Following is an extract of their Balance Sheet as at 31st March, 2016:
| Liabilities | ₹ | Assets | ₹ |
|---|---|---|---|
| Investment Fluctuation | | Investment (At Cost) | 6,00,000 |
| Reserve | 54,000 | | |
Show the accounting treatment under the following case: If the market value of Investments is ₹5,28,000.
Answer (2)
When the market value of investments is lower than the cost of investments, the accounting principle of prudence requires that such losses be recognized in financial statements to reflect the true and fair view of financial conditions. Here’s how you can treat the situation in the balance sheet when the market value of the investment is ₹5,28,000, which is lower than the cost of ₹6,00,000.
Calculate the Decline in Value:
The decline in value is calculated as follows:
Decline in Value = Cost of Investment − Market Value Decline in Value = 6 , 00 , 000 − 5 , 28 , 000 = 72 , 000
Adjust the Investment Fluctuation Reserve:
The Investment Fluctuation Reserve, which is originally ₹54,000, is used to absorb the decline in the investment value partially.
Record the Remaining Loss:
Since the decline is ₹72,000 and the reserve is ₹54,000, the remaining loss of ₹18,000 must be transferred to the Profit and Loss account.
Adjust the reserve fully to bring it to zero:
Record the loss in Profit and Loss account as:
Loss = Decline in Value - Investment Fluctuation Reserve Loss = 72,000 - 54,000 = 18,000
Adjust the Balance Sheet:
Reduce the value of the Investment on the Asset side to its market value of ₹5,28,000.
Reduce the Investment Fluctuation Reserve on the Liabilities side to zero, and adjust the remaining loss of ₹18,000 against the Profit and Loss Account.
By making these adjustments, the financial statements will reflect the realistic value of the investments and provide an accurate picture of the financial position.
If the market value of investments is ₹5,28,000, which is lower than the cost of ₹6,00,000, you must recognize a decline in value of ₹72,000. Use the Investment Fluctuation Reserve of ₹54,000 to absorb part of this decline, leaving a remaining loss of ₹18,000 to be recorded in the Profit and Loss account. Adjust the investments on the asset side of the Balance Sheet to ₹5,28,000 and reduce the reserve to zero.
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