Year-end adjustments at Wanjiku Traders: profit, stock and drawings
Wanjiku Traders is a sole proprietorship with a 31 December year end. Its draft statement of profit or loss for 2024 shows a profit of KES 620,000. The following have not yet been adjusted: (i) goods costing KES 180,000 held on consignment from a supplier were counted in closing inventory; (ii) an obsolete line costing KES 95,000 has a net realisable value of KES 40,000 and still stands at cost; (iii) in December the owner took goods costing KES 30,000 for his home, and the bookkeeper recorded a sale of KES 45,000, the cost of those goods already sitting in cost of sales; (iv) goods invoiced at KES 260,000 were shipped on 28 December on FOB destination terms and reached the customer on 3 January 2025, and were invoiced in January. The owner argues that profit 'looks healthy' and that no adjustments are needed.
1. Quantify the effect of items (i) to (iv) on the 2024 profit and state the corrected profit figure, justifying the treatment of each item.
Read the worked answer
Work through each item on its merits, not by pattern.
| Item | Effect on profit | Reason |
|---|---|---|
| (i) Consignment stock KES 180,000 | (180,000) | The entity does not control the goods; the supplier does. No asset, no inventory value. |
| (ii) Obsolete line KES 95,000 vs NRV 40,000 | (55,000) | Inventory is measured at the lower of cost and net realisable value; the write-down is a 2024 expense. |
| (iii) Owner's withdrawal | (15,000) | Remove the KES 45,000 'sale' and the KES 30,000 cost from cost of sales: net overstatement of profit is 15,000. |
| (iv) FOB destination shipment KES 260,000 | Nil | Control passes on delivery (3 January 2025); the revenue belongs to 2025 and is already excluded from 2024. |
Corrected profit: 620,000 - 180,000 - 55,000 - 15,000 = KES 370,000
Key judgement points: the consignment stock fails the definition of an asset (control), not merely the 'ownership' test; the NRV comparison is applied line by line, so the KES 40,000 is not netted against other profitable lines; and item (iv) is the trap - a tempting adjustment that is actually correct as already treated, which shows the accounting is driven by transfer of control rather than by the invoice date.
2. Explain to the owner why recording his own withdrawal as a sale misstates both profit and capital, and state the double entry that should have been made.
Read the worked answer
Two separate errors arise from one transaction.
- No income has arisen. Income requires an increase in economic benefits from a transaction with a customer. The owner is not a customer; the goods left the business for private use. Revenue of KES 45,000 must be reversed.
- Drawings are not an expense. The KES 30,000 cost is not a cost of trading, so it comes out of cost of sales and is charged against capital instead.
Correct entry: Dr Drawings (capital) 30,000 Cr Purchases / Inventory / Cost of sales 30,000
Quantified misstatement:
- Profit is overstated by the 15,000 margin (45,000 revenue less 30,000 cost).
- Drawings are understated by 30,000, so capital is overstated.
- Combined, capital is overstated by 45,000: 15,000 from inflated profit plus 30,000 that should have been shown as a withdrawal.
Advice to the owner: the sale entry makes the business look more profitable and better financed than it is, and it also overstates revenue for any turnover-based measure (VAT threshold, lender covenants, goodwill valuation). Profit measures trading performance; drawings measure the owner's take from the business. They must never be merged.