Financial Statements - II
Class 11 Accountancy · Financial Accounting Part II · Chapter 2
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Summary
Simple final accounts assume no accounting complexities, but because income and financial position are determined on the accrual basis, several items need adjustment before final accounts give a true and fair view. The accrual concept requires that revenues be taken on an earned basis and expenses on an incurred basis, regardless of when cash is received or paid. The common adjustments discussed are: closing stock, which is valued and shown both in the trading account and the balance sheet; outstanding expenses, which are expenses incurred but not yet paid; prepaid (unexpired) expenses, which are paid in advance; accrued income, which is earned but not yet received; and income received in advance (unearned income), received but not yet earned. Further adjustments include depreciation on fixed assets, bad debts written off, provision for bad and doubtful debts created on debtors, provision for discount on debtors, and manager's commission on profits. Each adjustment generally affects two accounts—one in the trading or profit and loss account and the other in the balance sheet—so that the matching principle is satisfied. By incorporating all such adjustments, the trading and profit and loss account and the balance sheet present a true and fair picture of the profitability and financial position of the business.
Need for adjustments and the accrual conceptClosing stock, outstanding and prepaid expensesAccrued income and income received in advanceDepreciation, bad debts and provisionsPreparation of adjusted final accounts
Key terms
Adjustment
An entry made while preparing final accounts so that incomes and expenses relate correctly to the accounting period under the accrual concept.
Outstanding Expense
An expense that has been incurred during the period but not yet paid, shown as a liability.
Prepaid Expense
An expense paid in advance whose benefit relates to the next period, shown as an asset.
Accrued Income
Income that has been earned during the period but not yet received, shown as an asset.
Income Received in Advance
Income received during the period that relates to a future period, also called unearned income and shown as a liability.
Provision for Doubtful Debts
An amount set aside out of profit to cover debts that may not be recovered.
Extra questions & answers
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Adjustments while preparing final accounts are needed because accounting follows the: