Ravinder Patel: four year-end adjustments
Ravinder Patel runs a sole trading business. His draft statement of profit or loss for the year ended 31 December 2025 shows a net profit of £86,400. The following have not yet been reflected.
• Closing inventory was counted at cost of £42,000. It includes a line discontinued by the supplier, which cost £6,000 and could now be sold for £3,500, incurring selling costs of £500. The net realisable value of all other inventory exceeds cost. • Rent of £18,000 paid during the year has been charged to draft profit. Of this, £1,500 relates to the three months to 31 March 2026; a further £2,000 for October to December 2025 was not invoiced until January 2026. • No depreciation has been charged. Equipment cost £120,000 and is depreciated at 15% a year on the reducing balance; its carrying amount at 1 January 2025 was £68,000. • Goods costing £3,600 were taken by Ravinder for personal use during the year. They were included in purchases, but no other entry was made.
1. Calculate the adjusted net profit, showing each adjustment and its direction.
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| Adjustment | Workings | £ |
|---|---|---|
| Draft profit | 86,400 | |
| Inventory write-down | NRV = 3,500 − 500 = 3,000 against cost 6,000: loss of 3,000 | (3,000) |
| Rent accrual/prepayment | 18,000 − 1,500 + 2,000 = 18,500 charged, so 500 more than already charged | (500) |
| Depreciation | 15% × 68,000 carrying amount = 10,200 | (10,200) |
| Goods for own use | Cost removed from purchases; the sale never happened | 3,600 |
| Adjusted net profit | 76,300 |
Two judgements carry the marks. Depreciation is charged on the £68,000 carrying amount, not the £120,000 cost - the reducing-balance method applies to the amount still carried forward. And the rent adjustment is net: the prepayment is stripped out and the accrual added, so only the £500 net difference hits profit. Closing inventory is stated at 42,000 − 3,000 = £39,000 in the statement of financial position.
2. By how much does the correction change Ravinder's capital, and why is the goods-for-own-use adjustment made against purchases rather than being shown as an expense?
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Effect on capital
- Profit falls by 86,400 − 76,300 = £10,100
- Drawings rise by £3,600
- Capital therefore falls by £13,700
The two effects are cumulative because they push in the same direction: lower profit reduces the capital generated, and higher drawings reduce the capital retained.
Why purchases, not an expense. Ravinder has not sold the goods - he has taken them. The business has simply stopped owning them, and the owner has received value in his capacity as owner. Charging the £3,600 to an expense account would understate profit by a cost that produced no revenue and would leave drawings understated by the same amount, so the capital account would be wrong twice over. Removing the cost from purchases leaves the trading account showing only goods actually sold, and the drawings account records the distribution to the owner. The net effect on capital is identical either way only if both entries are made - the error in the draft accounts is that neither was.
3. Ravinder argues that the discontinued line will not be sold below cost until late 2026, so no write-down is needed in 2025. Evaluate his argument.
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His argument confuses the date of sale with the date the loss arises. IAS 2 requires inventory to be measured at the lower of cost and net realisable value at each reporting date. The write-down is not a forecast of a future loss; it is a recognition that at 31 December 2025 the £6,000 of stock is worth only £3,000 in net cash terms. The loss of £3,000 has already happened - the supplier discontinued the line and the market price fell - and deferring it to 2026 would report an asset above the amount it can recover and overstate 2025 profit by £3,000.
The relevant characteristic is prudence, applied neutrally: it does not permit deliberately understating assets, but it does require that a known fall in value is recognised in the period in which it occurs rather than smoothed into the period of sale. Deferring the loss would also breach accruals, since the expense relates to goods held at the 2025 year end, and would flatter the 2025 result at the expense of 2026. If the £3,000 is immaterial to Ravinder's accounts the argument is academic, but the reasoning would still be wrong.