500. Total 1,64,000. Credit: Sales 1,95,000 less returns 4,000 = 1,91,000; Closing stock 22,000. Total 2,13,000. Gross profit c/d = 2,13,000 − 1,64,000 = 49,000.

Profit and Loss Account. Credit: Gross profit b/d 49,000; Discount received 800; Commission received 2,000 add accrued 400 = 2,400. Total 52,200. Debit: Salaries 18,000; Rent 9,000; Carriage outwards 1,500; Discount allowed 1,000; Insurance 2,400 less prepaid 600 = 1,800; Interest on bank loan 3,600 add outstanding 1,200 (40,000 × 12% × 3/12) = 4,800; Advertising 3,000; Bad debts 1,300 add further 700 = 2,000; Provision for doubtful debts 5% × (42,000 − 700) = 2,065; Depreciation on machinery 10% × 60,000 = 6,000; Depreciation on furniture 5% × 20,000 = 1,000. Total: 18,000 + 9,000 + 1,500 + 1,000 + 1,800 + 4,800 + 3,000 + 2,000 + 2,065 + 6,000 + 1,000 = 50,165. Net profit = 52,200 − 50,165 = 2,035, transferred to capital.

Balance Sheet as on 31st March 2026.

Check. Assets: 4,500 + 26,000 + 6,000 + 39,235 + 400 + 600 + 22,000 + 19,000 + 54,000 = 1,71,735. Liabilities: 28,000 + 9,000 + 1,500 + 1,200 + 40,000 + 92,035 = 1,71,735. The balance sheet tallies.

Tracing the effects. Every one of the eight adjustments can be found twice in the answer. Closing stock: trading credit and asset. Outstanding wages: added to wages and a liability. Prepaid insurance: deducted from insurance and an asset. Depreciation: two P&L debits and two deductions from assets. Further bad debts and provision: P&L debits and two deductions from debtors. Outstanding interest: added to interest and a liability. Accrued commission: added to commission and an asset. Goods withdrawn: deducted from purchases and added to drawings. Nothing from the trial balance has been used twice, nothing has been left out, and the net profit of 2,035 is the only figure that passes from the income statement to the balance sheet.

If the balance sheet had not tallied. Compute the difference and compare it with the adjustment amounts. A difference of 600 would point to prepaid insurance shown in one place only; of 400 to accrued commission; of 1,500 to outstanding wages; of 2,000 to goods withdrawn added to drawings but not deducted from purchases, or the reverse. A difference equal to net profit means the profit was not carried to capital. This mechanical comparison finds the fault far faster than re-adding every column, and it is the method to use in the examination hall when time is short.