Question

The adjustment required for overvaluation of closing stock, while calculating adjusted profit for calculating goodwill is:
(A) reduction from concerned years profit.
(B) reduction from next years profit.
(C) addition to next years profit.
(D) addition to previous years profit.
Choose the correct answer from the options given below :

• A. (A), (B), and (D) only
• B. (A) and (D) only
• C. (A) and (C) only
• D. (B), (C), and (D) only

Answer 1

The Correct Option is C

In the context of accounting, when closing stock is overvalued, it implies that the profit for that year has been reported higher than it should have been. To adjust the profit correctly when calculating goodwill, specific actions are required:

• Reduction from the concerned year's profit: Since the closing stock of the current year contributes to the profit calculation, overvaluation would lead to an inflated profit. Hence, a reduction should be made to correct this overvaluation.
• Addition to next year's profit: The overvaluation of closing stock in one year will affect the opening stock of the next year. The overvaluation inflates the profit of the current year, and when this stock is carried over to the next year's opening, it underestimates the profit of the next year. Therefore, an addition to the next year's profit is necessary.

This leads to the correct adjustments being: (A) reduction from concerned year's profit, and (C) addition to next year's profit. Hence, the correct answer is: (A) and (C) only

Answer 2

When the closing stock is overvalued, the profit for the current year is inflated. To correct this for calculating goodwill, we need to adjust the profit.

• (A) reduction from concerned year's profit: Overvaluation of stock leads to an inflated profit for the current year, so we reduce the overvalued amount from the current year’s profit.
• (C) addition to next year's profit: Since this adjustment relates to the previous year’s overstatement, it is adjusted in the following year's profit.

Thus, the correct answer is: (3) (A) and (C) only