• in Financial Accounting
In financial accounting, adjustments are transactions relating to the business, which have not yet been journalised. To incorporate these adjustments into accounting, we need to know the effect of the journal entry to be passed for each adjustment.
• in Funds Flow Analysis
Even in Funds Flow analysis, adjustments are transactions relating to the business. They sound similar to the ones we come across in financial accounting. The major difference is that they are transactions which have already been journalised.
» Why do we need them?
Adjustments are transactions relating to the business which have influenced the Fund Accounts and brought about a change in working capital. These transactions relating to Fund Accounts are needed for analysing the funds flow.
Thus we use adjustments to derive the information relating to transactions that have affected a change in the Fund Accounts/Working Capital during the period for which the flow is being measured.
What we need to do is to identify the effect of these transactions on the accounts within the Fund Area of the Balance sheet and thereby identify the Funds Flows.
Thus, even in Funds flow analysis we need to understand the journal entries relating to adjustments.
» Some Examples
- Depreciation charged on assets
- Sale of Assets at a profit/loss
- Appropriation of profits to reserves
- Drawings of Capital
- Additional Capital brought in or raised
- Payments and Appropriations in relation to Provisions for Taxations/Dividends where they are treated as Non-Current (Fund) liabilities.
- Payment of interim Dividend
- Purchases of Assets for Cash, in exchange for Current Assets
It would be convenient assuming Profit and Loss Appropriation a/c in place of Profit and Loss a/c in relation to all the transactions where there is a Funds Flow.
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Depreciation Charged on Assets
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| Recording Depreciation |
Charging Depreciation |
Net Effect |
Dr. Depreciation a/c
Cr. Asset a/c
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Dr. Profit/Loss Appropriation a/c
Cr. Depreciation a/c
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Dr. Profit/Loss Appropriation a/c
Cr. Asset a/c
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• using Depreciation Reserve a/c
Under this method, the depreciation charge is accumulated in a separate account named "Depreciation Reserve a/c" instead of writing off depreciation every year from the asset account.
| Recording/Charging Depreciation |
Dr. Profit/Loss Appropriation a/c
Cr. Depreciation Reserve a/c
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At any point of time, the written down value of an asset is ascertained by setting off the asset account and the relevant depreciation reserve account.
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Sale of Asset at a Profit
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| Recording Asset Sale |
Recording Profit |
Combined/Net Effect |
Dr. Cash/Bank a/c
Cr. Asset a/c
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Dr. Asset a/c
Cr. Profit/Loss Appropriation a/c
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Dr. Cash/Bank
Cr. Asset a/c
Cr. Profit/Loss Appropriation a/c
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» using Asset Disposal a/c
| Writing off Asset Sold |
Recording Asset Sale |
Recording Profit |
Combined/Net Effect |
Dr. Asset Disposal a/c
Cr. Asset a/c
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Dr. Cash/Bank a/c
Cr. Asset Disposal a/c
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Dr. Asset Disposal a/c
Cr. Profit/Loss Appropriation a/c
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Dr. Cash/Bank
Cr. Asset a/c
Cr. Profit/Loss Appropriation a/c
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• Where Depreciation Reserve a/c in relation to the asset exists
| Writing off Depreciation Reserve |
Recording Asset Sale |
Recording Profit |
Combined/Net Effect |
Dr. Depreciation Reserve a/c
Cr. Asset a/c
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Dr. Cash/Bank a/c
Cr. Asset a/c
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Dr. Asset a/c
Cr. Profit/Loss Appr a/c
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Dr. Cash/Bank
Cr. Asset a/c
Cr. Profit/Loss Appr a/c
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» using Asset Disposal a/c
| Writing off Asset Sold |
Writing off Depreciation Reserve |
Recording Asset Sale |
Recording Profit |
Dr. Asset Disposal a/c
Cr. Asset a/c
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Dr. Depreciation Reserve a/c
Cr. Asset Disposal a/c
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Dr. Cash/Bank a/c
Cr. Asset Disposal a/c
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Dr. Asset Disposal a/c
Cr. Profit/Loss Appropriation a/c
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| Combined/Net Effect |
Dr. Cash/Bank
Cr. Asset a/c
Cr. Profit/Loss Appropriation a/c
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Notice that the Net Effect in all the above cases is the same. Using Asset sale account would give a better understanding of the transaction by providing clear information.
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The basic purpose of accounting is derivation of information. The more the information we need the more the accounting heads we need to maintain.
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| Recording Asset Sale |
Recording Loss |
Combined/Net Effect |
Dr. Cash/Bank a/c
Cr. Asset a/c
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Dr. Profit/Loss Appropriation a/c
Cr. Asset a/c
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Dr. Cash/Bank
Dr. Profit/Loss Appropriation a/c
Cr. Asset a/c
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» using Asset Disposal a/c
| Writing off Asset Sold |
Recording Asset Sale |
Recording Loss |
Combined/Net Effect |
Dr. Asset Disposal a/c
Cr. Asset a/c
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Dr. Cash/Bank a/c
Cr. Asset Disposal a/c
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Dr. Profit/Loss Appropriation a/c
Cr. Asset Disposal a/c
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Dr. Cash/Bank
Dr. Profit/Loss Appropriation a/c
Cr. Asset a/c
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• Where Depreciation Reserve a/c in relation to the asset exists
| Writing off Depreciation Reserve |
Recording Asset Sale |
Recording Loss |
Combined/Net Effect |
Dr. Depreciation Reserve a/c
Cr. Asset a/c
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Dr. Cash/Bank a/c
Cr. Asset a/c
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Dr. Profit/Loss Appr a/c
Cr. Asset a/c
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Dr. Cash/Bank
Dr. Profit/Loss Appr a/c
Cr. Asset a/c
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» using Asset Disposal a/c
| Writing off Asset Sold |
Writing off Depreciation Reserve |
Recording Asset Sale |
Recording Loss |
Dr. Asset Disposal a/c
Cr. Asset a/c
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Dr. Depreciation Reserve a/c
Cr. Asset Disposal a/c
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Dr. Cash/Bank a/c
Cr. Asset Disposal a/c
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Dr. Profit/Loss Appropriation a/c
Cr. Asset Disposal a/c
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| Combined/Net Effect |
Dr. Cash/Bank
Dr. Profit/Loss Appropriation a/c
Cr. Asset a/c
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Notice that the Net Effect in all the above cases is the same. Using Asset sale account would give a better understanding of the transaction by providing clear information.
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The basic purpose of accounting is derivation of information. The more the information we need the more the accounting heads we need to maintain.
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Appropriation of Profits to Reserves
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| Creation of a Reserve |
Dr. Profit/Loss Appropriation a/c
Cr. Reserve a/c
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Additional Capital raised
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| Capital brought in/raised |
Dr. Cash/Bank/Current Asset a/c
Cr. Capital a/c
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The asset acquired in exchange for Capital can be any of the Current Assets
to effect a Funds Flow.
If the asset acquired is a Fund Asset, or if the Capital is being raised
to replace a Fund Liability, there would no funds flow.
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| Drawings made |
Drawings written off to Capital |
Net Effect/Combined Entry |
Dr. Drawings a/c
Cr. Cash/Bank/Current Asset a/c
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Dr. Capital a/c
Cr. Drawings a/c
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Dr. Capital a/c
Cr. Cash/Bank/Current Asset a/c
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The drawings made in the form of any of the Current Assets would effect a Funds Flow.
If the drawings made are in the form of a Fund Asset, or if the drawings are made by accepting a Fund Liability, there would no funds flow.
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Payments for Taxes/Dividends
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It is assumed that taxes and dividends are provided for and then paid. Thus, payment of tax/dividend implies paying out the amount provided for through the respective provision accounts
| Payment of Taxes |
Payment of Dividends |
Dr. Provision for Taxation a/c
Cr. Cash/Bank a/c
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Dr. Provision for Dividend a/c
Cr. Cash/Bank a/c
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This should be considered only when the provision for taxation/dividend account is a Fund liability i.e. a non-current account.
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Provision for Taxes/Dividends
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Reserves/Provisions are created out of profits.
| Reserve for Taxes |
Reserve for Dividends |
Dr. Profit and Loss Appropriation a/c
Cr. Provision for Taxation a/c
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Dr. Profit and Loss Appropriation a/c
Cr. Provision for Dividends a/c
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This should be considered only when the provision for taxation/dividend account is a Fund liability i.e. a non-current account.
» Where Provision for Taxes/Dividends accounts are Current Liabilities
Where the Provision for taxation and Provision for Dividends accounts are treated as current liabilities, then the provision created is accepted as a charge against profits and not as an appropriation of profits. Therefore, the provision is to be created out of profits from the Profit and Loss account.
| Reserve for Taxes |
Reserve for Dividends |
Dr. Profit and Loss a/c
Cr. Provision for Taxation a/c
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Dr. Profit and Loss a/c
Cr. Provision for Dividends a/c
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Normally the dividends of a company for a particular financial year can be paid only out of the profits for that year arrived at after providing for depreciation. Thus declaration of dividends would be possible only after finalising accounts.
Companies Act, 1956
Hide/Show
Sec 205. Dividend to be paid only out of profits
| (1) | No dividend shall be declared or paid by a company for any financial year except out of the profits of the company for that year arrived at after providing for depreciation in accordance with the provisions of sub-section (2) or out of the profits of the company for any previous financial year or years arrived at after providing for depreciation in accordance with those provisions and remaining undistributed or out of both or out of moneys provided by the Central Government or a State Government for the payment of dividend in pursuance of a guarantee given by that Government :
Provided that -
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if the company has not provided for depreciation for any previous financial year or years which falls or fall after the commencement of the Companies (Amendment) Act, 1960 it shall, before declaring or paying dividend for any financial year provide for such depreciation out of the profits of that financial year or out of the profits of any other previous financial year or years;
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| (b) |
if the company has incurred any loss in any previous financial year or years, which falls or fall after the commencement of the Companies (Amendment) Act, 1960 then, the amount of the loss or an amount which is equal to the amount provided for depreciation for that year or those years whichever is less, shall be set off against the profits of the company for the year for which dividend is proposed to be declared or paid or against the profits of the company for any previous financial year or years, arrived at in both cases after providing for deprecation in accordance with the provisions of sub-section (2) or against both;
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| (c) |
the Central Government may, if it thinks necessary so to do in the public interest, allow any company to declare or pay dividend for any financial year out of the profits of the company for that year or any previous financial year or years without providing for depreciation :
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Provided further that it shall not be necessary for a company to provide for depreciation as aforesaid where dividend for any financial year is declared or paid out of the profits of any previous financial year or years which falls or fall before the commencement of the Companies (Amendment) Act, 1960.
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Interim dividend can be declared by the Board of Directors at any time.
Companies Act, 1956
Hide/Show
Sec 205. Dividend to be paid only out of profits
| (1A) | The Board of directors may declare interim dividend and the amount of dividend including interim dividend shall be deposited in a separate bank account within five days from the date of declaration of such dividend.
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Interim dividends are first paid and then appropriated from profits.
| Payment of Interim Dividend |
Appropriation of Profits for Dividend |
Dr. Interim Dividend a/c
Cr. Bank a/c
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Dr. Profit and Loss Appropriation a/c
Cr. Interim Dividend a/c
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On the assumption that the balance sheet is prepared after completing finalisation of accounts, we will find no trace of the interim dividend having been paid, unless there is an indication in the form of adjustments or additional information.
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| Purchase of Assets |
Dr. Asset a/c
Cr. Cash/Bank a/c
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The purchase of an asset would result in a fund flow only if the payment is made in the form
of cash, bank, a current asset or by taking over a current liability.
Where the asset is purchased by issuing capital or by accepting any other long term liability,
there would be no flow of fund.
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