Adjustment Entries: Inventory, Depreciation, Provision for Bad Debts, Accrued, Prepaid, Outstanding and Unearned income and Expenditure

Adjustment entries are made at the end of the accounting period to update the books of accounts. These adjustments ensure that the financial statements, such as the Profit and Loss Account and Balance Sheet, reflect a true and fair view of the financial position.

1. Inventory

Inventory refers to the unsold goods at the end of the accounting period. It is adjusted to reflect the correct value in the financial statements.

Adjustment Entry:

• When there is a change in the inventory (increase or decrease), the entry is:
  • If inventory increases:
    Debit: Closing Inventory (Balance Sheet)
    Credit: Trading Account (Profit and Loss Account)

  • If inventory decreases:
    Debit: Trading Account (Profit and Loss Account)
    Credit: Closing Inventory (Balance Sheet)


2. Depreciation

Depreciation is the reduction in the value of fixed assets due to wear and tear over time. Depreciation is charged at the end of the accounting period and is adjusted accordingly.

Adjustment Entry:

• Depreciation on assets should be recorded by debiting the Profit and Loss Account and crediting the Accumulated Depreciation account.
  Debit: Depreciation Expense (Profit and Loss Account)
  Credit: Accumulated Depreciation (Balance Sheet)


3. Provision for Bad Debts

Provision for bad debts is made to account for the amount of accounts receivable that may not be collected. It is created based on the expected losses from credit sales.

Adjustment Entry:

• Provision for bad debts is made at the end of the period based on an estimated percentage of receivables.
  Debit: Bad Debt Expense (Profit and Loss Account)
Credit: Provision for Bad Debts (Balance Sheet)

• If a specific debtor is identified as bad, the entry will be:
  Debit: Provision for Bad Debts
  Credit: Accounts Receivable


4. Accrued Expenses

Accrued expenses are expenses that have been incurred but are not yet paid or recorded by the end of the accounting period.

Adjustment Entry:

• When an expense is accrued:
  Debit: Expense Account (Profit and Loss Account)
  Credit: Accrued Expenses (Liability in Balance Sheet)


5. Prepaid Expenses

Prepaid expenses are payments made in advance for goods or services that will be consumed in future accounting periods. These expenses should be adjusted at the end of the accounting period.

Adjustment Entry:

• When an expense is prepaid:
  Debit: Prepaid Expenses (Asset in Balance Sheet)
  Credit: Expense Account (Profit and Loss Account)


6. Outstanding Expenses

Outstanding expenses are those expenses that have been incurred but not yet paid or recorded by the end of the accounting period.

Adjustment Entry:

• When an expense is outstanding:
  Debit: Expense Account (Profit and Loss Account)
  Credit: Outstanding Expenses (Liability in Balance Sheet)


7. Unearned Income

Unearned income refers to the revenue that has been received but not yet earned, i.e., the business has not yet provided goods or services for the payment.

Adjustment Entry:

• When income is unearned:
  Debit: Unearned Income (Liability in Balance Sheet)
  Credit: Income Account (Profit and Loss Account)

• If some of the unearned income is now earned (after providing goods or services):
  Debit: Unearned Income (Liability in Balance Sheet)
  Credit: Income Account (Profit and Loss Account)


Summary of Adjustment Entries