Mercantile accounting treats disputed liability as deductible only when it becomes finally ascertained or settled.

Under the mercantile system, a disputed liability is deductible only when it has accrued and become ascertained, or is finally fixed by settlement or adjudication. A mere claim made by a buyer, when liability is denied in good faith and remains under challenge, does not require immediate recognition as a loss. Here, the assessee contested the claim through arbitration and court proceedings, and the liability was crystallised only by settlement in 1949, with payment completed in the relevant accounting year. The business loss was therefore admissible in the assessment year 1950-51, and not in the earlier year when the claim was first asserted.

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Issues: Whether the assessee, following the mercantile system of accounting, was entitled to claim the settlement amount of Rs. 1,20,000 as a business loss in the assessment year 1950-51, or whether the loss had to be brought into account earlier when the buyer's claim was first made.

Analysis: Under the mercantile system, income and expenditure are brought into account on accrual, but only where a legal liability has actually accrued or the loss has been ascertained. A mere claim disputed by the assessee does not compel a debit entry in the books. Where liability is denied in good faith and the claim is under challenge, the loss remains contingent until adjudication or settlement fixes the amount. The facts showed that the assessee repudiated liability, contested the claim in arbitration and court proceedings, and the liability was ultimately crystallised only by settlement in 1949, with payment completed in the relevant accounting year.

Conclusion: The loss of Rs. 1,20,000 was admissible in the assessment year 1950-51, and not in the earlier year when the claim was merely asserted.

Final Conclusion: The reference was answered in favour of the assessee on the timing of deduction of the business loss under the mercantile method of accounting.

Ratio Decidendi: Under the mercantile system, a disputed liability is deductible only when it becomes an accrued and ascertained liability or is otherwise finally fixed by settlement or adjudication; a merely claimed and denied liability is not required to be entered as a loss.

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