Four Year-End Judgement Calls at a Sole Trading House
M/s Raghunath & Sons, a sole trading house dealing in machine tools, closes its books on 31 March. The accountant, who has no formal training, has arrived at a draft profit of ₹9,20,000 for 20X4-15 and asks you to review four items before the accounts are signed.
(i) Goods costing ₹4,80,000 were invoiced at ₹6,00,000 on 26 March and sent to a customer under a written sale-or-return arrangement giving him 45 days to accept. No decision had reached the proprietor by 31 March, yet the full ₹6,00,000 stands recorded as a sale.
(ii) A grinding machine was invoiced at ₹12,00,000. Freight of ₹40,000 and installation wages of ₹75,000 were paid; only the invoice and freight were debited to Machinery, the wages going to Wages Account. The machine was ready for use on 25 March. Depreciation is charged at 15% on written-down value.
(iii) A debtor owing ₹2,60,000 has entered insolvency proceedings. The resolution professional expects a recovery of about 30%. No provision has been made because the court order is awaited.
(iv) A March fire caused damage assessed at ₹1,50,000. The claim was filed in April and the proprietor refuses to record anything until cash is received.
1. For each of items (i) to (iv), state the correct treatment for the year ended 31 March 20X5, giving the reason and the quantified effect on draft profit.
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Item (i) - sale or return. Revenue is recognised only when the significant risks and rewards of ownership pass to the buyer. Under a sale-or-return arrangement the buyer holds an unqualified right to return the goods, so there is no sale on 26 March, and none on 31 March merely because the 45-day window is running. Reverse the entry: remove the ₹6,00,000 sale and bring the goods back into closing stock at cost ₹4,80,000. Effect: −₹1,20,000, being the unrealised margin.
Item (ii) - installation wages. AS 10 requires all costs directly attributable to bringing an asset to its working condition for its intended use to be capitalised. Installation wages of ₹75,000 qualify. The machinery account should read ₹13,15,000 (12,00,000 + 40,000 + 75,000). Depreciation for the six days from 25 March would be trivial (about ₹325 at 15% WDV) and may be ignored, but if the machine had been ready earlier, part-year depreciation would be mandatory. Effect: +₹75,000.
Item (iii) - insolvent debtor. The insolvency and the resolution professional's estimate establish that the receivable is impaired before the year end. Waiting for the NCLT order is a procedural delay, not a reason to carry a known loss. Provide 70% of ₹2,60,000 = ₹1,82,000. Effect: −₹1,82,000.
Item (iv) - fire claim. A contingent asset is not recognised until the inflow is virtually certain. A lodged claim is not certain; an admitted claim, credited to a debtor, would be. No income is recognised and there is no effect on profit; a note may disclose the claim.
2. Compute the corrected profit and reconcile it with the draft figure, showing which balance sheet lines are also affected.
Read the worked answer
| Item | ₹ |
|---|---|
| Draft profit | 9,20,000 |
| Reverse sale-or-return sale (6,00,000 − 4,80,000) | (1,20,000) |
| Capitalise installation wages | 75,000 |
| Provision for impaired debtor | (1,82,000) |
| Fire claim (no recognition) | - |
| Corrected profit | 6,93,000 |
Balance sheet consequences:
- Stock rises by ₹4,80,000 and debtors fall by ₹6,00,000 (the returned goods), so the two movements offset in net worth apart from the ₹1,20,000 margin.
- Machinery rises by ₹75,000, matched by an equal fall in the wages expense.
- Debtors are shown net of the ₹1,82,000 provision (or the provision is disclosed separately and deducted).
- Overall net worth falls by ₹2,27,000: the ₹1,82,000 provision plus the ₹1,20,000 margin lost, less ₹75,000 of wages capitalised.
- The reinstated stock of ₹4,80,000 must itself be tested against net realisable value under AS 2, since the goods have been out with a customer for a season.
3. The proprietor objects that providing for the insolvent debtor before the NCLT approves the resolution plan is 'excessive conservatism' that will spoil his bank loan application. Evaluate the argument.
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The objection confuses prudence with deliberate understatement. Prudence is the exercise of caution where judgement is required, so that assets and income are not overstated and liabilities and losses are not understated. It is bounded by neutrality: it does not license creating hidden reserves, anticipating losses that have not occurred, or ignoring information that is already available.
Here, three facts existed before 31 March: the insolvency petition, the resolution professional's appointment, and an estimated 30% recovery. Recognising a ₹1,82,000 provision is therefore an application of the accrual concept, not conservatism - the loss event occurred in the accounting period. Not providing would overstate profit and net worth and would effectively anticipate income from a recovery that is uncertain.
The loan-application argument is not an accounting argument. A banker assessing the proprietorship will independently discount unprovided receivables, and a misstatement discovered later would damage credibility more than a prudent provision now. If the recovery estimate is genuinely a range, the entity should use the best estimate and disclose the uncertainty; it should not defer recognition.
Note the boundary: the fire claim is the mirror image. There the inflow is not virtually certain, so prudence works the other way and forbids recognition. Prudence is symmetrical - it cuts both ways.