Closing Entries
After entry of transactions of regular business activities in Accounts Books, to prepare Final Accounts to reflect the correct position of Profit & Loss and Assets & Liabilities, it is necessary to further make adjustments to make distinction between revenue & capital and to separate the Income & Expenses related to the accounting period. The Adjustment entries, called Book Closing Entries, are entered to prepare Financial Statements at Financial Year End.
| Adjustment related to Parties (Debtor & Creditor) Provision for Bad Debts Provision for Discount to DebtorsSet-off between Debtors & CreditorsDishonour of Cheques or Bills Adjustment for Stock Goods Distributed as Free SamplesLoss of stock Goods sent on Approval BasisClosing Stock Proprietor’s Transactions Drawings / Personal expensesMaterials Withdrawn by for personal use | Adjustment for Interest Interest on Loan takenInterest on Capital Interest on Drawings Adjustment for Income & Expenses Outstanding ExpensesManagerial CommissionPrepaid ExpensesAccrued IncomeIncome received in Advance |
Provision for Bad Debts
Credit sales are recognized as income at the time of the sale. However, later on, some customer may not pay, resulting in loss. It is prudent to create a provision for Bad Debts on principle of conservatism, in the current period. Provision for Bad debts is shown as deduction for Sundry Debtors in the Balance Sheet
Such Provision is required to be shown on the Debit Side of Profit and Loss Account. New Provision is added to the existing Provision, Bad Debts incurred are deducted from the total Provision and the Net Amount is shown on Debit Side of Profit and Loss Account. If the Old Provision is more than the new Provision required for Bad Debts, the Net Amount is shown on the Credit Side of Profit and Loss Account.
Making new Provision
Profit and Loss A/c Dr
To Provision for Bad debts A/c
For adjustment of existing provision
At first, calculate the amount of provision to be created at the end of the period. Now compare it with the provision already appearing in the Trial Balance.
- For additional Provision required than appearing in the Trial Balance
If the existing provision is less, make entry for Balance Provision to be made.
Profit and Loss A/c Dr
To Provision for Bad debts A/c
(By the amount of additional Provision required over the Existing Provision)
- When existing Provision is more than required provision
If the existing provision is more, make entry to write off the extra provision
Provision for Bad debts A/c Dr
To Profit and Loss A/c
The required position is then shown in the Balance Sheet as deduction from Sundry Debtors.
Writing off Bad Debts
Some of the dues may not be recoverable. The unrecoverable debts are called Bad Debts. It is a loss to the business.
Bad Debts written off A/c
To Sundry Debtors A/c
- Exisiting Provision : When provision for bad debts is already made, the Bad Debt written off is reduced from Provision for Bad Debt. Actual Bad Debts written off is reduced from the Provision for Bad Debts in the Balance Sheet.
- No existing Provision : When no provision is made for Bad Debt, The Bad Debts would appear in the Profit & Loss Account as expenses. In that case, there would be an entry :
Profit and Loss A/c Dr
To Bad Debts written off A/c
Provision for Discount on Debtors
Most traders give a cash discount to debtors who make prompt payment (i.e. within a specified time). So, the real worth of debtors will be the gross figure of debtors, less the cash discount that they would take.
The estimated amount of discount should be deducted from the total of debtors, and provision for discount on debtors should be made only on the balance.
The Provision on Discount is shown in the Balance Sheet as deduction from Sundry Debtors
Profit and Loss A/c Dr
Provision for Discount on Debtors A/c
Set-off between Debtors & Creditors
Sometimes, a Debtor (who purchased goods, like a finished product) may also be a Creditor (who supplied some goods, like Raw Materials) for the business. So, there will be balance in both his accounts. Instead of receiving payment for sale and making payment for purchase, these Debit & Credit balances of the Party may be mutually set-off, by the amount whichever is lower.
| Sundry Creditors A/c | Dr. | ||
| To Sundry Debtors A/c |
Dishonour of Cheques or Bill of Debtors
Sometimes, a cheque or Bill of Exchange given by a debtor in payment of his dues, may get dishonoured. The entry for Dishonour of Cheque or Bill of Exchange, will be exactly reverse to the original entry made at the time of receipt
Dishonour of Cheque : When a cheque previously received from a debtor, is dishonoured, the debtors is increased and the bank balance is decreased.
| Sundry Debtor A/c | Dr. |
| To Bank A/c |
Dishonour of Bill of Exchange : When a Bill of Exchange, previously drawn on a debtor, is dishonoured, Debtor Account is debited and the person who is holding the bill is credited.
The entry may differ to some extent depending on how the Bill was originally treated when it was received form the Debtor.
| Sundry Debtor A/c | Dr. | (Dishonour of Bill) |
| To Bill Receivable A/c | (When the Bill is Retained) | |
| To Bill for Collection A/c | (When the Bill is sent to Bank for Collection) | |
| To Bank A/c | (When the Bill is Discounted with Banker) | |
| To Endorsee A/c | (When the Bill is Endorsed) |
Goods Distributed as Free Samples
Goods are distributed to the prospective customers is a sort of advertisement, the difference being that instead of spending cash, materials in kind are given away. Hence stock is reduced
Goods distributed as Sample is to be treated as expense incurred (advertisement expense)
Advertisement (Sample) A/c Dr
To Purchases or Trading (Sample) A/c
The Purchases or Trading (Sample) A/c is charged to Profit & Loss A/c
Loss of Goods
If any Stock is lost (like theft, destroyed / damaged due to fire, the value of such loss is first to be ascertained and then accounting entry is recorded for the value of Goods.
Accounting for Loss
Loss of Goods Dr
To Trading A/c
(Value of Goods Lost)
Profit & Loss A/c Dr
To Loss of Goods
(Loss charged to P & L A/c)
Entry for Insurance Claimed lodged
Insurance claim Dr
To Loss of Goods
(Insurance claim for Loss of Goods)
On realisation of Insurance claim
Bank A/c Dr
To Insurance claim
(Amount received from Insurance company against claim)
If there is any balance in Insurance claim a/c (if Insurance pays less than the amount claimed, the balance is to be charged to Profit & Loss A/c
Goods sent on Approval Basis for Sale
When goods are sold to customers on sale or return or on approval basis, either the sale may treated at the time of delivery, or Sale may treated when the customer approves it.
Sale Treated immediately on delivery of goods
Sale A/c Dr
To Debtor A/c
Entry for Unsold Goods lying with customer
At the end of year, unapproved goods lying with customer is treated as Stock lying with customer and the sale is reversed
Debtor A/c
To Sale A/c
(Amount of sale value of goods lying with customer)
Sale Treated only on Approval
Sale A/c Dr
To Debtor A/c
Entry for Unsold Goods lying with customer
At the end of year, unapproved goods lying with customer is treated as Stock lying with customer and the sale is reversed
Stock with Customer
To Trading A/c
(Cost of goods lying with customer)
Proprietor’s Personal Transactions
Sometimes, Proprietor / Partner may withdraw money, materials, or some payment made to any party on behalf of Proprietor (like Expenses of Partners / Income Tax / Advance Income Tax).
Drawings in Cash
Drawings A/c Dr
To Cash or Bank
(Amount withdrawn by Partner / Proprietor )
Payments made from Business
Drawings A/c Dr
To Cash or Bank
(Amount paid on behalf of Partner / Proprietor )
Materials withdrawn by Proprietor for personal use
Sometimes, proprietor draws materials for his personal use. So, cost of such materials should be charged to his drawings personal account.
Drawings A/c
To Purchases
Balance of Drawings A/c is transferred to proprietor / Partner’s Capital A/c
Interest
Interest Payable on Loan Borrowings
Often, Interest is not fully paid till the end of the Financial year. You have to make entry Debiting Interest A/c for unpaid amount of Interest and credit to the Loan Account, like provision for liability for expenses.
Interest on Loan A/c Dr.
To Loan A/c
Example : Interest @ 12% on Loan of Rs 1,00,000 was paid upto 31.12.14 The books are closed on 31.03.15
Interest on Loan Taken Dr 3,000
Loan A/c 3,000
(Interest payable @ 12% for 3 months on 1,00,000 for Jan to Mar 15
Interest Receivable on Loan given
Often, Interest is not fully received till the end of the Financial year. You have to make entry Debiting Borrower A/c for unpaid amount of Interest and credit to Interest Account, like Income receivable.
Borrower A/c Dr.
To Interest Earned A/c
Example : Interest @ 12% on Loan give of Rs 1,00,000 was paid upto 31.12.14 The books are closed on 31.03.15
Borrower Dr 3,000
Interest earned A/c 3,000
(Interest payable @ 12% for 3 months on 1,00,000 for Jan to Mar 15
Interest on Capital
Sometimes, the agreement may provide for Interest to be paid on Capital contributed by Proprietor / Partner. Such interest is not a charge against profit but an appropriation of profit.
Profit and Loss Appropriation A/c
To Capital or Current A/c
(Interest on capital transferred to Capital or Current Account)
Interest on Drawings
Sometimes, interest may be charged on drawings by the partners. Such interest is not to be treated as income of firm.
Interest on Drawings A/c Dr
To Profit and Loss Appropriation A/c
Capital or Current A/c Dr
To Interest on Drawings A/c
(Interest on drawings transferred to Capital or Current Account)
Expenses
Outstanding Expenses
At the end of the accounting year some of the expenses may remain outstanding. Following entry is required at the end of the year for necessary adjustments.
| Relevant Expenses A/c | Dr. |
| To Outstanding Expenses A/c |
Outstanding Expenses A/c would appear in the Balance Sheet under Liabilities side.
Managerial Commission
Sometimes, the manager of a concern is given a percentage (%) of the net profit as commission. It is treated an expense (like salaries). If the amount is not paid within the accounting period, make entry Debiting Commission A/c for unpaid amount of Commission and credit to the Manager’s Account
Commission A/c Dr
To Manager
Prepaid/c
Example : % of profit before charging Commission
The Manager is entitled to a Commission of 10% on Net Profit before charging such Commission. Net Profit before charging such Commission is Rs.1,10,000.
Commission = Rs.1,10,000 x 10% = Rs.11,000
Example : % of profit before charging Commission
The Manager is entitled to a Commission of 10% on Net Profit after charging such Commission. Net Profit before charging such Commission is Rs.1,10,000.
Commission = Net Profit before Commission x ((Rate of Commission in %) / (100 + Rate of commission))
Commission = (1,10,000 x (10/(100+ 10)) = 1,10,000 x (10/110)= 10,000
Prepaid Expenses
Like Outstanding Expenses, if any expenses of the subsequent year have been paid in advance the following adjustment entry is required.
Prepaid Expenses A/c
To Relevant Expenses A/c
Prepaid Expenses Account will appear in the Balance Sheet under Asset side.
Income
Accrued Income
Accrued income is income earned but not due (e.g. interest accrued but not due). Since it is not due, it is not credited to the personal ledger account, but is shown separately in Balance Sheet as Accured but not Due
Accrued Income A/c Dr
To Relevant Income A/c
Accrued Income will appear on Assets side of the Balance Sheet.
Income received in Advance
If Income of subsequent Accounting Period has been received in advance during the Current Accounting Period, the following adjustment will be required:
Relevant Income A/c
To Income Received in Advance A/c
Income Received in Advance A/c will appear in the Balance Sheet under Liability side.
Closing Stock
The value of Closing Stock is to be incorporated in the book through following entry
Closing Stock A/c
To Trading A/c
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