Concept of Adjustments:
In the previous chapter, we have discussed how the final account. i.e. trading account, profit and loss account, profit and loss appropriation account and balance sheet are prepared with the help of trial balance. The items, which appear in the trial balance, are recorded either in trading account or profit & loss account or profit and loss appropriation account or balance sheet. They have single effect in final account. The transactions which do not appear in the trial balance are called adjustments. They are presented outside the trial balance. They may have dual effect in final account. The adjustments indicate such items of incomes and expenses, which relate to current year but have not yet brought into the book of accounts. Such transactions are adjusted after the preparation of trial balance. Adjustments help to ascertain true operation results and financial position of the business.
When adjustment entry is passed, it has at least two effects:
i. Trading account and profit & loss account, or
ii. Trading account and balance sheet, or
iii. Profit and loss account and balance sheet, or
iv. Profit and loss appropriation account and balance sheet or
v. Balance sheet and balance sheet.
vi. Trading account and profit & loss account and balance sheet (effects in the accounts)
Adjustments:
1. Closing Stock of Finished or Unsold Goods
The stock of goods remained unsold at the end of the accounting period is called closing stock of finishing goods. Closing stock is valued at cost price or market price whichever is lesser. The adjustment of closing stock is made with the following manner.
2. Closing Stock of Unused or Non-Consumed Expenses
The stock of some items other than goods like stationary, suppliers, medicines etc. may remain unused at the end of the accounting period. It is not credited in the trading account as the case of finished goods. However, it is deducted from the convened expenditures in the debit of profit and loss account and kept in the current assets of balance sheet.
3. Outstanding Expenses or Expenses due of Expenses Payable or Accrued Expenses or Owing Expenses or Unpaid Expenses
Those expenses which have incurred but not paid are outstanding or unpaid expenses. All such expenses should be recorded in that accounting year on which they have incurred. Such unpaid expenses increase the expenses on the concerned heads and on the other hand become liabilities of business.
For example, salary relating to the month of chaitra paid in baishkh will be considered as outstanding salary as on 31st chitra. They are added with the concerned heads in the debit side of trading or profit and loss account and shown in the liability side of the balance sheet.The adjustment entry will be follows:
4. Prepaid Expenses or Advance Paid or Unexpired Expenses
Prepaid expenses represent the expenses paid in advance for the next accounting period. In their words, it is the unused part of expenses paid in current year the reaming of which will other words, it is the unused in the next accounting period. For example, insurance premium paid for one year is consumed in the next account ting period. For example, insurance premium paid for one year up to 1st kartik 2062. It the accounting period ends on 31st chaitra 2061, the insurance premium for the period of six months starting from 1st baishakh 2062 to 30th ashwin will be treated as prepaid insurance during the account ting period ending 31st chitra 2061. These prepaid expenses are considered as assets and debited in adjustment entry and recorded in assets side of balance sheet. On the other hand be deducted from related expenses in trading in trading or profit and loss account, since they are not related with current year-end. The adjustment entry will be as follows:
5. Prepaid/Advance Expenses Expired
Prepaid expenses may be given in trial balances; actual expenses will be appeared outside of trial balance as expired expenses. The expired amount (given in the adjustment) is shown in the debit side of the profit and loss account and balance (unexpired amount) is shown in the assets side a balance sheet as shown below:
6. Income Received in Advance or Unearned Income
Income received in the current accounting year but the work to be done in the future is termed as advance received income. Unearned income represents to the liability and it is to be shown in liability side of balance sheet, on the other hand, it related to the next year's income and it should be deducted form related income in credit side of profit and loss account.
7. Income Received in Advance/Unearned Income Earned
Income received in advance during the accounting period may be given in trial balance and form advance some amount is earned during the period that amount is income, and recorded in credit side of profit and loss account and remaining unearned will be posted on liabilities side of balance sheet. If such advance income is given in trial balance following entry should pass for unearned portion of income.
8. Accrued Incomes or Income Earned but mot yet Received or Income Receivable or Outstanding Income
These are the incomes earned in current account ting year but yet to be received. For example, interest on investment, rent from sub-letting, commission earned by the business during the accounting year but not yet received. One side accrued income is assets and it is recorded in assets side of the balance sheet another side it is income and should be added to the related income in credit side of profit and loss account.
9. Depreciation
Depreciation is the reduction in the value of fixed assets due to wear and tear, passage of time and other reason. It is non-cash expenses and should be recorded in debit side of profit and loss account. On the other hand, it is shown in asset side of balance sheet deducting from related fixed assets.
10. Miscellaneous Expenditure and Intangible Assets Written Off (Amortization)
Preliminary expenses, underwriting commission, discount or loss on issue of share or debenture, are the example of the miscellaneous expenditure or fictitious assets. Likewise, goodwill, patent, copyright and trademark are the example of intangible assets. They are recorded in asset side of balance sheet. These assets should be amortized or written of within the fixed time period prescribed by the income tax act. The adjustment entry and tradesman in final account of miscellaneous expenditure and intangible assets are follows:
11. Appreciation
When the value of fixed assets increase than the its book value, the increased value is said to be appreciation. It normally takes place with land. It is considered as income and recorded in credit side of profit and loss account. On the other hand, the appreciation In the value of assets is added with related assets in the balance sheet.
12. Purchase of Fixed Assets
A company may purchase additional fixed assets within the accounting year. This may be included in the purchase account or omitted to be recorded in the book of account in this case, the following treatments is to be made in final accounts.
13. Sales of Fixed Assets
A company may sell the unsuited or obsolete fixed assets. Sometimes the selling price be omitted to be recorded in the books of account and sometimes the sales of fixed assets may be included in sales account.
14. Bad Debts to be Written Off (Including further Bad Debts)
A debt means the person or party to whom goods are sold on credit. Debtors account represents amount receivable from debtor. Sometimes debtors fail to pay their due amount and the debt decode irrecoverable. Such irrecoverable amount is knows as bad debts. It is considered as loss, which is incurred during the course of business transaction. Bad debt may be given in trial balance and on the adjustment or in both. The bad debt appearing in trial balance is considered as old bad debt and bad debt given in adjustment is considered as new bad debt or further bad debt. The following adjustment entry should be passed to record the bad debt.
15. Provision for Doubtful Debt
Besides bad debts, there be certain debts recovery may be doubtful. A bad debt is different from doubtful debts. The bad debt is definitely irrecoverable and a doubtful. It may be recoverable or not. A bad debt is knows as loss. But a doubtful debt an expected loss. An exported loss need not be treated as a loss before it actually occurs. Such debts cannot be written off as bad debt because non-recovery of such an amount is not certain. For such loss, as expected some provision is made in the form of provision for doubtful debts.
The provision for doubtful is created to show the true value of debtor. This provision is created by debiting the profit and loss account. In the other hand, the amount of provision for doubtful debt is to deducted from debtor after writing off further bad debt provision for doubtful debt may be in trial balance and adjustment. The provision for doubtful debt given in trial balance is considered as old provision and give in adjustment is considered as new provision for doubtful debt.
16. Provision for Discount on Debtors
Some business forms settle their accounts with the creditors by marking payment at the proper and scheduled time. This will create goodwill for them, prompt payment to creditor help the business to earn discount. Discount received form creditors is a profit. When a help the businessman received regular income on discount from creditors, he makes a provision for the some by crediting to profit and loss account and debiting to provision for discount on creditor account.
17. Interest on Loan (Outstanding)
The amount of borrowing is called loan. To fulfill the requirement to finance, money may be borrowed from banks or other financial financial institutions. A fixed rate of interest is payable on loan, interest paid on that loan is considered as expenses and unpaid amount of interest is considered as outstanding expenses.
18. Interest on Debenture (Outstanding)
It is expense of profit and loss account. Generally interest on debentures is paid half yearly. The unpaid amount of interest on debenture is considered outstanding interest on debentures.
19. Interest on Investment (Accrued)
The amount lending outside the business is considered as investment. Company may invest its cash or cash equivalent in the purchase of marketing securities or government's bond etc. a fixed rate of interest is receivable on investment. The interest received on investment given in the trial balance is considered as income and shown in credit side of p/l account. Interest earned but not received yet is considered as receivable and adjustment entry will be as follows:
20. Goods Used in the Business
Due to the various reasons, goods are used in the business. Following are the main purposes.
a. Goods given away as charity or donation: the value of goods given away as donation or charity is treated as expenses for the business. It is deducted from purchase is debit side of trading account. On the other hand, it is to be shown in debit side of profit and loss account.
b. Goods distributed as free sample: to promote the sales of its product, the business entities may distribute goods as free sample. The amount of goods given way of free samples are treated as selling expenses or advertisement expenses and charged to debit side of P/L account and on the other hand it is to be deducted from purchase in the debit side of trading account.
21. Goods used for Making of an Assets
The amount of goods used for making an asset for the business is debited to related assets account and deducted from purchase in the debit of trading account. In the same way part of the ways paid for the making of such asset should be added to the related assets and deducted from wages in the debit side of trading account.
22. Managerial Remuneration and Commission of Profit
The amount of managerial remuneration may be specified in memorandum or article of association. It is not specified in article, the directors may be given a bonus commission of not more than 5% of net profit, as per company act 2063. Commission on profit is the remuneration, which is charged on the basis of certain percentage of net profit either before or after charging such commission.
23. Loss of Goods due to Abnormal Reason (Abnormal Loss)
Generally, this type of loss occurs due to the carelessness of the management like accident, fire flood, theft ect. Such losses are considered as absobormal losses. The amount of abnormal loss debited with the amount of loss and trading is credited with same amount. At the end of the accounting year, the amount of abnormal loss is transferred to profit and loss account and closing it.
24. Sale of Goods on Approval Basis
In a business goods can be sold on sale or returnable basis. These types of sales indicate that if the quality or other conditions are acceptable to the buyer they will send information of his approval for the purchase of such goods otherwise he would return the goods to the suppliers. When goods are sold on these terms, it should not be treated as actual sales till the approval is received from the debtor. Under certain circumstances, if has been included in sales, on the one hand the sales value of such goods should be deducted from actual sales and on the other hand cost price of such goods should be treated as stock with customer.
25. Tax adjustments
a. Tax deducted at Source (TDS)
Generally, tax may be deducted at source on certain expenditures of the company like salary, interest; stationary etc. the deducted amount of tax at source should be deposited into the income tax office. The journal entry of such items will be as follows:
b. Advance Payment of Income Tax
The advance payment of tax is also known as "pay as you earn'. Though the income of the previous year will be assessment year, an assesses has to pay tax in advance in the previous year itself against his probable liability to tax in the assessment year immediately following.
c. Provision for Tax
Income tax payable by a company is a charge against the profit of the company. At the end of each accounting year, taxable income is computed by the company as per the provision of the income tax act. After determining the tax liability, the company makes a provision for it in the final accounts. If the provision for it in the final accounts. If the provision for tax appears outside the trial balance, the adjustment entry will be as follows.
d. If Income Tax Paid and Provision for Tax: are given in the debit and credit side of trial balance respectively, that is considered as last year's tax paid and provision. The treatment of the above items in the final accounts will be as follows:
(i) The amount of tax paid be shown in debit side of profit and loss appropriation account.
(ii) The amount of provision for tax given in credit side will be shown in credit side of profit and loss appropriation account.
e. If Income Tax Paid is given in Debit Side of Trial Balance but provision for tax is not given in credit side of trial balance, in this case the tax paid should be considered as advance paid tax and shown in assets side of balance sheet under the head of loan and advance or it can be shown in side of profit and loss account considering the payment of last year's tax liabilities.
26. Dividend
A dividend may be defined as a distribution of divisible profit of a company among the shareholders according to the number of shares held by each of them in the capital of the company. The board of directors recommends the amount of profit which is to be distributed as a dividend. The shareholders in the annual general may declare the dividend, recommended by the board, but no dividend shall exceed the amount recommend by the board.
a. Proposed Dividend
The dividend recommended by the board of directors is termed as proposed dividend. When the proposed dividend is adopted in the annual general meeting by the shareholders, it is termed as "declared should be paid within 45 days of declaration. The amount of dividend is calculated on the basis of paid up capital. Paid up capital means total called up minus call-in-arrears if any.
The preference shareholders are entitled are entitled to receive a dividend at a fixed rate. If the directors decide to declare a dividend on equity shares, it is compulsory to make a provision first for the payment of one yaear's dividend to preference shareholder.
The adjustment entry and treatment in final account of proposed dividend given in outside the trial balance will be as follows:
b. Interim Dividend
The dividend declared by the board of director before the preparation of final account is termed as interim dividend. The interim dividend is paid during the year and appears in the debit side of trial balance. The amount of interim dividend paid given in trial balance should be shown in debit side of profit and loss appropriation account.
c. Unclaimed Dividend
Any dividend, which remains unpaid or unclaimed for any reason up to 45 days of declaration of dividend is called unclaimed dividend. The amount of unclaimed dividend appearing the credit side of trial balance should be shown be shown in liabilities of balance sheet under the head of current liability.
d. Final Dividend
The directors after declaring interring dividend may declare dividend at the end of the accounting year as well. This dividend is declared unless the resolution mentions it specifically. Like interim dividend also appears in the debit side of trial balance and it is shown in debit side of profit and loss appropriation account.
e. Bonus Shares or Stock Dividend
Stock dividend or bonus share is the payment of dividend to the shareholders in the form of equity share. If amount of stock dividend paid in the debit side of trial balance should be shown in debit side of profit and loss appropriation account.
27. Transfer to Reserve
As per the provision of company act, 2063, dividend can be declared or paid by the company for any financial year out of the profit of the company for any financial year out of the profit of the company for that year after transferring certain amount of profit to reserve. General reserves and funds are created to meet the future contingency of the company. It provides financial strength to company to the contingencies, which may arise in future. Any amount of reserve and funds except those related to employee or workers are appropriated from the prifit and they are considered as the part of the profit. Reserve and fund relating to the employee or workers like bonus, pension fund and provident fund are not considered as that part of profit and they are considered as liability. If reserve and funds except those related employees are given in outside the trial balance, the adjustment entry and treatment in final accounts will be as follows:
28. Reserves and Funds Related with the Employees like Bonus, Pension Fund, Provident Fund etc.
If bonus, pension fund and provident fund etc are given outside the trial balance, one side they are considered as expenses and shown in debit side of profit and loss and on the other hand they are considered as current liability.
29. Bonus and Retirement Benefits to Employees in Cash
Joint Stock Company has policy to pay certain amount out of profit as bonus in cash and certain amount at the time of retirement as retirement benefit in cash. Treatment of these items on final accounts will be as follows:
30. Hidden Adjustments
Hidden adjustments are those adjustments, which are not clearly given, in additional information. It should be find out inside the trial balance. It is called hidden because it cannot be seen at once. For example, 10% debenture Rs. 100, 000. There is no mentioned regarding amount. Before determining the type of entries, it is essential to observe whether there is any hidden part to be adjusted.