Accountancy · Ch 9 — Financial Statements - II
Summary
Summary
- Need for adjustments: Under the accrual basis of accounting, the profit or loss of a year must be based on revenues earned and expenses incurred in that year, not on cash actually received or paid. So before the final accounts are drawn up, adjusting entries are recorded for items still to be accounted for. Almost every adjustment given outside the trial balance has a two-fold effect — it is shown once in the Trading or Profit and Loss Account and once in the Balance Sheet.
- Closing stock: Unsold goods at the year end are valued at cost or net realisable value, whichever is lower. Closing stock is credited in the Trading Account and shown as a current asset in the Balance Sheet.
- Outstanding (accrued) expenses: Expenses incurred during the year but not yet paid are added to the respective expense in the Trading/Profit and Loss Account and shown as a liability in the Balance Sheet.
- Prepaid (unexpired) expenses: The part of an expense paid this year whose benefit relates to the next year is deducted from the respective expense and shown as an asset in the Balance Sheet.
- Accrued income: Income earned during the year but not yet received is added to the respective income in the Profit and Loss Account and shown as an asset in the Balance Sheet.
- Income received in advance: Income received during the year that relates to the next accounting period is deducted from the respective income and shown as a liability in the Balance Sheet.
- Depreciation: The fall in the value of a fixed asset due to wear and tear or the passage of time is charged to the debit of the Profit and Loss Account and deducted from the value of the asset in the Balance Sheet.
- Bad debts and further bad debts: Debts that have become irrecoverable are written off as bad debts. Any further bad debts given as an adjustment are first deducted from debtors before any provision is calculated.
- Provision for doubtful debts: An amount set aside (a percentage of debtors remaining after writing off further bad debts) to cover debts that may not be recovered. The net charge — new provision + bad debts − old provision — is debited to the Profit and Loss Account, and the new provision is deducted from debtors in the Balance Sheet.
- Provision for discount on debtors: An estimate of the cash discount likely to be allowed to debtors who pay promptly, calculated on debtors left after further bad debts and the provision for doubtful debts. It is debited to the Profit and Loss Account and deducted from debtors in the Balance Sheet.
- Manager's commission: Commission payable to a manager as a percentage of net profit. If it is a percentage of profit before charging the commission, Commission = rate% × profit; if after charging it, Commission = rate ÷ (100 + rate) × profit before commission. It is debited to the Profit and Loss Account and, until paid, shown as an outstanding liability in the Balance Sheet. …