Past Adjustments :: Error Rectifications

Adjustments » Error Rectification

We know that "Interest on Capital", "Salary to Partners", "Commission to Partners", ... are all appropriations of profits. Not taking the interest, salary, commission etc., into consideration, recording wrong amounts, distributing the distributable profit in a wrong proportion are some examples of these mistakes in appropriations. When there is an error with regard to these appropriations, it would influence the amount that is being distributed to the partners (i.e. the amount that is ultimately credited to the partners capital accounts). But, where there are errors that are to be rectified either relatting to the current or the past periods, whose rectification effects Real and other personal accounts care should be taken to ensure that all the relevant accounts are adjusted apart from making adjustments in the capital accounts with regard to the net effect of these adjustments.

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 separate account to deal with these adjustment transactions. We name the account "Profit and Loss Adjustment a/c". This account in general is used whenever there are adjustments to be made of unconventional nature.

Illustration » A 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 20x4: Me You They Capital (as on 1st Jan 20x4) 1,00,000 1,50,000 2,00,000 Drawings during the year 15,000 20,000 20,000 Interest on Drawings 1,000 4,000 2,000 The draft accounts showed a net profit of Rs. 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: A machinery costing Rs. 50,000 purchased during 20x3 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. The interest on fixed deposit due to the firm Rs. 4,000 was used by "They" for his personal expenses. 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 Rs.18,000. Make necessary adjustments to incorporate the above aspects and Appropriate the profits of the firm.

Illustration » Working Notes

The journal entries for rectifying the errors would be Statement for calculation of adjustments to be made [+ ⇒ Debit and − ⇒ Credit] Machinery Int Rec Drawings P&L adj P&L (i) Machinery a/c Dr     To P&L adj (Repairs) a/c + 50,000     − 50,000   Depreciation for 20x3 P&L adj (Depriciation) a/c Dr     To Machinery a/c − 5,000     + 5,000   Depreciation for 20x4 P&L (Depriciation) a/c Dr     To Machinery a/c − 4,500       + 4,500 (ii) They's Drawings a/c Dr     To P&L (Int on FD) a/c     + 4,000   − 4,000 (iii) Interest Receivable a/c Dr     To P&L (Interest) a/c   + 18,000     − 18,000 Net Effect + 40,500 + 18,000 + 4,000 − 45,000 − 17,500 Journal Entries Whatever may be the adjustment you have to make, it would be very easy if you can think of the journal entry to be recorded to incorporate/rectify the same. If asset accounts are influenced by the adjustments made, care should be taken to check the influence of the adjustment on the calculation of depreciation both during the previous as well as the current periods. Methods for incorporating the adjustments Even here the number of entries recorded would depend on the need for information. Greater the information you need, greater the account heads we maintain and greater the entries that we record. There are basically two methods we can adopt for recording the adjustments. Recording all All the entries for transactions as they appear in the statement above can be recorded, thereby giving complete information. Simplification to an extent can be done by writing simple/complex compound entries (clubbing the entries) for deprectioin etc. Single Journal Entry The objective of rectification of errors is to correct the position rather than to re do everything. Therefore, if the firm wishes to ensure that the position is corrected without having to re-do everything, then a single journal entry for the Net Effect [as above] would be recorded. Direct Ledger Accounts » Precautions We generally 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 above adjustments in incorporated in the relevant accounts. Preparation of the above statement would thus be helpful either way. If you are writing the journal entries it works as a working note. If you are preparing the ledgers directly, you can ensure that all accounts which are influenced are taken care of.

Illustration » Solution [Recording All]

All the transactions that appear in the statement are recorded and they are posted to the respective ledger accounts. Since the balances of the "Machinery a/c" and "Interest Receivable a/c" are not know, postings in those accounts may be ignored. Ledger Accounts Dr Profit and Loss Adjustment a/c Cr Particulars Amount (in Rs) Amount (in Rs) Particulars Amount (in Rs) Amount (in Rs) To Machinery a/c To Net adj c/d   45,000 By Machinery a/c   50,000     50,000     50,000 To Share of Net Adj:       "Me"       "You"       "They" 22,500 13,500 9,000 45,000 By Net Adj b/d   45,000     45,000     45,000             Dr Profit and Loss a/c Cr Particulars Amount (in Rs) Amount (in Rs) Particulars Amount (in Rs) Amount (in Rs) To Machinery a/c To Net Profit c/d [To appropriation a/c]   4,500 4,17,500 By Net Profit b/d By Interest Receivable By They's Drawings   4,00,000 18,000 4,000     4,22,000     4,22,000 Dr Profit and Loss Appropriation a/c Cr Particulars Amount (in Rs) Amount (in Rs) Particulars Amount (in Rs) Amount (in Rs) To Interest on Capital:       "Me"       "You"       "They" To Distributable Profit c/d 10,000 15,000 20,000 45,000 3,79,500 By Net Profit b/d By Int on Drawings:       "Me"       "You"       "They" 1,000 4,000 2,000 4,17,500 7,000     4,24,500     4,24,500 To Profit Share:       "Me"       "You"       "They" 1,89,750 1,13,850 75,900 3,79,500 By Distr Profit b/d   3,79,500     3,79,500     3,79,500             Dr Partners Drawings a/c's Cr Particulars Me (in Rs) You (in Rs) They (in Rs) Particulars Me (in Rs) You (in Rs) They (in Rs) To Bal b/d To P&L adj 15,000 20,000 20,000 4,000 By Bal c/d 15,000 20,000 24,000   15,000 20,000 24,000   15,000 20,000 24,000 To Bal b/d 15,000 20,000 24,000         Dr Partners Capital a/c's Cr Particulars Me (in Rs) You (in Rs) They (in Rs) Particulars Me (in Rs) You (in Rs) They (in Rs) To Int on Dr To Drawings To Bal c/d 1,000 15,000 2,82,700 4,000 20,000 1,94,350 2,000 24,000 2,34,950 By Bal b/d By Int on Cap By P&L adj By Profit Share 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 Bal b/d 2,82,700 1,94,3500 2,34,950 Dr Machinery a/c Cr Date Particulars J/F Amount (in Rs) Date Particulars J/F Amount (in Rs)   To P&L adj – 50,000   By P&L adj a/c By P&L a/c – – 5,000 4,500   Total       Total                     Dr Interest Receivable a/c Cr Date Particulars J/F Amount (in Rs) Date Particulars J/F Amount (in Rs)   To P&L adj a/c – 18,000           Total       Total

Illustration » Solution [Recording Net Adjustment]

The Net Effect of the various adjustments is recorded using a single journal entry and the rest of the appropriations is done as earlier. The Difference The difference would be in the information available with regard to corrections or adjustments. The information available in the machinery account is reduced when we record the net effect. There would be no difference in the profit and loss appropriation account and the partners capital accounts. Journal Entries Journal in the books of M/s _____ for the period from ____ to _____ Date V/R No. Particulars L/F Debit Amount (in Rs) Credit Amount (in Rs) March 31st — Machinery a/c Dr Interest Receivable a/c Dr They's Drawings a/c Dr To P & L adj a/c To P & L a/c [For the net effect of rectification of errors.] — — — — — 40,500 18,000 4,000 45,000 17,500 Ledger a/c's Dr Profit and Loss Adjustment a/c Cr Particulars Amount (in Rs) Amount (in Rs) Particulars Amount (in Rs) Amount (in Rs) To Share of Net Adj:       "Me"       "You"       "They" 22,500 13,500 9,000 45,000 By Mach,...a/c's   45,000     45,000     45,000             Dr Profit and Loss a/c Cr Particulars Amount (in Rs) Amount (in Rs) Particulars Amount (in Rs) Amount (in Rs) To Net Profit c/d [To appropriation a/c]   4,17,500 By Net Profit b/d By Mach,...a/c's   4,00,000 17,500     17,500     17,500             Dr Profit and Loss Appropriation a/c Cr Particulars Amount (in Rs) Amount (in Rs) Particulars Amount (in Rs) Amount (in Rs) To Interest on Capital:       "Me"       "You"       "They" To Distributable Profit c/d 10,000 15,000 20,000 45,000 3,79,500 By Net Profit b/d By Int on Drawings:       "Me"       "You"       "They" 1,000 4,000 2,000 4,17,500 7,000     4,24,500     4,24,500 To Profit Share:       "Me"       "You"       "They" 1,89,750 1,13,850 75,900 3,79,500 By Distr Profit b/d   3,79,500     3,79,500     3,79,500             Dr Partners Drawings a/c's Cr Particulars Me (in Rs) You (in Rs) They (in Rs) Particulars Me (in Rs) You (in Rs) They (in Rs) To Bal b/d To P&L adj 15,000 20,000 20,000 4,000 By Bal c/d 15,000 20,000 24,000   15,000 20,000 24,000   15,000 20,000 24,000 To Bal b/d 15,000 20,000 24,000         Dr Partners Capital a/c's Cr Particulars Me (in Rs) You (in Rs) They (in Rs) Particulars Me (in Rs) You (in Rs) They (in Rs) To Int on Dr To Drawings To Bal c/d 1,000 15,000 2,82,700 4,000 20,000 1,94,350 2,000 24,000 2,34,950 By Bal b/d By Int on Cap By P&L adj By Profit Share 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 Bal b/d 2,82,700 1,94,3500 2,34,950 Dr Machinery a/c Cr Date Particulars J/F Amount (in Rs) Date Particulars J/F Amount (in Rs)   To P&L adj – 40,500   – –   Total       Total                     Dr Interest Receivable a/c Cr Date Particulars J/F Amount (in Rs) Date Particulars J/F Amount (in Rs)   To P&L adj a/c – 18,000           Total       Total

Author Credit : The Edifier

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