Adjustments in Financial Statements

Need for Accounting Adjustments

Accounting adjustments are required because of the following purposes:

  1. To know the correct net profit or net loss of the business for an accounting year.
  2. To know the correct financial position of the business.
  3. To record the expenses which have become due but have not been paid.
  4. To record the expenses which have been paid in advance for future years.
  5. To provide for depreciation on fixed assets.

Types of Adjustments

The number and nature of adjustments will differ from business to business.

  1. Closing Stock
  2. Outstanding Expenses
  3. Prepaid Expenses
  4. Depreciation on Fixed assets

Closing Stock

Closing stock is the stock of goods which remains unsold at the end of the accounting year. This item is, normally, not shown inside the Trial balance. It appears outside the
trial balance as additional information.

Outstanding Expenses

An expense which relates to the current year but has not been paid till the end of the accounting year is known as outstanding expenses such as factory rent, wages, salaries, office rent, telephone charges, etc. for current year may not have been paid till the end of the accounting year.

Prepaid Expenses

Sometimes, a part of the expenses given in the trial balance may relate to future years. Such part of expenses is known as ‘Prepaid Expenses’ or ‘Expense paid in Advance’ such as, out of the salaries paid during the current year, a part may relate to next accounting year.

Depreciation on Fixed Assets

The value of fixed assets such as Plant and Machinery, Building, Furniture, Computers, Motor Vehicles, etc. goes on decreasing or reducing every year due to their use, wear and tear. This decrease in the value of assets is called depreciation. Depreciation is an expense like any other expense of the business. Depreciation on various fixed assets is shown on the debit side of P&L A/c. The amount of depreciation on fixed asset is deducted from the concerned or related asset on the asset side of Balance Sheet.