Trading and Profit and Loss Account and Balance Sheet with Adjustments explained in easy way

Hello Guys, I am back with a content on Accountancy. In this content I am going to discuss how to prepare Trading Account and profit and Loss Account as well as Balance Sheet. And the best part of this content is that I am going to explain this with a difficult Example so that you guys would be able to do any kind of questions relating to Trading and Profit and Loss Account and balance Sheet. So, let’s start. Before starting with the Question, here is a quick format of trading and Profit and Loss Account.

Trading and Profit and Loss Account

It starts with the heading Trading and profit and Loss Account for the year ending dash dash dash means for whatever period we are preparing it.So, if we are preparing it for the year ended 31st March 2016, we will say Trading and Profit and Loss Account for the year ended 31st March,2016. So, It is prepared in a T format, T as in English alphabets which includes Particulars Amount as you can see in the slide. I still remember the time when I studied this format for the first time, I used to call it Papa P A P A Papa which is an Indian word for Father. So, this whole account is divided into two parts i.e Trading Account and Profit and Loss Account.

Firstly we start with Trading Account. on the Debit side, we write Opening Stock, then To Purchases, then Wages and then Other Expenses. Always remember that we add the expression ‘To’ to every account written on the Debit side of the Trading account. And on the Credit side we write By Sales and By Closing Stock. On the Credit side we add ‘ By’ to every account instead of To. Now, this is where almost our Trading Account ends. See, I said almost not completely.

The most important part of Trading Account still lefts. As you guys may know that in Accounts we balance both Debit and Credit side i.e the total of Debit side should always be equal to the total of Credit side. Therefore, to balance both the Debit and Credit side of Trading Account, we use Gross profit or Gross Loss which is the main purpose of preparing Trading Account. Now, if the Credit side is more than the Debit side, we have Gross profit and if the Debit side is more than the credit side, we have gross Loss. These are the balancing figure which means that their amount will depend upon the difference between the Debit and Credit side. This is where our Trading Accountends. In’t it simple? Don’t worry if you guys feel it is difficult, stay with me till we solve the question and all of your doubts will vanish. so, here is the total of Trading Account which we write inside two straight lines.

Gross profit /Gross Loss

Now it’s the turn of Profit and Loss Account. It always starts with either Gross profit or Gross Loss. It depends upon the result of the Trading Account. If the result of the trading account is Gross Profit, profit and Loss Account will start with Gross Profit on the Credit side and if the result is Gross Loss, profit and Loss Account will start with Gross Loss on the Debit side. Also On the debit side of profit and Loss account we record Indirect Expenses i.e all other expenses except Direct Expenses and on the Credit side, we record Indirect Incomes.

Now, comes the Totaling part. So, as I said Debit is always equal to Credit , therefore If the Credit side is more, we have Net profit and if the Debit side is more, we have Net loss. Now let’s solve an Example with Adjustments. So here is a Trial Balance given from which we have to prepare Trading and Profit and Loss Account as well as Balance Sheet. But before reading the question, you guys should have knowledge of Assets, Liabilities, Direct Expenses, Indirect Expenses and Indirect Incomes.

What are Direct Expenses And Indirect Expenses?

If you are studying Trading and profit and Loss Account, let me assume that you already know about Assets and Liabilities because we study them in starting. Now Direct Expenses are those which are directly related to production. Example of Direct Expenses are Wages, Carriage Inward, Freight Inward, Octroi, Royalty on Production etc. And Indirect Expenses are those Expenses which are not directly related to production. Example includes Salary, taxes, Postage, Telephone Expenses, Insurance, Printing and Stationery Expenses, Depreciation, Advertisement Expenses etc. Now let’s study the question. So, the question is the Following is the Trial Balance of Shri om as on 31st March, 2016. You are required to prepare the Trading and Profit and Loss Account for the year ended 31st March, 2016 and Balance Sheet as on that date after making the necessary adjustments. So,in this question we are given Trial Balance on left side and Adjustments on Right side. Adjustments are those entries which we forget to either add or they accrue after preparing Trial Balance. As you guys may know that each transaction in Accountancy has two sides i.e Debit and Credit which means they are recorded in two accounts. So, when we prepare Trial Balance, all those entries are included except adjustment entries. So, each entry in the trial balance will have one treatment in the Trading and profit and Loss Account whereas the entries in the Adjustments will have two treatments. They will come two times in the Trading and Profit and Loss Account as well as balance sheet. So, let’s prepare trading and profit and loss account first.

Now you have to write Trading and Profit and Loss Account for the year ended March 31, 2016 as given in the question. And on the top left side we write Debit and on the top right side we write credit. This is the format of the Trading and Profit and Loss Account. Now let’s move towards the inside of the format. If you guys recall the format then you may know that as I said Trading account always starts with Opening Stock on the Debit side.

Opening stock

Here, Opening stock is equal to 2,50,000 as you can see in the question. Therefore we will write To Opening Stock 2,50,000 Next comes Purchases, which is equal to 15,50,000. But remember these are not Net Purchases, these are Gross Purchases so will write the amount of Gross Purchases in the Particulars column because in the Trading account we are not concerned with Gross Purchases, we are concerned with Net purchases. Okay, Now, if we see the question we can see that in the adjustment entry No. 4 Proprietor had withdrawn goods worth Rs. 25,000 during the year. But in business we are only concerned with goods bought for business use not for personal use… Therefore, we will subtract goods worth Rs.25000 from the purchases. See, those goods are for personal use not for business use then why to record those expenses in the business accounts.. That’s  why we subtract them.

So, To purchases 15,50,000 Less Drawings Rs. 25,000. On subtracting we get Rs. 15,25,000 which are still not the Net Purchases , therefore we will record it inside the Particulars column. Now as I said that each adjustment entry has two treatments, therefore these drawings of goods will also have two treatments as they are in adjustments. You know that one treatment is to subtract the drawings from purchases. The other treatment is to subtract this drawing from the capital of the proprietor. Owner is also known as Proprietor as he has used the resources of business for his personal use. Therefore we will reduce the amount of capital in the balance sheet with Rs.25000 drawings as he has withdrawn his capital in the form of goods for his personal use. Now, as I said that this 15,25,000 is still not Net Purchases because if you see in the question, there is another adjustment No 7 which says Purchases include Rs.50000 worth of furniture. Now, furniture is an asset for the business but the purchases which are included in Trading Account are only related to those goods in which a business deals i.e those goods which a business manufactures or purchases for the purpose of sale.

Therefore we have to subtract this 50000 from the purchases so as to find the Net purchases. Okay So, Less Furniture Rs.50,000 which is equal to 14,75,000 which is our Net Purchases so we will write this amount in the Amount column. Now, as this is also an adjustment entry, its 2nd treatment will be to increase the amount of furniture in the balance sheet. We have to increase the amount of furniture in the balance sheet with the amount of Furniture purchased i.e Rs.50,000 .So,, the amount of furniture on the Asset side of Balance sheet will increase with Rs. 50,000 Now, after recording Opening Stock and Purchases comes the wages. In the question wages are Rs. 1,00,000, so we will record To wages Rs. 1,00,000 Next comes Direct Expenses. In this question Direct Expenses are Carriage Inwards and. Well there is only 1 Direct expenses which is carriage inwards , all other expenses are indirect. Therefore we will record To Carriage Inwards Rs.50,000 Now, we have almost completed our Debit side of Trading Account, now let’s move on to Credit side. Credit side always starts with Sales. Here it is. Sales is equal to 19,87,500 .Okay, Therefore we will record sales as By sales 19,87500 on the Credit side of Trading Account.

Closing stock

Next comes closing stock. Now Closing stock is always given in adjustments. Therefore, it also has 2 treatments. Its 1st treatment is to record the amount of closing stock on the Credit side of the Trading account and its other treatment is to record it on the Asset side of the Balance Sheet as closing stock of this year will become Opening Stock of the Next Year. Therefore it is a current asset in the hands of the business. Now Closing stock is given in the first adjustment Stock on March 31, 2016 was valued at Rs.7,75,000. So, we will write By Closing Stock Rs. 7,75,000. Okay, now what we have to do is to balance the both side as in Accounts Debit is always equal to credit.

Now, in order to equal the both sides, first of all we have to find out which side is higher. Here, in this example, credit side is bigger and its total is Rs.27,62,500. Now, we will write this total on the both sides i.e whichever side is bigger, its amount will be written on the both side so as to balance the other side. Now as I previously said that if the Credit side is more than Debit side of the Trading Account, we will have Gross Profit and its amount will be equal to the difference between Debit and Credit side. Here the difference is of Rs.8,87,500. Therefore, Gross Profit will be Rs. 8,87,500. This 8,87,500 is the balancing figure which is recorded so as to balance the both sides. So as our Trading account is prepared, now its time for the Profit and Loss Account. So Profit and Loss Account starts with the end result of Trading Account. Here the end result of Trading account is Gross Profit
c/d which is 887500, therefore Profit and loss account will also start with Gross Profit and in P&L account i.e Profit and Loss Account, Gross Profit is recorded at the Credit side.
Here. Therefore we will record gross profit = Rs.8,87,500 as By Gross profit c/d 8,87,500. Now on the Debit side of p&L account, we record Indirect Expenses and on the Credit side. We record Indirect Incomes. Starting with debit side, Indirect expenses in the question are. Let’s start from starting. Here it is. Carriage Outwards 1,10,000 Okay, so, it will be written as To carriage Outwards 1,10,000 on the debit side of the P& L Account as you guys know that all Indirect expenses are written om the Debit side. Therefore To carriage outwards Rs.1,10,000 Next is General Expenses which is equal to Rs. 70,000…So, to general expenses Rs.70,000 Next is Discount which is Rs. 20000. So to Discount Rs. 20,000 Next is Printing and Stationery which is Rs.15,000. So. To Printing and stationery Rs.15,000 Next is Advertisement which is Rs.85,000. So, similarly To Advertisement Rs. 85,000 Now as our left side has you know, no space left on the left side, so we will continue this question on the right side.

So, here is the same format of Profit and Loss Account. Now we are continuing the left side on the right side. So, Next is Insurance. Here it is. Insurance is Rs.45,000. But here is a twist. Wait. So, we will write To Insurance Rs. 45,000. Now, this 45,000 will be written Inside the Particulars column because if you guys see that in Adjustment entry No. 9 prepaid insurance is Rs. 5000….. Now prepaid insurance means that we have paid Insurance for the next year in the current year. So, the Insurance which we have to pay later, we have paid now. Means the Insurance which we have to pay in the next period or next year, we have paid in this year or this period but in Profit and loss account we only record incomes and expenses of current year…..therefore Insurance of Rs.45000 which is given in Trial Balance also includes Rs.5000 which we have paid for next year.

So, to arrive at the actual Insurance of the Current year, we have to less this prepaid Insurance from the Insurance. So, To Insurance Rs. 45,000 less Prepaid 5000, so that actual Insurance will be rs. 40,000 Next is Salesmen’s commission which is rs. 87,500. So to Salesmen’s Commission 87,500. Now I have written this commission inside the Particulars Column as you guys can see that in, where is it.

Yeah in adjustment no.5 Salesmen are entitled to a commission of 5% on total sales. So, 5% commission on Total Sales. okay. So, Sales equals to 19,87,500. So, the Salesmen are to be given commission of 5% on this 19,87,500 and 5% of 1987,500 is equal to 99,250. Thus the company has to pay Rs.99250 to its salesmen. But according to Trial balance, it has only paid Rs. 87500, Okay, therefore there is an outstanding commission of Rs.11,750 And therefore the expenses of sales commission will increase to Rs. 99250, because no matter whether the company has paid its expenses or not of the current year. It has to record them in its accounts.

SO, To Salesmen’ s commission 87,500. Les Outstanding. Sorry here i have to write Add Outstanding. So, I hope you got it. So, Add Outstanding rs. 11,750. So, we will get 99,250. So, any expenses Outstanding are always added and any Expenses Prepaid are always Subtracted. Okay, Got it. So, Next is Postage and telephone which is 57,500. So, To Postage and Telephone Rs. 87,500 Next is Salaries which is 1,60,000. So, To Salaries 1,60,000 . So, here is also an adjustment entry 8 which says Salaries Outstanding are Rs.20,000. So, as I said all Outstanding amount are added. So add outstanding salaries which is 20,000. So, our actual salaries will be 1,80,000 Now, Next is Rates and Taxes which is Rs. 25,000. So, To Rates and taxes Rs. 25,000. Now all the Indirect expenses in the Trial balance are taken care of except Bad debts Here it is. bad Debts is Rs. 10,000. I have left bad debts for last as it is little difficult. So, here bad debts equal to Rs.10,000 which is recorded on the debit side of Profit and loss account .

Now , as you guys can see that I have recorded these bad debts in the particulars column. Because there is an adjustment entry for the Bad Debts which is Adjustment entry no.6. Debtors include Rs.25,000 bad debts. Therefore these bad debts Rs.10,000 will be increases by further bad debts Rs.25000 which is equals to 35,000. Now if you guys see that there is another entry which is related to bad and doubtful debts.

Here it is, adjustment entry no.2. Provision for Bad and doubtful debts @5% is to be created. but this 5% is always calculated after deducting the bad debts present in adjustment i.e these Rs.25,000 from the debtors. Here is Debtors. Debtors are equal to Rs.5,00,000 So, if we reduce Debtors with Rs. 25000, then debtors will be Rs. 4,75000 i.e 5,00,000 minus 25,000 . Now we have to take 5% of 475000 which will be our provision for doubtful debts and it will also be recorded on the debit side of Profit and Loss Account. So To Provision for Doubtful Debts Rs. 23750 which is 5% of 4,75,000 Okay, Now all the Indirect expenses in the Trial balance are recorded but there is still one indirect expense left which is in the adjustment entry no..3. Depreciate Furniture and Fittings by 10% and Motor car by 20%. Now this entry says Depreciate Furniture and Fittings by 10%.

So where are Furniture and Fittings Rs.1,10,000 but there are additional furniture which is Purchases include Rs.50,000 worth of Furniture. So, total furniture will be 1,10,000 + 50,000 which is equal to 1,60,000. Now, it says Depreciate Furniture and Fittings by 10%. So, 10% of 1,60,000 will be to Depreciation on Furniture Rs.16,000 which is 10% of 1,60,000. okay, next is and Motor Car by 20%. So, we have to depreciate Motor Car by 20%. Here it is. Motor Car is equal to 2,40,000 which will be 20% of 2,40,000 which is equal to 48,000. So, To Depreciation on Motor Car Rs.48,000. Now all the Indirect Expenses in the question are taken care of . So, nothing else will come on the Debit side of the Profit and Loss Account.

So, if you guys see the question there are none Indirect incomes, so credit side will only include By Gross Profit c/d. Now if you guys calculate Both Debit and Credit side of the Profit and Loss Account, you guys will know that Credit side is more. So, in order to balance the Profit and Loss Account, we have to record the total of Credit side on the both sides. Like this. 8,87,500. So, now what we have to do is to balance the debit side with the Credit side.

As Debit side is less, so as I said that if Credit side is more than the Debit side of the Profit and Loss Account, we will have Net profit. So, the Net Profit will be Rs. 62,875 which is the balancing amount between Credit side and Debit side. Okay. So, I hope you guys got this. Now its the turn of Balance Sheet. So here is the format of balance sheet. It is also prepared in T format as you guys can see. On the left side of Balance Sheet, we record Liabilities and on the Right side, we record Assets.

Balance sheet, Assets and Liabilities

On the top we write Balance sheet as on March 31, 2016 or I can say Balance Sheet as on dash dash dash means on whatever date we are preparing it. Now let’s start with Liabilities side. I assume that you guys already know about Assets and Liabilities. So here I am starting with Capital. Here it
is. Capital which is Rs. 13,88,000. So, Capital equal to 13,88,000.

Now, we have to add Net Profit in this capital. Here you guys must know that If our business has incurred Net loss, then it will be subtracted but if it has earned net profit, it will be added in capital. So, if you guys recall that a minute before we have prepared our Profit and Loss Account and the result was Net Profit which was equals to Rs.62,875. So, we will add Net profit 62,875 which makes capital Rs. 14,50,875. Now as I said all adjustment entries comes one time in balance sheet and 1 time in trading and profit and loss account. Now let’s see our adjustment entries. If you guys see Adjustment entry No.4, proprietor had withdrawn goods worth Rs.25000 during the year. So, here proprietor has make drawings in the form of goods and its treatment in balance sheet will be to reduce the amount of capital with the amount of drawings . Okay so, Drawings are always subtracted from the capital. So, here we will subtract the amount of Drawings which is Rs.45,000 from the Capital. Now Drawings are rs. 45,000 because you can see that here we are already given drawings in the Trial balance which is Rs.20,000 and the further Drawings are proprietor had withdrawn goods worth Rs.25,000 during the year. So, 20,000 plus 25,000 equals to 45,000. So, 14,50,875 minus 45,000 will come equal to 14,05,875. Okay. So, Now next liability is. Let;’s start from the Trial Balance. Here it is. Creditors. Okay so, here it is written on the Credit side. All the Liabilities are given on the credit side. Okay. So, Creditors are 2,00,000 So Sundry creditors Rs.2,00,000. Next Liability is Sales. Now remember Sales are not Liability. Everything written on the Credit side does not mean that it is a Liability, it can be Income too . All the expenses and assets are written on the Debit side in Trial Balance and all the Incomes and Liabilities are written on the Credit side. Well there are no other liability in the Trial balance.

So let’s go towards Adjustment entries to search for Liabilities. You guys can see that adjustment entry No.5 says that salesmen are entitled to a commission of 5% on total Sales. So, if you guys remember our 5% on 19,87,500 comes to 99250 but the actual commission paid is 87500… Okay, so
the balance 11875 has to pay by the company in the near future. So it is a liability fir the business. So Salesmen’s commission outstanding rs.11875 Next liability in the adjustments are Adjustment entry No.8 Salaries outstanding rs. 20,000…Similarly as Salesmen’s commission outstanding , here salaries are also liability for a business . So, Salaries outstanding rs.20,000. You guys must know that all Outstanding expenses are to be recorded on the Liability side of the Balance sheet. Okay. So, now there are no other Liability left in the question so we will move on to the debit side. Let’s find the assets in Trial balance, first is Sundry Debtors.

So, Sundry Debtors are equal to 500,000 Now if you guys see adjustment entry No.6 says debtors include Rs.25000 bad debts. So, we will subtract this 25000 from the debtors as those debtors got bad i.e there is less chance of receiving them or less or no chance. So. Less Bad Debts Rs. 25,000 and out Debtors will become 4,75,000…. Now there is another adjustment related to
debtors which is adjustment no.2 which is Provision for bad and doubtful debts @5% is to be created ….This 5% will be calculated on the remaining debtors i.e Rs.475000 and 5% of 475000 is Rs. 23750 and these are also to be reduced from the debtors…So, Less provision for Doubtful Debts 23,750 and our debtors will become Rs. 451250. okay Now, next asset is Motor Car which is equal to 2,40,000 .So, Motor Car 2,40,000….Now, adjustment entry No.

3 says Depreciate Furniture and Fittings by 10% and Motor car by 20% , so we have to depreciate Motor Car by 20% …Now, 20% of 240000 is 48,000 so we will reduce this amount of Depreciation from the value of Motor Car. So, less Depreciation 48,000 and the value of Motor car will become 1,92,000. Here you should remember that Depreciation is always subtracted from the asset. Next asset is Furniture and Fittings which is 1,10,000 Now, adjustment entry No.7 says purchases include Rs.50000 worth of furniture which is not included in 1,1,0000 which is given in Trial Balance. Thus the value of Furniture becomes 1,60,000 after adding that rs.50,000. So Furniture and fittings 1,10,000 and addition during the year 50,000.

So, the Furniture and Fittings will become 1,60,000 Now in the question adjustment entry No.3 says Depreciate Furniture and fittings by 10%..So we have to charge Depreciation on Furniture by 10% . The value of Furniture is 1,60,000 and 10% of 1,60,000 is 16,000 and Depreciation is always subtracted from the Assets. So, less Depreciation and furniture and fittings will become 1,44,000 . Next asset is bank which is Rs.60,000. So, bank 60,000

Next is cash which is Rs.10,500. So, we will record Cash as 10,500. Now all the assets in the Trial balance are taken care of. But in the adjustment one assets still lefts which you can see in adjustmen entry No.9 Prepaid Insurance Rs.5000 Always remember that all prepaid expenses are assets for the business. So prepaid expenses Rs.5000 will be recorded on the Asset side. Here it is. Prepaid Insurance 5000 Now another adjustment entry left which I forget to tell you guys. It is adjustment entry No. 1. Stock on March 31,2016 was to be valued at Rs. 7,75,000. So, it is a closing stock for the business and Stock is an asset for the business. Okay, so it will also come on the asset side. So, Closing Stock 7,75,000 which will come on the Asset side. Now, if we total the both sides of our balance sheet, assets and Liability side we will see that both sides are equal..which proves that we have solved the question correctly. Here the total is Rs. 16,37,750 of both Liabilities and assets side.