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CA Intermediate · Advanced Accounting · Introduction to Accounting Standards

Ananya Traders Ltd. purchased goods costing ₹4,00,000 on 1 March. At the year-end 31 March, the goods remain unsold and the company, a going concern, records them at cost though their net realisable value is ₹3,60,000. The finance manager argues that the loss should be recognised only when the goods are actually sold. Which fundamental accounting consideration is violated, and what is the effect on profit if corrected?

The treatment violates prudence. Inventory must be valued at the lower of cost and net realisable value, so it should be stated at ₹3,60,000. The ₹40,000 anticipated loss must be recognised immediately, reducing profit by ₹40,000, rather than waiting for the sale.

  1. APrudence; profit is reduced by ₹40,000 by writing inventory down to ₹3,60,000Correct
  2. BMateriality; profit is reduced by ₹4,00,000
  3. CSubstance over form; profit is increased by ₹40,000
  4. DPrudence; profit is increased by ₹40,000 by recognising the net realisable value gain

Explanation

Prudence requires provision for all known losses though not anticipating profits. Inventory is valued at lower of cost and NRV: ₹4,00,000 vs ₹3,60,000 gives ₹3,60,000. The write-down is ₹40,000, reducing profit. Increasing profit options are wrong because they ignore the loss.

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