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Fundamentals of Accounting · Preparation of Final Accounts for Sole Proprietorship

Adjustments in Final Accounts for Sole Proprietorship

Updated 11 October 2026 · Fact-checked

Adjustments in final accounts are year-end items not yet recorded in the trial balance, such as closing stock, outstanding or prepaid expenses, accrued or advance income, depreciation, bad debts and interest. Each one has a double effect: it changes the Trading or Profit and Loss Account and also appears in the Balance Sheet.

Understand Adjustments in Final Accounts

A trial balance shows only what you have recorded during the year. But profit must match the year's real expenses and income, whether or not cash has moved. This is the accrual basis. Adjustments bring the books in line with it.

Every adjustment is given outside the trial balance, usually below it as notes. So it must be recorded twice: once in the Trading or Profit and Loss Account, and once in the Balance Sheet. If an item is already inside the trial balance, it is recorded once only.

Think of the adjustments in four groups. Expenses and income of the year are outstanding expenses, prepaid expenses, accrued income and income received in advance. Asset values are closing stock, depreciation and the provision for doubtful debts. Losses are bad debts. Owner-related items are interest on capital and interest on drawings.

The logic is simple. An outstanding expense belongs to this year but is unpaid, so you add it to the expense and show a liability. A prepaid expense belongs to next year but is already paid, so you deduct it from the expense and show an asset. Accrued income is earned but not received, so you add it to income and show an asset. Advance income is received but not earned, so you deduct it from income and show a liability.

Interest on capital is a notional expense charged to profit and added to capital. Interest on drawings is a notional income, taken from the proprietor, so it is added to profit and deducted from capital.

Key rules to remember

Closing stock
Credit side of Trading Account and asset in Balance Sheet
If it is given in the trial balance instead, it is already adjusted. Show it in the Balance Sheet only.
Outstanding expense
Expense for P&L = Amount paid + Outstanding
Show the outstanding amount as a current liability.
Prepaid expense
Expense for P&L = Amount paid − Prepaid
Show the prepaid amount as a current asset.
Accrued income
Income for P&L = Amount received + Accrued
Show the accrued amount as a current asset.
Income received in advance
Income for P&L = Amount received − Advance
Show the advance as a current liability.
Depreciation
Straight line: (Cost − Scrap value) ÷ Life. Fixed rate: Rate × Book value
Charge to P&L and deduct from the asset in the Balance Sheet. For a part year, charge for the months of use.
Bad debts
Total bad debts = Bad debts in trial balance + Further bad debts
Debit P&L. Deduct further bad debts from debtors in the Balance Sheet.
Provision for doubtful debts
New provision = Rate × (Debtors − Further bad debts). Charge to P&L = New provision − Old provision
If old provision is larger, the difference is a gain. Show it on the credit side of P&L. Deduct the new provision from debtors in the Balance Sheet.
Interest on capital
Interest = Opening capital × Rate × Time
Debit P&L. Add to capital in the Balance Sheet. Use the capital the question tells you to use.
Interest on drawings
Interest = Drawings × Rate × Average period ÷ 12
Average period: 6 months if drawn evenly, 6.5 if drawn at the start of each month, 5.5 if drawn at the end. Credit P&L. Deduct from capital.

How to solve Adjustments in Final Accounts questions

Use the same routine for any question. It keeps both effects of each adjustment in view.

  1. 1Read the trial balance and the adjustments together. Mark each adjustment as 'already in the trial balance' or 'new'.
  2. 2For each adjustment, decide its two places: the Trading or P&L Account side and the Balance Sheet side.
  3. 3Work out the adjusted figure for each expense or income, such as paid plus outstanding, or received minus advance.
  4. 4Prepare the Trading Account. Include closing stock on the credit side and find gross profit.
  5. 5Prepare the P&L Account with adjusted expenses, depreciation, bad debts, provision change and interest. Find net profit.
  6. 6Prepare the Balance Sheet. Show outstanding items as liabilities, prepaid and accrued items as assets, and net debtors and fixed assets after deductions.
  7. 7Update capital: opening capital + net profit + interest on capital − drawings − interest on drawings.
  8. 8Check that assets equal capital plus liabilities.

Quickest way: Two-column tick method

When to use it: Use it when time is short and the question has five to eight adjustments.

  1. Draw two columns next to each adjustment: 'P&L' and 'Balance Sheet'.
  2. Write the effect in both at once. For example, 'Outstanding rent ₹2,000' becomes P&L: add to rent, and Balance Sheet: liability.
  3. Tick each adjustment once both columns are filled. This stops you from missing the second effect.
  4. Remember the pattern: outstanding and accrued are added in P&L, prepaid and advance are deducted.
  5. Do the bad debts and provision sum on a side note first. Deduct further bad debts, then apply the rate.

Common mistakes in Adjustments in Final Accounts

  • Recording an adjustment only once, for example adding outstanding rent to rent but not showing it as a liability.

    Students treat the adjustment as a P&L change only.

    Fix: Always write the P&L effect and the Balance Sheet effect before moving on.

  • Adding prepaid expenses to the expense instead of deducting them.

    Students confuse 'prepaid' with 'outstanding'.

    Fix: Prepaid means paid in advance for next year, so deduct it. Outstanding means unpaid, so add it.

  • Calculating the provision for doubtful debts on the full debtors figure.

    Students forget that further bad debts are written off first.

    Fix: Deduct further bad debts from debtors, then apply the rate to the balance.

  • Charging the whole new provision to P&L when an old provision exists.

    Students ignore the opening provision in the trial balance.

    Fix: Charge only the difference: new provision − old provision. If it is negative, show it as a gain.

  • Showing closing stock twice or in the wrong place.

    Students do not check whether it is in the trial balance or in the adjustments.

    Fix: If it is in the adjustments, show it in the Trading Account and the Balance Sheet. If it is in the trial balance, show it in the Balance Sheet only.

  • Adding interest on drawings to drawings or deducting it from profit.

    It sounds like a cost to the owner, so students treat it as an expense.

    Fix: It is income for the business. Credit P&L, and deduct it from capital along with drawings.

Worked examples

Example 1

From Rahul's books on 31 March 2025: Debtors ₹80,000; Bad debts ₹2,000; Provision for doubtful debts (opening) ₹3,000; Rent paid ₹24,000; Insurance paid ₹12,000. Adjustments: (a) further bad debts ₹4,000; (b) provision for doubtful debts at 5% on debtors; (c) rent outstanding ₹2,000; (d) insurance prepaid ₹3,000. Show the P&L charges and the Balance Sheet figures.

Show the solution
  1. Total bad debts for P&L = ₹2,000 + ₹4,000 = ₹6,000.
  2. Debtors after further bad debts = ₹80,000 − ₹4,000 = ₹76,000.
  3. New provision = 5% × ₹76,000 = ₹3,800.
  4. Charge to P&L = ₹3,800 − ₹3,000 (old provision) = ₹800.
  5. Rent for P&L = ₹24,000 + ₹2,000 = ₹26,000.
  6. Insurance for P&L = ₹12,000 − ₹3,000 = ₹9,000.
  7. Balance Sheet: Debtors ₹76,000 less provision ₹3,800 = ₹72,200 (asset). Prepaid insurance ₹3,000 (asset). Outstanding rent ₹2,000 (liability).

Answer: P&L charges: bad debts ₹6,000, provision for doubtful debts ₹800, rent ₹26,000, insurance ₹9,000. Balance Sheet: net debtors ₹72,200, prepaid insurance ₹3,000 (asset), outstanding rent ₹2,000 (liability).

Example 2

Meera's net profit before the following adjustments is ₹1,00,000. Her opening capital is ₹5,00,000. Drawings during the year were ₹60,000, taken as ₹5,000 at the start of each month. Adjustments: interest on capital at 6% p.a.; interest on drawings at 10% p.a.; depreciation ₹20,000; outstanding wages ₹8,000; commission accrued ₹5,000; commission received in advance ₹2,000. Find the adjusted net profit and closing capital.

Show the solution
  1. Interest on capital = ₹5,00,000 × 6% = ₹30,000 (deduct from profit).
  2. Average period for drawings at the start of each month = 6.5 months.
  3. Interest on drawings = ₹60,000 × 10% × 6.5 ÷ 12 = ₹3,250 (add to profit).
  4. Start: ₹1,00,000 − ₹30,000 = ₹70,000.
  5. Add interest on drawings: ₹70,000 + ₹3,250 = ₹73,250.
  6. Deduct depreciation: ₹73,250 − ₹20,000 = ₹53,250.
  7. Deduct outstanding wages: ₹53,250 − ₹8,000 = ₹45,250.
  8. Add accrued commission: ₹45,250 + ₹5,000 = ₹50,250.
  9. Deduct commission received in advance: ₹50,250 − ₹2,000 = ₹48,250.
  10. Closing capital = ₹5,00,000 + ₹30,000 + ₹48,250 − ₹60,000 − ₹3,250 = ₹5,15,000.

Answer: Adjusted net profit = ₹48,250. Closing capital = ₹5,15,000. Outstanding wages ₹8,000 and advance commission ₹2,000 are liabilities. Accrued commission ₹5,000 is an asset.

Exam tips

  • Write the headings 'Adjustments' and the treatment next to each item. Examiners give marks for each correct effect, even if a later figure is wrong.
  • Check whether an item appears in the trial balance as well as in the adjustments. If it appears in both, add or deduct. If only in the adjustments, show the double effect.
  • For the provision for doubtful debts, show your working in a short note. It earns method marks.
  • Read interest on drawings carefully. When the question gives dates, the amounts, or says 'evenly', choose the average period from the rule.
  • Use the last two minutes to check that the Balance Sheet tallies. A mismatch usually points to a missed second effect.

Practice questions from Preparation of Final Accounts for 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

How do I treat outstanding expenses in final accounts?

Add the outstanding amount to the expense in the Trading or Profit and Loss Account. Then show the same amount as a current liability in the Balance Sheet. The expense belongs to this year even though it is unpaid.

How do I treat bad debts and provision for doubtful debts?

Charge bad debts, including further bad debts, to the P&L Account. Deduct further bad debts from debtors, then calculate the provision on the balance. Charge only the change from the old provision to P&L, and deduct the new provision from debtors in the Balance Sheet.

What is the treatment of interest on drawings?

Interest on drawings is income for the business. Credit it in the P&L Account, and deduct it from capital in the Balance Sheet. If a question gives only the total drawings and says they were taken evenly, use an average of 6 months.

Where does closing stock go when it is given in the adjustments?

Show it on the credit side of the Trading Account and as a current asset in the Balance Sheet. If it is in the trial balance, it has already been taken to the Trading Account, so show it in the Balance Sheet only.