STUDY NOTE - 6 ACCOUNTING STANDARDS This Study Study N ote includes
Accounting Standards Standards - Ap pli cability, Interpr Interpretat etation ion , Scope and Compli ance
Introduction
Acco Accoun un ting standa rds ar e wr itten itten , policy policy d ocum ocum ents issued issued by expert accounting accounting body or by Governm ent or other regu latory aut horities covering covering the asp ects of recognition, nition, m easurement, treatm ent, presentation and disclos disclosure ure of acco accoun un ting transaction transaction in the finan finan cial cial statemen t. The main purpose of formulating accounting standard is to standardize the diverse accoun accoun ting p olici olicies es with a view to elim elim inate to the extent p ossible ossible the incomp arability bility of information p rovid ed in finan finan cial cial statemen ts and ad d reliability reliability to such finan finan cial cial statements. To To d iscuss iscuss on wh ether such stand ards are necessary necessary in p resent days it will be benef benefic icial ial to go through th e adva ntages and disadvan tages which they are said to provide. ADVA NTAGES NTAGES :
1. It provides the acc accoun tancy professi profession on w ith useful useful w orking rules. 2. It assi assists sts in in imp roving quality of work p erformed erformed by accoun accoun tant. 3. It strength strength ens the accountan accountan t’s t’s resistance resistance against the pressu re from from d irectors irectors to use accounting policy which may be suspect in that situation in which they perform their work. 4. It ensu ensu res the various u sers of finan finan cial cial statements to get comp comp lete crystal information on mor e consistent consistent basis from period to period . 5. It helps helps th e users comp comp are the finan finan cial cial statemen statemen ts of two or m ore organisaitons engaged in same type of business operation. operation. DISADVANTAGES :
1. Users are likel likely y to think that said statements prepared using accoun accoun ting standard are infallible. infallible. 2. They have been been d erived erived from social social pressures which which m ay redu ced freedom freedom . 3. The working ru les may be rigid or bu reaucratic to some user of finan finan cial cial statemen statemen t. 4. The more stand ard s there are, the mor e costly costly the financial financial statements are to produce.
ACCOUNTING STANDARDS
Acco Account unting ing Standar Standard d N o.
Title itle of Account Accounting ing Standa Standarrd
A S-1
D is clo s u re r e o f A cc cco u n ti tin g P o licie s
A S-2
Va lu lu at a t io io n o f In ve v e n to to r ie ie s (Re v is is e d )
A S- 3
C a s h Flo w St a t e m en en ts ts (Re v is e d )
ASAS-4
Conti Co ntinge ngenc nciies and Events vents (Occ Occurring urring afte afterr the Balanc alancee Sheet heet Date) Date)
ASAS-5
Net Prof Profiit or Loss oss for the Peri Period, od, Pri Prior Peri Period od Items tems and Change Changess in Accoun ting Policies (Revised (Revised )
A S-6
D e p rree cia t io n A cco u n ntt in g
A S-7
C o n st st ru ru ct ct io n C o n tr tr ac act s (Re v is is e d )
ASAS- 8
Acc Accounti ounting for Resea esearc rch h and Deve Devellopment opment (stands stands withdrawn withdrawn afafter introduction of AS-26)
A S-9
Re v e n u e Re co g n it io n
A S-10
A cco u n ti tin g fo r Fixe d A s s e t s. s.
ASAS-11
The Effect ect of Changes Changes in Foreig oreign n Exchange Rates ates (Revise evised) d)
A S-12
A cco u n ti tin g fo r G o v er er nm nm en e n t G r an an ts ts
A S-13
A cco u n ntt in g fo r In v vee s t m en en ts ts
A S-14
A cco u n ntt in g fo r A m al a lg a m at a t io n s
A S-15
Em p lo lo y e e Be n ef efit s (Re v is is e d )
A S-16
Bo r r o w in in g C o s t
A S-17
Se g m en en t Re p o orr t in g
A S-18
Re la t e d P a r ty ty D is clo s u re re s
A S-19
Le a s e s
A S-20
Ea r n in g s P e r Sh a r e
ASAS-21
Cons Co nsol oliidate date d Financ na nciial State tatemen ments ts
A S-22
A cco u n ti tin g fo r Ta xe xe s o n In co co m e
ASAS-23
Acc Accounting ounting for Investment nvestment in Asso Assocciates ates in Co Conso nsollidated idated Finaninancial cial Statement s
A S-24
D is co n ti ti n u uiin g O p er er at at io n s
A S-25
In te te r im im Fin an an ci cia l Re p or or ti tin g
A S-26
In t a n g ib le A s s e t s
ASAS-27
Financi nancial Report eportiing of Intere nterest stss in Joint oint Venture enture
A S-28
Im pa p a ir m en en t o f A s s e t s
ASAS-29
Provi Provisi sions ons,, Co Conti ntinge ngent nt Liabili abiliti ties es and Co Conti ntinge ngent nt Asse Assets ts
AS-30
Finan Finan cial cial Instru Instru men ts: Recognition Recognition and M easurem ent
AS 31
Financ nancial Instr nstrumen ume nts ts:: Pre Pre s enta entati tion on
AS 32
Financ nancial Instr nstrumen ume nts ts:: Dis Dis clo s ures ures
Ap p licabi licabili lity ty of Accounting Accounting Stand ard s: A three tier classification has been framed to ensure compliance of accounting standards for reporting enterprises. Level I Enterprises:
Enterprises whose equ ity or debt secu secu rities rities are listed listed wh ether in India or outsid e Ind Ind ia.
Enterprises wh ich ich are in th e pr ocess ocess of listing listing their equ ity or d ebt secur secur ities ities as evidenced by the Board Board r esolut esolut ion in this regard .
Banks includ ing co-operative co-operative ban ks
Finan Finan cial cial institu tions
Enterprises carrying carrying insu rance business
Enterprises w hose tu rnov er exceeds exceeds Rs.50 Rs.50 crores crores
Enterprises having borrow ings in excess excess of Rs.10 Rs.10 crores at any time d u ring th e accoun accoun ting period.
Hold ing comp anies and su bsidiaries of enterp rises falling falling un d er any on e of the categories ries mentioned above.
Lev el II Enterpr Enterpris is es:
Enterprises w hose tu rnov er exceeds exceeds Rs.40 Rs.40 lakhs lakhs bu t d oes not exceed exceed Rs.5 Rs.50 0 crores. crores.
Enterp rises hav ing bo rro w ings in excess of Rs.1 Rs.1 cror cror e bu t no t in excess of Rs.1 Rs.10 0 cror cror es at any time du ring the acco accoun un ting period.
Holding companies and subsidiaries of enterprise falling under any one of the categories ries mentioned above.
ACCOUNTING STANDARDS
Lev el III Enterpr Enterprise ise s:
Enterprises wh ich ich are n ot covered u nd er Level Level I and Level II. II.
Acco Accoun un ting Stand ard
App lica licabil bility ity (Based (Based on the three three tier tier clas classi sifi fica cation) tion)
AS1, AS1,2, 2,44-16 16,2 ,22, 2,26 26,,28
All Enterprises Enterprises
AS 3,17 3,17,,18, 18,24,
Not applicabl applicablee to Level evel II and Level evel III enterpris enterprises es in their their entiret entirety. y.
AS 19,20,29
All All enter enterpri prise sess but rel relaxati axation on give given n to Level evel I and Level evel II enter enter pr ises ises for certain certain d isclosure isclosure requ irements.
AS 21,23,27
Not appli applicabl able to Level vel II and Level vel III enterpri nterprise sess
A S 25
N ot o t m an a n d at at o ri rily a pp p p li lica b le le t o Lev el el II a n d Le v el el III en te ter p ri ris es
AS 30,31,32
W.e. W.e.ff. acc accounting ounting periods periods commenci ommencing on or afte afterr 1-4-2009 and will will be recomm recomm endatory in natu re for an initial initial period of two years.
It will be man d atory for on or after 1-41-4-20 2011 11 for all comm comm ercial, ercial, ind ind ustr ial and bu siness entities except except to a Small and Med ium -sized -sized Entity.
AS-1: DISCLOSURE OF ACCOUNTING POLICIES This stand stand ard d eals w ith d isclosure isclosure of signifi significant cant accou accou nting p olicies olicies followed followed in the p repar ation and presentation presentation of the financi financial al statements statements and is mand atory in natu re. The accoun accoun ting p olici olicies es refer refer to th e specifi specificc accounting accounting pr inciples inciples ad opted by th e enterp rise. Proper d isc isclosure losure w ould ensure m eaningful eaningful comparison both inter/ intra intra enterprise and also also enable the users to pr op erly app reciate reciate the finan finan cial cial statements. Finan Finan cial cial statements ar e intend ed to p resent a fair reflec reflection tion of the financial position financial financial perform ance and cash flows of an enterp rise. Areas involving d iffe ifferent rent accountin g p olicies olicies by different different ent erprises are
Methods of depreciation, depletion and amortization
Treatment Treatment of expend expend iture d uring construction onstruction
Treatment of foreign currency conversion/ translation, Valuation of inventories
Treatment o f intangible assets
Valu Valu ation of investm investm ents
Treatment of retirement benefits benefits
Recognition Recognition of pr ofit ofit on long-term contracts Valuation Valuation of fixed fixed a ssets
Treatment of contingent liabili liabilities ties
Factors Factors gov erning the selection selection an d ap plication plication of accou accou nting po lici licies es are:
estimates,, which which is required u nd er cond cond iPrudence: Prud ence means making of estimates tions of u ncertainty. Profits are not a nticipa nticipa ted till till certain certain for r ealization, ealization, wh ile pr ovisions are mad e for all know n liabiliti liabilities es ascertainable ascertainable or based on estimates estimates (e.g. (e.g. war ranty expenses). expenses).
saction shou ld be accou accou nted for in in accoraccorS ubstance ubst ance over form: form: It means that tran saction d ance with actual actual h app ening an d econom econom ic reality reality of the tran sactions, sactions, i.e i.e.. events governed by substance and not m erely erely by the legal form form
M ateria ateriality lity :
a) As to the disclosure disclosure of all material items, items, ind ind ividu ally ally or in aggregate in the context of fair fair p resentation of financial statemen statemen ts as a w hole if its its om ission ission or misstatement cou ld influence the economic or finan finan cial cial decision decision of the u ser relying up on the finan finan cial cial statement statement s b) Depends on th e size size of the items items or errors jud jud ged in the p articular articular circumstance circumstancess of its its omissions or m isstatemen isstatemen ts. c) Is a cut cut off po int rather than being a prim ary qu alitative alitative chara chara cteristic cteristic wh ich ich information information mu st have. d) This This is a matter of jud jud gment, varies varies from from on e entity entity to another and over one period to another. AS-1 AS-1 requ ires that all “signific “significant” ant” (i.e (i.e.. only accoun accoun ting p olicy olicy that is u seful seful for an un d erstand ing by the u ser of the finan finan cial cial statemen statemen ts) accou accou nting p olici olicies es adop ted in th e prep aration an d pr esentation of financial financial statemen statemen ts, shou shou ld be d isclose isclosed d by w ay of ‘Not ‘Not e in one p lace lace as the note N o I (this is is the basis of the p repar ation of finan finan cial cial statements.) Changes Changes in A ccounting ccounting Policies:
Any change in the accounting policies which has a material effect in the current period or wh ich ich is reasonably expected to ha ve a mat erial effec effectt in the later p eriod shou ld be d isclose isclosed d. In the case of a change in accou accou nting policies, policies, hav ing m aterial eff effec ectt in th e current period , the amou nt by w hich any item in th e financial financial statements, is affec affected ted by such chang e shou ld also be d isclosed isclosed to th e extent as ascertainable, ascertainable, otherw ise the fact fact th at th e effec effectt is not (wholly or par tially) tially) ascertainable, ascertainable, shou shou ld be d isclose isclosed d.
ACCOUNTING STANDARDS
The following following are not considered as changes in accountin g p olicies olicies:: a)
Acc Accounting policie policiess adopted for events or transac transactions tions that diff differ in in substance substance at present (introducing Group Gratuity Scheme for employees in place of adhoc ex-gratia paymen t earlier earlier followed followed .)
b)
Acco Accoun un ting policie policiess pertains pertains to events or transactions transactions wh ich ich did not occur occur previously previously or that were imm aterial. aterial.
Fundamental Accounting Assumptions
Certain basic assumptions, in the preparation of financial statements are accepted and their u se are assum assum ed, no sepa rate disclosure disclosure is requ ired except except for non compliance in in resp ect ect ofa)
Going Concern: continuing o peration in th e foreseeabl foreseeablee futu futu re and no interim n ecessi ecessity ty
of liquid liquid ation or wind ing’ up or red ucing scale scale of operation . b)
accoun ting p olicies olicies are consistent consistent from on e period to anoth er Consistency: accoun
c)
Accrual:
i)
Revenues Revenues and costs costs are acc accrued i.e. i.e. they are earned or incurred incurred (not actually actually received ceived or p aid) and recorded in th e financial financial statements
ii) ii)
Extends Extends to to matching revenue against relevant relevant costs. osts.
PROBLEMS 1.
The gross block block of fixed fixed assets are shown at th e cost cost of acquisition, acquisition, which includ includ es tax, d u ties (net (net of MODVAT and set off off availed) availed) and other id entified entified d irect irect expenses. InterInterest on borrow ing to finance the fixe fixed d assets is is considered considered as revenu e.
Answ er: The policy policy ap pears to be correct. correct. 2.
Compensation payable to employees un der volun volun tary retirement retirement sc scheme has been deferred to be w ritten off over a p eriod of four years as against the p ast pra ctice ctice of charg charg ing out the same on paym ent/ d ue basis. basis. Comm Comm ent.
Answ er: The reason for for change mu st be incorporated with n otes to accou accou nts. 3.
Sales ales incl includ ud es inter-dep inter-dep artmental transfers, transfers, sales sales du ring trial trial run and are net of discoun coun ts. Comm Comm ent. An sw er: The po licy licy is not as p er AS-9, AS-9, Revenu e Recognition Recognition .
AS-2 AS -2:: VAL VA LUATION UA TION OF IN IN VEN VEN TORIES TORIES At the outset AS -2 excludes the following though appears to be inventory in common parlance: a)
Work-in-progress in construction contract and d irectly irectly related service service contract (ref: (ref: ASAS2), 2), inven inven tories not forming pa rt of construction w ork-in-progress w ill ill attract AS-2 AS-2
b)
Work-inWork-in-progress progress arising arising in in the ordinary course course of business of service service provid ers Shares, d ebentu res and other financial instru men ts held as stock-in-trad stock-in-trad e (ref: (ref: AS-1 AS-13 3 as Current Investments)
c)
Livestoc Livestock, k, agricultural agricultural and forest forest produ ct, ct, mineral oil/ oil/ gasses as measured measured at net reali realizzable value as per trad e practices practices at certain certain stage of prod uction.
AS-2 covers covers inv entories as an item of assets w hich are are
a]
held for for sale sale in the ordinary course course of business
b]
in the process process of prod uction uction for for such sale sale
c]
in the form form of material material or or sup plies plies for for the process process of prod uction uction or rend ering ering of servic servicee
Inventories are valued at lower of cost or net realizable value (NRV) a)
Cost to incl includ ud e pu rchase rchase price, price, conversio conversion n and other costs costs incurred incurred in bringing bringing the inventor ies to their present location location and condition. An enterprise should use the same cost formula for all inventories having similar nature and use - specific cost, FIFO, weighted average, standard cost, adjusted selling price
b) Net realizable realizable value is is the estimated estimated selling selling p rice rice in in the ord inary course of bu siness reduced by the estimated cost to bring the item in saleable condition, considered on each each balance sheet date, usua lly lly on item by item basis or un d er suitable group of similar similar or related item. Dis closure closure under AS-2
a)
the acc accounting polic policy adopted in in measuri measuring ng inventori inventories es
b)
the cost ost formula ormula used used
c)
carrying amount (value) (value) of inventory comm comm only clas classi sifi fied ed un der Raw Raw Material Material and Comp onents, Work in Prog ress, Finished Finished good s and Stores, Spar es and Loose tools.
d)
Schedu le-V le-VII and ASAS-2 disclos disclosure ure are at par
PROBLEMS 1. Raw mat erials erials pu rchased at Rs.10 Rs.10 per kg . price price of materials is is on the d ecli ecline. ne. The The finfinished good s in wh ich ich th e raw m aterial is incorp incorp orated ar e expected expected to be sold at below cost. 1,0 1,000 00 kgs of raw m aterial is in stock at th e year-end . Rep Rep lacement cost is Rs.8 Rs.8 per kg. How w ill ill you value the inventory? Answ er: As per p ara 24 of AS-2 AS-2,, on valuation of inven inven tories, material and other su pplies held for use in the production of inventories are not written down below cost if the finished products in which they will be incorporated are expected to be sold at or above cost. However, when there is a decline in the price of materials and it is estimated that th e cost cost of the finished finished p rod ucts will exc exceed eed n et realizable realizable value, the materials are written d own to net realizable realizable value.
ACCOUNTING STANDARDS
Hence, the value of stock of 1,000 kgs. of raw materials will be valued at Rs.8 per kg. The finished finished stock shou ld be valu ed at cost or net realizable value, wh ichever ichever is lower. 2. Inventories Inventories are valued at cost cost exc except for finis finished hed goods and by prod ucts, finished finished goods are valued at lower of cost cost of realizable realizable values and b y pr od ucts are valued at realizable value. Commen t on the accountin accountin g policy. policy. Answ er: The accounting accounting policy followed followed by the comp any is at p ar w ith AS-2. AS-2. 3. Cost of Produ ction of prod uct A is given below: below: Ra w m at a t e r ia ia l p er er u n it it
Rs .150
W a g es p er u n it
Rs .50
O v e r h e a d p e r u n it
Rs.50 Rs.250
As on th e balance sheet sheet d ate the replacement cost of raw material is Rs.1 Rs.110 10 p er un it. There are 100 u nits of raw ma terial on 31.3 31.3.0 .08. 8. Calculate Calculate th e value of closing closing stock of raw m aterials in in th e following following conditions: (i) (i)
If finished inished prod uct is sold sold at Rs. Rs.27 275 5 per unit, wh at will will be the value value of closi closing ng stock stock of raw material? material?
(ii) (ii)
If finished finished prod uct is is sold sold at Rs. Rs.23 230 0 per un it, wh at will will be the the value value of closi closing ng stock stock of raw material? material?
Answ er: (i) (i) The The realizable value of the p rod uct is more than the total cost of the p rod uct. The The cost of raw m aterial per u nit is more than the rep lacement lacement cost, hen ce, ce, raw m aterials shou ld be valued on actual cost. cost. Therefore, the v alu e of raw m aterials: 100 100 u nits x Rs.150 Rs.150 p er u nit= Rs.15, Rs.15,000 000 (ii) (ii)
The realiza realizable ble value of the produ ct is is less less than the total total cost of the produ ct. Though the cost of raw material per u nit is more than the rep lacement lacement cost, hen ce, ce, raw ma terials should should be valued on rep lacement lacement cost. cost.
Therefore, the v alu e of raw m aterials: 100 100 u nits x Rs.110 Rs.110 p er u nit= Rs.11, Rs.11,000 000
AS-3 AS -3 (REVIS (REVISE ED ): CASH CAS H FLOW S TATEMEN TATEMENT T Cash Flow Statement deals with the provision of information about the historical changes in cash and cash cash equ ivalents of an enterpr ise by m eans of a cash cash flow statemen t w hich classif classifies ies cash flows flows du ring the p eriod from op erating, investing investing an d financing activities activities..
Cash comp comp rises rises cash cash on hand and dem and d eposits eposits with banks.
Cash equ ivalents are short short term , highly liquid in vestment s that are readily conv conv ertible into know n am oun ts of cash cash an d w hich are subject subject to an insignific insignificant ant risk of chan chan ges in in value.
Cash flow flow s are inflows inflows and ou tflow tflow s of cash and cash equivalents.
Op erating activities activities are the p rincipa rincipa l revenue-pro d ucing activities activities of the enterprise and other activities activities that are n ot investing or financing activities. activities.
Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.
Finan Finan cing cing activities activities are activiti activities es that resu lt in changes in th e size and comp osition osition of the ow ners’ capital (incl (includ ud ing p reference reference share capital in the case of a comp any) an d borrowings of the enterprise.
Method s of prepar preparing ing Cash Cash Flow Stateme Stateme nt:
1. Direct Direct Method : In this meth od m ajor ajor classe classess of gross cash cash receipts receipts and gr oss cash cash pay men ts are disclosed. disclosed. 2. Indirect Indirect Method: Und er this method , the foll following owing adjustment to reported reported n et profit profit or or loss to be mad e:
Effec Effects ts of tra nsactions of n on-cash on-cash natu re.
Deferrals Deferrals in in accru accru als of pa st or futu re operating receipt receipt or p aym ents.
Chan ges in current a ssets and liabilities liabilities
Income & expenses associated associated w ith investing an d finan finan cing cing cash flows.
PROBLEMS 1. Oriental Bank Bank of Comm erce, erce, received received a gross Rs.4, Rs.4,50 500 0 crores crores d eman d d eposits from from customers and customers withdraw n Rs.4, s.4,00 000 0 crores crores of demand dep osits osits du ring the finan finan cial cial year 20072007-08 08.. How wo uld you classif classify y su ch cash flows? Answ er: It It w ill ill be treated as an Op erating activity, on n et basis Rs.50 Rs.500 0 crores,infl crores,inflow ow . 2. Consider Consider a h ypothetical ypothetical example example on the p reparation of cash cash from operating activi activitie tiess un der both direct direct and indirect indirect method of preparing cash cash flow flow statement. statement.
ACCOUNTING STANDARDS
D irect Metho d Cash Flo w Stateme nt [Paragra [Paragraph ph 18(a)] 18(a)] (Rs. (Rs. ’000) ’000) Cash Cash fl ow s from from op erating erating activi activi ties
C a s h r eceip t s fr o m cu s t o m er s C a s h p a id t o s u p p lie r s a n d e m p lo y e e s C a s h g e n er a t e d fr o m o p e r a t io n s In co m e t a xes p a id C a s h flo w b e fo r e e xt r a o r d in a r y it e m P r o ceed s fr o m ea r t h q u a k e d isa st er s et t lem en t N et cash cash from operatin operating g activ activ ities
33,150 (29,600) 3,550 (1,860) 1,690 1 80 1,870
Indi rect Me thod Cash Flow Stateme nt [Paragra [Paragraph ph 18(b)] 18(b)] (Rs. ’000) ’000) Cash Cash fl ow s from from op erating erating activi activi ties
N et et p ro ro fit b e fo r e t a xa t io n , a n d ext r a o r d in in a r y it em
3,350
Adjustments for: D ep r ecia t io n Fo r e ig n exch a n g e lo ss
4 50 40
In t er e s t in co m e
(300)
D i v i d e n d i n co m e
(200)
In t e r e st e xp e n s e
40 0
O p er er a t in g p rro o fit b efo r e w or or k in g ca p it it a l ch a n g e s
3,740
In cr e a s e in s u n d r y d e b t o r s
(500)
D ecr ea se in in v en t o r ies
1,050
D ecr ea se in su n d r y cr e d it o r s
(740)
C a s h g en e r a t ed fr o m o p er a t io n s
3,550
In co m e t a xe s p a id C a s h flo w b efo r e ext r a o r d in a r y it em P r o cee d s fr o m e a r t h q u a k e d is a s t e r se t t le m e n t Net cash from operating activities
(1,860) 1,690 18 0 1,870
AS-4(REVISED): CONTINGENCIES AND EVENTS OCCURRING AFTER THE BALANCE SHEET DATE A contingency is a cond cond ition or situation, the u ltimate outcome of wh ich, ich, gain or loss will be know n or determined on ly on the occurrence/ occurrence/ n on-occurrenc on-occurrencee of one one or m ore un certain ertain futu re events. For the p ur pose of AS-4 AS-4 the m eaning is restricted restricted to cond ition or situation at th e Balance Balance Sheet Sheet da te, the finan finan cial cial effe effect ct of wh ich ich is to be determ ined b y futu re events wh ich ich m ay or m ay not occur. AS-4 AS-4 do es not d eal with th e following following subjects, subjects, thoug h m ay resu lt in contingencies contingencies in respect of: a) Liabili Liabilities ties of Life Life and Gen eral Insu Insu rance out of p olicies olicies issued issued by th e enterp rise. b) Obligatio Obligations ns u nd er retirement retirement benefit benefit plan/ scheme scheme c) Comm itment arising arising from long-term long-term lease contract Estimates are required to be made for the amounts to be stated in the financial statement for many ongoing and recurring activities of an enterprise. Distinction should be made between an event th at is certain certain and that is uncertain. Contingent losses losses depend on th e outcome of the contingenci contingencies. es. It should be provid ed by w ay of a charg charg e in the statem ent of p rofit/ rofit/ loss a) if it is is probable that futu re events will confirm confirm after taking into account account th e probable recovery in this respect, that an asset has been imp aired or a liability liability has been incurred as at th e B/ B/ S date, and b) a reasonable estimate estimate of the resulting loss can can be estimated otherw ise the existence existence of the contingent loss shou shou ld be d isclose isclosed d in the financial statements. Provisions for contii1 contii1gencie genciess are not mad e in respect of general or u nsp ecif ecified ied bu siness risk risk since since they d o not relate to cond cond itions itions or situations existing existing at the B/ S d ate The disclosure disclosure requ irements ap ply on ly for those contingencies contingencies or events w hich affec affectt the finan cial cial position of the enterp rise to a material extent extent stating: a)
The nature of contingenc ontingency; y;
b)
The un certainty certainty wh ich ich may affe affect ct the futu futu re outcome;
c)
The estimate of the financial financial effe effect; ct;
d)
A statement statement that such such an estimate estimate cannot cannot be mad e;
Contingen t gains are not r ecognized ecognized because of u ncertainty of realization; realization; how ever, there is no restriction restriction to d isclose isclose as such such in the ‘Notes to Accoun Accoun ts’ in a m ann er not likely to mislead th e users of th e finan finan cial cial statements.
ACCOUNTING STANDARDS
Events occurring occurring after the B/ B/ S d ate or those signific significant ant event s, both favou rable and u nfavou rable that occur between the B/ S date and the date of approval of the financial statements by the ap pr opr iate auth ority (e.g. (e.g. Board Board of Directors Directors of a comp any) can be of a)
Those Those which which provide further evidence evidence of cond cond ition ition that exi existed sted at the B/ B/ S date adjustadjusting even ts (e.g. (e.g. insolvency of a custom custom er that occur occur after B/ B/ S d ate)
b)
Those wh ich ich are ind ind icati icative ve of cond itions itions that arose arose subsequent subsequent to the B/ B/ S date nonadjusting adjusting events (los (losss d ue to earthquake, war)
Events occur occur ring after the B/ S date b ut ind icative icative of the enterp rise ceases ceases to be a going concern (destru ction ction of major major p rod u ction ction p lant by fire fire after after B/ B/ S d ate) need s to be consid consid ered an d ev aluated to justify justify “going concern concept” for p repar ation of Finan Finan cial cial statements.
PROBLEMS 1. The assets assets in in a fac factory tory of a limite limited d compan y was dam aged d ue to a fire fire break out on 15 th Ap ril. The The Loss is estimated at Rs. 50 crores ou t of wh ich Rs.35 Rs.35 crores w ill be recovera ble from the insu rers. Explain Explain briefly briefly how the loss should be treated in th e final final account account for the pr evious evious year. Answ er: This has to be show n as a disclosur disclosur e by way of note to accoun accoun t. 2. Board of Directors Directors of a limited limited comp any ap pr oved th e financial financial accou accou nt for the year 2007-08 on 31st July,2008 uly,2008.. The following following events occurred before the ap pr oval of financial statements by Board Board of Directors. Directors. State how wo uld you d eal with these situ situ ations: (a) The Board of Directors at their meeting on June 30, 2008 has recommended a dividend of 10% 10% to be paid to the shareholders after after it is is app roved at the annu al general meeting. Answ er: Prop osed Dividend m ust be show n in the Balance Balance Sheet. (b) A d ebtor, wh o w as declared declared insolvent on 10 th July 2008 2008.. The total ou tstand ing amou nt w as Rs.2 Rs.2 lacs lacs as on 31 st March,2008. Answer: A provision provision for loss shou shou ld be p rovided in the books.
A5-S (REVISED): NET PROFIT OR LOSS FOR THE PERIOD, PRIOR PERI PERIOD OD ITE ITEMS AN D CHAN GE GES S IN ACCOUN TIN TIN G POLIC POLICIE IES. S. The statement requ ires the classif classific ication ation and d isclosure isclosure of extraord extraord inary an d p rior period items and the d isclosure isclosure of certain certain items with in the p rofit rofit or loss from from ord inary activities activities and also accoun accoun ting treatmen t for for changes in the accounting accounting estimate, and d isclosure isclosure regard ing changes in Accounting Policies Policies in in the finan finan cial cial statement.
To ensu ensu re prep aration of Profit Profit or Loss statement on a un iform iform b asis, in tur n to enh ance better compar ability ability of the enterp rise over time and with oth er enterpr ises. ises. All items of income and expense, which are recognized recognized in a period , are normally includ includ ed for the determination of the Net Profit/ Loss for the period unless otherwise permitted (AS-22 exception exception for deferred tax in th e income tax) Each extraordinary items, both income and expense arises from events/ transactions, which are clearly clearly distinct distinct from ord inary activities activities and n ot ex petted to recur frequ ently or regu larly, shou ld be disclosed disclosed as apart of net profit/ loss for the period in a distinct man ner to un derstan d the imp act on cur cur rent p rofit/ rofit/ loss An event or tran saction saction m ay be extraord extraord inary for one enterprise but not for the other because of difference difference between their resp ective ective ord inary activities activities.. Only on rar e occas occasion ion d oes an event/ tran saction saction give rise to extraordina ry items. Ord inary activities activities are those un d ertaken as p art of business of ail enterp rise and related activiactivities for for fu rtheran ce of, of, incid incid ental to or ar ising ising from th ese activiti activities. es. Frequ Frequ ency of occur occur rence is not th e sole sole criteri criteriaa to d etermine etermine extraordinary or ordinary natu re. How ever, when items of income income or expen se within p rofit/ rofit/ loss from from or d inary activities activities are of such a size, natu re or incidence that their d isclosure isclosure is relevant relevant to exp lain lain th e performa nce for for the period the natu re and amou nt of such items items shou ld be d iscl isclose osed d separately separately as exceptional exceptional items (distinct from from extraordina ry items) e.g. a)
wr ite off/ off/ w rite back of inventor ies to Net Realizable Realizable Value, Value, provision/ w rite back of cost of restructu ring
b)
disposal of fixe fixed d asset/ asset/ long term investments investments
c)
effec effectt of legislati legislative ve changes with retrospective ap plication plication
d)
settle settlement ment of litigat litigation ion
e)
other other reversa reversall of provisio provisions ns
Prior period items (income/ (income/ expense) arise in the cur cur rent p eriod as a result result of errors/ omissions in the p repar ation of the financial financial statements, in one or m ore pr ior period are generally infreinfrequ ent in natu re and d istinct istinct from from chan ges in in accoun accoun ting estimates. estimates. Prior period items are norm ally includ includ ed in the d etermination of net profit/ loss for the cur cur rent period show n after determ ination of cur cur rent p eriod p rofit/ rofit/ loss. The The objec objective tive is is to indicate the “effe “effect ct of such items in th e profit/ loss. The separate d isclosure isclosure is intend ed to sh ow the imp act on th e cur cur rent p rofit/ loss. loss. Disclosure Disclosure is mad e a)
by showing the prior period items items distincti distinctivel vely y un der the relevant relevant head of income/ income/ expenditure
b)
by pu tting tting und er “Prior “Prior Perio Period d Adjustment Adjustment A/ c either in the main statem ent of P/ L or in a schedule containing the respective details with the net figure in the P/ L A/ c of current p eriod in compliance with sched sched ule VI VI p art II requ irement.
ACCOUNTING STANDARDS
Notes to the Accoun Accoun ts should provid e detail description description with imp act act on th e current current p eriod eriod and tax implication implication arising th ereof (e.g. (e.g. stock stock valu ation not correctly correctly m ad e in the p revious p eriod). The use of reasonable estimate estimate b ased on then available informat informat ion circum circum stances are an essential part of the preparation of financial statement. There may arise a need to change the estimate on the basis of new information more experience or subsequent development. The revision in estimate does not bring the adjustment within the definition of an extraordinary item item or prior period item. The effect of change in Accounting Estimate should be included in the determination of net p rofit/ loss loss a)
in the period of change (if restrict restricted ed for for the period only)
b)
in the period of chan chan ge and futu re period (if (if the chan chan ge affec affects ts both) (e.g. (e.g. estimate of bad d ebt for (a) and change in estimated life life of a dep reciable reciable asset asset in term s of dep reciation reciation for (b»
Classifi Classificati cation on as to ord inary or extraord inary as pr eviously followed followed sh ould be maintained to d isclose isclose the effec effectt of chang es in accountin g estimate for better comp arability. arability. The natu re and change in an accoun accoun ting estimates having m aterial effec effectt in the current p eriod or in su bsequent p eriod shou ld be d isclose isclosed d . If If quan tific tification ation is not p redictable redictable such fact fact shou ld also be d isclose isclosed d. If it is diffi difficult cult to d istingu istingu ish between a change in Accoun Accoun ting Policy Policy an d change in Accounting Estimate Estimate th e chan chan ge is recognized as chan chan ge in Accounting Accounting Estimate with ap pr op riate disclosure. Example of various disclosures under AS-5
1.
change in depreciatio depreciation n method : change in acco accoun un ting polic policy
2.
useful life life redu ced ced bu t no change: change in in accounting accounting estimate estimate in dep reciation reciation method
3.
arithmetica arithmeticall error in in dep reciati reciation on comp comp utation: prior period item item
4.
du e to to oversight oversight depreciati depreciation on incorrec incorrectly tly comp comp uted : prior period item item
5.
fixed fixed asset asset destroyed in earth earth quake: extraordinary extraordinary item item
6.
major disposal of fixed fixed items: ord inary activity activity (exc (exceptional eptional item) item)
7.
maintenance provision provision no longer required required since since major major part of the assets assets no longer longer exis exist: t: the w rite-back. rite-back. if material shou ld be d isclosed isclosed as exceptional exceptional item an d not as extraord inary’ or or p rior period item.
PROBLEMS 1. Mr.Pradip an emp loyee of CCL Ltd.went on leave with a pa y for for 9 mon ths on 1.1. 1.1.20 2008 08 up to 30.9. 30.9.20 2008 08.. His m onth ly p ay w as Rs.25 Rs.25,0 ,000 00.. While pr eparin g th e financial statemen statemen t on 30.6.2002 for the year ended 31.3.08, the expense of salary of Mr.Pradip for 3 months (1.1 (1.1.0 .08 8 to 31.3 31.3.0 .08) 8) w as not p rov ided d u e to omission. Wh en Mr.Pra d ip joined joined on 1.10. 1.10.08 08,, the wh ole salary salary for for 9 months w as du ly paid to him. In this case, case, three mo nth s salary salary of Rs. Rs.75 75,0 ,000 00 is prior period expense and following following entry should be passed: Sa la r y A / c
D r . 1,50,000
Prior period expen se (Salary) (Salary) A/ c Dr. 75,0 75,000 00 To Ba n k A / c
2,25,000
If Mr. Prad ip w as terminated from service on 1.1.0 1.1.08 8 and wa s re-instated re-instated in service service by the Cour t on 30.9. 30.9.08 08 with fu ll pay p rotection(i. rotection(i.e. e. total salary salary w as reward ed to him). As the emp loyee was re-instated in service as per th e Cour t’s t’s Ord er as on 1.10 1.10.2 .200 008, 8, the following entry shou shou ld be made: Sa la r y A / c To Ba n k A / c
Dr.
2,25,000 2,25,000
In such such a case, case, there shall arise no error or omission omission wh ile pr eparin g the financial financial statements for the earlier years.
AS -6 (RE (REVISED) VISED ) DE D EPRE PRECIATION CIATION ACCOUN TING Deprecation is a measure of the wearing out consumption or other loss of value of a depreciable ciable asset asset d ue to u se effl efflux ux of time or obsolescence obsolescence throu gh techno logy and mar ket changes and also includ includ es amortization of assets havin g pred etermined life. life. Diffe Different rent accou accou nting policies policies are followed by d iffe ifferent rent enterp rises, rises, hence d isclosure isclosure is n ecesecessary to app reciate reciate the view p resented in th e financial financial statements. Depreciation Depreciation h as a signific significant ant effec effectt in d etermining an d pr esenting finan finan cial cial position and operating results.
ACCOUNTING STANDARDS
A de preciable preciable asset must fulfil l the follow ing criter criteria: ia:
a)
expecte expected d to be used for for more than one acco accoun un ting period
b)
limite limited d useful useful lif life
c)
held for for use in in the prod uction uction or supp ly of goods and services, services, for rental, rental, for for adm inistrainistrative pu rp oses, and not for sale in the ord inary course of business.
Specific exclusions from the scope of AS -6: -6:
1. Forest, plan tation and similar regenerative resource 2. Wasting asset, expend iture or a exploration exploration for and extraction extraction of minerals, oils oils natur al gas and similar similar non -regenerative resour resour ces. ces. 3. R& R&D D expend expend iture 4. Goodw Goodw ill ill 5. Livesto Livestock ck Depreciation Depreciation charge for a period is usu ally recognized recognized as an expense un less less includ includ ed in carrying am ou nt (e.g. (e.g. dep reciation reciation of manu factu factu ring p lant is includ includ ed in th e cost cost of conv conv ersion of inventor ies or d epreciation epreciation of assets assets used for d evelopm ent activities activities may b e treated as an intangible assets or capital redu ced ced ) Useful life is either:
( a) the p eriod ov er wh ich ich a d epreciable epreciable asset is is expected expected to b e used by th e enterpr ise or ( b) on the basis of pr od uction or similar un its obtainable from from the u se of assets. A change in dep reciation reciation meth od w ill arise in in th e following following situation: a)
adoption is required required by by the the statute, statute, or
b)
for comp liance liance with the relevant relevant AS, AS, or
c)
it is considered considered that the change wou ld result result in in more approp riate presentation presentation of the finan finan cial cial statemen ts
When the change is adopted, the depreciation is reworked with reference to the date of the asset pu t to use by the enterp rise, the d efic eficienc iency/ y/ surp lus is adju adju sted in the P/ L A/ c in in th e year of change given effec effectt w ith ap pr opr iate disclosure disclosure since as per AS 6. This is considered considered as a change in th e Accou Accou nting Policy. Policy. Change in depreciation method always applies retrospectively. following in formation sh ould be d isclosed isclosed in th e finan finan cial cial stateDisclosure under AS-6: The following ment 1) Historic Historical cost/ substituted cost cost of each class of d ep reciable asset 2) Total Total dep reciati reciation on for the period with respect respect to (1) (1) 3) Accum Accum u lated dep reciation: reciation: Ad d itional itional disclosure disclosure as par t of d isclosure isclosure of other accountaccounting policies
a)
Deprec Depreciati iation on method used
b)
Depreciation Depreciation rate or the useful lives lives of the assets, if they d iffe ifferr from rates specif specified ied in the govern ing statut e If If any dep reciable reciable asset asset is d isposed of, discard discard ed, dem olished olished or d estroyed, the n et surp lus or d efic eficienc iency, y, if if material shou shou ld be d isclose isclosed d separately (in contrast w ith th e concept of Block Block un d er I.T Act ’61) ’61)
In case case the dep reciable reciable assets assets are revalued revalued , the d epreciation epreciation shou ld be pr ovid ed as the revalued amou nt on t he estimate of remainin g u seful seful life life of such assets. Disclosure Disclosure shou ld be ma de in the year of revaluation, if the same h as a material effec effectt on th e amou nt of d epreciation. epreciation.
PROBLEMS 1. Plant has useful life life of 10 10 years. Depreciable Depreciable amou nt of Rs.3 Rs.30 0 lakhs. lakhs. The comp comp any h as th charged d epreciation epreciation u nd er SLM. SLM. At the end of the 6 year, the balance useful life wa s re-esti re-estimated mated at 8 years. The dep reciation reciation w ill ill be charg charg ed from t he 7 th year: = 30 – (30/ 10) x 6
= 1.5
8 2. B Ltd. Purchased certain certain p lant and machinery for Rs.50 Rs.50 lakhs. 20% 20% of the cost cost net of CENVAT credit is the su bsidy comp onent t o be realized realized from a State State Governm ent for establishing establishing in d ustry in a backw ard d istrict. istrict. Cost includ includ es exci excise se Rs. Rs. 8 lakhs against wh ich ich CENVAT credit can can be claimed claimed . Comp ute d epreciable amou nt. Answ er: We shall have to determ ine the historical historical cost cost of the p lant and machinery. P u r ch a s e P r ice
Rs .50 la k h s
Less: Less: Specific pecific Exci Excise se du ty against wh ich ich CENVAT is available
Rs. 8 lakhs
Origi Original nal Co Cost st of the machine machinery ry for acc accounting ounting purposes purposes
Rs. 42 lakhs
Les s : Su b sid y @ 20% o f Rs .42 la k h s
Rs. 8.4 la k h s
D e p r ecia b le A m o u n t
Rs . 33.6 la k h s
50% in the first year Note: As CENVAT Credit on Capital Good s can be availed u pt o 50% of acqu acqu isition isition and the balance in in th e next year, an alternative treatm ent ma y also be considered. The original cost cost of the plant an d m achinery can be taken at Rs. 50 lakhs and a sum of Rs.8. Rs.8.4 4 lakhs lakhs can be tr ansferred to d eferred eferred income accoun accoun t by w ay of subsidy reserve. The portion of u nav ailed ailed CENVAT Credit is also required t o be redu ced ced from cost.
AS-7 AS -7(RE (REVISED): VISED): ACCOUN TIN TIN G FOR CON CON STRUCTION STRUCTION CON TRACTS TRACTS The statement ap plies to accoun accoun ting for construction contracts, in in th e finan finan cial cial statements of contractors, A construction contract may be related to the constru ction ction of single asset asset or a nu mber of assets closely, closely, interrelated or interd epend ent in term s of the scope scope of the contract.
ACCOUNTING STANDARDS
For the purpose of this statement construction contract covers:
a) Contracts for for rend ering of services services directly directly related related to th e constru constru ction ction of the asset asset e.g. e.g. service of project-man project-man agers, architects etc. b) Contracts for d estruction/ restoration of assets and r estoration of environ men ts followfollowing demolition c) Consultancy Consultancy contracts contracts in projec projectt managem ent, designing, comp uters wh ere such such contracts are related related to the constru ction ction of the asset. d ) Those long-term contracts not relating to constru constru ction ction of an asset. A construction contract may be
a) a fixe fixed d -price contract with / withou t escal escalation ation b) a costcost-plus plus contract contract (provision (provision for for reimbu reimbu rsement of overhead on agreed basis in in ad dition to fixed p rice/ fees) fees) c) a mix of both (a costcost-plus plus contract contract with a minimu m agreed p rice) rice) The statement u sually app ly to each each contract separately, howev er, sometimes sometimes it is necessary necessary to ap ply th e statement to the separ ately id id entifiable entifiable comp comp onent s of a single contra contra ct or to a group of contr contr acts together in ord er to reflect reflect the substan ce. ce. When a contr act covers covers a) N u mber of each asset treated as sepa sepa rate contract contract wh en the prop osal, negotiation of assets: assets: each and cost/ revenue can be ident ified ified d istinctly istinctly b ) Negotiated single package of interrelated identifiable with an overall profit margin performed concurrently or continuous sequence: treated as a single contract whether a single customer or a grou p of customers. c) Construction of an additional asset as the provision of the contract: treated as separate contract if there is significant change in design, technology or transaction from original contract in in term s of the scope scope an d / or p rice. rice. Ad d itional asset asset shou ld be treated as a separate constru ction ction contract if there is signifi signifi-cant change in design, technology or function from the assets covered in the original contract p rice. rice. Contract Contract reve nue comprises o f
a) revenue agreed agreed in in the contract b) variations in in the scop scop e of contract, ad verse/ favou favou rable c) incentive incentive paym ent (degr (degr ee of certainty certainty and reliability) reliability) d) penalties penalties due to delay in exe executio cution n Contract Contract costs costs comprise of
a) d irectly irectly related related to specif specific ic contract
b) attribut able cost relating to contra contra ct activity activity in general and pr ecise ecisely ly allocable allocable to the contract as redu ced ced b y incid incid ental income not includ ed in contract revenu e (sale (sale of su su rplu s m aterial, disposal of contract sp ecif ecific ic plants etc). etc). Contract cost and revenue are recognized for accounting only when the outcome of the construction contract can can be m easured reliably reliably with r egard to the stage of comp comp letion letion of the contracts activity activity at its B/ B/ S date. All expected expected losses losses shou ld r ecognized ecognized as an expense for the contract. Under the percentage completion method, contract revenue is recognized in the P/ L in the acco accoun un ting period in w hich hich th e work is performed performed and the related related contract contract cost cost is shown as an expense. How ever, expected expected excess excess of total contract contract is recognized as an expense imm ediately. Revenue earlier recognized or becoming doubtful/ uncollectable should be treated as an expense. A long-term contract is sub sub ject ect to flu flu ctuation for variou s reasons in the original estimation thu s likely likely to affec affectt the d etermination of contract contract results. It It is necessary necessary tha t an ann ual review of the cost cost already incur red an d fu tu re cost cost required to complete the pr ojec ojectt on schedu le. While estiestimating th e futu futu re cost cost care care shou ld be taken for foreign foreign exchan exchan ge rate fluctuation, fluctuation, labour p roblem, chan chan ges in m aterial price etc. etc. Dis closure under under AS -7 (on reporting reporting dat e by an ent ent erprise) erprise)
A) An enterpr ise shou ld enclose a) The amou amou nt of contract contract revenue recognized recognized as revenue revenue in the period b) The method s used to determine the contract contract revenue recognized recognized in the period period c) Method u sed to determine the stage stage of comp comp letion letion of contract in in p rogress B) An enterp rise shou shou ld d isclose isclose the following following for contracts in in p rogress at the rep orting d ate 1. The aggregate amou nt of costs costs incurred an d recognized profit less recognized losses losses up to reporting reporting date. 2. The amou nt of adv ance recei received ved and amou nt retained retained C) An enterprise should should present a) Gross amou nt du e from customer customer is an asset asset b) Gross amou nt d ue to customer customer is a liabi liabili lity ty c) Contingen cies cies as per AS-4 AS-4 (warran ty cost, cost, pen alties, alties, gu arantee issued issued by banks against counter ind emn ity of contractor)
PROBLEM A Comp any un d ertook to pay contract for for a buildin g for Rs.4 Rs.40l 0lakhs. akhs. As on 31. 31.3. 3.20 2008 08,, it inincurred it incurred a cost of Rs. Rs.6 6 lakhs and expects that there w ill ill be Rs.3 Rs.36 6 lakhs lakhs m ore for completing the building. It has received Rs.4 lakhs as progress payment. What is the degree of completion?
ACCOUNTING STANDARDS
P e r cen ta ta g e o f C o m p le le t io n
=
C o s t t o d at ate x 100 Cum u lative cost cost incurred + Estimated Estimated cost cost to comp comp lete
=
6/ (6 + 36) 36) x 100 = 14.28 4.28% %
AS-8 ACCOUNTING FOR RESEARCH & DEVELOPMENT (STAND S WITHD WITHD RAWN ON INTRODU CTION CTION OF AS-26 AS-26 INTANG IBL IBLE ASSETS) ASSETS)
AS-9 REVENUE RECOGNITION The statement covers the recognition of revenu e arising arising in the course of ord inary activities. activities. of the enterp rise rise from a) sale sale of goods b) rendering of servic service c) ou tsourcing of resour resour ces ces yielding yielding interest, royalties royalties and d ividend Specific pecific exclusion exclusion stand ard p ertains ertains to from the stand a) construction onstruction contracts b) lease lease// hire pu rchase rchase agreement c) govt. grants/ subsidies d) insurance contract of insurance comp anies Essential Essential criterion criterion for recognition for r evenu e from ord inary activities activities as aforesaid aforesaid is that th e considerati consideration on is reasonably reasonably d eterminable eterminable even even th ough the p ayments are m ade by installments. installments. In the event of uncertainty, the recognition is postponed and considered as revenue of the period in w hich hich it is prop erly erly recognized. recognized. The standard requires, in addition to the AS- I, that an enterprise should also disclose the circum circum stances in wh ich ich revenu e recognition recognition has been p ostpon ed p end ing resolution of signifisignificant un certainties. certainties. NOTE:
Revenue includ e the gross inflow inflow o f economic economic benefits benefits only accrued accrued to an en terpr ise on its own e.g. sales tax, tax, service service tax, tax, VAT VAT etc. etc. do n ot accru accru e to th e enterp rise and thu s not considered as revenue under IAS-18 and US GAAP. Practices vary in India and tend to show larger gross tu rnov er for the en terpr ise (inci (inciden den tally section section 145A 145A of the Income Tax Act ’61 ’61 requ ire pu rchase, inventor y and tu rnov er inclusive inclusive of Tax, Tax, du ty and cess) cess) ICAI recommen d s disclosure disclosure in the mann er : Tu r n o v er (g r o ss )
xx x
Les s Excis e d u t y
x xx
N e t Tu r n o v e r
x xx
PROBLEMS 1. AB Ltd. Seeks you ad vise abou t the treatmen t of the foll follow ow ing in in the final final statemen statemen t of st accou accou nts for the year ended 31 Mar ch 2008: 2008: “ As a result of a recent recent ann ou nced p rice rice revision, revision, granted by the Govern men t of Ind ia st with effect from 1 July,2007, the company stands to receive Rs. 6 lakhs from its custom ers in resp ect of sales mad e in 20072007-08 08”” Answ er: The comp comp any is p repar ing the financial statements for the year en d ed 31.3. 31.3.08 08.. Due to p rice rice revision revision gran ted by th e Governmen t of Ind ia, the comp any h as to receive receive an ad d itional sales sales revenu e of Rs. Rs. 6 lakhs in resp ect ect of sales sales mad e du ring th e year 2007 2007-08. As p er AS-9, AS-9, w here u ncertainty exists in collec collection tion of reven ue, its recognition is p ostpon ed to th e extent extent of uncertainty uncertainty involved involved and it should be recognized recognized as revenue only w hen it is reasonably certain certain abou t its colle collecti ction. on. In view of the above statem ent, if there is no u ncertainty exists exists as to th e collec collectt ability ability of Rs. 6 lakhs, lakhs, it shou ld be r ecognized ecognized as revenu e in the financial statemen statemen ts for the year end ed 31.3. 31.3.08. 08. 2. Ad vise D Ltd Ltd .about the treatment of the following following in the final final statemen statemen t of accoun accoun ts for for the year ended 31st March,2008. A claim claim lodged w ith th e Railways Railways in March,200 March,2006 6 for for loss of good s of Rs.5 Rs.5 lakhs lakhs had been passed for payment in March,2008 for Rs.4 lakhs. No entry was passed in the books of the the company, w hen th e clai claim m was lodged . Answ er: The financial financial statemen statemen ts of the comp any ar e prep ared for th e year end ed 31.3. 31.3.08 08.. There was a loss of good s of Rs.5 Rs.5 lakhs in 2005 2005-0 -06 6 and the claim claim was lodged in March 2006 with the Railway authorities. No entry was passed in the books of the company wh en the claim claim w as lodged and the said treatm ent w as correct correct in in view of AS-9 AS-9,, which states that if un certainty certainty exists as to collec collectabili tability, ty, the reven ue r ecognition ecognition sh ould be postponed. Since, Since, the claim claim is p assed for pa ym ent of Rs.4 Rs.4 lakh lakh s in March ,200 ,2008, 8, it shou ld be recognized a s revenu e in the finan finan cial cial statements p repar ed for the year en ded 31.3 31.3.0 .08. 8. As per AS-5 Revised, the claim amount received will not be treated as extraordinary item. AS-5 AS-5 Revised Revised furth er states that w hen items of income and expense with in p rofit rofit 0r loss from from ord inary activities activities are of such size, nature, or incidence that their d iscloisclosure is relevant relevant to exp lain lain th e performan ce of the enterprise for for the p eriod, the natu re and amou nt of such items should be disclos disclosed ed separately. Acc Accordingly, the nature and amou nt of this item shou ld be disclosed disclosed separat ely.
ACCOUNTING STANDARDS
AS -10: -10: ACCOU N TING TIN G FOR FOR FIXE IXED ASS A SSE ETS Fixed Fixed assets for the pu rp ose of the statement are tho se held held by an enterp rise with th e inten inten tion of being being used for for the p urp ose of prod ucing or providing good s or servic services and n ot held for sale sale in the normal course of business and applies to financial statements prepared on historical cost/ substituted cost basis. basis. The following items need special consideration and normally not covered under this statement. un less less the expenditure on individu al items items are separable and identifie identified. d. a) forest plantation and regenerative regenerative natural resources resources b) wa sting assets assets and n on-generative resources (mineral rights. exploration of mineral, oil and n atural gas) gas) c) expend expend iture on real real estate estate development d) livestoc livestock k Ap art from d irect irect cost, cost, all all directly directly attribu table cost cost to bring th e asset asset concerned concerned to their w orking cond ition for for intend ed u se also also form form s the par t of fixed fixed asset. Sub sequen t expend iture after the initial cap cap italization italization th at increases the futu re benefits from from the existing existing assets beyond the p reviously assessed assessed stan d ard of performan ce (e.g. (e.g. increase increase in” qu ality of ou tpu t, substantial redu ction ction in op erating cost) is cap cap italized italized to form the gross book value. Finan Finan cial cial statements are norm ally prepa red on the basis of historical historical cost cost but som etimes a part or all of fixe fixed d assets, are restated (revalued) an d substitu ted for historical historical cost. cost. The The comm only acce accepted pted and preferred preferred method of restati restating ng is by app raisal raisal by a competent valuer. As p er Sched Sched ule VI, every B/ B/ S subsequ ent to revaluation shall disclose disclose the increased figur e w ith th e d ate of increase in in place of the original cost for the first 5(fi 5(five) ve) years, but the fact of such revalu ation w ill continue to be d isclosed isclosed till such time su ch assets ap pear in the B/ B/ S. Revalua Revalua tion is ma d e for an entire class class of assets or the selection selection of assets on a systematic basis basis (fact (fact of which should be app rop riately riately stated). An increase in net book value arising on revaluation of fixed assets should be credited to “Own er’s er’s Fund ” u nd er “Revaluation “Revaluation Reserve Reserve”” u nless nless the d ecreas ecreasee on any previously revaluarevaluation recorded as a change in P/ L A/ c or “Revaluation Reserve” if increase increase in p revious occasion occasion was credited credited thereto. All material items items retired from active use and n ot dispo sed off shou ld be stated at the lower of net book value or net realizable value as a separate item in the Sched Sched ule of Fixed Fixed Assets. Depreciation Depreciation as p er AS-6 AS-6 shou ld be charged on th e total value of fixe fixed d assets includ includ ing revalued portion. portion.
Disclosure Disclosure in ad d ition to AS-1 AS-1 and AS-6 AS-6,, should be mad e un d er AS-l0 AS-l0 in th e following following lines: a) Gross and net book value of fixe fixed d assets assets at the beginning beginning and end of an accoun accoun ting period with ad ditions, disposals, disposals, acquisit acquisitions ions and other m ovements. b) Expen Expen d itures incur incur red on account of fixe fixed d assets in in the course of constructional acqu acqu isition c) Revalued Revalued amou nts substitu ted for historical historical cost, cost, the basis of selecti selection on for revalua revalua tion, the method adopted, the year of appraisal, involvement of external valuer. d ) The revalued am ou nts of each each class class of fixed fixed assets are pr esented in th e B/ B/ S separately with ou t netting off the resu lt of revalu revalu ation of various classes classes of fixe fixed d assets.
PROBLEMS 1. A comp comp any has scrapp scrapp ed a semi-automatic semi-automatic part of a machine(not machine(not w ritten ritten off) off) and replaced placed w ith a more expensive expensive fully fully automatic part, wh ich ich h as dou bled bled the outp ut of the machine. At the same time the machine was m oved to m ore suitable place place in in th e factory, factory, wh ich ich involved th e building of new found ation ation in ad dition to the cost cost of dismantling dismantling an d re-erecti re-erection. on. The The compan y wan ts to charg charg e the whole expend iture to revenu e. As an aud itor, wh at wou ld you d o in this situation? situation? Answer: If the subsequent expenditure increases the expected future benefits from the asset beyond its pre-assessed standard of performance then as per AS-10 it should be capitalized. capitalized. Otherw ise, ise, it it shou ld be treated as an exp ense. In In th is case, case, the rep lacement lacement o f semi-autom semi-autom atic part w ith a fully fully autom atic part h as dou bled bled the outp ut of the machine thu s, it has increased increased futu re benefits benefits beyond the machines pre-assesse pre-assessed d stand ard p erforman ce, ce, hence this expend iture shou ld be capitalized capitalized as p art of cost cost of the m achine. How ever, the expenses for for shifting shifting the machine and bu ilding of a new foun d ation in add ition ition to the cost of dismantling and re-erection do not contribute to any new future benefits from the existing existing asset. They They on ly serve to maintain p erformance of the machine. Hence, this cost cost should be charged charged to revenue. 2. A pu blishing blishing comp comp any un dertook repair and ov erhauling of the machinery machinery at a cost of of Rs.5 lakhs to maintain them in good condition and capitalized the amount, as it is more than 25% 25% of the original cost of the m achinery. Adv ice. ice. Answ er: The size size of the expend iture is not the criteria criteria to decid decid e wh ether sub sequent expend iture should be capitali capitalized. zed. The The imp ortant qu estion estion is whether the expend expend iture increases creases the futu futu re benefits benefits from from the asset beyond its pre-assesse pre-assessed d stan d ard of performance as per A S-10. -10. Only then it shou ld cap italize. Since, in th is case, case, only the ben efits are m aintained at existing existing level, the expend iture shou ld n ot be cap cap italized. italized.
ACCOUNTING STANDARDS
3. Hero Ltd. pu rchased a ma chine of Rs.5 Rs.50 0 lakhs lakhs includ ing excise excise d uty of Rs. Rs. 10 lakhs. The The excise excise du ty is Cenvatable un der the excise excise laws. laws. The enterp rise intend intend s to avail CENVAT CENVAT credit and it is reasonably certain to utilize the same with reasonable time. How should the excise excise du ty of Rs.10 Rs.10 lakhs lakhs be treated ? Answ er: The foll follow ow ing jour jour nal entries should be record record ed: In the the y ear of acquisi tion:
(Rs. Lakhs)
M a ch i n e r y A / c
D r . 40
CENVA CENVAT T Credi Creditt Recei eceivabl vablee A/ c
Dr. 5
C EN VA VA T C r ed ed it it D e fer re re d A / c
Dr . 5
To Su p p lie r ’s A / c
50
In the next year:
CENVA CENVAT T Credi Creditt Recei eceivab vablle A/ c
Dr. 5
To CENVAT CENVAT Credit Deferred Deferred A/ c
5
4. A compan y p ur chased a m achinery in the year 20052005-06 06 for Rs. Rs.90 90 lakhs. A balance balance of Rs. Rs. 10 10 lakhs is still still payable to the sup pliers for for the same. The The sup p lier lier w aived off the balance amou nt d ur ing th e finan finan cial cial year 2007 2007-0 -08. 8. The comp comp any t reated it as income and credited to pr ofit ofit and loss accou accou nt d u ring 2007 2007-0 -08. 8. wh ether accoun accoun ting treatm ent of the comp comp any is correct? Answ er: As per p ara 9.1 9.1 of AS-1 AS-10, 0, the cost of fixed fixed assets may u nd ergo changes su bsequ ent to its acquisition acquisition or construction on accou accou nt of exchan exchan ge flu flu ctuation, price adju adju stments, changes in duties or similar factors. Considering para 9.1 the treatment done by the company is not correct. Rs.10 lakhs should be deducted from the cost of the fixed assets. 5.
Z Ltd.pu Ltd.pu rchased rchased a m achine achine costi costing ng Rs.5 Rs.5 lakhs lakhs for for its manu fact facturing uring op erations erations and p aid transportation costs Rs.80,000. Z Ltd. spent an additional amount of Rs.50,000 for testing and preparing the machine for for use. What amou nt shou ld Z Ltd. record record as the cost cost of the machine? Answ er: As per Para 20 of AS-1 AS-10, 0, the cost of the fixed fixed asset shou ld comp rise its pu rchase price and any attributable cost of bringing the asset to its working condition for its intended use. In this case, the cost of machinery includes all expenditures incurred in acquiring the asset and preparing it for use. Cost includes the purchase price, freight and han d ling ling charg es, insura nce cost cost on th e machine w hile in in tran sit, cost cost of sp sp ecial ecial foun foun d ations, and costs costs of assembling, installation installation and testing. Therefore, Therefore, the cost cost to be r ecord ecord ed is Rs.6,30,000(= 5,00,000 + 80,000 + 50,000)
AS-11: AS -11: THE EF EFFECTS OF O F CHAN CHA N GES IN FOREIGN EXCHAN CHA N GE RATES RATES The statement ap plies mand atorily in in resp ect ect of: a) Accou Accou nting for tran saction saction in in foreign foreign cur cur rencies rencies b) Translating the finan finan cial cial statemen statemen ts of foreign foreign br anches for for inclusion inclusion in th e financial financial statements of the reporting enterp rise. A transaction in a foreign currency is recorded in the financial records of an enterprise normally at the rate a) On the date of transactio transaction n i.e. i.e. spot rate, b) App roximate roximate actual rate i.e. i.e. averaging the rates du ring the week/ mon th in wh ich ich transactions occur occur if there is no signific significant ant flu flu ctuations. c) Weighted Weighted average in the above above line. line. How ever, for for interrelated tr ansaction (by virtue of being set off off against receivables receivables and p ayables) it is is translated w ith reference reference to the net amou nt on the d ate of transaction. After After initial recognition, recognition, the exchan exchan ge d iffere ifference nce on the r eportin g d ate of finan finan cial cial statement should be treated treated as und er: a) Monetary items like like foreign foreign cur rency balance, receivables, receivables, pay ables, loans at closing closing rate (in (in case of restriction restriction or remittan ce other th an tem por ary or w hen th e closi closing ng rat e is un realistic realistic,, it it is repor ted at th e rate likely likely to be realized realized ) b) Non -monetary items like like fixe fixed d assets, w hich are recorded at h istorical istorical cost, cost, shou ld be mad e at the rate on the d ate of transactio transaction. n. c) Non -monetary items other than fixed fixed assets are carried carried at fair fair value or net realizable realizable value on the d ate wh ich ich th ey are determ ined i.e. B/ S date (inven (inven tories, investmen ts in equity-shares) Exchange Exchange d iffe ifference rence on rep aym ent of liabili liabilities ties incurr incurr ed for acquiring fixed fixed a ssets should be ad justed in the carrying am oun t of fixed fixed assets on reporting d ate. The same concept concept ap plies to revaluation revaluation as w ell ell but in case such such ad justment on revaluation revaluation shou ld result into showing the actual book valu e of the fixe fixed d assets/ or class class of, exceeding exceeding th e recoverable recoverable amou nt, the remaining amount of the increase in liability should be debited to Revaluation Reserve or P/ L Statemen t in case case of inad equacy/ absence of Revaluation Revaluation Reserve. Exce Except pt as stated above (fixed (fixed assets) other exchange d iffere ifference nce shou ld be recognized as income or expense in in th e period in w hich hich th ey arise arise or spread over to pertaining acco accoun un ting period. Depreciati Depreciation on as p er AS-6 AS-6 should be provided on the u namortised carrying carrying am oun t of depreciable ciable assets (after taking into accou nt t he effect effect of exchan exchan ge d ifferen ifferen ce)
ACCOUNTING STANDARDS
D isclos ure ure und er AS -11: -11: An en ter terprise prise shou ld dis close:
a) The amoun t of exchan exchan ge difference difference includ includ ed in the net profit or loss for the period . b)
The amou nt of exchan exchan ge differe difference nce ad justed in the carrying carrying am oun t of fixed fixed assets assets du ring the acco accoun un ting period.
c) The amou nt of exchan exchan ge difference difference in in resp ect ect of forw forw ard contracts to be recognized in the pr ofit/ ofit/ loss for one or more subsequ ent accoun accoun ting period . d)
Foreign Foreign currency risk man agemen t policy.
PROBLEMS 1.
Exchange Rate
G oo oo d s p u r ch ch as a s ed o n 24.3.07 o f U S $1,00,000
Rs .46.60
Exch a n g e r a t e o n 31.3.2007
Rs .47.00
D a t e o f a ct u a l p a y m en t 5.6.08
Rs .47.50
Calculate th e loss/ ga in for th e financial years 2006-0 2006-07 7 and 20072007-08. 08. Answ er: As per AS-11 AS-11,, all all foreign foreign curren cy transactions transactions shou ld be recorded by ap plying th e exchan exchan ge rate at th e da te of transaction. transaction. Therefore, Therefore, goods p ur chased on 24.3 24.3.0 .07 7 and corr spon d ing creditor wou ld be recorded a t Rs.4 Rs.46. 6.60 60 = 1,00,000 x 46.60 = 46,60,000 As per AS-11 AS-11,, at the balance sheet sheet da te all all monetary items shou ld be repor ted u sing the closing closing rate. Therefore, the cred itors of US $1,0 $1,00, 0,000 000 ou tstan d ing on 31.3. 31.3.07 07 w ill be rep orted as: 1,00,000 x 47.00= 47,00,000. Excha Excha ng e loss Rs. 40,0 40,000 00(=47 (=47,0 ,00, 0,000 000 – 46,60, 46,60,00 000) 0) shou ld be d ebited in p rofit an d loss accoun t for 2006-07. As per AS-11 AS-11,, exc exchan han ge d iffe ifference rence on settlemen settlemen t on m onetary item s shou ld be tran sferred sferred to p rofit rofit and loss account account as gain or loss thereof: thereof: 1,00,00 1,00,000 0 x 47.50 47.50 = 47,50,0 47,50,000 00 -47,0 -47,00,0 0,000 00 = Rs.50, Rs.50,000 000 sh ou ld be d ebite d to p rofit o r loss for th e year 2007-08.
1.4.2006 006 costing US $ 1,0 1,00, 0,00 000. 0. The sup p liers agreed to th e 2. Z Ltd. acquired a ma chine on 1.4.2 follwing follwing term s of pa ymen t: 1.4.2006
: d o w n p a y m en t 50%
1.4.2007
:
25 %
1.4.2008
:
25 %
The compan y d epreciates machinery @ 10% 10% on th e Straight Straight Line Line Meth od . The The rate o f exchange exchange is stead y at US $ 1= 1= Rs.40 Rs.40 up to 30.9.2 30.9.2007 007.. On 1.10 1.10.0 .07, 7, du e to a n o ffici fficial al reva luat ion o f rates, th e excha excha ng e rate is ad ju sted to US $ 1= 1= Rs.48 Rs.48.. Show the extracts of the relevant en tries in in th e Profit Profit and Loss Loss Accoun Accoun t for the year end ing 31 st March,200 March,2008 8 and the Balance Balance Sheet Sheet as on that d ate, show show ing su ch wor kings as n ecessary. ecessary. Working N otes: otes: 2006-07:
1. Origi Original nal Co Cost st of the machine machine
= $1 $1,00,000 x Rs.4 s.40 = Rs.4 s.40,00,000
2. D e p re r e cia t io io n (SLM ) @ 10%
= Rs.4,00,000
2007-08:
1. Original Cost of the machine u pto 30/ 30/ 9/ 9/ 200 2007 7
= Rs.40 Rs.40,0 ,00, 0,00 000 0
2. Revised cost o f the m achine a s on 1.10. 1.10.200 2007 7 Due to official revaluation of exchange rates, the US $ 1 = Rs.48. There is a foreign exchange loss of Rs. Rs. 8 for each d ollar liability. liability. The total loss on foreign curr ency fluctu ation w as $25,0 $25,000 00 x Rs.8 Rs.8 = Rs.2, Rs.2,00, 00,00 000. 0. This has t o be ad d ed to th e origin al cost of the m achine. Therefore, revised cost of the machine as on 1.10.2007 is Rs.42,00,000 (i.e. Rs.40,00,000 + Rs.2,00,000) Th e re vi vi se se d co st st o f th e m ac ach in in e as o n 1.10.2007 :
O r ig in a l C o s t o n 1.4.2006
Rs .
40,00,000
Less: Dep reciation: 1.4.2006 t o 31.3.2007
4,00,000
1.4.2007 t o 30.9.2007
2,00,000
6,00,000 34,00,000
Ad d : Loss on foreign exchang e fluctu ation as on 1.10. 1.10.20 2007 07
2,00 2,00,00 ,000 0 36,00,000
ACCOUNTING STANDARDS
Depreciation: 1.4. 1.4.20 2007 07 to 30.9 30.9.2 .200 007 7
(40, (40,00 00,0 ,000 00 x 10/ 10/ 100 100 x 6/ 12) 12)
1.10 1.10..2007 2007 to 31.3 31.3.2 .200 008 8
( 36,0 36,00, 0,00 000 0 x 6 8.5 x 12 )
2,00 2,00,0 ,000 00
2,11,765
Total otal Depre Deprecciati ation for the year year 2007-08
4,11,765
N ote: As per AS-6 AS-6 Revised Revised , ‘Dep ‘Dep reciation Accoun ting ’, in in case of chan ge in histor ical cost du e to foreign foreign exchan exchan ge fluctuation, fluctuation, dep reciation reciation on the revised un amor tized dep reciable reciable amoun t should be provided prospectively over the residual life of the asset. In this case, the residual life is 8.5 8.5 year s. Prof Prof it and Los s A ccoun t (extract) (extract)
for the year end ed 31 st March, 2008 P a r t i cu l a r s
Rs .
To Deprec Deprecia iati tion on on Machine Machinery ry
P a r t icu la r s
Rs .
4,11 4,11,,765
Balance S he et (extract) (extract) as as at 31st March,2008
Li a b i l i t i e s Current Liabilities
Rs . 12,00,000
A s s et s
Rs .
Fixed A sse ts
C r ed it it o r s fo r Su p pp p ly ly
M a ch in in er er y (a t co s t ) 40,00,000
o f M a ch in e r y
A d d : A d j.fo r fo r e ig n Excha Excha ng e fluctu ation 2,00, 2,00,000 000 42,00,000 Less: Accumulated Depreciation
8,11,765 33,88,235
AS -12: ACCOUNTING FOR GOVERNMENT GRANTS Government refers to Union/ State, Govt. Agencies and similar bodies - Local, National or International. Grants also includ includ e subsidies, cash incentive, incentive, and du ty dr awb ack either either in cash cash or kind / benefits efits to an enterpr ise on recognition of comp comp liance liance in the past or futu re compliance with cond ition attached to it. The accounting for the grant should be appropriate to reveal the extent of benefit accrued to the enterprise enterprise du ring the reporting period. For the pu rp ose of the statement, following following are not d ealt w ith. a) Effec Effects ts of changing p rices rices or in in sup plemen tary information b) Government assi assistanc stancee other than than grants. c) Own ership ership participatio participation n by government. In ord er to recognize recognize the income there shou ld be conclusive conclusive eviden ce that cond itions attached attached to the grant have been or will be fulfilled to account for such earned benefits estimated on a prudent basis, even though the actual amount may be finally settled/ received after the accounting period . Mere receipt receipt w ou ld n ot suffice suffice for income income recognition. AS-4 AS-4 (contin (contin gen cies cies etc) an d A S-5 (Prior p eriod etc) w ou ld b e app licable licable as the case may b e. The accounting accounting for Govt. grants shou ld be based on the na tur e of the relevant grant: a) In the natu re of pr omoter’s contribution as shareh older’s older’s fund (cap (cap ital ap pr oach) b) Otherwise as Income Approach to match with related cost recognizing AS-1 accrual concept concept d isclosure. isclosure. Governm ent gran ts in the form of non-mon etary assets e.g. e.g. land or other resou rces is accounted accounted for at the acquisition acquisition cost or recorded at n ominal v alue if it is given given free of cost. Grants received specifically for fixed asset is disclosed in the financial statement either a) by way of d edu ction ction from from the gross block block of the asset asset conce concerned, rned, thu s grant is rec recognized in P/ L Accou Accou nt thr ou gh red uced d epreciation epreciation (in case case of fund ing of specific specific asset Cost entirely, the asset shou ld be stated at a nom inal value in B/ B/ S); S); or b) the grant treated treated as deferred deferred revenue income income and charged off on a systematic systematic and ratiorational basis over the useful life of the asset, until appropriated disclosed as “Deferred Govt. grant u nd er Reserve Reserve and Sur plu s in the B/ B/ S (gran (gran ts relating relating to d epreciable epreciable assets assets shou ld be cred cred ited to Capital Reserve Reserve and su itably credited credited t o P/ L Accou Accou nt to offse offsett the cost charg charg ed to income). Dis closure under under AS-12
a) the accounting accounting p olicy, olicy, meth od of p resentation in in the financial financial statements. b) the natu re and extent of Govt. gran ts recognized recognized in the finan finan cial cial statements, includ includ ing gran ts of non -monetary assets given at a concessional concessional rate or free of cost. cost.
ACCOUNTING STANDARDS
PROBLEMS in d esignated backw ard area wh ich ich ent itles itles it it to receive receive as 1. Z Ltd. has set up its business in per a public scheme announced by the Government of India, a subsidy of 25% of the cost of investment. Having fulfilled the conditions laid down under the scheme, the compa ny on its investm investm ent of Rs.1 Rs.100 00 lakhs in capital assets du ring its accoun accoun ting year ending on 31st March ,2008 ,2008,, received received a su bsid y of Rs.25 Rs.25 lakh s in Jan Jan u ary ,2008 ,2008 from t he Governm ent of Ind Ind ia. The Accountan Accountan t of the comp any w ould like like to record record the receipt receipt as an item of revenue and to reduce the losses on the Profit and Loss Account for the year ended 31st Mar ch,2008. ch,2008. Is his action ju stified stified ? Answ er: As per A S-12, -12, the Govern men t gran ts related to d epreciable epreciable fixed fixed assets to be treated as d eferred eferred in come which shou ld be recognized recognized in th e Profit Profit and Loss Account Account on a system atic and rational basis over the u seful seful life life of the asset. asset. Such Such gr ants sho uld be alloc allocated ated to income income over th e periods and in p roportions in w hich hich d epreciati epreciation on on those assets is is charged . The comp comp any has received received Rs.2 Rs.25 5 lakhs subsidy for investment in capital assets assets wh ich ich are dep reciable reciable in in n atur e. In view of the provisions un d er AS-1 AS-12, 2, the sub sidy am oun t Rs.25 Rs.25 lakhs received received shou ld n ot be credited to the Profit and Loss Account Account for the year ended 31st March,200 March,2008. 8. the sub sidy shou ld be recognized and credited to the Profit and Loss Accou Accou nt in th e pro por tion of dep reciation reciation charge over th e life life of the su bsidized assets. belongs to th e engineering engineering indu stry. The The Chief Acc Accoun oun tant h as prepared the 2. Hero Ltd. belongs draft accoun accoun ts,taking ts,taking note of the man datory acc accoun ting standard s. “The comp any pu rchased on 1.4. 1.4.20 2007 07 a special special pu rp ose machinery for Rs.50 Rs.50 lakhs. lakhs. It received received a Central Govern men t gran t for 20% 20% of the p rice. rice. The The m achine has an effe effecti ctive ve life life of 5 year s”. Answ er: AS-1 AS-12 2 pr escribes escribes two meth od s in accounting accounting tr eatmen t of Governm ent gran ts for sp ecific ecific fixed fixed assets. Method I: Governm ent grant s related related to d epreciable epreciable fixed fixed assets to be treated treated as d eferred ferred income wh ich ich is to be recognized recognized in the Profit and Loss Accoun Accoun t in pr op ortion in wh ich ich d epreciation epreciation on those assets is charged over th e useful life life of the asset. The deferred ferred income pend ing its appo rtionm ent to Profit and Loss Accou Accou nt to be d isclose isclosed d in the balance sheet separately with a suitable description,e.g. description,e.g. Deferred Deferred Gov ernm ent Gran ts, to be show n after “Reserves “Reserves & Su Su rp lus” bu t before “ Sec Secur ur ed Loans”.
AS-1 AS -13: 3: ACCOUN TING FOR INVESTME IN VESTMEN N TS The Standard deals with accounting for investments in the financial statements of an enterprise and relevant disclosure requirement. Investments are assets held for earning income, capital appreciation or for other benefits to the investing enterprise, obviously investments held as ‘stock-in-trade’ are not ‘Investments’.
The following following are ou tside the p ur view of AS-13 AS-13:: a) Recognition Recognition of income on investment as dealt with u nd er AS-9 AS-9 (Revenu (Revenu e Rec Recognition) ognition) b) Operating or Finance Finance Lease Lease.. c) Investment of retirement benefit benefit plans and Life Life Insuran ce Enterpr ise. ise. d ) Mu tu al fund , Asset Manag ement Com pan ies, ies, Banks, Public Finan Finan cial cial Institution, enenacted under specific Act/ Companies Act, 1956. Reasons, type, purposes etc varies widely and for this the standard is set to harmonize the accounting. Cost of investmen t, mean s and includ es, a) Acquisition Acquisition charges e.g. e.g. brokerage, fees, fees, d ut ies etc. etc. b) If acquired by issue issue of shares/ securities securities,, the acqu acqu isition isition cost is is the fair fair mar ket value, may be w ith reference reference to issue issue p rice rice determined by statutor y auth orities. orities. Fair market value may be determined with reference to market value or net realizable value (net of expenses to be incurred) or net of recovery of cost (dividend or interest accrued and includ includ ed in th e price of investmen ts). Curr Current i nve stment/Sho rt term term inv estmen t:
a) Readily Readily reali realizable zable and not intended to be held held for more than a year from date of investinvestment. b) The carrying carrying amou nt on the reporting d ate is is taken at lower of cost cost or fair fair value value to prudently account for the unrealized losses but not the unrealized gains, considering ind ividu al or category category of investmen ts (not on overall basis). basis). c) Any redu ction ction to the the fair fair value value and any reversal to such such redu ction is is incl includ ud ed in the P/ L Accoun Accoun t. Long -term -term inve stment:
a) Investments Investments held otherwise even even if readily readily marketable are long long term investments b) Intend ed to protect, facil facilitate itate and furtheran ce to existi existing ng op eration, also know n as Trad Trad e investments investments (not m eant to p rovide ad ditional cash cash resources) resources) c) Long-te Long-term rm investments are normally normally carried carried at cost cost un less less there is a permanent d iminu tion tion in th e value wh en the same is recognized recognized in the carrying carrying am oun t by charging or reversing reversing throu gh P/ L Accoun Accoun t. d) The carrying carrying amoun t is is determined on ind ind ividu ividu al investment investment basis. basis. On disposal, the difference between the carrying amount and the net proceed of disposal is recognized recognized in the P/ L Account. Account. Investment Investment in Property is in Land or Building, Building, not intend ed for for occup occup ation ation substantially for use by or in the operation of the Investing Enterprise, should be treated as long-term investment.
ACCOUNTING STANDARDS
Reclassification of Investments:
1)
Long Long term to current current : Take lower of of cost and “carrying “carrying amou nt”
2)
Current to Long Long term: Take Take lower lower of cost and and “ fair fair value” value”
Disclosure under AS-13:
a) Acc Accoun ting policy policy for for determination determination of carrying amoun t b) Income separ separ ately for for long-term and current inv estments, at gross i.e. i.e. inclusive inclusive of TDS. TDS. c) Profit Profit or or loss loss on disposal and changes in carrying carrying amoun t separately separately for for long term term and current investments. investments. d ) Significant ignificant restrictions restrictions on the right of own ership, realisabili realisability ty of investm investm ents or the remittance of income and pr oceeds oceeds of disposal. e) The aggregate aggregate amoun t of quoted and u nquoted investments investments and and aggregate market value value of quoted investments. investments. f) other specific specific d isclosure isclosure as requ ired by Statu Statu te governing the enterp rise, (e.g. (e.g. Schedu le VI requires classifications to be disclosed in terms of Govt. or Trust securities, shares, debentu res or bond s, investment investment p roperties roperties others)
PROBLEMS 1. In prep aring the finan finan cial cial statemen statemen ts of X Ltd.for Ltd.for the year end end ed 31 st March,2007, you come across the following information. State with reasons, how would you deal with them in the financial statements: “ An u nqu oted lon g term investmen t is carried carried in t he books at a cost of Rs. Rs.5 5 lakhs. lakhs. The pu blished blished accoun accoun ts of the u nlisted compan y received received in Jun Jun e 200 2008 8 show show ed th at the compan y w as incurring incurring cash losses losses with d ecli eclining ning m arket share and the long term investment investment may not fetch fetch m ore than Rs.1 Rs.1 lakh”. Answ er: As per A S-13, -13, the long term investmen ts shou ld be carried in th e finan finan cial cial statemen ts at cost. cost. If If there is is a dim inu tion in the valu e of long term investmen ts, w hich is not temporary in natu re, provision provision should be mad e for for each each investment ind ividu ividu ally. ally. Any redu ction in the carrying carrying am oun t should be charged charged to the Profit Profit and Loss Loss Acco Accoun un t. The long term investmen ts are carried at a cost cost of Rs.5 Rs.5 lakhs in th e books of accoun accoun ts. The The value of investments fall down to Rs.1 lakh due to cash losses and the declining market share of the comp comp any in w hich hich the investments were mad e. In view of the provision contained in AS-13, the carrying amount of long-term investments shou ld be brou ght d own to Rs.1 Rs.1 lakh and Rs.4 Rs.4 lakhs should be charged charged to Profit Profit and Loss Accoun Accoun t for the year end end ed 31 st March,2008. 2. A comp comp any has invested invested a substantial substantial amou nt in the shares of another comp comp any un der the same ma nagem ent. The The ma rket price of the shares of the aforesaid aforesaid comp any is about
half of that at w hich these shares were acqu acqu ired by th e comp comp any. The managem ent is not prepared to provide for the fall fall in in the value of shares on the ground that the loss loss is only only notional till the time th e shares are actually sold sold ? Answer: As per AS-13, for the purpose of determining carrying amount of shares the investmen t has to be classif classified ied into long-term an d cu rrent; in the instant case, it app ears that th e investment is long-term, hence it it shou ld be carried at cost, un less there is a permanent diminution in value of investment. At the market price, investment is half of its cost. The reduction reduction ap pears to be heavy and perm anent, hence hence the pr ovision ovision for for p ermanent diminution(decrease) in value of investment should be made. The contention of man agemen t is not as per AS-13 AS-13.. 3. MAGIC Ban Ban k ha s classif classified ied its total investm ent on 31.3. 31.3.20 2008 08 into th ree categor categor ies: (a) held to m atu rity (b) available available for sale (c) (c) held for trad ing. Held to maturity investment is carried at acquisition cost less amortised amount. Available for sale are carried at marked to market. Held for trading investments are valued at weekly intervals at mar ket rates or as p er the p rices rices declared by FIMMDA. Net d epreciation, epreciation, if any, is charged to revenue and net appreciation, if any, is ignored. Comment on the policy of the bank in accord accord ance with AS-1 AS-13. 3. Answ er: As per p ara 2(d) of AS-1 AS-13, 3, the accou accou nting stand ard is not ap plicable plicable to bank , insu insu rance compan y, mu tual fun d s. In In th is case, case, MAGIC MAGIC Bank Bank is a bank, th erefore erefore AS-13 AS-13 d oes not app ly here. For the ban ks, the RBI RBI has issued gu idelines for for classif classific ication ation an d valuation of the investmen t. Therefore, Therefore, the MAGIC MAGIC Bank Bank shou ld comp ly with RB RBII guid elines. elines.
AS -14: -14: ACCOUN TIN TIN G FOR AMALGAM AMALGAMATION ATIONS S Amalgam ation refers to an amalgam ation as p er the p rovision of the Comp anies Act,1 Act,195 956 6 or any other law ap plicable plicable to Com pan ies. Sections ections 391 to 394 394 if Compa nies Act,19 Act,1956 56 governs th e provisions of amalgamation. Amalgamation may be categori categorized zed broad ly as: I) Merger : - genu ine pooling of assets and liabili liabilities ties and shareho lder’s lder’s interest interest of the amalgamation comp anies. anies. II) II) Purchase: - the shareholder shareholder of the the acquired acquired comp any d o not continu continu e to have prop ortionortionate share in in th e combined combined comp comp any or wh ere the business business of the former former is not intended to be continued continued . Amalgamation in the natu re of merger: a) All the assets and liabili liabilities ties of the transferor comp comp any are taken over by the tran sferee sferee company. b) Such assets and liabiliti liabilities es are incorp incorp orated w ithou t any adjustm ent (exc (except ept to ensure un iform iform ity of accoun accoun ting p olicies) olicies) in th e finan finan cial cial statements of the tran sferee. sferee.
ACCOUNTING STANDARDS
c) At least least 90 90 percent equity hold ers of transferor become become equ ity shareholders of transferee feree by virtue of the amalgam ation. d) The considerati consideration on for the amalgamation is disc discharged by equity shareholders in the transferee, except for fractional shares by cash. e) The business of the transferor is is inten inten d ed to be carried carried on by th e transferee. transferee. Amalgamation in the n ature of Purchase: Absence/ non-fulfillment non-fulfillment of one or more cond itions as above will make th e amalgam ation in the natu re of purchase.
Accounting Accounting me thods: 1) Merger - Poolin g of interest interest method: -
(a) In prep aring th e balance sheet of the transferee transferee comp comp any after ama lgamation, line line by line ad d ition ition of the resp ective ective assets assets and liabili liabilities ties of the tran sferor sferor an d transferee compa ny shou ld be mad e exce except pt for share capital; capital; (b) If Purchase Consideration is more than Share capital(equity + preference) of the transferor comp any, the d iffere ifference nce will be adjusted adjusted with Reserves. Reserves. No g ood will can can be created or recognized since there is no acquisition. If Purchase consideration is less than share capital, such sh all be recognized recognized as Capital Reserve, Reserve, as per the Expert Ad visory C om mitt ee (EAC) (EAC) of the ICAI, April 2004. 2004. 2) Purcha Purchase se method:
a) The transferee transferee record record th e assets assets and liabili liabilities ties at their exis existing ting carrying carrying am oun t or by allocating allocating the consideration to ind ividu al identifiable identifiable assets assets and liabili liabilities ties (even may be unrecorded in transferors’ financial statements) at fair value on the d ate of amalgamation; amalgamation; b) If Pur chase consideration is more than the value of net asset acquired acquired by transferee be recognized as “Goodwill” in the financial statement. (if feasible and pr acticabl acticable, e, the good will is amortised over the u seful seful life, life, otherwise over a p eriod of not exceeding exceeding 5 years). years). In In a reverse situation it is Cap ital Reserve Reserve wh ich ich cannot be tran sferred sferred to General Reserve. Reserve. c) In case case of amalgam ation in the natu re of pu rchase the identity of reserves other than Statutory Reserve Reserve (Developm (Developm ent Allowa Allowa nce/ Investment Allowan ce ReReserve un der I.T I.T Act), Act), is not p reserved. (in th e first first financial financial statement a fter fter th e amalgam ation) Disclosure under AS-14 (in a) Nam es and general nature of business of the amalgamating amalgamating comp comp anies b) Effe Effecctive date of amalgamation for for accoun accoun ting pu rpose c) The method of acco accoun un ting used d) Particula Particulars rs of the scheme scheme sanctioned sanctioned un der statute
e) Add itional itional disclos disclosure ure for for merger 1. Desc Description and nu mber of shares issued issued 2. Percentage Percentage of each each compan y’s y’s equity shares shares exc exchanged un der am algamation algamation 3. The amou amou nt of diffe difference rence between the considerati consideration on and the value of net identifiable fiable assets assets acqu acqu ired an d tr eatment th ereof f) Add itional itional disclos disclosure ure und er ‘Purchase’ method 1. Consideration Consideration for for the amalgamation amalgamation and a description description of the considerati consideration on paid or contingently payable 2. Amoun t of differenc differencee as above and th e treatment/ treatment/ am ortizati ortization on period for for goodwill g) Where the scheme scheme sanctioned sanctioned u nd er a statute prescribe prescribess a different different treatment treatment other than AS-1 AS-14, 4, for better better u nd erstand ing: 1. A description description of the accounting accounting treatm ent and reason s for variation with AS-1 AS-14 4 2. Deviatio Deviation n in the acco accoun un ting treatment treatment as prescribe prescribed d in he scheme scheme un der statute as comp comp ared to AS-1 AS-14, 4, if followed followed had there been n o treatmen t pr escribed escribed by th e scheme.
PROBLEMS Rs.20 lakh s and Y Ltd.h avin g a sha re capital of Rs.30 Rs.30 lakh s. Z 1) X Ltd. ha vin g a sha re capital of Rs.20 Ltd. was formed to take over th e business of X Ltd an d Y Ltd. at a pu rchase considerat considerat ion of Rs. Rs. 25 lakhs an d Rs.28 Rs.28 lakhs, lakhs, p ayable in shar es of Z Ltd. The assets and liabili liabilities ties were taken at their carrying carrying amou nts. Solution: Since Since the pu rchase consid consid eration is payable in shares of the tran sferee sferee comp comp any an d all the assets and liabilities liabilities are taken over at th eir carrying carrying amou nts, the amalgam ation is in in th e natu re of merger, i.e i.e.. pooling of interests interests meth od . For X Ltd. Pu rchase consid eration = Rs.25 Rs.25 lakh s Less: Shar e cap cap ital of X Ltd = Rs.20 Rs.20 lakh s Exce Excess ss of pu rchase consideration = Rs.5 lakhs. This This shall hav e to be ad ju sted ag ainst th e Reserves of Z Ltd Ltd . For Y Ltd. Purchase Consideration = Rs.28 lakhs Less: Sha re Cap ital of Y Ltd = Rs.30 Rs.30 lakh s since since pu rchase consid consid eration is less less than share capital of the tran sferor sferor comp any, Rs.2 Rs.2 lakhs shall be treated as Cap ital Reserve. Reserve. Note: In case of amalgamation in the nature of purchase, goodwill shall have to be shown in the Balance Balance Sheet Sheet of the Transferee comp comp any. Such good w ill ill shall have to be w ritten off over a maximum period of 5 years. years. Tran sferor Camp an y : Rs. 20 lakh s. If Pu rchase Con sider ation is (i) Rs. 18 2) N et Assets of th e Tran lakhs (ii) (ii) Rs.2 Rs.23 3 lakhs lakhs & amalgam ation is in the natu re of pu rchase. Answ er: (i) (i) Net Assets Rs.20 Rs.20 lakhs > Pu rchase Con sider ation Rs.18 Rs.18 lakh s. So, So, Rs.2 Rs.2 lakh s will be treated as Capital Reserve. Reserve. (ii) (ii) Net Assets Rs20 lakh lakh s < Pu rchase Co nsid eration Rs.23 Rs.23 lakh lakh s. So, So, Rs.3 Rs.3 lakhs w ill be trea ted as Goodw ill. ill.
ACCOUNTING STANDARDS
A S -15: EMPLOYEE BENEF BEN EFITS ITS The statement statement ap plies to benefit benefit usu ally compr ising ising of Provid ent Fund , Sup erann u ation/ Pension Fund, Gratuity, Leave encashment or retirement, Post retirement health and welfare schemes schemes and other benefits benefits provided by an employer to emp loyees loyees either either in p ursu ance of legal legal requ irement or otherw ise, bu t does not extend to em ployers’ obligation which cannot be reasonably estimated (e.g. (e.g. ex-gratia ex-gratia ad -hoc on retiremen t). There may be obligation obligation on th e part of the emp loyer either either against d efined efined contribu tion plan or d efined efined benefit benefit schemes as elaborated elaborated below: a) Defined Defined Contribution Contribution Plans Plans (DCP) (DCP):: 1) Retiremen Retiremen t benefit benefit is d etermined by contribution at agreed/ specified specified rate to the Fund together with earnings thereof. thereof. 2) Contribution (e. (e.g. g. PF) PF) wh ether paid or p ayable for the the reporting period is charged charged to P/ L statemen statemen t 3) Exce Excess ss if any is treated as pr epaym ent b) Defined Defined Benefi Benefitt Plans (DB (DBP): P): 1) Amou nt paid is usually usually determined with referenc referencee to employee’s employee’s earnings earnings and/ or years of service (if (if the basis of contribu contribu tion are d etermined , it will be treated as defined defined contribution scheme) 2) How ever, if if the emp loyer’s loyer’s respon sibility sibility is is subject subject to sp ecif ecified ied benefits or a specified specified level of benefits, it is defined ben efit efit schem e. 3) The extent extent of employer’s employer’s obligation obligation is largely largely un certain certain and subject subject to estimaestimation tion of futu futu re cond cond ition ition an d events beyond control. Accounting treatment for Gratuity benefit and other defined benefit schemes depends on the arrangement mad e by the emp emp loyer: loyer: a) No separate fund i.e. i.e. out of nonsp ecif ecific ic own fund : 1) Provision for accruing accruing liability liability in in the P/ L Account Account for the accoun accoun ting period is made. 2) The provision provision is based based on an actuarial actuarial method or some other rational method (assum (assum ption th at all emp loyers are eligi eligible ble at the end of the accou accou nting p eriod) b) Own separate/specific fund established through Trust: The amou nt requ ired to be contributed on actuarial basis is certif certified ied by the Actuary , and the actual contribution contribution p lus and shortfall shortfall to to m eet the actuarial actuarial amoun t is charged charged to P/ L Accou Accou nt for the accou accou nting p eriod, any exce excess ss pa ymen t treated as pr epaym ent. c) Fund established through Insurer: in the same m ann er as in in (b) above Actual valuation may be carried out annually (cost can be easily determined for the pu rp ose of contribution as a charge to P/ L) or p eriodically eriodically (say, (say, once in in 3 years) where
Actuary’s certif certific icate ate specifies specifies contribu contribu tion on ann ua l basis du ring int er-valuation p eriod. Leave encashment is an accrued estimated liability based on employers’ past experience as to such such ben efit efit actually actually availed off and pr obability obability of encashm encashm ent in futu re and therefore should relate to the period in which relevant service is rendered in complian ce with section 209(3 209(3)) - accrua accrua l basis an d AS-15. AS-15. Disclosure under AS-15:
a) In view view of the varying p ractices, ractices, ad equ ate disclosure disclosure of meth od of accountin accountin g for for an un d erstand ing of the signific significance ance of such costs to an em ployer. b) Disclosure Disclosure separ separ ately mad e for statutor y comp comp liance liance or otherwise the retirement benefit efit costs costs are treated as an element of emp loyee remun eration w ithou t specific specific d iscloisclosure. c) Financia Financiall statements statements should d isc isclose lose wh ether actuarial actuarial valuation valuation is made at the end of the accoun accoun ting p eriod or earlier (in (in wh ich ich case the date of actu actu arial valuation and the method used for accrual accrual period if not based on actuary report) Treatment Tr eatment of Vo lun tar tary Retireme Retireme nt scheme paymen ts:
1) Term Term ination benefits to be paid irresp ective ective of the volu ntary r etirement schem schem e i.e i.e.. balance in P.F, leave encashmen t; gratuity etc. etc. 2) Term Term ination benefits wh ich ich are pay able on account account of VRS VRS i.e. i.e. mon etary pay men t on the basis of years of comp comp leted leted service service or for the ba lance period o f service service whichever is less less and notice pay . Expert Expert Ad visory Com mittee (EAC) (EAC) opines in favou r of treating th e costs costs (exc (except ept g ratu ity wh ich ich should have been p rovided for for in the respective respective acc accoun ting period) as d eferred eferred revenu e expend iture since since it it is construed construed up on as saving in su bsequent periods, on some rational basis basis over a p eriod, pr eferably eferably over 3 - 5 year. How ever, the termina l benefit benefit is, to th e extent extent th ese are not d eferred eferred sh ould be treated as expense in the P/ L Account Account w ith d isclosure. isclosure.
PROBLEMS 1. ZERO ZERO Bank Bank ha s followed followed the p olici olicies es for retirement benefits as und er: (a) contribution to p ension ension fun d is made based on actuarial actuarial valuation valuation at the year end . In respect respect of emp loyees wh o have op ted for pension scheme. (b) Contribution to the gratuity fun fun d is made based on actuarial valuation at the year end end . (c) (c) Leave Leave encashm ent is accoun accoun ted for on “PAY-AS “PAY-AS-Y -YOU-GO” OU-GO” meth od . Comm ent w heth er the p olicy olicy is in accord accord ance with AS-15 AS-15..
ACCOUNTING STANDARDS
Answer: (a) (a)
As the the contribution contribution to Pension Pension Fund is made on actuarial actuarial basis basis every every year, year, there fore the policy is as per AS-15 AS-15,, wh ich ich is based on actuarial basis of a counting.
(b)
As the contribution is being being made on annu al basis basis to gratuity fund on actuarial actuarial basis, the p olicy is is in accord an ce with A S-15. -15.
(c) (c) As regard leave encashmen t, wh ich ich is is accoun accoun ted for for on PAY-AS PAY-AS-Y -YOU-GO OU-GO basis, it is not in a ccord ccord ance with AS-1 AS-15. 5. It shou ld b e accoun accoun ted for on a ccru ccru al basis. 2. In the context context of relevant relevant Accoun Accoun ting Stand Stand ards, give your comment on the following following matter for th e financial financial year ending 31st March,2008: “ Increase in p ension liability liability on accou accou nt of wage revision in 20072007-08 08 is is being p rovid ed for in 5 instalments commen cing cing from th at year. The rem aining liability liability of Rs.30 Rs.300 0 lakhs as red etermined in actuarial valuation w ill ill be provid ed for in the next 2 years” years” Answ er: As p er AS-1 AS-15, 5, the costs arising arising from an alteration in th e retirement ben efits efits to employees shou ld be treated as follow follow s: (i) (i)
The cost cost may relate relate to the current year of service service or to to the the past years of servic service.
(ii) (ii)
In case case of costs costs relating relating to the current year, the same same may be charged to Profit Profit and Loss Account
(iii (iii))
Where the the cost cost relate relatess to the past years years of service service these should be charged charged to Profit Profit and Loss Account Account as ‘p ‘p rior p eriod’ items items in accord accord ance with AS-5 AS-5..
(iv) (iv)
Where retirement retirement benef benefit it scheme scheme is is amend ed in in a man ner wh ich ich results results in add itional benefits benefits being pro vided to retired emp loyees, loyees, the cost cost of the add itional itional benefits efits shou shou ld be taken a s “ Prior Period and Extraord Extraord inary Items” as per AS-5. AS-5.
In view of the above, the method ad opt ed for accoun accoun ting the increase in in p ension liabili liability ty is not in consonan ce to the p rovisions ment ioned in AS-1 AS-15. 5.
AS-1 AS -16: 6: BORROWIN BORROWIN G COST Borrow ing costs are interests and other costs incurr incurr ed by an enterp rise in in connection with the borrowing of fun fun ds. A qu alifyi alifying ng asset is is an asset th at necessarily necessarily takes substant ial period of time to get r eady for its intend intend ed u se of sale.
Examp Examp les of qu alifying alifying assets:
Any ta ngible fixe fixed d assets, w hich are in construction p rocess or acquired tangible fixed fixed assets, wh ich ich are n ot read y for use or resale. Su ch as plants and machinery.
Any intangible assets, assets, wh ich ich are in development ph ase or acquired acquired but not read y for use or resale, such as p atent.
Investment Investment pr operty.
Inventories that requ ire a sub sub stantial period(i.e. period(i.e. generally more than one accou accou nting period ) to bring bring th em to a saleable saleable cond cond ition. ition.
The Statemen Statemen t is applied in accou accou nting for borrow ing costs wh ich ich includ e: 1. Interest Interest and commitment charges charges on bank borrowing and other short short term borrowings borrowings 2. Amortization Amortization of discounts/ discounts/ premiu m relating relating to borrowings borrowings 3. Amortization Amortization of ancil ancillary lary cost cost incurred incurred in connection connection w ith arrangement of borrowings 4. Finan Finan ce charges for for assets assets acqu acqu ired un d er finance finance lease lease or other similar similar arrangem ent 5. Exchange Exchange d iffe ifference rence in in foreign cu cu rrency borrow ing to the extent it relates to interest element Borrowing cost incurred on assets, which takes substantial period, is treated as cost of that asset in r espect of (1) (1) above. As per the Gu idan ce Note on Au dit of Misce Miscell llaneou aneou s Expend Expend iture issued by ICAI, d efermen efermen t for amortization cost up to the tim e the asset is pu t to u se, in respect of (2) (2) and (3), (3), shou ld be capitalized (see below for AS-16 AS-16 p rov ision). Finan Finan ce charg charg es as in (4) can be capitalized capitalized u pto the tim e the asset is p ut to u se (AS-1 (AS-19 9 deals with elaborate provision) Conditions for capitalization of borrowing costs:
Directly Directly attributa ble costs costs for acqu acqu isition, isition, constru constru ction ction o r p rod uction of qu alifying alifying asset, are eligible for capitalization .
Qu alifying alifying assets will render fu tu re econom econom ic benefit benefit to the en terpr ise and th e cost cost can be measured reliably. reliably.
Amount of borrowing costs eligible for capitalization (specific borrowing):
Amou nt of borrowin g eligible eligible for cap cap italization italization = Actu Actu al borrowing cost incur incur red d ur ing the period less income income generated generated on the temporary investment of amount borrow ed.
All other borrowing costs are charged to P/L Account:
AS-1 AS-16 6 establishes establishes a key test for capitalization capitalization w hich states that “b orrow ing costs that ar e directly rectly attribu table to the acquisition, acquisition, construction or p rod uction of a qualifying qualifying asset are those
ACCOUNTING STANDARDS
costs costs that wou ld h ave been avoided if the expenditure on the qu alifyi alifying ng asset asset had not been made”. Accounting treatment treatment of borrow borrow ing cost as pe r AS-16: AS-16:
a) Borrowing costs costs shou shou ld either either be capitali capitalized zed or charged to P/ L Acc Accoun oun t dep ending on the situation situation bu t d eferment eferment is not p ermitted. ermitted. b) Borrow ing costs are capitalized capitalized as part of cost cost of qu alifyi alifying ng asset wh en it is is probab le that they will result in future economic benefits and cost can be measured reliably other borrowing costs are charged to P/ L Account in the accounting period in which they are incurred incurred . c) Capitalization, on one han d reflects reflects closely closely the total investmen t in in the asset and on the other han d to charge the cost cost to futu futu re period aga inst accrual accrual of revenu e. d ) Notion al interest cost cost are not allowed to be capitalized. capitalized. e) A qua lifyi lifying ng asset is an asset that necessaril necessarily y takes a sub sub stantial period of time time (usu ally a p eriod of 12 mon ths u nless otherw ise justifi justified ed o n th e basis of facts facts and circum circum stances) to get ready for its intend ed u se or sale. sale. f) Capitaliza Capitalization tion should be suspend ed du ring exte extend nd ed period in in which active active development is interrupted . g) Capitalization shou shou ld cease cease w hen su bstantially all the activities activities necessary necessary to prep are the qu alifying alifying asset for for its intend ed u se or sale are complete. h) Capitalization also also ceases ceases ‘w hen p art is completed , wh ich ich is capab capab le of being being u sed indep endent of the whole. Di sclos ure under under AS- 16
a) Acc Accoun ting Policy Policy adop ted b) Amou nt of borrowing cost cost capital capitalize ized d d uring the acco accoun un ting period period
PROBLEMS 1.
A comp any capitalizes interest cost cost of holding investm ents and ad d s to cost cost of investinvestmen t every year, thereby u nd erstating interest cost cost in profit and loss account. account. Whether it leads leads to un usu al acc accoun ting? Answ er: The Accountin Accountin g Stand Stand ard Board (ASB (ASB) has op ined th at investments oth er than investmen t p rop erties are not qu alifying alifying assets as p er AS-16 AS-16,, Borrow Borrow ing Costs. ThereTherefore, interest cost cost of holding su ch investmen ts cann cann ot be capitalized. capitalized. Furth er, even even interest in respect of investmen t pr operties can only be capitalized capitalized if such p rop erties meet the d efinition efinition of qu alifying alifying assets, nam ely, that it necessaril necessarily y takes a substan tial period of time time to get ready for its intend intend ed u se or sale, sale, even w here the investm ent p rop erties meet th e d efinition efinition of “qualifying “qualifying asset”, for the capitalization capitalization of borr owin g costs the other requirements of the stand stand ard such as that borrow ing costs costs should be directly directly at-
tributa ble to the acqu acqu isition isition or constru constru ction ction of the investment p rop erty and su spen sion of capitalization capitalization as per par agrap hs 17 and 18 of AS-1 AS-16 6 have to be comp lied lied with . 2.
X Ltd. has obtained an institu tional loan of Rs. Rs. 800 800 lakhs lakhs for mo d ernization and renovation of its machinery. Machinery Machinery acquired u nd er the mod ernization schem schem e and installation comp leted on 31.3 31.3.0 .08 8 amou nts to Rs.60 Rs.600 0 lakhs. Rs.8 Rs.80 0 lakhs h as been ad vanced to suppliers for additional assets and balance loan of Rs.120 lakhs has been utilized for working capital purpose. The total interest paid for the above loan amounted to Rs.80 lakhs during 2007-08. You ar e required to state how t he interest on the institutiona l loan loan is to be accounted accounted in the year 2007-08. Answer: The total interest of Rs.80 lakhs is related to two periods. Upto the date of installation of the machinery, amount disbursed is Rs.680 lakhs( Rs.600 + 80). Interest on su ch amou nting to Rs.68 Rs.68 lakhs lakhs shou ld be capitalized capitalized an d t he balance of the interest Rs.12 Rs.12 lakh lakh s (i.e. (i.e. Rs.8 Rs.800-68) 68) shou ld be tr eated as an expen se.
3.
Ha pp y Ltd.has taken a loan of US $10 $10 lakhs lakhs on 1 st Ap ril,2007 ril,2007,, for a specific p roject roject at an st interest rate of 10% 10% p.a., pay able ann ua lly. lly. On 1 Ap ril,200 ril,2007, 7, th e excha excha ng e rate betw een th e curr encies was Rs.45 p er US $. $. The The exchan ge rat e, as at 31 st Mar ch,2008, ch,2008, is Rs.48 Rs.48 per p er US $. The corresponding corresponding amou nt could h ave been been borrow ed by Hap py Ltd. in local local currency at an in terest rate of 15% 15% p.a. as on 1 st April,2007.
The foll following owing compu tation tation w ould be mad e to determine the amou nt of borrowing costs costs for for the p u rp oses of paragrap h 4(e) of AS-1 AS-16. 6. (a) Int erest for th e p eriod = US $10,00 $10,00,000 ,000 x 10% x Rs.48 Rs.48 per US $ = Rs. 48,00, 48,00,000 000 (b) Increase in the liability towa rd s the p rincipa l amou nt= US $ 10, 10,00 00,0 ,000 00 x (48 (48-4 -45) 5)= = Rs.30,00,000. (c) (c) Interest that w ou ld h ave resulted if the loan w as taken in Ind ian curren cy = US $ 10, 10,00 00,0 ,000 00 x 45 x 15% = Rs.67,50,000 Rs.67,50,000 (d) Diffe Difference rence between interest on local local cu cu rrency borrow ing and foreign foreign curr ency borrow in g = Rs.67,50,000 Rs.67,50,000 – Rs. 48,00,000 = Rs,19,50,000 Rs,19,50,000 Therefore, out of Rs.30,00,000 increase in the liability towards principal amount, only Rs. 19,50,000 will be considered as the borrowing cost. Thus, total borrowing cost would be Rs.67 Rs.67,5 ,50, 0,000 000 being th e agg regat e of interest of Rs.48, Rs.48,00, 00,000 000 on foreign curr ency bo rrow ings ( as p er Para 4(a) of AS-1 AS-16) 6) p lus th e exchan exchan ge d ifferen ifferen ce to th e extent of differen differen ce betw een inter est on local cur cur rency borro wing and interest on foreign cur rency borro win g of Rs.19 Rs.19,5 ,50, 0,00 000. 0. Thus, Rs.6 Rs.67, 7,50 50,0 ,000 00 wou ld b e considered as th e borrow ing cost to b e accou accou nted for as p er AS-16 AS-16 and the rem aining Rs.10, Rs.10,50 50,0 ,000 00 wou ld b e considered as the exchan exchan ge d iffe ifference rence to be accounted for as p er AS-11 AS-11 “The Effects Effects of Chan ges in Foreign Excha Excha ng e Rates”.
ACCOUNTING STANDARDS
4.
On 30.4 30.4.2 .200 008 8 MNC Ltd .obtained a loan from the ba nk for Rs.5 Rs.50 0 lakhs to be u tilized tilized as under:
(i) C o n st st r u ct ct io n o f a fa ct o r y s h ed ed
Rs.2
cr o r es .
(ii)P u r ch a s e o f M a ch in e r y
Rs . 1.5 cr o r e s.
(iii)W o r k in g C a p it a l
Rs. 1
(iv )A d v vaa n ce ce fo r P u rc rch as as e o f t r u ck ck
Rs . 50 la k h s. s.
cr o r e .
In March 2008, 2008, construction of shed was comp leted leted and machinery installed. installed. Delivery Delivery of tru ck w as not r eceived. eceived. Total interest charg charg ed by th e bank for the year en d ed 31.3. 31.3.08 08 wa s Rs.9 Rs.90 0 lakhs. Show the treatm ent of interest as p er AS-16 AS-16.. Answ er: As per AS-16 AS-16,, borrow ing cost(interest) cost(interest) shou ld b e capitalized capitalized if borrowing cost is is d irectly rectly attribu table to the acquisition, acquisition, constru ction ction or pr od uction of qu alifying alifying asset. Rs.5 Rs.5 crores borrow ed from Bank wa s utilized utilized for four four d iffe ifferent rent p ur po ses, only constru ction ction of factory factory shed is a qualifying asset as per AS-16, while the other three payments are not for the qualifying asset. Therefore, Therefore, borrowin g cost attributable to the constru ction ction of a factory factory shed shou ld on ly be capitalized w hich w ill be equ al to Rs. 90 lakh s x 2/ 2/ 5= Rs.36 Rs.36 lakh s. The balance of Rs. 54 lakhs ( Rs.90 lakhs – Rs.36 lakhs) should be treated as an expense and d ebited to Profit and Loss Accoun Accoun t.
AS 17: SEGMENT SEGMEN T REPORTIN REPORTING G In view of the comp lexiti lexities es of types of bu sinesses, sinesses, the aggregated finan finan cial cial information is not adequate to evaluate a company’s and management’s operating and financial strategies with regard to specific or distinct line of activities i.e. segment. As an enterprise deals in multipr od uct/ mu ltiple ltiple service servicess and op erates in different different geograph ical ical areas, the deg ree o f risk risk and return also varies considerably. Segment information information w ill ill enable the the u sers to und erstand erstand better better and also also to assess assess the u nd erlyerlying risks and returns of an enterprise. enterprise. Initially the segment needs to be broadly classified into either ‘Business Segments’ or ‘Geograp hical Segmen Segmen ts’ before being slotted as ‘Primary ‘Primary ’ or ‘Sec ‘Second ond ary’ for for r eportin g in the finan finan cial statem ents as p er AS- 7. A ‘Business Segme nt’ is a distingu ishable comp onent of an enterpr ise that is engag engag ed in p roviding an individu al prod uct or service service or a grou p of prod ucts or service services, s, and that is subjec subjectt to risk and return as distinctly different from those of other business segments. For grouping related p rod u cts or service services, s, following following factors are consid consid ered: a) The natu re of prod uct/ servic service; e; b) The nature of pr od uction processes (e.g. (e.g. labour or capital intensive); intensive); c) The type or Class Class of customer (e.g. (e.g. gend er, income).
d ) The method used to describe the p rod ucts or prov ide services services (e. (e.g. g. wholesaler, wholesaler, franchifranchisee, d ealer) similarity similarity of econom econom ic and po litic litical al cond cond ition relationsh relationsh ip betw een op erations in d iffe ifferent rent g eograph ical ical areas p roximity of operation special special risks associated associated w ith operation in a particular area exchange control regulation underlying currency risk (geograph ical ical location location m eans th e location location of p rod u ction ction or service faci faciliti lities es and other assets of an enterpr ise and the location location of markets and customers.) e)
Na tur e of regu latory env env ironm ent e.g. e.g. insura nce, bank ing, pu blic u tilitie tilitiess etc the majority of the factors factors w ill ill be considered considered to form a single segment even thou gh, there m ay be dissimilarities dissimilarities and a single bu siness segment d oes not includ includ e prod ucts and services services with significant differing risks and returns (risk in investment and potential earnings as reward).
A ‘Geographical segment’ is a distingu ishable comp comp onen t of an enterp rise that is engaged in pr ovidin g prod ucts or service servicess within a part icu icu lar economic economic env env ironm ent and that is subjec subjectt to risk and r eturn s that are different different from those of comp comp onen ts operating in oth er econom econom ic environm ents. Factors Factors for id entificati entification on of geograp hical segmen segmen ts are: a) Signific ignificant ant difference difference in risk risk and rew ard s; b) Internal Internal MIS MIS and organ ization ization structure; structure; c) Essential Essential factors factors that defines defines a bu siness segment. Segment accounting policies: AS-17 does not require that the enterprise apply accounting
policies to reportable segments on stand-alone reporting entities, hence, additional segment information information may be disclos disclosed ed p rovided that: i)
Information Information is is reported reported internally internally to the Board Board or CEO CEO for for the pu rpose of making d ecisi ecisions ons abou t allocating allocating resou rces to the segmen t and assessing assessing its performan ce. ce.
ii) The basis basis of measu remen t for for add itional itional information is closely closely d escribed. escribed. enterp rise’s rise’s total revenu e that is attributSegmen t Revenue is the aggregate of the portion of enterp able to a segment on a reasonable basis as distinct from other segments including inter-segmen t transfer with the exception exception of a) extra extra ordinary item item as AS-5 AS-5 b) income income by way of interest interest// d ividend ividend etc un less less the operation operation of the segments segments are pr imarily of a financial financial nature c) gains or sale sale of investment investment or on extinguishments extinguishments of debts unless unless the operation operation of the segment, are prim arily of a finan finan cial cial natu re Inter-segmen Inter-segmen t transfer should be mad e on the basis that is actu actu ally ally u sed to p rice rice those transfers i.e. i.e. at cost, cost, below below cost or market p rice rice and the sam e shou ld be d isclosed isclosed and followed followed consisconsistently. Segmen t result result is segme nt rrevenu evenu e less se gment expense
Segmen t Assets comp comp rise of directly directly attribut able or reasonably allocable allocable operat ing asset to th e segment as reduced by related allowances or provisions pertaining to those assets including allocabl allocablee commo n a ssets, ssets, how ever exclud exclud e:
ACCOUNTING STANDARDS
a)
income income tax asset asset
b)
general enterprise asset/ asset/ H.O asset asset
Segme nt liabilities are are w orked orked out or above above basis but excluding:
a) income tax liabili liabilities ties b) general enterp rise liabil liabiliti ities/ es/ H.O lease liabil liabilitie ities. s. For primar primary y s egm ent d isclos ure requ requ ired fo r:
a) segment revenu revenu e with a break-up break-up of sales sales to external external customers customers and inter segment segment result ded uction uction m ade to arrive at segment segment r esult in in r espect espect of total amou nt of non cash cash expenses (provisions, unrealized foreign exchange gain/ loss as included in segment expenses); b) total amount of depreciation and amortization in respect of segment assets (not requ ired if cash cash flow of the enterp rise reports op erating, investing and finan finan cing cing activities; c) total carrying carrying amoun t of segment assets assets;; d ) total amou nt of segment liabili liabilities ties;; e) total cost cost incurred incurred d uring the period to acquire acquire segment segment assets assets that are expected expected to be used for more than one p eriod (both fixed fixed assets and intan gible assets). assets). For secondary secondary se gme nt, disclosu re required fo r:
a) If primary format for reporting reporting segment is business business segment, segment, it it should also report; 1. segment revenu e from external external cu cu stomers by geograp hical location location of customers for each each g eograp hical segmen segmen t consisting consisting 10 percent or mor e of enterprise revenue. 2. total carrying carrying am oun t of segment assets, by geograp hical location location of assets for each of such geographical segment accounting for 10 percent or more of the total assets of all geograph ical ical segments. 3. total cost cost incurred incurred d uring the accoun accoun ting period to acqu acqu ire segment assets, assets, wh ich ich are expecte expected d to be used for for m ore than one accoun accoun ting period w ith 10 percent percent mor e criteria criteria as in th e aforesaid aforesaid line. b) wh ere pr imary format is geograp hical, hical, d isclosure isclosure also also required for each each business segsegmen t accou accou nting for 10 percent percent or mor e of revenu revenu e from sales to external external custom custom ers of enterp rises’ rises’ total revenu e or w hose segmen t assets are 10 10 percent or m ore of the total assets of all business segments: 1. segment revenue from from external external customers 2. total carrying amount of segment asse assets ts 3. total cost incurred incurred d uring the accoun accoun ting period to acquire acquire segment segment assets assets with expecte expected d use extend extend ing beyond one accoun accoun ting period (both tangible and intangible) of all geographical location where geographical segment used for primar y format is based on a location, location, of assets which is d iffe ifferent rent from location location of customers.
Addit ional d isclosure requ required ired for
1) revenu e from from sales to external external custom custom ers for for each each customer based geograp hical segmen t w hose revenu e from from sales to external cu cu stomers constitutes 10 percent or m ore of enterp rise’s rise’s revenu e. 2) in a reverse situation, d isclosure isclosure for for i ) total carrying carrying am ou nt of segment assets by geograp hical location location of assets ii ) total cost incurred during the accounting period to acquire segment assets expected pected to be used for more than one accoun accoun ting period both tangible and intangible by location of assets.
AS -18: RELATED PARTY DISCLOSURE The scope scope an d objec objective tive of the stand ard is to establish establish requ irements for d isclosure isclosure of (a) related par ty relationsh relationsh ip (b) tran saction saction between a repor ting enterp rise and its related related pa rties. This d isclosure isclosure wou ld mak e the financial financial statements of the repor ting enterp rise more tran sparent and allow the users to compare both intra-enterprise with corresponding earlier accounting period an d inter-enterp rise as well. well. How ever disclosur disclosur e is is not required (i) (i)
if there is statutory bar on the reporting reporting enterprise enterprise on confi confidentiali dentiality ty (banks) (banks) in respect respect of constituen constituen ts
(ii) (ii)
in case case of consolidated onsolidated financial financial statements statements in respec respectt members of the group (holding & subsidiary) with exc exception eption for for transaction transaction with Assoc Associate iated d Enterprise Enterprise a cco u n t ed for for un der equity method
(iii) (iii)
in the finan finan cial cial statement of State (Central (Central or State) controlled controlled enterp rises with other state controlled controlled en terpr ise even related p arty relationship exists. exists. When pa rties are conconsidered sidered related? related?
If at any time d uring th e reporting period on e party h as the ability ability (a) to control control the other party (b) to exerci exercise se signific significant ant influence over the other p arty in ma king financial financial and / or op erating d ecisi ecisions, ons, then by v irtue of AS -18 -18 both p arties wou ld be considered as related. Definition a) Control Control :
(i) (i) ow nership d irectly irectly or ind ind irectly, irectly, of more than 50 percent of the voting voting p ower of an enterprise (ii) (ii) th e comp comp osition osition of the board of directors (compan (compan y) or the Governin g Bod y (other enterprise) (iii)a substantial interest in voting power and the power to direct by Statute or by agreemen t, the finan finan cial/ cial/ operatin g p olicies olicies of the enterp rise (20 (20 percent or mor e interest in voting power)
ACCOUNTING STANDARDS
b) Sign ificant Influence: Influence:
(i) (i) refers refers to par ticipation ticipation in the finan finan cial cial and / or operatin g policy d ecisi ecisions ons of an pr ise but n ot control of those policies. policies.
enter-
(ii) (ii) may be gained by ow nership in share (includ (includ ing investment throu gh intermed iaries iaries restricted restricted to m ean sub sidiaries as defined in AS-21 AS-21 Consolidated Finan Finan cial cial Statement ) Related party party disclos ures ures are are appli cable cable only to the foll ow ing related party party relationsh relationsh ips:
1. enterp rises that d irectly irectly or indirectly indirectly thr oug h on e or more interm ediaries control control or are controlled ontrolled by or un der common control control with the rep orting enterprise enterprise 2. assoc associates iates and joint venturers of the reporting enterprise and the investing investing party or ventu rer in respect of which the rep orting ent erpr ise is an associate associate or joint joint ventu rer, . 3. ind ividu als owning d irectly irectly or indirectly indirectly an interest in the voting p ow er of the repor ting enterp rise that gives them control or significant significant influen influen ce over th e enterpr ise and r elatives tives of any such ind ividu ividu al 4. key m anagement p ersonnel and relative relativess of such ind ividu ividu als. als. 5. enterp enterp rise over w hich an y p erson in (3) (3) and (4) (4) is able to exercise exercise signific significant ant influen influen ce (includ (includ ing enterp rise own ed by d irectors irectors or major shareho lders of the repor ting enterprise and enterprise that have a member of key key man agement in comm comm on w ith the reporting enterprise). Related Related p arty tran sactions sactions involve tran sfer sfer of resources or obligations obligations betw een related p arties, regardless of whether or not .a price is charged, e.g. use of logo/ brand name provision of man agemen t services, services, pr ovid ing finan finan cial cial guaran tee use of common infrastructure etc. Ty pe of dis closure under under AS-18 AS-18
a) in case case of related p arty relationship by v irtue of signifi significant cant influ influ ence (not (not control) e.g. e.g. those of associates associates,, key man agemen t p ersonn el, relatives, relatives, there is no n eed. to d isclose isclose the related related party relati relationship onship u nless nless there have been actual transactio transaction n du ring the reporting p eriod eriod w ith such related related p arties arties b) in the event of transaction between related p arties du ring the existence existence of a related related par ty relationship (control (control or significant significant influ influ ence) the rep orting enterp rise shou shou ld d isclose (i) (ii) ii)
the name of transa transaccting ting rel related ated party descripti description on of the relati relationshi onship p between between parties parties
(iii) iii)
descri description ption of nature of transac transacti tion on
(iv)
volum volum e of transac transacti tion, on, either either in amount or approximate approximate proportions proportions
(v)
any other other element element of the relate related d party transac transacti tions ons neces necessar sary y for und erstanderstanding of financial statements (e.g. transfer of major asset taken at price different from norm al comm comm ercial ercial terms i.e. i.e. not at fair value)
(vi)
either either in amount or proportion proportion of outstanding outstanding items items and provisio provisions ns for doubtful debts p ertaining to related p arties on B/ B/ S date.
(vii) vii)
amounts writte written n off off/ back back in in the acc accounting period period in in respec respectt of debts du e from or to related par ties. ties.
AS -19: LEASES Lease is an arrangement by which the “Lessor” gives the right to use an asset for given period of time to the “Lesse “Lesse e” on rent. It involv in volves es two tw o parties, a Lessor Lessor and a Lessee Lessee an an d an asset w hich is t o be be lease leased d . The Lessor, Lessor, w ho own s
the asset, agrees to allow to the Lessee to use it for a specified period of time in return for periodic rent rent p ayments. Types of lease
(a) Finance Lease – It is is a lease, lease, which tran sfers sfers substan tially tially all the risks and rewar d s incid incid ental to own ership of an asset to the Lessee Lessee by the Lessor but n ot the legal own ership. In followfollowing situ ations, the lease transactions transactions are called called Finan Finan ce Lease. Lease.
The lessee lessee will get get the ow nership of leased leased asset at th e end of the lease lease tern.
The lessee has an option to buy the leased asset at the end of term at price, which is lower tha n its expected expected fair value at the d ate on w hich option w ill be exerci exercised. sed.
The lease term covers th e ma jor p art of th e life life of asset.
At the beginning o f lease term, present valu e of minim um lease rental covers substan tially tially th e initial fair fair valu e of the leased leased asset.
The asset asset given on lease to lessee lessee is is of specialized specialized natu re and can only be used by th e lessee lessee withou t m ajor ajor m od ific ification. ation.
(b) O perating Lease is a lease lease wh ich ich d oes not transfer substan tially tially all the risk risk and rewar d Lease – It is incidental incidental to ow nership. Classification of lease is made at the inception of the lease; if at any time the Lessee and Lessor agree to change the provision of lease and it results in different category of lease, it will be treated as separate agreement.
Applicability
The Accounting Accounting Stand ard is not ap plicable plicable to following following ty pes of lease: lease: Lease agreement to exp lore natu ral resources such as oil, oil, gas, timber, metal and other Lease mineral rights.
Licensing agreements for motion picture film, video recording, plays, manuscripts, patents and other rights.
Lease Lease agreement to u se land land .
ACCOUNTING STANDARDS
Definitions
1. Guaranteed Guaranteed Resi dual value – (G.R.V.) (G.R.V.)
(R.V.), ), w hich is guar antee by or on In resp resp ect of Lesse Lesse e: Su ch par t of the residu al value (R.V. beh alf of the lessee.
In respect of Lessor: Such part of the residual value, which is guaranteed by or on
behalf of the less lessee ee or by an ind epend ent third party. For the Less Lessor or the residu residu al value value gu aranteed by th e third p arty can arise arise wh en the asset is is leased leased to the th ird p arty after the first lease lease has expired an d therefore it can can be called called th e residu sidu al value value gu aranteed by the th ird p arty to the Lesso Lessor. r. Unguarant eed Residual Value (U.R.V) (U.R.V) – The difference 2. Unguarant difference between residu al value of asset and its guaranteed residu residu al value value is un guaran teed teed residu residu al value. value. [R.V- G.R.V.]
3. Gross Inv lease is the sum of the foll follow ow ing: Inv estm ent ent (=MLP+URV) (=MLP+URV) – Gross investment in lease
Minimu m lease pay men t (from (from the stand poin t of Lessor) Lessor) and
Any u ngu aranteed residual value accruing accruing to the Lessor. Lessor.
4. Interest rate implicit in the lease – When the Lessor gives an asset on lease (pa (pa rticularly rticularly on finance lease), the total amount, which he receives over lease period by giving the asset on lease, lease, includ includ es the element element of interest plus pay men t of p rincipal rincipal am oun t of asset. The rate at w hich the interest am ou nt is calculated calculated can be simp ly called called imp licit licit rate of interest. It can can b e expressed expressed as u nd er:er:It is t he discount discount rate at w hich hich
Fair air Value alue of leas leased ed Asse Assett
=Pre =Prese sent nt value value of [Mini Minimum mum lease ease payment payment (in respe respecct of Lessor)]
(At the incept nceptiion of lease) ase)
+ Any unguarant unguaranteeed resi residual dual val value acc accruing ruing to the Lessor.
5. Contingent Rent – Lease Rent fixed on the basis of percentage of sales, amount of usage, pr ice ice indices, mar ket rate of interest interest is calle called d contingent ren t. In other w ord s, lease rent is not fixed, fixed, but it is based on a factor other than time. 6. Minimum lease payments [MLP]
For Lessor essor =
Total lease lease rent to be paid by less lessee ee over over the lease lease terms terms + any gu arant eed residu al value (by or on b ehalf of lessee) lessee) – contincontingent Rent – cost cost for service service and tax to be paid by t he reimbu rsed to Lessor Lessor + residu residu al value value gu aranteed by third party.
For Lesse esseee =
Total Total lease lease rent to be paid by less lessee ee over the lease lease terms terms + any gu arant eed residu al value (for (for lessee) lessee) – contingent r ent – cost cost for service service and tax to be paid by and reimbu rsed to Lessor. Lessor.
urchase – The d efinition 7. Lease includes Hire P urchase efinition of a ‘lease’ lease’ inclu inclu d es agreemen ts for th e hire o f an asset, wh ich ich contain a pr ovision giving the hirer an op tion to acquire title title to the asset up on the fulfill fulfillmen men t of agreed cond itions. itions. These agreemen ts are common ly know n as hire pur chase agreements. Accounting for Finance Lease – In the books of Lessee
Leased Leased asset as well as liabili liability ty for lease shou ld b e recognized at the lower of – o
Fair Fair value of the leased leased asset at he inception of lease lease or
o
Present Present value value of minimu m lease lease paym ent from from the less lessee ee point of view.
Apportionment of lease payment-Each lease payment is apportioned between finance charge and principal principal amou nt.
The lessee lessee in its books shou ld charge d epreciation epreciation on finan finan ce lease lease asset as p er AS-6( AS-6(in in this case, case, straight line method will be followed followed )
Initial direct cost for financial lease is included is asset under lease.
Account Account ing for Finance Finance Lease Lease – In t he books of Lessor
The Lessor Lessor should recognize asset asset given u nd er finan finan ce lease as receivable receivable at an amo un t equa l to net investm investm ent in the lease and correspond ing credit to sale sale of asset. Investm ent – Unearn ed Finance Income. Income. Ne t Investment =Gross Investm =Minimu m lease lease payment from Lessor Lessor p oint of view view + Un guaran Gross Gr oss Investment =Minimu teed teed residu residu al value. Investm ent – Present Present Value Value of Gross Investment. Une arned arned Finance Income =Gross Investm
Recognition of Finance Income The Lessor Lessor shou ld recognize the finance income income b ased on a p attern r eflec eflecting, ting, conconstant periodic return return on th e net investment ou tstanding in respect respect of the finance finance lease. lease. In simp simp le wo rd s interest interest / finan finan ce income will be recognized recognized in p rop ortion to ou tstand ing balance receivable receivable from from lease over lease period .
Accounting for Operating Lease- In the books of Lessor:
Record Record leased out asset as the fixed fixed asset in the balan ce sheet.
Charge d epreciation epreciation as p er AS-6 AS-6
ACCOUNTING STANDARDS
Recognize Recognize lease lease income income in p rofit rofit & loss loss account account u sing straight line meth od . If any oth er method reflects more systematic allocation of earning derived from the diminishing value of lease leased d out asset, that ap proach can be ad opted.
Other costs of operating lease shou shou ld be recognized as expen ses in in th e year in w hich they are incurred incurred .
Initial Initial direct cost cost of the lease may be expensed imm ediately or d eferred. eferred.
Account Account ing for operat operat ing lease – In In the Books of Lessee
Lease Lease paym ents shou ld be recognized as an expense in the pr ofit ofit and loss accoun accoun t on a straight line basis basis over the lease lease term term . If any oth er method is mor e representative of the time pattern of the u ser’s ser’s benefit, benefit, su su ch method can be used. “Sale and Lease b ack”
A sale and lease back transaction involves the sale of an asset by vendor and leasing of the same asset back back to the vend or. Accounting treatment treatment of Sale and Lease back
Lease 1. If lease ba ck is Finance Lease
-
-
Any profit profit or loss loss of sale sale proceeds proceeds over the carrying carrying amou amou nt should no t be immediately recognized as profit or loss in the financial statements of a sellerlessee. It should be deferred deferred and amortized over over lease lease term in in proportion to the dep reciation of leased asset.
Examp le 1 – H Ltd. Sells Sells machin ery, WDV of wh ich w as Rs. 400 400 lakh lakh s for Rs. 500 lakh s to B Ltd Ltd . The same m achinery w as leased leased b ack to H Ltd . by BLtd. BLtd. for for 10 years resulting resulting in finan finan ce lease. lease. What shou ld be th e treatmen t of profit in the book s of sell seller er lessee lessee (H (H Ltd.)? Ltd.)?
The pr ofit ofit of Rs.1 Rs.10 0 lakhs on sale of machinery by H Ltd. (sell (seller er lessee) lessee) shou shou ld n ot be imm ediately ately recognized recognized in books rather it should be deferred deferred and amortized amortized over 10 years in in p roportion of the depreciati depreciation on am oun t to be charged by the H Ltd. Ltd. on th e machinery. lease back is O perat perat ing Lease Lease 2. If lease
Any pr ofit ofit or loss arising arising ou t of sale sale transaction is recognized recognized imm ediately wh en sale price is is equ al to fair fair value. Sale price” below below ” fair v alue (A) If Sale
-
Profit – i.e. i.e. carrying amou nt (=book (=book value or value as per balance sheet) is less than the sale value, recognize recognize p rofit rofit imm ediately. Loss Loss – i.e. i.e. carrying carrying amou nt is more than the sale value, recognize recognize loss imm imm ediately, pr ovided loss is no t comp comp ensated ensated by future lease paym ent. Loss Loss – i.e. i.e. carrying carrying amou nt is is more than sale price defer and amortize loss if loss is comp ensated ensated by future lease lease paym ent.
(B)If (B)If Sale Sale price “abov e” fair fair v alue
-
-
If carryi arrying ng amount is equal to fair fair valu e wh ich ich w ill ill result in profit, amor tize the pr ofit ofit over lease period. Carry Carryiing amount amount less than fair fair value w ill result in pr ofit ofit – amortize and d efer efer the p rofit rofit equ al to “sale price price less less fair fair valu e” and recognize balance balance pr ofit ofit immediately. Carry Carryiing amount amount is more than the fair value – wh ich ich w ill result in loss equal to – (carrying amount less than fair value), should be recognized immediately. Profit Profit equ al to – sell selling ing p rice rice less less fair fair valu e – should be amor tized.
Examp le 2: H Ltd . sold m achiner y ha ving WDV of Rs. Rs. 400 400 Lakhs to B Ltd Ltd . for for Rs. 500 500 Lakhs an d the same m achinery was leased back by B Ltd. to H Ltd. The Lease Lease back back is operating lease. Comm ent if –
a) Sale price of Rs. Rs. 500 500 lakhs is equal to fair fair valu e b) Fair Fair value is Rs. 600 600 lakhs c) Fair value is Rs. Rs. 450 450 lakh s and sale price is is Rs. Rs. 380 lakh s d ) Fair value is Rs. 400 lakh s and sale price is Rs. 500 500 lakh lakh s e) Fair value is Rs. Rs. 460 lakh s and sale price is is Rs. Rs. 500 500 lakh lakh s f) Fair Fair value is Rs. Rs. 350 350 lakhs and sale price price is Rs. Rs. 390 390 lakhs Answer: a) H ltd . shou ld imm ediately recognize recognize the pro fit fit of Rs. 100 100 lakhs in its books. b) Profit Rs. 100 100 lakhs should b e imm imm ediately recognized recognized by H Ltd . c) Loss of Rs. Rs. 20 lakhs to be imm imm ediately recognized recognized b y H Ltd. in its books pr ovid ed loss is not comp comp ensated ensated by future lease lease paym ent. d ) Profit of Rs. Rs. 100 100 lakhs lakhs is to be amortized over th e lease lease period. e) Profit of Rs. Rs. 60 60 lakhs (460 (460-4 -400 00)) to be imm ediately recognized in its book s and balance p rofit of Rs. 40 lakh s (500 (500-4 -460) 60) is to be amo rtized / d eferred ov er lease p eriod . f) Loss of Rs. Rs. 50 lakhs (400 (400-3 -350 50)) to be imm imm ediately recognized recognized by H Ltd. in in its books and pr ofit ofit of Rs. Rs. 40 40 lakhs lakhs (390(390-35 350) 0) shou ld be am ortized / d eferred eferred over lease period.
AS -20: EARN IN G PER PER SHARE SHA RE (E (EPS) PS) Dis closure under AS-20: AS-20:
a) The app licabili licability ty of the stand ard is mand atory with effec effectt from from accou accou nting year comcommen cing cing on or after 01-0 01-044-20 2001 01 in in r espect of enterprises wh ose equity shares or po tential equ equ ity shares are listed listed on a recognized stock exchange exchange in Ind ia. b) How ever un d er Part IV of Schedu Schedu le VI of the Comp anies’ Act ’56 ’56 every compan y is required to disclose EPS in accordance with AS-2O, whether listed on a recognized stock exchange exchange or n ot.
ACCOUNTING STANDARDS
c) Presentation of EPS is requ ired to be mad e both on the basis of consolid consolid ated financial statement, as well as individ ua l financial financial statements of the parent comp any. d ) Presentation shou ld be mad e in terms of Basic and Diluted EPS on th e face face of ‘the Profit & Loss Loss Accou Accou nt for each class class of equity sha re that has a d iffe ifferent rent r ight to share in th e net p rofit rofit for the accounting accounting p eriod. For For equity shar es having d iffere ifferent nt n omina l value but carrying carrying same voting rights shou ld be covered covered into equivalent equivalent nu mber of shares of the same nom inal value. value. e) Both Basi Basicc and Diluted EPS should be presented presented with equ al prominence for for all periods even if the amou nts are n egative (a (a loss per share). f) In add ition ition to above, foll following owing are also also disclos disclosed: ed: 1. the amount u sed as the num erator and a reconci reconcili liation ation of of those amou nts to the net p rofit/ rofit/ loss for for the accou accou nting p eriod. 2. the weighted weighted average nu mber of equity shares used as the the denominator and a reconcil reconciliation iation of those denom inator to each other. 3. the nominal value value of shares along with EPS EPS figure. g) Disclosure Disclosure may also be mad e of terms and cond itions of contracts generating p otential equity w hich affe affect ct the basic and d ilu ilu ted EPS both on th e weighted av erage nu mb er of shares outstanding an d any consequent ad justments to n et profit profit attributable to to equity shareho lders, foll follow ow ing the comp ut ation of the denom inator in accord accord ance with AS-20 AS-20.. Basic EPS: a) Basic EPS is worked out by d ividing th e net profit / loss for for the accou accou nting p eriod by th e equity share using using w eighted eighted average num ber of equity shares outstand ing du ring the same period. b) Net p rofit rofit or loss loss shou ld be arrived at after after consid consid ering all income and expense recogrecognized d uring th e period includ includ ing tax expense expense extraordinary extraordinary as red uced by preferenc preferencee dividend in respect respect of non cum ulative and cum ulative for for the p eriod eriod c) Disc Disclosure losure as an alternative alternative maybe p resented resented for basic basic and d iluted iluted on the basis of of earnearning exclud exclud ing extraord inary items (net of tax expenses). expenses). Impact of bonus element in rights issue on EPS denominator:
In a right issue th e exerci exercise se price in in often less than fair value of shares thu s it includ includ es a bonu s element element and moreover, an adjustment is needed to recomp recomp ute the fair value in relation relation to theoretical retical ex-right ex-right v alue p er shar e. Diluted Dilu ted EPS EPS ind icates icates the p otential variability variability or risk attached to th e basic EPS as a consequen ce
of the issue of potential equity shares and potential dilutive securities having significant imp act on lowering EPS. EPS. How ever, no p otential equ equ ity shares be includ includ ed in the compu tation of any d iluted iluted per share am ount in case case of continuing continuing loss loss from operation, even even th ough the entity repor ts an overall net profit.
i)
Adjustments Adjustments should be made both in in nu merator merator and d enominator enominator conse consequent quent up on the conversion of po tential d ilution to arrive at d ilut ilut ed EPS in keeping w ith the natu re of conv conv ersion includ includ ing tax imp licati lication on th ereon in th e respective respective year
ii) ii) Potential Potential equity equity shares are: a) debt instruments/ p referenc referencee share convertibl convertiblee into into equity shares b) share warrants c) employees and other stock stock option p lans which which entitles entitles them to recei receive ve equity shares as part of their remun eration eration an d other similar similar p lans d ) contingently issuable issuable shares und er contractual arran gemen ts e.g. e.g. acquisition acquisition of a business/ assets, loan converted to equ ity on d efau efau lt e) share applicatio application n p ending allotment allotment if not statutorily statutorily required required to be kept sepaseparately and is being being u tilized tilized for business is treated as poten tial (d (d ilutive) ilutive) equity share. PROBLEMS
equ ity shares has been illustrated in AS-2 AS-20 0 in in th e following following line: 1. Weighted a vg. nu mb er of equ Accou Accou ntin g y ear: 20072007-08 08 Date
D e s cr ip t io n
Sh a r es Iss u e d (N o s )
Bu y b a ck (N o s )
O/ S
01/ 04/ 2007
O p . Ba la n ce
1800
-
1 80 0
30/ 09/ 2007
Is su ed fo r C a s h
600
-
2 40 0
29/ 02/ 2008
Bu y b a ck
-
300
21 0 0
31/ 03/ 2008
C 1. Ba la n ce
2400
300
2 10 0
Weighted average number
a) (1800 x 5/ 12) + (2400 x 5/ 12) + (2100 x 2/ 12) i.e. 2100 shares or b) (1800 x 12/ 12) + (600 x 7/ 12) - (300 (300 x 2/ 12) i.e. 2100 sha res ro fit for 2006-07: 2006-07: Rs 18,00, 18,00,000; 000; N et p rofit for 2007-08 2007-08:: Rs 60,00 60,00,00 ,000; 0; N o. of equ ity sh ares ar es 2. N et p rofit as on 31.12.07: 31.12.07: Rs.20,00,000. Rs.20,00,000. Bon u s issued on 1-1-08 1-1-08 : 2 equity shar es for each Equity Share ou tstan d ing at 31-1231-12-08 08 i.e. i.e. Rs. Rs. 40,00,000.
ACCOUNTING STANDARDS
Answer: EPS for 2007-08: (Rs 60,00,000)/ 60,00,000)/ (20,00,000+40,00.000 (20,00,000+40,00.000)) = Re 1.00 Ad ju sted EPS for 2006-07 2006-07:: (earliest p eriod rep ort ed ) (Rs (Rs 18,00 18,00,000 ,000)) / 60,00, 60,00,000 000 = Re 0.30 0.30 EPS: 3. Comp ute EPS: a) N et pro fit for 2006 2006 Rs 11,0 11,00, 0,000 000 N et p rofit ro fit for 2007 Rs 15,00, 15,00,000 000 b) Nos. of shares outstan d ing pr ior to Right Right Issue: Issue: 5,0 5,00, 0,00 000 0 shares shares c) Right Right Issue: one new share for 5 ou tstand ing i.e. i.e. 1,00 1,00,0 ,000 00 new shares d ) Right Right p rice: rice: Rs 15/ 15/ e) Last d ate of right opt ion: 1st March 2007 2007 f) Fair Fair value pr ior to the right right op tion on 1st mar ch 200 2007: 7: Rs 21/ 21/ - per equ ity share Computation:
1)
Theoretical Theoretical ex-right ex-right fair fair value per share: [(Rs 21 x 5,00,000) + (Rs 15 x 1,00,000)] / (5,00,000+ 1,00,000) i.e. 1,20,00,000/ 1,20,00,000/ 6,00,000 6,00,000 = Rs 20/
2)
Ad ju stment factor:factor:- fair fair value prior to exerci exercise se of rights/ th eoretical eoretical ex-right ex-right value. i.e i.e.. 21/ 20=1.05
3)
Computation Computation of EPS: PS: Y ear 2006
Y ear 2007
EPS as originally rep orted Rs. 11.00,000/ 5,00,000 s h a r es
Rs 2.20
EPS restated for r ight issue Rs. 11,00,000/ (5,00,000xRs 1.05)
Rs 2.10
EPS-f EPS-for or 2007 includ ing r ight s Rs. Rs. 15,0 15,00, 0,00 000/ 0/ (5,0 (5,00, 0,00 000x 0x 1.05 1.05x2 x2// 12)+( 12)+(6. 6.00 00,0 ,000 00x x 1 0/ 12) 12)
Rs 2.25 2.25
AS -21: -21: CON SO SOL LIDATE ID ATED D FIN FIN AN CIAL STATEME STATEMEN N TS Consolidated Consolidated financial financial statements statements are p resented resented by the parent or h olding enterprise to provid e finan finan cial cial inform inform ation abou t the economic activiti activities es of its group - information information abou t the p arent and subsidiaries as a single economic entity revealing economic resources controlled by the group , the obligati obligation on of the group and the result that the group achieved achieved w ith its resource resources. s.
AS-21 lays down the principles and procedures for preparation and presentation of consolidated financial statements in the backdrop of the facts that the Company’s Act ’56 doesn’t pr ovide for consolida consolida tion vis-à-vis vis-à-vis the compliance to be mad e by listed listed comp anies in terms of AS-21. Thus in p arent enterp rise’s rise’s separate finan finan cial cial statemen statemen ts, investmen t in subsidiaries should be accounted for as per AS-l3, i.e. Accounting for Investments. The consolidated consolidated finan finan cial cial statements even if mad e volun tarily should comp ly with AS -21. -21. The key key note is the control control by the p arent wh ich ich m eans and includes: includes: i)
the ownership, directly directly or ind ind irect irectly ly throu throu gh subsidiary/ subsidiaries subsidiaries of more than 50% 50% of the voting pow er of an enterprise or,
ii) control of the comp comp osition osition of the Board Board of Directors Directors or Governing Body (e.g. (e.g. in in th e form of restric restriction, tion, holding a p osition osition an d r ight in nom ination exercisabl exercisablee by the par ent with reference reference to the sub sidiary) as the case may be so as to obtain economic benefits benefits from its activities. Furth er “Control” is also also furth er screened screened t o exclud exclud e a subsidiary if; a) it is is intend intend ed to be temporary i.e. i.e. the subsidiary subsidiary is acquired acquired an d held exclusi exclusively vely with a view to subsequent d isposal isposal in in n ear furth furth er, in other word s not intended for long term purpose. b) there is long term restriction restriction on the subsid iary wh ich ich significantly significantly imp imp air its its ability ability to transfer fu fu nd s to the parent enterp rise. (e.g. (e.g. embar go on fun d tran sfer sfer by foreign foreign subsidiary-severe devaluating currency) In above cases investm investm ent w ould be valued as per AS -13 -13 and not A S-21. -21. AS-2 AS-2)) does not d eal with the sp ecif ecific ic AS as und er: i) AS-1 AS-14 4 - Accoun Accoun ting for Amalgam ation ii) AS-2 AS-23 3 - Accoun Accoun ting for Inv Inv estment in Association Association iii) iii) AS-2 AS-27 7 - Accountin Accountin g for inv estment in Joint Joint Ventu re Since sched sched ule VI is is not tailored to t he p resentation of consolid consolid ated finan finan cial cial statement. ICAI has pr ovid ed general gu ideline vide GC-5/ GC-5/ 200 2002 2 w hich broad ly states states that the following following p rinciples ciples should be served: a) notes wh ich ich are necessary necessary for for presenting a tru e and fair view of the consolidated consolidated finance statements statements shou ld be includ includ ed as an integral part thereof. thereof. b) Only the notes involving involving items, items, which are material, material, need to be d isc isclosed losed and the materiality riality is jud ged in th e context of consolidated consolidated finan finan cial cial statement. Ap plicabili plicability ty of oth er Acc Accoun ting Stand Stand ard, in th e prep aration aration an d presentation presentation of consolidated consolidated statements are stated below:
ACCOUNTING STANDARDS
a) irrespec irrespective tive of the format format foll followed owed , the minimum disclos disclosure ure un der various mand atory standard standard s should should be made. AS-1: AS-1: d isclosu isclosu re of accou accou nt ing p olicies olicies (e.g. (e.g. goin g concern ) AS-2 AS-22: 2: accou accou nting for taxes taxes and income as app licabl licablee to the ind ividu al entity only cannot b e given setoff setoff treatmen t in CFS. CFS. Specific items to AS in respect of balances of individual enterprise and not as a group e.g. “Cur rent Investmen t valued at lower of cost cost or mark et price” Segmen tal informa informa tion on consolidated solidated nu mbers of ind ind ividu ividu al enterprise enterprise in in the grou p on ly. Disclosure Disclosure relating -to op erating lease (AS-1 (AS-19) 9) w ould not be requ ired since the same is setoff and eliminated eliminated at consolidated consolidated level. Related party transaction, within the group would not require discloser since eliminated at consolid consolid ated level. level. Accounting related treatment treatment for in conso lidated f inancial stateme stateme nts:
a) Consolidation Consolidation should be m ade on line line by line basis basis by add ing together like like itemsitems- assets, liabilities, income and expense b) All grou p balances balances and grou p transactions transactions and un realized realized profits arising arising thereon should eliminated c) Dividend Dividend - minority share share when p aid is ded uced from from opening “Minority “Minority Interest Interest”” A/ c and the por tion attributable to parent is eliminat eliminat ed from Consolidated Reserves. d ) Exce Excess ss of cost cost to the parent of its investmen t in a sub sub sidiary over the par ent’s ent’s portion of equity of the su bsidiary on da te of investm investm ent is recognized recognized as ‘good ‘good will’ or in reverse situation a s ‘capital ‘capital reserve’ and the ‘minority interest’ as a liabili liability ty sep arately in th e consolida consolida ted financial statemen statemen t as a d istinct istinct item. e) When carrying carrying am oun t of the investment investment in the subsidiary is different different from from its cost, cost, the carrying amount is considered f) Usually consolidated consolidated finan finan cial cial statemen statemen ts are d raw n u pto th e same date for for repor ting. In In case, case, the repo rting d ates are different, different, the subsidiary n orm ally ally p repar es statemen statemen ts as at the same d ate of the p arent. How ever, imp imp racticabl racticable, e, d iffe ifferent rent d ates may be repor ted but th e differenc differencee should not be m ore than six months w ith adjustments mad e for for the effec effects, ts, of signific significant ant tr ansactions du ring th e intervening period in resp ect ect all the items in the financial statements pertaining to that transaction e.g. cost of sales, inventory, unrelated gains, inter group balances. If not material otherwise, may be adjusted in income statement. g) AS-2 AS-21 1 perm its the use of d iffere ifferent nt accou accou nting p olici olicies es and estimates between grou p mem bers, as long long as th e prop ortion of these in the in th e context context of the CFS are pr operly disclos disclosed ed and explained. explained. h) AS-2 AS-21 1 allows allows the u se of finan finan cial cial statements of the subsidiary for the imm ediately preced ced ing p eriod if the finan finan cial cial statements as on th e date of investmen ts are not ava ilable ilable or imp racticabl racticablee to d raw the financial statements as on that d ate. As stated stated earlier, earlier, efeffects fects of signific significant ant tra nsactions or events occur occur between th e two d ates are mad e.
i)
I several investmen ts are Trade over time to make it 51 % control, good will may be d etermined wh en the last investm investm ent is made to bring th e slake slake to 51 51 % or alternatively on each step-u step-u p investm ent basis.
j)
Good will is d etermined on th e basis basis of carrying value of assets/ liabili liabilities ties of the subsid iary at the balance sheet date, thu s fair fair value accou accou nting for acquisition is not perm itted un d er AS-21 AS-21..
k) Where a group h as acquired acquired several subsidiaries, subsidiaries, some resulting resulting in goodwill and others a capital reserve, reserve, set off off is is not m ad e for consolidation consolidation pu rp ose. Disclosure in terms of AS-21
a) Disc Disclosure losure shou ld be mad e in acco accord rd ance with the format of the the parent comp any’s any’s financia financiall statements. statements. Furth Furth er d isc isclosure losure un der all the mand atory accoun accoun ting stand ards wh en m aterial and also comp comp liance liance with General Classif Classific ication ation n o. 5/ 5/ 2002 2002 shou shou ld b e mad e in order to ensure comparability comparability for one period to the next, sup plementary information abou t the effec effectt of acqu acqu isition isition and d isposal of subsid iaries iaries on th e finan finan cial cial position at the reporting date and results for for the reporting p eriod eriod with comparative precedpreceding period am oun t, shou shou ld be d iscl isclosed. osed. b) Reasons Reasons for excl exclu u sion from from consolid consolid ation of subsidiaries shou shou ld be d isclose isclosed d . List List of all subsidiaries- name, country of incorporation/ residence, proportion of ownership interest and if d iffere ifferent nt p rop ortion of voting p ower. c)
Natu re of relatio relationship nship if the parent does not own directly directly or ind ind irec irectly more than 50% 50% of voting voting p ower of the subsidiary.
d) Nam es of subsidiary/ subsidiaries subsidiaries of wh ich ich rep orting orting d ates are are different different from from th at of the p arent and the d iff ifference erence in reporting d ates. ates.
AS-2 AS -22: 2: ACCOUN TING FOR FOR TAXE TAXES ON IN COME The need for establishing a standard arises due to difference between profit computed for acco accoun un ting and that for tax pu rpose. As per this stand stand ard, the income tax-expense tax-expense shou shou ld be treated just like any oth er expenses on accrual basis irrespective irrespective of the timing of paym ent of tax. Tax expense = curren t tax + deferred tax Curr ent tax is the amou nt of income-tax income-tax d etermined to be payable(recoverable) payable(recoverable) in respect of the taxable income income ( tax loss) for a period . Deferred tax is the tax effect effect of timin g d ifferen ifferen ce. The dif ference accoun accoun ts for:
a) treatment of revenue and expenses as as appearing in the profit profit and and loss loss Ale Ale and as conconsidered sidered for for the tax pu rpose. b) the amoun t of revenue or expenses expenses as reco recognized gnized in the P/ L A/ c and as allowed allowed for for tax purpose.
ACCOUNTING STANDARDS
The difference difference as arising arising in the a bove context gives rise to ‘d ‘d eferred eferred tax’ and it needs to be ensured that the tax charges in in futu re acc accoun ting period is not vitiated. vitiated. The difference difference in in accoun accoun ting p rofit rofit and taxable pr ofit ofit can be broadly categorized into tw o: a) Permanent difference: wh ich ich originates originates in one period and do n ot reverse reverse in in su bsequent period s, e.g. e.g. personal expenses d isallowed isallowed , interest/ interest/ p enalty d isallowed isallowed as expense or tax-free tax-free agricultu agricultu ral income, various d edu ction ction u nd er section section 10, benefit/ benefit/ relief reliefss un d er section section 80 in in comp ut ing taxable income. Perman ent d iffe ifferences rences do not resu lt in in d eferred eferred taxes. b) Timing diffe differe rence nce:: which originates in one period and is capable of reversal in subse-
quent period(s): period(s):
difference difference in in n et block block of fixe fixed d assets as per accou accou nts an d as per tax du e to d ifferifference ence in the rate an d method of depreciati depreciation; on;
pr ovision for for dou btful debts and ad vances, pr ovision for for warr anties, pr ovision for for VRS VRS, prov ision ision for asset w rite-off rite-off,, disallowed pay men ts u nd er 43B of Income Tax Act, provision for excise liabilities, provision for diminution in value of investmen ts, scientif scientific ic research research expend iture (not weighted d edu ction ction w hich is a perm anent difference) difference),, secti section on 350 dedu ction, ction, amor tization of deferred reven ue expen d itu re, lease lease income.
Situations w hich leads to Deferred Tax: Deferred Deferred tax is the tax effec effectt d ue to timing d iffe ifference. rence. They arise du e to th e following following reasons:
Accou Accou nting Income less than Tax Income
Accou Accou nting Income more than Tax Income
Accoun ts but loss as p er IT Act Income as per Accoun
Accoun ts but income as p er IT Act Loss as per Accoun
Imp act of such timin g d iffe ifferences rences may lead to:
Deferred Tax Liability (DTL): postponement of tax liability, which states Save Now, Pay Later. Profit an d Loss A/ c………. c………..Dr .Dr To Deferred Tax Liability A/ c
Deferred Tax Asset (DTA): pay you tax liability in advance, which states Pay Now, Save Later . Deferred Tax Asset A/ c……… c……….Dr .Dr To Profit Profit and Loss Loss A/ c
In the y ear of reversing tim e d iffere ifference, nce, either either DTL is is w ritten back to p rofit and loss or the DTA is reversed by d ebiting ebiting p rofit rofit and loss accou accou nt. For the recognition recognition of DTA, pr u d ence shou shou ld be ap plied. Such Such recognition is based on “ reasonable certainty” certainty” th at suffici sufficient ent taxable income income w ou ld be av ailable ailable in the futu re to realize the DTA. In case case of un absorbed d epreciation epreciation and carry forw forw ard losses, DTA shou ld only be recognized recognized to the extent that th ere is “virtu al certainty” certainty” th at in futu re suffici sufficient ent taxable income income w ou ld be available to realize the DTA. Reasonable certainty shall be deemed to be in existence if the probability of future taxable income is greater than 50%. 50%. Virtu Virtu al certainty certainty shall be deemed to be in existence existence only w hen th e evidence suggests that th ere will be suffici sufficient ent taxable income in the futu re. D isclos ure ure u nde r AS-22 Mandator Mandatory y:
a)
Break up of the deferred deferred tax asset/ liabili liability. ty.
b) DTL DTL should should be shown after the head “Unsecured “Unsecured Loans” Loans” and DTA DTA after the head “Investments” with a separate heading.
PROBLEMS 1. From th e following following information for R Ltd. for the year end ed 31st Mar ch,2008, ch,2008, calculate calculate th e d eferred t ax asset/ liability as per AS-22 AS-22 A cco u n t in g P r o fit
Rs .10,00,000
Book Prof Profit as per MAT( MAT(Mini Minimum mum Alte Alternat rnatee Tax) ax)
Rs.9 s.9,00,000
P r o fit a s p er In co m e Ta x A ct
Rs .1,00,000
Ta x Ra t e
30 %
M A T Ra t e
10 %
Answer: Tax as per acc accounting profit: profit: 10,00 0,00,,000 x 30%= 3,00 3,00,,000 Tax Tax as per Income Income Tax Tax profit : 1,00 1,00,0 ,000 00 x 30% 30% = 30,0 30,000 00 Ta x a s p er er M A T : 9,00,000 x 10% = 90,000 Tax expense = Curr ent tax + deferred tax 3,00,0 3,00,000 00 = 30,00 30,000 0 + d eferre d tax Ther efore, D eferre d Tax Liability as on 31.3.0 31.3.08 8 = Rs.3,00,00 Rs.3,00,000 0 – Rs.30,000 Rs.30,000 = Rs.2,70,0 Rs.2,70,000. 00. Amou nt of tax to be d ebited in Pro fit fit and Loss Account Account for th e year 31.3 31.3.0 .08: 8: = Cur rent tax + d eferred eferred tax liabili liability ty + Excess Excess of MAT over cur cur rent t ax = 30,000 + 2,70,000 + (90,000 – 30,000) = 3,60,000 3,60,000
ACCOUNTING STANDARDS
2. Z Ltd,has p rovid ed d epreciation epreciation as p er accoun accoun ting records Rs.40 Rs.40 lakhs bu t as per tax records Rs.60 lakhs. Unamortized preliminary expenses, as per tax records is Rs.20,000. there is adequ ate evidence of futu re pro fit fit suffici sufficiency. ency. How mu ch deferred tax asset/ liabili liability ty shou ld be recognized as tr ansition ad justm ent? Tax rate 30% 30%.. Answ er: As per Para 13 of AS-2 AS-22, 2, d eferred eferred tax shou ld be r ecognized ecognized for all the timing d ifferifferences. In th is situation, the timing d iffe ifference rence i.e. i.e. the d iffe ifference rence between taxable income income and accoun accoun ting income is : Excess Excess d epr eciation eciation as p er ta x Rs. (60 (60 – 40) 40) lakh lakh s = Rs.20. Rs.20.00 00 lakhs Less: Less: Expen Expen ses pr ovided in taxable income
= Rs. 0.20 0.20 lakhs
Tim in g d iffer en ce
Rs .19.80 la k h s
As tax expense is m ore tha n th e current tax d ue t o timing d iffere ifference nce of Rs.1 Rs.19. 9.80 80 lakhs, therefore d eferred tax liability = 30% of Rs.1 Rs.19. 9.80 80 lakhs = Rs.5.9 Rs.5.94 4 lakh s. P r o fit a n d Lo s s A / c………….D r
5.94
To D e fer r ed Ta x Lia b ilit y A / c
5.94
AS -23: -23: ACCOUN TIN TIN G FOR FOR IN VESTME VESTMEN N TS IN AS SOCIATES SOCIATES IN IN CON SOLID SOLID ATED ATED FINAN IN AN CIAL STATEME STATEMEN N TS (CFS) (CFS) An en terpr ise that p resents CFS shou ld accou accou nt for investmen ts in Associates Associates as per th is standard. This standard is not applicable for preparing and presenting stand-alone Investors’ financial statem ent (in su ch cases AS] AS] 3 is followed followed ). An A ssociate ssociate is is an en terpr ise in in w hich the inv estor has significant significant influen influen ce (pow er to p articiarticip ate in the finan finan cial/ cial/ op erating p olicy olicy d ecisi ecisions ons of the investee but n ot control over those p oliolicies) cies) and wh ich ich is n either a su bsidiary n or a joint ventu re of the Investor. The ‘control’ ‘control’ for the p u rp ose of AS-2 AS-23 3 is similar similar t o th at of AS-21. AS-21. Significant ignificant influen influen ce may be evidenced in one or m ore wa ys in the followin followin g line: a) Repr Repr esentation on the Board Board of Directors Directors or Governing Bod Bod y of the Investee. Investee. b) Partici Participation pation in polic policy making process process c) Material Material transac transaction tion between between investor investor and investee. investee. d) Interchange Interchange of managerial personnel e) Provision of essential essential technical technical information
Bu t it does not extend to p ower to gov ern th e financial financial and / or op erating p olicies olicies of an enterprise. Significant ignificant influence influence may be gained th rou gh shar e ownersh ip, statu statu te or agreemen t: a)
For For share ownership, 20% 20% or or more in voting voting p ower in investee investee (held d irect irectly ly or ind ind irectly through subsidiary) indicates significant influence but that is not the ultimate, the significant significant influen influen ce mu st be clearly clearly demon strated.
b) A substantial or majority majority ownership by another investor in the investee investee does not necesnecessarily preclud preclud e an investor to have significant significant influence. c) Voting Voting power is determined on the basis of current ou tstanding securitie securitiess and not p otential equ equ ity. No n applicability of AS-23: AS-23:
1) Investment in associates associates are accounted accounted for using th e ‘equity ‘equity m ethod ’ in the CFS except except when, a) the investment investment is mad e and held excl exclusivel usively y with a view view to subsequent subsequent d isposal isposal in the near futu re, or b) the associate associate op erates u nd er severe severe long-term long-term restrictions restrictions that significantly significantly imimpairs its ability ability to transfer fun fun d s to investor. Investm Investm ents in such a situa tion is accou accou nt ed for in accord an ce w ith AS-3 in CFS. CFS. 2) Equity method of accountin accountin g is is also not app licabl licablee if a) it has no investment investment in Assoc Associati iation on b) it has investmen t in Associ Association ation but h as no subsidiaries, CFS is not requ ired c) it has subsidiaries and associates associates but these are not ma terial, terial, hence CFS is not prepared. d) It is is not liste listed d enterprise hence not mand atory to present CFS CFS or has not chosen volun tarily to present CFS. CFS. Equity method of accounting recognizes the investment initially recorded at cost identifying good will/ cap ital reserve at the time of acqu acqu isition. isition. The The carrying am oun t of inv inv estment is thereafter after ad justed for the p ost-acqu ost-acqu isition isition charge in the inv estor’s estor’s share of net a ssets of the inv estee and consolidated P/ L A/ c reflec reflectt th e investor’s investor’s shares in the resu lt of operation of the investee. Furth er any perm anen t decline decline in the value of investmen t is redu ced ced to arrive at the carrying amou nt for each each su ch investment. Exce Except pt inconsistent inconsistent with AS-2 AS-23, 3, other accou accou nting treatmen t w ould follow follow AS-2 AS-21 1 Disclosure Disclosure un d er AS-2 AS-23 3 a) Reasons Reasons for for not app lying Equ Equ ity Method Method in accounting accounting for investm investm ents in associ associates ates in CFS . b) Goodw ill/ ill/ capital capital reserve reserve as as includ includ ed in the carrying carrying am oun t of investment investment in AssociAssociates d isclosed isclosed separately.
ACCOUNTING STANDARDS
c) Description Description of associates, associates, pr op ortion of own ership interest and if d iffe ifferent rent pro por tion of voting p ower h eld d isclosed isclosed in CFS. CFS. d) Investment Investment u sing sing equ ity method shou ld be classi classifi fied ed as long-term long-term investment in consolid solid ated balance sheet, similarly similarly investor’s investor’s share in pr ofit/ ofit/ loss loss in consolidated consolidated P/ L Accou Accou nt and also investor’s investor’s share of extraordina ry or pr ior period items shou ld be disclosed closed separately. e) The names of associ associates ates of wh ich ich rep orting d ate is d iffere ifferent nt from th at of the finan finan cial cial statements of the investor and d iffe ifference rence in in rep orting d ate shou ld be d isclose isclosed d in CFS. CFS. f) Diffe Difference rence in in the accou accou nting p olici olicies es if if not p racticabl racticablee for for app rop riate adju adju stment in Associate’ Associate’ss financial statemen statemen t for being ad justed in CFS, CFS, the fact as su ch w ith d escripescription of d iffe ifference rence in accoun accoun ting p olicies olicies should be d isclosed. isclosed. g) In comp comp liance liance with AS-4, AS-4, Contingen cies cies and even ts occurring occurring after the balance sheet sheet d ate, the investor d isclose isclosess in the CFS: CFS: (i) (i) its its share of conting conting encies encies and capital comm comm itments of an Associate Associate for which the inv estor is contingently liable, and (ii) (ii) th ose con con ting encies that arise because th e investor is severely liable for the liabilities liabilities of th e associate.
PROBLEMS 31-03-2 -2001 001.. Ou t of Y’s Y’s sha res cap ital 1. X ho lds, 25% share in Y Ltd at a cost of Rs 5 lakhs as on 31-03 and reserve Rs 20 20 Lakh Lakh each. For the y ear end ed 31-0 31-033-08 08 Y mad e a p rofit rofit of Rs 80, 80,00 000 0 and 50% 50% distribu ted as d ividend . IIn n the CFS, CFS, the valu e (carrying (carrying amou nt) as at 31-0 31-033-20 2008 08 will be as un d er: Rs in Lakhs Lakhs
C o s t o f s h a r e s i n Y Lt d .
5.00
Sh a r e o f Re s er v e
5.00
Sh a r e o f p r o fit
0.20 10.20
Less: d iv id en d r e ce iv ed Va lu lu e o f in ve v es t m en en t a s a t 31.03.08
0.10 10.10
2. Style Ltd. acqu ired 30% of Ugly Ltd .’s .’s sha res on Ap ril 10,200 10,2007, 7, th e p rice pa id w as Rs.20,0 Rs.20,00,0 0,000. 00. Rs. Eq u it y sh a r e s(P a id u p )
5,00,000
Se cu r it ie s P r em iu m
5,00,000
Rese r v e
5,00,000 25,00,000
Furt her , Ugly Ltd Ltd rep orted a net in come of Rs.3 Rs.3,0 ,00, 0,00 000 0 and p aid d ivid end s of Rs.1 Rs.1,0 ,00, 0,000 000.. Style Style Ltd. has subsidiary on 31.3 31.3.0 .08. 8. Calculate Calculate the am oun t at w hich the investment in Ugly Ltd sh ould be show n in t he conso lidat ed Balance Sheet Sheet of Style Ltd Ltd . as on 31.3. 31.3.08 08 Answ er: As per A S-23, -23, wh en th e investor comp any p repar es the consolid consolid ated Balance Balance Sheet, Sheet, the investm ent in associate associate i.e. i.e. Ugly Ltd. shall be carried carried by equ ity method and good will and capital reserve reserve to be identified identified and d isclosed isclosed separately. Value Value of the investm investm ent as per equity m ethod = 20,00,000 + 30% (3,00,000 – 1,00,000)= Rs.20,40,000. Good w ill id entified en tified = (20,00,00 (20,00,000 0 – 30% of 25,00,000) 25,00,000) = Rs. 12,50, 12,50,000 000
AS-24: DISCONTINUING OPERATION AS-24 requires disclosure to be made when the discontinuation is in process and not merely once it it has been fully comp leted for reporting information, to enh ance the ability ability of the user of the financial statements to study projection of cash flow, earnings generating capacity and finan finan cial cial information d iffe ifferentiating rentiating betw een ‘continuin ‘continuin g’ and ‘d iscontinu iscontinu ing’ operat ion. Prerequ isites isites to determ ine ‘d ‘d iscontinu iscontinu ing op eration’ – 1. The enterp rise in in term a single plan: a) d isposing substan tially tially in its its entirety e.g. e.g. by selli selling ng th e comp comp onen t in a single transaction or by demerger or spin-off of ownership of the component to the enterp rise’s rise’s shareh older, or b) d isposing in piecemeal man ner e.g. selling selling off the assets-and assets-and settling settling its liabil liabiliities ind ividu ally ally or c) terminati terminating ng through abandonment 2. That rep resent, a separate m ajor ajor line of business or geograp hical area of operation, and 3. That can can be distinguished op erationally for finan finan cial cial repor ting pu rp ose. A restructurin g event or transaction that d oes not meet with the d efinition efinition of a ‘d ‘d iscontinu iscontinu ing operation ’ with in the am bit of AS-2 AS-24, 4, shou ld n ot be called called or treated as discontinuin g op eration. Typ Typ ical ical example of instances which by itself d oes not m ean ‘d ‘d iscontinu iscontinu ing op eration’ bu t may lead to su ch in combin combin ation with oth er circ circum um stances: a) gradu al or or evolutionary evolutionary ph asing asing ou t of a prod uct line line or clas classs of servic service b) abrup t discontinuing discontinuing of several several prod ucts within within an ongoing line line of business c) shifting shifting of some prod uction or mark eting activitie activitiess for for a particular line line of bu siness from one location location to an other d ) closing closing of a factory factory to achieve pr od uctivity imp imp rovem ents or other cost savings. ‘d ‘d iscontinuing operation’ are expected to occur infrequently, but resulting income or ex-
ACCOUNTING STANDARDS
penses arising thereof needs to be disclosed in terms of AS-5 ~o explain the performan ce of the enterp enterp rise for the period. Above all any transaction or event or in combination in order to be treated as ‘discontinuing op eration.’ mu st be in terms of an overall plan falling falling w ithin the p rerequ isites isites of ‘d iscontinu iscontinu ing op eration. eration. AS- 17 for segment reporting would normally satisfy the definition of ‘discontinuing operation’, tion’, but the significance significance for reporting u nd er AS-2 AS-24 4 will d epen d on ind ividu al jud jud gm ent e.g. an enterp rise rise operates in in a single single business/ business/ geographical geographical segment segment th ough not reportable un der AS- 17 may fall w ithin the a m bit of AS-24 AS-24.. The criteria criteria of d iscontinu iscontinu ation which can be d istingu istingu ished operationally and for repot ting pu rp ose mu st fu fu lfil lfilll the following: following:
finan finan cial cial
a) the operating assets/ liabili liabilities ties of the compon ent can be d irectly irectly attributed to it. b) revenue can can be directly directly attributed attributed to it c) at least least a majority of op erating expenses can be d irectly irectly attributed to it. Going concern concept concept is not d isturbed if an en terpr ise merely disposes off few few of its its segments bu t continu continu es to op erate its its other business profitably, on the oth er hand if a substan tial par t of its operation is d iscontinu iscontinu ed an d there is no op eration to carry as a result, it will cease cease to be going concern. Discontinuing process need not necessarily arise out of binding sale agreement but relates back to the announcement of a detailed, formal plan approved by the Board of Directors / Governing Body, if precedes sales agreement and therefore require initial disclosure event/ transaction. However the announcement must demonstrate the commitment to discontinue resulting into a constru ctive ctive obligation for the enterp rise. Requ Requ irement of initial disclosure disclosure in the financial statement for the p eriod in w hich the event of discontinuin g op eration occur occur , are: I.
A description description of of discontinuing discontinuing operation operation
2
The date and nature of initial initial disclos disclosure ure event event
3. Probable Probable date or period by wh ich ich the d isc iscontinuan ce is is expecte expected d to be completed completed 4. Carrying am oun t of the total of assets to be disposed off and the total of liabili liabilities ties to be settled as of the Balance sheet date 5. The amount of revenu revenu e and expenses in in respect respect of ordinary activiti activities es attributable attributable to the discontinuing discontinuing operation d uring the current financial financial reporting reporting p eriod. eriod. the pre-tax profit/ loss and tax expense (AS-22) in the above line. the amount of net cash cash flow attribu table to the operating / investing/ financing financing activities activities of the discontinu ing operation du ring the cur cur rent financial financial repor ting period. If If the initial initial d isclosure isclosure event occurs in between the balance sheet date and the date of approval of financial statements statements by the board of direct directors/ ors/ correspond correspond ing app roving auth ority, disclos disclosure ure compliance should be mad e as per AS-4 AS-4 not u nd er AS-2 AS-24. 4. Disclosure Disclosure shou ld continu e till the d iscontinu iscontinu ance is substan tially tially comp leted or aban d oned , irrespective irrespective of receipt receipt of payments from its buyer.
In case case the discontinuan discontinuan ce plan is aband oned or w ithdraw n as p reviously reviously reported, the fact, fact, reasons and effe effects cts thereof includ includ ing reversal of any prior im pairm ent of loss loss or pro vision that was recognized in the p lan, shou shou ld be disclosed. disclosed. Dis closure under under AS-24
1. By way of a note in the financial statement in respect of each discontinuing operation, in ad d ition ition to disclosure disclosure on the face face of the statements of p rofit/ rofit/ loss in respect of: a) the amou nt of pr e-tax e-tax profit/ loss from ord inary activities activities,, income tax expense as attributable to d isco iscontinuing ntinuing operation, du ring the current financi financial al reporting p eriod; eriod; and b) the amou nt of pr e-tax e-tax gain gain or loss recognized on the disposal of assets or settlement settlement of liabili liabilities ties attribu attribu table to the discontinu ing op eration. 2. Comp arative inform inform ation for prior period th at is pr esented in finan finan cial cial statemen statemen ts prep ared after after the initi initial al discl disclosure osure should be restated restated to segregate segregate assets assets,, liabil liabiliti itiesrev esrev en u e exp en se and cash flows flows of continu continu ing and discontinuing discontinuing operations. 3. AS-2 AS-24 4 does not p rovid e for the pr inciples inciples to recognize and measu re pr ofit/ ofit/ loss in respect of discontinuing discontinuing operation and therefore, therefore, other other accoun accoun ting standard s wou ld be app lic licable e.g. e.g. AS-4 AS-4,, AS-1 AS-10 0 and other A S as and w hen app licable. licable.
PROBLEMS comp any is m anu fac facturing two brand s of soap. Cinthol Cinthol and Breeze. reeze. Company has 1. A FMCG comp gradu ally ally p lanned to shift all all the manu fac facturing op eration eration engaged in two soaps to m anu fac factur e only ‘B ‘Breeze Soap Soap ’ with out closing closing the factory/ p lant p rod u cing cing the ‘Cinthol ‘Cinthol Soap’, Soap’, rather utilizing the production facilities of ‘Cinthol Soap’ for producing the ‘Breeze Soap’. Can we consider the operation to have been been discontinued discontinued ? Answ er: Discontinu Discontinu ing op eration is relatively relatively large large comp onen t of an enterp rise which is major major line line of business or geograp hical segment, that is d istingu istingu ishable operationally or for finan finan cial cial reporting such component of business is being disposed on the basis of an overall plan in its entirety or in p iecemeal. iecemeal. Disc Discontinu ontinu ance will be carried carried either th rou gh d emerger or spin-off, spin-off, piecemeal piecemeal d isposal of assets and settling of liabili liabilities ties or by aband onm ent. In the given case, it is not a d iscontinu iscontinu ing op eration. 2. B Ltd. is a softw softw are comp any, has su bsidiary C Ltd . B Ltd.hold 70% shares shares in C Ltd . During
2007 2007-0 -08, 8, B Ltd. sold its entire investmen t in C Ltd. Is it a d iscontinu iscontinu ing op eration? Answ er: As per the d efinition efinition an d scope scope of ‘d ‘d iscontinu iscontinu ing op eration’, eration’, the sell sell of inv inv estments in subsid iary compan y d oes not attract the p rovisions of AS-2 AS-24. 4. Hen ce, ce, it it is not a discontinuing operation . lines of business: steel steel,, tea and pow er generation. It has d ecided ecided to sell 3. C Ltd.has thr ee major lines the tea d ivision ivision d ur ing th e finan finan cial cial year 2007 2007-0 -08. 8. A sale agreement h as been entered into on 30th Septem ber 2007 2007 with P Ltd . und er wh ich ich th e tea division shall be transferred to P Ltd . on st 31 March,200 March,2008. 8. Is Is it a d iscontinu iscontinu ing o peration ?
ACCOUNTING STANDARDS
Answ er: This This is a case case of disposing of th e tea d ivision ivision su bstantially and in its entirety. It It w ill ill be considered considered as a d isco iscontinuing ntinuing operation. H owever, if a special resolution is passed for sale of variou s assets and to repa y the var ious liabiliti liabilities es individ ua lly lly of the tea d ivision, ivision, it is a case case of “disposing by p iecemeal” iecemeal” and not a “discontinuing “discontinuing operation”. line may not be treated as a discontinuing operaNote: An y planned change in the prod uct line operation.
AS -25: -25: IN TE TERIM RIM FIN AN CIAL REPORTIN REPORTING G Interim financial repor ting is the rep orting for p eriods of less less than a year, generally for for a p eriod of 3 mon ths. As per Clause 41 of listi listing ng ag reement th e comp comp anies are required t o pu blish blish th e finan finan cial cial results on a qu arterly basis. AS-2 AS-25 5 prescribe prescribe minim um content of an interim financial report an d pr inciples inciples for recognition recognition and measurement in a complete or condensed financial statement for an interim period or sp ecific ecific d ates in resp ect of asset, liability, liability, incom e and expen se. There are certain certain typ ical ical problems not faced faced w hile pr eparin g ann ua l account account as the reportin g period is shortened , the effe effect ct of errors in estimation a nd allocation allocation are m agnified agnified e.g. e.g. i)
accru accru al of tax credits in different different interim period, makes d etermination of tax expense often diffic difficult, ult, one period may r eveal tax pr ofit ofit wh ile the oth er interim period hav e tax losses;
ii) benefit benefit of expenses spr spr ead beyond interim period e.g. ad vertising expenses, expenses, major repair and maintenance expenses; expenses; iii) iii) d etermination of app roximate amou nt of pr ovisions, e.g. e.g. wa rran ties, ties, pen sion, gratu ity, maybe comp lex lex ‘and ‘and time consum consum ing; iv) revenu e may be seasonal or cyclic cyclical, al, hence concentration concentration falls in in certain interim periods; v) inter-comp inter-comp any reconcil reconciliation, iation, full stock-taking stock-taking and valu ation may be cumb ersome and time consum consum ing; vi) transaction based on Annual Targets e.g.: bonus or incentives would be difficult to estimate. The stand ard itself itself d oes not categorize the enterp rise or frequ frequ ency of interim financial repor t and the time limit for presentation from the end of an interim period, but if it is required to prep are and present, it it shou ld comply w ith ASAS-25. 25. Instances for for interim finan finan cial cial repor t: (i) (ii) ii) (ii i )
quarterly quarterly report to the board of directors directors or bank incase incase of merger merger and amalgamati amalgamation on for IPO purpose purpose
(iv) (v)
for consolidati onsolidation on of of parent and subsidiary subsidiary when year year ends are are diff different erent for for declaring declaring interim interim dividend ’ Acc Accoun ting for for interim interim transaction: transaction: (a) interim period is considered as integral part of annual accounting period e.g. ann ual op erating expc!1se expc!1sess are estimated estimated and then allocated allocated to th e interim period based on estimated sales or other parameters and results of subsequent interim period s are ad justed for estimation estimation errors (integral (integral app roach) (b) each interim period is considered as discrete and separate accounting period like like a full accounting accounting period e.g. e.g. no estimation or allocation allocation an d operatin g expenses are recognized in the concerned interim period irrespective of benefit accru accru ing to other interim p eriod (discrete app roach).
Form and contents of interim fin ancial statemen statemen t:
a) AS 25 d oesn’t oesn’t proh ibit an enterp rise from p resenting a complete set of finan finan cial cial statestatemen ts (e.g. (e.g. balance sheet, pr ofit ofit & loss statement, cash cash flow flow statement notes to accoun accoun t and accoun accoun ting p olici olicies, es, other statemen ts and other explanator y’ materials as form form ing integral p art of the financial statemen statemen t). b) The recognition and measu remen t principles as stated stated in AS-2 AS-25 5 also app ly to complete set of financial statements for an interim period, full disclosure under this statement and other acco accoun un ting standard will be required. c) Alternatively, the statement allows allows prep aration and p resentation ‘of ‘of interim financial financial report in a condensed form, containing as a minimum, a set of condensed financial statements, statements, providing up date on the latest latest ann ual financia financiall statements statements (does not du plicate the information already reported) Contents of a condens ed Interim Interim Financial Financial Stateme Stateme nts as a min imum :
1. A statement statement that the same same accounting accounting p olicies olicies are foll follow ow ed as in the most recent recent annu al financial financial statemen statemen ts - for for chang e, description description of the natu re and effe effect ct of the chang e. Explanatory comment, about the seasonality of the interim operations the nature and amount of items affecting assets, liability, equity, net income or cash flows that are un usu al becau becau se of their natu re, size size or incidence. incidence. 2. The nature and amou nt of changes in esti estimates mates of amou nts reported in prior interim interim periods of the current financial year or changes in estimates of amount reported in pr ior finan finan cial cial year - if the those chang es have a material effec effectt in th e current interim period. 3. Issues, Issues, buy-back, buy-back, repaym ent and restructuring of debt, equity and p otential equity shares. 4. Dividend s, aggregate per share (in (in absolut absolut e or percentage) separately for for equity and other shares
ACCOUNTING STANDARDS
5. If compliance requ ired un d er AS-1 AS-17, 7, segment revenu e, segment capital emp loyed and segment result for Business or Geographical segments (whichever is primary for reporting). 6. Effe Effect ct of changes in the comp comp osition osition of the enterp rise d ur ing the interim period (e.g. (e.g. amalgamation, acquisition. or disposal of subsidiaries and long term investments, restructuring and discontinuing discontinuing op eration. eration. 7. Material change in contingen contingen t liabil liabilitie itiess since since last ann u al B/S date. The above selec selected ted explan atory notes shou ld no rmally be reported on a finan finan cial cial year to date basis. includ e interim interim financial statePeriod Period of Interim Interim Financial Statement: interim reports shou ld includ men ts (cond (cond ensed o r comp lete) lete) for for p eriods as follows: follows: a) Balance Balance She et:
(1) (1) As at the end of cur cur rent interim period (2) (2) As at the end of the imm ediately pr eceding eceding finan finan cial cial year b) Stateme Stateme nt of Profit Profit and Loss:
(1)F (1)For or th e current period (2)Cumu (2)Cumu lative for for the cur rent financial year to d ate (3) (3) Comp arative for for the comp comp arable interim interim p eriod (cur (cur rent arid year to d ate c) Cash Cash fl ow Stateme Stateme nt:
(1)Current (1)Current finan finan cial cial year to d ate (2)Compar (2)Compar ative for the comp comp arable year to da te for imm ediately pr eceding eceding finan finan cial cial
year.
PROBLEMS 1. S Ltd. p resents interim finan finan cial cial rep ort q ua rterly on 1.4. 1.4.20 2008 08.. S Ltd Ltd .has carried forw ard loss of Rs.8 Rs.800 00 lakhs for income tax pu rp ose for for w hich d eferred eferred tax asset has not been recognized. S Ltd.earn s Rs. 600 600 lakh lakh s; Rs.7 Rs.700 00 lakh lakh s; Rs.7 Rs.750 50 lakh lakh s an d Rs.80 Rs.800 0 lakhs r esp ectively in th e su bsequent quarters, excluding the carried forward losses. Income tax rate is 30%. Calculate the amou nt of tax expense expense to be reported in each each q uarter. Answer: The estimated payment of the annual tax on Rs.2850 lakhs earnings for the current yea r = Rs.(2,8 Rs.(2,850 50 – 800) 800) lakh s = Rs.2,050 Rs.2,050 lakh s. Therefore, tax = 30% of Rs.2,050 lakhs = Rs.615 lakhs. Average annual effective tax rate = (615/ 2,850) x 100 = 21.58% Tax Tax expense expense to be shown:
Rs.la s.lakhs khs
1st qu arter ar ter = 600 x 21.5 21.58%=129 8%=129.48 .48
2nd qu arter ar ter = 700 x 21.58% 21.58%=151.0 =151.06 6 3rd qu arter ar ter = 750 x 21.58%=16 21.58%=161.8 1.85 5 4th qu arter ar ter = 800 x 21.58%=172 21.58%=172.64 .64 2. M Ltd. presents interim financial report(IFR) quarterly, earns Rs.800 lakhs pre-tax profit in the first qu arter en d ing 30.6. 30.6.08 08 but exp ect ect to incur losses losses of Rs.25 Rs.250 0 lakhs in each each of the rem aining th ree qu arter s. Effec Effective tive income tax rate is 35%. 35%. Calculate the incom e-tax expen se to be repor ted for each qu arter as p er AS-2 AS-25. 5. Answ er: Tax expense to be reported in each of the qu arters are: 1st quarter= 800 x 35%=Rs.280.00 lakhs 2nd quarter= (250) x 35%=Rs. (87.5)lakhs 3rd quarter = (250) x 35%=Rs. (87.5)lakhs 4th quarter = (250) x 35%=Rs.(87.5) lakhs Ann u al Tax Expen se = Rs.1 Rs.17. 7.5 5 lakh lakh s
AS – 26: IN TAN GIBLE GIBLE ASSETS AS SETS An intan gible asset asset is is an iden tifiable tifiable non -monetary asset, withou t ph ysical ysical substance held for prod uction uction or sup ply of goods an d servic services for for rental to others or for adm inistrati inistrative ve pu rposes. AS-26:
(i) (i) pr escribes escribes the accoun accoun ting treatmen t for for intangible assets assets that are not specifi specifical cally ly covcovered in other acc accoun oun ting standard ; (ii) recognizes an intangible asset on fulfillment of certain criteria; (iii) (iii) d eals with d efermen t of exp exp enses except in a few sp ecific ecific instan ces. How ever AS -26 -26 does not app ly to: a) Intangible assets assets covered by other accounting accounting stan d ard s e.g. e.g. AS-2 AS-2 (valuation of inventories), AS-7 (accounting for construction contracts), AS-22( accounting for taxes on income), leases falling within scope of AS-19, goodwill on amalgamation (AS-14) and on consolid ation (AS-2 (AS-21) 1).. b) Mineral rights and expend expend iture on the exploration exploration .for .for or d evelopm evelopm ent and extrac extractio tion n of minerals, oils, oils, natu ral gas and similar similar n on-generative resources and intang ible assets arising in insu insu rance enterpr ises ises from from contracts with p olicy olicy holders how ever, compu ter software expenses, start u p cost cost p ertaining to above activities activities are covered b y AS-26 AS-26)) c) Disco Discoun un t Premium on borrowings. AS-26 applies, among other things, to expenditure on advertisement, training, startup, R&D activities activities,, Rights Rights un der Licensing Licensing Agreemen t for motion p ictur ictur e video recording, plays, manu script, script, patents and copyrights, the criteria criteria is that expend iture shou ld pr ovid e fut fut ur e economic economic benefits benefits to an enterp rise.
ACCOUNTING STANDARDS
Sometimes, an asset may incorp orate both tan gible and intangible comp comp onen t and it is is practically cally insepar able. “Jud “Jud gmen t is requ ired to d etermine th e ap plicabili plicability ty of AS-10 AS-10 (fi (fixed xed asset) an d AS-26 AS-26 (intan gible asset). Example: (1 ) comp comp uter software wh ich ich is integral integral part an d withou t that the compu ter-c ter-controlled ontrolled machine cannot op erate - treated as fixed fixed a sset. (2) (2) comp comp ut er softw softw are, not an integral par t of related’ related’ hard war e - treated as. an intan gible asset, Esse ntial criter criteria ia for recogni recogni tion o f an in tangi tangi ble asset:
a) identifiable:- It must be separate from goodwill and the enterprise could rem. sell: exchange or d istribu istribu te the fut fut ur e econom econom ic benefits benefits attributable to the asset withou t disposing of future economic benefits that flow from other assets in the same revenue earning activity - but goodwill cannot be meaningfully transferred to a new owner with ou t also sell selling ing th e other assets or the op eration of the bu siness. e.g. e.g. patents, copyrights, lic license, ense, bran d n ame, impor t qu ota, comp comp uter softwar e, lease hold right, marketing righ ts, technical technical know -how etc. etc. b ) control:- The enterprise has the power to obtain the future economic benefits, flowing from the u nd erlying resources and also can can restrict the acce access ss of others I to those benefits efits (not (not n ecessaril ecessarily y legal right right an d m ay be in some oth er wa y – I mar ket and techn techn ical ical know ledge m ay give rise to futu re economic benefit) benefit) . I c) future economic benefits:- An enterp rise shou ld asses the probability of futu re econom econom ic benefits benefits using reasonable reasonable and sup portable assum assum ptions that represent represent best estimate estimate of the set of economic cond cond itions itions th at w ill ill exist exist over th e u seful seful life life of the asset on the basis of weight age to external external evid ence available available at th e time of initial recognition.. recognition.. d) Cost can can be measured measured reliably reliably : i)
Initially Initially recognized at cost - pu rchase p rice, rice, taxes d ut y and oth er directly directly attribattributable expenses to make the asset ready for its intended use, if acquired separately - pu rchase consideration in the form form of cash cash or other mo netary asset.
ii) In exchan exchan ge for shares or secu secu rities rities at fair fair value of those shares or secur secur ities. ities. iii) iii) In exchan exchan ge or p art exchan exchan ge for anoth er asset - as per A S-l0. -l0. The cost of an internally generated intangible asset comprises all expenditure that can be directly rectly attribu ted or allocated allocated on a reasonable and consistent consistent basis for for creating, creating, pro du cing cing an d mak ing the asset ready for its intend ed u se, bu t in no case case once treated as an expen se, cannot be reversed for capitalization capitalization even if the essential essential criteria criteria for recognition are comp lied lied w ith a later date.
Nor mally the follow follow ing cost are not recognized for internally generated intang ible asset: 1) selli selling, ng, adm inistrative and oth er general overh ead un less d irectly irectly attributa ble. 2) clearly clearly identified identified ineffi ineffici cienci encies es and initial initial operating loses loses incurred before before an asset achieves planned performance. 3) expend expend iture on training training the staff staff to to operate the asset asset.. Subsequ ent expend iture on an internally internally generated intangible asset asset after after its pur chase or comp comp leletion is norm ally treated as expense u nless it is is assessed assessed to g enerate futu re econom econom ic benefits benefits over and above the originall originally y assessed assessed stand ard of performance performance or it can can be measured and reliably reliably attributed to the concerned in tangible asset. Amor tization is the systematic allocati allocation on of th e d epreciable epreciable amou nt (cost less less resid resid u al value usu ally ally “NIL” unless determined in terms of comm comm itted itted value by a third party or determined by active mark et pr ice) ice) of an intang ible asset asset over its u seful seful life (period (period of time for use, nu mber of prod uction or oth er similar units expected to obtain or legal restriction). restriction). Und er AS-26 AS-26,, useful life life shall not exceed exceed 10 years from the d ate the asset is available available for u se un less less there is persu asive evidence to establish establish useful life life longer th an 10 years provid ed th e enterprise (a) amo rtizes over the best estimated estimated useful life life (b) estimates the recoverable amou nt at least ann ually to identify the imp imp airmen t loss loss (c) (c) d isclose isclose the reasons and factors factors in determ ining a longer life. life. The amortization period and the amortization method should be reviewed at least at each, finan finan cial cial year and if the expected life is revised, revised, th e amor tization period is revised revised accord accord ingly but in n o case case it would tantamou nt to inap prop riate deferment to later later years. AS-5 AS-5 will be relevant relevant in this regard as to w hat constitutes a chan ge in accoun accoun ting p olicy olicy an d wh at constitutes a chan chan ge in estimate estimate e.g. a chan chan ge from from stra ight-line ight-line to d iminishing m ethod or vice-versa would be change in accounting policy whereas reduction in the amortization period is chan chan ge in accounting accounting estimate. estimate. Dis closure under under AS-26
A) Genera Genera l 1. for each each class of intan intan gible asset asset distingu ishing betw een internally generated and others (a) useful lives lives and amo rtization rates used (b) amortization amortization method used (c) (c) gross carrying carrying amou nt and the acc accum ulated amortization amortization includ includ ing impairment loss at the beginning beginning an d end of the reporting reporting p eriod eriod (d) a reconcil reconciliation iation of the carrying carrying am oun t (open (open ing balance/ balance/ add ition/ d isposal/ imp airment/ loss loss charged/ charged/ reversed/ reversed/ amortization amortization for the p eriod eriod and other changes)
ACCOUNTING STANDARDS
2.
class class of intangible asset asset by grou ping of a simil similar ar nature and use by the enterpr enterpr ise ise informa informa tion on imp aired intan gible asset und er AS-2 AS-28 8 chan chan ge in accoun accoun ting p olicy olicy or accoun accoun t ing estimate as p er AS-5 AS-5 reasons for amor tization beyond 10 years w ith list of factors factors considered in d etermining th e useful life life..
3.
Descri Description, ption, the carrying amou nt and remaining amortization amortization period of of any ind ind ividu ividu al asset wha t is material to the finan finan cial cial statement as a w hole.
4.
Exis Existenc tencee and carrying carrying amoun t of intangible intangible asset assetss whose title title is restric restricted ted and th e carrying am ou nt of intan gible asset asset pled ged as secur secur ity for liabili liabilities. ties.
5.
Amou nt of comm comm itments for for acquis acquisiti ition on of intangible intangible assets. assets.
B) R&D R&D expen d iture: R&D R&D expen expen se (that is d irectly irectly attribu table or reason ably allocated allocated on a consistent consistent basis) recognized as an expense du ring the p eriod. C) Other information: encou encou raged to d isclose isclose a d escription escription of only fully amortized in tangible asset but still in in u se. Specific pecific guideline for intern ally generated comp uter software - criteria criteria for capitalization: capitalization: ap art from th e broad recognition recognition p rinciples, rinciples, AS-2 AS-26 6 prov ides for specific specific gu idan ce on internally generated erated comp comp uter software. (a) At p reliminar reliminar y p rojec rojectt stage, it is is not r ecognized ecognized as an a sset since since the enterp rise cann cann ot d emon strate then exists as an asset from from wh ich ich fut ur e econom econom ic benefit benefit w ill ill foll follow ow (making strategic decision, decision, determ ination of performan ce requ irements alternative mean s to achieve achieve specified performance requirements. determination of technology to achieve performance requ irements and selec selection tion of consultant to assist in develop men t and / or installation installation of the software) (b) At development stage involving involving d etaile etailed d program design, coding coding w orking mod el in in op erative version version for all all major major plann ed fun ction ction and testing to bring it to acomp leted version together with related related docum entation entation an d training training m aterial. aterial. At this stage the internal1y generated computer software can be recognized as an asset on satisfying 1.
The technical technical feasibi feasibility lity to make it available for intern intern al use
2.
Intention Intention to comp comp lete lete to to perform perform ind ividu ividu al fun fun ctions ctions e.g. e.g. comm itment for for fun fun ding the project.
3.
Ability Ability to use the software software
4.
Usefuln Usefuln ess of the softw softw are to generate futu futu re economic economic benefit
5.
Availability Availability of techn techn ical, ical, finan finan cial cial and other resources to comp comp lete the develop men t and use
6.
Reli Reliably ably measure measure the expend expend iture to the software software development b) cost cost has some some connoconnotation as described described earlier in in the stand ard .
c) Accounting for software acquired or purchased should meet with the basic principle of AS-2 AS-26 6 as discussed discussed elsewh elsewh ere in this stand ard . For computer software considering the fact technological change and obsolescence.It is 3-5 years of useful life, life, wh ich ich n eeds to be r easoned in th e disclosur disclosur e.
Expenditure for Website:
The expend expend iture for pu rchasing, rchasing, developing, developing, maintaining maintaining and enhancing hard ware (servers, (servers, internet conn ection) ection) related to web site are accounted accounted for un d er AS-10 AS-10 (fi (fixed xed asset). The expend expend iture may be incurred incurred internally internally when d eveloping eveloping enh ancing ancing and maintaining maintaining its own website in in the context of plann ing, ap plication plication and infrastructure d evelopmen t, grap hical design and content content d evelopm evelopm ent and operating stage wh ich ich are directly directly attributable attributable or alloallocable on a reasonable basis to creating, producing and preparing the asset for intended use. The natu re of each activity activity should be evaluated to decide web site stage of d evelopm ent. Accounting treatment treatment and recognition :
a) planning stage expend expend iture are akin to researc research h cost cost and recognized recognized as expense expense when incurred. b) expend expend iture arisi arising ng onw ard d evelopm evelopm ent stage stage comp comp lying lying with the developm developm ent cricriteria (refe (referr to comp uter softwar e) shou ld be recognized as an Intangible asset. asset.
PROBLEMS 1. On Febru ary 2008, 2008, J Ltd.bough t a trad emark from I Ltd. for for Rs.50 Rs.50 lakhs. J Ltd. retained an ind epend ent consultant, who estimated the trad emark’s remaining life life to be 14 14 years. years. Its unamortized cost on I ltd. records was Rs.35 lakhs. J Ltd.decided to amortize the trad emark over th e maximu m p eriod allowed . In In J Ltd Ltd .’s .’s Balance Balance Sheet Sheet as on 31 st DeDe cember cember 2008 2008,, what am oun t shou ld be reported as acc accum ulated am ortizatio ortization? n? Answ er: As per p ara 23 of AS-2 AS-26, 6, intang ible assets assets shou ld be measu red initially initially at cost therefore. J Ltd. shou ld am ortize the trad emark at its cost cost of Rs.5 Rs.50 0 lakhs. The The u nam ortized cost on th e seller’ seller’ss books Rs.35 Rs.35 lakhs is irrelevant irrelevant to the bu yer. Although the trad emar k h as a rem aining u seful seful life life of 14 14 years, intan intan gible assets assets are generally am ortized over a m aximum period of 10 10 years as per AS-2 AS-26. 6. Therefore, Therefore, the maximu m am ortization expense and accum accum ulated amor tization is Rs. Rs.5 5 lakhs lakhs (Rs.5 (Rs.50 0 lakhs lakhs / 10) 10) 2. Du ring 20072007-08, 08, A Ltd Ltd .incurr ed org an ization costs/ p relimin ary expen ses of Rs.40 Rs.40,0 ,000. 00. What portion of the organization costs will A Ltd. defer to years subsequent to the 2007-08? Answ er: As per p ara 56(a) 56(a) of AS-2 AS-26, 6, organ ization costs / p relimina relimina ry expen ses are those incurred in the form ation of a corporation. Since Since uncertainty exists concerning concerning the futu re benefit benefit of these costs costs in futur e years, they are prop erly record record ed as an expense in 2007-08. 3. D Ltd. is is developing a n ew d istribution system of its its material, following following th e costs costs inincurred a t different different stages on research research and d evelopm ent of the system:
ACCOUNTING STANDARDS
Yea r e n d ed ed 31.3.
P h as as e/ Exp en en s es
A m ou ou n ntt (Rs . In la k h s )
2004
Res ea r ch
8
2005
Res ea r ch
10
2006
D e v e lo p m e n t
30
2007
D e v e lo p m e n t
36
2008
D e v e lo p m e n t
50
On 31.3 31.3.0 .08, 8, D Ltd. iden tified tified the level of cost cost savin gs at Rs. 16 lakh s expected t o be achieved by the new system system over a p eriod eriod of 5 years, in add ition ition this system system d eveloped eveloped can can be m arketed arketed by w ay of consu consu ltancy wh ich ich w ill ill earn cash flow flow of Rs.1 Rs.10 0 lakhs lakhs p er ann u m. D Ltd.demo nstrated that new system meet the criteria of asset recognition as on 1.4.2006. Determine the am oun t/ cash wh ich ich w ill ill be expensed an d to be capitalized capitalized as intang ible assets, presuming that no active market exist to determine the selling price of product i.e. system d evelop ed . System System shall be ava ilable for for u se from 1.4.2 1.4.2008 008.. Answer: As per AS-26, research cost of Rs.18 lakhs to be treated as an expense in respective year ended 31st Mar ch 2004 2004 and 2005 2005 respectively. The development expenses can be capitalized from the date the internally generated assets ( new d istribu istribu tion system in this given case) meet th e recognition recognition criteria on an d from 1.4.2 1.4.200 006. 6. Therefore, cost of Rs.30+ Rs.30+ 36+ 36+ 50= 50= Rs.116 Rs.116 lakh s is to be capitalized as an intan gible asset. H owever, as p er p ara 62 of AS-2 AS-26, 6, the intan gible asset asset shou ld be carried at cost less less accumu accumu lated lated amortization amortization and acc accum ulated imp airment losses. losses. At the end of 31 31st Mar ch,2008 ch,2008,, D Ltd. shou ld recogn ize im im p airm ent loss of Rs.22. Rs.22.32 322 2 lakh lakh s (= (= 116 - 93.678 93.678)) and carry th e new d istribu tion syst em at Rs. 93. 93.67 678 8 lakh lakh s in the Balance Sheet Sheet as p er the calculation calculation given below: Imp airment loss is is excess excess of carrying carrying amou nt o f asset asset over r ecoverable ecoverable amou nt. Recoverable Recoverable amo un t is higher of two i.e. value in u se( d iscou iscou nted futu re cash cash inflow) and m arket realizable realizable value of asset. asset. The calc calculation ulation of discounted futu re cash cash flow flow is as un d er assum ing 12% 12% discou discou nt rate.
(Rs. Lakhs) Yea r
C o s t Sa v in gs gs
In In fl flo w b y in t r o d u cin g the system
To t a l ca s h in flo w
D is co u nt n t ed a t 12%
D is co u nt n t ed ca s h flo w
2009
16
10
26
0.893
23.218
2010
16
10
26
0.797
20.722
2011
16
10
26
0.711
18.486
2012
16
10
26
0.635
16.51
2013
16
10
26
0.567
14.742
93.678
No amor tization of asset asset shall be d one in 2008 2008 as amortization starts after u se of asset asset wh ich ich is du ring the year 20082008-09 09..
AS-27 AS -27:: FIN AN CIAL REPORTIN REPORTING G OF IN TE TERE REST ST IN JOIN JOIN T VENTURE VEN TURE AS-2 AS-27 7 is is app licable licable for for accoun accoun ting in joint ventu re interest and repor ting of joint joint ven tur e assets, liabili liabilities, ties, income and expenses in th e finan finan cial cial statements o f ventu rer an d investors, regard less of the structure or forms u nd er wh ich ich th e joint joint ventu re activiti activities es take place, place, The statement provides for display and disclosure requirement for accounting for the investmen t in the stand stand -alone -alone and consolid consolid ated financial statements of the ventu rer. A joint joint venture is a contractual contractual arrangement between two or more p arties arties un dertaking an ecoeconom ic activity, activity, subjec subjectt to joint joint contro l (control (control is the pow er to govern the financial and op erating p olicies olicies of an econ om ic activity to obta in ben efit efit from it). The arrangement may be: a) Jointly ointly controll controlled ed operations operations b) Jointly controlled controlled asset asset c) Jointly controlled controlled entities entities
ACCOUNTING STANDARDS
In the event an enterp rise by a contra contra ctual arrangem ent establishes establishes joint joint control over an en tity w hich is a subsid iary of that en terpr ise within th e mean ing of AS-2 AS-21( 1(CFS CFS), ), it will be treated as joint ven tu re as p er AS-27 AS-27.. Joint Joint control requ ires all the v entu rers to jointly jointly agr ee on key d eciecisions, else else decision decision cannot be tak en, as such even a m inority hold er (own er) may enjoy joint joint control. Contractual Contractual arrangement is normally made in writing touching up on: (a) The activity, activity, d ur ation and rep orting obligation obligation (b) The ap pointment of the board of direct director/ or/ governing bod y and the respective respective voting rights/ capital contribution/ sharing by ventures of the output, income, expenses or results of the joint joint ventu re. Contractu al arrangem ent and joint control together makes an activity a joint ventu re, (invest(investmen t in Associates Associates in w hich the investor h as significant significant influence is covered covered by AS-23) AS-23) Some joint joint ven tu res involve use of own fixed fixed assets and other resou rces on its own and obligation of its its own . For its interest in jointly controlled operations, a venturer should recognize in its separate finan finan cial cial statements an d consequently in its CFS CFS, (a) the assets that it controls and the liabiliti liabilities es it incurs incurs (b) th e expen expen se it it incu incu rs and th e share of income earned from th e joint joint ventu re. As the above are already recognized in stand-alone financial statements of the venturer and consequent ly in in th e CFS CFS, there us no requ irement for adjustmen t or other consolid consolid ation pr oced u re, wh en the ventu rer present the CFS. CFS. Separa te accounting accounting record s may not be requ ired for the joint joint ventu re itself itself and finan finan cial cial statemen statemen ts may n ot be prep ared for the joint joint ven tu re. Some joint joint v entu res involve joint joint control; by m eans of joint joint ow nership by th e ventu rers of one or more assets contributed/ acquired for the purpose of joint venture - the asset are used to obtain economic benefit for the venturers, agreeing to share the output from the assets and sharing of expen expen ses incurred . In respect of jointly controlled assets , each each ventu rer recognize in its separa te finan finan cial cial statemen t and consequently in its CFS CFS: a) Share of the jointly jointly contro contro lled lled assets und er distinct head of each asset asset and n ot as an investment b) Any liabili liability ty incurr ed (e.g. (e.g. finan finan cing cing its share of the assets) c) Share of joint joint liabili liability ty in respect of the ventu rer d) Any income from from sale or use of its share of the outp ut in the joint joint venture and share of expenses. e) Expen Expen se is is incur incur red in resp ect ect of its in in the joint joint ven tu res e.g. e.g. financing financing the ventu rer’s rer’s
interests in in th e asset asset and selling selling its share of ou tpu t The treatment of jointly controlled controlled assets, recognizes the su bstance and econom econom ic reality reality (legal (legal from from of the joint joint ventu re) separate financial statements m ay not be p repar ed for the joint joint ventu re itself itself.. A jointly controlled entity involves the establishment of a corporation, partnership or lither entity entity in w hich hich each each v enturer h as an interest as per contractual contractual arrangement. a) in in a separate/ stan d alone finan finan cial cial statement of each ventu rer, the interest in a jointly jointly controlled trolled entity shou ld be accoun accoun ted for as an investm ent as per AS-13 AS-13 only the resou rces contributed, forms a part of the investment and the share’ of joint venture result is treated in the income statement of the ventu rers. b) proportionate consolidation for joint venture is applied in case where the preparation and pr esenting a CFS is required, reflec reflecting ting th e substan ce and econom econom ic reality of the arran gemen t in the CFS. CFS. Many of the p rocedu re in this regard are similar to AS-2 AS-21 1 and requ ire to be followed followed for treatment and disclosure. Joint ventu re interest in in th e financial financial statements, of an investor is treated ap pr opr iately iately in term s of AS-13, AS-21 or AS-23 in CFS but for separate financial statements is should be accounted for as per AS-13. Dis closure under AS-27: AS-27:
I. In separ ate an d CFS in resp ect ect of: a) Aggregate amou nt of contingent liabili liabilities ties unless the p robability of loss loss is remote separately from oth er contingent liabili liabilities ties in relation to: 1. Its interest in in joint joint ven tu re and its share share in each of the contingent liabiliti liabilities es incur incur red jointly 2. Its share of the conting conting ent liabili liability ty of the joint joint ventu res themselves for for wh ich ich it is is concontingently liable. liable. 3. Those liabil liabilitie itiess wh ich ich arise because of the ven tur er is conting conting ently liable liable for the liabilliability of other ven tur ers. b) Aggregate of commitm ents in respect of joint ventu re separately from oth er commitm ents in respect of: 1. Capital comm comm itment of its own and shares in in the capital comm comm itment incurred incurred jointly jointly with oth er ventu res in in relation to the joint joint ventu re. 2. Share of capital commitm ent of the joint joint ventu res them selves c) A list of all joint ventures and description of interest in significant joint venture and for jointly contro contro lled lled en tities tities the pr op erties of ownersh ip interest nam e of the coun try of incorp incorp oration/ residen ce. ce.
ACCOUNTING STANDARDS
PROBLEMS 1. N Ltd has 80% shares in a joint joint v entu re with Suzu ki Ltd Ltd . N Ltd. sold a p lant WDV Rs. Rs.20 20 lakhs for Rs.3 Rs.30 0 lakhs. Calculate Calculate how mu ch pr ofit ofit N Ltd. shou ld r ecognize ecognize in its book in case joint joint venture is: is: (a) jointly contr contr olled olled op eration; (b) jointly controlled asset; (c) (c) jointly controlled controlled entity. Answ er: As per AS-2 AS-27, 7, in in case of jointly jointly controlled operation and jointly controlled assets joint ventu re, the vent ur e should recognize the profit to the extent extent of other ventu rer’s rer’s interest. In the given case, case, N Ltd. shou ld recognize p rofit rofit of: = Rs.(30 Rs.(30 – 20)lakh 20)lakh s = Rs.10 x 20%= Rs.2 Rs.2 lakh s on ly. H owever, in case case of jointly jointly controlled entities N Ltd . shou ld recognize full profit of Rs.10 Rs.10 lakhs in its separ separ ate financial financial statement. How ever, while prep aring consolidated finan finan cial cial statement it shou ld r ecognize ecognize th e pr ofit ofit on ly to th e extent of 20% 20% i.e. i.e. Rs. Rs. 2 lakhs lakhs o nly.
AS -28: -28: IMPAIRME IMPAIRM EN T OF AS SETS An asset is imp imp aired aired if its its carrying carrying amou nt exceeds exceeds the am oun t to be recovered recovered throu gh use or sale of the asset and given the situation the standard requires the enterprise to recognize an imp airment loss i.e. i.e. the am oun t by wh ich ich th e carrying carrying am ou nt of an asset exc exceeds eeds its recoverrecoverable amou nt. Impairment loss is a normal expense and thu s will have impact on d istributabl istributablee profit and other p rovisions of the compan y’s y’s act and app licabl licablee enactment (Acceptan (Acceptan ce of Deposit Rules, BIFR etc) Imp airment loss may be d iscussed iscussed in the following following areas: 1) Imp airment loss on a specific specific asset; 2) Impairment loss loss for for a cash cash generating generating unit; 3) Impairment loss loss for for discontinuing discontinuing operation. Recoverable amou nt. Impairment Loss = Carrying am oun t of the Asset – Recoverable is show n in th e Balance Balance Sheet. Sheet. Carrying amount is the amou nt at w hich asset is
Recoverable amount of an asset is higher of:
Net selling selling p rice rice
Value Value in u se
Expected realizable realizable value of an asset – cost cost of disp osal Ne t Selling Price Price= Expected Net Selling Selling pr ice ice can be obtained from:
Active Active m arket for th e asset
Bind ing sale agreement
Best estimate estimate based on information
Value in Use = Present value of estimated future cash flow arising from the use of asset +
residu al value at th e end of its its u seful seful life. life. Present value is calc calculated ulated by ap p lying discount ra te to futu futu re cash cash flows. Estimated stimated cash flow s in cludes :
Cash inflows from from continu ing u se of the asset
Projec Projected ted cash cash ou tflows tflows to generate cash inflows from continu ing u se of the asset.
Net cash flows if any to be received received ( or paid ) for for th e disp osal of the asset at the en d of its u seful life. life.
Estimated cash flows excludes:
Cash flows flows from finan finan cing cing activities activities
Payment / refun refun d of income income tax
cost of capital to be app lied lied to calculate calculate th e pr esent value of estimated estimated D iscoun t rat rate: e: It is the cost cash cash flows and is based on th e following following factors:
Pre-tax rate
Cur rent m arket assessment of time valu e of money after considering specifi specificc risk risk of the asset
Enterpr ises ises w eighted average cost of capital or incremental financial cost. cost.
The cur cur rent rate of inflation inflation is also considered.
AS-28 doe s not apply to:
inv ento ries (as (as p er AS 2);
construction contract assets ( as per AS 7);
ACCOUNTING STANDARDS
d eferred t ax assets (as per AS 22) 22);;
investmen ts covered by AS-1 AS-13 3 and finan finan cial cial instrum ents, becau becau se other AS provid e for recognizing and measuring these assets.
ication 1) Asse ssme nt for imp airmen airmen t of assets nee ds to be m ade at the the B/S date: as to any ind ication in this context based on external or intern al source of information. External xternal so urces:
Market value changes with p assage assage of time time or normal u se (typewriter (typewriter on invention invention of computer)
Ad verse effec effectt in the light of techn techn ological, ological, market, econom econom ic, ic, or legal environ men t in which the enterprise operates.
Change in market rate of interest or returns on investment affect the discount rates used to assess an assets value in u se (if (if the effec effectt is not a short-term p hen omen on)
Carrying am oun t of the net asset, exceeds exceeds its market capitalization capitalization (determin ed by futur e growth , pr ofitabili ofitability, ty, threat of new p rod ucts/ entran ts etc) etc)
Internal sources:
Obsolescence Obsolescence / ph ysical ysical dam age is evid evid ent
Ind ication ication obtained internally that economic performan ce of an asset asset has wo rsened or likely likely to worse than expected expected .
Continuous cash loss may indicate that one or more of the business division is impaired.
ividu al asset asset basis, basis, exc except ept w hen; Assessme nt for impairment impairment should be mad e on ind ividu (i) (i) The asset asset value in u se cann cann ot be estimated to be close to the n et se1li se1ling ng p rice rice i.e. i.e. futu re cash cash flow from continu ing u se of the asset cannot be estimated to be negligible or th ere is no plan to d ispose of the assets in in near fut ur e. (ii) (ii) The The asset d oes not generate cash inflow inflow s from continu ing use that are largely pen d ent of those from from oth er assets. assets.
ind e-
In the exceptional exceptional case as above, the value in use/ recoverable amou nt can be d etermined with regard assets cash generating units (generate cash inflows from outside the reporting enterp rise and ind epend ent of cash inflows inflows from other assets assets / grou p of assets 2) Impairment Impairment Loss Loss to a cash gen erating erating u nit :
Cash gen erating u nit (CGU): (CGU): The smallest smallest grou p of an asset for for w hich cash cash flows can be d etermined independently. independently.
Even if if the cash cash flows flows can can d etermined ind epend ently, aggregation of cash generating u nits becomes becomes n ecessary ecessary in some situation s. To determine imp airment loss of a CGU, w e have to follow follow ‘bottom up ’ or ‘top ‘top d ow n’ test. [These [These tw o tests are discussed in Pap er 16: 16: Ad van ced ced Finan Finan cial cial Accounting Accounting and Repo Repo rting, in details.] 3) Impa irment Loss for for d iscontinu iscontinu ing op eration : In this type of situation, situation, the impairment loss shall shall depend on th e way the d isc iscontinuing op eration is disp osed off: a) substantially substantially in its its entirety; entirety; b) as piecemeal sales; sales; c) by abandonment. abandonment.
PROBLEMS 1. X Ltd.p u rchased a m achiner y on 1.1. 1.1.20 2002 02 for for Rs.20 lakh s. WDV of the m achine a s on 31.3 31.3.0 .08 8 Rs.1 Rs.12 2 lakhs. The The Recoverable Recoverable amou nt of th e machine is Rs.11 Rs.11 lakhs. What is th e imp airment loss? Answ er: Imp airment Loss = Carrying amou nt – Recoverable Recoverable Amou nt = Rs.12 Rs.12 lakhs – Rs.11 Rs.11 lakh s = Rs. Rs. 1 lakh . 2. Carrying amount Rs.200 lakhs. Net Selling Price Rs.210 lakhs. Value in use Rs. 220 lakhs. What is the imp imp airment loss? Answ er: Carrying am oun t Rs.20 Rs.200 0 lakhs lakhs Recoverable Recoverable amou nt Rs. 220 220 lakhs (being (being the h igher of net selli selling ng pr ice ice and value in u se) Since, ince, recoverable recoverable amou nt is mor e than carrying amo un t of the asset, there w ill ill arise no impairment loss. loss. 3. C Ltd .acquired a m achine for Rs.3. Rs.3.2 2 cror cror es on 1.1. 1.1.20 2005. 05. It has a life of 5 years w ith a salvag e valu e of Rs.4 Rs.40 0 lakhs. App ly the test o f imp imp airm ent o n 31.3. 31.3.200 2008: 8: (a) Present value of fu fu tur e cash cash flow flow Rs.1. Rs.1.3 3 crores crores (b ) N et et se llin g p ri r ice
Rs .1.2cr o r es es
An sw er: Carryin g am ou nt of the a sset: [3. [3.2 2 – (3. (3.2 2 – 0.4 0.4)) x 39/ 39/ 60] = 1.38 1.38 cror cror es. Time p eriod for u se of th e asset: 1.1. 1.1.200 2005 5 to 31.3. 31.3.200 2008 8 = 39 mon th s Total lif lifee period of the asset= 5 years = 60 month s.
ACCOUNTING STANDARDS
Recoverable Recoverable amou nt: being being th e higher of pr esent value and n et sell selling ing pr ice ice = Rs.1. Rs.1.3 3 crores. Impairment Loss= Rs(1.38 – 1.3) crores= Rs.0.08 crores. AS 29: PROVISION S, CON TING EN T LIABIL LIABILITI ITIE ES AN D CON TING EN T ASSETS
The objec objective tive of this Stand Stand ard is to ensu ensu re that ap pr opr iate recognition recognition criteria criteria and measu remen t bases are applied to p rovisions and contingent liabilitie liabilitiess and that su ffic fficient ient information is disclosed disclosed in the notes to the financial financial statements to enable users to un d erstand their natu re, timing timing and am ount. The objec objective tive of this Stand Stand ard is also also to lay dow n ap pr opr iate accounting accounting for contingen contingen t assets. This stand ard is not ap plicable plicable to:
Finan Finan cial cial instrum ents carried at fair value
Insurance enterprises
Contract Contract u nd er wh ich ich n either either party has p erformed erformed any of its obligati obligations ons or both parties hav e partially perform ed th eir obligation obligation to an equal extent extent
AS 7,AS 15,AS 19 and AS 22.
A provision is a liabil liability ity wh ich ich can be measu red o nly by u sing a substan tial degree of estimation. A liability is a present obligation of the enterp rise arising arising from p ast events, the settlemen settlemen t of w hich is expected expected to resu lt in in an ou tflow tflow from th e enterprise of resources embod ying economic benefits. An obligating event is an event th at creates creates an obligation obligation th at results in an enterp rise having no realistic realistic alternative to settling th at obligation. A contingent contingent liability is: (a) a p ossible ossible obligation obligation th at arises from from pa st events an d the existence existence of which w ill ill be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not w holly within th e control control of the enterpr ise; ise; or (b) a pr esent obligation obligation th at arises from from past even ts but is not recognized because: (i) (i) it it is not p robable that an ou tflow tflow of resources embod embod ying econom ic benefits w ill ill be required to settle the obligation; or (ii) (ii) a reliable reliable estimate estimate of the am ou nt of the ob ligation ligation cann ot be m ad e.
A contingent ssible asset that arises from p ast events th e existence existence of which w ill ill be contingent asset is a po ssible confirmed confirmed only by the occu occu rrence or nonoccur nonoccur rence of one or mor e uncertain futu re events not wh olly w ithin the control of the enterp rise. available, its its Prese Prese nt oblig ation ation - an obligation is a p resent obligation if, based on t he evid ence available, existence existence at the balance sheet d ate is considered considered p robable, i.e i.e., ., mor e likely likely than not. ossible obligation if, if, based on the evid ence available, available, Possible oblig ation ation - an obligation is a p ossible its existe existence nce at the balan ce sheet d ate is consid consid ered n ot p robable. A restructuring restructuring is a program me that is planned and controlled ontrolled by m anagement, and m ateriall aterially y changes either: (a) the scope of a business un d ertaken by an enterp rise; or (b) the man ner in w hich hich th at bu siness siness is cond cond ucted. called ed a n obligating event. For an Past Eve Eve nt- A p ast event th at leads to a p resent obligation is call event to be an obligating obligating ev ent, it is is necessary necessary tha t the enterp rise has no realistic realistic alternative alternative to settling settling th e obligation obligation created by the event. best estimate estimate of the expenBest Estimate : The amou nt recognized as a p rovision should b e the best ditu re required to settle the present obligation at the balance sheet date. The amoun t of a provision provision shou ld n ot be discoun discoun ted to its present value. risks and u ncertainti ncertainties es that that inevitably inevitably surrou surrou nd many events Risks and Uncertainties : The risks and circum circum stances shou shou ld be taken into account in reaching th e best estimate estimate of a pr ovision. events that may affect affect the amou nt requ ired to settle settle an obligation Future Events : Futu re events shou ld be reflec reflected ted in th e amou nt of a provision w here there is suffic sufficient ient objec objective tive evidence that th ey will occur. occur. Disclosure:
For each each class class of prov ision, ision, an enterp rise should d isclose: isclose: (a) the carrying carrying amou nt at the beginning and end of the the period; (b) ad d itional itional p rovisions mad e in the period , includ includ ing increases increases to existing existing pr ovisions; (c) amou nts u sed (i.e (i.e.. incurred incurred and charged against the provision) provision) du ring the p eriod; eriod; and (d) unu sed amoun ts reversed reversed du ring the period. An en terpr ise shou shou ld d isclose isclose the following following for each each class of pr ovision: (a) a brief d escription escription of the n atur e of the obligation and the expected timing of any resulting outflows of economic benefits;
ACCOUNTING STANDARDS
(b) an indication of the uncertainties about those outflows. Where necessary to provide adequate information, an enterprise should disclose the major assumptions made concerning future events, as addressed in p aragraph 41; 41; and and (c) (c) the amou nt of any expected reimbu rsement, stating stating the amou nt of any asset that has been recognised for that expected expected reimbu rsement.
PROBLEMS 1.There is a income tax demand of Rs.2.5 lakhs against the company relating to prior years against which which th e comp comp any has gone on app eal to to the app ellat ellatee authority in the d epartment. The groun d of app eal deals with th e points covering Rs. Rs.1. 1.8 8 lakhs lakhs of the dem and . State how t he matt er will have to be d ealt with in th e finan finan cial cial account account for th e year. Answ er: A prov ision ision o f Rs.0 Rs.0.7 .7 lakhs an d a contingent liabili liability ty of Rs. 1.8 1.8 lakhs shou ld b e pr ovid ed in th e financial financial accounts accounts for the year. 2. A compan y follows follows a p olicy olicy of refund ing m oney to th e dissatisfied dissatisfied customers if they claim claim within 15 days from from the d ate of pu rchase rchase and return the goods. It It app ears from from th e past experience that in a month only 0.10% of the customers claim refunds. The company sold goods amo un ting to Rs.20 Rs.20 lakhs d u ring th e last last mon th of the finan finan cial cial year. Is there any conting ency? Answ er: There There is a p robable p resent obligation as a resu lt of past obligating event. The obligating event is the sale of the product. Provision should be recognized as per AS-29. The best estimate for provision is Rs. 2,000 ( Rs.20 lakhs x 0.1%) AS -30: -30: FINA N CIAL INS TRUMEN TRUMEN TS: RECOGN RECOGN ITION ITION AN D MEASUREMENT MEASUREMENT
The objec objective tive of this Stand Stand ard is to establish establish p rinciples rinciples for recognising recognising and measu ring financial assets, financial liabilities and some contracts to buy or sell non-financial items. Requirements for presenting inform ation abou t finan finan cial cial instru instru men ts are in in Accou Accou nting Stand ard (AS) (AS) 31, 31, Financial Requ irements for disclosing disclosing information abou t Financial Instrum Inst rum ents: Prese Present nt ation. Requ finan finan cial cial instrum ents are in Accoun Accoun ting Stand ard (AS) (AS) 32, 32, Financia Financiall Instrum In strum ent s: Definitions:
The terms d efined efined in AS 31, 31, Financial Instruments: Presentation are used in this Standard with the m eanings sp ecif ecified ied in par agrap h 7 of AS 31. 31. AS 31 defines defines th e following following terms:
financial instrument
financial asset
financial liability
equity instrum instrum ent
and provides gu idance on app lying lying th ose definit definitions. ions.
De finition of a Derivative: Derivative:
A derivative is a financial financial instru men t or other contract within th e scop scop e of this Stand Stand ard w ith all three of the following characteristics: (a) its value chang es in respon se to the chan ge in a sp ecif ecified ied interest rate, finan finan cial cial instrum ent pr ice, ice, comm comm od ity pr ice, ice, foreign foreign exchange rate, ind ex of prices prices or rates, credit rating or credit ind ex, or oth er variable, pr ovided in the case of a non -financial -financial variable that th e variable is is not specifi specificc to a pa rty t o th e contract (sometimes called called th e ‘un ‘un d erlying’); erlying’); (b) it requires no initial net investm ent or an initial net investm investm ent that is smaller than w ould be required for other types of contracts that would be expected to have a similar response to changes in m arket factors; factors; and (c) (c) it is is settled settled at a futu re d ate. D efin itions of Four Categories Categories of Financial Instrume Instrume nts :
A financial asset asset or finan finan cial cial liability liability at fair value throu gh pr ofit ofit or loss is a finan finan cial cial asset or finan finan cial cial liability liability that meets either o f the followin followin g cond itions. (a) It It is classifi classified ed as h eld for t rad ing. A finan cial asset or financial liability liability is classified classified a s held for trad ing if it is: is: (i) acquired or incurred principally for the purpose of selling or repurchasing it in the near term; or (ii) part of a portfolio of identified financial instruments that are managed together and for wh ich ich th ere is evid evid ence of a recent actual pattern of short-term p rofit-taking; rofit-taking; or (iii (iii)) a d erivative (exc (except ept for a d erivative that is a finan finan cial cial gu arantee contra ct or a d esignated esignated and effective hedging instrument). (b) Up on initial recognition recognition it is designated by th e entity as at fair fair valu e throu gh p rofit or loss. loss. Accoun Accoun ting Stand ard (AS) (AS) 32, 32, Financial Financial Instru Instru men ts: Disc Disclosures losures , requ ires the entity t o p rovide d isclosures isclosures abou t financial assets and finan finan cial cial liabili liabilities ties it it h as d esignated esignated as at fair value throu gh p rofit rofit or loss, includ includ ing how it has satisfi satisfied ed th ese cond cond itions. itions. finan cial cial assets with fixed fixed or d eterminable Held-to-maturity investments are non -derivative finan paym ents and fixe fixed d matu rity that an entity has the p ositive ositive intention intention and ability ability to hold to m aturity other than: (a) (a)
those that the entity up on initi initial al recogniti recognition on designates designates as at fair value through p rofit rofit or loss;
(b)
those that meet meet the definiti definition on of loans and recei receivable vables; s; and
(c) (c)
those that the entity designates as available available for for sale. sale.
ACCOUNTING STANDARDS
An en tity shou ld n ot classif classify y any financial assets assets as held to m atur ity if the entity ha s, d u ring the curren t finan finan cial cial year or d ur ing th e two p reced reced ing financial financial years, sold or reclassif reclassified ied m ore than an insignificant amount of held-to-maturity investments before maturity (more than insignific significant ant in relation to the total amou nt of held-to-matu rity investments) other tha n sales or reclassifications financial assets with fixed fixed or d eterminable payLoans and receivables are non-derivative financial ments that are n ot qu oted in an active active market, other than: (a) those that th e entity intend s to sell sell imm imm ediately or in the near term , which shou ld be classi classi-fied fied as held for trading , and those that th e entity up on initial recognition designates as at fair fair value throu gh p rofit rofit or loss; (b) those th at th e entity u pon initial recognition recognition d esignates as available available for sale; sale; or (c) (c) those for wh ich ich th e hold er ma y n ot recover substan tially tially all of its its initial investmen t, other than because of cred cred it deterioration, w hich shou ld b e classif classified ied as a vailable for for sale. Available-for-sale financial assets are those non-derivative financial assets that are desig-
nated as available for for sale or ar e not classi classifi fied ed as (a) loans loans an d receivables, receivables, (b) held held -to-matu -to-matu rity investmen ts, or (c) (c) ffinancial inancial assets assets at fair value throu gh pr ofit ofit or loss. D efin ition o f a financial guarantee guarantee contrac contractt
A finan finan cial cial guara ntee contract is is a contract that requ ires the issuer issuer to m ake specified specified p aym ents to reimburse the holder for a loss it incurs because a specified debtor fails to make payment wh en d ue in accordan accordan ce with the original or mod ifie ified d terms of a debt instrument. D efinitions Relating to Recognition Recognition and M easurement easurement
Th e amortised asset or financial liabil liability ity is the am ou nt at w hich th e finan finan cial cial amortised cost of a financial asset asset or finan finan cial cial liabili liability ty is measu red at initial recognition recognition m inu s prin cipal cipal rep aym ents, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial initial amount and the matu rity amount, and minu s any redu ction ction (direc (directly tly or thro ug h th e use of an allowa allowa nce account) account) for imp imp airment or un collec collectibil tibility. ity. Th e eff ective interest calculating ulating th e amor tised tised cost of a finan finan cial cial asset asset interest method is a method of calc or a finan cial liability liability (or gr ou p o f finan finan cial cial assets or finan cial liabilities) liabilities) and of allocatin allocatin g th e interest income income or interest expense over the relevant period . Th e eff ective interest rat exactly discou discou nts estimated futu re cash cash p aym ents or ratee is the rate that exactly receipts through the expected life of the financial instrument or, when appropriate, a shorter p eriod to the n et carrying am oun t of the financial asset or finan finan cial cial liabili liability. ty. ecognised finan finan cial cial asset or financial liabili liability ty Derecognition is the rem oval of a p reviously r ecognised from an entity’s entity’s balance sheet. exchanged , or a liabili liability ty settled, between Fair value is the amou nt for w hich an asset could b e exchanged know ledgeable, willing willing p arties in in an arm ’s length length transaction.
A regu lar way p u rchase or sale sale is a pu rchase or sale of a financial financial asset und er a contract whose terms requ ire delivery delivery of the asset asset within th e time fram fram e established established generally by regu lation lation or convention in the mark etplace concerned concerned . irectly attributab le to the acquisition, issue issue Transaction costs are incremental costs that are d irectly or d isposal of a financial financial asset asset or financial liabili liability. ty. An incremen tal cost cost is one tha t w ou ld n ot have been incurred if the entity had not acquired, issued or disposed of the financial instrument. De finitions Relating Relating to He dge Accounting
A firm firm commitment is a binding agreement for the exchange of a specified quantity of resources at a specified specified p rice rice on a sp ecif ecified ied futu re d ate or d ates. A fo recast transaction is an un comm itted itted but an ticipated ticipated futu re transactio transaction. n. ich the entity Functio nal curren curren cy is the currency of the primary econom ic environ men t in wh ich operates. A hedgin g instrument (a) a designated d erivative or (b) for a hed ge of the risk of changes in instrument is (a) foreign currency exchange rates only, a designated non-derivative financial asset or non-derivative finan finan cial cial liabili liability ty w hose fair value or cash cash flow flow s are expected to offset offset changes in the fair fair value or cash flow flow s of a designated hed ged item. A hedged item is an asset, liabili liability, ty, firm firm commitm ent, highly pr obable forecast forecast tran saction saction or net investm ent in a foreign op eration that (a) exposes the entity to risk of chan chan ges in fair fair valu e or futu re cash cash flows and (b) is designated as being hed ged flows of the h edged Hedge effectiveness is the degree to w hich changes in the fair value or cash flows item that ar e attributable to a hed ged r isk are offse offsett by chang es in the fair fair valu e or cash flows flows of the hedging instrum instrum ent. Embedde d De rivative: ivative:
An embed ded derivative is a comp comp onent of a hybrid (combined) (combined) instrument that also includ includ es a non-derivative host contract—with the effect that some of the cash flows of the combined instrument v ary in a way similar similar to a stand -alone -alone derivative. derivative.
AS 31: FINANCIAL INSTRUMENTS: PRESENTATION The objec objective tive of this Stand Stand ard is to establish establish p rinciples rinciples for pr esenting financial instru men ts as liabilities liabilities or equ ity and for offsetting offsetting finan cial assets and financial liabilities. liabilities. It app lies to the classification of financial instruments, from the perspective of the issuer, into financial assets, finan finan cial cial liabiliti liabilities es and equ ity instru men ts; the classifi classification cation of related interest, divid end s, losses losses and gains; and t he circu circu mstan ces ces in w hich finan finan cial cial assets assets and finan finan cial cial liabili liabilities ties shou shou ld be offset. The principles in this Standard complement the principles for recognising and measuring financial assets and financial liabilities in Accounting Standard (AS) 30.
ACCOUNTING STANDARDS
Definitions
The following following terms are used in this Stand Stand ard w ith the meanin gs specifi specified: ed: A financial instrument is any contra contra ct that gives rise to a finan finan cial cial asset asset of one entity and a finan finan cial cial liabili liability ty or equ ity instrum ent of anoth er entity. A financial asset is any asset that is: (a) cash; (b) an equity instrument of another entity; entity; (c) (c) a contractual right: (i) (i)
to recei receive ve cash cash or another financia financiall asset asset from from another entity; or
(ii) (ii)
to exchange exchange financi financial al assets assets or financial inancial liabil liabiliti ities es with another entity un der conditions th at are p otentially otentially favour able to the entity; or
(d) a contract contract that w ill ill or may be settled settled in th e entity’s entity’s own equity instru men ts and is: (i) (i) a non-d erivative for for wh ich ich the entity is or may be obliged to receive receive a variable nu mber of the entity’s entity’s own equity instruments; or (ii) (ii) a derivative that w ill ill or may be settled settled oth er than by th e exchange exchange of a fix fixed ed am ou nt of cash cash or anoth er finan finan cial cial asset asset for a fixed fixed n um ber of the entity’s entity’s own equity instruments. For For this pu rpose the entity’s entity’s own equity instruments d o not includ includ e instru men ts that are th emselves contr contr acts for for the futu re receipt receipt or d elivery elivery of the entity’s entity’s own equ ity instruments. A financial liability is any liabili liability ty th at is: (a) a contractual obligation: (i) (i) to deliver cash cash or anoth er financial financial asset to anoth er entity; or (ii) (ii) to exchan exchan ge finan finan cial cial assets or financial financial liabil liabilitie itiess with anoth er entity u nd er cond itions that are p otentially unfavou rable to the entity; or (b) a contract that will or may be settled settled in th e entity’s entity’s own equity instru men ts and is: (i) (i) a non-derivative non-derivative for for wh ich ich the entity is is or may be oblige obliged d to d eliver eliver a variable variable nu mber of the entity’s entity’s own equ ity instrum ents; or (ii) (ii) a derivative that w ill or may be settled settled oth er than by th e exchange exchange of a fixed fixed amou nt of cash cash or anoth er financial financial asset for a fixed fixed nu mber of the entity ’s ’s own equ ity instru ments. For For this pu rpose the entity’s entity’s own equity instrum instrum ents do n ot include include instrum ents that ar e themselves contracts contracts for the futu re receipt receipt or d elivery elivery of the entity’s entity’s own equity instruments.
An equity instrument resid ual interest in th e assets of an en tity instrument is any contract that evid ences a resid after d ed u cting all of its liabilities. liabilities. ich an asset could be exchan exchan ged , or a liabili liability ty settled settled , between Fair value is the amou nt for wh ich know ledgeable, willing willing p arties in in an arm ’s length length transaction. Financia Financiall Instrum Instrum ents: Rec Recognition ognition an d Measurement and are used in this Standard Standard with th e mea nin g sp ecifie ecified d in AS 30. 30.
am ortised cost of a financial asset or financial liability liability
ava ilable-for-sale ilable-for-sale finan finan cial cial assets
derecognition
derivative
effective interest method
finan finan cial cial asset or financial liabil liability ity at fair valu e thro ug h pr ofit ofit or loss
finan finan cial cial gu arantee contr act
firm firm comm itment
forecast transaction
hedge effectiveness
hedged item item
hedging instrument
held-to-maturity held-to-maturity investments investments
loans and receivables receivables
regular way p urchase or sale sale
transaction costs. costs.
In this Stand Stand ard, ‘contract’ an d ‘contractual’ refer refer to an agreement between two or m ore parties that has clear clear economic consequ consequ ences that th e par ties have little, little, if any, d iscretion iscretion to av oid, usu ally ally becau becau se the agreemen t is enforceable enforceable by law. Contracts, and thu s financial financial instru ments, may take a variety variety of forms forms and need n ot be in writing. In this Stand Stand ard, ‘entity’ includes includes ind ividu ividu als, als, partnerships, incorporated incorporated bodies, trusts and government agencies.
ACCOUNTING STANDARDS
AS 32: 32: FINAN IN AN CIAL INSTRUMENTS: IN STRUMENTS: D ISCLOS ISCLOSURE URES S The objective of this Standard is to require entities to provide disclosures in their financial statements tha t enable u sers to evaluate: (a) the significance significance of financial financial instru instru men ts for the entity’s entity’s finan finan cial cial position an d performan ce; ce; and (b) the natu re and extent of risks arising arising from finan finan cial cial instru instru men ts to wh ich ich th e entity is is exposed exposed d uring the p eriod eriod an d at the reporting date, and how the entity entity manages those risks. The principles in this Accounting Standard complement the principles for recognising, measur ing an d pr esenting finan finan cial cial assets and finan finan cial cial liabili liabilities ties in in Accounting Stand ard (AS) (AS) 30, 30, Finan Finan cial cial Instrum ents: Rec Recognition ognition an d Measurem ent an d Accou Accou nting Stand ard (AS) (AS) 31, 31, Finan Finan cial cial Instru men ts: Presentation. Sig nif icance of financial instruments for fin ancial position and pe rformance
An en tity shou ld d isclose isclose inform inform ation that en ables users of its its finan finan cial cial statements to evaluate the significanc significancee of finan finan cial cial instru instru men ts for its its financial financial po sition sition an d perform ance. Balance sheet Categories of financial assets and financial liabilities
The carrying am oun ts of each each of the following categories, categories, as defined defined in AS 30, 30, shou ld be d isclosed closed either on the face of the balance sheet or in th e notes: (a) finan finan cial cial assets at fair fair value th rou gh pr ofit ofit or loss, showing separately (i) (i) those designated designated as such upon initial initial recogniti recognition on and (ii) (ii) those classif classified ied as h eld for trad ing in accordan ce with AS 30; 30; (b) held-to-maturity investments; (c) loans and receivables; (d) av ailable-for-sale ailable-for-sale finan cial cial assets; (e) finan finan cial cial liabili liabilities ties at fair fair va lue th rou gh pr ofit ofit or loss, show ing sep arately (i) (i) those designated as such up on initial recognition recognition and (ii) (ii) those classif classified ied ash eld for trad ing in accordan ce with AS 30; 30; and (f) financial liabilities measured at amortised cost. Financial assets o r financial l iabili ties at fair value value thr throug oug h profit or loss
If the entity has designated a loan or receivable (or group of loans or receivables) as at fair value th rou gh p rofit rofit or loss, it should d isclose isclose::
(a) the maximum exposure to cred eceivable (or (or grou p of loans loans or receivreceivcred it risk of the loan or r eceivable ables) at the repor ting d ate. (b) the amount by which any related credit derivatives or similar instruments mitigate that maximum exposure exposure to credit credit risk. (c) (c) the amou nt of chan chan ge, d ur ing the p eriod and cumu latively, latively, in in th e fair fair value of the loan or receivable receivable (or (or gro up of loans or receivables) receivables) that is attributab le to changes in th e credit risk of the financial asset determin ed either: (i) (i) as the amou nt of chan chan ge in its its fair fair value that is not attribu table to changes in market conditions tha t give rise to market ris ris k; or (ii) (ii) u sing an alternative method the entity believes believes more faithfully faithfully represents the amou nt of chan chan ge in its fair fair value th at is attributable to changes in th e cred cred it risk of the asset. Changes in market conditions that give rise to market risk include changes in an observed (benchm ark) interest rate, commod ity price, foreign foreign exchange rate or ind ex of pr ices ices or rates. (d) the amou nt of the change in th e fair fair value of any related credit d erivatives or similar similar instru ments that h as occurred occurred d uring the p eriod eriod and cum ulatively ulatively since since the loan loan or recei receivable vable was designated. If the en tity has d esignated esignated a financial liabil liability ity as at fair value thr throug oug h profit or loss in accorda nce with AS 30, 30, it shou ld d isclose isclose:: (a) the am oun t of chan chan ge, du ring th e period an d cu mu latively, latively, in in th e fair fair value of the financial financial liabili liability ty th at is attributab le to chan chan ges in the cred it risk of that liabili liability ty d etermined either: (i) (i) as the amou nt of chan chan ge in its its fair fair value that is not attribu table to changes in market conditions th at give rise to mar ket risk ,or ,or (ii) (ii) u sing an alternative alternative method the entity believes believes mor e faithfully faithfully repr esents the amo un t of chan chan ge in its fair value th at is attributab le to changes in th e credit risk of the liability. liability. Changes in market conditions that give rise to market risk include changes in a benchmark interest rate, the p rice rice of another entity’s entity’s finan finan cial cial instrum ent, a comm od ity pr ice, ice, a foreign foreign exchan exchan ge rate or an ind ex of pr ices ices or rates. For contracts contracts that includ e a un it-li it-linking nking featu featu re, changes in market conditions include changes in the performance of the related internal or external external investment investment fund . (b) the d iffe ifference rence between th e finan finan cial cial liabili liability’ ty’ss carrying am ou nt an d the am ou nt th e entity wou ld be contractually contractually required to p ay at m aturity to the h older of the obligatio obligation. n. Reclassification
If the en tity has r eclassi eclassifi fied ed a financial asset as one m easured : (a) at cost cost or amor tised tised cost, rather th an at fair value; or (b) at fair fair value, rather than at cost cost or amor tised cost, cost, it should d isclose isclose the am oun t reclassi reclassifi fied ed into an d ou t of each category category an d th e reason for for that reclassific reclassification ation .
