Show the treatment of prepaid expenses depreciation, closing stock at the time of preparation of final account

Long Answer Questions · Q3

Q. Show the treatment of prepaid expenses depreciation, closing stock at the time of preparation of final accounts when:

(a) When given inside the trial balance?

(b) When given outside the trial balance?

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Concept understanding — Accrual Basis Accounting

Accrual Basis Accounting – A First Look

Think about a newspaper delivery. You pay for a month's subscription at the start. The newspaper company gets your money on 1st April, but it hasn't earned that money yet — it still has to deliver papers for the next 30 days. The company's profit for April isn't the cash it collected; it's the revenue from the papers actually delivered in April.

That's the core intuition behind accrual accounting: record income when it is earned, not when cash is received; record expenses when they are incurred, not when cash is paid.

The Precise Meaning

Under the accrual basis, transactions are recorded in the books of account at the time they occur, regardless of when the actual cash changes hands.

Revenue is recognised when the goods are sold or services are rendered — even if the customer will pay later.
Expenses are recognised when the benefit is consumed or the liability arises — even if the payment will be made later.

This is the opposite of cash basis accounting, where you record only when cash is received or paid.

Important

The accrual basis is mandatory under the Companies Act, 2013 for all companies, and it is the foundation of the Generally Accepted Accounting Principles (GAAP) followed in India.

Why It Matters

Accrual accounting gives a true and fair view of the business's financial performance and position.

Matching Principle: Expenses are matched with the revenues they help generate in the same period. If you sell goods in March but receive payment in April, the sale belongs to March's profit calculation, not April's.
Realistic Profit: Profit under accrual basis reflects the actual economic activity of the period, not just the timing of cash flows.
Better Decision-Making: Owners, investors, and creditors see what the business has earned and owes, not just what it has in the bank.

Watch out

A common mistake: thinking profit equals cash in hand. Under accrual accounting, a business can show a healthy profit but have very little cash (if most sales are on credit), or show a loss but have plenty of cash (if it collected old debts while making few new sales).

Accounting Treatment – The Journal Entries

Accrual accounting gives rise to two special types of accounts: Outstanding Expenses and Accrued Incomes (also called Prepaid Expenses and Unearned Incomes on the other side).

1. Outstanding Expenses (Expense incurred but not yet paid)

Example: Salary for March is ₹50,000, but it will be paid in April.

Journal Entry (at the end of March):

Date	Particulars	Debit (₹)	Credit (₹)
March 31	Salary A/c Dr.	50,000
	To Outstanding Salary A/c		50,000
	(Being salary for March due but not paid)

Debit: Salary A/c (expense is recorded in the period it belongs to)
Credit: Outstanding Salary A/c (a liability — the business owes this money)

When paid in April:

Date	Particulars	Debit (₹)	Credit (₹)
April 10	Outstanding Salary A/c Dr.	50,000
	To Cash/Bank A/c		50,000
	(Being outstanding salary paid)

2. Accrued Income (Income earned but not yet received)

Example: Commission earned ₹20,000 in March, but will be received in April.

Journal Entry (at the end of March):

Date	Particulars	Debit (₹)	Credit (₹)
March 31	Accrued Commission A/c Dr.	20,000
	To Commission Income A/c		20,000
	(Being commission earned but not received)

Debit: Accrued Commission A/c (an asset — the business is owed this money)
Credit: Commission Income A/c (revenue is recorded in the period it was earned)

When received in April:

Date	Particulars	Debit (₹)	Credit (₹)
April 15	Cash/Bank A/c Dr.	20,000
	To Accrued Commission A/c		20,000
	(Being accrued commission received)

3. Prepaid Expenses (Expense paid in advance)

Example: Insurance premium of ₹12,000 paid on 1st January for the full year.

Journal Entry (at the end of the accounting year, say 31st March):

Only 3 months' insurance (Jan–Mar) has been used. The remaining 9 months' worth (₹9,000) is still an asset.

Date	Particulars	Debit (₹)	Credit (₹)
March 31	Prepaid Insurance A/c Dr.	9,000
	To Insurance A/c		9,000
	(Being insurance prepaid for the remaining period)

Debit: Prepaid Insurance A/c (asset)
Credit: Insurance A/c (reduces the expense to only the consumed portion)

4. Unearned Income (Income received in advance)

Example: Rent received ₹30,000 on 1st March for three months (March, April, May).

Journal Entry (at the end of March):

Only one month's rent (₹10,000) has been earned. The remaining ₹20,000 is a liability. …

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A golden rule governs where an item appears in the final accounts:

An item inside the trial balance has already been recorded in the ledger, so it is shown at only one place in the final accounts.
An item outside the trial balance (an adjustment) is not yet recorded, so it is shown at two places — once in the Trading/Profit & Loss Account and once in the Balance Sheet.

Item	Inside trial balance (one place)	Outside trial balance / adjustment (two places)
Prepaid expense	Shown only in the Balance Sheet (asset)	Deducted from the related expense in P&L and shown as an asset in the Balance Sheet
Depreciation	Shown only on the debit of P&L A/c	Debited to P&L A/c and deducted from the asset in the Balance Sheet

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Where an item goes depends on where it appears: an item already in the trial balance is posted at one place in the final accounts; an item given outside the trial balance (an adjustment) is posted at two places (Trading/P&L and Balance Sheet).

The rule. Every ledger balance is shown once. An adjustment is not yet in the books, so passing it creates two effects — hence it appears twice.

(a) When the item is inside the trial balance

Item	Treatment
Prepaid expenses	Appear on the debit side of the trial balance as an asset; shown only on the assets side of the Balance Sheet (the related expense has already been reduced).
Depreciation	Appears on the debit side; shown only on the debit of the Profit & Loss Account (the asset has already been shown net).
Closing stock	If it is inside the trial balance, the adjusting entry has already been passed, so it is shown only on the assets side of the Balance Sheet (not in the Trading A/c again).

(b) When the item is outside the trial balance (an adjustment)

Item	Trading / Profit & Loss A/c	Balance Sheet
Prepaid expenses	Deducted from the concerned expense on the debit of P&L	Shown on the assets side
Depreciation	Debited to the Profit & Loss A/c	Deducted from the concerned fixed asset
Closing stock	Shown on the credit side of the Trading A/c	Shown on the assets side

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Q.Show the treatment of prepaid expenses depreciation, closing stock at the time of preparation of final accounts when:

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