Gross Profit and Net Profit with Drawings, Free Samples and Year-End Adjustments
M/s Sagar Traders is a proprietary concern. For the year ended 31 March 2024, its trial balance shows: opening stock ₹80,000; purchases ₹5,20,000; sales ₹8,40,000; returns inward ₹20,000; returns outward ₹15,000; wages ₹45,000; carriage inward ₹10,000; salaries ₹60,000; rent ₹24,000; bad debts ₹8,000; debtors ₹1,20,000; provision for doubtful debts (opening) ₹6,000; closing stock ₹95,000. Additional information: the proprietor took goods costing ₹12,000 for personal use and distributed goods costing ₹8,000 as free samples; neither transaction is recorded. Salaries of ₹5,000 are outstanding, rent of ₹3,000 is prepaid, and depreciation on furniture is ₹7,000. A 5% provision for doubtful debts is to be maintained on debtors. The proprietor wants to know gross profit, net profit, and whether the goods taken for personal use should be treated as a business expense.
1. Compute gross profit, showing clearly how the goods taken by the proprietor and the free samples are treated.
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Net sales = ₹8,40,000 − returns inward ₹20,000 = ₹8,20,000.
Adjusted purchases = ₹5,20,000 − returns outward ₹15,000 − drawings of goods ₹12,000 − free samples ₹8,000 = ₹4,85,000.
Cost of goods sold = opening stock ₹80,000 + adjusted purchases ₹4,85,000 + wages ₹45,000 + carriage inward ₹10,000 − closing stock ₹95,000 = ₹5,25,000.
Gross profit = ₹8,20,000 − ₹5,25,000 = ₹2,95,000.
Goods taken by the proprietor are deducted from purchases because they were never sold; the cost is treated as drawings. Free samples are also deducted from purchases, but their cost is then charged as an advertisement expense, so profit bears the cost.
2. Compute net profit and state the provision for doubtful debts adjustment.
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Net profit = gross profit ₹2,95,000 − salaries (₹60,000 + ₹5,000 outstanding) − rent (₹24,000 − ₹3,000 prepaid) − bad debts ₹8,000 − depreciation ₹7,000 − advertisement/free samples ₹8,000.
Provision for doubtful debts: new provision = 5% of debtors ₹1,20,000 = ₹6,000. Opening provision = ₹6,000. Since the new provision equals the old provision, there is no charge or credit to the Profit and Loss Account.
Net profit = ₹2,95,000 − ₹65,000 − ₹21,000 − ₹8,000 − ₹7,000 − ₹8,000 = ₹1,86,000.
3. Should the goods taken by the proprietor be treated as a business expense? How does this affect capital?
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No. Goods taken for personal use are drawings, not a business expense. The correct treatment is to deduct ₹12,000 from purchases and deduct the same amount from capital as drawings. If it were wrongly treated as an expense, profit would be understated and the proprietor's capital would not reflect the withdrawal. Free samples are different: they are a business promotion expense, so their ₹8,000 cost is charged to the Profit and Loss Account and is not deducted from capital as drawings.