How to prepare Financial Statements with adjustments

Adjustments at the Balance Date and Preparation of Sole Proprietorship Financial Statements

What you need

• A Trial Balance at the period-end date (e.g. 31 December 2024)
• A list of adjustment notes (closing stock, accruals, prepayments, depreciation, bad debts, provision for doubtful debts)
• Familiarity with the format of the Income Statement and the Statement of Financial Position
• An understanding of double entry (debit and credit), and a calculator

Step by step

1. 1

   Gather the Trial Balance and list the adjustment notes

   Take the Trial Balance of Perniagaan Setia at 31 December 2024, which shows, among other items, Sales RM120,000, Purchases RM70,000, Opening stock RM8,000, Rent RM12,000, Salaries RM18,000, Insurance RM3,000, Office equipment (cost) RM40,000 and Debtors RM10,000. List the adjustments: closing stock RM6,000, accrued rent RM1,000, prepaid insurance RM500, depreciation of equipment 10% on cost, bad debts RM500, and provision for doubtful debts 5%. Mark which items affect the Income Statement only, which affect the Statement of Financial Position only, and which affect both.

2. 2

   Adjust for closing stock

   Closing stock RM6,000 appears in two places. Entry: Debit Closing Stock RM6,000; Credit Closing Stock (trading section) RM6,000. In the Income Statement, cost of sales = Opening stock RM8,000 + Purchases RM70,000 − Closing stock RM6,000 = RM72,000. Gross profit = Sales RM120,000 − Cost of sales RM72,000 = RM48,000. The closing stock RM6,000 is then carried to current assets in the Statement of Financial Position.

3. 3

   Adjust accrued and prepaid expenses

   Accrued rent RM1,000 is added to the rent expense: RM12,000 + RM1,000 = RM13,000 reported in the Income Statement, while RM1,000 is shown as accrued expenses (current liability). Prepaid insurance RM500 is deducted: RM3,000 − RM500 = RM2,500 in the Income Statement, while RM500 is shown as prepaid expenses (current asset). Remember the rule: an accrual adds to the expense and creates a liability; a prepayment reduces the expense and creates an asset.

4. 4

   Calculate and record depreciation

   Depreciation of equipment = 10% × cost RM40,000 = RM4,000. Entry: Debit Depreciation Expense RM4,000; Credit Accumulated Depreciation of Equipment RM4,000. The RM4,000 becomes an expense in the Income Statement. In the Statement of Financial Position, the equipment is shown at cost RM40,000 less accumulated depreciation RM4,000 = net book value RM36,000.

5. 5

   Write off bad debts

   Bad debts RM500 are written off from debtors. Entry: Debit Bad Debts RM500; Credit Debtors RM500. The RM500 becomes an expense in the Income Statement. Debtors fall: RM10,000 − RM500 = RM9,500. Use this new balance of RM9,500 to calculate the provision for doubtful debts in the next step, not the original RM10,000.

6. 6

   Create the provision for doubtful debts

   Provision for doubtful debts = 5% × RM9,500 = RM475. Entry: Debit Provision for Doubtful Debts Expense RM475; Credit Provision for Doubtful Debts RM475. Because this is a new provision, the whole RM475 becomes an expense in the Income Statement. In the Statement of Financial Position, debtors RM9,500 less provision RM475 = net debtors RM9,025.

7. 7

   Prepare the Income Statement

   Begin with gross profit RM48,000. Deduct all adjusted expenses: Rent RM13,000, Salaries RM18,000, Insurance RM2,500, Depreciation RM4,000, Bad debts RM500 and Provision for doubtful debts RM475, giving total expenses RM38,475. Net profit = Gross profit RM48,000 − Total expenses RM38,475 = RM9,525. This net profit is carried to the owner's equity section.

8. 8

   Prepare the Statement of Financial Position

   Non-current assets: Office equipment (net book value) RM36,000. Current assets: Closing stock RM6,000 + net Debtors RM9,025 + Prepaid insurance RM500. Owner's equity: Capital + Net profit RM9,525 − Drawings. Current liabilities: Accrued expenses (rent) RM1,000. Confirm that Total Assets = Owner's equity + Liabilities so the statement balances.

Second example

Suppose Kedai Harmoni closes its accounts on 31 December 2024. Its Trial Balance shows Commission Received RM2,000 and Rent Received RM4,800. Adjustments: accrued commission RM300 is still to be received, and of the rent received, RM800 relates to 2025. For income, the direction of adjustment is the opposite of expenses. Commission: RM2,000 + RM300 = RM2,300 is included as income in the Income Statement, and RM300 is shown as accrued income (current asset). Rent: RM4,800 − RM800 = RM4,000 as income, and RM800 is shown as rent received in advance (current liability).

Now suppose Kedai Harmoni already has a Provision for Doubtful Debts of RM200 from last year and must raise it to RM300 on debtors of RM6,000. Only the increase of RM100 is charged as an expense: Debit Provision for Doubtful Debts Expense RM100; Credit Provision for Doubtful Debts RM100. In the Statement of Financial Position, debtors RM6,000 less provision RM300 = RM5,700.

Common mistakes

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