Lecture-13- Financial Statements with Adjustments (Part-2)

[Music] [Music] [Applause] [Music] welcome students so we will proceed further what we discussed in my previous lecture we'll proceed further from there and we were talking about the uh adjust ments different type of adjustments are to be done uh in the financial statements uh after say learning how to prepare the financial statements without adjustments now we are learning about the adjustments and we have learned about the first six adjustments that additional information adjustments mean the additional information which is given uh to us how to adjust that in the financial statements and then finally take the

effect of that to the say profit and loss account and the balance sheet so I'll take up now the remaining and different type of the adjustments and today we will talk about uh one more adjustment that adjustment is called as the bad debts bad debts bad debts means what is a bad debt bad debt is basically uh a kind of a loss you would say it's a kind of a loss loss which is uh uh uh on the credit sales when the Farms sell on credit they are selling on one day and uh sales proceeds

will be received at some uh future date so it happens sometimes that uh 100% of the credit sales are not recovered part of the credit sales remain unrecovered and that's a kind of the loss to The Firm there's a kind of the loss to the company and that's called as a bad debt now there are two kind of the bad Debs one is the bad debt which is uh the company is sure the firm is sure that the bad de has happened and uh that part of the credit sales will never come back means that

will never be received by the form the person or the company who has bought from the selling form they will not pay it to the selling firm and the buyer has either refused the payment or the buyer is not in a position to make the payment back to the company to the selling firm so that is called as the bad debt so bad debt is basically uh if it is given in the adjustments we have to treat it as a as a loss so uh we have already discussed that profit and loss account is a

nominal account is a nominal statement and we debit that statement with all expenses and losses and be credit that statement with all incomes and gains so it's a loss kind of a loss on the sales so we are not going to recover it so again it it will also have a double effect and the first effect of this will be that this will be shown in the uh bad debts first effect will be uh debit side debit side of P and L account or statement profit and loss account or the profit and loss statement we

will show this bad debts amount in the debit side of profit and loss account this is the first effect and then the second effect is the balance sheet and in the balance sheet we will show this amount as uh mean after deducting subtracting it from the sunary dats so we will show one item there in the balance sheet as sary dats and less we'll show in the balance sheet this is on the asset side sary datas are assets and we will show current assets and we'll show these current assets sary datas after subtracting the bad

debts law so it is less bad debts so sunry dat is less bad debts and finally whatever the amount comes that will be shown in the balance sheet so your asset means current asset which is the recovery which is the receipt of the credit sales on some future date by the amount of the bad debt that receipt that recovery bill come down so your Sury datas will be reduced by that amount of the bad debts and will show in the balance sheet sunry datas minus bad debts and the remaining figure will be shown as asset

in the balance sheet so first effect is in the profit and loss account and second effect is in the balance sheet this is about the bad debts next thing is the interest on Capital next adjustment is the at interest on Capital interest on Capital interest on Capital it is again a kind of a financial charge it's a kind of for example we uh pay the interest on loan so that interest on loan we show it on the again the debit side of the profit and loss account because interest is a interest on the on the

loan is a financial expense and that Financial expense has to be recorded and shown in the debit side of profit and loss accountant sometimes we are given uh an item in the adjustment that interest on the capital also has to be paid if the interest on Capital has to be paid so what happen this is basically a book entry in the real sense form never pays interest on its capital to its uh owner or to the shareholder but if it is to be made a book provision then we'll have to show it in the books

of accounts so uh interest on Capital also uh is also shown like the interest on loan and with that amount of the interest on Capital we debit the profit and loss account so again if the interest on capital is given to us in the adjustments we'll have to say uh make a proper record of that and we'll have to take the effect of the interest on Capital on the financial statements also so again the two effects first effect will be in the profit and loss account and second effect will be the balance sheet so both

the statements both the financial statements get affected because of the interest on Capital first effect in the profit and loss account will be we will be debiting the profit and loss account with the amount of interest on Capital to be calculated that percentage will be given to us in the adjustment that interest at the rate of 5% has to be provided on the capital and it is like the interest on loan so we have to show it as expense in the debit side of profit and loss account and we have to debit the profit and

loss account by that amount of the interest and second effect of this will be in the balance sheet and in the balance sheet it will be on the liability side of the balance sheet because in capital is a liability is a kind of a liability so how we will show this interest on Capital in the balance sheet will be like say when we prepare the balance sheet which showed on the top of the balance sheet the first item on the liability side is the capital or you call it as a share Capital right so we'll

show that amount of the share capital for example the figure of the share capital is 1 lakh 100,000 it is 1 lakh that will be shown in the balance sheet as 1 lakh rupees and this interest on Capital with which we have debited the profit and loss account it means we have taken that money out of the profit and loss account for example that is 5,000 rupees so it's as I told you it's only a book entry we never uh pay this interest to anybody only a book entry is made so on the one side

in the debit we debit the profit and loss account by this 5,000 rupees and because it is not paid to the owner of the business or shareholder of the firm so it is added back in the capital here so the capital amount will become 1ak 5,000 rupees so you will write here add interest on Capital so your share Capital will become Now 1 lakh 5,000 rupees so this is the one means the effect that comes in the balance sheet on account of the interest on Capital so interest on Capital has to be treated like this

first effect on the profit and loss account debit side with that amount which is given to us and that because it is not paid to the shareholder it's only a book entry so we add that amount we withdraw from the profit and loss account and we add it in the capital account account in the balance sheet so in the balance sheet the capital appreciates goes up by that amount of the interest on Capital with which we have debited the profit and loss account so first effect in the profit and loss account and second effect will

be in the balance sheet now we talk about the next item is interesting item that is interest on drawings interest on drawings this is a another item interest on Capital and interest on drawings now first of all we would like to understand what is the drawings drawings is basically that part of the funds or Goods withdrawn by the owner of the business for its personal use honor of the business for it personal use normally this kind of the things this kind of the withdrawals of the cash or the goods and services doesn't happen in case

of the company form of organizations but in case of the partnership forms and in case of the sole proprietor firms drawings exists for example now there is one person who is a sole proprietor he's a sole owner of the business and he withdraws some Goods which he's manufacturing and selling in the market for his personal use now that has to be recorded somewhere and that is called as drawing now these drawings when they are withd drawn only interest on drawing has to be uh given the double treatment how that has to be given the double

treatment like say for example we are given that total amount of the drawings is uh 10,000 rupees and we have to pay the interest on that drawings at the rate of 5% now in this case if you take the 5% of 10,000 rupees this works out as 500 rupees so total amount it's assumed that he has not withdrawn 10,000 rupees from the business maybe the cash or the goods worth rupees 10,000 rupees but he has withdrawn the goods or the cash worth rupe 10,500 rupees because we calculate that bid interest because had this particular amount

not withdrawn by the owner it means this would have been there in the business and if it is a capital if it is a cash if it is a funds it would have been earning something for the business maybe the rate of earning is 5% so and if it is a Goods then we could have sold these Goods in the market for 10,500 rupees so it means drawings are not only considered as the original amount withdrawn by the owner of the business from the business but along with the interest so we are talking about the

interest on drawing means we are here concerned about this 500 rupees this interest part so again we have to treat it in a double uh manner in in a two way effect the double effect of it will be there twofold effect of this will be there and in that case interest on drawings when it is means when it was interest on Capital that was the expense be treated as an expense being paid by the form to the shareholder but when it is drawings it means person is taking kind of a loan for example we are

assuming it's not a loan it never comes back to the form once it something is withdrawn it is with drawn by the owner but we say that is a kind of the loan and it is drawn with the interest so interest in that case the interest on drawings is a income interest on drawings is a income so first effect of means again it has to have the two fold effect and two fold effect if you talk about first effect here is in the profit and loss account and in the profit and loss account you show

it on the credit side this effect is shown on the credit side and when you show it on the credit side it is shown as income for example the interest on drawings as income of the firm and we will show it on the credit side of the profit and loss account and second effect of this will come in the balance sheet and in the balance sheet we will now talk about both both the amounts principal amount he has withdrawn is 10,000 rupees but he's considered to have withdrawn this amount with interest so that interest we

will add 500 rupees so total drawings amount will work out as 10,500 rupees and that total amount of 10,500 Rupees is considered as withdrawn from the business and it has to be shown in the balance sheet on the liability side in the capital so we will have to subtract whatever the for example the amount of the capital is 100,000 1 lakh and 10,000 rupees at the rate of with that 5% interest he has withdrawn so it means he has withdrawn from the businesses less Capital less drawings less drawings this amount will be 10,500 rupees along

with the interest so you will show it as less drawings or you can show independently also less drawings 10,000 rupees and then you would say another entry less interest on drawings will be 500 rupees so total amount he has withdrawn he invested 1 lakh rupees in the business and out of that he has withdrawn 10,000 plus interest on this 500 rupees so it has come down so it will be now the balance amount in the capital will be left as 89,500 rupees this is the concept of drawings so when any amount maybe the cash or

goods or services are withdrawn they are to be recorded in the business in the books of accounts and maybe it's being drawn by the owner but the owner also is not entitled we have to record that this much of the uh loss or the erosion of the capital has taken place so 1 lakh rupees minus drawings 10,000 and less interest on drawings is 500 rupees so total is 89,500 rupes will be now the balance in the capital account so first effective is the interest on drawings is a income that is to be in the credit

side of profit and loss account and second is in the balance sheet by adding it in the Sorry by subtracting it from the capital basic amount principal amount of the drawings plus interest on that total amount these two 10,500 stands withdrawn from the capital so 1 lakh minus 10,500 the balance amount in the capital account to be shown in the balance sheet will be 89,500 rupees next we will be talking about some the other adjustments also we have many adjustments so we'll be taking care of almost all the adjustments and we'll be talking about the

other adjustments also and then we have now the next is the provision for doubtful debts next adjustment is provision for doubtful debts provision for doubtful debts that's another adjustment 10th adjustment provision for doubtful debts number one first you have to understand what are the doubtful debts doubtful debts are we had just now we discussed one item that was bad debts and provision means doubtful debts is also the part of the bad debts is a kind of a bad debts but this is a provision this is not actual bad debt this is a provision for the

bad debt so that's why now I am taking it separately after the bad debts bad debt as I told you is that kind of the credit sales part which will never be recovered by The Firm the buyer has refused to make the payment or he's not able to make the payment or any other reason so Farm is not going to receive that particular part which has become no a bad debt for us or for the form and form will never re it it is for sure it has become for sure that they have discussed both

the buyer and seller and buyer is not able to pay so firm has to write it off and they will have to consider it as their loss but doubtful debts is the next part to the bad debts form mean every form is allowed as per the Indian companies act all the forms are allowed that as bads are happening and all the credit sales are not recoverable by the firms so bad debts are taking place so it means bad debts should not be considered as only B has happened till the date of balance sheet or profit

and loss account that become sure that it will not be recovered one part is that that which will not be recovered but there are certain amounts that on the date of balance sheet there will be further more credit sales part of which will be Miss doubtful to be recovered because we have preparing the balance sheet and the profit and loss account on the last day of the accounting period maybe a year you can say so it means if the firm is preparing their balance sheet on um say 31st December on any year and firm has

sold on 1st of December to somebody on credit and he has been given the credit period of 60 days right so it means the sales which are made on 1 December he'll be they are made in this year but he'll be paying for those after 2 months it means December 1 full and January full so he'll pay somewhere on 31st January next year or 1st February next year but there are sales of this year which will be recovered later on so now we can say that as part of the previous sales has become bad debts

part of these sales may also part of me I'm not saying full part of these sales may also become bad debts because for example we have sold to this person for 10,000 rupees and he has to pay sold in this year but he has to pay next year in the month of January or February 10,000 rupees but when the time of the payment comes he says that I'm not able to pay you 10,000 rupees so we would have to now negot iate with him that how much you can pay he can say okay give me

a discount of 10% and I'll pay you not 10,000 but 9,000 rupees or he may say that either you accept 9,000 rupees or I'll not pay you anything in that case form considers that it's always better to have a loss of 1,000 rupees rather than having a loss of 10,000 rupees so they may say that okay we'll give you discount of 1,000 rupees you pay us 9,000 rupees and we'll close your account so it means this kind of the debts or the credit sales which are to be received in future they are receivable in future

as some part of the sales have become bad debts in the past so it means the credit sales to be recovered in the future may part of that also become the bad debts but and at that time it becomes a bad debt and in this year we are showing as a income of this year it means the firm is in trouble so under the convention of conservatism if you remember those conventions four conventions one convention was the convention of conservatism so under the convention of conservatism forms are allowed under the Indian companies act that they

can make Provisions for the doubtful debts because bad debts are happening in the business so they can make the provision for the doubtful debts and so what we will do they'll have to make a provision for doubtful debts and this provision again has a two-fold effect so first effect of this will be in the profit and loss account and second effect of this will be in the again in the balance sheet two fold effect of the provisions there are two parts one is the bad debts which has already happened second is the provision further bad

debts may also take place so firm should be given the benefit of that so in the profit and loss account what we are doing we are debiting again now we are debiting the profit and loss account with the provisions amount Also earlier we debited for the bad debts for example now bad debts amount was 1,000 rupees so we had debited it and we have in the balance sheet we have subtracted it from the sunary dats so whatever the figure of the sunry data will be that will be coming down as an asset by 1,000 rupees

one part second part is now the provisions for the doubtful debts that after the bad debts further more bad debts can also be there and if those bad debts take place for example provision are again of 500 rupees that 500 more may not be recovered by the form when the actual due date will arrive so it will what will happen you will first s in the profit and loss account bad debts bad debts b o d 1,000 rupees and then you would write there add provision for bad debts provision for bad Debs so total amount

will become 10,500 rupe this is the first effect of the provisions like bad debts bad debts have happened Provisions May further bad debts may take place and second effect is in the balance sheet again when you show the sunary detas in the balance sheet as an asset first you will say sunry dat is for example the amount is 10,000 rupees total amount is total credit sales so first what we have already learned about less bad debts b obl d bad debts this is 1,000 rupees we will write in the balance sheet now one more less

less provision for bad Debs BDS this is 500 rupees so total now the reduction will be by 10 1,500 rupees so now we'll not be recovering total amount will be 8 8,000 uh uh to total amount which we will not be recovering will be 8,500 rupees me sorry which will be not be recovering 1,500 rupees and total amount which will be recovered expected to be recovered by The Firm on account of the credit sales will be 8,500 rupees means, 1500 has means 1,000 has become the bad debt already and 500 more may become the bad

debt so total amount which is unrecoverable by the firm is going to be 1,500 rupees this plus this and the balance amount which will be recovered by The Firm expected by The Firm on the credit sales is 8,500 rupees so Provisions for the bads are also like bad debts and miss one has already happened another may happen but the treatment is same both will be debited in the profit and loss account and both will be subtracted from the sundary datas in the balance sheet but step by step not together step by step we have to

show the independent entries individual entries and we have to show it uh independently separately in the profit and loss account as well as in the balance sheet next is the provision for discount on datas this is the 11th adjustment but again related to the B Debs provision for discount on DTS provision for Discount provision for discount on dats again this is a number one to be learned this is again is going to be a provision provision provision means this loss May further happen to the farm so we have to make the provision in the current

years profit and loss account because these are the sales pertaining to the current year so this is the third thing in the row pertaining to M it's a kind of a debt or possible bad debts me have has to be treated not a possible bad debt but has to be treated like bad debts so provision for uh discount on datas will be again having twofold effect first effect is in the profit and loss account profit and loss account second effect will be in the balance sheet and as we are talking about the two effects profit

and loss account will having the same effect as we could see in case of the bads so with this amount also provision for the discount on DS we will be debiting the profit and loss account it's again considered a possible loss and second effect will be as we have treated the first two items bad debts and provision for the bad debts we'll be treating the same in the balance sheet by subtracting it from the sunry datas so first effect it will be shown in the profit and loss account that by this amount of discount debiting

the profit and loss account so as I told you there now there are three amounts first amount was bad debt as we have discussed and bad debt is uh as he assumed that it is 1,000 rupees provision for bad debts provision for bad debts is as we have seen the figure we have assumed the figure is 500 rupees and now discount on DS disc provision for discount on dats will be again say for example 500 rupees so total amount with which the we are going to debit the profit and loss account is 2,000 Rupees it

means this amount has already become bad debt will never be recovered for sure this may not be recovered and this may also become the bad debt clear then third is the provision for discount on datas means now whatever the leftover sundry datas are left credit sales are left how much sales were left Sury dors were left with us as we assumed it was 10,000 in the beginning we have 1,000 as a bad debt 500 as uh provision for the bad debts so now how much is recoverable 8,500 Rupees is recoverable but now we are talking

about the third item also that for recovering this 8,500 Rupees to persuade the buyers who have bought in the past to pay in future we may have to persuade them and sometime we have to request them that you make the payment on the due date or sometime even before the due date and if you do so we'll give you discount of 500 rupees so now 500 more kind of a loss The Firm has to bear and the total recovery on account of the 10,000 rupees credit sales will be 8,000 rupees Total Recovery will be 8,000

rupees so it means is all almost they belong to the same category this is a loss to the firm because they sold on the credit sometime in the past and they are going to recover those credit sales in future maybe even after the date of balance sheet so how much they had sold for 10,000 rupees and it is assumed that by 31st December of the current year when we are preparing the profit and loss account 1,000 has become the bad debt but it is not recorded in the profit and loss account so far so we

have to record it on the day of profit and loss account so it means it came down to recovery came down to 9,000 possible recovery then we are saying that as 1,000 is already happen 500 further may happen it will become further loss it is 1,500 so it is 8,500 rupees now the possible recovery and when it may be possible we are assuming that when the due date will will arrive maybe in January or February next year we'll have to persuade the the the credit buyers that please make the payment either on the due date

or before that and if you do so we'll give you a further discount of 500 rupees so we will have to make a provision for that also for example if we have not made the provision in the current profit and loss account for the discount and on the due date or before getting the money before due date we have to give them a discount it means from where this 500 rupees will come so we have already anticipated that situation and we have already made the provision here and we have to we have that provision 500

rupees so we can give 500 rupees discount to that buyer and or to different kind of buyers and finally the total amount to be received by the form will be on the due date will be 8,000 rupees on account of the credit sales now if for example this discount is not required to be given in future on the due date and this 500 provision we have made so where this 500 rupees will go number one second thing is we have made one more provision here for bad debts for the 500 rupees but on the due

date there is no further bad debt and all buyers pay on the due date honestly they pay on the due date and this 500 Rupees is also left so what to do with this amount of the 500 rupees this and this which we made two Provisions but they were not required on the due date people paid honestly and we could recover out of 10,000 rupees 1,000 was a bad debt 500 rupees Provisions are not required and people have paid honestly 9,000 rupees back to the firm so it means we had made the provisions but that

is not utilized so what would do be that 1,000 rupees 500 plus 500 that I will discuss with you that is called as the provision for doubtful debts but we have to reverse it as we have debited with these two amounts the profit and loss account we will have to now credit the profit and loss account and we'll have to a reverse entry next time next year if that amount doesn't become a bad debt and this discount is not required to be given a reverse entry has to be passed and while providing making a provision

be debited to the profit and loss account then while not utilizing this amount returning this amount back to the firm we will be making a reverse entry in the profit and loss account showing it as a income or a credit balance in the profit and loss account but how to do it then I'll be talking about the provision for the debtors as a credit balance in the profit in the trial balance we will be given two kind of balances one balance will be the debit balance second balance will be the credit balance debit balance means

the loss of the Year actually which with which we have to debit the profit and loss account and the credit balance means this provision was made last year but it has not been utilized so it has to be adjusted so we'll have to show it as a income in the or gain in the credit side of the profit and loss account how to do that I'll discuss with you when I'll be talking about the credit balance of the bad debt Provisions it means or even if you can be clear here that if in the trial

balance you are given information that the balance of the bad debts is this much which is a normally debit balance and if credit balance is also given it means that credit balance we have to adjust we had provided in the previous year but that has not happened as a bad debt and we are not to give any discount also it means that money is saved 1,000 rupe saved and we will have to pass a reverse entry show it as a income in the credit side of the profit and loss account so when we make a

provision we show it in the debit side but when we don't utilize those that money set aside by provisions and that is saved we have to reverse it back to the form we have to return it to the back in the next year's profit and loss account and we show as a income or a gain in the credit side of the next year's profit and loss account so this is all for today uh in this lecture up to this these adjustments 11 adjustments we have talked so far remaining part of the adjustments I'll be talking

to you in my next lecture thank you very [Music] [Applause] [Music] much