Income received in advance or Unearned income Part 2

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Sometimes, firms receive advance payments for their orders in next accounting period. Those advance payments are may be incomes in next accounting period but they are not real incomes for this current accounting period. These incomes should be deducted from the financial statements.

Adjustment Entry Baiscs

Adjustment Entry Baiscs

Adjustment Entry Baiscs

Effect of Adjustment entry on Financial Statements:

  • Income received in advance should be deducted from particular (relevant) heads. And, they will appear on Credit side of the P&L A/c.

  • Incomes received in advance are liabilities to the firm and they will appear on debit side of the Balance Sheet.

    Effect of Adjustment Entry

    Effect of Adjustment Entry

    Effect of Adjustment Entry

Interest on Capital:

As per Business Entity concept, proprietor and business are two different items. Business Entity needs to pay interest to the proprietor for his capital.

Adjustment Entry:

Adjustment Entry Interest on Capital

Adjustment Entry Interest on Capital

Adjustment Entry Interest on Capital

Effect of Adjustment entry on Financial Statements:

  • Interest on capital is an expense to the firm. And, that will appear on debit side of the P&L A/c.

  • Interest on capital should be deducted from the capital and that will appear on debit side of the Balance Sheet.

Interest on Drawings:

We already mentioned earlier, business entity and proprietor are two different items in accounting. Proprietor need to pay interest for his drawings from the business.

Adjustment Entry:

Adjustment Entry Drawings

Adjustment Entry Drawings

Adjustment Entry Drawings

Effect of Adjustment entry on Financial Statements:

  • Interest on Drawings is an income to the firm. And, that will appear on credit side of the P&L A/c.

  • Interest on drawings should be added to the drawings and then deducted from the capital. This will appear on debit side of the Balance Sheet.

Depreciation:

The value of a fixed asset goes on decreases year after year, due to wear and tear. Business Entities consider it as an expense but that expense is not for a particular accounting period. The expense needs to be considered for every year though out its life. Basically, the depreciation is calculated based on a standard method e.g. Straight-line method.

Adjustment Entry:

Adjustment Entry Depriciation

Adjustment Entry Depriciation

Adjustment Entry Depriciation

Effect of Adjustment entry on Financial Statements:

  • Depreciation is an expense to the firm for that particular accounting period. And, that will appear on debit side of the P&L A/c.

  • The amount of depreciation is deducted from the concerned asset, in the asset side of the Balance Sheet.

Further Bad Debts:

Sometimes, firms will give credit on sales. Those sundry debtors need to pay the due on time. But some debtors do not return either full amount or some part of the amount. Those are bad debts to the firm. It is a loss to the firm. There may be amount of bad debt which was not recorded in the books of accounts and hence did not appear in the Trial Balance. But the same was discovered before preparing the financial statements. Those are called further bad-debts.

Adjustment Entry:

Adjustment Entry Bad Depts

Adjustment Entry Bad Depts

Adjustment Entry Bad Depts

Effect of Adjustment entry on Financial Statements:

  • Bad debts are loss to the firm and further bad debts are added to the bad bets a/c on debit side in P&L A/c.

  • Sundry debtors are current assets to the firm. Further Bad debts should be deducted from the sundry debtors and that will appear on credit side of Balance Sheet.

Provisions for Bad and Doubtful Debts:

Every business firm maintains certain level of funds for provisions of bad and doubtful debts. It may be around 5% of total debt per year.

Adjustment Entry:

Adjustment Entry Bad and Doubtful Depts

Adjustment Entry Bad and Doubtful Depts

Adjustment Entry Bad and Doubtful Depts

Effect of Adjustment entry on Financial Statements:

  • Bad debts are loss to the firm and provisions made for bad debts are expenses to the firm. Provisions are added to the bad bets a/c on debit side in P&L A/c.

  • Sundry debtors are current assets to the firm. Provisions made for bad and doubtful debts should be deducted from the sundry debtors and that will appear on credit side of Balance Sheet.