Session 13 - Incorporating adjustment in financial statements

Session Plan : Incorporating adjustment in financial statements

Introduction (5 min): Explain the need for adjustments (accrued, prepaid, depreciation, provisions, closing stock, etc.) in financial statements.

Concept (10 min): Discuss types of adjustments and their dual effect on Trading A/c, P&L A/c, and Balance Sheet.

Illustrations (15 min): Solve practical problems showing adjustments incorporated in final accounts.

Class Activity (10 min): Students prepare adjusted financial statements from a sample Trial Balance.

Recap & Q/A (5 min): Summarize importance and clarify doubts.

Lecture Material : (PDF, PPT)

Incorporating_Adjustments_Financial_Statements.pptx 

Learning Material (IV Quadrant Approach)

(Q1) : Text and Image based Content (PDF/Image Formats)

Incorporating adjustments into financial statements is essential to ensure they accurately reflect a company's financial position and performance. These adjustments align with the accrual basis of accounting and the matching principle, which states that revenues and related expenses should be recognized in the same accounting period.

Common Adjustments and Their Treatments

1. Closing Stock

• Definition: Unsold inventory at the end of the accounting period.

• Treatment:

  • Trading Account: Credited to reflect the cost of unsold goods.

  • Balance Sheet: Shown as a current asset.

• Example: If closing stock is ₹50,000:

• Closing Stock A/C  Dr. ₹50,000

•   To Trading A/C                ₹50,000

This entry increases the gross profit in the Trading Account and reflects the inventory in the Balance Sheet.

2. Accrued Income

• Definition: Income earned but not yet received by the end of the accounting period.

• Treatment:

  • Profit & Loss Account: Added to the respective income to reflect income earned but not yet received.

  • Balance Sheet: Shown as a current asset.

• Example: Interest income of ₹10,000 earned but not received:

• Accrued Income A/C  Dr. ₹10,000

•   To Interest Income A/C                ₹10,000

This entry ensures that the income is recognized in the period it was earned.

3. Prepaid Expenses

• Definition: Expenses paid in advance for benefits to be received in future periods.

• Treatment:

  • Profit & Loss Account: Deducted from the respective expense to reflect only the expense pertaining to the current period.

  • Balance Sheet: Shown as a current asset.

• Example: Insurance premium of ₹12,000 paid for a year on December 1st; by March 31st, only four months' worth (₹4,000) is applicable to the current financial year.

• Prepaid Insurance A/C  Dr. ₹8,000

•   To Insurance Expense A/C                ₹8,000

This entry adjusts the expense to reflect only the portion applicable to the current period.

4. Depreciation

• Definition: The systematic allocation of the cost of a tangible asset over its useful life.

• Treatment:

  • Profit & Loss Account: Recorded as an expense to allocate the cost of tangible assets over their useful lives.

  • Balance Sheet: Deducted from the respective asset's value to reflect its book value.

• Example: A machine purchased for ₹100,000 with a useful life of 10 years:

• Depreciation A/C  Dr. ₹10,000

•   To Machinery A/C                ₹10,000

This entry spreads the cost of the asset over its useful life.

5. Provision for Bad and Doubtful Debts

• Definition: An estimate of the amount of accounts receivable that may not be collectible.

• Treatment:

  • Profit & Loss Account: Recorded as an expense to anticipate potential future bad debts.

  • Balance Sheet: Deducted from accounts receivable to reflect the expected collectible amount.

• Example: Accounts receivable total ₹200,000; 5% is estimated to be uncollectible:

• Profit & Loss A/C  Dr. ₹10,000

•   To Provision for Doubtful Debts A/C                ₹10,000

This entry accounts for potential losses from uncollectible debts.

📊 Incorporating Adjustments into Financial Statements

Adjustments impact both the Income Statement and the Balance Sheet:

• Income Statement (Profit & Loss Account):

  • Adjustments ensure that revenues and expenses are recognized in the period they pertain to, providing an accurate measure of net profit or loss.

• Balance Sheet:

  • Adjustments affect asset and liability balances, ensuring that the financial position reflects all accrued and deferred items.

For instance, as per ACCA guidelines, adjustments for inventory, accruals, prepayments, depreciation, and bad debts are essential for accurate financial reporting.

(Q2) : Video Based Content (Youtube): www.youtube.com/watch?v=t73DmfSeBrc&list=PLLhSIFfDZcUXEs3UhIv5tMn6AAU1GNnPr&index=41 

(Q3) : Formative Assessment (Google Form/Any Other Online Quiz Platform): forms.fillout.com/t/fNrgYJNgbHus