In accounting, every business entity is expected to prepare its report (final account) at the end of a financial/accounting year. The accounting year end is the date in which such entity prepares its account to, eg 31st December, 20xx.
2. INCOME RECEIVED IN ADVANCE
All the accounting jobs/tasks cannot be concluded on that particular date. The reasons are that first, transactions are done on daily basis and secondly, financial account is historical in nature . Thus, the preparation of the accounting report will certainly be on a date after the accounting date of the business entity.
Traditionally, some important items to be shown on the report may not be ready on that date. For this, we have so many unresolved issues which bring about the need to make adjustments in the accounts. After the trial balance has been prepared, it is observed that some other adjustments will have to be made. This is to ensure that the final account prepared and presented will show a true and fair view position of the state of affairs of the business entity. To present a set of fair reports, it is imperative that adjustments are made.
The following adjustments are thus discussed in this chapter.
1. CLOSING STOCK
This is the balance of stock that remains unsold or unused as at the trial balance date or balance sheet date. There is need to make adjustments for closing stock in the account for the following reasons:
I. Ignoring closing stock in the final account will lead to understatement of profit. This is so because the value of the closing stock ought to be deducted total value of goods available to arrive at the value of cost of goods sold.
II. Matching concept requires that income and expenses of the same period are matched together to arrive at a profit for that period. Since closing stock will yield revenue in a subsequent period, it has to be adjusted for.
III. Closing stock is not shown in the trial balance. Since it forms part of the accounts, standard practice requires that it has to be accounted for. The way to account for it is to adjust for it in the accounts.
IV. As stated in II above, only a part of the entire stock have been sold / used. Since closing stock has not been sold / used, it becomes prudent to adjust for it in the accounts.
Treatment
Closing stock is treated in the accounts as stated below:
In the income statement, closing stock is deducted from total goods available to have cost of goods sold/used/consumed.
In the statement of financial position, closing stock is shown as current assets.
2. INCOME RECEIVED IN ADVANCE
This is income that has been received but for which the (receiving) entity has not yet worked for. Because the entity has not worked for such, it is regarded as a liability.
Treatment
In the income statement, deduct the income received in advance from the total income shown in the trial balance to arrive at the true income for the accounting period under reference.
In the statement of financial position, income received in advance is shown as a current liability.
3. ACCRUED INCOMES
Accrued incomes are revenues or incomes worked for but for which payment is yet to be received. They therefore become asset receivable from those that are to make the payment
Treatment
In the income statement, add accrued incomes to the incomes shown in the trial balance to arrive at the full income earned in the period under reference.
In the statement of financial position, show accrued incomes as current asset.
4. PROVISION
When income statement is prepared, certain events may not have been known as at the time when profit for the period is reported. To safeguard against this, a certain amount is usually set aside out of the profit to cater for eventualities. This amount set aside out of profit for any eventuality is called a provision. The following provisions are discussed here.
a) Provision for Bad/Doubtful Debts and Discount on Debtors
Provision for bad/doubtful debts is a provision made against profit to safeguard the effects of debts becoming bad or doubtful. The amount set aside for this purpose cannot be specific since there is uncertainty as to the amount that will become irrecoverable, and the time this will happen is equally unknown. And because the amount cannot be accurately specified, management of the business entity will have to make an estimate that they considered reasonable.
Treatment
In the income statement, provision for bad/doubtful debts is debited to the income statement to reduce the value for debt.
To do this,
Dr. Income Statement
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}with the amount of provision
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Cr. Provision for bad/doubtful debts
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In the statement of financial position, provision for bad/doubtful debts is shown as deduction from the amount of debtors.
Note
If a provision had been made in prior year(s) and there is need to increase it in the current year
Dr. Income Statement
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}with the amount of increase in provision
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Cr. Increase in Provision
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b) Provision for Depreciation
This is also a year-end adjustment item. It requires that a fraction of the value of fixed asset be written off to the profit for the period. The notion is that fixed assets employed to generate revenue are worn out. And this tear and wear nature of the fixed assets be fairly estimated for, and charged against the profit generated during the period.
Treatment
Note
The same treatment of provision for bad/doubtful debts applies to the treatment of provision for depreciation. The only difference is that while bad/doubtful debts relate to debtors, depreciation relates to fixed assets
5. Accruals
Accruals are also known as accrued expenses. They are expenses that are due for payment but for which payment have not be made. Examples of unpaid wages as at trial balance date.
Treatment
In the income statement, add accruals back to the affected expenses to arrive at the total expenses incurred and chargeable to that particular period.
In the statement of financial position, accruals are treated as current liabilities as they represented creditors’ balances.
6. Prepayments
These are also known as prepaid expenses. They are expenses paid for but for which the payer has not received value for them. An example of prepayment is where a tenant pays for five-year rent in advance. Obviously, the property rented has not been used but payment has been effected upfront. To have a fair position, an adjustment is needed in the accounting report where this occurs.
Treatment
In the income stock, the value of repayment is deducted from the affected expenses to arrive at the true position of actual unit incurred in such expenses.
7. Bad Debt
These are debts that are now considered irrecoverable by the reported entity. After the TB has been drawn, the business entity observes that the debts cannot be recovered. For this, they are considered and classified as Bad Debts.
The reasons for the occurrence of bad debt include:
a) Debt of the debtor
b) Insolvency of the debtor
c) Sudden disappearance of the debtor
d) Legal matters
e) Etc.
Treatment
When debt have been classified irrecoverable the treatment shall be in the income stock, show bad debts as expenses in the stock of financial position, no treatment is incurred.
Note
If debts are later classified as bad after the trial balance date, the correct practice is to charge bad debt as expense in the income stock and show it as deduction in the current assets (i.e deduct from debtors balance). If debts are classified as bad before the TB date, the convert mantic shall be to raise a journey to debit this debts and credit debtor’s account. After this, no further adjustments is required.
8. Drawing
A young lady selling articles may, from time to time, give some of the articles such as biscuits to her crying child, or, she may spend out of the business money to prepare a meal for the household. She may also spend some of the business money to buy a dress for her personal use (outing). All these constitute what is regarded as drawing. At the end of the accounting period the total of all the goods taken or cash used for personal purposes id considered as drawing for that period.
Thus, ‘drawings’ is the value of goods or cash taken out of the business for personal use.
Treatment of Drawings
Let’s discuss the treatment in two ways:
Drawings of Goods
In the income statement, ‘drawing’ is deducted from the purchases. To do this,
Dr. Drawings A/C
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}with the value of goods taken for personal use
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Cr. Purchases A/C
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Drawings of Cash
Drawings in cash is deducted from cash as shown below
Dr Drawings A/C
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} with the amount of cash taken for personal use.
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Cr Cash A/C
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