7

Reporting and Preparing

Financial Statements
CLASSIFICATION OF CAPITAL AND REVENUE

The Going Concern Assumption allows the accountant to

classify the expenditure and receipts as:
 Capital Expenditure
 Revenue Expenditure
 Deferred Revenue Expenditure
 Capital Receipts
 Revenue Receipts.
CAPITAL EXPENDITURE: is that expenditure which
yields benefits which extend beyond the current accounting
period. They are of non-recurring nature. For e.g. cost of
land and building, plant and machinery, furniture and
fixtures etc.

REVENUE EXPENDITURE: is that expenditure which

is incurred for the running productivity or earning capacity
of a business. Such expenditure yields benefit in the
current accounting period only. For e.g. Office and
Administration Expenses, Selling & Distribution Expenses
etc.
DEFERRED REVENUE EXPENDITURE: is that
expenditure for which payment has been made or a liability
incurred but is carried forward on the presumption that it
will be benefit over a subsequent period or periods.
Sometimes, revenue expenditure incurred during the year
is very large and it is expected to benefit not only the
current year operations but also subsequent period or
periods. Such expenditure should be normally written off
over a period of 3 to 5 years.
For e.g. heavy Advertising Campaign, Research &
Development Expenditure.
CAPITAL RECEIPTS AND REVENUE RECEIPTS
The recurring receipts are normally the outcome of normal
trading activities and are regarded as Revenue Receipts.
Foe e.g. sale price received from sale of goods, interest on
investments made in past etc. The benefits of recurring
receipts do not extend beyond the current accounting
period. The Revenue Receipts are shown in the Income
Statement.
The non-recurring receipts are Capital Receipts and may
take form of raising of long-term loans, capital contribution
by the owner, sale price of fixed asset etc. The benefits of
non-recurring receipts may or may not be confined to
current accounting period. The capital receipts create a
liability of an equal amount to be paid in future.
RATIONALE OF MAKING ADJUSTMENTS
The important considerations are:
1. Revenue Recognition Principle which requires that
revenue should be recognised in the period in which the
sale is deemed to have occurred.
2. Matching Principle which requires that the expenses
should be recognised in the same period as associated
revenues. Expenses recognition is tied to revenue
recognition. Let the expenses follow the revenue.

An adjusting entry is recorded to bring an asset or liability

account balance to its proper amount.
1. CLOSING STOCK:

Adjusting Entry Closing Stock Dr.

To Trading A/c
Trading A/c Shown on the credit side
Balance Sheet Shown on the asset side as Current Asset
2. OUTSTANDING EXPENSES:
Expenses incurred but not paid at the end of the year are
called outstanding expenses
Adjusting Entry Respective Expense A/c Dr.
To Outstanding Expense A/c

Trading A/c Added to the respective expense on

the debit side.
Profit & Loss A/c Added to the respective expense on
the debit side.
Balance Sheet Shown on the Liability side as Current
Liability
3.PREPAID EXPENSES:
Prepaid Expenses refer to amount paid in the current
accounting year for services to be received in the next
accounting year

Adjusting Entry Prepaid Expense A/c Dr.

To Respective Expense A/c
Trading A/c Deducted from the respective
expense on the debit side.
Profit & Loss A/c Deducted from the respective
expense on the debit side.
Balance Sheet Shown on the Asset side as Current
Asset
4. ACCRUED INCOME (Income earned but not received) :
If income for the current year is not received during the
year, it is termed as accrued income.

Adjusting Entry Accrued Income A/c Dr.

To Respective Income A/c
Profit & Loss A/c Added to the respective Income on
the credit side.
Balance Sheet Shown on the Asset side as Current
Asset
5. UNEARNED INCOME (Income received in advance):
It refers to income received for the current year against
which services are to be provided in the next accounting
year

Adjusting Entry Respective Income A/c Dr.

To Unearned Income A/c

Profit & Loss A/c Deducted from the respective Income

on the credit side.
Balance Sheet Shown on the Liabilities side as Current
Liability.
6. DEPRECIATION on FIXED ASSET:
Depreciation is the depreciable cost of a fixed asset
allocated to a particular accounting year.

Adjusting Entry Depreciation A/c Dr.

To Asset A/c
Profit & Loss A/c Shown on the debit side as separate item.

Balance Sheet Shown on the Asset side by way of

deduction from the value of the concerned
fixed asset.
7. BAD DEBTS:
When a business enterprise becomes certain about non-
recovery of the amount from debtors, it is treated as Bad
Debts and charged to Profit & Loss A/c

Adjusting Entry Bad Debts A/c Dr.

To Assets A/c
Profit & Loss A/c Shown on the debit side by way of
addition to Bad Debts
Balance Sheet Shown on the Assets side as
deduction from the amount of Sundry
Debtors.
 Illustration 2: Trial Balance of M/s Pandit Bros. as at 31st March,2007 was as follows:
Rs. Rs.

Cash 1,000Capital 22,000

Bank 5,000Sales 1,25,000
Wages 8,000Creditors 15,000
Salaries 25,000
Furniture 15,000
Rent of Building 13,000
Debtors 15,500
Bad Debts 4,500
Purchases 75,000

1,62,000 1,62,000
Adjustments:
1. Rent of building for one month was paid in advance
2. Closing Stock as on March 31, 2007 amounted to Rs.10,000/-
3. Wages Outstanding amounted to Rs.500/-
4. Salaries included Rs.5,000/- paid in advance to an employee
5. Furniture to be depreciated @ 10%.
6. Debtors included bad debts Rs.2,500/-
Prepare Trading and Profit and loss A/c and Balance Sheet
8. PROVISION FOR BAD AND DOUBTFUL DEBTS:
As the exact amount of bad debts cannot be calculated at the time of
sale, a provision for bad and doubtful debts may be created in the year
of sale and charged to P&L A/c of this year.

Adjusting Entry Profit & Loss A/c Dr.

To Provision for Bad Debts A/c
Profit & Loss A/c Shown on the debit side as separate
item

Balance Sheet Shown on the Assets side by way of

deduction from the amount of Sundry
Debtors (net of additional bad debts)
9. PROVISION FOR DISCOUNT ON DEBTORS:
Provision for discount on debtors is created to take care of discount to
be allowed to debtors for prompt payment. But before calculating
provision for discount, provision for doubtful debts is deducted from
debtors.

Adjusting Entry Profit & Loss A/c Dr.

To Provision for Discount on Debtors

Profit & Loss A/c Shown on the debit side as separate item
Balance Sheet Shown on the Assets side by way of deduction
from the amount of Sundry Debtors (net of
additional bad debts & Provision for Bad and
Doubtful Debts)
10. PROVISION FOR DISCOUNT ON CREDITORS:
Although Provision for discount on creditors is against the
principle of conservatism but it is an accepted accounting
practice

Adjusting Entry Provision for Discount on Creditors A/c Dr.

To Profit & Loss A/c
Profit & Loss A/c Shown on the CREDIT side as separate item
Balance Sheet Shown on the Liabilities side by way of deduction
from the amount of Sundry Creditors
11.INTEREST ON CAPITAL:
To calculate true profit for the year, interest on capital
invested by the owner of business is provided in the books
and treated as business expense.

Adjusting Entry Interest on Capital A/c Dr.

To Capital A/c
Profit & Loss A/c Shown on the DEBIT side as separate item
Balance Sheet Shown on the Liabilities side by way of addition to
the capital.
12.INTEREST ON DRAWINGS:
Cash, goods or any other asset withdrawn by the owner for
his personal use is termed as drawings. Sometimes interest
on drawings is calculated by the business enterprise and
treated as business income.

Adjusting Entry Capital A/c Dr.

To Interest on Drawings A/c
Profit & Loss A/c Shown on the CREDIT side as separate item
Balance Sheet Shown on the Liabilities side by way of deduction
from the capital.
13.MANAGER’S COMMISSION ON PROFIT:
(i) Commission on Profits Before Charging Such Commission:
Profit before Commission X Rate of Commission
100
(ii) Commission on Profits After Charging Such Commission:
Profit before Commission X Rate of Commission
100 + Rate

Adjusting Entry Manager’s Commission Dr.

To Outstanding Commission A/c
Profit & Loss A/c Shown on the CREDIT side as separate item
Balance Sheet Shown on the Liabilities side as Current Liability.
14. ABNORMAL LOSS OF STOCK:
Sometimes loss of goods takes place due to fire, theft,
earthquakes, etc.

Trading A/c Total value of abnormal loss of stock (whether or

not recovered) is shown on the credit side of the
Trading A/c
Profit & Loss A/c Total value of irrecovered loss of stock is shown on
the debit side as separate item.
Balance Sheet The amount due from the insurance company is
shown on the asset side as a Current Asset.
15. GOODS SENT ON SALE OR APPROVAL BASIS :
Generally, goods supplied on approval are recorded as
sales. But this cannot be treated as sales until the
express or implied consent of the buyer is obtained.
Adjusting Entry Sales A/c Dr.
To Debtors A/c
(with sale price of goods sold on approval basis)
Stock A/c Dr.
To Trading A/c
(with cost of goods sold on approval basis)

Trading A/c Shown as a deduction from Sales (with sale price)

Added to the Closing Stock on credit side.
Balance Sheet Shown on the Assets side by way of deduction from the
Debtors. (with sale price)
Shown on the Assets side by way of addition to the
Closing Stock. (with cost price)
 Illustration 3: From the following Trial Balance of Mr. Ram, prepare a Trading and
Profit and Loss A/c for the year ending on 31st March, 2006 and a Balance Sheet as
on that date:
Dr. Trial Balance Cr.
Rs. Rs.
Plant & Machinery 51,000Capital 41,000
Office Furniture 2,600Creditors 52,000
Stock (1.4.2005) 48,000Sales 4,80,000
Motor Van 12,000Bills Payable 5,600
Debtors 45,000Purchase Return 5,500
Cash in Hand 400Provision for Bad Debts 2,500
Cash at Bank 6,500Discount Received 3,700
Wages (factory) 1,50,000
Wages (office) 14,000
Purchases 2,13,500
Bills Receivable 7,200
Sales Return 9,300
Drawings 6,000
Rent 6,000
 Illustration 3 contd………………………..
Lightning 800
Telephone 1,350
Insurance 300
Advertisement 6,350
General Expenses 1,000
Bad Debts 2,500
Discount Allowed 6,500

5,90,300 5,90,300
The following adjustments are to be made:
(a) Stock on 31st March,2006 was valued at Rs.52,000/-
(b) Rent due but not paid Rs.2,000/-
(c) Lightning due but not paid Rs.300/-
(d) Insurance Paid in advance Rs.100/-
(e) Depreciate Plant & Machinery @ 331/3%; Office Furniture @ 10%; Motor Van @
331/3%
(f) The Provision for Bad Debts has to be increased to Rs.3,000/-
(g) The Provision for Discount on Debtors and Discount on Creditors is to be made @
2.5%
(G.P. Rs.1,16,700/-; N.P. Rs.57,890/-; B/S Total Rs.1,51,490/-)
 Illustration 4: From the following information prepare Final Accounts:

Trial Balance as on 31st March,2006

Purchases (Adjusted) 1,49,600Sales 1,60,000
Wages 10,450Capital 37,550
Rent of Building 4,200Commission 450
Insurance and rates (including 200Creditors 15,000
premium of Rs.150 p.a. paid up
to 30-9-2006)
Stock (31-3-2006) 20,625
Cash 925
Loose Tools 2,000
Plant 17,000
Debtors 3,000
Sundry Expenses 5,000

2,13,000 2,13,000
Illustration 4 contd………………….
Adjustments:
1. Loose Tools were valued at Rs.1,600/- on 31-3-2006
2. Depreciate Plant by 10%
3. Manager is entitled to a commission of 10% of net profits after
charging such commission.
4. One-third of the building was occupied by the employees who
reside in the business building. Treat the value of the perquisite as
wages.
5. Wages include Rs.500/- for installation of a plant on 1-10-2005.
6. Loss of stock by fire on 20-3-2006 amounted to Rs.10,000/- and
100% claim was admitted by the Insurance Company.
(G.P. Rs.9,050/-; N.L. Rs.575/-; B/S Total Rs.51,975/-)
 Illustration 5: The following is the Trial Balance extracted from the books of
Akhilesh as on 30th September, 2007:
Particulars Dr. (Rs.) Cr. (Rs.)
Capital A/c ---- 1,00,000
Plant and Machinery 78,000 ----
Furniture 2,000 ----
Purchases and Sales 60,000 1,27,000
Returns 1,000 750
Opening Stock 30,000 ----
Discount 425 800
Sundry Debtors / Creditors 45,000 25,000
Salaries 7,550 ----
Manufacturing Wages 10,000 ----
Carriage Outwards 1,200 ----
Provision for Doubtful Debts ---- 525
Rent, rates and Taxes 10,000 ----
Advertisements 2,000 ----
Cash 6,900 ----

2,54,075 2,54,075
Prepare Trading & Profit and Loss A/c for the year ended
on 30th September,2007 and a Balance Sheet as on that
date after taking into account the following adjustments:
1. Closing Stock was Valued at Rs.34,220/-
2. Provision for Doubtful Debts is to be kept at Rs.500/-
3. Depreciate Plant & Machinery @ 10%
4. The proprietor has taken goods worth Rs.5,000/- for
personal use and additionally distributed goods worth
Rs.1,000/- as samples.
5. Purchase of furniture Rs.920/- has been passed through
Purchases Book.
(G.P. Rs.67,890; N.P. Rs.38,740/-, B/S Total
Rs.1,58,740/-)