Financial Statement with Adjustment with Examples-II

Through adjustments in the financial statement, we consider all the accounting items which are relevant to the current financial year, but not recorded in the books due to any reason or wrongly recorded. This helps us in getting the actual profit or loss for the year and the accurate financial position of the company. Five adjustments such as Interest on Capital, Interest on Drawings, Interest on Deposits, Interest on Loans, and Proprietor’s Salary are discussed below:

1. Interest on Capital:

Interest on Capital means when the proprietor renders money to the firm for running the business, in turn, the firm provides interest on capital to the proprietor. The rate of interest shall be pre-determined on the basis of the time period. For example, if the proprietor has lent an amount at the beginning of the given period, he shall receive an interest on capital for the whole period and if it is lent between the year then the rate of interest on capital shall be calculated accordingly in the proportion of time.

Adjustment:

A. If Interest on Capital is given outside the trial balance:

In such case, two effects will take place –

• Interest on Capital will be shown on the debit side of the Profit & Loss A/c, being an item of expense for a business.
• It will be added to the Capital A/c in the Liabilities side of the Balance Sheet.

B. If Interest on Capital is given inside the trial balance:

In such a case, Interest on Capital will be shown only in the Dr. side of the Profit & Loss A/c, being an expense for a business.

2. Interest on Drawings:

Drawings is the amount withdrawn by partners for their personal use from the business. Therefore, the firm charges a certain rate of interest for the amount withdrawn by partners. The interest on Drawings is considered an income for the firm and an expense for the partners.

Adjustment:

A. If Interest on Drawings is given outside the trial balance:

In such case, two effects will take place –

• Interest on Drawings will be shown in the Cr.. side of the Profit & Loss A/c, being an income for the business.
• It will be added to the Drawings A/c  and subtracted from the Capital A/c in the Liabilities side of the Balance Sheet.

B. If Interest on Drawings is given Inside the trial balance:

In such a situation, Interest on Drawings will only be shown in the Cr. side of the Profit & Loss A/c, being an income for the business.

3. Interest on Loan:

A business usually takes loans from banks in order to make expenditures in their business. They also need to pay certain interest on this loan amount. If a business is unable to pay the interest on the loan in the same financial year, then this interest is called Outstanding Interest. The adjustments, in this case, are shown below:

Adjustment:

A. If Interest on Loan is given outside the trial balance:

In such case, two effects will take place:

• Firstly, Interest on the loan will be shown in the Dr. side of the Profit & Loss A/c, being an item of expense.
• It will be added to the Loan A/c in the Liabilities side of the Balance Sheet.

B. If Interest on Loan is given Inside the trial balance:

In such a case, Interest on the loan will only be shown in the Dr. side of the Profit & Loss A/c, being an expense of the business.

4.  Proprietor’s Salary:

If the proprietor works in the firm, the firm has to a pay salary to the proprietor. The proprietor’s salary is an expense to the firm.

Adjustment:

A. If Proprietor’s Salary is given outside the trial balance:

In such case, two effects will take place:

• Proprietor’s salary will be shown in the Dr. side of the Profit & Loss A/c, being an expense for the business.
• It will be added to the Capital A/c in the Liabilities side of the Balance Sheet.

B. If Proprietor’s Salary is given Inside the trial balance:

In such a case, Proprietor’s salary will only be shown in the Dr. side of the Profit & Loss A/c, being an item of expense.

5. Interest on Deposits: 

When an investment is made and deposited into the bank, the bank pays interest on that deposit. This is known as interest on deposits. For example, Opening of Fixed Deposit into the bank. The bank pays a fixed rate of interest on these deposits.

Adjustment:

A. If Interest on Deposits is given outside the trial balance:

In such case, two effects will take place:

• Interest on deposits will be shown in the Cr. side of the Profit & Loss A/c.
• Amount of Interest on Deposits is added to the Bank Deposits in the Assets side of the Balance Sheet.

B. If Interest on Deposits is given Inside the trial balance:

In such a case, Interest on Deposits will be shown only once in the Cr. side of the Profit & Loss A/c.

Illustration:

The following adjustments were noted:

• Interest on capital @ 5% to be provided.
• Interest on Drawings is to be charged at 10% p.a. These Drawings have been made at the beginning of the year.
• Salary to be provided to proprietor i.e. 5000.
• Interest on loan to be provided at 6% p.a.
• Interest on Bank Deposits is to be provided @ 4%.

Solution: