Sawant Traders: the trial balance agrees, so why is the profit wrong?
M/s Sawant Traders, a sole proprietor trading in hardware at Nashik, closed its books on 31 March 2024 with a draft net profit of ₹1,86,400. The trial balance agreed, so no suspense account was opened. During the audit the following were noticed: (i) furniture costing ₹24,000 bought on 1 October 2023 was debited to Purchases and no depreciation was charged on it; (ii) goods costing ₹9,000 were taken home by the proprietor for his daughter's wedding and no entry was passed anywhere; (iii) bad debts of ₹5,600 were written off, but the provision for doubtful debts carried at ₹9,000 was not reworked although debtors after the write-off are ₹1,40,000 and the policy is a 5% provision; (iv) a sales return of ₹2,400 was not recorded at all; (v) wages of ₹6,000 paid to workers who installed a new cutting machine were debited to Wages. The auditor refuses to sign until a corrected statement of profit is placed before the proprietor.
1. Prepare a statement showing the corrected net profit for the year ended 31 March 2024, dealing with each of the five items and giving a one-line reason for every adjustment.
Read the worked answer
Statement of corrected net profit
| Item | Nature of adjustment | ₹ |
|---|---|---|
| Draft net profit | as per books | 1,86,400 |
| (i) Furniture debited to Purchases | capital expenditure wrongly treated as revenue, add back | +24,000 |
| (i) Depreciation on furniture, 10% p.a. for 6 months (1.10.2023 to 31.3.2024 = 24,000 × 10% × 6/12) | charge now, it was never provided | −1,200 |
| (ii) Goods taken by proprietor | add back, it is drawings and not a sale or an expense | +9,000 |
| (iii) Provision required 5% of 1,40,000 = 7,000 against 9,000 already held | excess provision of 2,000 written back | +2,000 |
| (iv) Sales return omitted | sales and debtors both overstated, deduct | −2,400 |
| (v) Installation wages debited to Wages | part of the cost of the machine, add back | +6,000 |
| Corrected net profit | 2,23,800 |
How the figure is arrived at
1,86,400 + 24,000 − 1,200 + 9,000 + 2,000 − 2,400 + 6,000 = 2,23,800.
Reasoning you should show, not just the total
- Item (i) is two errors in one: a capital cost inside revenue purchases, and an omission of depreciation. Fixing only the first overstates profit; fixing only the second double-counts. Take both.
- Item (iii) is not an expense of this year. The provision is a balance-sheet estimate; the movement (9,000 to 7,000) is what touches profit. Writing off ₹5,600 of bad debts does not automatically reduce the provision - the provision is then re-measured on the surviving debtors of ₹1,40,000.
- Item (v) fails the test of revenue expenditure: the wages created an asset with a life beyond the year, so they belong in the Machinery account. Depreciation on the capitalised amount from the date of installation may also need to be checked.
2. The proprietor says that because the trial balance agreed, none of these five items can matter. Explain which of the five would have disturbed the trial balance and why, and state whether a suspense account is needed.
Read the worked answer
Answer: none of the five disturbs the trial balance, and no suspense account is needed.
A trial balance fails only when the two sides of a single transaction are not recorded equally. Each of these items is either a complete double entry with an equal debit and credit, or a complete omission:
- (i) The entry passed was Dr Purchases 24,000 / Cr Cash or Bank 24,000. Equal on both sides; the only fault is the name of the account debited. A wrong head of account does not change any total.
- (ii) No entry at all. Both aspects are missing, so both sides are equally short by ₹9,000 - the two omissions cancel.
- (iii) The provision was simply not revised. A non-entry again, equal on both sides.
- (iv) Complete omission of a sales return: neither Sales Return nor the customer's account is touched, so nothing shifts.
- (v) Dr Wages 6,000 / Cr Cash 6,000 - equal, wrong head only.
What would have forced a suspense account
One-sided errors only: an amount posted to one account and not to the other; a casting error in a subsidiary book; a wrong side posting (for example a credit purchase posted to the debit of the supplier); an amount carried forward wrongly from a subsidiary book; a wrong figure entered in one account only.
Consequence for the audit
The absence of a suspense balance is not evidence of accuracy. These errors are errors of principle and errors of omission, which a trial balance can never detect. They must be found by checking the purchases ledger, the drawings records, the provision workings and the fixed asset register - not by looking at the trial balance. The correcting entries pass through the Profit and Loss Account or Drawings, never through Suspense.
3. How should item (ii) be presented in the final accounts, and why is it not a business expense? State also the indirect tax point that the auditor should check.
Read the worked answer
Accounting treatment
- Correcting entry: Dr Drawings A/c ₹9,000; Cr Purchases A/c ₹9,000 (or Cr Purchases Returns, if the firm treats own-use goods that way).
- In the Trading Account, purchases are reduced by ₹9,000, which is what increases the profit by ₹9,000.
- In the Balance Sheet, Drawings of ₹9,000 are deducted from the proprietor's Capital, together with any other drawings during the year.
Why it is not an expense
- The goods produced no revenue and no business benefit; they were consumed by the owner in his personal capacity.
- Under the business entity concept, the proprietor and the business are separate for accounting purposes. Anything the owner takes out is a reduction of his capital, not a cost of running the firm.
- If it were left in Purchases, the gross profit would be understated, the capital overstated and the drawings of the year under-reported - three misstatements from one missing entry.
- Note: if the goods had been sold to the proprietor at cost plus a margin, the correct treatment would be a sale with the margin as profit. Only because they were taken free of charge is it drawings.
Indirect tax point to verify
- Under Schedule I, para 1 of the CGST Act, 2017, permanent transfer or disposal of business assets on which input tax credit has been availed is a supply even where made without consideration. Goods taken by a proprietor for personal use are therefore normally a taxable supply, and the firm must reverse the credit or pay tax on the value (cost or open market value) in its return for the period.
- Check first whether Sawant Traders is registered, and which rate applies to hardware of this type; if the firm is unregistered, no GST entry arises and only the drawings entry is needed.