Chapter 10: Financial Statements – 2

In the accrual base of accounting, profit and loss for a year are not dependent only on revenues in cash or expenses paid in cash during the year. Some parts of the receipts and expenses that occurred in a year might belong to previous/future accounting periods. There can be some expenses which are yet to be brought to the books of account. Adjusting these items will provide a true and fair view of the business.

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 also, it shows the true financial position of the 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 transaction of past or future is taken into account.

4. It provides the scope for introducing various provisions which can be made at year-end, only after assessing the whole year’s performance.

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

Provision for doubtful debts is shown as the deduction from debtors on the asset side of the balance sheet. It presents a true and fair view of the business. Provision for doubtful debts created at the end of the accounting period is carried forward to the next accounting period.

Adjustment entries for the provision for doubtful debts

Profit and Loss Account

Balance Sheet

(b) When given outside the trial balance:  It will be posted in the P & L account as well as the balance sheet

(ii) Depreciation

In the trial balance, depreciation is shown in the P & L account, as it is an expense. When present in the trial balance, it means a deduction has been taken from the concerned asset, and when depreciation is shown outside the trial balance, it needs to be recorded both in the P & L account as well as the balance sheet.

1) Inside Trial Balance

2) Outside Trial Balance

(iii) Closing stock

(a) Closing stock is valued based on the least among cost price or realisable value. If present in the trial balance, it gets posted only on the assets side of the balance sheet.

(b) When closing stock is given outside trial balance, it gets posted in two places, i.e. P & L account and balance sheet.