Balance sheet is the third financial statement which reveals the financial status of the
enterprise through the total amount of resources raised and applied in the form of assets.
This is the fundamental statement of the firm which explores the firm financial stature
through the resources mobilized and investments applied i.e. Liabilities and Assets
respectively. From the early, according to double entry concept or Duality concept, the
balance sheet can be divided into two distinct sides, known as liabilities and assets.
The balance sheet can be disclosed in two different orders
(i) in the order of long lastingness - permanence
(ii) in the order of liquidity
Proforma Balance Sheet as on dated…………………….
(In the order of Long lastingness)
The downward arrow shows the order / arrangement of the assets and liabilities on the
basis of permanence or long lastingness
The upward arrow shows the order /arrangement of the assets and liabilities on the
basis of liquidity.
Methods of determining the accounting income includes:
i. Cash method of accounting
ii. Mercantile method of accounting
3.4.1 Cash Method of Accounting
Under this method, cash receipts are matched with the cash payments irrespective of
the time period in order to determine the income.
3.4.2 Mercantile Method of Accounting
Under this method, time period is given greater importance than the actual receipts and
payments. It records the receipts and expenses pertaining to the specified period whether
them are actually received /paid or not. The receipts as well as payments of the other
periods should be ignored /eliminated in determining the income of the stipulated duration.
It is popularly known in other words as "Accrual Accounting System".
Next stage is to classify the types of income of the enterprise:
To determine income of the business, what should be in character ? Either in accounting
income or taxable income.
Taxable income can be computed from the transactions of the enterprise but they are
subject to frequent modifications on the tax provisions from one year to another year.
This cannot be uniquely found out unlike the accounting income. The accounting income
should have to be found out only to the tune of accounting principles and concepts.
The process of final accounts diagram is illustrated in the next page for easier
understanding not only to adopt the mercantile system of accounting but also to implement
the duality principle of accounting throughout the transactions.
Adjustment entries
The adjustment entries are classified into three segments viz on expenses, incomes and others.
On expenses
The adjustment entries on expense can be classified into two categories
(1) Outstanding Expenses: These are incurred expenses but not paid in cash
E.g. Rent of the office is Rs. 22, 000 for 11 months only The enterprise has failed
to remit the payment of last month rent amounted Rs. 2, 000. According to mercantile
system of accounting, the rent of the office, whether fully paid or not, it should be
totally considered for the entire duration to determine the income of the enterprise.
Finally, what is to be done ? The amount of actual rental should be added with the
rent which has not been paid by the enterprise i-e (Rs. 22, 000+Rs. 2, 000=Rs. 24,
Treatment of the transaction
Debit the expense account
Credit the liability i-e of the person to whom the amount to be paid

Profit &Loss A/c:- Add the outstanding amount with the total expenses already paid
Balance sheet:-Include it as an item of responsibility under the liabilities side
(2) Prepaid expenses: Normally, some of the expenses paid for availing the services
are not fully extracted during the term; which left / unused should be normally
carried forward to the next term. It means that the expense which is paid in
advance to make use of the service for forthcoming period to whom is known as
debtor; the person who keeps the money of the enterprise for the definite duration
is nothing but an asset.
Debit the asset - Advance payment for service
Profit &Loss A/c:- Deduct the prepaid amount from the total expenses already paid
Balance sheet:-Include it as an item of application under the assets side
Next major segment in the adjustment entry is on Incomes
Income Outstanding
Perceived Income
(3) Income outstanding: It happens during the enterprise then and there ; which means
income earned but not received. It happens in the case of certain income of dividend
on shares, interest on loans granted not yet received. The income earned but not
received is also an income that should be credited in the income account to know
the total volume of the income pertaining to the accounting period. The income
earned but not received is nothing but an asset not yet received. The income not
yet received from whom should be debited as an asset due to the enterprises'
money income with the other person / institution.
(4) Bad debts
Bad debts is the result of credit sales which only due to the inability of
customers / consumers to settle the overdue. The inability may be due to poor
repaying capacity or insolvent during the moment of the sales. The bad debt due to
the inability cannot be deducted from the sales volume which was already transacted.
The debts cannot be recovered has to be treated as a loss of the firm.
Debit all losses of the firm. The losses due to bad debts should be appropriately
effected as well as adjusted in the individuals' account i-e in the consumers' account
who received the goods on credit
Profit &Loss A/c:- Non recovery of credit sales is deemed to be a losses – should be debited to
Profit & Loss A/c
Balance sheet:-Non recovery of credit sales should be deducted from the volume of credit sales
transacted by the firm under the Assets side in order to determine the original amount of credit

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