Chapter 2 Financial Statements II Solutions

Question - 1 : - Why is it necessary to record the adjusting entries in the preparation of final accounts?

Answer - 1 : -

Recording adjusting entries in preparing final accounts is necessary because of the following reasons:

It helps in assessing whether the final accounts reflect true profit or loss, it also shows true financial position of a business.
It ensures accounts comply with the accrual basis of accounting.
It makes sure that all financial transaction belong to current fiscal year. No transaction of past or future are taken into account.
It provides the scope for introducing different provisions which can be made at year end, only after assessing the whole year’s performance.

Question - 2 : - What is meant by closing stock? Show its treatment in final accounts.

Answer - 2 : -

Cost of goods that remains unsold in the inventory after completion of the accounting period is referred to as the closing stock. The closing stock value is determined by comparing the realisable value and cost price. The lesser among two values is considered as the value of closing stock.

In final accounts the closing stock is adjusted by:

1) Crediting the closing stock to trading and profit and loss account.

2) Placing it on the asset part of the balance sheet.

Following entries need to be passed for adjustment

Closing Stock A/c Dr.

To Trading A/c

Question - 3 : -
State the meaning of:
(a) Outstanding expenses
(b) Prepaid expenses
(c) Income received in advance
(d) Accrued income

Answer - 3 : -

(a) Outstanding Expenses: Such expenses are incurred in the present accounting period but are not paid. As expense is generated during accounting period it makes perfect sense to charge it against revenue earned to arrive at true profit or loss. These are liabilities and need to be paid.

(b) Prepaid Expenses: Those type of expenses in which the associated benefit has not been materialized, but the payment is already done in advance are known as prepaid expenses.

(c) Income received in advance: The income is received in the present accounting period and the benefits will be realised in the upcoming accounting period, such income is called income received in advance.

(d) Accrued Income: Income that is earned in the accounting period, but yet to be received by end of accounting period is known as accrued income. It is due to be received in the future accounting periods. It is shown on asset side of balance sheet.

Question - 4 : - Give the proforma of income statement and balance in vertical form.

Answer - 4 : -

Income statement for the period ended ….
		Particulars		Amount ₹		Amount ₹
Sales
Less: Sales returns (Return inwards)

Total Sales Revenue

Cost of goods
Purchases
Less: Purchase returns (Return outwards)
Carriage on purchases
Wages
Add: Outstanding wages
Less: Prepaid wages
Fuel and power
Factory rent
Installation or erection of machines
Octroi
Less: Closing stock
Gross Profit/Gross Loss (whichever is applicable)
Operating Expenses/Losses
Selling Expenses/Losses
……………………
……………………		……………………
……………………		……………………
……………………		……………………
……………………		……………………
……………………		……………………
……………………		……………………
……………………		……………………
Total Selling expenses
General & Administrative expenses/losses
……………………
……………………		……………………
……………………		……………………
……………………		……………………
……………………
……………………		……………………
……………………		……………………
……………………		……………………
Total General & Administrative Expenses
Total Operating Expenses/Losses
Balance sheet
	Particulars		Amount ₹		Amount ₹
Current Assets
……………………
……………………
……………………
……………………
……………………
……………………
……………………
……………………
Prepaid expenses
Total current assets
Current Liabilities
……………………
……………………
……………………
……………………
……………………
……………………

……………………
Total current Liabilities
Non-Current Assets
……………………
……………………
……………………
……………………
……………………

……………………
……………………
Total non-current assets
Non-Current Liabilities
……………………
……………………
……………………
……………………
……………………
……………………
……………………
……………………
Total non-current Liabilities
Capital

Question - 5 : - Why is it necessary to create a provision for doubtful-debts at the time of preparation of final accounts?

Answer - 5 : -

In an ideal scenario, it is expected that debtors will be paying all the amount owed by them to the business, in reality it doesn’t happen as some debtors might default on paying. It can be the full amount or a part of the sum borrowed. It is uncertain as to how much will that debt actually becomes bad debt. A business has to make a reasonable estimate for such an event. This estimate is called as provision for bad debts. It is created by debiting P & L account.

Profit and Loss A/c Dr

To Provision for doubtful debts A/c

Question - 6 : -
What adjusting entries would you record for the following?
(a) Depreciation
(b) Discount on debtors
(c) Interest on capital
(d) Manager’s commission

Answer - 6 : -

(a) Depreciation

Dr.			Cr.
Particulars	Amount	Particulars		Amount	Liabilities	Amount	Assets		Amount
Depreciation							Assets
								Less: Depreciation

(b) Discount ondebtors

Dr.			Cr.
Particulars	Amount	Particulars		Amount	Liabilities	Amount	Assets		Amount
Discount on Debtors							Debtors


								Less: Discount on Debtors

Dr.			Cr.
Particulars	Amount	Particulars		Amount	Liabilities		Amount	Assets	Amount
Interest on Capital					Capital
						Add: Interest on Capital

(d) Manager’scommission

Two types of managercommission can be seen.

Case 1: Whencommission is applied on the profit before commission being charged.

Dr.			Cr.
Particulars	Amount	Particulars		Amount	Liabilities	Amount	Assets	Amount
Manager’s Commission					Outstanding Manager’s
					Commission

Case2: When commissionis applied on the profit after charging the commission.

Dr.			Cr.
Particulars	Amount	Particulars		Amount	Liabilities	Amount	Assets	Amount
					Outstanding Manager’s
					Commission




Manager’s Commission

Question - 7 : - What is meant by provision for discount on debtors?

Answer - 7 : -

A business allows discounts to debtors for encouraging them to clear the debts. The amount of discount that a debtor will receive is estimated and accounted for by creating a provision for discount on debtors. It is only for those debtors who repay on time. The journal entry for such event can be written as:

Profit and Loss A/c

Dr.

To Provision for Discount on Debtors A/c

Discount to debtors is an expense and hence it is shown in expense side of P & L account and deducted from assets side in the balance sheet.

Question - 8 : -
Give the journal entries for the following adjustments:

(a) Outstanding salary at ₹ 3,500.
(b) Rent unpaid for one month at ₹ 6,000 per annum.
(c) Insurance prepaid for a quarter at ₹ 16,000 per annum.
(d) Purchase of furniture costing ₹ 7,000 entered in the purchases book.

Answer - 8 : -

S. No.

Particulars

L.F.

Debit

₹

Credit

₹

Salaries A/c Dr.

3,500

To Outstanding Salaries A/c

3,500

(Salaries outstanding for Rs 3,500)

Rent A/c Dr.

500

To Outstanding Rent A/c

500

Prepaid Insurance A/c Dr.

4,000

To Insurance A/c

4,000

(Insurance premium paid in advance for 3 months i.e. ₹ 4000)

Furniture A/c Dr.

7,000

To Purchases A/c

7,000

(Correction entry for Wrong debit of Furniture to Purchases Account)

(Rent unpaid for one month = 6000/12 = ₹ 500)

Question - 9 : - What are adjusting entries? Why are they necessary for preparing the final accounts?

Answer - 9 : -

In accrual base of accounting, profit and loss for a year is not dependent only in revenues in cash or expenses paid in cash during the year. Some part of the receipts and expenses that occurred in a year might be belonging to previous/future accounting period. There can be some expenses which are yet to be brought to books of account. Adjusting these items will provide a true and fair view of business.

Recording adjusting entries in preparing final accounts is necessary because of the following reasons:

1. It helps in assessing whether the final accounts reflect true profit or loss also it shows true financial position of the business.

2. It ensures accounts comply with the accrual basis of accounting.

3. It makes sure that all financial transaction belong to current fiscal year. No transaction of past or future are taken into account.

4. It provides the scope for introducing various provisions which can be made at year end, only after assessing whole year’s performance.

Question - 10 : - What is meant by provision for doubtful-debts? How are the relevant accounts prepared and what journal entries are recorded in the final accounts? How is the amount for provision for doubtful-debts calculated?

Answer - 10 : -

Profit and Loss A/c Dr

To Provision for doubtful debts A/c

Provision for doubtful debts is shown as deduction from debtors on asset side of balance sheet. It presents a true and fair view of business. Provision for doubtful debts created at the end of the accounting period is carried forward to the next accounting period.

Adjustment entries for the provision for doubtful debts

Profit and Loss Account

Expenses/Losses	Amount ₹	Revenues/Gains	Amount ₹
Provision for doubtful debts
Bad debts
Further bad debts
New provision
*Less:* Old Provision

BalanceSheet

Liabilities	Amount ₹	Assets	Amount ₹
		Sundry debtors
		*Less:* Further bad debts
		*Less:* Provision for doubtful debts

Free - Previous Years Question Papers

Chapter 2 Financial Statements II Solutions

Subscribe Now!