Theory question 103
Final Accounts of a Sole Trader(a) Explain three reasons why an accountant will consider end-of-year adjustments.
(b) Explain how the following items are treated in the Profit and Loss Account and Balance Sheet: (i) provision for doubtful debts; (ii) depreciation on fixed assets; (iii) accrued income; (iv) prepaid expenses.
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(a) Any three: to match income and expenses with the period they belong to (accruals/matching); to arrive at the true profit or loss; to show assets and liabilities at fair values in the balance sheet; to apply prudence (e.g. provisions for doubtful debts, depreciation); to separate capital from revenue items; to bring closing stock into account.
(b)(i) Provision for doubtful debts: the provision (or increase in it) is debited to profit and loss (a decrease is credited); in the balance sheet the provision is deducted from debtors.
(ii) Depreciation: the year's charge is debited to profit and loss; in the balance sheet accumulated depreciation is deducted from the cost of the fixed asset to give net book value.
(iii) Accrued income: added to the income in profit and loss (credit side); shown as a current asset in the balance sheet.
(iv) Prepaid expenses: deducted from the expense in profit and loss; shown as a current asset in the balance sheet.
For each item in (b), give both the profit and loss entry and the balance sheet entry.