CA IPCC Group 2 accounting standards

CA IPCC-Accounting Standards by CA Kisan Rajpurohit

AS 11: THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES INTRODUCTION 

An enterprise may have transaction in foreign currency



It may also have foreign operations like branches, subsidiaries, joint ventures etc.



However the transactions must be expressed in the reporting currency & financials of foreign operations must be translated into the enterprise‟s reporting currency



The principal issue is to decide the exchange rate & how to treat the effect of change in forex rates

SCOPE 

Accounting for transactions in foreign currencies



Translating the financial statements of foreign operations



Accounting for foreign currency transactions in the nature of forward exchange contracts

DEFINITIONS 

Reporting Currency –



Foreign Currency –



Currency other than reporting currency

Exchange rate –



Currency of country where financial statements are reported

Rate at which foreign currency is converted into reporting currency or vice versa

Monetary items &non-monetary items

MONETARY-NON MONETARY ITEMS MONETARY ITEMS •They are money held & assets & liabilities receivable in fixed & determinable amounts of money •E.g. cash, receivables, payables

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NON MONETARY ITEMS •They are assets & liabilities other than monetary items •E.g. Fixed assets, inventories, investment in equity shares

AS 11- Effects of changes in Foreign Exchange Rates

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CLASSIFICATION OF TRANSACTIONS Foreign Currency Transactions

Foreign Operations

Forward Exchange Contracts

•Buying/selling good/services

•Foreign Branch

•For managing risk/hedging

•Lending/borrowing in foreign currency

•Associate

•For trading & speculations

•Acquisition/disposition of assets denominated in foreign currency

•Foreign Subsidiary

•JV •Integral •Non Integral

Foreign Currency Transactions Initial Recognition

Apply date of transaction rate Monetary Item

Valuation at Sheet Date

Balance

Contingent Liabilities



Apply closing rate Historical cost items

Actual (original)

Fair value items

Closing rate

Non Monetary Item

rate

Closing rate

Three types of exchange differences Difference in transaction rate & reporting date rate Settlement at a rate different from rate at which it was initially recorded Settlement at a rate different from the last reporting date

All types of differences recognized to P&L Account

Foreign Operations 

For the purpose of translation of financial statement of foreign operation, foreign operations have been classified into two types Integral Operation Non integral Operation



Integral Foreign Operation It is carried on as if it were extensions of the reporting enterprise E.g. dependent branch, sales depot, foreign arm that produces raw material & transfers it to head office

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Cost & Depreciation of Tangible Fixed Assets



Date of purchase

Assets carried at Fair Value

Date of determination of fair value

Inventories

Date on which such costs were incurred

Assets at realizable value

Date on which such value was determined (closing rate)

Contingent liability

Closing rate

Resulting Exchange Difference

Recognize in P&L

Non Integral Operations Independent activity without much dependence Not much transaction with reporting enterprise Financing through local borrowings Cash flows of reporting enterprise independent of foreign enterprise

Translation of accounts of foreign operation:

Asset & Liabilities- Apply closing rate

Income & Expenses- Apply relevant rate on date of transaction

Resulting exchange difference arising from Above noted procedureAccumulated in foreign currency reserve

Translating Opening Net Investment at a rate at which it was previously reportedAccumulated in foreign currency reserve

Other changes in the equity of non integral foreign operation-Accumulated in foreign currency reserve

Contingent Liability -Apply closing rate

Forward Contracts 

It is an agreement between two parties whereby one party agrees to buy from or sell to the other party an asset at future date for an agreed price



In case of forward exchange contract the asset is “foreign currency”.



Two types of Forward Exchange Contracts Forward contract for hedging risk Forward contract for speculation

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CA IPCC-Accounting Standards by CA Kisan Rajpurohit For hedging risk

The forward premium or discount should recognized over the period of contract

For speculation/ trading

The forward premium or discount is to be ignored. At each balance sheet date the value of the contract is marked to market & resulting gain or loss recognized to P&L

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CA IPCC-Accounting Standards by CA Kisan Rajpurohit ILLUSTRATION 1. Kalim Ltd. borrowed US$ 4,50,000 on 01/01/2010, which will be repaid as on 31/07/2010. X Ltd. prepares financial statement ending on 31/03/2010. Rate of exchange between reporting currency (INR) and foreign currency (USD) on different dates are as under: 01/01/2010 1 US$ = Rs 48.00 31/03/2010 1 US$ = Rs 49.00 31/07/2010 1 US$ = Rs 49.50 Solution

ILLUSTRATION 2. A company had imported raw materials worth US Dollars 6,00,000 on 5th January, 2007, when the exchange rate was Rs.43 per US Dollar. The company had recorded the transaction in the books at the above mentioned rate. The payment for the import transaction was made on 5th April, 2007 when the exchange rate was Rs.47 per US Dollar. However, on 31st March, 2007, the rate of exchange was Rs.48 per US Dollar. The company passed an entry on 31st March, 2007 adjusting the cost of raw materials consumed for the difference between Rs.47 and Rs.43 per US Dollar. In the background of the relevant accounting standard, is the company’s accounting treatment correct? Discuss. Solution As per AS 11 (revised 2003), „The Effects of Changes in Foreign Exchange Rates‟, monetary items denominated in a foreign currency should be reported using the closing rate at each balance sheet date. The effect of exchange difference should be taken into profit and loss account. Sundry creditors is a monetary item, hence should be valued at the closing rate i.e, Rs.48 at 31st March, 2007 irrespective of the payment for the same subsequently at lower rate in the next financial year. The difference of Rs.5 (48-43) per US dollar should be shown as an exchange loss in the profit and loss account for the year ended 31st March, 2007 and is not to be adjusted against the cost of raw- materials. In the subsequent year, the company would record an exchange gain of Re.1 per US dollar, i.e., the difference between Rs.48 and Rs.47 per Us dollar. Hence, the accounting treatment adopted by the company is incorrect.

ILLUSTRATION 3. A company had imported raw materials worth US Dollars 6,00,000 on 5th January, 2010, when the exchange rate was Rs.43 per US Dollar. The company had recorded the transaction in the books at the above mentioned rate. The payment for the import transaction was made on 5th April, 2010 when the exchange rate was Rs.47 per US Dollar. However, on 31st March, 2010, the rate of exchange was Rs.48 per US Dollar. The company passed an entry on 31st March, 2010 adjusting the cost of raw materials consumed for the difference between Rs.47 and Rs.43 per US Dollar. In the background of the relevant accounting standard, is the company’s accounting treatment correct? Discuss.

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CA IPCC-Accounting Standards by CA Kisan Rajpurohit As per AS 11 (revised 2003), „The Effects of Changes in Foreign Exchange Rates‟, monetary items denominated in a foreign currency should be reported using the closing rate at each balance sheet date. The effect of exchange difference should be taken into profit and loss account. Sundry creditors is a monetary item, hence should be valued at the closing rate i.e, Rs.48 at 31st March, 2010 irrespective of the payment for the same subsequently at lower rate in the next financial year. The difference of Rs.5 (48-43) per US dollar should be shown as an exchange loss in the profit and loss account for the year ended 31st March, 2010 and is not to be adjusted against the cost of raw- materials. In the subsequent year, the company would record an exchange gain of Re.1 per US dollar, i.e., the difference between Rs.48 and Rs.47 per Us dollar. Hence, the accounting treatment adopted by the company is incorrect.

ILLUSTRATION 4. S Ltd. purchased fixed assets costing Rs 3,000 lakhs on 1.1.2010 and the same was fully financed by foreign currency loan (U.S. Dollars) payable in three annual equal instalments. Exchange rates were 1 Dollar = Rs 40.00 and Rs 42.50 as on 1.1.2010 and 31.12.2010 respectively. First instalment was paid on 31.12.2010. The entire difference in foreign exchange has been capitalized. You are required to state, how these transactions would be accounted for. Solution As per para 13 of AS 11 (Revised 2003) „The Effects of Changes in Foreign Exchange Rates‟, exchange differences arising on the settlement of monetary items or on reporting an enterprise‟s monetary items at rates different from those at which they were initially recorded during the period, or reported in previous financial statements, should be recognized as income or expense in the period in which they arise. Thus, exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets are recognized as income or expense. Calculation of Exchange Difference: Foreign Currency Loan =

= Rs 75 lakh US Dollars

Exchange difference = 75 lakhs US Dollars * (42.50 – 40.00) = Rs 187.50 lakhs (including exchange loss on payment of first instalment) Therefore, entire loss due to exchange differences amounting Rs 187.50 lakhs should be charged to profit and loss account for the year.

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AS 12: GOVERNMENT GRANTS PURPOSE OF AS 12  Users of financial statements should know the extent to which the enterprise has benefitted from grants  Comparability is enhanced  Accounting for government grants is correctly done

AS 12 COVERAGE  Does not cover Other forms of indirect assistance (e.g. tax holiday, tax exemptions, sales tax subsidy etc) Government participation in the ownership of the enterprise (subscription to equity capital)

DEFINITIONS  Government Grants They are assistance by government in cash or kind to an enterprise for past or future compliance with certain conditions Do not include other forms of government assistance on which a value cannot be placed

ACCOUNTING APPROACH Two approaches have been prescribed to treat Government Grants

CAPITAL

Grant is treated as part of shareholders funds

INCOME

Grant is taken to income over one or more periods

WHEN TO RECOGNIZE GRANTS?  Government grants should be recognized only when there is a reasonable assurance that The enterprise will comply with the conditions attached to them & The grants will be received

Types of grants

TYPES OF GOVERNMENT GRANTS

AS by CA Kisan Rajpurohit 8008149787, 9908063153

Monetary

Cash assistance, reimbursement

Non monetary

Land or other resources

AS 12- Government Grants

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GRANT RELATING TO FIXED ASSETS ALTERNATIVE I  Asset is given at a concessional rate Account the asset at its acquisition cost Fixed Asset A/c

Dr

50000

To Bank A/c

50000

 Asset is given free of cost Account the asset at its nominal value Fixed Asset A/c

Dr

100

To P&L A/c

100

ALTERNATIVE II  Grant relating to a depreciable fixed asset Treat as deferred income & recognize in the P&L account on a systematic & rational basis i.e. in the proportion in which the depreciation is charged on those assets  Grant relating to non depreciable assets Credit the grant to Capital Reserve However if the grant requires fulfillment of certain obligations, then the grant should be credited over the same period over which the cost of meeting such obligation is charged to income. The balance of deferred should be disclosed separately in financial statements Reduce the grant from the gross value of the asset

Option I

Fixed Assets Depreciable asset

Recognize as income in the proportion of depreciation

Non depreciable asset

Capital Reserve

Option II

REVENUE GRANTS 

Recognize on a systematic basis in the P&L Account



Such recognition should be spread over the periods necessary to match them with the related costs



Such grants should be shown separately under “Other Income” or deduction from the related expense

PROMOTERS CONTRIBUTION  Government grants take the nature of promoter’s contribution when they are given – with reference to total investment in the project OR – By way of contribution towards total capital outlay – Example of promoter’s contribution •

Capital subsidy in a project

– Such promoter’s contribution should be credited to Capital Reserve



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REFUND OF GRANTS  It is an extra-ordinary item as per AS 5  Amount refundable should be first debited to any unamortized deferred credit remaining in respect of such grant  Where the amount exceeds such deferred credit or where no deferred credit exists then charge to P&L A/c  Any refund if it relates to a specific fixed assets should be accounted by – increasing the book value of the asset or – by reducing the Capital Reserve – by reducing the deferred income balance  Where book value of an asset is increased as per above the depreciation should be provided PROSPECTIVELY

ACCOUNTING ENTRIES Grant is taken to income over one or more periods Option I

Bank A/c

Dr

To Fixed Asset A/c Option II

Bank A/c

Dr

To Government Grant A/c (This amount should be credited to P&L in proportion to depreciation charged every year)

Grant received in respect of a non depreciable asset Option I Option II

Bank A/c

Dr

To Fixed Asset A/c Bank A/c

Dr

To Capital Reserve A/c If the grant requires fulfillment of certain conditions then it should be credited to income over the period which the cost of meeting such obligations is charged to income

Option III

Bank A/c

Dr

To Deferred Income

Grant received in the form of promoter’s contribution Bank A/c

Dr

To Capital Reserve

Grant received in the form of revenue grant Bank A/c

Dr

To P&L A/c OR Credit to P&L over the period in which related costs are incurred



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CA IPCC-Accounting Standards by CA Kisan Rajpurohit ILLUSTRATION 1. A firm acquired a fixed asset from Rs 250 lakhs on which the government grant received was 40% Solution Alternative I-Show as deduction from the cost of the asset Alternative II-Treat it as deferred income & recognize in the proportion of depreciation charged to P&L

ILLUSTRATION 2. A capital subsidy was received from the Central Government for setting up a plant in a notified backward area. The cost of the plant was Rs 300 lacs & the subsidy received was Rs 100 lacs Solution Capital subsidy received is in the nature of promoter‟s contribution & should be credited to the Capital Reserve A/c

ILLUSTRATION 3. Rs 50 lakhs received for setting up a water treatment plant Solution Alternative I-Show as deduction from the cost of the asset Alternative II-Treat it as deferred income & recognize in the proportion of depreciation charged to P&L

ILLUSTRATION 4. Rs 25 lakhs received from the local authority for providing medical facilities to the employees Solution It is a case of revenue grant & should be credited to the P&L. However if the medical facilities are to be provided over a period of more than one year it may be treated as deferred income & then taken to P&L over a systematic basis

ILLUSTRATION 5. Alex Ltd received an area of land for free from the Govt of AP. This amount is not recorded at all. The company argues that –

No money has been spent by the company on its acquisition &

–

Land is not depreciable

Solution Asset received free of cost should be recorded at nominal value (say Rs 100). The fact that the asset is not a depreciable asset is irrelevant

ILLUSTRATION 6. Indu Ltd has received a grant of Rs 20 lakhs under the government subsidy scheme for acquiring an imported machinery. The entire grant has been credited to P&L. Comment Solution The grant should be shown as a deduction from the gross value of the asset Alternatively, if it is a depreciable fixed asset then the grant should be recognized to income in the proportion in which depreciation is charged over the life of the asset

ILLUSTRATION 7. Shankar Ltd purchased a special machinery on 1st April of a Financial year for Rs 20 lakhs. It received a Government grant of Rs 8 lakhs. The machine has a life of 4 years (RV is 4 lakhs). Give the accounting treatment for the grant under both methods if grant becomes refundable in 3rd year AS by CA Kisan Rajpurohit 8008149787, 9908063153


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CA IPCC-Accounting Standards by CA Kisan Rajpurohit Solution NON DEPRECIABLE ASSET Fixed Asset/Capital Reserve A/c

Dr

6 lacs

To Bank A/c

6 lacs

Deferred Income a/c

Dr

4

P&L

Dr

2

To bank

6 DEPRECIABLE ASSET

Fixed Asset

Dr

6 lacs

To Bank A/c

6 lacs

Deferred Income a/c

Dr

4

P&L

Dr

2

To bank

6

ILLUSTRATION 8. Z Ltd. purchased a fixed asset for Rs. 50 lakhs, which has the estimated useful life of 5 years with the salvage value of Rs. 5,00,000. On purchase of the assets government granted it a grant for Rs. 10 lakhs. Pass the necessary journal entries in the books of the company for first two years. Solution OPTION 1

OPTION 2



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CA IPCC-Accounting Standards by CA Kisan Rajpurohit 

Grants related to depreciable assets are treated as deferred income which is recognized in the profit and loss statement on a systematic and rational basis over the useful life of the asset.



Grants related to non-depreciable assets are credited to capital reserve under this method, as there is usually no charge to income in respect of such assets.



If a grant related to a non-depreciable asset requires the fulfilment of certain obligations, the grant is credited to income over the same period over which the cost of meeting such obligations is charged to income.



The deferred income is suitably disclosed in the balance sheet after „Reserves and Surplus‟ but before „Secured Loans‟ with a suitable description, e.g., „Deferred government grants‟.



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AS 16: BORROWING COSTS WHAT ARE BORROWING COSTS? 

Borrowing costs are interest and other costs incurred by an enterprise in connection with the borrowing of funds



However borrowing costs do not include actual or imputed cost of owners’ equity, including preference share capital not classified as liability

BORROWING COSTS 

Borrowing costs include Interest and commitment charges on bank borrowings Amortisation of discounts or premiums relating to borrowings; Amortisation of ancillary costs incurred in connection with the arrangement of borrowings; Finance charges in respect of assets acquired under finance leases or under other similar arrangements.

Qualifying Asset 

It is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.

Examples •Manufacturing plants •Manufacturing plants •Inventories that require a substantial period to bring them to a saleable condition



Exclusions •Assets that are ready for their intended use or sale when acquired •Routinely manufactured inventories in short period

Substantial period means a period of 12 months unless a longer or shorter period can be justified.

Borrowing Costs

Borrowing Costs

Directly attributable to the acquisition, construction or production of a qualifying asset

Capitalize with the cost of asset

Treat as an expense

Other costs

How MUCH to capitalise? 

If the funds have been specifically borrowed for the Qualifying Asset the amount to be capitalized is – Amount of borrowing cost incurred on that borrowing in that period LESS Any income on temporary investments of those borrowings

INTEREST ON GENERAL BORROWINGS 

Many times the enterprise borrows money for the enterprise as a whole & used for different qualifying assets. Thus the borrowing is not asset specific



This is a case of general borrowings

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AS 16- Borrowing Costs

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CA IPCC-Accounting Standards by CA Kisan Rajpurohit 

Interest on general borrowings should be determined by applying a capitalisation rate to the expenditure on the asset



This capitalisation rate is the weighted average cost of general borrowings outstanding during the period



Steps a. Calculate total borrowing cost (excluding specific) b. Multiply each general borrowing by the outstanding period (months) c. Take the total of all products d. Calculate average borrowing by dividing B by 12 months e. Divide the total borrowing cost (excluding specific) by D above & you get the weighted average borrowing cost (capitalisation rate) f.

Multiple this WABC to the project expenditure

COMMENCEMENT OF CAPITALIZATION 

Capitalisation should commence when ALL the following conditions are satisfied 1. Expenditure on the acquisition, construction or production of QA is being incurred 2. Borrowing costs are being incurred 3. Activities that are necessary to prepare the asset for its intended use or sale are in progress

WHAT IS EXPENDITURE? 

Expenditure includes Payment of cash Transfer of other assets Assumption of interest bearing liabilities



Any government grant received in respect of the Qualifying asset should be reduced from the above expenditure

SUSPENSION 

Capitalisation of borrowing costs should be suspended during extended periods in which active development is interrupted



Exceptions Substantial technical & admin work is going on. Temporary delay is necessary for preparing asset for intended use or sale.

CESSATION 

Capitalisation of borrowing costs should cease when SUBSTANTIALLY all the activities necessary to prepare the qualifying asset for its intended use or sale are complete



When construction of a qualifying asset is completed in parts & a completed part is capable of being used while construction for the other parts, capitalisation of borrowing costs in relation to that part should cease when substantially all the activities necessary to prepare that part for its intended use or sale are complete

DISCLOSURE 

Disclose:

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CA IPCC-Accounting Standards by CA Kisan Rajpurohit The accounting policy adopted for borrowing costs The amount of borrowing costs capitalised during the period

ILLUSTRATION 1. An industry borrowed Rs.40,00,000 for construction of building on 1.6.2007. Interest on loan is 9% per annum. The building was ready use from 1.1.2008. Suggest the accounting treatment for the above. Solution

Interest upto 31.3.2008 [40,00,000×9%×10/12] Less: Interest relating to pre-operative period [3,00,000×7/10] Amount to be charged to P&L Pre-operative interest to be capitalised

Rs 3,00,000 2,10,000 90,000 2,10,000

ILLUSTRATION 2. Interest on Term Loan from a bank for a particular plant amounting to Rs 150 lakhs has been capitalised& added to the cost of the project. This amount of interest includes interest of Rs 25 lakhs in respect of funds used for other purposes. Please comment. Solution As per AS 16, “Borrowing costs” any cost directly attributable to the acquisition, construction or production of a qualifying asset should be capitalized. In all other cases the amount should be charged to P&L Account. Therefore in the given case, the interest amount of Rs 125 lakhs will be capitalised. The remaining interest amount of Rs 25 lakhs will be charged to P&L account.

ILLUSTRATION 3. Apex Ltd has taken a loan of Rs 20 lakhs which has been used to buy trees. The average remaining period for the maturity of the tree to be sold as timber is 3 years. The company wants to include the interest cost for the period of three years in the inventory cost of timber. Comment Solution As per AS 16, “Borrowing costs”, a qualifying asset an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. The use of the words “for sale” in the definition indicates that even inventory can come into the definition of qualifying asset. Thus the interest cost relating growing of timber can be added to the cost of timber and need not be charged to P&L Account.

ILLUSTRATION 4. Parul ltd took a loan of Rs 500 lakhs for upgradation of its plant. Out of the said loan Rs 350 lakhs was spent on the plant during the yea & balance Rs 150 lakhs was spent on general working capital requirements of the company. The total interest cost for the period was Rs 70 lakhs. Advise the company in respect of capitalisation of interest Solution Amount to be capitalized = 70 × 350/500 = 49 lakhs Amount to be charged to P&L Account = 7 × 150/500 =21 lakhs

ILLUSTRATION 5.

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CA IPCC-Accounting Standards by CA Kisan Rajpurohit Alex ltd borrowed Rs 12 crores for its capital expansion which lasted 18 months. The relevant borrowing rate was 12.5%. During this period the company invested the temporary surplus funds at 4.5% on short term basis & earned interest of Rs 25 lakhs which was credited to the P&L under other income. The company capitalised the entire interest cost. Solution Amount to be capitalised

= Borrowing cost Less income on temporary investments

st

For 1 Year For 2

nd

= [12 * 12.5%] – 25

= 1.5 lakhs

year = [12 * 12.5% * 6/12]

= 0.75 lakhs

TOTAL

= 2.25 lakhs

ILLUSTRATION 6. Parag Ltd had the following borrowings during a year in respect of capital expansion Plant

Cost of asset

Remarks

P

100 lakhs

No specific borrowing

Q

125 lakhs

Bank loan of Rs 65 lakhs @ 10%

R

175 lakhs

9% debentures of Rs 125 lakhs

In addition to the above the company had obtained term loans from two banks-Rs 100 lakhs from SBI @ 10% & Rs 110 lakhs at 11.5% from Canara. Determine borrowing cost to be capitalised for each plant. Solution 

Specific borrowing cost Plant P= Nil Plant Q= 65 lakhs * 10%= Rs 6.5 lakhs Plant R= 125 lakhs* 9%= Rs 11.25 lakhs



Capitalisation Rate Type of loan

Amount o/s

No of months

product

interest

Related expense

Total borrowing cost

SBI 10%

100

12

1200

10

Nil

10

Canara 11.5 %

110

12

1320

12.65

Nil

12.65

2520

22.65

22.65

Average loan=2520/12 months=210 lakhs Capitalisation rate = 22.65/210=10.79% Capitalisation of borrowing costs Asset

Borrowing

Loan amount

Interest rate

Interest Rs lakhs

P

General

100

10.79%

10.79

Q

specific

65

10%

6.5

general

60

10.79%

6.47 12.974

R

specific

125

9%

11.25

general

50

10.79%

5.39 16.64

Total

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AS 19: LEASES INTRODUCTION 

Lease is an agreement whereby the lessor conveys to the lessee the right to use an asset for an agreed period of time in return for a payment or series of payments (called as lease rentals) & Includes hire purchase agreements



Lessor is the person who gives the asset on lease



Lessee is the person who takes the asset on lease

PURPOSE & COVERAGE 

To prescribe the accounting treatment & the disclosures in respect of leases



AS 19 does not cover –

Lease for use of natural resources such as oil, gas, timber, metals & other mineral rights

–

Licensing agreements for movie films, video recordings, plays, manuscripts & copyrights

–

Lease in respect of land

–

Service contracts because there is no transfer of right to use an asset

DEFINITIONS Minimum Lease Payments 

In case of lessor Total lease rentals (excluding contingent rent) + residual value guaranteed by or on behalf of the lessee or any third party



In case of lessee Total lease rentals (excluding contingent rent) + residual value guaranteed by or on behalf of the lessee



Contingent rent is that part of lease payments that is not dependent on time but on other factors such as sales, usage amount. It should not be included in MLP

MLP COMPUTATION 

Monthly lease rental is Rs 25000, lease term is 32 months. Ali a third party provides a guarantee to the lessor of Rs 55000 as residual value.



Monthly lease rental is Rs 15000 plus 2.5% of sales revenue per annum, lease term is 48 months. The sales revenue is Rs 10 lakhs The lessee also provides a guarantee to the lessor of Rs 10000 as residual value.

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AS 19- Leases

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Types

TYPES OF LEASES Finance Lease

It is a lease which transfers significantly all the risks & rewards incident to the ownership of an asset

Operating Lease

It is a lease other than a Finance Lease

TESTS FOR FINANCE LEASE 

Transfer of ownership of the asset to the lessee by the end of the lease period



Option to the lessee to purchase the asset at a price sufficiently lower than the fair value of the date on the date on exercise of the option which at the inception of the lease is reasonably certain that the option will be exercised



The lease term covers the major part of life of the asset



Present Value of the MLP almost equal to the Fair Value of the asset



The leased asset is of a specialized nature that only the lessee can use it & no one else without major modification

Significant risks & rewards of ownership transferred Transfer of ownership at end of lease period Option to purchase asset which is reasonably certain Lease period covers economic life of asset PV of MLP equals Fair Value

If any answer is YES then Finance Lease ELSE Operating Lease

Asset is of specialized nature & can be used by lessee only

RESIDUAL VALUE

For lessor

Amount guaranteed by lessee or any third party

For lessee

Amount guaranteed by lessee only

Guaranteed Residual Value Residual Value Unguaranteed Residual Value

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AS 19- Leases

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SOME IMPORTANT TERMS 

Gross Investment (GI)

=MLP + UNGUARANTEED RESIDUAL VALUE



Unearned Finance Income

=GI – PRESENT VALUE OF GI



Net Investment

=GI - UNEARNED FINANCE INCOME

ACCOUNTING TREATMENT-OPERATING LEASE 

LESSEE Lease payments are expenses & should be charged to P&L



LESSOR Present the asset under Fixed Assets Recognize lease income in P&L on a systematic basis over the lease term Depreciate the asset as per AS 6

ACCOUNTING TREATMENT-FINANCE LEASE 

LESSEE Though there is no transfer legal ownership the substance of the transaction the lessee enjoys the economic benefits for a major part of its life as if he was the real owner A finance lease should be recognized both as an asset & liability Do no net off the asset & the liability Amount to be recognized as asset & liability is lower of –

Fair Value &

–

Present Value of Minimum Lease Payments (lessee viewpoint)

Subsequently when the lease rentals are paid they should be separated into 2 components –

Towards the liability (to be reduced from liability)

–

Towards Finance Charges (to be charged to P&L)

The asset should be depreciated as per AS 6

Lessee Initial Recognition

Recognize lower of FV & PV of MLP as asset & liability

Subsequently

Separate the lease rentals into principal repayment & finance charges Depreciate the asset as per AS 6



LESSOR Recognize a receivable (asset) at an amount equal to Net Investment in the lease Break up lease rent received into –

Finance Income (credit to P&L)

–

Principal (reduce from receivable)

Do not provide depreciation since no Fixed Asset A/c is created in the books of Lessor

SALE & LEASE BACK 

If Sale and Lease back results into Finance LeaseSeller Lessee

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AS 19- Leases

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

–

Should not recognize the income or loss (difference between carrying amount & sale value) immediately to P&L

–

Defer & recognize in proportion to depreciation over lease period

If Sale And Lease Back results into Operating Lease Seller lessee should –

Recognize the gain/loss immediately

–

However if at time of sale FV is less than carrying amount the loss (difference between carrying amount & FV) to be recognized over period of use

Particulars

Situation I

Situation II

Situation III

Fair value at the time of sale & lease back

Rs 1,00,000

Rs 1,00,000

Rs 1,00,000

Sale proceeds

Rs 1,00,000

Rs 88,000

Rs 1,15,000

Rs 96,000

Rs 96,000

Rs 1,12,000

Profit Rs 4,000

Loss of Rs 8,000 recognized immediately

Recognize impairment loss of Rs 12,000 first & then recognize gain of Rs 15,000 over lease period

Carrying amount of asset Difference between Carrying amount & sale proceeds

Recognize immediately

ILLUSTRATION 1. X & Co is in the business of providing cars to corporates on yearly contract basis. The life of a car is estimated to be 10 years. Lease rentals of one year is Rs 150000. After one year the lease may be renewed. In case any car creates a problem then that will be replaced by X & Co. Examine the type of lease. Solution Operating Lease because 

Lease term is one year & life is 10 years & renewal of lease is not certain.



Risk of problem in car borne by lessor

ILLUSTRATION 2. X & Co leased an asset to Y Ltd on the following terms & conditions 

Cost of the asset- Rs 20 lacs



Lease period 5 years



Annual lease rentals is Rs 596650



Life of the asset is 5 years

Examine the type of lease Solution Finance Lease because Lease term covers major part of life of asset

ILLUSTRATION 3. X & Co leased an asset to Y Ltd on the following terms & conditions 

Cost of the asset- Rs 20 lacs



Lease period 5 years

8008149787, 9908063153

AS 19- Leases

Page 4


Annual lease rentals is Rs 596650



Life of the asset is 15 years

Examine the type of lease if discount rate is 15% Solution Finance Lease because The PV of MLP is almost equal to the cost of the asset

ILLUSTRATION 4. Kim Ltd took a machine costing Rs 20 lakhs on lease for 5 years. The lease rentals are Rs 2 lakhs p.a. & life of asset is 12 years. The discount factors @ 15% for 5 years are 0.87, 0.76, 0.66, 0.57, 0.50 Solution Operating lease because life is 12 years & lease period is 5 years PV of MLP is not equal to cost/fair value of the asset

ILLUSTRATION 5. Alex Ltd took a machine on lease the details are as follows 

Lease period 5 years & lease rentals Rs 3 lakhs



Cost of machine Rs 30 lakhs & life is 14 years



Implicit rate of interest is 15%.

Give the type of lease Solution Life is 14 years & lease period is 5 years PV of MLP is Rs 10.08 & cost of machine is Rs 30 lakhs

ILLUSTRATION 6. A Ltd leased a machinery to B Ltd on the following terms 

Fair value of machinery-Rs 20 lakhs



Lease term- 5 years



Lease rentals – Rs 5 lakhs



Guaranteed Residual Value- Rs 1 lakh



Expected Residual Value- 2 lakhs



Discount Rate- 15%

Compute unearned financial income Solution PV of GI

= PV of Lease rentals + PV of GRV + PV of UGRV = 5,00,000 * PVAF(15%, 5yrs) + 1,00,000 * PVF(15%, 5yrs) + 1,00,000 * PVF(15%, 5yrs) = Rs 16,76,078 + Rs 49,718 + Rs 49,718 = Rs 18,74,948

Unearned Finance Income = GI – PV of GI = [5,00,000*5 + 1,00,000 + 1,00,000] - 18,74,948 = Rs 8,25,052

ILLUSTRATION 7.

8008149787, 9908063153

AS 19- Leases

Page 5

CA IPCC-Accounting Standards by CA Kisan Rajpurohit A Ltd leased a machinery to B Ltd on the following terms (treat as finance lease) 

Fair value of machinery-Rs 20 lakhs



Lease term- 5 years



Lease rentals – Rs 5 lakhs



Guaranteed Residual Value- Rs 1 lakh



Expected Residual Value- 2 lakhs



Discount Rate- 15%



Depreciation to be provided on SLM @ 10% p.a. Please do the necessary accounting in the books of lessee

Solution Particulars Initial Recognition

Asset a/c

Rs

Rs

Dr

17,25,820

17,25,820

Dr

2,58,873

2,58,873

Dr

5,00,000

5,00,000

Dr

1,72,582

1,72,585

To A Ltd a/c At the year end

Finance charges To A Ltd a/c A ltd To Bank a/c Depreciation a/c To Asset a/c

ILLUSTRATION 8. Apex Ltd has taken a machinery on lease from Shiva Ltd on 1st Jan, 2007. The lease term covers the entire economic life of the machinery i.e. 3 years. The fair value is Rs 3,50,000. Lease rentals are RS 1,50,000 p.a. Apex has guaranteed a residual value of Rs 11,400. Implicit rate of interest is 15%. Compute the amount to be recognized by Apex & also the finance charges every year.

ILLUSTRATION 9. (Very Important) Fair value- 20 lakhs Lease term- Rs 5 years Lease rentals- Rs 5,00,000 p.a. Guaranteed Residual Value- Rs 1,00,000 Expected Residual value- Rs 2,00,000 Implicit Interest rate- Rs 15% Depreciation is provided on @ 10% p.a on SLM. Ascertain unearned finance income and pass necessary entries in the books of the lessee in the first Calculate the amount to be recorded by the lessee & the finance charges. Solution Computation of Unearned Finance Income (i) Gross investment = Minimum lease payments + Unguaranteed residual value = (Total lease rent + Guaranteed residual value) + Unguaranteed residual value = [(Rs. 5,00,000 * 5 years) + Rs. 1,00,000] + Rs. 1,00,000 = Rs. 27,00,000

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AS 19- Leases

Page 6


(ii) Table showing present value of (i) Minimum lease payments (MLP) and (ii) Unguaranteed residual value (URV).

Year 1 2 3 4 5 5 5

MLP inclusive of URV 5,00,000 5,00,000 5,00,000 5,00,000 5,00,000 1,00,000 [GRV} 1,00,000 [UGRV}

PV Factor @ 15% 0.8696 0.7561 0.6575 0.5718 0.4972 0.4972

PV 434783 378072 328758 285877 248588 49718

0.4972

49718 1775513

Journal Entries in the books of B Ltd. Rs.

Rs.

At the inception of lease Machinery account

Dr.

7,25,820

To A Ltd.’s account

17,25,820*

(Being lease of machinery recorded at present value of MLP) At the end of the first year of lease Finance charges account (Refer W. N.)

Dr.

2,58,873

To A Ltd.’s account

2,58,873

(Being the finance charges for first year due) A Ltd.’s account

Dr.

5,00,000

To Bank account

5,00,000

(Being the lease rent paid to the lessor which includes outstanding liability of Rs. 2,41,127 and finance charge of Rs. 2,58,873) Depreciation account

Dr.

1,72,582

To Machinery account

1,72,582

(Being the depreciation provided @ 10% p.a. on straight line method) Profit and loss account

Dr.

4,31,455

To Depreciation account

1,72,582

To Finance charges account

2,58,873

8008149787, 9908063153

AS 19- Leases

Page 7

CA IPCC-Accounting Standards by CA Kisan Rajpurohit (Being the depreciation and finance charges transferred to profit and loss account)A Working Note: Table showing apportionment of lease payments by B Ltd. between the finance charges and the reduction of outstanding liability.

Outstanding liability (opening balance)

Lease rent

Finance charge

Rs.

Rs.

Rs.

Rs.

Rs.

1

17,25,820

5,00,000

2,58,873

2,41,127

14,84,693

2

14,84,693

5,00,000

2,22,704

2,77,296

12,07,397

3

12,07,397

5,00,000

1,81,110

3,18,890

8,88,507

4

8,88,507

5,00,000

1,33,276

3,66,724

5,21,783

5

5,21,783

5,00,000

78,267

5,21,783

1,00,050*

8,74,230

17,25,820

Year

Reduction in Outstanding liability outstanding liability (closing balance)

*The difference between this figure and guaranteed residual value (Rs. 1,00,000) is due to approximation in computing the interest rate implicit in the lease. * As per para 11 of AS 19, the lessee should recognise the lease as an asset and a liability at an amount equal to the fair value of the leased asset at the inception of lease. However, if the fair value of the leased asset exceeds the present value of minimum lease payments from the standpoint of lessee, the amount recorded should be the present value of these minimum lease payments. Therefore, in this case, as the fair value of Rs. 20,00,000 is more than the present value amounting Rs. 17,25,820, the machinery has been recorded at Rs. 17,25,820 in the books of B Ltd. (the lessee) at the inception of the lease. According to para 13 of the standard, at the inception of the lease, the asset and liability for the future lease payments are recognised in the balance sheet at the same amounts.

8008149787, 9908063153

AS 19- Leases

Page 8


AS 20: EARNINGS PER SHARE OBJECTIVE OF AS 20 

Earnings Per Share an important financial ratio



EPS influences market price of a share



AS 20 lays down the principles for the computation & presentation of EPS



The standard makes inter firm & intra firm EPS comparison possible

TYPES OF EPS 

Two types of EPS to be reported on face of P&L A/c Basic EPS Diluted EPS

BASIC EPS 

Basic EPS =



Net Profit or Loss for the period attributable to equity shareholders Net profit/loss from operations

xxxxxxx

+/-Prior Period Items

xxxxxxx

+/-Extra Ordinary Items

xxxxxxx

-Tax provision -Preference Dividend

xxxxxxx

-Corporate Dividend Tax on Preference Dividend

xxxxxxx

Net Profit or loss attributable to equity shareholders

xxxxxxx

Any transfers to reserves should be ignored 

Weighted Average No of Equity Shares Outstanding during the Period Determine the number of shares outstanding at the beginning of the period Determine the number of shares issued during the period Determine the shares bought during the period Computer Weighted Average Number of Shares by multiplying by outstanding period & dividing by total period Note- Partly Paid shares to be equalized to fully paid up shares



Date of inclusion of shares

Shares issue for cash

Date on which consideration becomes receivable

As a result of conversion of debt into equity

Date of conversion

In exchange for settlement of a liability

Date when settlement becomes effective

As consideration for acquisition of asset

Date on which the acquisition is recognized

In an amalgamation in the nature of purchase

Date of acquisition


AS 20- Earnings Per Share

Page 8.1

CA IPCC-Accounting Standards by CA Kisan Rajpurohit In amalgamation in the nature of merger

From the beginning of the reporting period

Bonus issue

From the beginning of earliest period reported

Share split

From the beginning of the earliest period reported

Right issue

Bonus element

From the beginning of the earliest period reported

Cash element

From the date of issue of shares

Bonus & Share Split 

Bonus & share split result in increase in the number of shares without a corresponding increase in the resources



They are assumed to be issued from the beginning of the earliest period reported



Thus bonus/share split should not be subjected to the time factor



The previous year’s EPS also has to be restated

Right Issue 

In a right issue the exercise price is often less then the fair value of the share



Thus there is bonus element in a right issue



This bonus element should be treated as bonus issue & should be counted from the beginning of the earliest reported period



The cash element should be counted from the date of issue of shares



Steps Take the fair value of shares before the right issue Calculate theoretical ex right price=[No of shares before right issue*FV+No of shares in right issue * issue price] / Total shares after right issue Calculate adjustment factor=FV/Theoretical Ex right price Weighted Average no of equity shares=AF*shares before right issue*time weight+ shares after right issue*time weight

DILUTED EPS Potential Equity Share 

A potential equity share is a financial instrument or other contract that entitles or may entitle its holder the right to acquire equity shares



Examples of potential equity shares – Debentures/debt convertible into equity – Convertible preference shares – Share warrants – Stock options given to employees – Share application money



The formula for diluted EPS the same as Basic EPS



However the numerator & the denominator both need to be adjusted



Adjustment to Net profit Attributable to Equity Shareholders Add back dividend on convertible preference shares Add dividend distribution tax on preference dividend Interest on convertible debentures Loss of tax shield on interest on convertible debentures



Page 8.2

CA IPCC-Accounting Standards by CA Kisan Rajpurohit Any other changes in expenses or income that would result from the conversion of the potential equity shares 

Adjustment to weighted Average no of equity shares outstanding Add the equity shares that would arise on the conversion of all potential equity shares The potential equity shares are deemed to have been issued at the beginning of the period & if issued later then the date of issue of potential equity shares

Dilutive & Anti-Dilutive 

Potential Equity Shares are dilutive when their conversion would decrease the EPS



Potential Equity shares are anti-dilutive when their conversion would increase the EPS



If the diluted EPS is more than the basic EPS then the potential equity shares are anti-dilutive & SHOULD NOT be reported in that case the Basic EPS should be taken as diluted EPS

AS 20 DISCLOSURE REQUIREMENTS 

Basic & Diluted EPS should be disclosed on the face of the P&L



EPS should be disclosed even if it is negative



The restated EPS for the previous year should also be disclosed



The nominal value of shares along with the EPS

ILLUSTRATION 1. ABC Ltd has 10000 equity shares outstanding on 1-1-04. Compute the weighted average number of equity shares for the year 2004 in EACH of the following cases a) Issued 2000 shares for cash on 1-1-2004 b) Issued 2000 shares for cash on 1-4-2004 c) Issued 2000 shares for cash on 1-10-2004 Solution a) Weighted Average Number of shares (WANES) = 10000 + 2000 = 12000 shares b) WANES = 10000 + 2000 × 9/12 = 11500 shares c) WANES = 10000 + 2000 × 3/12 = 10500 shares

ILLUSTRATION 2. Ravi Ltd follows calendar year. 

It issued Rs 80 lakh equity shares at par on 15th September.



It also bought back Rs 20 lakh equity shares at par on 1st December.



The equity capital was Rs 150 lakhs at the end of the year. Computer WANES if face value per share is Rs 100. Also calculate Basic EPS if Net profit to equity is Rs 10 lakhs

Solution

Shares at the end (FV Rs 100) Add: Buyback Less: Fresh Issue Shares at the beginning

Opening Shares (FV Rs 100) Fresh issue Buyback


150000 20000 -80000 90000 Nos 90000 80000 20000

No of months 12 3.5 1

Weight 1 3.5/12 1/12 WANES

Product 90000 23333 -1667 111667


Page 8.3

CA IPCC-Accounting Standards by CA Kisan Rajpurohit Basic EPS

= =

=Rs 8.96 per share

ILLUSTRATION 3. Calculate Basic EPS from the following: No of equity shares in the beginning

6,00,000

12% Preference Share Capital in the beginning

Rs 15,00,000

10% Debentures

Rs 20,00,000

Fresh Issue of shares at the end of the 3rd month

1,20,000

Profit for the year (after tax)

Rs 21,00,000

Solution

PAT Less: Preference Dividend [1500000*12%] PAT to Equity Shareholders

2100000 -180000 1920000

WANES = 600000 + 120,000 * 9/12 = 690000 shares Basic EPS

= 192000/690000 = Rs 2.78 per share

ILLUSTRATION 4. At the beginning of a financial year a company issued 120,000 equity shares of Rs 100 each, Rs 50 per share was called up on that date which was paid by all shareholders. The remaining Rs 50 was called up on 1st September. All shareholders paid the sum in September except one shareholder having 24000 shares. Net profit attributable to equity is Rs 264000. Calculate Basic EPS. Solution

Nos

Weight

Product

Shares at the beginning (Equivalent Shares) [120000 * 50/100]

60000

5/12

25000

Shares post call excluding one shareholder [120000 - 24000] (fully paid for 7 months)

96000

7/12

56000

7/12

7000 88000 shares Rs 264000 Rs 3 per share

Shares held by one shareholder [24000 * 50/100] 12000 A. WANES B. Profit attributable to equity shareholders C. Basic EPS [B/A] ILLUSTRATION 5.

Alex Ltd provides the following information. Compute Basic EPS.



Page 8.4


No of equity shares at the beginning of the period= 500000



Bonus issue on 1st July of current year= 3 shares for every 1 share held



Net profit for the current year & the previous reporting period Rs 160 lakhs & Rs 50 lakhs

Solution As per AS 20 “Earnings Per Share” bonus shares should be considered from the beginning of the earliest period reported. Also the EPS of previous years is also revised. The weighted average number of shares have been accordingly calculated. 

Number of bonus shares issued = 500000 × 3 = 150000



WANES = (500000×1) + (1500000×1) = 20,00,000



Basic EPS = 160/20 = Rs 8 per share



Restated EPS of last year = 50/20 = Rs 2.5 per share

ILLUSTRATION 6. PQR Ltd has 500000 equity shares outstanding on 1-4-2009. The FV of the shares was Rs 45. Right issue of 2:5 @ Rs 36/share was made on 1-10-2009. Find basic EPS given that net profit is Rs 2500000 Solution No of shares in the beginning

500000

Right issue ratio

2 for every 5

No of right shares to be issued

500000*2/5= 200000 shares

FV of shares before right issue

Rs 45/share

Issue price

Rs 36/share

Theoretical ex right price

Rs 42.43

(500000*45)+(200000*36) (500000+200000) Adjustment Factor=FV/ex right price

45/42.43=1.06

Weighted Average No of shares=

615000 shares

(AF*shares at beginning*6/12) + (post right shares * 6/12) Net profit for the current year

Rs 2500000

Basic EPS=Net Profit/weighted average no of shares outstanding

2500000/615000= Rs 4.06 per share

ILLUSTRATION 7. RST Ltd has 1,00,000 equity shares outstanding at the beginning of the year. After 3 months it issued right shares in the ratio of 1:5 @ Rs 20 per share. The FV of the shares before the right issue was Rs 30 per share. Net profit for the current year is Rs 18,00,000& for the previous year was Rs 14,00,000. Find out the basic EPS for the current year & the restated EPS for the previous year. Solution Rs 15.45 & Rs 13.21

ILLUSTRATION 8. Computer weighted average no of equity shares. 1st April, 2001

Balance of equity shares

360000

31st August, 2001

Equity shares issued for cash

120000

1st February, 2002

Equity shares bought back

60000



Page 8.5

CA IPCC-Accounting Standards by CA Kisan Rajpurohit 31st March, 2002

Balance of equity shares

420000

Solution

Balance of equity shares Equity shares issued for cash Equity shares bought back

360000 120000 -60000

Weight 1 7/12 2/12 WANES

Product 360000 70000 -10000 420000

ILLUSTRATION 9. Calculate Basic EPS from the following-Accounting year is calendar year Net profit

Year 2002

Rs 20,00,000

Year 2003

Rs 30,00,000

No of shares prior to right issue

10,00,000

Right issue

1:4

Right issue price

Rs 20

Last date of exercising rights

31/3/2003

Fair value before right issue

Rs 25 per share

Solution Rs 2.5 per share & 1.92

ILLUSTRATION 10. Calculate Basic EPS from the following 1st April

Number of shares outstanding

10,000

1st June

Issue of shares- Face value Rs 100, paid up amount Rs 70

10,000

1st July

Buyback of shares fully paid up

4000

1st November

Issue of shares fully paid up Rs 100

6000

Net profit before tax for the year (tax rate=35%) Preference dividend (dividend distribution tax=12.5%)

Rs 12 lakhs Rs 5 lakhs

Solution Rs 14.19 per share

ILLUSTRATION 11. Compute Basic & Diluted EPS  Net profit after tax for the current year-Rs 1,00,00,000  No of equity shares outstanding – 50,00,000  Income Tax- 30%  No of 12% debentures of Rs 100 each-1,00,000  Each debenture is convertible into 10 equity shares. Solution



Page 8.6

CA IPCC-Accounting Standards by CA Kisan Rajpurohit CALCULATION OF BASIC EPS A B C

PAT as given No of equity shares outstanding Basic EPS [A/B]

1,00,00,000 50,00,000 Rs 2 per share

CALCULATION OF DILUTED EPS D PAT as given E Add: Interest on debentures [100000*12] F Loss on tax shield [12,00,000 × 30%] G Adjusted profit H Shares to be issued on conversion [100000×10] I TOTAL SHARES [50,00,000+10,00,000] J Diluted EPS [G/I]

1,00,00,000 12,00,000 -3,60,000 1,08,40,000 10,00,000 60,00,000 Rs 1.81 per share

ILLUSTRATION 12. Compute Basic & Diluted EPS  Net profit after tax for the current year-Rs 50 lakhs  No of equity shares outstanding – 10 lakhs  No of 15% convertible debentures of Rs 100 each-50,000  Each debenture is convertible into 5 equity shares  Income Tax Rate is 30% Solution Basic Rs 5 & Diluted EPS- 4.42

ILLUSTRATION 13. Compute Basic & Diluted EPS  Net profit after tax attributable to equity for the current year-Rs 50 lakhs  No of equity shares outstanding – 10 lakhs  No of 12% convertible preference shares of Rs 100 each-50,000  Each preference share is convertible into 8 equity shares  Income Tax Rate is 30% & dividend distribution tax is 12.5% Solution

CALCULATION OF BASIC EPS A B C

PAT as given No of equity shares outstanding Basic EPS [A/B]

50,00,000 10,00,000 Rs 5 per share

CALCULATION OF DILUTED EPS D PAT as given E Add: Preference Dividend [50,000*12] F Add: Dividend Distribution tax [6,00,000 × 12.5%] AS by CA Kisan Rajpurohit 8008149787, 9908063153

50,00,000 6,00,000 75,000


Page 8.7

CA IPCC-Accounting Standards by CA Kisan Rajpurohit G Adjusted profit H Shares to be issued on conversion [50,000×8] I TOTAL SHARES J Diluted EPS

56,75,000 4,00,000 14,00,000 Rs 4.05 per share

ILLUSTRATION 14. Compute Basic & Diluted EPS  Equity share of Rs 10 each as at the beginning of the FY- 50,00,000.  Net profit for the year- Rs 2,00,00,000  Issue of shares for cash on 1st July- 10,00,000 shares  Bonus issue 1:5 on 1st Oct only to shares existing at the beginning of the year  Convertible debentures FV Rs 100 outstanding at the beginning of the year= 10% debentures for Rs 1,00,00,000 (each is convertible into 10 equity shares)  Company tax rate is 40% Solution Basic 2.96 & Diluted 2.66

ILLUSTRATION 15.  Outstanding equity shares at the beginning of the year- 10,00,000  Net profit attributable to equity- Rs 35,00,000  1,00,000 10% convertible preference shares of Rs 100 each to be converted into 2 equity shares  Corporate dividend tax is 10% & income tax rate is 30%. Compute Basic & Diluted EPS Solution

A B C

CALCULATION OF BASIC EPS PAT as given 35,00,000 No of equity shares outstanding 10,00,000 Basic EPS [A/B] Rs 3.5 per share CALCULATION OF DILUTED EPS

D PAT as given E Add: Preference Dividend [1,00,000×10] F Add: Dividend Distribution tax [10,00,000 × 10%] G Adjusted profit H Shares to be issued on conversion [100000×2] I TOTAL SHARES J Diluted EPS

35,00,000 10,00,000 1,00,000 46,00,000 2,00,000 shares 12,00,000 shares Rs 4.05 per share (Anti-Dilutive)

The Diluted EPS is anti dilutive (it is more than Basic EPS). Therefore Basic EPS will be Diluted EPS. Thus Basic EPS is Rs 3.5 per share & Diluted EPS is also Rs 3.5 per share



Page 8.8


AS 26: INTANGIBLE ASSETS ASSET An Asset is a resource Controlled by an enterprise As a result of past events & From which future economic benefits are expected to flow to the enterprise Example-Purchase of a machinery on 8th April, 2010 for Rs 50 lakhs

TYPES OF ASSETS Tangible

They have a physical substance & can be seen & touched E.g. land, building, plant & machinery etc

Intangible (they do not have physical substance & cannot be seen or touched)

Unidentifiable They cannot be identified separately from other assets like internally generated goodwill Acquired identifiablee.g. patents, licences & trademarks for which a cost is incurred Internally generated identifiable Brands etc

OBJECTIVE OF AS 26 

Prescribe the accounting treatment for intangible assets



Prescribe the criteria for recognition of assets in books of account



How to measure the amount at which the intangible assets should be recorded in books



Amortization method for intangible assets



Disclosure about intangible assets in financial statements of the enterprises

WHAT IS AN INTANGIBLE ASSET? 

It is an identifiable non monetary asset without physical substance held for use – in the production or – supplying of goods or services for rentals to others or – for administrative purposes



Thus the main features are: identifiable, non monetary& without physical substance

8008149787 9908063153

AS 26- Intangible Assets

Page 1

CA IPCC-Accounting Standards by CA Kisan Rajpurohit Identifiable

Non monetary

•An asset is identifiable if it is separable from other assets & can be sold, rented or exchanged.

•Non monetary means the value to be received against the assets is not fixed by contract or otherwise.

•However separability is not a necessary condition if the asset can be identified in some other way

•E.g. of monetary assets are debtors, B/R etc

Physical substance •Intangibles should not have physical substance •If any physical substance is there then cost of physical substance should be insignificant

•E.g. of non monetary assets are fixed assets

RECOGNITION CRITERIA Asset

The intangible asset must have the characteristics of an asset

Future economic benefits

There must be probable future economic benefits flowing to the enterprise

Reliably measured

The cost of the intangible can be measured reliably

INITIAL MEASUREMENT 

Once the intangibles fulfill the criteria for asset recognition next point is at what amount should the asset be shown



The intangible asset should be initially shown at cost

WHAT IS COST OF INTANGIBLES? 

Separate acquisition If acquired separately then cost shall be purchase price, import duties &non refundable taxes & directly attributable expenses



Exchange of assets If acquired in exchange of assets the cost shall be fair value of assets given up



Acquired by issue of shares/securities Fair value of intangibles acquired or fair value shares/securities issued whichever is more clearly evident



Acquisition through Government grants Some intangibles for e.g. radio licences may be given by granted free or at concessional rate. In such case record at nominal value or concessional rate

INTERNALLY GENERATED INTANGIBLES Goodwill 

An enterprise gradually develops goodwill during the continuance of business



This is internally generated goodwill



Such goodwill is generated because of number of factors such as good business practice, well trained employees, advertisement etc



Though cost is involved in the above it cannot be reliably measured-NOT



Thus self generated goodwill is NOT RECOGNIZED in books

Research & Development 

Most of the internally generated intangible go through the two phases

8008149787 9908063153


Page 2

CA IPCC-Accounting Standards by CA Kisan Rajpurohit Research- Aimed at creating/inventing a new product Development- Conversion of research results into a marketable product 

Research Cost Should be treated as an expense & charged to P&L & should NOT BE CAPITALISED



Development Expenses They should also be treated as expenses to be charged to P&L until they meet the asset recognition criteria. The following points need to be demonstrated –

Technical feasibility of the product & ability to sale or use it

–

Capability to generate economic benefits

–

Availability of technical, financial & other resources to complete development & to use or sell it

–

Ability to measure the expenditure during development

Cost of internally generated intangibles: Comprise of the following

Excludes the following

•Expenditure on materials & services used or consumed

•OH not directly attributable like selling, admin etc

•Salaries, wages etc of persons engaged in the development

•Inefficiencies & initial losses before the recognition criteria is met

•Any other directly attributable expenditure

•However internally generated publishing titles should not be recognized as an asset because the cost cannot be measured reliably

•OH that can be reasonably allocated

RECOGNITION AS EXPENSE 

Expenditure on intangible is charged as an expense when incurred unless it meets the recognition criteria



Certain expenditure though incurred to provide future economic benefits but does not create any intangible or other asset is recognized as expense



Example –

Expenditure on research

–

Startup cost

–

Preliminary expenses

–

Expenditure on training

–

Advertising

–

Promotional activities

–

Relocation or re organization of the enterprise

PAST & SUBSEQUENT EXPENSE 

Expenditure on intangible item once charged as expense in the financial statements cannot be later on reversed or treated as asset



Expenditure incurred subsequent to purchase or completion of intangible asset shall be treated as expense except in the following cases The expenditure results into future economic benefits higher than originally assessed & the expenditure can be measured & attributed to the asset reliably

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AMORTIZATION 

The intangible asset should be amortized on a systematic basis over the best estimate of its useful life



The period should not normally exceed 10 years or legal life whichever is less



Amortisation period & method should be reviewed atleast each financial year end



Amount of amortisation should reflect the pattern in which economic benefits are consumed by the enterprise



The intangible asset should be amortized on a systematic basis over the best estimate of its useful life



The period should not normally exceed 10 years or legal life whichever is less

RETIREMENT & DISPOSAL 

Eliminate from balance sheet if The intangible has been disposed or No future economic benefits are expected from the use of the asset

DISCLOSURES 

Disclose Each class of intangibles Useful life &amortisation period Amortisation method Gross carrying amount & accumulated amortisation Other disclosures like additions, retirements, disposals etc

ILLUSTRATIONS ILLUSTRATION 1. Alex Ltd is developing a new production design. The costs incurred are as followsYear

Phase

Amount Rs crores

1998

Research

8

1999

Research

10

2000

Development

30

2001

Development

36

2002

Development

40

On 1-1-2000 Alex Ltd demonstrated the criteria of asset recognition Determine the treatment of expenses incurred in different years Solution As per AS 26, “Intangible Assets” research expenses should be treated as an expense & charged to P&L & should not be capitalised. Even development expenses should also be treated as expenses to be charged to P&L until they meet the asset recognition criteria. The following points need to be demonstrated –

Technical feasibility of the product & ability to sale or use it

–

Capability to generate economic benefits

–

Availability of technical, financial & other resources to complete development & to use or sell it

–

Ability to measure the expenditure during development

In the given case the recognition criteria is met in 2000 and therefore Rs 106 lakhs will be capitalised & Rs 18 lakhs will be charged to profit & loss account being research expenses.

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CA IPCC-Accounting Standards by CA Kisan Rajpurohit ILLUSTRATION 2. A company spent Rs 45 lakhs on research & Rs 20 lakhs on publicity of a new product in 2010. However the product failed. Please comment. Expenditure on intangible is charged as an expense when incurred unless it meets the recognition criteria. Certain expenditure though incurred to provide future economic benefits but does not create any intangible or other asset is recognized as expense. In the given case Rs 45 lakhs has been spent on research and Rs 20 lakhs has been spent on publicity. However since the product failed and the research can be used for other purposes even then the recognition criteria was not met and therefore the entire amount of Rs 65 lakhs will be charged to P&L account.

ILLUSTRATION 3. Himalaya spent in the past three years Rs 75 lakhs to develop a drug to treat cancer which was charged to P&L since it did not meet the recognition criteria. However in the current the recognition criteria has been met & Himalaya wants to capitalise the Rs 75 lakhs spent & disclose as prior period item. Is the company correct.

ILLUSTRATION 4. Alex Ltd has paid Rs 5 crores for technical knowhow for 4 years for bikes The production is as follows 

Year 1-25000 bikes



Year 3-75000



Year 2-50000



Year 4-100000

Calculate amount to be amortised in each year. The intangible asset should be amortized on a systematic basis over the best estimate of its useful life. Amount of amortisation should reflect the pattern in which economic benefits are consumed by the enterprise. The given case the amortisation will be calculated as follows:

Year Production Ratio 1 25000 1 2 50000 2 3 75000 3 4 100000 4 10

Amortisation (lacs) 50 100 150 200 50000

ILLUSTRATION 5. ABC Ltd. developed know-how by incurring expenditure of Rs.20 lakhs. The know-how was used by the company from 1.4.2002. The useful life of the asset is 10 years from the year of commencement of its use. The company has not amortised the asset till 31.3.2009. Pass Journal entry to give effect to the value of know-how as per Accounting Standard-26 for the year ended 31.3.2009. Solution Profit & Loss A/c (Prior Period Item)

Dr. 12,00,000

Depreciation A/c

Dr. 2,00,000

To Knowhow A/c

14,00,000

(Being depreciation of 7 years out of which 6 years depreciation charged as prior period item)

ILLUSTRATION 6. Shoolini launched a project for producing a new product. The company incurred Rs 20 lakhs towards R&D expenses upto 31st March. Due to prevailing conditions, the management came to the conclusion that the product cannot be manufacture and sold in the market for the next 10 years. The management hence wants to defer the expenditure write off to future years. Advise. 8008149787 9908063153


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CA IPCC-Accounting Standards by CA Kisan Rajpurohit Solution The entire expenditure on research should be recognized as expense when it is incurred. Any deferment thereof is not allowed. In the given case the company should treat the entire amount spent on research as an expense in the year in which is expenditure is incurred.

ILLUSTRATION 7. Explain the provisions of AS 26 relating to retirement and disposal of intangible assets. Solution As per AS 26 “Intagible Assets”, intangible asset should be derecognised (eliminated from the balance sheet) on disposal or when no future economic benefits are expected from its use and subsequent disposal. Gains or losses arising from the retirement or disposal of an intangible asset should be determined as the difference between the net disposal proceeds and the carrying amount of the asset and should be recognised as income or expense in the statement of profit and loss. An intangible asset that is retired from active use and held for disposal is carried at its carrying amount at the date when the asset is retired from active use. At least at each financial year end, an enterprise tests the asset for impairment under Accounting Standard on Impairment of Assets, and recognises any impairment loss accordingly.

ILLUSTRATION 8. Can internally generated brands, publishing titles and other similar items be recognized as intangible assets? Solution Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance should not be recognized as intangible assets. Expenditure on internally generated brands, mastheads, publishing titles, customer lists and items similar in substance cannot be distinguished from the cost of developing the business as a whole. Therefore, such items are not recognized as intangible assets.

ILLUSTRATION 9. A Pharma Company spent Rs. 33 lakhs during the accounting year ended 31st March, 2010 on a research project to develop a drug to treat “AIDS”. Experts are of the view that it may take four years to establish whether the drug will be effective or not and even if found effective it may take two to three more years to produce the medicine, which can be marketed. The company wants to treat the expenditure as deferred revenue expenditure. Solution As per AS 26 „Intangible Assets‟, no intangible asset arising from research (or from the research phase of an internal project) should be recognised. Expenditure on research (or on the research phase of an internal project) should be recognised as an expense when it is incurred. Thus the company cannot treat the expenditure as deferred revenue expenditure. The entire amount of Rs. 33 lakhs spent on research project should be charged as an expense in the year ended 31st March, 2010.

ILLUSTRATION 10. On January 2, 2009, Devansh Co. Ltd. bought a trademark from Induga Co. for Rs.10,00,000. Devansh Co. Ltd. hired an independent consultant, who estimated the trademark’s remaining life to be 20 years. Its unamortized cost on Induga Co.’s accounting records was Rs.5,00,000. Devansh Co. Ltd. decided to amortize the trademark over the maximum period allowed. In Devansh Co. Ltd.’s December 31, 2009 balance sheet, what amount should be reported, as accumulated amortization? Solution As per AS 26 „Intangible Assets‟ intangible assets should be measured initially at cost. Therefore, Devansh Co. Ltd. should amortise the trademark at its cost of Rs.10,00,000. The unamortised cost on the seller‟s books 8008149787 9908063153


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CA IPCC-Accounting Standards by CA Kisan Rajpurohit (Rs.5,00,000) is irrelevant to the buyer. Although the trademark has a remaining useful life of 20 years, intangible assets are generally amorised over a maximum period of 10 years per AS 26. Therefore, for the year 2009, amortisation expense and accumulated amortisation is 1,00,000 (Rs.10,00,000 ÷ 10 years).

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AS 29: PROVISIONS, CONTINGENT LIABILITIES & CONTINGENT ASSETS ASPECTS COVERED BY AS 29 AS 29

Provisions

Contingent Liabilities

Provision for restructuring cost

Contingent Assets

PROVISIONS Provision •It is a liability which can be measured only by using a substantial degree of estimation

Liability

Present obligation

•It is a present obligation of the enterprise arising from past events the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits

•An obligation is a present obligation if based on evidence available its existence on the balance sheet date is considered probable i.e. more likely than not

The following 3 conditions need to be satisfied to recognize provisions



1. The enterprise has a Present Obligation as a result of past events 2. It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation 3. A reliable estimate can be made of the amount of the obligation

CONTINGENT LIABILITY 

It is a possible obligation that arises from past event & existence of which will be confirmed only by the occurrence or non occurrence of one or more uncertain future events non wholly within the control of the enterprise

CONTINGENT ASSETS 

It is a possible asset that arises from past events the existence of which will be confirmed only by the occurrence or non occurrence of one or more uncertain future events not wholly within the control of the enterprise

PROVISION FOR RESTRUCTURING 

What is restructuring? It is a program that is planned & controlled by the management & materially changes either 

The scope of a business undertaken or

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AS 29- Provisions, Contingent Liabilities & Contingent Assets

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CA IPCC-Accounting Standards by CA Kisan Rajpurohit  



The manner in which that business is conducted

Examples –

Sale or termination of a line of business

–

Closure of business in a region/country

–

Relocation of business activities from one country or region to another

–

Change in management structure

Does not include –

Retraining or relocating continuing staff

–

Marketing

–

Investment in new system & distribution networks

What is restructuring cost? 

It includes Direct Expenditure arising from restructuring & not associated with ongoing activities of the enterprises Does not include



–

Cost of retraining or relocating continuing staff

–

Marketing cost

–

Investment in new system & distribution network

–

Expected loss on sale of assets due to restructuring

ILLUSTRATIONS ILLUSTRATION 1. The sales tax authority ordered an additional demand on the company for under payment of sales tax on the basis of under invoicing or goods. The company contended the case. The lawyer advised the company as on 31-3-2004 that there would be no liability. As on 31-3-2005 the lawyer advised the company that on the basis of latest development in the case, a liability would arise. Please advise the company. Solution For the year ended 31st March, 2004 –

There is no present obligation. The company should not make a provision but should disclose it as a contingent liability

For the year ended 31st March, 2005 –

On the basis of the evidence there is a present obligation & therefore a provision is required for the best estimate of amount to settle the obligation

ILLUSTRATION 2. Alex Ltd has filed the damages case of Rs 2 crores against Zee Ltd for not supplying the quantity & quality of goods as per order. The chances of winning the case by Alex Ltd is probable. Please comment. Solution 

Possible asset –



As a result of past events –



Past event is non supply of goods as per order

Existence will be confirmed by the future event –



Yes, possible assets are 2 crores because if Alex win the case it will get Rs 2 crores

Court order

Future event not controlled –

Alex Ltd cannot control/influence the court order

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CA IPCC-Accounting Standards by CA Kisan Rajpurohit Hence suit for damages is a contingent asset for Alex Ltd

ILLUSTRATION 3. At the end of the financial year ending on 31st December, 2008, a company finds that there are twenty law suits outstanding which have not been settled till the date of approval of accounts by the Board of Directors. The possible outcome as estimated by the Board is as follows: Probability

Loss (Rs.)

In respect of five cases (Win)

100%

-

Next ten cases (Win)

60%

-

Lose (Low damages)

30%

1,20,000

Lose (High damages)

10%

2,00,000

Win

50%

-

Lose (Low damages)

30%

1,00,000

Lose (High damages)

20%

2,10,000

Remaining five cases

Outcome of each case is to be taken as a separate entity. Ascertain the amount of contingent loss and the accounting treatment in respect thereof. Solution According to AS 29 ‘Provisions, Contingent Liabilities and Contingent Assets’, contingent liability should be disclosed in the financial statements if following conditions are satisfied: (i) There is a present obligation arising out of past events but not recognized as provision. (ii) It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation. (iii) The possibility of an outflow of resources embodying economic benefits is also remote. (iv) The amount of the obligation cannot be measured with sufficient reliability to be recognized as provision.

In this case, the probability of winning of first five cases is 100% and hence, question of providing for contingent loss does not arise. The probability of winning of next ten cases is 60% and for remaining five cases is 50%. As per AS 29, we make a provision if the loss is probable. As the loss does not appear to be probable and the possibility of an outflow of resources embodying economic benefits is not remote rather there is reasonable possibility of loss, therefore disclosure by way of note should be made. Forthe purpose of the disclosure of contingent liability by way of note, amount may be calculated as under: Expected loss in next ten cases

= 30% of Rs. 1,20,000 + 10% of Rs. 2,00,000 = Rs. 36,000 + Rs. 20,000 = Rs. 56,000

Expected loss in remaining five cases

= 30% of Rs. 1,00,000 + 20% of Rs. 2,10,000 = Rs. 30,000 + Rs. 42,000 = Rs. 72,000

To disclose contingent liability on the basis of maximum loss will be highly unrealistic. Therefore, the better approach will be to disclose the overall expected loss of Rs. 9,20,000 (Rs. 56,000 10 + Rs. 72,000 5) as contingent liability.

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AS 4: CONTINGENCIES & EVENTS OCCURRING AFTER THE BALANCE SHEET DATE AS 4 COVERAGE

Contingencies

Covered by AS 29

Events after balance sheet date

Covered by AS 4

AS 4

DEFINITIONS  Events occurring after Balance Sheet date are those significant events (favourable or unfavourable)  that occur between the Balance Sheet Date &  the date on which the Financial Statements are approved by the appropriate authority 31st March FY ends

30th July (assumed) Approval by Board of Directors

Adoption by shareholders

TEST Which of the following are events occurring after Balance Sheet Date? FY ending on

Financial Statements approved on

st

31 March, 2010 th

30 June, 2010 st

31 Dec, 2010

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Event-A fire took place in factory causing huge damage

st

nd

31 July, 2010 st

31 August, 2010 st

1 March, 2011

2

June

st

1 September th

5 March, 2011

AS 4- Contingencies & Events occurring after the Balance Sheet date

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AS 4: COVERAGE

Events after balance sheet date

Events relate to circumstances existing on balance sheet date

Events not relating to circumstances existing balance on balance sheet date

Adjusting event Should be adjusted in the accounts & A&L should be adjusted

Non adjusting event No adjustment-Only disclosure by way of notes to accounts

ADJUSTING EVENTS

Nature of event

Example

Events relating to conditions existing on Balance Sheet date & which provide additional information materially affecting the assets & liabilities

A debtor defaulted in payment on 15th Feb & then became insolvent on 5th April

Events that make the fundamental accounting assumption inappropriate (going concern)

Earthquake in the factory premises destroying almost 80%. The company has only one factory

Statutory requirement

Proposed dividend needs to be adjusted as per Schedule VI of the Companies Act

Accounting Treatment  Such events should be accounted for in the P&L Account  The assets & liabilities as at the Balance Sheet should also be adjusted  Suitable disclosure should also be made

NON ADJUSTING EVENTS

Nature of event

Example st

Events does not relate to conditions existing on the Balance Sheet date

On 31 March the cost of investments is 30 lacs. Its value declines to 10 lacs on 5th April

Events that do not affect the figures stated in the financial statements

An important director of the company resigns

Accounting Treatment  No adjustment is required in the financial statements  However if the figures are significant, disclosure should be made in the report of the Board of Directors

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CA IPCC-Accounting Standards by CA Kisan Rajpurohit QUESTION 1.

A Ltd., whose accounting year ends on 31/03/2011, agreed in principle to sell a plot of land on 18/03/2011 at a price to be determined by an independent valuer. Pending the agreement for sale and due to nonreceipt of valuers report, the sale of the land could not be completed up to 31/03/11. The company received the report on April 7, 2011 and the agreement was signed on April 10, 2011. The financial statements for 2010-11 were approved by the board on May 12, 2011. Please comment. The sale of land, is an event occurring after the balance sheet date. Also, the condition, which led to the sell, existed on the balance sheet date. The signing of the agreement provides further evidence as to the condition that existed on the balance sheet date. The sale of land after the balance sheet date is therefore an adjusting event, which means the sale transaction should be recorded in books of A Ltd. for the purpose of its financial statements for 2010-11.

QUESTION 2.

An earthquake destroyed a major warehouse of C Ltd. on April 20, 2011. The last accounting year of the company ended on 31/03/11 and the financial statements for the year were approved on May 8, 2011. The destruction of warehouse is a significant event occurring after the balance sheet date, but since the earthquake did not exist on the balance sheet date, the destruction by earthquake is a non-adjusting event. The value of property lost by earthquake therefore need not be recognised in financial statement of 201011. The Report of the Directors for 2010-11 should disclose the fact of earthquake together with an estimate of loss on earthquake. If no estimate of loss can be made, the report should state that loss on earthquake could not be estimated.

QUESTION 3.

A company follows April-March as its financial year. The company recognizes cheques dated 31st March or before, received from customers after balance sheet date but before approval of financial statement by debiting Cheques in hand A/c and crediting the Debtors A/c. The Cheques in hand is shown in balance sheet as an item of cash and cash equivalents. All Cheques in hand are presented to bank in the month of April and are also realised in the same month in normal course after deposit in the bank. Even if the cheques bear the date 31st March or before, the cheques received after 31st March do not represent any condition existing on 31st March. Thus the collection of cheques after balance sheet date is not an adjusting event. Recognition of cheques in hand is therefore not consistent with requirements of AS 4. Moreover, the collection of cheques after balance sheet date does not represent any material change or commitments affecting financial position of the enterprise, and so no disclosure of such collections in the Directors‟ Report is necessary.

QUESTION 4.

In X Co. Ltd., theft of cash of Rs.5 lakhs by the cashier in January, 2011 was detected only in May, 2011. The accounts of the company were not yet approved by the Board of Directors of the company. Whether the theft of cash has to be adjusted in the accounts of the company for the year ended 31.3.2011. Decide. As per AS 4 (revised) „Contingencies and Events occurring after the Balance Sheet Date‟, an event occurring after the balance sheet date may require adjustment to the reported values of assets, liabilities, expenses or incomes. If a fraud of the accounting period is detected after the balance sheet date but before approval of the financial statements, it is necessary to recognize the loss amounting Rs. 5,00,000 and adjust the accounts of the company for the year ended 31st March, 2007.

QUESTION 5.

An earthquake destroyed a major warehouse of ACO Ltd. on 20.5.2009. The accounting year of the company ended on 31.3.2009. The accounts were approved on 30.6.2009. The loss from earthquake is estimated at Rs.30 lakhs. State with reasons, whether the loss due to earthquake is an adjusting or nonadjusting event and how the fact of loss is to be disclosed by the company? 8008149787 9908063153


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CA IPCC-Accounting Standards by CA Kisan Rajpurohit AS 4 “Contingencies and Events Occuring after the Balance Sheet Date”, states that adjustments to assets and liabilities are not appropriate for events occurring after the balance sheet date, if such events do not relate to conditions existing at the balance sheet date. The destruction of warehouse due to earthquake did not exist on the balance sheet date i.e. 31.3.2009. Therefore, loss occurred due to earthquake is not to be recognised in the financial year 2008-2009. However, according to the standard, unusual changes affecting the existence or substratum of the enterprise after the balance sheet date may indicate a need to consider the use of fundamental accounting assumption of going concern in the preparation of the financial statements. As per the information given in the question, the earthquake has caused major destruction; therefore fundamental accounting assumption of going concern is called upon. Hence, the fact of earthquake together with an estimated loss of Rs. 30 lakhs should be disclosed in the Report of the Directors for the financial year 2008-2009.

QUESTION 6.

While preparing its final accounts for the year ended 31st March, 2011 a company made a provision for bad debts @ 5% of its total debtors. In the last week of February, 2011 a debtor for Rs 2 lakhs had suffered heavy loss due to an earthquake; the loss was not covered by any insurance policy. In April, 2008 the debtor became a bankrupt. Can the company provide for the full loss arising out of insolvency of the debtor in the final accounts for the year ended 31st March, 2011? As per AS 4 on Contingencies and Events Occurring after the Balance Sheet Date, Assets and Liabilities should be adjusted for events occurring after the balance sheet date that provide additional evidence to assist estimation of amounts relating to conditions existing at the balance sheet date. So full provision for bad debt amounting to Rs 2 lakhs should be made to cover the loss arising due to the insolvency in the Final Accounts for the year ended 31st March, 2011. It is because earthquake took place before the balance sheet date. Had the earthquake taken place after 31st March, 2011, then mere disclosure would have been sufficient.

QUESTION 7.

A Limited Company closed its accounting year on 30.6.11 and the accounts for that period were considered and approved by the board of directors on 20th August, 2011. The company was engaged in laying pipe line for an oil company deep beneath the earth. While doing the boring work on 1.9.2011 it had met a rocky surface for which it was estimated that there would be an extra cost to the tune of ` 80 lakhs. You are required to state with reasons, how the event would be dealt with in the financial statements for the year ended 30.6.11. As per AS 4 Contingencies and Events Occurring after the Balance Sheet Date defines 'events occurring after the balance sheet date' as 'significant events, both favourable and unfavourable, that occur between the balance sheet date and the date on which financial statements are approved by the Board of Directors in the case of a company The given case is discussed in the light of the above mentioned definition and requirements of the said AS 4 (Revised). In this case the incidence, which was expected to push up cost, became evident after the date of approval of the accounts. So that was not an 'event occurring after the balance sheet date'. However, this may be mentioned in the Directors‟ Report.

QUESTION 8.

In preparing the financial statements of R Ltd. for the year ended 31st March, 2011, you come across the following information. State with reasons, how you would deal with this in the financial statements: The company invested 100 lakhs in April, 2011 in the acquisition of another company doing similar business, the negotiations for which had started during the financial year. As it is stated in the question that financial statements for the year ended 31st March, 2011 are under preparation, the views have been given on the basis that the financial statements are yet to be completed and approved by the Board of Directors. AS 4 (Revised) defines "Events occurring after the balance sheet date" as those significant events, both favourable and unfavourable, that occur between the balance sheet date and the date on which the financial statements are approved by the Board of Directors in the case of a company. Accordingly, the acquisition of another company is an event occurring after the balance sheet date. However no adjustment to assets and liabilities is required as the event does not affect the determination and the condition of the amounts stated in the financial statements for the year ended 31st March, 2011. The AS also clearly states that/disclosure should be made in the report of the approving authority of those events occurring after the 8008149787 9908063153


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CA IPCC-Accounting Standards by CA Kisan Rajpurohit balance sheet date that represent material changes and commitments affecting the financial position of the enterprise, the investment of Rs 100 lakhs in April, 2011 in the acquisition of another company should be disclosed in the report of the Board of Directors to enable users of financial statements to make proper evaluations and decisions.

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AS 5: NET PROFIT OR LOSS FOR THE PERIOD, PRIOR PERIOD ITEMS & CHANGES IN ACCOUNTING POLICIES COVERAGE OF AS 5 AS 5 Covers 4 aspects:

AS 5

Net profit or loss for the period

Prior period items

Changes in accounting estimates

Effects of changes in accounting policies

NET PROFIT OR LOSS FOR THE PERIOD  The net profit or loss for the period has the following two components P&L from ordinary activities Extra ordinary items

Profit and Loss from Ordinary Activities  Ordinary activities are Activities which are undertaken by an enterprise as part of its business & any related activities which are incidental to the main business

 Disclosure of ordinary items No need to disclose separately However where item of income or expense  Falls within the meaning of P&L from ordinary activities  Are of special size, nature & incidence  Disclosure is necessary to explain the performance of the enterprise for the period Then disclosure is required in the notes to accounts Examples of ordinary items whose separate disclosure is required  Write down of inventory to NRV & vice versa  Restructuring activities  Disposal of Long Term Activities  Litigation Settlements

Extraordinary Items  They are items of income & expense that arise from transactions that are clearly distinct from ordinary activities.  They are not expected to recur frequently or regularly  Examples AS by CA Kisan Rajpurohit 8008149787, 9908063153

AS 5- Net Profit or Loss for the period, Prior period item, changes…

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CA IPCC-Accounting Standards by CA Kisan Rajpurohit – Loss due to earthquake – Attachment of property – Government grants becoming refundable  Disclosure of extraordinary items They should be disclosed in such a manner that their impact on the current profit or loss can be understood But it forms part of the net profit or loss for the period

PRIOR PERIOD ITEMS  Prior period items are items of income & expense that arise in the current period as a result of error or omission in the preparation of financial statements of one or more prior periods

 Examples – Error in calculation of any expenditure or income – Non provision of salary already due in earlier year – Applying incorrect rate of depreciation – Treating revenue expense as capital – The nature & amount of prior period items should be separately disclosed in the statement of P&L in a manner that their impact is understood

ACCOUNTING ESTIMATE  They are items that cannot be measured with precision but can be estimated based on judgments  Examples – Provision for bad debts – Estimating the life of a fixed asset – Computation of income tax provision

Change in Accounting Estimate  The effect of a change in accounting estimate should be disclosed in the P&L account of The period of change if the change affects the current period only (example- estimation of provision for bad debts) The period of change & the future periods if the change affects both periods (e.g. valuation of fixed assets)

Change in Accounting Policy  Meaning of accounting policy  Examples of change in accounting policy AS by CA Kisan Rajpurohit 8008149787, 9908063153


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CA IPCC-Accounting Standards by CA Kisan Rajpurohit – SLM to WDV – FIFO to Weighted Average  Change in accounting policy may be required in the following three circumstances For compliance with an accounting standard For compliance with any statute For better & appropriate presentation of financial statements  Any change in an accounting policy which has a material effect should be disclosed  This impact should be disclosed in the period in which the policy is changed. Where such impact cannot be ascertained then such fact should be disclosed  If the change has no impact on the current period but materially affect future periods then the fact of such change must be disclosed in the year of change

AS 5 SUMMARY Net profit or loss for the period •Include all items of income & expense for the period •Disclose separately •Ordinary items •Extraordinary items


Prior period items •Disclose separately •The nature •Amount so that impact can be understood

Change in accounting estimate

Change in accounting policy

•Not a prior period or extra ordinary item •Disclose the impact on current as well as future periods

•Disclose separately material effect of change on •Current period •Future periods •If impact unascertainable then disclose the fact


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CA IPCC-Accounting Standards by CA Kisan Rajpurohit ILLUSTRATION 1. Please classify into prior period items, change in accounting estimate, extra ordinary items Expenses of Rs 50000 of the previous year which were omitted from books of account of the previous year due to mistake- Prior Period Item There is a loss of Rs 50 lacs due to an earthquake- Extra-ordinary item Last year stock was overvalued by Rs 530000- Prior Period Item Bad debt provision last year was 5%. This year the company want to make it 8%- Change in Accounting Estimate

ILLUSTRATION 2. The company found in 2002-2003 that stock sheet as on 31-3-2000 has included twice an item of Rs 200000. Comment Solution As per AS 5 ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’, omission of two pages containing details of inventory worth Rs.20 lakhs in 31.3.2010 is a prior period item. Prior period items are normally included in the determination of net profit or loss for the current period. Accordingly, Rs.20 lakhs must be added to opening stock of 1.4.2010. An alternative approach is to show such items in the statement of profit and loss after determination of current net profit or loss. In either case, the objective is to indicate the effect of such items on the current profit or loss.

ILLUSTRATION 3. The company has to pay delayed cotton clearing charges over and above the negotiated price for taking delayed delivery of cotton from the Suppliers' Godown. Up to 2009-10, the company has regularly included such charges in the valuation of closing stock. This being in the nature of interest the company has decided to exclude it from closing stock valuation for the year 2009-10. This would result into decrease in profit by Rs 7.60 lakhs Solution As per AS 5 (Revised) ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies” a change in an accounting policy should be made only in the following circumstances: 1. The adoption of a different accounting policy is required by statute or 2. For compliance with an accounting standard or 3. It is considered that the change would result in a more appropriate presentation of the financial statements of an enterprise. Therefore the change in the method of stock valuation is justified in view of the fact that the change is in line with the recommendations of AS 2 (Revised) ‘Valuation of Inventories’ and would result in more appropriate preparation of the financial statements. As per AS 2, this accounting policy adopted for valuation of inventories including the cost formulae used should be disclosed in the financial statements. Also, appropriate disclosure of the change and the amount by which any item in the financial statements is affected by such change is necessary as per AS 1, AS 2 and AS 5. Therefore, the under mentioned note should be given in the annual accounts.

ILLUSTRATION 4. Fuel surcharge is billed by the State Electricity Board at provisional rates. Final bill for fuel surcharge of Rs 5.30 lakhs for the period October, 2005 to September, 2009 has been received and paid in February, 2010. Solution The final bill having been paid in February, 2010 should have been accounted for in the annual accounts of the company for the year ended 31st March, 2010. However it seems that as a result of error or omission in the preparation of the financial statements of prior period i.e., for the year ended 31st March 2010, this material charge has arisen in the current period i.e., year ended 31st March, 2011. Therefore it should be treated as 'Prior period item' as per AS 5. Prior period items are normally included in the determination of net profit or loss for the current period. An alternative approach is to show such items in the statement of profit and loss after determination of current net profit AS by CA Kisan Rajpurohit 8008149787, 9908063153


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CA IPCC-Accounting Standards by CA Kisan Rajpurohit or loss. In either case, the objective is to indicate the effect of such items on the current profit or loss. It may be mentioned that it is an expense arising from the ordinary course of business. Although abnormal in amount or infrequent in occurrence, such an expense does not qualify an extraordinary item as per Para 10 of AS 5 (Revised). For better understanding, the fact that power bill is accounted for at provisional rates billed by the state electricity board and final adjustment thereof is made as and when final bill is received may be mentioned as an accounting policy.'

ILLUSTRATION 5. A limited company created a provision for bad and doubtful debts at 2.5% on debtors in preparing the financial statements for the year 2011-2012. Subsequently on a review of the credit period allowed and financial capacity of the customers, the company decided to increase the provision to 8% on debtors as on 31.3.2012. The accounts were not approved by the Board of Directors till the date of decision. While applying the relevant accounting standard can this revision be considered as an extraordinary item or prior period item? Solution The preparation of financial statements involves making estimates which are based on the circumstances existing at the time when the financial statements are prepared. It may be necessary to revise an estimate in a subsequent period if there is a change in the circumstances on which the estimate was based. Revision of an estimate, by its nature, does not bring the adjustment within the definitions of a prior period item or an extraordinary item [AS 5 (Revised) on Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies]. In the given case, a limited company created 2.5% provision for doubtful debts for the year 2011-2012. Subsequently in 2012 they revised the estimates based on the changed circumstances and want to create 8% provision. As per AS-5 (Revised), this change in estimate is neither a prior period item nor an extraordinary item. However, as per the standard, a change in accounting estimate which has material effect in the current period, should be disclosed and quantified. Any change in the accounting estimate which is expected to have a material effect in later periods should also be disclosed.

ILLUSTRATION 6. A company wrote down its inventory to 50% since it was damaged. However in the subsequent it found that the inventory can be used completely. It wants to write back the amount under prior period. Please comment. Solution As per AS 5, write down of inventory is an ordinary item. However where item of income or expense  Falls within the meaning of P&L from ordinary activities  Are of special size, nature & incidence  Disclosure is necessary to explain the performance of the enterprise for the period Then disclosure is required in the notes to accounts. Therefore the disclosure of write down of inventory is necessary in light of the above circumstances.

ILLUSTRATION 7. A company signed an agreement with the Employees Union on 1.9.2007 for revision of wages with retrospective effect from 30.9.2006. This would cost the company an additional liability of Rs. 5,00,000 per annum. Is a disclosure necessary for the amount paid in 2007-08? Solution It is given that revision of wages took place on 1st September, 2007 with retrospective effect from 30.9.2006. Therefore wages payable for the half year from 1.10.2006 to 31.3.2007 cannot be taken as an error or omission in the preparation of financial statements and hence this expenditure cannot be taken as a prior period item. Additional wages liability of Rs. 7,50,000 (for 1½ years @ Rs. 5,00,000 per annum) should be included in current year’s wages. It may be mentioned that additional wages is an expense arising from the ordinary activities of the company. Although abnormal in amount, such an expense does not qualify as an extraordinary item. However, as per para 12 of AS 5 AS by CA Kisan Rajpurohit 8008149787, 9908063153


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CA IPCC-Accounting Standards by CA Kisan Rajpurohit (Revised), when items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately.

ILLUSTRATION 8. Nischit Ltd. has acquired a generator on 1.4.2009 for Rs. 50 lakhs. On 2.4.2009, it applied to IREDA (Indian Renewable Energy Development Authority) for a subsidy of 10% of the cost as the generator was using solar energy. The subsidy was granted in June, 2009 after the accounts for 2008-09 were finalised. The company has not accounted for the subsidy for the year ended 31.3.2009. Give your views on the following: a. Is this a prior period item? b. How should the subsidy be accounted in the accounting year 2009-10? Solution a) As per AS 5 ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’, prior period items are incomes or expenses arising out of errors in one or more prior accounting periods. The question is "whether co. has committed an error in 2008-09 by not recognising the subsidy?" The answer is there was no error, AS 12 permits recognition of grant only when there is reasonable assurance that (i) the enterprise will comply with the conditions attached to them, (ii) the subsidy will be received. Mere making application does not provide the reasonable assurance that the subsidy will be received. Letter of sanction from IREDA is required to provide this assurance. Hence the company was not recognising the grant. Further, AS 4 requires adjustment of events occurring after the balance sheet date only up to the date of approval of accounts by the Board of Directors. In view of this, the company is correct in not adjusting the same in the accounts for the year 2008-09. Hence, this is not a prior period item. b) The subsidy should be deducted from the cost of the generator. The revised unamortised, amount of generator should be written off over the remaining useful life. Alternatively, the same may be treated as deferred income and allocated over the remaining useful life in the proportion in which depreciation is charged.



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CA IPCC Group 2 accounting standards

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