Important Adjustments to Ledger Account Balances to Arrive at Proper Profit
Adjustments - Financial Accounting
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Depreciation
Fixed assets have a certain life period after which they are no longer useful for efficient production. So we can visualize that fixed assets getting used up every year and their value to the business is coming down every year. It means every year, the firm is using some portion of the value of the fixed assets. Hence, to determine the profit may be a business in any period or year, the profit and loss account must contain an item as fixed asset expense in that period.
Depreciation is the name given to the expense item that reflects usage of fixed assets in a period for producing goods or services.
The amount of depreciation is determined at the end of the period and recorded in the books as adjustment entry. In various countries company law or act and income tax act specify the percentage on the fixed assets that can be charged as depreciation every year.
Outstanding expenses
Normally, only those transactions that are recorded on documents are entered in account books. If some expenses are incurred but are not recorded on documents, ledger will not have any entries related to them. Accountants have to find out if any expenses are outstanding for payment and they have to show them on the profit and loss account to arrive at proper profit.
Accrued income receivable
Similar to outstanding expenses, there can be outstanding income. The employee of a firm went and provided a service to a firm but the bill was not raised. Or the practice of raising the bill is not there. But this outstanding income is to be shown on the profit and loss account.
A more realistic example of this nature is the fixed deposit with a bank. If the fixed deposit is a cumulative deposit, bank will pay interest and principal on the maturity date. There will not be any entries related to interest in the ledger account of the firm. But when a profit and loss account is to be made, accountant has to ascertain the interest due as on that date and show it as a credit entry on the profit and loss account.
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