by The concept of adjustments in accounting is based on the accrual system and matching principle. It ensures that all incomes and expenses relating to a particular accounting period are properly recorded, whether cash is received or paid or not. Adjustments help in allocating revenues and costs to the correct period so that financial statements reflect accurate results and true financial position of the business.
Meaning of Adjustments
Adjustments are accounting entries passed at the end of an accounting period to bring unrecorded or partially recorded transactions into the books. These entries adjust incomes and expenses to ensure they relate to the current period. Adjustments are necessary for preparing final accounts and for presenting a true and fair view of profit or loss and financial position.
Definitions of Adjustments
- According to R.N. Carter,
“Adjustments are entries made at the end of the accounting period to record those transactions which have occurred but have not yet been recorded in the books of account.”
- According to William Pickles,
“Adjustments are made to allocate income and expenditure to the correct accounting period so that accurate profit can be ascertained.”
- According to A.N. Anthony,
“Accounting adjustments ensure that revenues and expenses are recognized in the period in which they arise, irrespective of cash flows.”
Objectives of Adjustments
- To Ascertain Correct Profit or Loss
One of the primary objectives of adjustments is to determine the correct profit or loss of the accounting period. Many expenses and incomes are not fully recorded during the year due to non-payment or non-receipt. Adjustments ensure that all revenues earned and expenses incurred during the period are properly recorded, preventing overstatement or understatement of profits and ensuring accurate financial results.
- To Follow the Accrual Concept
Adjustments help in following the accrual concept of accounting, which states that transactions should be recorded when they occur and not when cash is paid or received. Expenses such as outstanding expenses and incomes like accrued income are adjusted to ensure that financial statements reflect actual business performance for the period, irrespective of cash movements.
- To Match Income with Related Expenses
Another important objective of adjustments is to apply the matching principle. According to this principle, expenses should be matched with the revenues they help to generate. Adjustments such as depreciation, prepaid expenses, and outstanding expenses ensure that only relevant expenses are charged against current period income, leading to fair measurement of profit.
- To Present a True and Fair View of Financial Statements
Adjustments play a crucial role in presenting a true and fair view of the financial position and performance of a company. Without adjustments, assets, liabilities, incomes, and expenses may be misstated. Proper adjustments ensure realistic valuation of assets and correct disclosure of liabilities, thereby improving the reliability and credibility of financial statements.
- To Ensure Correct Valuation of Assets
Adjustments help in proper valuation of assets by accounting for depreciation, bad debts, and provisions. Assets such as fixed assets and trade receivables must not be overstated. Adjustments ensure that assets are shown at their true realizable or written-down value, which is essential for accurate assessment of the company’s financial strength.
- To Account for Outstanding and Prepaid Items
One of the key objectives of adjustments is to account for outstanding and prepaid items correctly. Outstanding expenses represent liabilities, while prepaid expenses represent future benefits. Adjustments ensure that such items are properly classified as assets or liabilities in the Balance Sheet, improving clarity and correctness in financial reporting.
- To Comply with Accounting Principles and Standards
Adjustments ensure compliance with fundamental accounting principles such as prudence, consistency, accrual, and matching concepts. They also help in adhering to accounting standards and statutory requirements. This objective is important for maintaining uniformity, legality, and professionalism in corporate accounting practices.
- To Improve Decision-Making for Stakeholders
By ensuring accurate profit calculation and correct presentation of financial position, adjustments enhance the usefulness of financial statements for decision-making. Investors, creditors, management, and regulators rely on adjusted financial data to evaluate profitability, liquidity, and solvency. Thus, adjustments support informed and rational economic decisions.
Types of Adjustments
1. Outstanding Expenses
Outstanding expenses are expenses that have been incurred during the accounting period but remain unpaid at the end of the year. These expenses relate to the current period and must be added to the concerned expense account. They are shown as current liabilities in the Balance Sheet. This adjustment ensures correct profit calculation and proper disclosure of liabilities.
2. Prepaid Expenses
Prepaid expenses are expenses paid in advance for benefits to be received in future accounting periods. Such expenses do not relate to the current period and should be deducted from the expense account. They are shown as current assets in the Balance Sheet. This adjustment avoids overstatement of current period expenses.
3. Accrued Income
Accrued income refers to income that has been earned during the accounting period but has not yet been received. This income is added to the relevant income account and shown as a current asset in the Balance Sheet. This adjustment ensures income is recognized in the correct accounting period.
4. Income Received in Advance
Income received in advance is income received during the current accounting period for services to be rendered in future periods. Since it does not belong to the current period, it is deducted from the income account and shown as a current liability in the Balance Sheet.
5. Depreciation
Depreciation is the systematic allocation of the cost of a fixed asset over its useful life. It is treated as an expense and charged to the Profit and Loss Account. Depreciation reduces the value of assets in the Balance Sheet and ensures proper valuation of fixed assets.
6. Bad Debts
Bad debts are amounts due from debtors that are considered irrecoverable. They are written off as an expense in the Profit and Loss Account and deducted from trade receivables in the Balance Sheet. This adjustment ensures realistic valuation of receivables.
7. Provision for Doubtful Debts
This adjustment is made to provide for possible future losses from debtors who may fail to pay. The provision is charged to the Profit and Loss Account and deducted from trade receivables in the Balance Sheet. It follows the prudence concept of accounting.
8. Provision for Discount on Debtors
Provision for discount on debtors is created to account for discounts that may be allowed to customers for early payment. It is treated as an expense and deducted from debtors after adjusting for bad debts and provision for doubtful debts.
9. Provision for Taxation
Provision for taxation is made to account for the estimated tax liability of the company for the accounting period. It is treated as a charge against profits and shown as a short-term provision in the Balance Sheet until the tax is paid.
Journal Entries for Each Type of Adjustment
| Type of Adjustment | Debit (Dr.) | Credit (Cr.) |
|---|---|---|
| Outstanding Expenses | Concerned Expense A/c | Outstanding Expenses A/c |
| Prepaid Expenses | Prepaid Expenses A/c | Concerned Expense A/c |
| Accrued Income | Accrued Income A/c | Concerned Income A/c |
| Income Received in Advance | Concerned Income A/c | Income Received in Advance A/c |
| Depreciation | Depreciation A/c | Asset A/c |
| Bad Debts Written Off | Bad Debts A/c | Trade Receivables (Debtors) A/c |
| Provision for Doubtful Debts | Profit & Loss A/c | Provision for Doubtful Debts A/c |
| Provision for Discount on Debtors | Profit & Loss A/c | Provision for Discount on Debtors A/c |
| Provision for Taxation | Profit & Loss A/c | Provision for Taxation A/c |
| Interest on Capital | Profit & Loss A/c | Capital A/c |
| Interest on Drawings | Capital A/c | Profit & Loss A/c |
| Closing Stock | Closing Stock A/c | Trading A/c |
