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Accounting of Inventory converted to Fixed asset and sold subsequently

Hariharan Iyer (DGM-F&A) (24 Points)

24 February 2021

Our company manufactures mining equipment. Some newly developed products are sent on trial basis. When they are sent to customers they are transferred from Inventory to Fixed Asset(capitalized )in our books. Depreciation is also charged during the trial period. Sometimes the customer accepts the product and buys the same equipment. Should the sale of this item be treated as sale of capital asset or it can again be transferred to Inventory and recognized as normal revenue)?

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9 Replies

yasaswi gomes (My grammar is 💯 good I) (7290 Points)
Replied 25 February 2021

Let me guess

Dr COS a/c

Cr. Inventory a/c

when they are finished goods. Next,

Dr. Trial Fixed Asset a/c

To Inventory a/c

when they are capitalised. Next,

Dr. Depreciation a/c

Cr. Fixed Asset

That is depreciation. Ok since there is no law that current assets cannot be classified as long term assets, you can sell it as capital goods and pay capital gains tax. If indian it act allows you to convert it back to inventory, gst will be applicable. Choose which ever is an advantage, of course sellin inventory, before recognising a sale.

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yasaswi gomes (My grammar is 💯 good I) (7290 Points)
Replied 25 February 2021

I think you understand that the equipment must fall under PPE to be capitalised. If you have done it and distributed goods at a personal interest, there is nothing wrong. But your scenario is impossible because it is not defined in AS and you’ll have auditing issues. Instead, explore revenue recognition or create a special provision for tax to claim depreciation when goods are distributed as samples. Even in showrooms, they dedicate a trial cars/suv/tesla electric cars at a company’s expense. So, you also can send just n equipment.

yasaswi gomes (My grammar is 💯 good I) (7290 Points)
Replied 25 February 2021

Ok, i tried to check tax deductible expenses list to check if internally generated good Will is there, since advertising is tax deductible, you can keep aside a list of equipments and give them to your customers and claim tax over it. A promotional change is required like above car example because what your doing doesn’t fall under prototype definition as per intangibles standard in AS as well to capitalise.

yasaswi gomes (My grammar is 💯 good I) (7290 Points)
Replied 25 February 2021

In order to facilitate your marketing, we have to undergo the following changes

Some one had a unique marketing strategy of handing over brand new equipment to customers without selling it, requesting them to use it as a trial and purchase that equipment if they like it in their trial. I said impossible!!

Now it is possible like below and going to write my first recommendation to standard setters. I might get lucky and Revenue Recognition might include my suggestion.

Deferred Revenue Asset a/c Dr.

To Inventory Cr.

(When equipment is handed to the customer for trial)

Bank a/c Dr.

Revenue a/c Cr.

(When the customer agreed to purchase the asset and made payment)

COS a/c Dr.

Deferred Revenue Asset a/c Cr.

(To reflect the inventory closing balance)

Inventory a/c Dr.

Loss on trial Dr.

Deferred Revenue Asset a/c Cr.

(When the customer returns the product due to dissatisfaction)

The Loss on trial will be calculated as per days depreciation

Inventory is revalued at lower of: (Trial equipment)

Cost less wear and tear (Depreciation)

NRV less wear and tear (Depreciation)

Depreciation is not tax deductible. The returned trial equipment could be resold at an arms length transaction at a new mark-up or lowered selling price. :)

yasaswi gomes (My grammar is 💯 good I) (7290 Points)
Replied 02 March 2021

@ Hariharan

Please use this entry

Inventory a/c

To COS a/c

instead of

Cos

to inventory

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Hariharan Iyer (DGM-F&A) (24 Points)
Replied 09 March 2021

Such transactions are common in heavy equipment industry. To market a product one needs to have a proven ness certificate which can only be obtained by sending the newly developed product on trail basis.

My querry is only to know whether the sale of such a product is Capital Revenue or it can be treated as normal Sales Revenue by again tranferring the same to inventory.

Is it a better idea to treat the equipment as Equipment sent on 'Sale on approval basis' and continue to treat this as Inventory in our books? Also since this equipment will be actually deployed commercially the useful life will diminish whether this will be Depreciation or Obsolecence?

yasaswi gomes (My grammar is 💯 good I) (7290 Points)
Replied 09 March 2021

Since your the person who knows better than me about your operations, you are asking the right thing. The economic reality is not defined, and the legal form is following AS. It is better to show it as a separate ‘Contract asset or stripped asset’ version instead of keeping it in the inventory. Obsolescence is much better becaus tax allowable depreciation is for capital assets. Then, it does have a scope to be amortised as per AS if you can check that out.

yasaswi gomes (My grammar is 💯 good I) (7290 Points)
Replied 09 March 2021

There is another easy solution for this, follow, leases accounting.

Receivables a/c - no need to recognise sale

To Inventory a/c

yasaswi gomes (My grammar is 💯 good I) (7290 Points)
Replied 09 March 2021

As of now, you can give lessor treatment, then credit sales and debit bank when the sale occurs. Then reconcile your receivables by crediting them.

Or else, you must have been following your old method of accruals where you will credit sales and debit receivables and account for sales return and treat the returned goods as obsolete or recycle the goods in factory and use inventory valuation again.

To conclude, this is all I could find.

All the best.