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CA Intermediate · Advanced Accounting · Framework for Preparation and Presentation of Financial Statements

Meenakshi Pharma Ltd. holds inventory with cost Rs 8,00,000. At year end its net realisable value is Rs 6,50,000. Separately, it has a dispute where it expects to win a claim of Rs 3,00,000, which is probable but not virtually certain. Applying the recognition and prudence principles from the Framework, what is the net effect on the year's profit of recognising only what is appropriate?

Profit decreases by Rs 1,50,000. Inventory is written down from cost Rs 8,00,000 to net realisable value Rs 6,50,000, while the probable claim of Rs 3,00,000 is not recognised because prudence forbids anticipating gains that are not virtually certain.

  1. ADecrease of Rs 1,50,000Correct
  2. BIncrease of Rs 1,50,000
  3. CDecrease of Rs 4,50,000
  4. DNo effect, as both are uncertain

Explanation

Inventory is valued at lower of cost and NRV, so a write-down of 8,00,000 - 6,50,000 = Rs 1,50,000 is recognised. The expected gain of Rs 3,00,000 is not recognised because gains are not anticipated until realised or virtually certain (prudence). Net effect is a decrease of Rs 1,50,000. Netting the claim gain would wrongly give an increase of Rs 1,50,000.

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