Fundamentals of Financial and Cost Accounting · Adjustment Entries and Rectification of Errors

Depreciation, Bad Debts and Provisions Adjustments in Final Accounts

Updated 10 October 2026 · Fact-checked

Adjustment entries bring the books in line with the accrual basis before final accounts. Depreciation, bad debts, provision for doubtful debts, discount provisions and interest on capital or drawings are expenses or incomes of the year. Each is debited or credited to Profit and Loss Account, with the balance sheet item adjusted.

Understand Depreciation, Bad Debts and Provisions Adjustments

At year end, the trial balance does not show every expense or income of the year. Some items are missing because no cash moved or no entry has been made. Adjustment entries fix this so profit is correct and the balance sheet shows true values.

Depreciation is the fall in value of a fixed asset from use or time. You charge it to Profit and Loss Account as an expense and reduce the asset (or credit a provision for depreciation account). It is a non-cash expense, so no money leaves the business.

Bad debts are amounts from debtors that you cannot collect. They are a loss of the year. Provision for doubtful debts is an estimate of further losses likely from debtors who are still outstanding. You charge it now so that profit is not overstated.

Provision for discount on debtors covers cash discount you expect to allow when debtors pay promptly. It is calculated on good debtors, that is, debtors left after deducting bad debts and the provision for doubtful debts. Discount on creditors works the other way: it is a likely gain. The provision for discount on creditors is credited to Profit and Loss Account as a gain, and it is shown in the balance sheet as a deduction from creditors.

Interest on capital is a notional item for a sole proprietor, because the owner cannot truly charge the business for using their own money. Charge it only if the question instructs you to, usually with a rate. In a partnership, it is charged only if the partnership deed provides for it. When it is charged, it is an expense for the business and income for the owner. Interest on drawings is charged to the owner, so it is an income for the business. Charge it only if the question tells you to.

Key formulas to remember

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.

How to solve Depreciation, Bad Debts and Provisions Adjustments questions

Use the same routine for any adjustment question so that you never double count or miss an item.

1Read each adjustment and mark whether it is already in the trial balance. If it is, do not record it again.
2Identify the type: expense, loss, gain, provision or appropriation of owner's interest.
3Write the entry: debit the expense or loss, credit the asset or provision.
4Compute the amount in the right order: bad debts first, then provision for doubtful debts, then provision for discount.
5For provisions, compare with the old provision from the trial balance and charge only the difference.
6Show the effect in the Profit and Loss Account: expenses on the debit side, gains on the credit side.
7Show the effect in the Balance Sheet: deduct bad debts and provisions from debtors, and depreciation from the asset.
8Check that each adjustment has been used twice: once in the P&L account and once in the balance sheet.

Quickest way: Debtors ladder and the net effect method

When to use it: Use it when an MCQ asks for the amount charged to P&L or the closing figure of debtors.

Start with debtors given in the trial balance.
Subtract new bad debts to get debtors after bad debts.
Provision for doubtful debts = rate × that figure. Subtract it to get good debtors.
Provision for discount = rate × good debtors.
Charge to P&L for the adjustment items = new bad debts + (new provision for doubtful debts − old provision) + (new provision for discount − old discount provision, if any). Bad debts already in the trial balance are also a P&L charge in total, but leave them out when the question asks only for the adjustment items.
The balance sheet shows debtors less new bad debts, less provision for doubtful debts and less provision for discount. Show it net or with each provision as a separate deduction, as the question requires.

Common mistakes in Depreciation, Bad Debts and Provisions Adjustments

Charging the full new provision to P&L instead of only the increase.
Students forget that the old provision is already in the books.
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.
The rate is applied directly on the trial balance debtors figure.
Fix: Deduct additional bad debts first, then apply the rate.
Calculating discount provision on total debtors.
Students ignore the order of provisions.
Fix: Apply it on debtors after bad debts and after provision for doubtful debts.
Treating interest on drawings as an expense.
Both interest items have the word interest and look alike.
Fix: When charged, interest on capital is an expense; interest on drawings is an income of the business.
Deducting bad debts recovered from debtors.
Students link recovery with debtors account.
Fix: A debt already written off in a past year is not in debtors. Credit the recovery to Bad Debts Recovered account as income.
Charging a full year of depreciation on an asset bought during the year.
The date of purchase is overlooked.
Fix: Charge depreciation only for the months of use, unless the question says otherwise.

Worked examples

Example 1

Debtors as per trial balance are ₹2,00,000. Further bad debts are ₹10,000. Provision for doubtful debts is to be 5% and provision for discount on debtors 2%. Old provision for doubtful debts is ₹7,000. Find the total amount charged to Profit and Loss Account for these items.

Show the solution

Debtors after further bad debts = ₹2,00,000 − ₹10,000 = ₹1,90,000.
New provision for doubtful debts = 5% × ₹1,90,000 = ₹9,500.
Increase in provision = ₹9,500 − ₹7,000 = ₹2,500.
Good debtors = ₹1,90,000 − ₹9,500 = ₹1,80,500.
Provision for discount = 2% × ₹1,80,500 = ₹3,610. (No old discount provision is given.)
Total charge = ₹10,000 + ₹2,500 + ₹3,610 = ₹16,110.

Answer: ₹16,110

Example 2

Aarav started business on 1 April 2026 with capital of ₹5,00,000. Assume the capital stayed at ₹5,00,000 throughout the year. Interest on capital is allowed at 6% per year. He withdrew ₹10,000 at the start of every month. Interest on drawings is charged at 12% per year. Find the interest on capital and the interest on drawings for the year ended 31 March 2027.

Show the solution

The capital was invested for the full year, from 1 April 2026 to 31 March 2027, and stayed at ₹5,00,000. Drawings are not deducted from capital here, because interest on them is charged separately.
Interest on capital = ₹5,00,000 × 6% = ₹30,000 for the full year.
Total drawings = ₹10,000 × 12 = ₹1,20,000.
Drawings at the start of each month: average period = 6.5 months.
Interest on drawings = ₹1,20,000 × 12% × 6.5 ÷ 12 = ₹7,800.
Entries: Interest on Capital A/c Dr. ₹30,000 To Capital A/c; Drawings A/c Dr. ₹7,800 To Interest on Drawings A/c.
Both interest accounts are then transferred to Profit and Loss A/c: Interest on Capital A/c to the debit and Interest on Drawings A/c to the credit.

Answer: Interest on capital ₹30,000; interest on drawings ₹7,800

Exam tips

Check the trial balance first. A provision or bad debt already there changes the answer.
Memorise the order: bad debts, then doubtful debts provision, then discount provision.
For interest on drawings, read when the money was drawn, because the average period depends on it.
MCQs often ask for the net debtors figure. Work it with the debtors ladder in under a minute.
Remember that depreciation, provisions and interest on capital never involve cash at the time of entry.

Practice questions from Adjustment Entries and Rectification of Errors

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Depreciation, Bad Debts and Provisions Adjustments: frequently asked questions

What is the difference between bad debts and provision for doubtful debts?

Bad debts are debts already known to be uncollectable, so they are written off. Provision for doubtful debts is an estimate of future losses from debtors still outstanding. Bad debts reduce debtors directly, while the provision is shown as a deduction.

How is provision for doubtful debts shown in the balance sheet?

Deduct it from sundry debtors on the asset side. Debtors are shown after reducing new bad debts and provision. Some questions ask for the gross figure and the provision shown separately.

Is interest on drawings an income or expense?

It is an income for the business, because the owner pays it. It is credited to Profit and Loss Account and debited to the owner's capital or drawings account.

Do I charge interest on capital if the question does not mention it?

No. For a sole proprietor, interest on capital is a notional item, so charge it only if the question instructs you to. In a partnership, it is charged only if the partnership deed provides for it. Without such a statement, make no entry.