17.6. Adjustments in Final Accounts

Add to concerned expense in P&L, show as liability in BS

Outstanding expenses are costs that a business has incurred but has not yet paid by the end of the accounting period. For example, if a company has received services like electricity or internet but has not yet settled the bill, this expense still needs to be recorded. In the Profit & Loss (P&L) account, the outstanding expenses are added to the related expense category, increasing the total expenses. In the Balance Sheet (BS), these amounts are reported as a liability, indicating that the company owes this money.

Think of a person who regularly eats at a restaurant but decides to pay their bill the following month. Even though they enjoyed their meal and benefited from it this month, they still owe the restaurant money for the service in their current period. Similarly, businesses record this 'owed' amount as outstanding expenses.

Deduct from concerned expense, show as asset in BS

Prepaid expenses refer to payments made for services or goods that will be received in future accounting periods. For instance, if a company pays its insurance premium for six months in advance, it should not record this entire amount as an expense in the current accounting period because part of it pertains to future periods. In the P&L, the prepaid expense is deducted from the total expense, and on the BS, it is shown as an asset since the company has a right to services or goods that it has already paid for.

Consider a subscription service that you pay for a year in advance. Even if you pay for it now, you are actually 'using' that subscription over the next 12 months. Just like the subscription, when businesses pay for something in advance, they record it as a prepaid expense, acknowledging that they still have a benefit coming in the future.

Add to income in P&L, show as asset in BS

Accrued income represents revenue that has been earned but not yet received by the end of the accounting period. For instance, if a consulting firm completes a project in December but will only bill the client in January, this income must still be recognized in December's financial reports. In the P&L, this accrued income is added to total income since it is revenue that the business has earned during the period. In the BS, it is reported as an asset because the business expects to receive this money soon.

Imagine a freelancer who finishes a project for a client in December, but the payment is not due until January. Although the money isn't in their account yet, they still earned that income in December, similar to how businesses account for accrued income.

Deduct from income in P&L, show as liability in BS

Income received in advance refers to money received by a business before it has actually earned that income. An example would be a magazine publisher that receives payments for magazine subscriptions before the magazines are published. In the P&L, this amount is deducted from total income since it doesn’t reflect actual earned revenue. In the BS, it is shown as a liability because the company still owes the subscribers their magazines in the future.

Think of ordering a pizza. If you pay for the pizza ahead of time, you haven't yet received the product; you're entitled to it in the future. Hence, the restaurant has a liability to fulfill your order, similar to how businesses treat income received in advance.

Charge in P&L, deduct from asset in BS

Depreciation is the process of allocating the cost of tangible assets over their useful lives. For example, if a company buys machinery for ₹100,000 and estimates it will be useful for 10 years, it might record an annual depreciation expense of ₹10,000. This expense is charged in the P&L account, reducing the net profit. In the BS, the machinery's value is deducted by the same amount, reflecting its decreased value over time.

Imagine buying a new car. As time passes, the car loses value due to wear and tear. You wouldn’t expect to sell it for the same price you paid after a few years. Similarly, businesses factor in this loss of value through depreciation, showing the true worth of their assets.

Charge to P&L, deduct from debtors in BS

Bad debts are amounts owed by customers that are unlikely to be collected. For instance, if a business sells goods on credit and later realizes that a customer has gone bankrupt, the owed amount is deemed uncollectible. The business must charge this amount as an expense in the P&L, reducing overall profit. Additionally, in the BS, it is deducted from the debtors (accounts receivable) since that amount will no longer be received.

Think of lending money to a friend who promises to pay you back, but later you find out they can’t. You’d recognize that you won’t get that money back—just like businesses must account for bad debts, recognizing that they may not receive what is owed.

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