Why accounts need adjusting

A shop pays salary of ₹1,000 a month. The March salary has not been paid yet, so the books show only ₹11,000 of salary for the year. But the staff worked all twelve months. On the accrual basis, the year's expense is ₹12,000, paid or not. Items like this, left out or wrongly included during the year, are put right at the year end with adjustments.

The rule: a year's profit uses the revenue earned and the expenses incurred in that year, not just the cash received and paid. Adjustments are usually given below the trial balance, and every adjustment appears in two places: once in the trading or profit and loss account, and once in the balance sheet.

Closing stock. It is counted at the year end, so it enters the books only then: Closing Stock A/c Dr, To Trading A/c. It goes to the credit of the trading account and to the assets in the balance sheet. It is valued at cost or net realisable value, whichever is lower. In the book, bringing in Ankit's closing stock raises his profit to ₹19,500. (If closing stock is already inside the trial balance, the entry has been made: show it in the balance sheet only.)

Outstanding expense (incurred, not yet paid). Entry: Expense A/c Dr, To Outstanding Expense A/c. Add it to that expense in the trading or profit and loss account, and show it as a current liability. Ankit's outstanding wages of ₹500 bring his profit down to ₹19,000.

Prepaid expense (paid now, for next year). If ₹13,000 of salary was paid but only ₹12,000 belongs to this year, ₹1,000 is prepaid. Entry: Prepaid Expense A/c Dr, To Expense A/c. Deduct it from the expense, and show it as a current asset. Ankit's prepaid salary of ₹5,000 lifts his profit to ₹24,000.

Months matter. Insurance of ₹1,200 paid on 1 July for a year, with books closing on 31 March: 9 months (July to March) belong to this year, ₹900; the other ₹300 is prepaid.