Accountancy – Past Adjustments

After the final accounts have been prepared and profits have been distributed among the partners of the firm, it can be possible that there are some errors that have occurred or some items that have been omitted while recording the transactions or in preparing the summary statements. The omission of items could include interest on capital, interest on drawings, interest on partner’s loan, partner’s commission or outstanding expenses. It is required to adjust these omissions or they could create an error in the books of accounting. Necessary adjustments are made: through profit and loss adjustment A/c or directly in a partner’s account.

Methods of Rectification

A and B are two equal partners. Their capitals as of April 01, 2018, were Rs. 50000 and Rs. 100000 respectively. After preparing the final accounts for the financial year ending March 31, 2019, it was found that interest at the rate of 6% p.a. that was mentioned in the partnership deed was not credited to the partners’ capital account before distributing the profits. The interest on capital not credited to their respective capital account would be – for A, the interest on capital would be Rs. 3000 and for B, it would be Rs. 6000. The total amount of profit has been distributed among the partners and the interest on capital is not credited to their capital accounts. This could be rectified in two ways:

1. Through Profit and loss Adjustment Account

Profit and loss adjustment account is made in order to rectify the errors and omissions that weren’t recorded when the final accounts were being made and profits were being distributed among the partners, and later on, it was found that there may be some items that weren’t recorded. The entries would be-

(a)   Through Profit and Loss Adjustments A/c

(1) Profit and Loss Adjustment A/c                                      Dr.   9000

                     To A’s capital A/c                                                                    3000

                     To B’s capital A/c                                                                    6000

               (Interest on capital)

(2) A’s capital A/c                                                                     Dr.   4500

       B’s capital A/c                                                                     Dr.   4500

                   To Profit and Loss Adjustment A/c                                                             9000

   (Loss on adjustment)

(b)  Directly in Partner’s Capital Account

For a direct adjustment in partners’ capital accounts, first of all, a statement to determine the net effect of omission on partners’ capital account would be worked out, as mentioned, and then the entries regarding the adjustments could be recorded.

Details                                                                                       A                              B

1.Amount which should have been credited         3000(Cr.)                   6000(Cr.)

as interest on capital

2.Amount actually credited by way of                    4500(Dr.)                   4500(Dr.)

share of profit

3.Difference between 1 and 2                                    Dr. 1500                       Cr. 1500

(Net effect)                                                                       (Excess)                        (Short)

Past Adjustments in Partnership

In a partnership firm, sometimes errors occur or some omissions may have happened while recording the transactions and these are found out after the final accounts have been prepared. Then these adjustments are made to nullify the effects of those omissions. As per the above-mentioned example, the interest on capital was not recorded and the final accounts were made along with the distribution of profits. Then the error was corrected through profits and loss adjustment A/c.

It is observed that even with the utmost care, it is possible for a few errors and omissions to make their way to accounts. This could lead to further errors in the book of account and financial statements and they need to be corrected. These may be because of interest on capital, partner’s salary, partner’s loan’ interest on drawings, etc. It is also possible that an error occurs because of any change in the profit-sharing ratio between the partners.

In case of a single error, a journal entry is passed to rectify the error. However, sometimes it is required to prepare profit and loss appropriation A/c, and the adjustments are made accordingly.

Conclusion

Past adjustments state that if an error is found in recording transactions after the preparation of final accounts, it must be corrected so that there is no scope for any further mistakes. After the financial statements are prepared, it is problematic for the accounts to be rectified. Past adjustments are then made in order to rectify these mistakes. These errors could be rectified in two ways – through profit and loss adjustment A/c or directly in the partner’s capital account. Necessary journal entries are made to maintain the balance.