How to treat inventory under cash basis accounting

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Vijay

Learner

21 Points Joined January 2018

I asked this already to a CA who told me I am wrong, but did not explain in detail. Please help.

Let's assume: I am a sole proprietor starting a new business. And:

* Starting assets: 9 lakh cash
* Trading 30 days/year
* Everyday of trading, 9 lakh is paid out as expenses, and 10 lakh is deposited as revenue by end of day. Thus, profit of 1 lakh per trading day.
* Tax rate: 30% flat

Under these assumptions, after 30 days of trading, my income statement and balance sheet would look like this (whether under cash basis or accrual basis):

* Revenue: 300 lakh
* Cost: 270 lakh
* Profit: 30 lakh
* Tax owed: 9 lakh

* Assets: 39 lakh cash
* Liabilities: 0 lakh

Now after 30 days of trading, on the last day of the financial year, I buy inventory worth 39 lakh. Then under cash basis my income statement looks like:

* Revenue: 300 lakh
* Cost: 309 lakh
* Profit: -9 lakh
* Tax owed: 0 lakh

But under accrual basis it remains unchanged (since inventory not sold, cost of goods is not incurred), so I still have to pay 9 lakh as tax even though I have no cash. Whereas under cash basis, I can carry a loss of 9 lakh into my next tax return.

The CA said something like closing stock should be considered, so tax is still payable on 30 lakh. I didn't understand fully, as I am not an accounting expert. I though under cash basis, income is simply net cash gained in the year. According to you, what should income statement look like at end of year, under cash basis?

Replies (3)

Atul M

aaa

729 Points Joined August 2009

Your CA said the right .

UNDER THE CASH BASIS OF ACCOUNTING

☺Revenues are reported on the income statement in the period in which the cash is received from customers, deposited, and cleared the bank account.

☺Cost of Goods Sold (Expenses) are reported on the income statement when the cash is paid out and that payment clears the bank account.

☺Payroll expenses are recognized when the payroll check is cashed and the clears the bank account.

☺Revenues are reported on the income statement when they are earned; which often occurs before the cash is received from the customers.

☺Expenses are reported on the income statement in the period when they occur or when they expire; which is often in a period different from when the payment is made.

Atul M

aaa

729 Points Joined August 2009

Cost of Goods sold (Expenses ) are reported on the Income Statement when the cash is paid out and that payment clears the Bank account .

Cost Of Goods Sold = Opening Inventory + Purchases - Ending Inventory

satish

teaching

2046 Points Joined February 2009

Cost per unit = 100

Profit on above = 50

i.e. selling price = 150

Particulars	Qty	Amount (Rs)	Particulars	Qty	Amount (Rs)

To Purchases	5	500	By sales	3	450
To Gross profit		150	By closing stock	2	200

		650			650

In the above statement totally purchased in units is 5. out of stock we have sold only 3 units. that means profit we have recognised only on 3 units. balance 2 units profit can be realised in future.

By applying Matching concept (accounting concepts) Income Relavent expenditure is to be recognised. so we should consider only the cost of 3 units only. not entire stock.

so balance 2 units cost is to be carried forward to future period as current asset (unsold stock).