Class 11 Notes

Class 11 Accountancy Notes Chapter 2 (Financial Statements – II) – Accountancy-I Book

Philoid

Philoid

— 8 min read

Accountancy-I
Detailed Notes with MCQs of Chapter 2: Financial Statements – II from your NCERT Class 11 Accountancy-I book. This chapter is crucial, especially when preparing for competitive government exams, as it deals with the adjustments required to present a true and fair view of a business's financial performance and position. We move beyond the simple Trial Balance to incorporate information that pertains to the accounting period but hasn't yet been recorded.

Chapter 2: Financial Statements – II (Adjustments in Preparation of Financial Statements)

1. Need for Adjustments

  • Accrual Basis of Accounting: Financial statements are prepared on an accrual basis, meaning revenues are recognized when earned (not necessarily when cash is received) and expenses are recognized when incurred (not necessarily when cash is paid).
  • Matching Principle: This principle dictates that expenses incurred in an accounting period should be matched with the revenues earned during that same period to determine the correct profit or loss.
  • Limitations of Trial Balance: A Trial Balance simply checks arithmetic accuracy. It doesn't guarantee that all transactions pertaining to the accounting period have been recorded, or that all recorded items fully pertain only to the current period.
  • Purpose: Adjustments are necessary to account for items like outstanding expenses, prepaid expenses, accrued income, unearned income, closing stock, depreciation, etc., ensuring compliance with the accrual basis and matching principle. This leads to the ascertainment of the true net profit/loss and a fair presentation of the financial position.

2. Common Adjustments and their Treatment

Adjustments are typically given outside the Trial Balance. Each adjustment has a dual effect, impacting at least two accounts and consequently affecting both the Trading/Profit & Loss Account and the Balance Sheet.

Here’s a breakdown of common adjustments:

S.No. Adjustment Item Meaning Adjustment Entry (Journal) Treatment in Trading A/c Treatment in P&L A/c Treatment in Balance Sheet
1 Closing Stock Value of goods unsold at the end of the accounting period. Closing Stock A/c Dr.
To Trading A/c		 Shown on the Credit side. - Shown on the Asset side (Current Asset).
2 Outstanding Expenses Expenses incurred during the period but not yet paid. Concerned Expense A/c Dr.
To Outstanding Expense A/c		 Add to the concerned expense on the Debit side (if Trading item like Wages). Add to the concerned expense on the Debit side (if P&L item like Salary, Rent). Shown on the Liability side (Current Liability).
3 Prepaid Expenses Expenses paid in advance; the benefit extends to the next period. Prepaid Expense A/c Dr.
To Concerned Expense A/c		 Deduct from the concerned expense on the Debit side (if Trading item). Deduct from the concerned expense on the Debit side (if P&L item). Shown on the Asset side (Current Asset).
4 Accrued Income Income earned during the period but not yet received. Accrued Income A/c Dr.
To Concerned Income A/c		 - Add to the concerned income on the Credit side (e.g., Accrued Interest). Shown on the Asset side (Current Asset).
5 Unearned Income (Income Received in Advance) Income received during the period, but not yet earned (relates to the next period). Concerned Income A/c Dr.
To Unearned Income A/c		 - Deduct from the concerned income on the Credit side (e.g., Rent Received in Advance). Shown on the Liability side (Current Liability).
6 Depreciation Decrease in the value of fixed assets due to wear & tear, usage, time. Depreciation A/c Dr.
To Concerned Asset A/c		 - Shown on the Debit side. Deduct from the concerned Fixed Asset on the Asset side.
7 Bad Debts (Further Bad Debts) Amount due from debtors that has become irrecoverable (identified after preparing Trial Balance). Bad Debts A/c Dr.
To Sundry Debtors A/c		 - Add to existing Bad Debts (if any in Trial Balance) on the Debit side. Deduct from Sundry Debtors on the Asset side.
8 Provision for Doubtful Debts An estimated amount set aside for potential future bad debts (based on prudence concept). Profit & Loss A/c Dr.
To Provision for Doubtful Debts A/c		 - Shown on the Debit side (as a new provision created or increase in existing provision). Deduct from Sundry Debtors (after deducting further bad debts) on the Asset side.
9 Provision for Discount on Debtors An estimated amount set aside for discount likely to be allowed to debtors for prompt payment. Profit & Loss A/c Dr.
To Provision for Discount on Debtors A/c		 - Shown on the Debit side. Deduct from Sundry Debtors (after deducting further bad debts and provision for doubtful debts) on the Asset side.
10 Manager's Commission Commission payable to the manager, often based on net profit. Manager's Commission A/c Dr.
To Outstanding Manager's Commission A/c		 - Shown on the Debit side. Shown on the Liability side (Current Liability) as Outstanding Commission.
11 Interest on Capital Interest allowed to the proprietor on their capital investment. Interest on Capital A/c Dr.
To Capital A/c		 - Shown on the Debit side. Add to Capital on the Liability side.
12 Interest on Drawings Interest charged from the proprietor on their drawings. Drawings A/c (or Capital A/c) Dr.
To Interest on Drawings A/c		 - Shown on the Credit side. Deduct from Capital on the Liability side.
13 Goods taken for Personal Use Goods withdrawn by the proprietor for personal use. Drawings A/c Dr.
To Purchases A/c		 Deduct from Purchases on the Debit side. - Deduct from Capital (as Drawings) on the Liability side.
14 Goods distributed as Free Samples Goods given away for sales promotion. Advertisement A/c (or Free Samples A/c) Dr.
To Purchases A/c		 Deduct from Purchases on the Debit side. Show as Advertisement/Free Samples on the Debit side. -
15 Abnormal Loss of Stock (e.g., by Fire/Theft) Loss of stock due to unforeseen events. Entry depends on insurance:
1. Loss by Fire A/c Dr. To Trading A/c (Full value)
2. Insurance Co. A/c Dr. (Claim Amt), P&L A/c Dr. (Net Loss) To Loss by Fire A/c		 Credit side (Full value of goods lost) OR Deduct from Purchases (Cost of goods lost) Debit side (Net Loss = Cost of goods lost - Insurance Claim Admitted). Insurance Claim Receivable shown on Asset side (if claim admitted but not received).

Important Notes on Specific Adjustments:

  • Closing Stock Valuation: Valued at Cost or Net Realizable Value (Market Value), whichever is lower (Concept of Prudence/Conservatism).
  • Provision for Doubtful Debts Calculation: Usually calculated as a percentage on Good Debtors (Sundry Debtors - Further Bad Debts).
  • Provision for Discount on Debtors Calculation: Calculated as a percentage on Good and Collectible Debtors (Sundry Debtors - Further Bad Debts - Provision for Doubtful Debts).
  • Manager's Commission Calculation:
    • On Net Profit before charging such commission:
      Commission = (Net Profit before Commission) × (Rate / 100)
    • On Net Profit after charging such commission:
      Commission = (Net Profit before Commission) × (Rate / (100 + Rate))
  • Abnormal Loss: If goods lost were insured, the amount recoverable from the insurance company reduces the loss charged to P&L A/c.

3. Preparation of Adjusted Financial Statements

  1. Prepare Trading Account: Start with Opening Stock, Purchases (adjust for returns, drawings of goods, free samples, abnormal loss if deducted here), Direct Expenses (adjust for outstanding/prepaid). On the credit side, show Sales (adjust for returns) and Closing Stock. The balancing figure is Gross Profit or Gross Loss.
  2. Prepare Profit & Loss Account: Start with Gross Profit (or Gross Loss). Add all other incomes/gains (adjust for accrued/unearned). Deduct all indirect expenses and losses (adjust for outstanding/prepaid, depreciation, bad debts, provisions, manager's commission, interest on capital, etc.). Add Interest on Drawings. The balancing figure is Net Profit or Net Loss.
  3. Prepare Balance Sheet: List all Assets (Fixed Assets less depreciation, Current Assets like Closing Stock, Debtors less provisions, Prepaid Expenses, Accrued Income, Cash, Bank) on the right side (or bottom). List all Liabilities (Capital add Net Profit, add Interest on Capital, less Drawings, less Interest on Drawings; Long-term Liabilities; Current Liabilities like Creditors, Bills Payable, Outstanding Expenses, Unearned Income, Bank Overdraft) on the left side (or top). The Balance Sheet must tally.

4. Worksheet (Optional Tool)

A worksheet is a columnar statement used to facilitate the preparation of financial statements by incorporating adjustments systematically before drafting the final accounts. It typically includes columns for Trial Balance, Adjustments, Adjusted Trial Balance, Trading Account, Profit & Loss Account, and Balance Sheet. It helps in minimizing errors.

Importance for Exams:

  • Understanding the why behind each adjustment (principles).
  • Knowing the correct journal entry for each adjustment.
  • Accurately tracing the dual effect of each adjustment on the Trading A/c, P&L A/c, and Balance Sheet.
  • Correct calculation for provisions and commissions.
  • Ability to prepare the final accounts incorporating multiple adjustments.

Multiple Choice Questions (MCQs)

Here are 10 MCQs to test your understanding of this chapter:

  1. The adjustment for Prepaid Rent involves:
    a) Debiting Rent A/c and Crediting Prepaid Rent A/c
    b) Debiting Prepaid Rent A/c and Crediting Rent A/c
    c) Debiting Profit & Loss A/c and Crediting Rent A/c
    d) Debiting Prepaid Rent A/c and Crediting Profit & Loss A/c

  2. Outstanding Salaries appearing in the Trial Balance are shown in:
    a) Debit side of P&L A/c only
    b) Liability side of Balance Sheet only
    c) Added to Salaries in P&L A/c and Liability side of Balance Sheet
    d) Deducted from Salaries in P&L A/c and Liability side of Balance Sheet

  3. Closing Stock is generally valued at:
    a) Cost Price
    b) Market Price (Net Realizable Value)
    c) Cost Price or Market Price, whichever is higher
    d) Cost Price or Market Price, whichever is lower

  4. If an adjustment for Accrued Commission (earned but not received) is required, the effect will be:
    a) Increase Profit and Increase Assets
    b) Decrease Profit and Increase Assets
    c) Increase Profit and Increase Liabilities
    d) Decrease Profit and Decrease Assets

  5. Further Bad Debts given in adjustments are:
    a) Added to existing Bad Debts in P&L A/c and Added to Debtors in Balance Sheet
    b) Deducted from existing Bad Debts in P&L A/c and Deducted from Debtors in Balance Sheet
    c) Added to existing Bad Debts in P&L A/c and Deducted from Debtors in Balance Sheet
    d) Shown only on the Debit side of P&L A/c

  6. Provision for Doubtful Debts is created by:
    a) Debiting Sundry Debtors A/c
    b) Crediting Sundry Debtors A/c
    c) Debiting Profit & Loss A/c
    d) Crediting Profit & Loss A/c

  7. Goods costing ₹5,000 withdrawn by the proprietor for personal use, if adjusted, will require:
    a) Crediting Sales A/c by ₹5,000
    b) Debiting Drawings A/c by ₹5,000 and Crediting Purchases A/c by ₹5,000
    c) Debiting Purchases A/c by ₹5,000 and Crediting Drawings A/c by ₹5,000
    d) Debiting P&L A/c by ₹5,000

  8. Manager's commission is payable at 10% on net profit after charging such commission. If the profit before commission is ₹132,000, the commission amount will be:
    a) ₹13,200
    b) ₹12,000
    c) ₹14,520
    d) ₹11,880

  9. Which accounting principle primarily necessitates the adjustment for outstanding expenses?
    a) Business Entity Concept
    b) Matching Principle
    c) Conservatism Principle
    d) Cost Concept

  10. Depreciation on Machinery appears in the Trial Balance. It means:
    a) Depreciation is yet to be charged to P&L A/c and deducted from Machinery.
    b) Depreciation has already been charged to P&L A/c but not yet deducted from Machinery.
    c) Depreciation has already been deducted from Machinery but not yet charged to P&L A/c.
    d) Depreciation has already been charged to P&L A/c and deducted from Machinery (or credited to Provision for Depreciation A/c).

Answer Key for MCQs:

  1. b
  2. b (If it's in the Trial Balance, the expense adjustment is already done. It's just a liability.)
  3. d
  4. a
  5. c
  6. c
  7. b
  8. b (Calculation: 132,000 * (10 / (100 + 10)) = 132,000 * (10/110) = 12,000)
  9. b
  10. d (Items inside the Trial Balance represent ledger balances after primary recording, implying the accounting entry affecting P&L and the Asset/Provision has already occurred).

Study these adjustments thoroughly. Understanding their logic and impact is key to solving problems accurately in your exams. Let me know if any specific adjustment needs further clarification!

Read more