1.

A dealer of Mobile TV has the following items in inventory as on March 31,2018

QUANTIT COST MARKET
ITEM Y PRICE PRICE
Nokia 50 100000 98000
Samsung 70 88000 90000
Sony 100 120000 115000
Motorol
a 80 75000 76000
Discuss the accounting standard which talks about inventory valuation. Also, find out
and define the overall value of inventories as per the applicable accounting standard.

Answer: Accounting Standards

The term standard denotes a discipline, which provides both guidelines and yardsticks for
evaluation. As guidelines, accounting standard provides uniform practices and common
techniques of accounting. As a general rule, accounting standards are applicable to all corporate
enterprises. They are made operative from a date specified in the standard. The Institute of
Chartered Accountant of India (ICAI) constituted the Accounting Standards Board (ASB) in
April, 1977 for developing accounting standards.

The Accounting Standards Board is entrusted with the responsibility of formulating standards
on significant accounting matters keeping in view the international developments and legal
requirements in India. The main function of the ASB is to identify areas in which uniformity
in standards is required and to develop draft standards after discussions with representatives of
the Government, public sector undertaking, industries and other agencies. In case of non-
compliance, the companies are required to disclose the reasons for deviations and their
financial effect.

Valuation of inventory - per AS 2

The objective of this standard is to formulate the method of computation of cost of inventories
/ stock, determine the value of closing stock / inventory at which the inventory is to be shown
in balance sheet till it is not sold and recognized as revenue.

Inventories are assets:

a) held for sale in ordinary course of business;
b) in the process of production for such sale (WIP);
c) in the form of materials or supplies to be consumed in the production process or in the
rendering of services.

However, this standard does not apply to the valuation of following inventories:
a) Work-in-progress (WIP) arising under construction contract (Refer AS – 7);
b) Work-in-progress (WIP) arising in the ordinary course of business/service providers;
c) Shares, debentures and other financial instruments held as stock intrade; and
d) Producers’ inventories of livestock, agricultural and forest products and mineral oils, ores
and gases to the extent that they are measured at net realizable value in accordance with well
established practices in those industries.

Net realizable value: is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs necessary to make the sale. Inventories
constitute a substantial portion of assets. The cost involved in their purchase and the revenues
generated thereon are generally high. Smallest deviation would result in overstatement or
understatement of financial statements. As per AS-2, Inventories should be valued at the lower
of cost and net realizable value. The cost of inventories should comprise
a) All costs of purchase
b) Costs of conversion
c) Other costs incurred in bringing the inventories to their present location and condition.

Joint or by products:
In case of joint or by products, the costs incurred up to the stage of split off should be allocated
on a rational and consistent basis. The basis of allocation may be sale value at split off point or
sale value at the completion of production.

Valuation of inventory as per AS 2

COST MARKET LOWE VALUE OF
QUANTIT PRICE PRICE R
ITEM Y (a) (b) of a or b INVENTORY
Nokia 50 100000 98000 98000 4900000
Samsun
g 70 88000 90000 88000 6160000
Sony 100 120000 115000 115000 11500000
Motorol
a 80 75000 76000 75000 6000000
Total 28560000

2. Define and Discuss the concepts of prepaid expenses and outstanding expenses and
their impact on the income statement and Balance Sheet of an Entity? In case of firm A
which largely has the balance of prepaid expenses and another firm B which largely has
the balance of outstanding expenses, what does this reflects? Discuss

Answer: Certain transactions may occur after ledger accounts have been closed and trial
balance has been drafted. However, such transactions must be provided before preparing the
final accounts if they belong to the current year. Such entries are called adjustments.

A prepaid expense is an expenditure paid for in one accounting period, but for which the
underlying asset will not be consumed until a future period. When the asset is eventually
consumed, it is charged to expense. If consumed over multiple periods, there may be a series
of corresponding charges to expense.

A prepaid expense is carried on the balance sheet of an organization as a current asset until it
is consumed. The reason for the current asset designation is that most prepaid assets are
consumed within a few months of their initial recordation. If a prepaid expense were likely to
not be consumed within the next year, it would instead be classified on the balance sheet as a
long-term asset. Expenses paid in advance or prepaid expenses should be not be charged against
the revenues related to the current period but it must be taken to the coming period.

For example:
Insurance Premium for the year – Rs. 1500 (50% prepaid for next year)

Journal entry:
Insurance Premium a/c Rs. 1500
 To bank account Rs. 1500

Prepaid Insurance Premium A/C Rs. 750

To Insurance Premium A/C Rs. 750

Insurance premium account

Date Particulars Amount Date Particulars Amount
To bank a/c 1500 By prepaid Insurance a/c 750
By profit & loss a/c 750
1500 1500

Prepaid Insurance account

Date Particulars Amount Date Particulars Amount
To Prepaid Insurance a/c 750 By balance c/d 750

750 750

Income Statement
Particulars Rs. Particulars Rs.
Insurance Premium 1500
Less: Prepaid Insurance 750 750

Balance Sheet
Particulars Rs. Particulars Rs.
Current Assets
Prepaid Insurance Premium 600

While making advance payments may seem like a good idea, for many businesses, they may
do more harm than good. A healthy cash flow must be able to sustain monthly expenses and
inventory purchases, but any increase in prepaid expenses immediately decreases cash flow
and working capital. For businesses with marginal cash flow, prepayments can mean less cash
to pay for immediate expenses and revenue-generating investments. A decrease in prepaid
expenses results in an increase in cash flow. Operating expenses are typically paid on a monthly
basis, which is why any reduction in prepaid expenses will immediately benefit cash flow for
the current month. As an example, reducing the stock of prepaid supplies from three months to
one month immediately makes available cash equivalent to two months’ worth of supplies.

Outstanding expenses are recorded in the books at the end of an accounting period to show
true numbers of a business. Outstanding expense is a personal account and is shown on the
liability side of a balance sheet.

Expenses are amounts paid for goods or services purchased. According to the accrual concept
of accounting, transactions are recorded in the books of accounts at the time of their occurrence
and not when the actual cash or a cash equivalent is received or paid. Therefore, payments are
not necessarily made immediately, they may be late or in advance. Outstanding expenses and
prepaid expenses are both a result of this.
Principles relating to treatment of Adjustments:
1. For each adjustment given outside the trial balance, there will be 2 treatments.
2. Prepaid items should be deducted from the respective account head.
3. Outstanding items should be added to the respective account head.
4. Depreciation on asset should be deducted from the asset
5. Outstanding incomes and prepaid expenditures are treated as assets and outstanding
expenditures and Income received in advance are treated as liabilities.

For example:
Rent during the year – Rs. 100000.
Outstanding rent of the Year 2018 – Rs. 50,000.
The period has ended and the payment has not been made.

Journal Entry for Outstanding expenses

Rent Account A/c 50,000
To Outstanding Rent A/c 50,000

Journal entry for rent payment

Outstanding Rent Account 50,000
To Cash/Bank A/c 50,000

Income Statement
Particulars Rs. Particulars Rs.
Rent account 100000
Add: outstanding rent 50000 150000

Balance Sheet
Particulars Rs. Particulars Rs.
Outstanding rent account 50000

Outstanding expense are considered as current liability if it is payable within a year and as
long-term liability if payment will be due in more than a year. Any increase in current, or long-
term liability will not affect cash flow since no cash is paid yet at the time the goods or services
are acquired.

A decrease in this expense is a decrease in cash flow. It may be tempting to acquire more goods
and services on credit since such transactions do not affect cash flow at the time of purchase.
But business owners must keep in mind that subsequent payments will directly reduce cash
flow. Improperly managed, accounts payable can accumulate and the resulting monthly
obligations can suffocate working capital used to generate income.

3. a. A logistics company sold a car of Rs 2.5 lacs. The company had purchased the car
three years back for Rs 10 lacs and had depreciated the same using straight line method
of depreciation, assuming its useful life to be five years and a residual value of Rs77760.
Calculate the WDV after charging depreciation for third year, accumulated depreciation
for three years and profit on sale, if any.
b. Consider the following transaction pertaining Ammar’s business-
1. started business with cash Rs 3 lacs
2. Purchased goods for cash Rs 1.2 lacs
3. purchased goods on credit Rs 60000
4. purchased furniture for cash Rs 20000
5. deposited RS 50000 in the bank
Perform transaction analysis for each transaction undertaken and present accounting
equation for these transactions.

Answer: a) Calculation
Value of Machine 10,00,000
Salvage Value 77,760
Net Value
(Value of Machine-Salvage Value) 9,22,240
Life of Asset 5

Depreciation
(Net Value/Life of asset) 1,84,448
Accumulated Depreciation
(Depreciation*3years) 5,53,344

Value of Machine after 3 years

(Value of Machine - Accumulated Depreciation) 4,46,656
Sale Value 2,50,000
Loss
(Value of Machine after 3 years-Sale Value of
Machine) 1,96,656

b) Transaction analysis
First Transaction
Assets= Liabilities + Equity
3,00,000 (Assets)=Liabilities+3,00,000 (Equity)

Transaction Analysis
Mr. Ammar is starting a business by investing 3,00,000 cash and by doing so his Equity
would increase to 3,00,000.

Second Transaction
Assets= Liabilities + Equity
1,20,000(Goods)-1,20,000(Cash)=Liabilities + Equity

Transaction Analysis
Mr. Ammar has bought Goods in Cash. Thereby, reducing cash and increasing the value of
Goods.

Third Transaction
Assets= Liabilities + Equity
60,000(Goods)=60,000(Liabilities)+Equity

Transaction Analysis
Mr. Ammar has bought goods on credit due to which there is an increase in value of Fixed
Assets by 60,000 and simultaneously there is an increase in value of liabilities by 60,000

Fourth Transaction
Assets= Liabilities + Equity
20,000(Furniture)-20,000(Cash)=Liabilities + Equity

Transaction Analysis
Mr. Ammar has bought Furniture in Cash. Thereby, reducing cash and increasing the value
of Fixed Assets.

Fifth Transaction
Assets= Liabilities + Equity
50,000(Bank)-50,000(Cash)=Liabilities + Equity

Transaction Analysis
Mr. Amaar deposited cash in Bank, thereby reducing Cash and increasing Bank Balance.