Year-End Adjustments Involving Fire Loss, Goods Taken, and Manager Commission
M/s Sharma Enterprises presents the following balances for the year ended 31 March 2024: opening stock ₹1,20,000; purchases ₹8,40,000; wages ₹96,000; carriage inward ₹24,000; salaries ₹1,44,000; rent ₹60,000; advertisement ₹36,000; bad debts ₹18,000; debtors ₹3,60,000; machinery ₹4,80,000; furniture ₹1,20,000; bank ₹84,000; drawings ₹72,000; sales ₹12,60,000; creditors ₹1,80,000; provision for doubtful debts ₹12,000; capital ₹10,02,000. Closing stock is ₹1,80,000. Goods costing ₹30,000 were destroyed by fire and the insurer admitted a claim of ₹18,000; these goods are not in closing stock. Goods costing ₹12,000 were taken by the proprietor and goods costing ₹15,000 were distributed as free samples. Salaries outstanding are ₹6,000 and rent is prepaid ₹5,000. Depreciate machinery at 10% and furniture at 15%. Write off further bad debts ₹9,000 and maintain a provision for doubtful debts at 5% of debtors. The manager is entitled to a commission of 10% of net profit before charging such commission. The proprietor asks whether the fire loss and the insurance claim should both be taken to the trading account.
1. Compute gross profit and net profit after all adjustments. Explain the treatment of the goods taken by the proprietor, the free samples, and the fire loss.
Read the worked answer
Net purchases = ₹8,40,000 − ₹12,000 − ₹15,000 − ₹30,000 = ₹7,83,000. Goods taken by the proprietor are drawings, not a business expense. Free samples are advertisement expense, so they are added to advertisement. The goods destroyed by fire are removed from purchases because they were never available for sale; the net loss of ₹12,000 is charged to profit and loss, and the admitted claim of ₹18,000 is shown as an asset.
Trading Account: Sales ₹12,60,000 Opening stock ₹1,20,000 Net purchases ₹7,83,000 Wages ₹96,000 Carriage inward ₹24,000 Less closing stock ₹1,80,000 Cost of goods sold = ₹8,43,000 Gross profit = ₹4,17,000.
Profit and Loss Account: Salaries ₹1,44,000 + ₹6,000 = ₹1,50,000 Rent ₹60,000 − ₹5,000 = ₹55,000 Advertisement ₹36,000 + ₹15,000 = ₹51,000 Bad debts and provision: bad debts ₹18,000 + ₹9,000 = ₹27,000; new provision 5% of ₹3,51,000 = ₹17,550; less old provision ₹12,000; charge ₹32,550 Depreciation: machinery ₹48,000 + furniture ₹18,000 = ₹66,000 Loss by fire: ₹30,000 − ₹18,000 = ₹12,000 Total expenses = ₹3,66,550 Profit before manager commission = ₹50,450 Commission = 10% of ₹50,450 = ₹5,045 Net profit = ₹45,405.
2. Prepare the capital account and the balance sheet extract. Why is the insurance claim shown as an asset while the fire loss is charged to profit and loss?
Read the worked answer
Capital account: Opening capital ₹10,02,000 Add net profit ₹45,405 Less drawings ₹72,000 + goods taken ₹12,000 = ₹84,000 Closing capital = ₹9,63,405.
Balance sheet liabilities: Capital ₹9,63,405 Creditors ₹1,80,000 Outstanding salaries ₹6,000 Commission payable ₹5,045 Total = ₹11,54,450.
Balance sheet assets: Machinery ₹4,80,000 − ₹48,000 = ₹4,32,000 Furniture ₹1,20,000 − ₹18,000 = ₹1,02,000 Debtors ₹3,60,000 − ₹9,000 = ₹3,51,000; less provision ₹17,550 = ₹3,33,450 Closing stock ₹1,80,000 Bank ₹84,000 Insurance claim receivable ₹18,000 Prepaid rent ₹5,000 Total = ₹11,54,450.
The insurance claim is a resource controlled by the firm because the insurer has admitted liability; it meets the definition of an asset. The destroyed goods themselves no longer exist, so their cost cannot be an asset. Only the uninsured portion of ₹12,000 is a loss. If the claim had not been admitted, the full ₹30,000 would be charged as a loss and no claim asset would be shown.
3. The manager argues that his commission should be 10% of net profit after charging commission. Recalculate the commission and net profit, and explain the difference.
Read the worked answer
Let commission be C. If it is 10% of profit after charging itself, then C = 0.10 × (₹50,450 − C). 1.1C = ₹5,045, so C = ₹4,586.36, and net profit = ₹50,450 − ₹4,586.36 = ₹45,863.64.
The phrase before charging such commission makes ₹50,450 the base, giving ₹5,045. The phrase after charging makes the commission a residual after the commission itself, so the fraction is 10/110 of ₹50,450, not 10/100. The difference is ₹458.64. The wording must be read carefully because it changes both the expense and the closing capital.