Meaning and Need for Adjustments

Meaning and Need for Adjustments

Adjustments are year-end entries passed to correctly recognise income and expenses in the period to which they relate, and to correctly state assets and liabilities as on the closing date — regardless of when cash was actually received or paid. They exist because of the accrual (matching) concept: profit is measured by matching the revenue EARNED in a period against the expenses INCURRED to earn it, not by simply comparing cash received against cash paid.

Where adjustment information comes from: items appearing INSIDE the Trial Balance are already recorded and simply flow into the Trading/P&L Account or Balance Sheet as usual (as in the previous chapter). Adjustments, by contrast, are given as ADDITIONAL information OUTSIDE the Trial Balance (usually as notes below it) — because they have NOT yet been recorded anywhere in the books.

The Golden Rule of adjustments — the Double Effect: every adjustment is shown TWICE:

1. Once in the Trading Account or Profit and Loss Account (as an addition to or deduction from an existing item, or as a fresh item), and
2. Once in the Balance Sheet (as a new asset, a new liability, or a correction to an existing asset).