At the end of an accounting period, it is customary to close all the accounts, extract a trial balance, and then prepare the set of final accounts : the income statement and the balance sheet.
However, there are a number of adjustments that may be required prior to the preparation of the final accounts. These include : (a) adjustments for owings and prepayments; ( b) adjustments for bad debts and provision for bad debts; and (c) adjustments for depreciation.
(a) ADJUSTMENTS FOR OWINGS AND PREPAYMENTS
At the end of the accounting period, the revenue earned must be matched against the expenses incurred, in order to derive the profit or loss for the period.
In some cases, though, the actual revenue earned may not correspond with the amount recorded in the books. Likewise, the expenses incurred may be different from the total cash paid for them. A contractual amount may either be owing ( called accrual), or paid in advance (called prepayment), at the end of the period.
However, in keeping with certain accounting concept, revenue must be accounted for in the period when it was earned, and not necessarily when it was received. The same principle applies to expense items. Thus, some items of revenue and expenses may need to be adjusted when preparing the final accounts. These adjustments are classified and treated as follows:
| | | | |CLASSIFICATION |TREATMENT IN THE |TREATMENT IN | | |INCOME STATEMENT |THE BALANCE SHEET | | | | | |a) Expense Owing | | | |---------------------- | | | |This is the portion of the expense |The amount owing must be added to the amount |The unpaid portion, called accrued expense, | |item that is unpaid or owing at the|already paid |is treated as a current liability | |end period | | | | | | | | | | | |b) Expense Prepaid | | | |------------------------- | |The prepaid portion must be included | |The portion of the expense |The prepaid portion must be deducted from the total|as a current asset | |item that is paid in advance |amount paid | | | | | | | | | |