Because of the adopting of accrual accounting, after the preparation of Trial Balance, adjustments relating to the accounting period have to be made in order to make the financial statements complete these adjustments are necessary for transactions that have not been recorded but that affect the business ‘ financial position and operating results. They can be divided into four types: two related to income and two related to expenditure. In terms of revenue, the two are:

  • Unrecorded revenues: i.e. income earned for the period but not received in cash. For e.g. interest for the last quarter of the accounting period is yet to be received though fallen due. The adjustment entry to be passed is:

Accrued interest A/c(Dr)

Interest A/c(Cr)

  • Revenues received in advance: i.e. income relating to the next period received in the current accounting period, e.g. rent received in advance. The adjustment entry is:

Rent A/c(Dr)

Rent received in advance A/c(Cr)

The two relating to expenses are:

  • Unrecorded expenses: i.e. expenses were incurred during the period but no record of them as yet have been made, e.g. Rs.500 wages earned by an employee during the period remaining to be paid. The adjustment entry would be:

Wages A/c(Dr)

Accrued wages A/c(Cr)

  • Prepaid expenses: i.e., expenses relating to the subsequent period paid in advance in the current accounting period. An example which is frequently cited is insurance paid in advance. The adjustment entry would be:

Prepaid Insurance A/c(Dr)

Insurance A/c(Cr)

Unrecorded revenues and prepaid expenses are assets in the above four cases and are therefore debited (as debit may mean an increase in assets) and revenues received in advance and unrecorded expenses are liabilities and are therefore credited (as credit may mean an increase in liabilities).

In addition to the four adjustments mentioned above, a little more needs to be done before the financial statements are prepared. They are:

  • Inventory at the end
  • Provision of Depreciation
  • Provision for Bad Debts
  • Provision for Discount on receivables and payables
  • Interest on Capital and Drawings

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