Financial Statements II - Class 11 Accountancy NCERT

Welcome to Chapter 10 of CBSE Class 11 Accountancy! In your journey through financial statements 2 class 11 ncert, you will master the art of making adjustments before preparing the final accounts. Preparing a simple Trading and Profit & Loss Account and Balance Sheet from a Trial Balance is only half the story. Real-world business requires matching revenues and expenses accurately to the correct financial period, adhering strictly to the accrual system of accounting. In this chapter, you will learn why certain adjustments like outstanding expenses, prepaid insurance, accrued income, and depreciation must be made. You will also learn how to calculate and present complex provisions such as bad debts and managers' commissions. Let's dive deep into this topic with YoLearn AI's easy-to-follow explanations and worked steps!

The Need for Adjustments & The Accrual Concept

At the end of an accounting period, the Trial Balance may not present the true economic reality of a business. This is because transactions are continuous, and some financial events spanning across years might not have been recorded yet in cash. Under the Accrual Concept and Matching Principle, we must record all expenses and revenues belonging to the current accounting year, whether cash has changed hands or not. Similarly, we must exclude any cash transactions that belong to the preceding or succeeding years.

To achieve this, we make adjustment entries at the time of finalization. Every adjustment given outside the Trial Balance represents a transaction that has not yet been routed through the ledger. Therefore, using the double-entry system, each adjustment must be posted in two different places in our final accounts: once as a debit aspect and once as a credit aspect. This ensures that our Trading Account, Profit and Loss Account, and Balance Sheet offer a 'true and fair' view of the company's performance and financial position.

Key Adjustments and Accounting Treatment

Outstanding Expenses: Expenses incurred during the current accounting period but not yet paid by the end of the year. Treatment: Added to the respective expense in Trading/P&L A/c, and shown under Current Liabilities in the Balance Sheet.
Prepaid Expenses: Expenses paid in advance for the next accounting period. Treatment: Deducted from the respective expense in Trading/P&L A/c, and shown under Current Assets in the Balance Sheet.
Accrued Income: Income earned during the current accounting period but not yet received in cash. Treatment: Added to the respective income in the P&L A/c, and shown under Current Assets in the Balance Sheet.
Unearned Income (Income Received in Advance): Income received in cash but not yet earned during the current year. Treatment: Deducted from the respective income in the P&L A/c, and shown under Current Liabilities in the Balance Sheet.
Depreciation: The systematic reduction in the book value of a fixed asset due to wear and tear or obsolescence. Treatment: Debited to the P&L A/c, and deducted from the respective asset on the Assets side of the Balance Sheet.

Step-by-Step Treatment of Bad Debts and Provision for Doubtful Debts

Step 1: Identify Further Bad Debts — Locate any bad debts mentioned in the adjustments (outside the Trial Balance). These are 'Further Bad Debts'. Deduct this amount directly from the Sundry Debtors in the Balance Sheet.
Step 2: Calculate the New Provision for Doubtful Debts — Calculate the specified percentage of the New Provision on the Adjusted Debtors (i.e., Sundry Debtors minus Further Bad Debts). Deduct this New Provision from the Sundry Debtors in the Balance Sheet.
Step 3: Account in Profit & Loss Statement — In the P&L Account, group these together as: [Bad Debts (from Trial Balance) + Further Bad Debts (Adjustments) + New Provision (Adjustments)] - Old Provision (from Trial Balance). Debit the net positive amount to the P&L Account. If the result is negative, credit it to the P&L Account.

The Golden Rule of Final Accounts

Always remember this crucial exam tip to avoid silly mistakes:

Items inside the Trial Balance have already been processed through the double-entry journal. They will be placed in only one place in the final accounts (either Trading, P&L, or Balance Sheet).
Adjustments outside the Trial Balance have not been journalized yet. They must always be posted to at least two places (one debit impact, one credit impact).

Double Check: If you adjust an item in the Profit & Loss Account, make sure you perform its corresponding second entry in the Balance Sheet!

Practice Questions with Solutions

Q: Trial Balance shows Sundry Debtors as Rs. 80,000. Adjustments state: (a) Write off further bad debts Rs. 2,000. (b) Create a provision for doubtful debts @ 5% on debtors. Show how these will appear in the Profit and Loss Account and Balance Sheet. A: Step 1: Deduct further bad debts of Rs. 2,000 from the total debtors of Rs. 80,000. Adjusted Debtors = Rs. 80,000 - Rs. 2,000 = Rs. 78,000. Step 2: Calculate the New Provision for doubtful debts at 5% on Adjusted Debtors: New Provision = 5% of Rs. 78,000 = Rs. 3,900. Step 3: Total amount debited to Profit and Loss Account = Further Bad Debts + New Provision = Rs. 2,000 + Rs. 3,900 = Rs. 5,900. Step 4: Present in Balance Sheet (Assets Side): Sundry Debtors = Rs. 80,000 Less: Further Bad Debts = Rs. 2,000 Less: New Provision = Rs. 3,900 Net Debtors = Rs. 74,100. Final answer: P&L Account is debited with Rs. 5,900; Net Debtors in the Balance Sheet is Rs. 74,100.
Q: Net Profit before charging manager's commission is Rs. 66,000. Calculate the commission and show the journal entry if the manager is entitled to a commission of 10% on Net Profit after charging such commission. A: Step 1: Use the formula for commission 'after charging such commission': Commission = [Net Profit before Commission Rate] / (100 + Rate) Step 2: Substitute the values: Commission = [Rs. 66,000 10] / 110 = Rs. 6,000. Step 3: Write the journal entry: Debit: Profit and Loss Account A/c Rs. 6,000 Credit: Commission Outstanding / Payable A/c Rs. 6,000. Step 4: Show the treatment in final accounts: Debit Rs. 6,000 in the P&L Account and list Rs. 6,000 as Outstanding Commission under Current Liabilities in the Balance Sheet. Final answer: Manager's commission is Rs. 6,000.
Q: Trial Balance lists Insurance Premium paid as Rs. 12,000. Adjustments state that prepaid insurance at the end of the year is Rs. 3,000. Pass adjustment entry and show how it affects the final accounts. A: Step 1: Pass the adjustment journal entry: Debit: Prepaid Insurance A/c Rs. 3,000 Credit: Insurance Premium A/c Rs. 3,000. Step 2: Calculate the expense for the current year to be shown in the Profit and Loss Account: Insurance Expense = Total Paid - Prepaid Amount = Rs. 12,000 - Rs. 3,000 = Rs. 9,000 (debited to P&L A/c). Step 3: Present Prepaid Insurance in the Balance Sheet on the Assets side under Current Assets as Rs. 3,000. Final answer: P&L A/c debited with Rs. 9,000; Balance Sheet shows Prepaid Insurance of Rs. 3,000 under Assets.
Q: Machinery is listed in the Trial Balance at Rs. 2,000,000. Depreciation is to be charged at 10% per annum. A new machine costing Rs. 50,000 was purchased on 1st October of the accounting year (which ends on 31st March). Find the total depreciation and show the asset value in the Balance Sheet. A: Step 1: Identify the components of machinery: Old Machinery (used for the full year) = Rs. 2,000,000 - Rs. 50,000 = Rs. 1,950,000. New Machinery (used for 6 months: Oct to Mar) = Rs. 50,000. Step 2: Calculate depreciation for both parts: Depreciation on Old Machinery = 10% of Rs. 1,950,000 = Rs. 1,95,000. Depreciation on New Machinery = 10% of Rs. 50,000 for 6/12 year = Rs. 2,500. Step 3: Sum the total depreciation: Total Depreciation = Rs. 1,95,000 + Rs. 2,500 = Rs. 1,97,500. Step 4: Debit Rs. 1,97,500 to the P&L Account. In the Balance Sheet (Assets Side), show: Machinery = Rs. 2,000,000 Less: Depreciation = Rs. 1,97,500 Net Machinery = Rs. 1,802,500. Final answer: Total depreciation is Rs. 1,97,500; Net Machinery in Balance Sheet is Rs. 1,802,500.

Frequently Asked Questions

Why is closing stock shown outside the Trial Balance?

Closing stock is evaluated at the end of the financial year after the books of accounts are closed. Since it does not arise out of active bookkeeping during the year, it remains outside the Trial Balance and must be adjusted.

What is the difference between Outstanding Expenses and Prepaid Expenses?

Outstanding expenses represent unpaid services that have already been consumed, acting as liabilities. Prepaid expenses represent advance payments for future services, acting as current assets.

How do we treat Provision for Discount on Debtors?

Provision for Discount on Debtors is calculated only on remaining good debtors. It is computed after deducting further bad debts and the new provision for doubtful debts from Sundry Debtors.