Year-End Adjustments and Closing Stock Valuation for a Sole Trader
Meera, a sole trader, has prepared a draft statement of profit or loss for the year ended 31 March 2025 showing a net profit of ₹3,00,000. Before finalising the accounts you review the following: (a) closing stock has been taken at cost, ₹2,40,000; this figure includes goods sent to a customer on sale or return at cost ₹24,000, although the related sale of ₹30,000 has already been recorded; (b) of the remaining stock, 10% is slow-moving and its net realisable value is only half of cost; (c) wages include ₹18,000 paid for installing new machinery; (d) insurance of ₹12,000 was paid on 1 July 2024 for twelve months; (e) debtors of ₹1,60,000 include the ₹30,000 from the sale-or-return customer; bad debts of ₹8,000 are to be written off and a provision of 5% is required; the existing provision is ₹4,000. Ignore depreciation on the new machinery.
1. Compute the correct value of closing stock and explain the treatment of the sale-or-return goods.
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Sale-or-return goods: the customer has not given approval, so the risks and rewards of ownership have not passed. The goods remain Meera's stock at their cost of ₹24,000, and the ₹30,000 sale already recorded must be reversed. The stock figure is therefore not reduced for these goods, but the sale is.
Slow-moving stock:
- Stock excluding sale-or-return goods = ₹2,40,000 − ₹24,000 = ₹2,16,000
- Slow-moving portion = 10% × ₹2,16,000 = ₹21,600 at cost
- Net realisable value = 50% × ₹21,600 = ₹10,800
- Write-down required = ₹21,600 − ₹10,800 = ₹10,800
Correct closing stock = ₹2,40,000 − ₹10,800 = ₹2,29,200.
The write-down applies the lower of cost and net realisable value rule; the loss is charged to profit.
2. Reconcile the draft net profit to the corrected net profit, showing each adjustment and the reasoning.
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| Adjustment | ₹ |
|---|---|
| Draft net profit | 3,00,000 |
| Reverse sale recorded on sale-or-return goods | −30,000 |
| Write stock down to net realisable value | −10,800 |
| Wages wrongly charged: installation is capital | +18,000 |
| Insurance prepaid (3 months: Jan–Mar 2025) | +3,000 |
| Bad debts written off | −8,000 |
| Increase in provision for doubtful debts | −2,100 |
| Corrected net profit | 2,70,100 |
Provision working: debtors ₹1,60,000 − ₹30,000 (sale reversed) − ₹8,000 (bad debts) = ₹1,22,000. Provision at 5% = ₹6,100. Existing provision ₹4,000, so the charge is ₹2,100.
Insurance working: ₹12,000 covers 1 July 2024 to 30 June 2025. At 31 March 2025, nine months have expired and three months (₹3,000) are prepaid.
3. Show the relevant balance sheet extracts and explain why reversing the sale reduces profit by ₹30,000 even though the stock is retained.
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| Balance sheet extract as at 31 March 2025 | ₹ |
|---|---|
| Non-current asset: Machinery (installation capitalised) | 18,000 added |
| Current assets: | |
| Stock | 2,29,200 |
| Debtors | 1,22,000 |
| Less: Provision for doubtful debts | (6,100) |
| Net debtors | 1,15,900 |
| Prepaid insurance | 3,000 |
Why the full ₹30,000 is removed from profit: the sale was recorded at ₹30,000 and the goods were also left in closing stock at ₹24,000. No cost of sale was ever charged against that revenue. Reversing the sale therefore removes ₹30,000 of revenue with no matching cost to add back, so profit falls by the full ₹30,000. The stock stays at ₹24,000 because ownership has not passed; the error was recognising revenue too early, not valuing the stock.