Final accounts are a crucial aspect of financial accounting that summarize a business’s financial position and performance for a specific period. To ensure accuracy, adjustment entries (provisional entries) are made before finalizing the accounts. These entries account for transactions or events that are not yet recorded in the books but are relevant to the period.
This post will guide you through final accounts, the need for adjustment entries, and provide examples to help you understand their practical application.
What Are Final Accounts?
Final accounts are the end products of the accounting process. They provide a complete financial overview of a business at the end of an accounting period and include:
- Trading Account: Determines the gross profit or loss.
- Profit and Loss Account: Calculates the net profit or loss.
- Balance Sheet: Displays the financial position by listing assets, liabilities, and equity.
Purpose of Final Accounts
- Financial Performance: Show profitability over a period.
- Financial Position: Provide a snapshot of the company’s assets and liabilities.
- Compliance: Fulfill legal and tax reporting requirements.
- Decision-Making: Guide management and stakeholders in planning and strategy.
What Are Adjustment Entries?
Adjustment entries (provisional entries) are made to account for transactions that are relevant to the current period but have not been recorded in the books of accounts. These adjustments ensure that income and expenses adhere to the accrual principle, meaning they are recognized when earned or incurred, not when cash is exchanged.
Common Types of Adjustment Entries
Outstanding Expenses: Expenses incurred but not paid.
- Example: Salary for March 2024 (₹20,000) remains unpaid as of the financial year-end.
- Entry:
- Debit: Salary Expense ₹20,000
- Credit: Outstanding Salary ₹20,000
Prepaid Expenses: Expenses paid in advance for the next period.
- Example: Insurance of ₹12,000 paid for the year April 2024–March 2025.
- Entry:
- Debit: Prepaid Insurance ₹12,000
- Credit: Insurance Expense ₹12,000
Accrued Income: Income earned but not received.
- Example: Interest of ₹5,000 earned but not yet received.
- Entry:
- Debit: Accrued Interest ₹5,000
- Credit: Interest Income ₹5,000
Unearned Income: Income received in advance for future periods.
- Example: Rent of ₹10,000 received for April 2024.
- Entry:
- Debit: Rent Income ₹10,000
- Credit: Unearned Rent ₹10,000
Depreciation: Allocation of an asset’s cost over its useful life.
- Example: Depreciation on machinery is ₹15,000.
- Entry:
- Debit: Depreciation Expense ₹15,000
- Credit: Accumulated Depreciation ₹15,000
Bad Debts: Debts that are not recoverable.
- Example: ₹3,000 owed by a customer is written off as bad debt.
- Entry:
- Debit: Bad Debt Expense ₹3,000
- Credit: Accounts Receivable ₹3,000
How Adjustment Entries Impact Final Accounts
- Trading Account: Adjustments related to inventory affect the calculation of the cost of goods sold (COGS).
- Profit and Loss Account: Adjustments for accrued income, outstanding expenses, and depreciation influence net profit or loss.
- Balance Sheet: Adjustments like prepaid expenses, accrued income, and depreciation alter asset and liability balances.
Example: Preparing Final Accounts with Adjustment Entries
Scenario:
ABC Traders has the following balances on 31st March 2024:
- Sales: ₹10,00,000
- Purchases: ₹6,00,000
- Opening Stock: ₹1,50,000
- Closing Stock: ₹2,00,000
- Salaries: ₹1,00,000
- Rent: ₹50,000
Adjustments:
- Outstanding Salary: ₹20,000
- Prepaid Rent: ₹10,000
- Depreciation on Machinery: ₹15,000
Step 1: Trading Account
| Particulars | Amount (₹) | Amount (₹) |
|---|---|---|
| Opening Stock | 1,50,000 | |
| Purchases | 6,00,000 | |
| Gross Profit (Bal. fig) | 4,50,000 | |
| Total | 12,00,000 | 12,00,000 |
| Sales | ||
| Closing Stock |
Step 2: Profit and Loss Account
| Particulars | Amount (₹) | Amount (₹) |
|---|---|---|
| Salaries | 1,00,000 | |
| Add: Outstanding Salaries | 20,000 | |
| Depreciation | 15,000 | |
| Rent | 50,000 | |
| Less: Prepaid Rent | (10,000) | |
| Net Profit | 3,75,000 | |
| Total | 4,75,000 | 4,75,000 |
| Gross Profit | ||
| Accrued Income |
Step 3: Balance Sheet
| Liabilities | Amount (₹) | Assets | Amount (₹) |
|---|---|---|---|
| Capital | 5,00,000 | Fixed Assets | 2,00,000 |
| Add: Net Profit | 3,75,000 | Less: Depreciation | (15,000) |
| Closing Stock | 2,00,000 | ||
| Outstanding Salaries | 20,000 | Prepaid Rent | 10,000 |
| Total | 8,95,000 | Total | 8,95,000 |
Conclusion
Final accounts and adjustment entries ensure the accuracy and completeness of financial statements. They reflect the true financial performance and position of a business, adhering to the accrual basis of accounting.
At Commands Global, we provide practical training in Final Accounts and Adjustment Entries as part of our Financial Accounting courses. Learn to prepare accurate financial statements and master the art of professional accounting.
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