Key Points

Adjustments are required to prepare financial statements on an accrual basis. This ensures that revenues are recognized when earned and expenses when incurred, providing a true and fair view of profitability and financial position.

Closing stock is the value of unsold goods at the end of an accounting period. It is credited to the Trading Account to calculate gross profit and shown as a Current Asset in the Balance Sheet.

Outstanding expenses are expenses incurred during the current period but not yet paid. They are added to the respective expense in the Trading or Profit & Loss Account and shown as a Current Liability in the Balance Sheet.

Prepaid expenses are expenses paid in advance, the benefit of which extends to a future accounting period. They are deducted from the total expense in the Profit & Loss Account and shown as a Current Asset in the Balance Sheet.

Accrued income is income that has been earned during the current period but not yet received. It is added to the relevant income on the credit side of the Profit & Loss Account and shown as a Current Asset in the Balance Sheet.

Income received in advance, or unearned income, is income received in the current period that relates to a future period. It is deducted from the respective income in the Profit & Loss Account and shown as a Current Liability in the Balance Sheet.

Depreciation is the decline in the value of a fixed asset due to wear and tear or passage of time. It is treated as an expense debited to the Profit & Loss Account and is deducted from the value of the concerned asset in the Balance Sheet.

Bad debts are amounts due from debtors that are confirmed to be irrecoverable. Further bad debts, identified at year-end, are added to existing bad debts in the Profit & Loss Account and also deducted from Debtors in the Balance Sheet.

A provision for doubtful debts is an estimate of potential future bad debts made to adhere to the principle of prudence. The amount is debited to the Profit & Loss Account and shown as a deduction from debtors in the Balance Sheet.

This provision is created for the estimated discount that may be allowed to debtors for prompt payment. It is calculated on 'good debtors', which is the amount of debtors after deducting further bad debts and the provision for doubtful debts.

Manager's commission can be calculated on profit either before or after charging such commission. The formula for 'after charging' is (Profit before commission × Rate) / (100 + Rate). This commission is an expense in the Profit & Loss Account.

Interest on capital is treated as a business expense provided to the proprietor for the capital invested. It is debited to the Profit & Loss Account and added to the Capital account in the Balance Sheet.

According to the double-entry system, every adjustment provided outside the trial balance has a dual effect. It is recorded in two places, typically affecting both the Trading and Profit & Loss Account and the Balance Sheet.