Preparation of Company Financial Statements with Adjustments

Understand Preparation of Company Financial Statements with Adjustments

Key rules to remember

Profit before tax

Gross profit − operating expenses − depreciation − finance costs − bad debts written off − additional provisions + other income

Charge every adjustment that is an expense before you compute tax. Tax is computed on the profit after these charges, unless the question gives a tax figure.

Profit after tax

Profit before tax − provision for tax

Use the tax rate given in the question. Do not compute the tax rate yourself.

Closing balance of Statement of Profit and Loss

Opening balance + profit after tax − transfer to reserves − interim dividend paid − final dividend of the previous year approved in this year

This figure goes under Reserves and Surplus. A negative balance is shown as a deduction.

Provision for doubtful debts charge

Required provision − existing provision

Charge the difference to profit. If required is lower, the difference is written back as income. Apply the percentage to debtors after deducting any bad debts written off.

Depreciation, straight line

(Cost − residual value) ÷ useful life

For a part-year addition, charge depreciation from the date of use. Follow the rate or method given in the question.

Proposed dividend rule

Dividend = rate ÷ 100 × paid-up equity share capital

Apply the rate to paid-up capital, not authorised capital. Deduct a dividend from surplus only in the year shareholders approve it. A dividend proposed after the Balance Sheet date is not provided for. Disclose it in the notes.

How to solve Preparation of Company Financial Statements with Adjustments questions

1. 1Read all the adjustments first. Tick each one as you use it. Mark which ones affect only the Balance Sheet, such as a call in arrears or the classification of an item.
2. 2Write the effect of each adjustment in a small working table with four columns: item, effect on profit, effect on asset, effect on liability or reserve.
3. 3Compute depreciation, interest, provisions and other charges. Show the working for each on the page, because these workings earn step marks.
4. 4Prepare the Statement of Profit and Loss to find profit before tax. Then deduct tax to get profit after tax. Show current tax and deferred tax separately if both are given.
5. 5Deal with appropriations: transfer to reserves, interim dividend paid, and dividend approved by shareholders during the year (including the previous year's final dividend). Add the opening balance to find the closing balance of surplus. Disclose a proposed dividend in a note only.
6. 6Prepare the Balance Sheet in Schedule III order: equity and liabilities, then assets. Carry each adjusted figure, such as net fixed assets, net debtors and the provision for tax.
7. 7Check that totals of both sides agree. If they do not, recheck the double effect of each adjustment before touching any other figure.
8. 8Add short notes: proposed dividend, contingent liability and any assumption you made. Assumptions you state clearly are marked.

Quickest way: Adjustment grid and tick method

Common mistakes in Preparation of Company Financial Statements with Adjustments

• Deducting the proposed dividend from surplus and showing it as a liability

  Students treat dividend like an expense or an accrued payable.

  Fix: If the dividend is proposed after the Balance Sheet date, it is not a liability under AS 4. Disclose it in the notes. Deduct a dividend only in the year shareholders approve it, or when it is an interim dividend paid in the year.

• Missing the previous year's final dividend approved in the current year

  Students see no dividend in the adjustments list and assume nothing is deducted.

  Fix: Check the facts for a final dividend of the last year approved at the annual general meeting this year. Deduct it from surplus in the current year.

• Charging the whole provision for doubtful debts to profit

  Students forget that an old provision already exists in the trial balance.

  Fix: Charge only the difference between required and existing provision. Show debtors net of the total required provision.

• Treating transfer to reserves as an expense

  It appears on the same page as the other adjustments.

  Fix: A transfer to reserves is an appropriation. It reduces the surplus balance but not profit. Show it after profit after tax.

• Computing tax before charging all adjustments

  Students rush to the tax line from a profit figure given earlier.

  Fix: Compute tax only after depreciation, interest, bad debts and provisions are charged. Then apply the given rate to this profit before tax.

• Ignoring the opening balance of the Statement of Profit and Loss

  It is hidden in the trial balance and not in the adjustments list.

  Fix: Scan the trial balance for the opening balance of surplus. Include it, with the right sign, in the closing balance of Reserves and Surplus.

• Showing outstanding interest only in the Statement of Profit and Loss

  Students forget the second effect.

  Fix: Credit the outstanding amount to a liability, normally under other current liabilities as interest accrued but not due or due. Check that the Balance Sheet tallies.

Worked examples