Often while preparing the financial statements; it happens that a few items remain unrecorded. These items are either omitted to be recorded or are wrongly recorded in the books. In both these scenarios, financial statements are abstained from revealing true and fair financial performances. Thus, in order to get a clear financial picture, it is mandatory to incorporate such adjustments. These adjustments are always given outside the Trial Balance. Also, as these adjustments provide additional information related to the financial items, so these are also termed as additional information. In order to incorporate such adjustments in the financial statements, we pass the required Journal entries, which are termed as adjusting entries.
Need and Purpose of Adjusting Entries
These adjusting entries help in disclosing the true financial position. The given below are the various purposes served by the adjusting entries.
- It helps to assess the true financial position of a business on the accrual basis of accounting.
- It helps to record the items which were omitted to be recorded in the books of accounts.
- It helps in knowing the actual figure of profit or loss.
- It helps in providing the depreciation on fixed assets.
- It assists in separating all the financial transactions into a year-wise category. The financial statements include only those transactions which belong to the current year. That is, it rules out the transactions related to the previous year and next year.
- It provides room for making various provisions which are made at the end of the year, after assessing the entire year’s performance.
Some Important Points to be Noted
➢ According to the double-entry system, all the adjustments given outside the Trial Balance are posted at two places. That is, first, in the Trading or Profit and Loss Account and second, in the Balance Sheet.
➢ Lastly, all the adjustments given inside the Trial Balance are to be recorded only in one place. That is, either in the Trading and Profit and Loss Account or in the Balance Sheet.
What is Operating Profit?
Operating Profit can be defined as the profit earned by carrying the normal business activities. It is computed by subtracting the operating expenses from the gross profit.
The balance sheet is the last financial statement that is prepared by any organization. This statement helps to ascertain the true financial position of an enterprise at the end of an accounting period
Profit and Loss Account
A profit and Loss Account is the second financial statement prepared by an organization. This account is prepared to ascertain the net results of a firm in form of net profit earned or net loss incurred during an accounting period.