How to Treat Common Adjustments in Final Accounts

A trial balance only shows what has already been recorded in the books. It does not care whether an expense belongs to this year or the next, or whether a customer has actually paid for goods sold. That is exactly why adjustments exist. They correct the trial balance figures so that the final accounts reflect what was actually earned and spent during the year, not just what was paid or received in cash. Get these adjustments wrong, and your profit figure, your asset values, and your balance sheet all go wrong with them.

Why adjustments make final accounts trustworthy 🔗

Financial accounting runs on the accrual concept: income is recorded when it is earned, and expenses are recorded when they are incurred, regardless of when cash actually changes hands. A trial balance, however, is prepared purely from ledger balances at a point in time, so it misses transactions that have not yet been billed, paid, or recorded. Adjustments close this gap. Each one typically needs a journal entry and then a specific treatment in the Trading Account, Profit and Loss Account, and Balance Sheet.

The six adjustments covered here, closing stock, outstanding expenses, prepaid expenses, accrued income, income received in advance, and depreciation, appear in almost every Final Accounts problem in a B.Com syllabus. Once you understand the logic behind each one, the entries stop feeling like something to memorise and start making practical sense.

Closing stock: valuing what is still on the shelves 🔗

Closing stock is the inventory that remains unsold at the end of the accounting period. Since it usually needs a physical count and valuation, it does not appear in the trial balance, and it has to be brought into the books through an adjustment entry:

Closing Stock A/c Dr.
    To Trading A/c

This single entry has a dual effect, and that is the part students often find confusing. The value of closing stock is shown on the credit side of the Trading Account, which reduces the cost of goods sold and increases gross profit. At the same time, the same figure appears as a current asset on the assets side of the Balance Sheet. This dual treatment prevents the same stock from being counted twice in the financial statements.

Valuation matters just as much as the entry itself. Closing stock is valued at cost or net realisable value, whichever is lower, following the accounting principle of conservatism. This stops a business from showing inflated profits by valuing unsold goods above what they could realistically fetch in the market.

Outstanding expenses: bills incurred but not yet paid 🔗

Outstanding expenses are costs that relate to the current accounting period but remain unpaid at the year-end. Salaries due for March, unpaid electricity bills, or wages payable are common examples. The adjustment entry is:

Expense A/c Dr.
    To Outstanding Expense A/c

In the final accounts, the outstanding amount is added to the relevant expense head on the debit side of the Trading or Profit and Loss Account, increasing total expenses for the year. It also appears on the liabilities side of the Balance Sheet as a current liability, since the business still owes this amount. This treatment matches expenses to the period in which they were actually incurred, not the period in which they get paid.

Prepaid expenses: paying now for a benefit that arrives later 🔗

Prepaid expenses work the opposite way. These are payments made in the current year for goods or services that will actually be consumed in a future period, such as insurance premiums or rent paid several months in advance. The entry is:

Prepaid Expense A/c Dr.
    To Expense A/c

The prepaid portion is subtracted from the concerned expense on the debit side of the Trading or Profit and Loss Account, so only the amount actually used up during the year is charged against this year’s profit. The remaining amount is shown as a current asset on the Balance Sheet, since the business has already paid for a benefit it will receive later. Without this adjustment, current-year profit would appear understated because a future year’s expense would wrongly reduce it.

Accrued income: money earned before it lands in the bank 🔗

Accrued income is income that has been earned during the year but not yet received in cash, such as interest on investments or commission that is due but unpaid. The adjustment entry is:

Accrued Income A/c Dr.
    To Income A/c

The accrued amount is added to the relevant income head on the credit side of the Profit and Loss Account, since it was genuinely earned this year. It is also shown as a current asset on the Balance Sheet, representing the business’s right to collect this amount in the future. Ignoring accrued income would understate both revenue and total assets for the period.

Income received in advance: cash today, obligation for tomorrow 🔗

The mirror image of accrued income is income received in advance, sometimes called unearned income. This is cash that has already been collected but relates to services or goods the business is yet to deliver, such as rent or subscription fees received for future months. The entry is:

Income A/c Dr.
    To Income Received in Advance A/c

This amount is deducted from the concerned income on the credit side of the Profit and Loss Account, because it has not actually been earned yet. On the Balance Sheet, it appears under current liabilities, since the business still owes goods or services against this money it has already received. Recording it as ordinary income would overstate profit and misrepresent the business’s obligations.

Depreciation: spreading an asset’s cost over its working life 🔗

Depreciation is the systematic reduction in the book value of a fixed asset to reflect wear and tear, usage, or obsolescence over its useful life. It is a non-cash charge, meaning no money actually leaves the business when depreciation is recorded, yet it still reduces reported profit because the asset genuinely loses value while helping generate revenue. The basic adjustment entry is:

Depreciation A/c Dr.
    To Asset A/c (or Accumulated Depreciation A/c)

Depreciation is charged using either the Straight Line Method, where an equal amount is written off every year, or the Written Down Value Method, where a fixed percentage is applied to the reducing balance of the asset each year. The depreciation expense account appears in the income statement while accumulated depreciation shows up in the balance sheet as a contra-asset, reducing the asset’s book value without erasing its original cost from the records.

In the final accounts, depreciation is shown on the debit side of the Profit and Loss Account, reducing net profit. On the Balance Sheet, it is deducted from the concerned asset, so the asset appears at its written-down value rather than its original purchase price. This presentation lets a reader see both what the asset originally cost and how much of that value has already been used up. For companies operating in India, the useful lives and rates used for computing depreciation are also guided by Schedule II of the Companies Act, 2013, which prescribes indicative useful lives for different classes of assets.

A quick summary of every adjustment 🔗

Notice the pattern here. Every adjustment that adds an amount to an expense or subtracts it from income tends to create a current liability, since the business still owes something. Every adjustment that subtracts from an expense or adds to income tends to create a current asset, since the business is owed something or has already paid for a future benefit. Once this pattern clicks, remembering the treatment for each item becomes far easier than memorising six separate rules.

Getting the sequence right 🔗

A practical tip that helps in exam answers and real bookkeeping alike: always read every adjustment given in a question twice before starting the Trading and Profit and Loss Account. Adjustments interact with each other. Depreciation changes the asset’s value shown on the balance sheet, while outstanding and prepaid items affect both statements simultaneously. Missing even one adjustment throws off the final profit figure and the balance sheet totals, since a proper balance sheet must always balance after every adjustment is correctly posted.

What do you think? Which of these six adjustments do you usually find trickiest to place correctly, income received in advance, or something else? And when you are solving a problem, do you prefer passing full journal entries for each adjustment first, or do you jump straight to adjusting the figures in the final accounts?

References

1. https://www.geeksforgeeks.org/accountancy/adjustment-of-closing-stock-in-final-accounts-financial-statements/
2. https://www.vedantu.com/commerce/closing-stock-formula
3. https://www.accountingcapital.com/question/why-is-income-received-in-advance-treated-as-a-current-liability/
4. https://www.accountingtools.com/articles/what-is-the-accounting-entry-for-depreciation.html
5. https://upload.indiacode.nic.in/schedulefile?aid=AC_CEN_22_29_00008_201318_1517807327856&rid=9