Fundamentals of Financial and Cost Accounting · Financial Statements of Sole Proprietorship

Adjustments in Final Accounts for CMA Foundation

Updated 10 October 2026 · Fact-checked

Adjustments are year-end entries that bring the trial balance in line with the accrual basis. You record each one twice: once in the Trading or Profit and Loss Account, and once in the Balance Sheet. This is the double effect. Apply it item by item and the final accounts will balance.

Understand Adjustments in Final Accounts

A trial balance shows only what was recorded during the year. Some expenses are unpaid. Some were paid for next year. Some income is earned but not received. Because of this, the profit shown by raw figures is wrong.

Adjustments fix this. They follow the accrual concept (also called the matching concept): charge the expenses that belong to this year and credit the income that belongs to this year, whether or not cash moved.

Every adjustment given outside the trial balance has a double effect. One effect is on the Trading or Profit and Loss Account. The other is on the Balance Sheet. If you show only one effect, the Balance Sheet will not tally.

An adjustment that is already inside the trial balance has a single effect only. For example, if bad debts appear in the trial balance and a further bad debt is given as an adjustment, you add the two for the P&L but deduct only the further amount from debtors.

Drawings and interest on capital relate to the owner. Drawings reduce capital. Interest on capital is a notional expense charged to P&L and added to capital. Interest on drawings is a gain to the business. Credit it to P&L and deduct it from capital (add it to drawings).

Key formulas to remember

Outstanding expense: P&L expense = Paid + Outstanding − Prepaid; Outstanding expense is a liability in the Balance Sheet. Prepaid is an asset.
Accrued income: P&L income = Received + Accrued − Received in advance; Accrued income is an asset. Income received in advance is a liability.
Depreciation: Depreciation is a P&L expense and is deducted from the asset in the Balance Sheet; If the asset was bought during the year, charge only for the period of use unless the question says otherwise.
Bad debts: Bad debts (P&L) = Bad debts in trial balance + Further bad debts; Deduct only the further bad debts from Sundry Debtors.
Provision for doubtful debts: New provision = % × (Debtors − Further bad debts); P&L charge = Total bad debts (trial balance + further) + New provision − Old provision; Total bad debts means the bad debts in the trial balance plus the further bad debts. If the result is negative, the old provision was larger than the amount needed. Treat the net amount as a gain and show it as a credit in P&L.
Interest on capital: Interest = Capital × Rate × Time; Debit P&L and add to capital. Use opening capital unless the question says otherwise.
Interest on drawings: Interest = Drawings × Rate × Time; Credit P&L and deduct from capital. Use the period that the question states.

How to solve Adjustments in Final Accounts questions

Use this routine for any adjustment question. It keeps both effects visible.

1Read every adjustment and tick the ones that are already in the trial balance. These get single effect.
2Decide the P&L side: expense or income, and the amount for the year.
3Decide the Balance Sheet side: asset or liability, or a deduction from an existing item.
4For expenses, work out Paid + Outstanding − Prepaid. For income, work out Received + Accrued − Advance.
5For bad debts, deduct further bad debts from debtors first. Then calculate the new provision on the reduced figure.
6Compute depreciation on the correct base and period. Deduct it from the asset.
7Deal with capital items: drawings, interest on capital and interest on drawings.
8Total each side of the Balance Sheet and check that they match.

Quickest way: Two-column shortcut

When to use it: Use it when the question asks for a single figure such as the P&L expense, net profit or debtors in the Balance Sheet.

Make two quick columns on rough paper: P&L and Balance Sheet.
Write each adjustment in the column where it belongs, with the sign: expense or loss, income or gain, asset, liability.
For expense or income figures, use the formula Paid + Outstanding − Prepaid directly.
For net profit change, add every gain and subtract every expense.
Eliminate options that show only one effect or add a prepaid amount to the expense.

Common mistakes in Adjustments in Final Accounts

Showing outstanding expense only in P&L and not in the Balance Sheet.
Students forget the double effect once the expense is added.
Fix: Always write the liability on the Balance Sheet as soon as you add it to the expense.
Deducting prepaid expense from the expense but adding it to nothing on the Balance Sheet.
The deduction feels like the end of the work.
Fix: Show prepaid expense as a current asset.
Deducting total bad debts from debtors when part of it is already in the trial balance.
Students do not check which items are inside the trial balance.
Fix: Deduct only the further bad debts from debtors. Add the two bad debts figures for P&L.
Calculating provision for doubtful debts on gross debtors.
The further bad debts step is skipped.
Fix: Take debtors, subtract further bad debts, then apply the percentage.
Treating drawings as an expense.
Drawings look like a payment out.
Fix: Drawings reduce capital. Never charge them to P&L.
Treating the old provision as a fresh charge instead of adjusting it.
Students ignore the opening provision in the trial balance.
Fix: Charge only the net change: new provision minus old provision.

Worked examples

Example 1

Rent paid during the year was ₹48,000. This includes ₹4,000 paid for the next year. Salaries paid were ₹60,000 and salaries of ₹5,000 are outstanding. Find the amounts shown in P&L and the Balance Sheet.

Show the solution

Rent: P&L expense = 48,000 − 4,000 = ₹44,000.
Prepaid rent of ₹4,000 is a current asset in the Balance Sheet.
Salaries: P&L expense = 60,000 + 5,000 = ₹65,000.
Outstanding salaries of ₹5,000 is a current liability in the Balance Sheet.

Answer: P&L: rent ₹44,000 and salaries ₹65,000. Balance Sheet: prepaid rent ₹4,000 (asset) and outstanding salaries ₹5,000 (liability).

Example 2

The trial balance shows Sundry Debtors ₹1,00,000, Bad Debts ₹2,000 and Provision for Doubtful Debts ₹4,000. Further bad debts are ₹5,000. A provision of 5% on debtors is required. Find the P&L charge and the debtors figure in the Balance Sheet.

Show the solution

Debtors after further bad debts = 1,00,000 − 5,000 = ₹95,000.
New provision = 5% × 95,000 = ₹4,750.
Total bad debts = 2,000 + 5,000 = ₹7,000.
P&L charge = Bad debts 7,000 + New provision 4,750 − Old provision 4,000 = ₹7,750.
Balance Sheet: Debtors 95,000 less provision 4,750 = ₹90,250.

Answer: P&L charge is ₹7,750. Debtors are shown at ₹90,250 net in the Balance Sheet.

Exam tips

Look for the words 'in the trial balance' or 'given in the trial balance'. They decide whether the effect is single or double.
If an option shows a sum that adds a prepaid amount to the expense, eliminate it.
Compute provision only after deducting further bad debts. Many wrong options use gross debtors.
Interest on capital and interest on drawings are recorded in P&L and adjusted against capital in the Balance Sheet. Check whether the question asks for net profit before or after them.
With no negative marking, always attempt every question. Eliminate wrong options first.

Practice questions from Financial Statements of Sole Proprietorship

Adjustments in Final Accounts in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Adjustments in Final Accounts: frequently asked questions

What is the double effect of adjustments?

Each adjustment given outside the trial balance affects two places. One is the Trading or P&L Account and the other is the Balance Sheet. For example, outstanding rent increases the expense and also creates a liability.

How do you treat outstanding expenses in final accounts?

Add the outstanding amount to the expense in the Trading or P&L Account. Show the same amount as a current liability in the Balance Sheet. Prepaid expenses work the other way: deduct from the expense and show as an asset.

How are bad debts and provision for doubtful debts treated?

Charge bad debts to P&L and deduct further bad debts from debtors. Then calculate the new provision on the remaining debtors. Charge only the difference between the new and old provision to P&L.

Is interest on capital an expense?

For the business it is a notional expense. It is debited to P&L and added to the owner's capital. Interest on drawings is the reverse: it is credited to P&L and deducted from capital.