Chapter 10: Financial Statements – 2

Recording adjusting entries in preparing final accounts is necessary because of the following reasons:

1. It helps in assessing whether the final accounts reflect true profit or loss, and it also shows the true financial position of a business.
2. It ensures accounts comply with the accrual basis of accounting.
3. It makes sure that all financial transactions belong to the current fiscal year. No transactions of past or future are taken into account.
4. It provides the scope for introducing different provisions, which can be made at year-end, only after assessing the whole year’s performance.

The cost of goods that remains unsold in the inventory after the completion of the accounting period is referred to as the closing stock. The closing stock value is determined by comparing the realisable value and cost price. The lesser among the two values is considered as the value of the closing stock.

In final accounts, the closing stock is adjusted by:

1) Crediting the closing stock to trading and profit and loss account.

2) Placing it on the asset part of the balance sheet.

The following entries need to be passed for adjustment

Closing Stock A/c Dr.

To Trading A/c

Solution coming soon.

In an ideal scenario, it is expected that debtors will be paying all the amount owed by them to the business, in reality, it doesn’t happen as some debtors might default on paying. It can be the full amount or a part of the sum borrowed. It is uncertain as to how much will that debt actually becomes bad debt. A business has to make a reasonable estimate for such an event. This estimate is called the provision for bad debts. It is created by debiting the P & L account.

Profit and loss A/c Dr

To Provision for doubtful debts A/c

(c) Interest on capital

(d) Manager’s commission

Two types of manager commission can be seen as follows:

Case 1: When the commission is applied to the profit before charging the commission.

Case 2: When the commission is applied to the profit after charging the commission.

A business allows discounts to debtors to encourage them to clear their debts. The amount of discount that a debtor will receive is estimated and accounted for by creating a provision for discount on debtors. It is only for those debtors who repay on time. The journal entry for such an event can be written as follows:

Profit and Loss A/c

Dr.

To Provision for Discount on Debtors A/c

Discount to debtors is an expense, and hence it is shown in the expense side of the P & L account and deducted from the assets side in the balance sheet.

Solution coming soon.