Understanding Approval Sales
In the context of sales on approval, goods are sent to a buyer, like Ram and Company, but the sale is contingent upon the buyer's acceptance of the goods. If the goods remain unsold, they may still be reflected in the seller's inventory until a decision is made.
Details of the Transaction
- Goods sent to Ram and Company: ₹15,000
- Cost of goods: ₹10,000
- Status as of 31 March 2021: Unsold
Accounting Implications
- Revenue Recognition: Since the goods were sent on approval and are still unsold, the revenue of ₹15,000 should not be recognized.
- Inventory Treatment: The goods should remain in the inventory of the seller, recorded at their cost of ₹10,000.
Impact on Financial Statements
- Balance Sheet:
- Inventory will show an increase by ₹10,000 for the cost of goods sent on approval.
- No impact on current liabilities, as there is no obligation until the sale is confirmed.
- Income Statement:
- No sales revenue will be recorded for the ₹15,000.
- No cost of goods sold will be recognized, maintaining the gross profit margin intact until the approval status changes.
Conclusion
In summary, sales on approval require careful accounting treatment. The goods sent to Ram and Company remain in inventory, and revenue is not recognized until the goods are sold or accepted. This approach ensures accurate financial reporting and maintains the integrity of the company's financial position.