Credit Profit and Loss.

ADJUSTMENTS

When preparing final accounts it will be necessary to consider the question of the period in respect of which an expense has been incurred. It is easy to realize that at any given date, an expense may have been paid, or charged if an Expenses Day Book or Journal is used, in respect of a period which is not co-extensive with the period of accounts, either falling short of, or stretching beyond such period, and as it is essential that the period for which accounts are prepared should bear the true expenditure-no more, no less-an adjustment is usually called for to give effect to this principle. Where a payment is made in respect of a period beyond the date of the accounts it is in the nature of an asset; that is, the benefit of the expenditure is still to be derived and by so treating it the subsequent period bears the incidence of the expenditure. Conversely, if a payment for expenditure does not cover the whole period in question, provision has to be made for accruals, and this will be in the nature of a liability, and by so treating it relief will be made to the subsequent period, which will have debited against it the payment of the expense which has arisen in the preceding period.

In order to ensure that the accounts of a period do contain all the expenses and gains properly attributable to that period, all or some of the following adjustments will usually be required:

1. Carry forward of payments in advance, e.g. Insurance, Rates, and in certain circumstances, Advertising (pp. 0510-0513).

2. Charges for accrued or accruing expenses, e.g. Rent, Heating, Light- ing. Telephone (pp. 0513-0515).

3. Carry forward of income received but only PARTIY earned or ac- crued, e.g. Subscriptions or Rents Received in Advance: and its converse, entries for income earned or accrued, not yet wholly received (pp. 0515-0516).

4. Incorporation of stock into the accounts, e.g. Stationery Stock.

5. (a) Depreciation (pp. 0518-0521).

(b) Bad and Doubtful Debts (pp. 0521-0523).

(d) Loan Interest (pp. 0526-0528).

6. Transfers:

(a) Correction of errors of commission, as for instance, correction of posting to (i) wrong account, (ii) wrong side of an account, e.g. charging private withdrawals to Expenses Accounts.

(b) Correction of errors of omission, e.g. omission of returns, etc. (c) (i) Special or abnormal charges against Profit and Loss Account. (ii) Appropriations of Profits, e.g. commissions based upon profits.

1. Expenses Prepaid

The book-keeping entry required to deal with prepayments or payments in advance is: debit Expenses Prepaid Account, credit Expense Account; and the effect of the entry is to reduce the expenses debited to Profit and Loss Account. The Expenses Prepaid Account is an asset and will appear on the Balance Sheet as such.

Illustration 2

A commenced business on 1st April 19.., and at the date of the Trial Balance extracted on 31st December 19.., has paid rates to 31st March next, the proportion of such prepayment, i.e. for the three months between 1st January and 31st March, being £30. Make the adjustment for the purpose of preparing final accounts in respect of the period ended 31st December 19...

JOURNAL

19.. Dec. 31

Expenses Prepaid

Rates

Being transfer of Rates prepaid at this date.

The item will be shown in the Balance Sheet at 31st December 19.., as an asset, and on the following 1st January 19.., it will be transferred back to Rates Account, thus throwing the charge therefor on to the following period.

This entry will be:

19.

Jan. 1 Rates

Expenses Prepaid

JOURNAL

Being transfer of Rates applicable to three months ended

31st March 19..

TRADING. PROFIT. LOSS ACCOUNT-BALANCE SHEET 0511

The Ledger Accounts will then be:

RAIES

Oct. 3 Cash (sav)

120

Dec. 31, Expenses Prepaid

Profit and Laws Account

£120

19.

Jan. 1 Expenses Prepaid

EXPENSES PREPAID

19.

Dec. 31 Rates Prepaid'

Jan. 1 Rates

This would appear in the Balance Sheet on 31st December 19... as an asset, and on the following 1st January, the first day in the new period, be re-transferred to Rates Account.

The same procedure will be followed in all cases of prepayments. In practice, a simpler alternative method is generally adopted, whereby the adjustments are made within the one account.. The method is as follows:

The amount prepaid is credited to the Expense Account and brought down as a balance on the account (in the same way as a cash balance is brought down). The balance of the Expense Account is then transferred to the Trading and Profit and Loss Account. The amount brought down on the Expense Account is shown in the Balance Sheet as an asset.

Illustration 3

The facts in the preceding illustration may be shown thus:

Oct. 3 Cash

(say)

19.

Jan. 1 Rates Prepaid

RATES

19.

120

Dec. 31 Amount Prepaid Profit and Lans Account

c.d

£120

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It is important to see that the final balance transferred to Profit and Loss Account shows a consistent result, e.g. if rates are £30 prepaid, the rates for the whole year should be £120, and this can be seen with reference to the account for the following year, which will appear as follows:

RAILS

Jan 1 Rates Prepant

Okt 3 Cash

บ Dec 11 Amount Prepan! Profit and Loss Account 120

311

120

£150

#10

1 Rates Prepand

Succeeding year

Care, however, must be exercised in obtaining all invoices for accrued items even if a Day Book or Journal is employed, particularly where time must elapse before the invoice is received, e.g. Electricity Account. The meter may be read to 6th December, and the accounts of the consumer be drawn up to 10th December. At this date it is improbable that the invoice for the quarter to 6th December will have been received. The Expenses Day Book or Journal might be kept 'open' till its receipt but, if it is closed off promptly, provision will be required for (a) Electricity accrued to 6th December, and (b) Electricity accruing from 7th December to 10th December. If no Expenses Day Book or Journal is employed, the entries not being recorded till payment (neither of the above-having been paid) both (a) and (b) will have to be provided for.

The above distinction, it should be emphasized, applies to all expenses.

3. Income

(a) Unearned Income. Where sums have been received during a period in respect of future service, only part of such sums will be applicable to service, rendered in the period of accounts during which they were eceived. The part apportionable to future periods will be treated similarly to an 'accrued' expense. A debit entry above the line and a credit entry below the line in the income account will ensure that the Profit and Loss Account is credited with the correctly apportionable amount. The credit balance will appear as a liability in the Balance Sheet.

Illustration 7

A club rece ves £3,000 in subscriptions from members during the year ended 31st December 19.. but £240 is in respect of subscriptions for the ensuing year.

The 'Subscriptions' Account will appear:

SUBSCRIPTIONS

19..

-£

19..

Dec. 31 Profit and Loss Account Balance.

c/d

2,760 Jan.- 240

Dec. Cash

£3,000

19..

Jan. 1 Balance

3.000

£3,000

b/d

240

(b) Income Accrued and/Accruing. The principle involved under this heading is analogous to that of expenses accrued or accruing except that the adjustment will operate in the reverse manner. The accrual for expenses, it will be remembered, has the effect of increasing the charge to the Profit and Loss Account and increasing the liabilities. The effect, therefore, of the adjustment now under consideration is to increase the income in the Profit and Loss Account, and increase the amount of the

assets.

The rule is: Credit above the 'line'; debit below the 'line.'

Illustration 8

The amount standing to the credit of Loan Interest at 31st December 19.1, is £100; an amount of £30 is due and unpaid by a borrower to 30th November 19.1, and £6 accruing.

Show Journal entries (ignoring narratives).

JOURNAL

19.1

Dec. 31 Loan Interest Accrued and Accruing

Loan Interest

Dr.

Alternatively, the simple device of crediting above the "line" and debit ing below the 'line' may be, and usually is, adopted. The Ledger account is shown on p. 0517.

In examination work the precise words used in the Trial Balance should be carefully scrutinized because if the words 'Loan Interest RECEIVED' are employed, the accrued and accruing amounts given in the question are not

TRADING. PROFIT, LOSS ACCOUNT-BALANCE SHEET

part of the balancing figures; if, on the other hand, the words 'Loan Interest RECEIVED AND ACCRUED (and/or ACCRUING)' are employed, the account has already been adjusted and the accrual is a DEBTT in the books; the former instance, where the loan interest shown is only the amount hence it is part of the Trial Balance, calling for no further adjustment. In received, the adjustment must be made.

19.1

LOAN INTEREST

Dec. 31 Profit and Loss Account

L 136

19.1

Dec. 31 (details)

£136

19.2

Jan. 1

Loan Interest Accrued

Loan Interest Accruing

h/d

b/d

Loan Interest Accrued to

100

30th Nov., 19.1

Loan Interest Accruing"

c/d

£136

'Shown as an asset in the Balance Sheet.

4. Expenses Stock

When stock is held other than of goods for resale, e.g. advertising or stationery stock, it should always be dealt with in the account to which it relates. It will therefore be included in the particular expense figure in the Profit and Loss Account and not in the stock of goods figure in the Trading Account. Thus, if the Trial Balance shows:

Opening Stock (Stationery) Stationery Purchases

100

470

and as a note (not in the Trial Balance) closing stock of £70, the Profit and Loss Account will show a net debit of £500, i.e. £100+£470-£70, and the Balance Sheet, Stationery Stock £70 as an asset. If the closing stock is shown as part of the Trial Balance it presupposes that the Stationery Account has been fully dealt with, and in reference to the preceding illustration the Trial Balance would in these circumstances show:

Stationery Account

Stationery Stock (Closing)

500 (Profit and Loss Account) 70 (Balance Sheet)

In the Expense Account itself, the entries for stock will be a credit 'above the line' and a debit 'below the line,' thus:

STATIONERY

19.

Jan. 1 Stock

b,d

100

19.. Dec. 31

Stock

c/d