# Past period corrections - Adjustments

Adjustments in accounting for partnership firms may be needed whenever something relating to the past period has to be corrected or adjusted. For the purpose of their treatment in accounting, these past period corrections can be classified into two
1. # Re-appropriations

Corrections pertaining to the past periods which involve appropriations only.

These corrections would only influence the Nominal a/c's and/or Partners Capital/Current a/c's.

Corrections pertaining to the past periods which involve adjustments.

These corrections may influence all types of accounts Real, Personal and Nominal including Partners Capital a/c's.

# Account types - accounting period

## Nominal accounts

Nominal accounts are closed at the end of the accounting period by transfer to the trading account or the profit and loss account as the case may be. Trading and Profit and Loss accounts are also nominal accounts. Trading account is closed by transfer to the profit and loss account. Profit and loss account is closed by transfer to the profit and loss appropriation account or the capital account.

Thus, at the end of the accounting period, after having closed the profit and loss account, there would not be any nominal accounts in the books of accounts. This implies that the nominal accounts that we use are the ones that relate to the current accounting period, since the ones relating to the earlier accounting periods would have been closed.

## Real and Personal accounts

Real and Personal accounts do not relate to a specific accounting period as they flow from one accounting period to another. That is the reason we consider their balances as being carried forward to the subsequent accounting period and being brought forward from the prior accounting period.

## Need

Where errors in accounting are identified they need to be corrected by making appropriate adjustments.

## Methodology

The methodology adopted for rectifying errors is dependent on the period to which these errors pertain. This is done by recording appropriate journal entries for rectification. We call them the rectification entries.

### Current Period

Where the errors pertain to the current period, the rectification entries may affect all types of accounts i.e. real, personal and nominal.

### Past Periods

Where the errors pertain to the past periods, the rectification entries should not affect the nominal accounts as they pertain to the current period but may affect real and personal accounts.

# Profit and Loss Adjustment a/c

To give a clear understanding as to the reason for which the recordings are being done, we use a ledger account by name "Profit and Loss Adjustment a/c".

To ensure that past period error rectification does not affect the current period nominal accounts, we replace nominal accounts with Profit and Loss adjustment a/c in the rectification entries, whenever the rectification pertains to past periods.

Journal
Particulars Amount
(Dr)
Credit
(Cr)
Depreciation on Machinery a/c
To Machinery a/c
Dr 4,000

4,000

We show the actual account in brackets instead of striking it off.

Journal
Particulars Amount
(Dr)
Credit
(Cr)
(Depreciation on Machinery)
To Machinery a/c
Dr 4,000

4,000

## balance

The net balance in the Profit and Loss adjustment a/c indicates the net effect of all such rectifications pertaining to the past periods. This account is closed by appropriating the balance between the partners and transferring them to their capital/current accounts.

This account in general is used whenever there are adjustments to be made of unconventional nature.

# Rectification of current period error after preparation of profit and loss a/c

If the error pertains to the current period and the profit and loss account has already been prepared, it is an indication that all the nominal accounts other than the profit and loss account have been closed.

In such cases, we use profit and loss a/c in place of nominal accounts in the rectification entries. This would affect the current period profit which is acceptable since the error relates to the current period.

If the profit and loss account balance i.e. the net profit or loss is not available, we assume that the profit and loss account has also been closed by transfer to the profit and loss appropriation a/c or the capital accounts. In the absence of the information relating to the current period profit, we rectify the current period error as if it is a past period error i.e. by using profit and loss adjustment a/c in place of nominal account.

# Problem Solving

Write down the journal entries for all the adjustments to be made, working out all the data that is needed for such entries. Where there are calculations to be made, keeping them at the same place would help.

Prepare a working note in the below format wherever possible. In addition to the particulars column, provide a column for each ledger account affected.

Particulars Machinery Rao Account 3 P & L
P & L
A) a.

b.

c.

Dr. Machinery
Cr. Machinery
Dr. P/L (Depr)
Cr. Machinery
+36,000

− 1,200

− 4,800

− 36,000
+ 1,200

+ 4,800
1) Net + 30,000 − 34,800 + 4,800
B) a.
Dr. Rao
+ 6,000

− 6,000
2) Net + 6,000 − 6,000
C) a.

Single entry (1) + (2) + + 30,000 + 6,000 − 40,800 + 4,800

+ indicates Debit and indicates Credit

Using the format used in mechanised (computerised) accounting for journal entries may be convenient here.

## Complete information

The process of rectification may be carried in such a way that it reveals the complete information relating to all the errors and the transactions recorded to rectify them. This requires us to record all the transactions in the journal and then post them into the leder to obtain the appropriate balances in the ledgers.

## Minimal information (single journal entry)

The purpose of rectification is to set right the position. If the organisation does not intend to have the details regarding the errors and the transactions recorded to rectify them, then it may carry on the rectification by passing a single journal entry which would give the net effect of all the corrections. This would also set the ledger balances at their correct figures, though it does not reveal all the information relating to corrections.

## Direct Ledger Accounts - Caution

We get accustomed to preparing the key ledger accounts as part of problem solving, especially in chapters like Consignments, Joint Ventures, Partnership Accounts etc.

If we are preparing the ledger accounts directly, we should be careful enough to ensure that the effect of all the adjustments required to be made is posted to the relevant accounts.

Preparation of the statements as above would always be helpful. If we are writing the journal entries it works as a working note. If we are preparing the ledgers directly, we can ensure that all transactions are taken into consideration.

There is no one method suits all. As you get the idea behind the working notes, you can always make modifications to suit your need, minimise working etc.

# Illustration - Problem

"Me", "You" and "They" are partners in a firm sharing profits and losses in the ratio 5 : 3 : 2. The following is the information relevant to the partners as on 31st December 20_4:
Me You They
Capital (as on 1st Jan 20_4)
Drawings during the year
Interest on Drawings
1,00,000
15,000
1,000
1,50,000
20,000
4,000
2,00,000
20,000
2,000
The draft accounts showed a net profit of 4,00,000 before making adjustments for interest on capital @10% per anum and the interest on drawings.

While checking the records they have noticed the following:

1. A machinery costing 50,000 purchased during 20_3 was debited to Repairs Account. 10% depreciation on reducing balance (on the last day of the accounting period) method is provided on plant and machinery.
2. It is decided that the method of recording Special Fee in the books was to be changed from "Cash Basis" to "Accrual Basis". The fees still receivable stood at 18,000.
3. The interest on fixed deposit due to the firm 4,000 was used by "They" for his personal expenses.

Make necessary adjustments to incorporate the above aspects and Appropriate the profits of the firm.

# Illustration - Working Notes

## Partners Profit Sharing Proportions

 You : Me : They = 5 : 3 : 2 = $\frac{5}{10}:\frac{3}{10}:\frac{2}{10}$
Particulars Machinery Interest
Receivable
They's
Drawings
P & L
P & L
A) a.

b.

c.

Dr. Machinery
Cr. Machinery
Dr. P/L (Depr 20_4)
Cr. Machinery
+50,000

− 5,000

− 4,500

− 50,000
+ 5,000

+ 4,500
1) Net + 40,500 − 45,000 + 4,500
B) a.
Dr. Intererst Receivable
Cr. P/L (Interest)
+ 18,000

− 18,000
2) Net + 18,000 − 18,000
C) a.
Dr. They's Drawings
Cr. P/L (Int of FD)
+ 4,000

− 4,000
3) Net + 4,000 − 4,000
Single entry (1) + (2) + (3) + 40,500 + 18,000 + 4,000 − 45,000 − 17,500
• ## Machinery

On account of rectification,

for 2003

 Increase in Capital value = 50,000 depreciation chargeable = Increased closing balance × Rate of depreciation = 50,000 × 10% = 5,000

for 2004

 Increase in Capital value = Increase in closing balance for 2003 = Increased closing balance − depreciation thereon = 50,000 − 5,000 = 45,000 depreciation chargeable = Increased closing balance × Rate of depreciation = 45,000 × 10% = 4,500
• ## Profit and Loss Adjustment a/c balance

Since − indicates a credit, the balance in this account indicates a credit balance which means a profit.

Partners share = adjustment profit × profit sharing proportion

 You's Share : $45,000×\frac{5}{10}$ = 22,500 Me's Share : $45,000×\frac{3}{10}$ = 13,500 They's Share : $45,000×\frac{2}{10}$ = 9,000 45,000
Working Notes (Profit Appropriations)
Particulars Firm You Me They
a) Net Profit
+ 4,00,000
+ 17,500
c) Appropriable Profits
d) Interest on Capital
e) Interest on Drawings
+ 4,17,500
− 45,000
+ 7,000

+ 10,000
+ 1,000

+ 15,000
+ 4,000

+ 20,000
+ 2,000

g) Distributed Profits
+ 3,79,500
− 3,79,500
+ 11,000
+ 1,89,750
+ 19,000
+ 1,13,850
+ 22,000
+ 75,900
f) Total Appropriations + 2,00,750 + 1,32,850 + 97,900
• Working notes (adjustment) table gives a net adjustment of − 17,500 to P/L a/c which indicates a credit in that account. This represents an increase of 17,500 in net profits.
• Interest on capital is assumed to be calculated on the opening balances.

Interest on Capital = Opening balance of capital × 10%

 You : 1,00,000 × 10% = 10,000 Me : 1,50,000 × 10% = 15,000 They : 1,00,000 × 10% = 20,000 45,000
• Partners share of distributable profits = distributable profits × profit sharing proportion  You's Share : $3,79,500×\frac{5}{10}$ = 1,89,750 Me's Share : $3,79,500×\frac{3}{10}$ = 1,13,850 They's Share : $3,79,500×\frac{2}{10}$ = 97,900 3,79,500

# Illustration - Solution [Complete information]

Journal
Particulars Amount
(Dr)
Credit
(Cr)
Machinery a/c
To Profit and Loss Adjustment a/c
Dr 50,000
50,000
[For the capital value of machinery erroneously treated as repairs expenditure in the past brought back into books.]
To Machinery a/c
Dr 5,000
5,000
[For the depreciation charge on the value of machinery brought back into books for the past period taken into account.]
Profit and Loss a/c
To Machinery a/c
Dr 4,500
4,500
[For the depreciation charge on the value of machinery brought back into books for the current period taken into account.]
Interest Receivable a/c
To Profit and Loss a/c
Dr 18,000
18,000
[For the interest receivable which was not recorded on account of treating it on cash basis brought into books on deciding to treat it on accrual basis from hereon.]
They's Drawings a/c
To Profit and Loss a/c
Dr
Dr
4,000
4,000
[For the Interest on Fixed deposits receivable taken away by they for his personal purposes.]
To You's Capital a/c
To Me's Capital a/c
To They's Capital a/c
Dr 45,000
22,500
13,500
9,000
[For the profit on rectifying past period errors distributed among partners in their profit sharing ratio.]
Profit and Loss Appropriation a/c
To Interest on Capital a/c
Dr 45,000
45,000
[For the total interest on capital payable to partners.]
Interest on Drawings a/c
To Profit and Loss Appropriation a/c
Dr 45,000
45,000
[For the total interest on drawings chargeable to partners.]
Profit and Loss Appropriation a/c
To Distributable Profits a/c
Dr 3,79,500
3,79,500
[For the distributable profits available for being shared among partners.]
Interest on Capital a/c
To You's Capital a/c
To Me's Capital a/c
To They's Capital a/c
Dr 45,000
10,000
15,000
20,000
[For the interest on capital transferred to partners capital accounts.]
You's Capital a/c
Me's Capital a/c
They's Capital a/c
To Interest on Drawings a/c
Dr
Dr
Dr
1,000
4,000
2,000

7,000
[For the interest on drawings charged to partners capital accounts.]
Profit and Loss Appropriation a/c
To You's Capital a/c
To Me's Capital a/c
To They's Capital a/c
Dr 3,79,500
1,89,750
1,13,850
75,900
[For the distributable profits transferred to partners capital accounts.]

## Ledger Accounts [Books of You, Me, They]

DrCr
Particulars Amount Particulars Amount
To Machinery
To You Capital
To Me Capital
To All Capital
5,000
22,500
13,500
9,000
By Machinery 50,000
50,000   50,000
Profit and Loss a/c
DrCr
Particulars Amount Particulars Amount
To Machinery
To Appropriable Profit
4,500
4,17,500
By Net Profit
By Interest Receivable
By They's Drawings
4,00,000
18,000
4,000
4,22,000   4,22,000
Profit and Loss Appropriation a/c
DrCr
Particulars Amount Particulars Amount
To Interest on Capital
To Distributable Profit
45,000
3,79,500
By Appropriable Profit
By Interest on Drawings
4,17,500
7,000
4,24,500   4,24,500
Partners Drawings a/c's
DrCr
Particulars Me You You Particulars Me You They
To Balance b/d
15,000
20,000
20,000
4,000
By Balance c/d

15,000

20,000

24,000

15,000 20,000 24,000   15,000 20,000 24,000
To Balance b/d 15,000 20,000 24,000
Partners Capitals a/c's
DrCr
Particulars Me You You Particulars Me You They
To Interest on Drawings
To Drawings
To Balance c/d
1,000
15,000
2,82,700
4,000
20,000
1,94,350
2,000
24,000
2,34,950
By Balance b/d
By Interest on Capital
By Distributable Profits
1,00,000
10,000
22,500
1,89,750
1,50,000
15,000
13,500
1,13,750
2,00,000
20,000
9,000
75,900
3,03,700 1,96,450 2,50,700   3,03,700 1,96,450 2,50,700
By Balance b/d 2,82,700 1,94,3500 2,34,950
Machinery a/c
DrCr
Particulars Amount Particulars Amount
To balance b/d

50,000
By Profit and Loss
By Balance c/d
5,000
4,500

To balance b/d
Interest Receivable a/c
DrCr
Particulars Amount Particulars Amount
To P/L adjustment 18,000 By Balance c/d 18,000

To Balance b/d 18,000

# Illustration - Solution [Adjustment using single journal entry]

The single journal entry for recording the adjustment to be made for the past period errors and the appropriations thereafter would be as below.
Journal
Particulars Amount
(Dr)
Credit
(Cr)
Machinery a/c
Interest Receivable a/c
They's Drawings a/c
To Profit and Loss Adjustment a/c
To Profit and Loss a/c
Dr 40,500
18,000
4,000

45,000
17,500
[For the net effect of adjusting past period errors brought into books.]
To You's Capital a/c
To Me's Capital a/c
To They's Capital a/c
Dr 45,000
22,500
13,500
9,000
[For the profit on rectifying past period errors distributed among partners in their profit sharing ratio.]
Profit and Loss Appropriation a/c
To Interest on Capital a/c
Dr 45,000
45,000
[For the total interest on capital payable to partners.]
Interest on Drawings a/c
To Profit and Loss Appropriation a/c
Dr 45,000
45,000
[For the total interest on drawings chargeable to partners.]
Profit and Loss Appropriation a/c
To Distributable Profits a/c
Dr 3,79,500
3,79,500
[For the distributable profits available for being shared among partners.]
Interest on Capital a/c
To You's Capital a/c
To Me's Capital a/c
To They's Capital a/c
Dr 45,000
10,000
15,000
20,000
[For the interest on capital transferred to partners capital accounts.]
You's Capital a/c
Me's Capital a/c
They's Capital a/c
To Interest on Drawings a/c
Dr
Dr
Dr
1,000
4,000
2,000

7,000
[For the interest on drawings charged to partners capital accounts.]
Profit and Loss Appropriation a/c
To You's Capital a/c
To Me's Capital a/c
To They's Capital a/c
Dr 3,79,500
1,89,750
1,13,850
75,900
[For the distributable profits transferred to partners capital accounts.]

## Ledger Accounts [Books of You, Me, They]

DrCr
Particulars Amount Particulars Amount
To You Capital
To Me Capital
To All Capital
22,500
13,500
9,000
By Miscellaneous accounts 45,000
45,000   45,000
Profit and Loss a/c
DrCr
Particulars Amount Particulars Amount
To Appropriable Profit 4,17,500 By Net Profit
By Miscellaneous accounts
4,00,000
17,500
4,17,500   4,17,500
Profit and Loss Appropriation a/c
DrCr
Particulars Amount Particulars Amount
To Interest on Capital
To Distributable Profit
45,000
3,79,500
By Appropriable Profit
By Interest on Drawings
4,17,500
7,000
4,24,500   4,24,500
Partners Drawings a/c's
DrCr
Particulars Me You You Particulars Me You They
To Balance b/d
15,000
20,000
20,000
4,000
By Balance c/d

15,000

20,000

24,000

15,000 20,000 24,000   15,000 20,000 24,000
To Balance b/d 15,000 20,000 24,000
Partners Capitals a/c's
DrCr
Particulars Me You You Particulars Me You They
To Interest on Drawings
To Drawings
To Balance c/d
1,000
15,000
2,82,700
4,000
20,000
1,94,350
2,000
24,000
2,34,950
By Balance b/d
By Interest on Capital
By Distributable Profits
1,00,000
10,000
22,500
1,89,750
1,50,000
15,000
13,500
1,13,750
2,00,000
20,000
9,000
75,900
3,03,700 1,96,450 2,50,700   3,03,700 1,96,450 2,50,700
By Balance b/d 2,82,700 1,94,3500 2,34,950
Machinery a/c
DrCr
Particulars Amount Particulars Amount
To balance b/d
To Miscellaneous accounts

40,500
By Balance c/d

To balance b/d
Interest Receivable a/c
DrCr
Particulars Amount Particulars Amount
To P/L adjustment 18,000 By Balance c/d 18,000

To Balance b/d 18,000
Author : The Edifier