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Need for Adjustments in the Final Accounts of a Business

As we know, basic accounting records are on the basis of Going Concern Assumption. But the Final Accounts are prepared every year on the basis of 'Accounting Period Assumption', 'Revenue Recognition Assumption' and 'Matching Principle' besides others. The purpose is to make a continuous assessment of the final affairs of the firm. It is necessary that all expenses and incomes for the year for which accounts are being prepared be taken. It, therefore, necessitates that:
  • Expenditure whether paid or note be included
  • Income whether received or not be included
  • Expenditure relating to the succeeding years be excluded and
  • Income relating to the succeeding years be also excluded.
Let us understand with the help of examples.
Suppose, a firm closes its books on 31st March and rent for the month of March has not yet been paid. This amount has to be paid in any case because the expense has been incurred. Therefore, it would be proper to include the rent for this month along with other expenses for the year.
Take another example. Insurance premium has been paid for twelve months beginning 1st October. It is apparent that insurance protection will be available for six months this year and six months next year. Half the premium, therefore, should be treated as the next year's expense.
In a firm there are a number of transactions related to expenses and incomes, which have to be adjusted. If such items are not adjusted or brought into the current year's books of account, the Final Accounts will not reveal a true and fair picture of the results. All such items which need to be brought into books of accounts at the time of preparing Final Accounts are called 'adjustments'. Journal entries are passed to effect the required adjustments. These entries are known as Adjusting Entries.

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