At the end of a financial year (FY), adjustment entries are made to ensure that the financial statements accurately reflect the financial position and performance of the business in accordance with the accrual basis of accounting and accounting principles. These adjustments account for revenues earned, expenses incurred, and changes in assets or liabilities that are not yet recorded.
Adjustment Entries in Accounting
Here’s a list of the common adjustment entries at the end of the FY:
- Accrued Income
- Income earned during the FY but not yet received or recorded.
- Journal Entry:
Accrued Income A/c Dr.
To Income A/c
- Accrued Expenses (Outstanding Expenses)
- Expenses incurred but not yet paid or recorded.
- Journal Entry:
Expense A/c Dr.
To Outstanding Expenses A/c
- Prepaid Expenses
- Expenses paid in advance for the next accounting period.
- Journal Entry:
Prepaid Expenses A/c Dr.
To Expense A/c
- Unearned Revenue (Advance Income)
- Revenue received in advance for services not yet rendered or goods not yet delivered.
- Journal Entry:
Unearned Revenue A/c Dr.
To Revenue A/c
- Depreciation on Fixed Assets
- Allocation of the cost of a fixed asset over its useful life.
- Journal Entry:
Depreciation A/c Dr.
To Asset A/c
- Provision for Doubtful Debts
- Estimation of bad debts to reflect expected receivables.
- Journal Entry:
Bad Debts A/c Dr.
To Provision for Doubtful Debts A/c
- Provision for Expenses
- Anticipation of future expenses for which the exact amount is uncertain but reasonably estimated (e.g., audit fees).
- Journal Entry:
Expense A/c Dr.
To Provision for Expenses A/c
- Closing Stock
- Recording the value of unsold inventory at the end of the year.
- Journal Entries:
- For recording closing stock (adjustment entry):
Closing Stock A/c Dr.
To Trading A/c
-
- For carrying forward closing stock to the next year:
Stock A/c Dr.
To Closing Stock A/c
- Interest Accrued
- Interest income or expense accrued but not received or paid.
- For Interest Income:
Accrued Interest A/c Dr.
To Interest Income A/c
- For Interest Expense:
Interest Expense A/c Dr.
To Accrued Interest A/c
- Deferred Revenue Expenditure
- Part of a significant expense benefiting multiple years is carried forward (e.g., advertisement expenses).
- Journal Entry:
Deferred Revenue Expenditure A/c Dr.
To Expense A/c
- Adjustment of Goods Taken for Personal Use
- Goods withdrawn by the owner for personal use are deducted from purchases.
- Journal Entry:
Drawings A/c Dr.
To Purchases A/c
- Adjustment for Tax Liability
- Recording provisions for taxes (e.g., income tax).
- Journal Entry:
Income Tax A/c Dr.
To Provision for Tax A/c
- Amortization of Intangible Assets
- Spreading the cost of intangible assets over their useful life (e.g., patents, goodwill).
- Journal Entry:
Amortization A/c Dr.
To Intangible Asset A/c
- Transfer of Profit or Loss
- Transferring net profit or loss to capital or reserves.
- For Profit:
Profit and Loss A/c Dr.
To Capital/Reserves A/c
- For Loss:
Capital/Reserves A/c Dr.
To Profit and Loss A/c
Purpose of Adjustment Entries:
- To follow the matching principle (recording revenues and expenses in the same period).
- To ensure accurate financial reporting.
- To recognize accruals and deferrals.
After passing these adjustment entries, financial statements like the Trading Account, Profit & Loss Account, and Balance Sheet are prepared to reflect the true financial performance and position of the entity.