NIOS Public Exam

Accountancy (224) | Module V: Lesson 15

Official Textbook Study Guide: Financial Statements With Adjustments (Code: 224en15)

Strictly PDF Extracted 100% Exam Syllabus

Official NIOS Syllabus Notes (1,000–2,500 Word Content Guarantee)

Strictly compiled from Chapter 15 textbook text: Need for Adjustments, Closing Stock, Outstanding Expenses, Prepaid Expenses, Depreciation on Fixed Assets, and Comprehensive Final Accounts Preparation.

Word Count: ~2,100 Words 5 Major Sections
Major Section 15.1

1. Concept, Meaning & Need for Accounting Adjustments

Definition & Theoretical Foundation

In the preceding lessons, business transactions were recorded in the subsidiary books and posted to the ledger, culminating in the extraction of balances to draft a Trial Balance. While the Trial Balance confirms the arithmetical accuracy of the books, the balances shown in it may not represent the exact revenue earned or the total expenses incurred exclusively for that financial year.

It frequently happens that some expenses relating to the current accounting year have become due but have not been paid in cash till the last day of the financial year. Conversely, certain expenses paid during the current year may partially relate to the next financial year (future period). Furthermore, fixed assets lose part of their value due to constant operational use and wear and tear, and some merchandise remains unsold at the end of the year.

If financial statements are drafted directly from such an unadjusted Trial Balance, they will fail to present a true and fair view of the business. The Income Statement will not reveal the correct net profit or net loss, and the Balance Sheet will reflect an incorrect financial position. Therefore, it becomes indispensable to incorporate necessary modifications in respect of such unrecorded or prepaid items before drafting final accounts. These modifications are formally termed Accounting Adjustments, and the journal entries recorded to incorporate them are called Adjusting Entries.

Official Purposes of Accounting Adjustments (Textbook Section 15.1)

As outlined in the official NIOS syllabus, accounting adjustments are required for five central corporate objectives:

  1. To know the correct net profit or net loss: To ensure that only revenues and expenses relating strictly to the current accounting period are matched against each other.
  2. To know the correct financial position of the business: To display true asset values and actual external and internal obligations on the Balance Sheet.
  3. To record the expenses which have become due but have not been paid: To bring accrued expenses (outstanding expenses) into the accounts of the current year.
  4. To record the expenses which have been paid in advance for future year(s): To exclude unexpired costs from the current year's profits.
  5. To provide for depreciation on fixed assets: To account for the expired utility and wear and tear of capital assets employed in generating revenue.

The 4 Standard Adjustments Covered in Chapter 15

While the number and nature of adjustments vary across industries, the NIOS Chapter 15 curriculum prescribes four core adjustments for complete mastery:

1. Closing Stock

Unsold merchandise evaluated at year-end; credited to Trading A/c and shown as Current Asset.

2. Outstanding Expenses

Expenses incurred and due in current year but unpaid; added to expense and shown as Current Liability.

3. Prepaid Expenses

Expenses paid in current year relating to subsequent year; deducted from expense and shown as Current Asset.

4. Depreciation

Loss in value of fixed assets through operational use; debited to P&L A/c and deducted from asset in Balance Sheet.

Exam Tip: Every adjustment appearing outside the Trial Balance as additional information requires a dual entry: one effect in the Income Statement (Trading or P&L Account) and one effect in the Position Statement (Balance Sheet).
Major Section 15.2 (Part I)

2. Closing Stock: Valuation & Dual Accounting Treatment

Meaning, Nature & Valuation Principle

Closing Stock represents the value of unsold merchandise remaining in hand at the conclusion of the accounting year. Because it is physically determined by taking inventory on the final day of the financial period, it normally does not appear inside the Trial Balance. Instead, it is given as additional information outside the Trial Balance.

The Valuation Rule (Cost vs. Market Price): In accordance with the fundamental accounting convention of Prudence (Conservatism), closing stock is always valued at Cost Price or Market Price, whichever is lower (less). For example, if stock has a cost of ₹38,000 and a market value of ₹20,000, it must be recorded at ₹20,000 (Illustration 1). Recording at the lower value prevents the anticipation of unrealized profits while ensuring that potential inventory losses are immediately absorbed.

Official Adjusting Journal Entry for Closing Stock

Date Particulars L.F. Dr. Amount (₹) Cr. Amount (₹)
31.03.2012 Closing Stock A/c .................................................... Dr.
    To Trading A/c
(For closing stock transferred to Trading Account) 		- 30,000 30,000
1. Trading Account (Credit Side)

Shown on the Credit side as 'By Closing Stock' (₹30,000). This offsets the total cost of purchases and opening stock, enabling the computation of Cost of Goods Sold and Gross Profit.

2. Balance Sheet (Assets Side)

Shown on the Assets side under Current Assets as 'Closing Stock' (₹30,000), representing available economic resources to be realized during the next trading cycle.

Critical Textbook Rule: Closing Stock Inside the Trial Balance

If Closing Stock is already given inside the Trial Balance, it signifies that an adjusting entry has already been recorded through Purchases (i.e. Adjusted Purchases = Opening Stock + Net Purchases - Closing Stock).

In this case, Closing Stock is NOT recorded on the credit side of Trading Account. It is shown exclusively on the Assets side of the Balance Sheet!

Exam Tip: Whenever two figures for closing stock are presented (Cost Price and Market Value), always select the smaller number. For instance, in Illustration 1, between ₹38,000 (Cost) and ₹20,000 (Market), ₹20,000 must be entered into the accounts.
Major Section 15.2 (Part II)

3. Outstanding Expenses: Accounting for Accrued Liabilities

Definition & Rationale

An expense which relates to the current accounting year but has not been paid till the end of the accounting year is known as an Outstanding Expense (or accrued expense). Standard examples highlighted in Chapter 15 include factory rent, manufacturing wages, office salaries, rent, and telephone charges.

The Matching Principle Necessity: Even though cash was not paid during the year, the enterprise enjoyed the benefits of the labor, premises, or services during the period. Under the accrual concept, if such unpaid costs are ignored, the current year's expenses will be understated, resulting in an artificial overstatement of profit. Concurrently, external debts will be omitted from the Balance Sheet.

Case A: Outstanding Wages (Direct Expense)

Textbook Example (Mr. X): Wages paid during the year = ₹45,000. Wages outstanding at year-end = ₹5,000.

Wages A/c .................................... Dr. ₹5,000
    To Wages Outstanding A/c ........ ₹5,000
  • Trading Account: Debited as: Wages (₹45,000) + Outstanding (₹5,000) = ₹50,000.
  • Balance Sheet: Shown on Liabilities side as 'Wages Outstanding' (₹5,000).
Case B: Outstanding Salaries (Indirect Expense)

Textbook Example (Mr. X): Salaries paid = ₹1,00,000. Salaries due but unpaid = ₹10,000.

Salaries A/c ................................ Dr. ₹10,000
    To Salaries Outstanding A/c ..... ₹10,000
  • Profit & Loss Account: Debited as: Salaries (₹1,00,000) + Outstanding (₹10,000) = ₹1,10,000.
  • Balance Sheet: Shown on Liabilities side as 'Salaries Outstanding' (₹10,000).

Step-by-Step Treatment for Outstanding Expenses

Stage Nature of Expense Income Statement Location Position Statement Location
Direct Expense Wages, carriage inward, factory power Trading A/c (Dr): Added to the relevant item Balance Sheet: Liabilities side (Current Liabilities)
Indirect Expense Salaries, office rent, telephone charges Profit & Loss A/c (Dr): Added to the relevant item Balance Sheet: Liabilities side (Current Liabilities)
Exam Tip: If no adjustment is made for outstanding wages, the Gross Profit will be more than actual (Intext Question 15.3 III.i), and the enterprise's liabilities will be understated.
Major Section 15.2 (Part III)

4. Prepaid Expenses: Accounting for Unexpired Costs

Definition & Theoretical Rationale

Sometimes, a portion of the expenses paid during the current accounting year relates to the future year(s). Such an expenditure is known as a Prepaid Expense (or Expense Paid in Advance / Unexpired Expense). Standard examples include insurance premiums paid for a period running into the next calendar year, prepaid office rent, taxes, or advance salaries.

Because the benefit of this expenditure will be enjoyed in the subsequent accounting period, charging the entire payment against the revenues of the current year would unjustly reduce current net income. Hence, the unexpired portion must be subtracted from the total payment and carried forward into the Balance Sheet as a current resource.

Official Adjusting Journal Entry for Prepaid Expenses

Date Particulars L.F. Dr. Amount (₹) Cr. Amount (₹)
31.03.2012 Prepaid Expenses A/c ................................................ Dr.
    To Concerned Expense A/c
(For expenses paid in advance for the next year) 		- 25,000 25,000
Demonstration: Prepaid Salaries in the Books of Mr. X

Total salaries paid during 2011–12 = ₹2,00,000, out of which ₹25,000 relates to 2012–13.

Profit and Loss Account (Debit Side):
To Salaries: ₹2,00,000
Less: Prepaid Salaries: ₹25,000
Net Salaries Debited: ₹1,75,000
Balance Sheet (Assets Side):
Shown under Current Assets as:
Prepaid Salaries: ₹25,000
Textbook Mathematical Example: 3 Months Prepaid Insurance

In Illustration 2 (M/s Gupta Furnitures), annual Insurance premium paid in Trial Balance was ₹600. The adjustment specifies: "Insurance prepaid for 3 months".

Prepaid Insurance = (₹600 × 3) / 12 = ₹150

Therefore, ₹150 is deducted from Insurance in the Profit & Loss Account (leaving ₹450 to be debited), and ₹150 is displayed on the Assets side of the Balance Sheet.

Exam Tip: Remember: Outstanding expenses are added to expenses in P&L and shown on the Liabilities side; Prepaid expenses are deducted from expenses in P&L and shown on the Assets side.
Major Section 15.2 (Part IV) & Section 15.3

5. Depreciation on Fixed Assets & Comprehensive Master Cases

Meaning, Accounting Nature & Depreciation Entry

Fixed assets such as Plant and Machinery, Land and Building, Furniture and Fixtures, Computers, and Motor Vehicles lose their value and service potential year after year due to continuous business use, passage of time, wear and tear, and obsolescence. This permanent reduction or decrease in the value of fixed assets is termed Depreciation.

Depreciation represents a genuine operational business expense. Even though no direct cash outflow occurs when charging depreciation, it must be accounted for to ensure the asset is not shown in the Balance Sheet at an inflated figure and to ascertain true net income.

Official Adjusting Journal Entry for Depreciation

Date Particulars L.F. Dr. Amount (₹) Cr. Amount (₹)
31.03.2012 Depreciation A/c .................................................... Dr.
    To Plant and Machinery A/c
    To Furniture A/c
(For depreciation charged on fixed assets @ 10% p.a.) 		- 55,000 50,000
5,000
1. Profit and Loss Account: Debited on the Dr. side under indirect expenses as 'To Depreciation on Fixed Assets'.
2. Balance Sheet: Deducted directly from the gross value of the respective fixed asset on the Assets side.

Master Case Study 1: M/s Kaushal Traders (Textbook Illustration 1)

Trading and Profit & Loss A/c for year ended 31st March, 2012
To Opening stock 16,000 By Sales (2,00,000 - 5,000) 1,95,000
To Purchases (75,000 - 2,000) 73,000 By Closing stock (Market value) 20,000
To Carriage inwards 1,500
To Wages (30,000 + 2,000 O/S) 32,000
To Factory lighting 800
To Gross Profit c/d 91,700 Total 2,15,000
To Carriage outwards 400 By Gross Profit b/d 91,700
To Salaries (18,000 + 1,500 O/S) 19,500 By Discount received 500
To Travelling expenses 1,200
To Rent and taxes 4,800
To Insurance (450 - 150 Prepaid) 300
To General expenses 12,200
To Depreciation (P&M 2,000 + F&F 500) 2,500
To Net Profit (to Capital) 51,300 Total 92,200
Balance Sheet of M/s Kaushal Traders as on 31st March, 2012
Bills payable 1,500 Cash in hand 5,000
Sundry creditors 10,000 Sundry debtors 28,000
Outstanding wages 2,000 Closing stock 20,000
Outstanding salaries 1,500 Prepaid insurance 150
Capital: 80,000
Add: Net Profit: +51,300 = 1,31,300
Less: Drawings: -5,000 		Furniture (5,000 - 500) 4,500
Closing Capital 1,26,300 Plant & Machinery (40,000 - 2,000)
Freehold property		 38,000
45,650
Total Liabilities 1,41,300 Total Assets 1,41,300
Exam Tip: Notice in Illustration 1 that both sides of the Balance Sheet tallied perfectly at ₹1,41,300 only because each of the 4 adjustments was recorded in exactly two places.