CMA Foundation · Fundamentals of Financial and Cost Accounting

Adjustment Entries and Rectification of Errors: formula sheet

Full chapter guide

Key formulas

Outstanding expense entry: Expense A/c Dr. ; To Outstanding Expense A/c; Expense is incurred but unpaid. It is added to the expense in the P&L and shown as a liability.
Prepaid expense entry: Prepaid Expense A/c Dr. ; To Expense A/c; Part of the amount paid belongs to next year. It is deducted from the expense and shown as an asset.
Accrued income entry: Accrued Income A/c Dr. ; To Income A/c; Income is earned but not received. It is added to income and shown as an asset.
Income received in advance entry: Income A/c Dr. ; To Income Received in Advance A/c; Part of the receipt belongs to next year. It is deducted from income and shown as a liability.
Expense for the year: Expense for the year = Paid + Outstanding at end − Outstanding at start − Prepaid at end + Prepaid at start; Use this to find the amount charged to the P&L.
Adjustment vs closing entry: Adjustment: matches items to the year. Closing: transfers nominal balances to final accounts.; Adjustments are passed first, closing entries later.
Expense chargeable to P&L: Expense for the year = Cash paid + Closing outstanding − Opening outstanding − Closing prepaid + Opening prepaid; Use this when opening balances are given.
Outstanding expense entry: Expense A/c Dr. To Outstanding Expense A/c; Passed at year end. The outstanding account is a liability.
Prepaid expense entry: Prepaid Expense A/c Dr. To Expense A/c; Passed at year end. The prepaid account is an asset.
Final accounts treatment (outstanding): P&L: add to expense. Balance Sheet: show under current liabilities.; Applies when the item is given as an adjustment, not already in the trial balance.
Final accounts treatment (prepaid): P&L: deduct from expense. Balance Sheet: show under current assets.; Applies when the item is given as an adjustment, not already in the trial balance.
Opening balance reversal: Outstanding Expense A/c Dr. To Expense A/c; Expense A/c Dr. To Prepaid Expense A/c; Passed on the first day of next year. This stops double counting.
Income to be credited to P&L: Income for the year = Income received + Accrued income at end − Accrued income at start − Advance received at end + Advance received at start; Use this when opening balances are given. Without opening balances, use only the closing adjustments.
Accrued income entry: Accrued Income A/c Dr. ; To Income A/c; Accrued Income is an asset. It appears in the Balance Sheet.
Income received in advance entry: Income A/c Dr. ; To Income Received in Advance A/c; Income received in advance is a liability. It appears in the Balance Sheet.
Adjusted income in final accounts: Adjusted income = Income per Trial Balance + Accrued − Received in advance; Shows the amount for the P&L credit side.
Accrued amount for part of a year: Accrued income = Annual income × Months unreceived ÷ 12; Use the same method for received in advance: Annual amount × Months of next year ÷ 12.
Depreciation entry: Depreciation A/c Dr. To Asset A/c (or Provision for Depreciation A/c); Depreciation A/c is then transferred to Profit and Loss A/c.
Straight line depreciation: Annual depreciation = (Cost − Scrap value) ÷ Life in years; Charge for part of the year if the asset was bought or sold during it.
Bad debts entry: Bad Debts A/c Dr. To Debtors A/c; If bad debts are already in the trial balance, do not record them again.
Bad debts recovered: Cash A/c Dr. To Bad Debts Recovered A/c; Recovery of a debt written off in an earlier year is a gain of the current year.
Provision for doubtful debts: Profit and Loss A/c Dr. To Provision for Doubtful Debts A/c (for the increase only); New provision = Rate × (Debtors − new bad debts). The entry is for the increase (new provision − old provision). If the provision decreases, debit Provision for Doubtful Debts A/c and credit Profit and Loss A/c with the decrease.
Provision for discount on debtors: Provision = Rate × (Debtors − Bad debts − Provision for doubtful debts); Calculated after the provision for doubtful debts.
Discount on creditors: Provision for Discount on Creditors A/c Dr. To Profit and Loss A/c; The gain is credited to Profit and Loss A/c. The provision account has a debit balance and is shown as a deduction from creditors in the balance sheet. The rate is applied on creditors as given. If an old provision exists, take only the change.
Interest on capital: Interest on Capital A/c Dr. To Capital A/c; Interest = Capital × Rate × Time. Use the capital balance for the period it was invested. If the question gives no change in capital, use the opening capital for the full period. If the business starts during the year, count time only from the date of starting. Drawings are not deducted from capital for this calculation, because interest on drawings is charged separately.
Interest on drawings: Drawings A/c Dr. To Interest on Drawings A/c; Interest = Drawings × Rate × Time. For equal amounts drawn monthly at start, average period is 6.5 months; at middle, 6 months; at end, 5.5 months. Interest on Drawings A/c is then transferred to the credit of Profit and Loss A/c.
Errors not affecting the trial balance: Complete omission, error of principle, compensating errors, posting to the wrong account of the same nature (commission), and equal wrong amount on both sides; Debits and credits stay equal, so the trial balance agrees and the error stays hidden.
Errors affecting the trial balance: Partial omission, one-sided posting, wrong amount on one side only, wrong totalling or balancing (unless offset by another error), a wrong balance carried to the trial balance (unless offset by another error); Total debits no longer equal total credits. The difference is put in a Suspense Account until the errors are found. If another error offsets a wrong total or balance, the errors are compensating and the trial balance still agrees.
One-sided vs two-sided errors: One-sided = one account wrong. Two-sided = two accounts wrong, one on the debit and one on the credit.; A one-sided error disturbs the trial balance unless another error offsets it. A two-sided error does not disturb it if debit and credit are wrong by equal amounts, but does if the amounts differ.
Four classic types: Omission | Commission | Principle | Compensating; Learn one-line meanings of each; options in MCQs are built from these.
Rectifying entry rule: Rectifying entry = Correct entry − Wrong entry already passed; Reverse the wrong effect and add the right effect, then combine into one entry.
Suspense account balance: Trial balance credit total > debit total → Dr Suspense A/c; debit total > credit total → Cr Suspense A/c; Suspense is the balancing figure that makes the trial balance agree.
One-sided error: Entry involves Suspense A/c; Only one account was posted or wrongly posted, so the other side goes to suspense.
Two-sided error: Entry does not involve Suspense A/c; Both debit and credit were affected, so the trial balance agreed; rectify between the proper accounts.
Next-period rectification: Use Profit and Loss Adjustment A/c in place of any nominal account of the closed year; Personal and real account entries stay as they are.
Corrected profit: Corrected profit = Profit before correction + Errors that increase profit − Errors that decrease profit; Check each error for its effect on a nominal account only.

Quick revision

Adjustments follow the accrual basis: record income earned and expense incurred, not just cash.
Outstanding expense is added to the expense in P&L and shown as a liability in the Balance Sheet.
Prepaid expense is deducted from the expense in P&L and shown as an asset.
Accrued income is added to income in P&L and shown as an asset.
Income received in advance is deducted from income in P&L and shown as a liability.
Bad debts are written off first. The provision is then made on the debtors that remain.
Depreciation is a non-cash expense that reduces the asset's book value.
Error of omission: a transaction is left out. Complete omission of a transaction does not affect the trial balance, whereas partial omission (only one side recorded) does affect it.
Error of principle: wrong class of account used, such as capital treated as revenue. The trial balance still tallies.
Compensating errors cancel out, so the trial balance still agrees.
One-sided errors affect the trial balance and are routed through the Suspense Account until found.
After rectification, the Suspense Account balance must become nil.

Common mistakes

Treating adjustment entries as corrections of errors Fix: Adjustments are planned and follow the accrual concept. Rectification corrects a mistake already made.
Confusing adjustment entries with closing entries Fix: Adjustment entries fix timing and valuation. Closing entries transfer nominal account balances to the final accounts.
Subtracting outstanding expense from the expense in the P&L. Fix: Outstanding means you still owe it, so the year's expense is higher. Add it.
Showing prepaid expense as a liability. Fix: You have already paid and will receive the benefit later, so it is an asset.
Deducting accrued income from income instead of adding it. Fix: Accrued income is added to income, just as outstanding expense is added to expense. It is an asset, while outstanding expense is a liability.
Showing income received in advance as an asset. Fix: You owe the service or space for the future period, so it is a liability.
Charging the full new provision to P&L instead of only the increase. Fix: Always do new provision minus old provision. If the result is negative, credit it to P&L as a reduction.
Calculating provision for doubtful debts before deducting new bad debts. Fix: Deduct additional bad debts first, then apply the rate.
Saying every error of omission is hidden from the trial balance. Fix: Check whether both sides were omitted. Only complete omission leaves the trial balance unaffected. Partial omission disturbs it.
Calling a wrong posting to another account an error of principle. Fix: Principle needs a capital/revenue (or similar nature) mistake. Posting to another account of the same nature is commission.

Exam tips

Link every adjustment to the accrual concept. Many MCQs ask for the reason, and this is the answer.
Memorise the four core entries and whether each is an asset or a liability.
Questions on difference ask you to pick between adjustment, closing and rectification entries. Recall the purpose of each.
Be ready for 'which appears in the balance sheet' questions. Outstanding and advance items are liabilities. Prepaid and accrued items are assets.
There is no negative marking, so attempt every question after eliminating wrong options.
Look for keywords: due, unpaid, accrued mean add. In advance, unexpired mean subtract.
Check the final answer in the options. A wrong sign gives a number that often appears as a distractor, so verify direction.
For part-year payments, find the monthly amount first and count months carefully.