Financial Statements - IIClass 11 Accountancy 2 NCERT Solutions

1. To Ascertain True Profit or Loss: According to the accrual concept, profit is not simply the difference between cash receipts and cash payments. Revenues must be recognized when they are earned, and expenses must be recognized when they are incurred, irrespective of the timing of cash flow. Adjusting entries for items like accrued income, outstanding expenses, prepaid expenses, and unearned income ensure that all revenues and expenses for the period are correctly recorded. This leads to the calculation of the true profit or loss for the accounting period.
2. To Present a True and Fair View of the Financial Position: The Balance Sheet should reflect the true and fair value of assets and liabilities on a specific date. Adjusting entries help in achieving this. For example:
   • Recording outstanding expenses and unearned income ensures all liabilities are correctly stated.
   • Recording prepaid expenses and accrued income ensures all assets are correctly stated.
   • Charging depreciation ensures that fixed assets are shown at their appropriate written-down value.
   • Creating a provision for doubtful debts ensures that debtors are shown at their estimated realizable value.
3. To Provide for Future Losses: The principle of conservatism requires that all anticipated losses should be provided for. Adjusting entries for creating provisions for doubtful debts and provision for discount on debtors adhere to this principle, preventing the overstatement of profits and assets.
4. To Rectify Errors: Some errors, like treating a capital expenditure as a revenue expenditure (e.g., purchase of machinery recorded in the purchases book), are corrected through adjusting entries to ensure that assets and expenses are correctly classified.

1. Profit and Loss Account: The amount of the new provision required, along with any further bad debts, is debited to the Profit and Loss Account. If an old provision already exists in the trial balance, it is deducted from the total of bad debts and new provision. The net amount is shown on the debit side.
2. Balance Sheet: The total amount of the new provision is deducted from Sundry Debtors on the asset side to show the debtors at their net realizable value.

1. Start with the closing balance of Sundry Debtors as per the trial balance.
2. Deduct the amount of any 'Further Bad Debts' (bad debts identified after preparing the trial balance, given in adjustments).
3. The resulting figure represents the 'good' debtors on which the provision is to be calculated.
4. Apply the given percentage to this amount.

• Prepaid Expenses: If 'Prepaid Expenses' appears in the trial balance, it is an asset. It will be shown only on the asset side of the Balance Sheet under 'Current Assets'. It will not be adjusted in the Profit and Loss Account because the related expense account in the trial balance would already be showing the net amount after the adjustment.
• Depreciation: If 'Depreciation' appears in the trial balance, it is an expense. It will be shown only on the debit side of the Profit and Loss Account. The corresponding asset in the trial balance will already be at its written-down value.
• Closing Stock: If 'Closing Stock' appears in the trial balance, it means the adjustment entry for it has already been passed by adjusting it against purchases. In this case, the trial balance will show 'Adjusted Purchases' instead of 'Purchases' and 'Opening Stock'. The closing stock will be shown only on the asset side of the Balance Sheet under 'Current Assets'. It will not be shown on the credit side of the Trading Account.

• Prepaid Expenses:
  1. It is deducted from the respective expense on the debit side of the Trading or Profit and Loss Account.
  2. It is shown on the asset side of the Balance Sheet under 'Current Assets'.
• Depreciation:
  1. It is shown on the debit side of the Profit and Loss Account as an expense.
  2. It is deducted from the cost of the concerned asset on the asset side of the Balance Sheet.
• Closing Stock:
  1. It is shown on the credit side of the Trading Account.
  2. It is shown on the asset side of the Balance Sheet under 'Current Assets'.

Books of M/s Rahul Sons

Trading and Profit and Loss Account

Balance Sheet

1. Provision for Doubtful Debts: Debtors = ₹ 82,000 Less: Further Bad Debts = ₹ 1,000 Debtors for provision = ₹ 81,000 New Provision @ 5% on ₹ 81,000 = ₹ 4,050
2. Provision for Discount on Debtors: Debtors for discount = ₹ 81,000 - ₹ 4,050 = ₹ 76,950 Provision for Discount @ 2% on ₹ 76,950 = ₹ 1,539

Books of M/s Green Club Ltd.

Trading and Profit and Loss Account

Balance Sheet

1. Provision for Doubtful Debts: Debtors = ₹ 50,000 Less: Further Bad Debts = ₹ 1,500 Debtors for provision = ₹ 48,500 New Provision @ 6% on ₹ 48,500 = ₹ 2,910
2. Provision for Discount on Debtors: Debtors for discount = ₹ 48,500 - ₹ 2,910 = ₹ 45,590 Provision for Discount @ 5% on ₹ 45,590 = ₹ 2,279.5 or ₹ 2,280 (rounded off)
3. Interest on Investment: 5% on ₹ 23,100 = ₹ 1,155

Books of M/s Runway Shine Ltd.

Trading and Profit and Loss Account

Balance Sheet

1. Provision for Doubtful Debts: Debtors = ₹ 53,000 Less: Further Bad Debts = ₹ 1,000 Debtors for provision = ₹ 52,000 New Provision @ 5% on ₹ 52,000 = ₹ 2,600
2. Provision for Discount on Debtors: The amount is given as ₹ 500.
3. Interest on Investment: Accrued Interest @ 5% on ₹ 32,000 = ₹ 1,600

• To account for outstanding and prepaid items: There may be expenses that have been incurred but not yet paid (outstanding expenses) or paid in advance for a future period (prepaid expenses). Similarly, there can be incomes earned but not yet received (accrued income) or received in advance (unearned income). Adjusting entries bring these items into the accounts of the current period.
• To record non-cash expenses: Certain expenses like depreciation on fixed assets are not recorded on a day-to-day basis. An adjusting entry is required at the end of the accounting period to account for the decline in the value of assets.
• To provide for anticipated losses: To follow the principle of conservatism, provisions are made for expected future losses, such as provision for doubtful debts or provision for discount on debtors. These are recorded through adjusting entries.

1. In the Trading Account: It is shown on the credit side of the Trading Account. This is done to match the cost of goods sold with the revenue of the period. The value of closing stock is deducted from the cost of goods available for sale (Opening Stock + Net Purchases + Direct Expenses) to arrive at the Cost of Goods Sold.
2. In the Balance Sheet: It is shown on the asset side under the head 'Current Assets'. This is because it represents an asset that is expected to be sold and converted into cash in the next accounting period.

1. Matching Principle (Accrual Concept): When a business sells goods on credit, the revenue from the sale is recognized in the current accounting period. However, it is a common business experience that not all debtors will pay the full amount they owe. The loss arising from such irrecoverable debts (bad debts) is a cost associated with the credit sales of that period. To accurately match the expenses with the revenues of the period, an estimated amount for potential bad debts from the current year's sales must be charged against the current year's profit. A provision for doubtful debts helps achieve this matching.
2. Principle of Conservatism (Prudence): This principle states that a business should anticipate and provide for all possible losses but should not anticipate profits. Since it is possible that some of the debtors at the end of the year may not pay, it is prudent to make a reasonable estimate of such a loss and create a provision for it. This ensures that profits are not overstated and that assets (debtors) are not shown at a value higher than their expected realizable value in the Balance Sheet.