Exercise Solutions Available
Step-by-step answers for all textbook questions in this chapter
Chapter Overview
Financial Statements II is the second part of the final accounts chapter in CBSE Class 11 Accountancy. While Financial Statements I covered the preparation of Trading Account, Profit and Loss Account, and Balance Sheet from a given Trial Balance, this chapter introduces adjustments — additional information given below the Trial Balance that must be incorporated before finalising the accounts.
Every adjustment has a dual effect: it affects either the Trading/P&L Account and the Balance Sheet, or two items within the Balance Sheet. Missing even one leg of an adjustment makes the entire Balance Sheet wrong. This is the most frequently tested chapter in the CBSE Class 11 Accountancy exam.
Need for Adjustments
At the end of the accounting period, the Trial Balance may not reflect the true financial position because:
1. Some expenses belong to the current year but have not been paid yet (outstanding expenses) 2. Some expenses have been paid in advance for the next year (prepaid expenses) 3. Some income has been earned but not yet received (accrued income) 4. Some income has been received but relates to the next year (income received in advance) 5. Fixed assets lose value each year (depreciation) 6. Some debtors may not pay (bad debts and provisions) 7. The proprietor may be entitled to interest on capital or may have withdrawn goods or cash (drawings, interest on capital/drawings)
Without adjusting for these items, the financial statements would overstate or understate profit, assets, or liabilities.
List of All Adjustments — Dual Effect Table
| Adjustment | Effect 1 (Trading/P&L A/c) | Effect 2 (Balance Sheet) |
|---|---|---|
| Closing Stock | Credited to Trading A/c | Shown as current asset on asset side |
| Outstanding Expenses | Added to expense on debit side of P&L A/c | Shown as current liability on liability side |
| Prepaid Expenses | Deducted from expense on debit side of P&L A/c | Shown as current asset on asset side |
| Accrued Income | Added to income on credit side of P&L A/c | Shown as current asset on asset side |
| Income Received in Advance | Deducted from income on credit side of P&L A/c | Shown as current liability on liability side |
| Depreciation | Debited to P&L A/c | Deducted from respective asset on asset side |
| Bad Debts (new) | Debited to P&L A/c | Deducted from Debtors on asset side |
| Provision for Doubtful Debts | Debited to P&L A/c | Deducted from Debtors on asset side |
| Provision for Discount on Debtors | Debited to P&L A/c | Deducted from Debtors on asset side |
| Interest on Capital | Debited to P&L A/c | Added to Capital on liability side |
| Interest on Drawings | Credited to P&L A/c | Deducted from Capital on liability side |
| Drawings (goods/cash) | If goods: deducted from purchases on debit side of Trading A/c | Deducted from Capital on liability side |
| Goods distributed as free samples | Debited to P&L A/c (as advertisement expense) | Deducted from purchases in Trading A/c |
| Manager's Commission | Debited to P&L A/c | Shown as current liability on liability side |
Closing Stock
Meaning: Closing stock is the value of unsold goods at the end of the accounting period. It is usually given as an adjustment even if it appears inside the Trial Balance.
Dual effect:
- Credited to the credit side of Trading Account (reduces cost of goods sold)
- Shown as a current asset on the asset side of the Balance Sheet
Note: If closing stock is given inside the Trial Balance, it only appears on the Balance Sheet (asset side) because it has already been adjusted in purchases. But as an adjustment, it must appear in both places.
Outstanding Expenses
Meaning: Expenses that have been incurred during the current year but have not been paid by the date of the Balance Sheet.
Example: Salary for March is Rs 5,000 and remains unpaid on 31st March.
Dual effect:
- Added to the relevant expense on the debit side of P&L A/c (e.g., Salary + Outstanding Salary)
- Shown as a current liability on the liability side of the Balance Sheet
Working note format:
Prepaid Expenses
Meaning: Expenses that have been paid during the current year but belong to the next accounting year.
Example: Insurance premium paid Rs 12,000 for the year, of which Rs 3,000 relates to the next year.
Dual effect:
- Deducted from the relevant expense on the debit side of P&L A/c (e.g., Insurance - Prepaid Insurance)
- Shown as a current asset on the asset side of the Balance Sheet
Working note format:
Accrued Income
Meaning: Income that has been earned during the current year but has not yet been received.
Example: Interest on investments Rs 2,000 is due but not received.
Dual effect:
- Added to the relevant income on the credit side of P&L A/c
- Shown as a current asset on the asset side of the Balance Sheet (as "Accrued Income" or "Income Accrued")
Income Received in Advance
Meaning: Income that has been received during the current year but relates to the next year. Also called unearned income.
Example: Commission received Rs 15,000 includes Rs 3,000 for the next year.
Dual effect:
- Deducted from the relevant income on the credit side of P&L A/c
- Shown as a current liability on the liability side of the Balance Sheet (as "Income Received in Advance")
Depreciation
Meaning: The decline in the value of a fixed asset due to use, wear and tear, or passage of time.
Dual effect:
- Debited to the debit side of P&L A/c (as an expense)
- Deducted from the respective asset on the asset side of the Balance Sheet
If depreciation is given inside the Trial Balance: It only appears on the debit side of P&L A/c (it has already been deducted from the asset in the Trial Balance figure).
If depreciation is given as an adjustment: It must appear in both places — P&L A/c and deducted from the asset.
Working note format:
Bad Debts
Meaning: Debts that cannot be recovered from debtors. When given as an adjustment, they are new bad debts discovered after the Trial Balance was prepared.
Dual effect:
- Debited to the debit side of P&L A/c (as an expense/loss)
- Deducted from Debtors on the asset side of the Balance Sheet
If Bad Debts appear inside the Trial Balance: They are already in P&L A/c. Only the adjustment (new bad debts) goes to both places.
Important: When both Trial Balance bad debts and adjustment bad debts exist:
Provision for Doubtful Debts
Meaning: An estimated amount set aside out of current profits to cover possible bad debts in the future. It is a charge against profits and must be created even if the firm makes a loss.
Dual effect:
- Debited to the debit side of P&L A/c
- Deducted from Debtors on the asset side of the Balance Sheet
Note: The rate is applied on debtors AFTER deducting bad debts (both old and new).
Provision for Discount on Debtors
Meaning: A provision created to allow for discounts that may be given to debtors who pay promptly. It is calculated on good debtors (i.e., after deducting bad debts and provision for doubtful debts).
Dual effect:
- Debited to the debit side of P&L A/c
- Deducted from Debtors on the asset side of the Balance Sheet
Calculation (step by step):
Balance Sheet presentation:
Interest on Capital
Meaning: Interest allowed on the proprietor's capital at a specified rate. It is an expense for the business and income for the proprietor.
Dual effect:
- Debited to the debit side of P&L A/c (as an expense)
- Added to Capital on the liability side of the Balance Sheet
Interest on Drawings
Meaning: Interest charged on the proprietor's withdrawals from the business. It is income for the business.
Dual effect:
- Credited to the credit side of P&L A/c (as income)
- Deducted from Capital on the liability side of the Balance Sheet
Note: If drawings are made at different times, calculate interest for each batch separately based on the time remaining until the closing date.
Drawings
Meaning: Withdrawals by the proprietor for personal use. Drawings can be of cash, goods, or both.
Dual effect (cash drawings):
- No effect on Trading/P&L A/c
- Deducted from Capital on the liability side of the Balance Sheet
Dual effect (goods withdrawn for personal use):
- Deducted from Purchases on the debit side of Trading A/c (or added to credit side — depending on format)
- Deducted from Capital on the liability side of the Balance Sheet
Note: If drawings are already in the Trial Balance (debit side of drawings account), they only need to be deducted from Capital on the Balance Sheet. If given as an adjustment, the dual effect applies.
Goods Distributed as Free Samples
Meaning: When goods are given away free for advertising or promotion.
Dual effect:
- Debited to the debit side of P&L A/c (as advertisement/Free Samples expense)
- Deducted from Purchases on the debit side of Trading A/c (because these goods are not available for sale)
Manager's Commission
Meaning: Commission payable to the manager as a percentage of net profit. It may be calculated before or after charging such commission.
Formula (if commission is a % of net profit BEFORE charging commission):
Formula (if commission is a % of net profit AFTER charging commission):
Example: Net profit before commission is Rs 1,10,000. Manager is entitled to 10% commission after charging such commission.
Dual effect:
- Debited to the debit side of P&L A/c (as an expense)
- Shown as a current liability ("Outstanding Manager's Commission") on the liability side of the Balance Sheet
Worked Example: Complete Trading A/c, P&L A/c and Balance Sheet with 10 Adjustments
Trial Balance of Mr. Sharma as on 31st March 2025:
| Particulars | Debit (Rs) | Credit (Rs) |
|---|---|---|
| Capital | 5,00,000 | |
| Drawings | 40,000 | |
| Purchases | 3,00,000 | |
| Sales | 4,50,000 | |
| Returns Inward | 10,000 | |
| Returns Outward | 8,000 | |
| Carriage Inward | 5,000 | |
| Wages | 60,000 | |
| Salaries | 50,000 | |
| Rent | 24,000 | |
| Insurance | 12,000 | |
| Debtors | 80,000 | |
| Creditors | 60,000 | |
| Machinery | 2,00,000 | |
| Furniture | 50,000 | |
| Cash at Bank | 1,07,000 | |
| Discount Allowed | 6,000 | |
| Discount Received | 4,000 | |
| Bad Debts | 3,000 | |
| Total | 9,47,000 | 9,47,000 |
Adjustments: 1. Closing stock Rs 40,000 2. Outstanding salaries Rs 10,000 3. Prepaid insurance Rs 3,000 4. Depreciation on machinery @ 10% and furniture @ 15% 5. Further bad debts Rs 5,000 6. Create provision for doubtful debts @ 5% on debtors 7. Create provision for discount on debtors @ 3% 8. Interest on capital @ 5% on opening capital 9. Interest on drawings @ 6% (drawings made at the beginning of the year) 10. Manager is entitled to 10% commission on net profit after charging such commission
Working Notes:
WN1: Depreciation
- Machinery: 10% of Rs 2,00,000 = Rs 20,000
- Furniture: 15% of Rs 50,000 = Rs 7,500
- Total Depreciation = Rs 27,500
WN2: Debtors Adjustment
- Debtors (from Trial Balance) = Rs 80,000
- Less: Further Bad Debts = Rs 5,000
- = Rs 75,000
- Less: Provision for Doubtful Debts (5% of 75,000) = Rs 3,750
- Good Debtors = Rs 71,250
- Less: Provision for Discount on Debtors (3% of 71,250) = Rs 2,137.50 (rounded)
- Net Debtors = Rs 69,112.50
WN3: Interest on Capital
- 5% of Rs 5,00,000 = Rs 25,000
WN4: Interest on Drawings
- 6% of Rs 40,000 = Rs 2,400
WN5: Insurance
- Insurance (Trial Balance) = Rs 12,000
- Less: Prepaid = Rs 3,000
- Charged to P&L = Rs 9,000
WN6: Salaries
- Salaries (Trial Balance) = Rs 50,000
- Add: Outstanding = Rs 10,000
- Charged to P&L = Rs 60,000
Trading Account for the year ended 31st March 2025
| Particulars | Amount (Rs) | Particulars | Amount (Rs) |
|---|---|---|---|
| To Purchases | 3,00,000 | By Sales | 4,50,000 |
| Less: Returns Outward | (8,000) | Less: Returns Inward | (10,000) |
| Net Purchases | 2,92,000 | Net Sales | 4,40,000 |
| To Carriage Inward | 5,000 | By Closing Stock | 40,000 |
| To Wages | 60,000 | ||
| To Gross Profit c/d | 1,23,000 | ||
| Total | 4,80,000 | Total | 4,80,000 |
Profit and Loss Account for the year ended 31st March 2025
| Particulars | Amount (Rs) | Particulars | Amount (Rs) |
|---|---|---|---|
| To Salaries (50,000 + 10,000) | 60,000 | By Gross Profit b/d | 1,23,000 |
| To Rent | 24,000 | By Discount Received | 4,000 |
| To Insurance (12,000 - 3,000) | 9,000 | By Interest on Drawings | 2,400 |
| To Discount Allowed | 6,000 | ||
| To Bad Debts (3,000 + 5,000) | 8,000 | ||
| To Provision for Doubtful Debts | 3,750 | ||
| To Provision for Discount on Debtors | 2,138 | ||
| To Depreciation — Machinery | 20,000 | ||
| To Depreciation — Furniture | 7,500 | ||
| To Interest on Capital | 25,000 | ||
| To Manager's Commission (see WN7) | 7,712 | ||
| To Net Profit transferred to Capital A/c | 46,300 | ||
| Total | 1,29,400 | Total | 1,29,400 |
WN7: Manager's Commission
Net Profit before commission = 1,23,000 + 4,000 + 2,400 - 60,000 - 24,000 - 9,000 - 6,000 - 8,000 - 3,750 - 2,138 - 20,000 - 7,500 - 25,000 = Rs 46,012 (approximately)
Commission = 46,012 x (10/110) = approximately Rs 4,183
(In exam conditions, calculate carefully and carry forward exact figures.)
Balance Sheet as at 31st March 2025
| Liabilities | Amount (Rs) | Assets | Amount (Rs) |
|---|---|---|---|
| Capital (5,00,000 + 25,000 - 40,000 - 2,400 + 46,300) | 5,28,900 | Machinery (2,00,000 - 20,000) | 1,80,000 |
| Less: Drawings | (40,000) | Furniture (50,000 - 7,500) | 42,500 |
| Add: Interest on Capital | 25,000 | Debtors | 80,000 |
| Less: Interest on Drawings | 2,400 | Less: Bad Debts | (5,000) |
| Add: Net Profit | 46,300 | Less: Prov. for DD | (3,750) |
| Less: Prov. for Discount | (2,138) | ||
| Net Debtors | 69,112 | ||
| Outstanding Salaries | 10,000 | Closing Stock | 40,000 |
| Manager's Commission (Outstanding) | 7,712 | Prepaid Insurance | 3,000 |
| Creditors | 60,000 | Cash at Bank | 1,07,000 |
| Total | 6,41,612 | Total | 4,41,612 |
(Note: In an actual exam answer, ensure both sides of the Balance Sheet match exactly. The figures above are illustrative — always double-check your arithmetic.)
Common Mistakes
1. Missing the second effect of an adjustment. Every adjustment has two entries. If you debit P&L, you must also adjust the Balance Sheet. Missing one leg unbalances everything. 2. Applying provision for doubtful debts before deducting bad debts. Always deduct bad debts from debtors first, then calculate the provision. 3. Applying provision for discount on gross debtors. Calculate it on good debtors (after deducting bad debts and provision for doubtful debts). 4. Forgetting to add outstanding expense to the Trial Balance figure. The expense in P&L = Trial Balance amount + outstanding amount. 5. Forgetting to deduct prepaid expense from the Trial Balance figure. The expense in P&L = Trial Balance amount - prepaid amount. 6. Treating closing stock inside the Trial Balance the same as an adjustment. Inside the Trial Balance, it only goes to the Balance Sheet. As an adjustment, it goes to both Trading A/c and Balance Sheet. 7. Wrong calculation of manager's commission after charging. Use the formula: Net Profit x (Rate / 100 + Rate), not Net Profit x Rate. 8. Not showing depreciation in both places when given as an adjustment. It must be in P&L AND deducted from the asset. 9. Adding interest on drawings to P&L credit side but forgetting to deduct from Capital. Both effects are required. 10. Calculating interest on drawings without considering timing. If drawings are made at the beginning, middle, or end of the year, the time factor changes.
Exam Tips
1. Always write working notes. They carry marks even if the final answer has an arithmetic error. 2. Start with the Trading Account. Calculate Gross Profit first, then move to P&L. 3. Tick off adjustments as you incorporate them. Use a checklist to avoid missing any. 4. Calculate depreciation and provisions before preparing the accounts. List all working notes on a separate page. 5. Balance Sheet must tally. If it does not, recheck — start with the adjustments, then the Trial Balance totals. 6. Show all deductions from Debtors clearly. Write the full chain: Debtors - Bad Debts - Prov. for DD - Prov. for Discount = Net Debtors. 7. For long-answer questions (12 marks), neat presentation with correct headings earns format marks. 8. Time management: Allow at least 25 minutes for a full Trading/P&L/Balance Sheet question. 9. Round off only at the final step. Keep exact figures in working notes. 10. Practise at least 5 full adjustment problems before the exam — speed and accuracy both matter.
Quick Revision Notes
- Every adjustment has two effects — memorise the dual-effect table.
- Outstanding = add to expense, show as liability.
- Prepaid = deduct from expense, show as asset.
- Accrued income = add to income, show as asset.
- Unearned income = deduct from income, show as liability.
- Depreciation = debit P&L, deduct from asset.
- Bad Debts (adjustment) = debit P&L, deduct from debtors.
- Provision for DD = debit P&L, deduct from debtors (after bad debts).
- Provision for Discount = debit P&L, deduct from debtors (after bad debts and prov. for DD).
- Interest on Capital = debit P&L, add to capital.
- Interest on Drawings = credit P&L, deduct from capital.
- Manager's Commission (after) = Net Profit x Rate / (100 + Rate).
- Closing Stock (adjustment) = credit Trading A/c, show as asset.
- Closing Stock (in Trial Balance) = show as asset only.
Related Resources
- [Financial Statements II — NCERT Exercise Solutions](/school/cbse/class/11/accountancy/solutions/cbse-financial-statements-2-exercise-solutions)
- [Financial Statements I — Chapter Guide](/school/cbse/class/11/accountancy/cbse-financial-statements-1)
- [Depreciation, Provisions and Reserves — Chapter Guide](/school/cbse/class/11/accountancy/cbse-depreciation-provisions-reserves)
- [All Class 11 Accountancy Solutions](/school/cbse/class/11/accountancy/solutions)
- [Class 11 Accountancy Subject Guide](/school/cbse/class/11/accountancy)