Why adjustments? Closing stock
Adjustments bring into the accounts items that belong to the year but are not yet recorded, so that income and expenses follow the accrual and matching principles.
Closing stock (given outside the trial balance): Closing Stock A/c Dr; To Trading A/c. Shown on the credit side of the trading account and as a current asset in the balance sheet. If closing stock is given inside the trial balance (purchases already adjusted), show it only in the balance sheet.
Outstanding and prepaid expenses
Outstanding expense (due, not paid): Expense A/c Dr; To Outstanding Expense A/c. Add to the expense in P&L (or trading, if direct); show as a current liability.
Prepaid expense (paid in advance for next year): Prepaid Expense A/c Dr; To Expense A/c. Subtract from the expense; show as a current asset.
Accrued income and income received in advance
Accrued income (earned, not received): Accrued Income A/c Dr; To Income A/c. Add to the income in P&L; show as a current asset.
Income received in advance (received, not yet earned): Income A/c Dr; To Income Received in Advance A/c. Subtract from the income; show as a current liability.
Depreciation
Depreciation A/c Dr; To Asset A/c. Debit P&L; subtract from the asset in the balance sheet. If a rate is given with no dates, charge a full year on the closing balance; for additions during the year, charge for the months used.
Bad debts
Bad debts are amounts that cannot be recovered from debtors. Bad debts in the trial balance: debit P&L only (debtors already reduced). Further bad debts (adjustment): Bad Debts A/c Dr; To Debtors A/c → debit P&L and subtract from debtors in the balance sheet.
Provision for doubtful debts and provision for discount on debtors
Provision for doubtful debts (conservatism): calculated on debtors after deducting further bad debts. P&L is debited with: new provision + bad debts (trial balance + further) − old provision. If the result is negative, credit P&L. In the balance sheet, subtract the new provision from debtors.
Provision for discount on debtors: calculated on debtors after deducting further bad debts and the new provision for doubtful debts. Charged to P&L and subtracted from debtors.
Example: debtors 50,000; further bad debts 2,000; PDD 5%; discount 2%. Debtors 48,000 → PDD 2,400 → 45,600 → discount 912 → net 44,688.
Abnormal loss
A loss from an unusual cause (fire, theft, accident) — not normal wastage. Remove the goods from trading at cost: Abnormal Loss A/c Dr; To Trading/Purchases A/c. If insured: Insurance Claim A/c Dr (asset) with the amount accepted; the rest is debited to P&L as loss by fire. If uninsured, the whole cost is debited to P&L.
Goods taken for personal use (or given as charity or free samples)
Goods taken by the owner: Drawings A/c Dr; To Purchases A/c (at cost). Subtract from purchases in trading; subtract from capital (as drawings) in the balance sheet. Goods given as charity: Charity A/c Dr; To Purchases. Free samples: Advertisement A/c Dr; To Purchases (both debited to P&L).
Interest on capital and interest on drawings
Interest on capital rewards the owner's money: Interest on Capital A/c Dr; To Capital A/c. Debit P&L; add to capital. It is calculated on opening capital (and on additional capital for the months it was used). Interest on drawings is the reverse: Capital A/c Dr; To Interest on Drawings A/c — credit P&L, subtract from capital.
Manager's commission
A manager may get commission as a % of net profit.
- Before charging such commission: Commission = Net profit (before commission) × Rate/100.
- After charging such commission: Commission = Net profit (before commission) × Rate/(100 + Rate).
Entry: Manager's Commission A/c Dr; To Outstanding Commission A/c. Debit P&L; show as a current liability.
Example: profit before commission ₹66,000; 10% after charging → 66,000 × 10/110 = ₹6,000. Check: 10% of (66,000 − 6,000) = 6,000 ✓.
Key formulas and definitions
- Outstanding expense: + expense (P&L), current liability (BS)
- Prepaid expense: − expense (P&L), current asset (BS)
- Accrued income: + income, current asset
- Income received in advance: − income, current liability
- P&L charge for PDD = New PDD + Bad debts (all) − Old PDD
- Commission (after charging) = Profit × R/(100 + R)
- Commission (before charging) = Profit × R/100
Worked examples
1. Rent paid ₹22,000 (trial balance); rent outstanding ₹2,000. Show treatment.
P&L: Rent 22,000 + 2,000 = ₹24,000 (Dr). Balance sheet: Outstanding rent ₹2,000 under current liabilities.
2. Insurance paid ₹6,000 on 1 October 2025 for one year. Books close 31 March 2026. Prepaid?
Used 6 months = 3,000; prepaid 6 months = ₹3,000. P&L insurance ₹3,000; prepaid insurance ₹3,000 as current asset.
3. Debtors ₹50,000; bad debts in trial balance ₹1,000; further bad debts ₹2,000; old PDD ₹1,500; new PDD 5%. Find the P&L charge and net debtors.
New PDD = 5% × 48,000 = 2,400. P&L charge = 2,400 + 1,000 + 2,000 − 1,500 = ₹3,900. Debtors in BS = 48,000 − 2,400 = ₹45,600.
4. Goods costing ₹10,000 destroyed by fire; insurance company admits ₹6,000. Show effects.
Trading A/c Cr ₹10,000 (or less from purchases). Insurance claim ₹6,000 current asset. Loss by fire ₹4,000 debited to P&L.
5. Capital ₹2,00,000; interest on capital 10% p.a.; additional capital ₹60,000 on 1 October 2025 (year ends 31 March 2026). Interest?
2,00,000 × 10% = 20,000; 60,000 × 10% × 6/12 = 3,000. Total ₹23,000 — debit P&L, add to capital.
6. Net profit before manager's commission ₹66,000. Commission 10% (a) before charging, (b) after charging it.
(a) 66,000 × 10/100 = ₹6,600. (b) 66,000 × 10/110 = ₹6,000.
7. Goods ₹3,000 taken by the owner for personal use (not recorded). Treatment?
Less ₹3,000 from purchases in trading; add ₹3,000 to drawings and subtract from capital in the balance sheet. Net profit is unchanged.
Common mistakes
- Showing an adjustment in only one place. Every adjustment has two effects.
- Calculating provision for doubtful debts before deducting further bad debts.
- Using rate/100 when commission is to be calculated after charging it (use rate/(100 + rate)).
- Charging the whole abnormal loss to P&L when part is covered by insurance.