Adjustments are accounting entries or changes made at the end of an accounting period to ensure that all income, expenses, assets, and liabilities are recorded correctly.
Adjustments are important because some transactions may have been omitted from the Trial Balance or may relate partly to another accounting period. Proper adjustments help calculate the correct profit or loss and show the true financial position of the business.
2. Why are Adjustments Necessary?
Adjustments are made to follow the matching concept of accounting, under which expenses and income should be recognized in the accounting period to which they relate.
The main purposes of adjustments are:
To calculate the correct profit or loss.
To record outstanding expenses.
To account for prepaid expenses.
To record accrued income.
To account for income received in advance.
To calculate depreciation.
To adjust bad debts and provisions.
To show assets and liabilities correctly in the Balance Sheet.
3. What are the Common Types of Adjustments?
The most common adjustments in Final Accounts are:
Closing Stock
Outstanding Expenses
Prepaid Expenses
Accrued Income
Income Received in Advance
Depreciation
Bad Debts
Provision for Doubtful Debts
Interest on Capital
Interest on Drawings
4. What is Closing Stock Adjustment?
Closing Stock represents the value of goods that remain unsold at the end of the accounting year.
For example, if goods worth ₹50,000 remain unsold at the end of the year, ₹50,000 is treated as closing stock.
Treatment:
Closing Stock is generally shown:
On the credit side of Trading Account
On the Assets side of Balance Sheet
Closing Stock helps calculate the correct Gross Profit or Gross Loss.
5. What are Outstanding Expenses?
Outstanding Expenses are expenses that have been incurred during the current accounting period but have not yet been paid.
Example:
Salary paid during the year = ₹40,000 Salary outstanding = ₹5,000
Total salary expense:
₹40,000 + ₹5,000 = ₹45,000
Treatment:
₹5,000 is added to the expense in the Profit & Loss Account.
₹5,000 is shown as a liability in the Balance Sheet.
6. What are Prepaid Expenses?
Prepaid Expenses are expenses that have been paid in advance but relate to a future accounting period.
Prepaid amount is shown as a current asset in the Balance Sheet.
7. What is Accrued Income?
Accrued Income is income that has been earned during the current accounting period but has not yet been received.
Example:
Interest received = ₹8,000 Interest accrued = ₹2,000
Total income:
₹8,000 + ₹2,000 = ₹10,000
Treatment:
Accrued income is added to the income in the Profit & Loss Account.
It is shown as an asset in the Balance Sheet.
8. What is Income Received in Advance?
Income Received in Advance is income received during the current accounting period that actually belongs to a future accounting period.
Example:
Rent received = ₹30,000 Rent received in advance = ₹5,000
Current year’s rent income:
₹30,000 − ₹5,000 = ₹25,000
Treatment:
Advance income is deducted from the income.
It is shown as a liability in the Balance Sheet.
9. What is Depreciation Adjustment?
Depreciation is the reduction in the value of a fixed asset due to use, wear and tear, passage of time, or obsolescence.
Example:
Machinery = ₹1,00,000 Depreciation = 10%
Depreciation:
₹1,00,000 × 10% = ₹10,000
Treatment:
₹10,000 is shown as an expense in the Profit & Loss Account.
₹10,000 is deducted from the asset’s value in the Balance Sheet.
10. What are Bad Debts?
Bad Debts are amounts owed by customers that the business does not expect to recover.
Example:
A customer owes ₹10,000, but the amount becomes irrecoverable.
The ₹10,000 is treated as a bad debt.
Treatment:
Bad debts are treated as an expense/loss in the Profit & Loss Account.
They reduce the amount of Debtors shown in the Balance Sheet.
11. What is Provision for Doubtful Debts?
A Provision for Doubtful Debts is an estimated amount set aside for debts that may become irrecoverable in the future.
For example, if debtors are ₹1,00,000 and the business estimates that 5% may not be recovered:
Provision = ₹1,00,000 × 5% = ₹5,000
The provision helps present debtors at a more realistic amount.
12. What is Interest on Capital?
Interest on Capital is the interest allowed by the business to the owner on the amount invested in the business, when applicable according to the accounting arrangement.
Example:
Capital = ₹2,00,000 Interest on Capital = 5%
Interest:
₹2,00,000 × 5% = ₹10,000
Treatment:
It is treated as an expense for the business.
It is added to the owner’s Capital Account.
13. What is Interest on Drawings?
Interest on Drawings is the amount charged from the owner for withdrawing money or goods from the business for personal use, when applicable.
Example:
Drawings = ₹50,000 Interest = 10%
Interest on Drawings:
₹50,000 × 10% = ₹5,000
Treatment:
It is treated as income for the business.
It is deducted from the owner’s Capital Account.
14. What is the Double Effect of Adjustments?
Many adjustments have a double effect in Final Accounts.
This means the same adjustment affects two places.
Example: Outstanding Salary
Salary outstanding = ₹5,000
First Effect: Added to salary expense in the Profit & Loss Account.
Second Effect: Shown as a liability in the Balance Sheet.
Similarly:
Adjustment
First Effect
Second Effect
Outstanding Expense
Added to expense
Liability
Prepaid Expense
Deducted from expense
Asset
Accrued Income
Added to income
Asset
Income Received in Advance
Deducted from income
Liability
Depreciation
Expense
Deducted from asset
Bad Debts
Expense/Loss
Deducted from Debtors
15. Why are Adjustments Important in Final Accounts?
Adjustments are essential for preparing accurate Final Accounts. Without adjustments, the business may report incorrect profit, incorrect expenses, or incorrect asset and liability values.
For example, if outstanding salary is ignored, expenses will be understated and profit will be overstated.
Therefore, adjustments help ensure that the financial statements present a more accurate picture of the business.
16. Simple Example of Adjustments
Suppose a business has:
Salary = ₹50,000
Outstanding Salary = ₹5,000
Insurance = ₹20,000
Prepaid Insurance = ₹2,000
Adjusted Salary:
₹50,000 + ₹5,000 = ₹55,000
Adjusted Insurance:
₹20,000 − ₹2,000 = ₹18,000
Therefore:
Salary expense = ₹55,000
Prepaid Insurance = ₹2,000
Insurance expense = ₹18,000
17. Key Points to Remember
Adjustments = Changes Made to Prepare Accurate Final Accounts
Remember:
Outstanding Expense → Add to Expense + Liability
Prepaid Expense → Less from Expense + Asset
Accrued Income → Add to Income + Asset
Income Received in Advance → Less from Income + Liability
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