Step-by-Step Guide to Preparing Final Accounts with Adjustments

A trial balance only tells you half the story. It shows what has actually been recorded in the books, but by the closing date of the year, some expenses are unpaid, some income is unreceived, and assets have quietly lost value through use. Preparing final accounts with adjustments is the process of correcting the trial balance for all of this before it becomes the Trading Account, Profit and Loss Account, and Balance Sheet. Skip this step, and the “profit” you calculate is really just a cash summary, not a true measure of business performance.

Why adjustments exist in the first place 🔗

Accounting follows the accrual concept: income is recorded when it is earned, and expenses are recorded when they are incurred, regardless of when cash actually moves. A trial balance, however, is built from transactions that were entered as they happened during the year, which means it often mixes cash timing with accounting timing. Adjustments realign the two so that the financial statements reflect the true financial position of the business for that specific period, not just the cash that happened to change hands.

This matters because every adjustment usually affects two things at once: one figure in the Trading or Profit and Loss Account, and one figure in the Balance Sheet. Get this dual effect right, and the rest of final accounts preparation becomes mechanical.

Outstanding expenses 🔗

An outstanding expense is one that belongs to the current accounting year but hasn’t been paid yet. Say a firm’s accounting year ends on 31 March, but the electricity bill for March, worth ₹6,000, is paid only in April. That ₹6,000 was consumed this year, so it must be charged to this year’s Profit and Loss Account even though the cash hasn’t left the business yet.

Treatment:

• Add the outstanding amount to the concerned expense in the Trading Account or Profit and Loss Account.
• Show it separately as a current liability on the liabilities side of the Balance Sheet.

This is a common exam trap because outstanding wages are shown in the Trading Account (since wages are a direct expense), while outstanding rent, salaries, or electricity go into the Profit and Loss Account.

Prepaid expenses 🔗

Prepaid expenses work the opposite way. Here, cash has already been paid, but the benefit hasn’t been fully used up in the current year. If a business pays ₹24,000 for a one-year insurance policy on 1 October, and the accounting year closes on 31 March, only six months (₹12,000) belongs to this year. The remaining ₹12,000 is an asset, not an expense, because the business will still receive insurance cover for those months next year.

Treatment:

• Deduct the prepaid portion from the concerned expense in the Profit and Loss Account.
• Show the prepaid amount as a current asset on the assets side of the Balance Sheet.

Accrued income and income received in advance 🔗

Just as expenses can be outstanding or prepaid, income can be earned-but-unreceived or received-but-unearned. Both situations need correction before the final accounts are drawn up.

Accrued income 🔗

Accrued income is income that has been earned during the year but not yet received in cash. For example, if a firm is entitled to ₹5,000 of commission for work already completed, but the client hasn’t paid it by year end, that ₹5,000 still counts as this year’s income. It gets added to the relevant income in the Profit and Loss Account and shown as a current asset in the Balance Sheet, since the amount is still recoverable from the customer.

Income received in advance 🔗

This is the reverse case: cash has come in, but the service or goods haven’t been delivered yet, so the income hasn’t actually been earned. If a landlord receives ₹60,000 in rent for the year but ₹10,000 of it relates to next year, that ₹10,000 is deducted from the total rent shown in the Profit and Loss Account and instead shown as a current liability, because the business still owes that period’s service to the tenant.

Closing stock 🔗

Closing stock is the value of unsold goods lying with the business on the last day of the accounting year. It rarely appears in the trial balance because it can only be determined by physically counting inventory after the books have already been drawn up. As a result, it almost always shows up as an adjustment rather than a trial balance entry.

When closing stock is given outside the trial balance 🔗

In this common scenario, the figure needs a dual treatment: it is credited to the Trading Account, which reduces the cost of goods sold and increases gross profit, and it is also shown on the assets side of the Balance Sheet under current assets.

When adjusted purchases are given 🔗

Sometimes the trial balance already shows a figure called “adjusted purchases,” which means the opening stock has already been added and the closing stock has already been deducted from the purchases figure behind the scenes. In this case, closing stock is shown only once, on the assets side of the Balance Sheet, and not again in the Trading Account, since crediting it twice would overstate gross profit.

Depreciation 🔗

Fixed assets like machinery, furniture, and vehicles lose value every year through wear and tear, usage, or simply becoming outdated. Depreciation spreads the cost of these assets across their useful life instead of charging the entire cost in the year of purchase. Two methods dominate B.Com syllabi.

Straight line method 🔗

Under this method, a fixed amount of depreciation is charged every year, calculated as:

Depreciation = (Cost of Asset − Estimated Residual Value) ÷ Estimated Useful Life

For a machine costing ₹1,00,000 with a residual value of ₹10,000 and a useful life of 5 years, annual depreciation works out to ₹18,000, charged equally every year until the asset reaches its scrap value.

Written down value method 🔗

Here, depreciation is calculated as a fixed percentage of the asset’s book value at the start of each year, not its original cost. Since the book value keeps shrinking, the depreciation amount also gets smaller every year. A machine worth ₹50,000 depreciated at 10% would lose ₹5,000 in year one, but only ₹4,500 in year two, since it is now calculated on the reduced book value of ₹45,000. This method is often preferred when repair costs are expected to rise as the asset gets older, since higher repairs in later years are offset by lower depreciation charges.

Treatment (both methods): Debit the depreciation amount to the Profit and Loss Account as an expense, and deduct it from the concerned asset’s value on the assets side of the Balance Sheet.

Other frequent adjustments 🔗

A few more items appear regularly in B.Com problems and deserve quick attention:

• Bad debts: Debts that are confirmed as irrecoverable during the year are written off. If they appear as an adjustment (not already in the trial balance), they are added to any existing bad debts figure in the Profit and Loss Account, and deducted from debtors in the Balance Sheet.
• Provision for doubtful debts: Since some debtors may default even without confirmation, businesses create a provision as a safety margin, usually a percentage of the remaining debtors after bad debts are removed. This is charged to the Profit and Loss Account and shown as a deduction from debtors in the Balance Sheet.
• Interest on capital: When the owner is credited notional interest on their capital investment, it is treated as an expense in the Profit and Loss Account and added to the capital account in the Balance Sheet.
• Interest on drawings: The reverse applies here. Interest charged on the owner’s withdrawals is treated as income in the Profit and Loss Account and deducted from capital in the Balance Sheet.

Where each adjustment lands: a quick reference 🔗

Since most confusion in exams comes from forgetting the dual effect, this table summarizes where each common adjustment appears.

Putting it all together 🔗

In practice, final accounts problems rarely test one adjustment at a time. A single trial balance might combine outstanding salaries, prepaid rent, closing stock, and depreciation on machinery, all needing to be handled in the same set of accounts. The safest approach is to list out every adjustment given in the question first, decide its dual effect before touching the Trading Account or Profit and Loss Account, and only then start posting figures. Rushing straight into the accounts without this step is where most calculation errors creep in.

It also helps to remember that adjustments follow the matching and accrual principles consistently: every rupee of income or expense is placed in the period it actually belongs to, not the period in which cash happened to move. Once this logic is internalised, the specific adjustment, whether it’s depreciation, a provision, or a prepaid amount, becomes a routine of applying the same underlying rule.

What do you think? If a firm forgets to adjust for outstanding expenses, would its profit for the year appear higher or lower than the true figure? And between the straight line and written down value methods of depreciation, which one would you choose for an asset that needs frequent repairs as it ages?

References

1. https://www.pearson.com/channels/financial-accounting/learn/brian/ch-3-accrual-accounting-concepts/introduction-to-adjusting-journal-entries-and-prepaid-expenses
2. https://www.toppr.com/guides/accountancy/financial-statements/prepaid-expenses-accrued-income-and-income-received-in-advanced/
3. https://www.toppr.com/guides/accountancy/financial-statements/need-adjustment-closing-stock-outstanding-expenses/
4. https://www.vedantu.com/commerce/closing-stock
5. https://www.shaalaa.com/textbook-solutions/c/ncert-solutions-accountancy-financial-accounting-1-english-class-11-chapter-7-depreciation-provisions-and-reserves_6339
6. https://www.accountingnotes.net/final-accounts/preparation-of-final-accounts-with-adjustments-financial-accounting/17178