Professional Documents
Culture Documents
Accounting Standards
Accounting Standards
Accounting Standards
[With Ind AS and the Companies Act, 2013]
CA/CMA Final
[For November 2016 Examinations]
Seventh Edition
Carvinowledge
P R E S S
[email protected]
www.carvinowledge.com
Carvinowledge
P R E S S
Accounting Standards
With Ind AS and the Companies Act, 2013, 7e
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Dedication
This book belongs to my dearest and respectable Father
“Late Abdul Razzak”
and
my beloved brother
“Late Jamil Shaikh”
These Angels kept me working everytime.
Amendments Applicable for November 2016 Examination
(As per ICAI’s Notification Dated 21-06-2016)
Accounting Standards
AS No. AS Title
1 Disclosure of Accounting Policies
2 Valuation of Inventories
3 Cash Flow Statements
4 Contingencies and Events Occurring after the Balance Sheet Date
5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies
6 Depreciation Accounting
7 Construction Contracts (Revised 2002)
9 Revenue Recognition
10 Accounting for Fixed Assets
11 The Effects of Changes in Foreign Exchange Rates (Revised 2003)
12 Accounting for Government Grants
13 Accounting for Investments
14 Accounting for Amalgamations
15 Employee Benefits
16 Borrowing Costs
17 Segment Reporting
18 Related Party Disclosures
19 Leases
20 Earnings Per Share
21 Consolidated Financial Statements
22 Accounting for Taxes on Income
23 Accounting for Investment in Associates in Consolidated Financial Statements
24 Discontinuing Operations
25 Interim Financial Reporting
26 Intangible Assets
27 Financial Reporting of Interests in Joint Ventures
28 Impairment of Assets
29 Provisions, Contingent Liabilities and Contingent Assets
Accounting Standards with Ind AS and the Companies Act, 2013 (Seventh Edition) has benefited from an
extensive development process. Over 30 faculty reviewers, students and industry professionals provided
feedback about the accuracy and relevance of the content as well as suggestions for its improvements. Though
we could not incorporate every one’s suggestion, we do acknowledge that their feedback was invaluable in
our attempt at creating the best possible Accounting Standards book.
CONSULTANT BOARD
The consultant board provided us with a detailed and critical analysis of each chapter and worked with us
throughout the development of the book. We would like to thank the following for their time and commitment:
STUDENT REVIEWERS
We took the help of many students who class-tested the manuscript, evaluated it for clarity, and assessed
each feature. Their comments helped us to expand the book’s content, improved the pedagogical features,
and strengthened the assessment features. We are thankful to the following:
Abhishek Kapuria Shilpa Singhvi Bhavesh Vaghela Krishna Ravesh Akshay Garg
PREFACE
Welcome to this revised edition of Accounting Standards Simplified (with Ind AS and the Companies Act, 2013)!
It gives us immense pleasure and utmost satisfaction to present the seventh thoroughly revised edition of the
book on “Accounting Standards Simplified (with Ind AS and the Companies Act, 2013)!” Due to enactment of
the Companies Act, 2013 and introduction of Ind AS by ICAI, some additional needs regarding accounts have
come into place. These requirement have been incorporated in appropriate places of respective accounting
standards with a separate section on Ind AS. It is a comprehensive book explaining concepts, problems of
Accounting Standards and Ind AS in a lucid and informative manner. It has been developed exclusively for the
students of CA/CMA Final (New Course). The book will also be useful for the practitioners, professionals and
industry people. The book has been updated with provisions of New Schedule II, III, reference to IAS/IFRS
numbers, latest provisions on AS, MCA circulars.
Key features of the textbook:
◘◘ Comprehensive coverage of the syllabus of Accounting Standards prescribed by Institute of Chartered
Accountants of India relevant for November, 2016 Examination.
◘◘ Ind AS covered with problems and solutions.
◘◘ Comparison between IFRS Vs Ind AS is being included wherever necessary.
◘◘ Detail Theory and Practice book on I – GAAP.
◘◘ Updated references of Revised Schedule II and III
◘◘ Extensive coverage of Forex AS-11, Group Consolidation, Financial Instruments
◘◘ MCA Circular para 46A explained with related problems and solutions
◘◘ Simplified presentation through charts and illustrations.
◘◘ Solved Past 28 exams’ paper with solution till May, 2016.
◘◘ Each chapter begins with an overview to help students know, at a glance, what they would learn in the chapter.
◘◘ ‘Do You Know?’ incorporated in each chapter acts as “knowledge alert points”.
Valuable suggestions and constructive feedback from learners is welcome and would be gratefully
acknowledged.
Acknowledgements
We are grateful to our esteemed colleagues, friends and students who have contributed to this book by
advising us and by giving constructive feedback. Special thanks to Dr. Mahesh Gour and Amit Rajpurohit
who have encouraged me to write this book. This book would not have taken its present shape without the
continuous support and encouragement from CA Rakesh Makkar and the editorial and production team of
Carvinowledge Press. It has been a real pleasure working in coordination with their extremely professional
set up. We have immensely benefitted from referring to several books and publications. Thus, we owe an
enormous intellectual debt to all authors, publications, publishers and institutions whose work we have
drawn upon in developing this textbook.
We hope this book serves the purpose of its readers. Their valuable suggestions and constructive feedback
will be greatly acknowledged. Please feel free to e-mail your feedback, problems or suggestion to us on
[email protected] or call us: +91-9953922272.
Authors
CONTENTS
Editorial Board vi
Preface and Acknowledgements vii
Part II - Ind AS
Chapter 1 Ind AS 1: Presentation of Financial Statements 1
Chapter 2 Ind AS 2: Inventories 12
Chapter 3 Ind AS 7: Cash Flow Statements 15
Chapter 4 Ind AS 8: Changes in Accounting Estimates, Policies and Errors 18
Chapter 5 Ind AS 10: Events after the Balance Sheet Date 22
Chapter 6 Ind AS 12: Taxes on Income 24
Chapter 7 Ind AS 16: Plant, Property and Eqipment 29
Chapter 8 Ind AS 17: Leases 36
Chapter 9 Ind AS 19: Accounting for Employees Benefits 40
Chapter 10 Ind AS 20 / IAS 20: Accounting for Government Grants and
Disclosure of Government Assistance 43
Chapter 11 Ind AS 21: Effects of Changes in Foreign Exchnage Rates 47
Chapter 12 Ind AS 23: Borrowing Costs 54
Chapter 13 Ind AS 24: Related Party 56
Chapter 14 Ind AS 33: Earning Per Share 61
Chapter 15 Ind AS 34: Interim Financial Reporting (IFR) 66
Chapter 16 Ind AS 36: Impairment of Assets 68
Chapter 17 Ind AS 37: Events after the Balance Sheet 70
Chapter 18 Ind AS 38: Intangible Assets 75
Chapter 19 Ind AS 40 / IFRS 40: Investments Property 78
Chapter 20 Ind AS 41 / IAS 41: Agriculture 83
Chapter 21 Ind AS-105 Noncurrent Assets Held for Sale and Discontinued Operations 88
Chapter 22 Ind AS 108: Operating Segments 95
Chapter 23 FINANCIAL INSTRUMENTS: IND AS – 109 / IFRS – 9: Recognition
IND AS – 107 / IFRS – 7: Presentation, IND AS – 32 / IAS – 32: Disclosures 98
Question Paper—CA Final-May 2016 144
T R END A NA LYSIS O F P REVIOUS Y EAR EXAMINATI ON S
Accounting Standards: Chapter-Wise Analysis from November June 2009 – May - 2016
J 09 N 09 M 10 N 10 M 11 N 11 M 12 N 12 M 13 N 13 M 14 N 14 M 15 N 15 M 16
AS-2 5 5 10 9 5 9 5
AS-3 4
AS-4 5 19 10
AS-5 5 5 4 4 4
AS-6 4 4
AS-7 5 5 5
AS-9 5 5 5 5 4 9 4
AS-10 5 9 9 5 5 4
AS-11 5 4
AS-12 9 5 4 4
AS-13 4 5 4
AS-15 5 10 11 9 5 5 8
AS-16 5 5 9 4 5
AS-17 5
AS-18 4 4
AS-19 5 4 11 5 5 4 4
AS-20 5 4 4 4 5 5
AS-21
AS-23 5 8 5 4 4
AS-27
AS-22 5 5 10 5 6 5 4 5 4
AS-24 4 4
AS-25 5 10 5 5
AS-26 4 8 4
9
AS-28 5 4 5 5 5 5
AS-29 5 5 4 4 10 3 4 4
AS-30 4 8 17 20 5 12 8 4 10 8 8 4
Misc. 12 4 12 5 8
Sch. VI
4 - 5 4 5 8 4 4
or III
Total 46 54 42 84 40 51 48 56 57 68 41 60 60 47 54
Average 54 marks
PART I
Accounting Standards
Chapter 1 Accounting Standard Introduction and Framework 1
Chapter 2 AS-1: Disclosure of Accounting Policies 7
Chapter 3 AS-2 (Revised): Valuation of Inventories 10
Chapter 4 AS-3 (Revised): Cash Flow Statement 22
Chapter 5 AS-4: Events Occuring After the Balance Sheet 32
Chapter 6 AS-5 (Revised): Net Profits or Loss for the Period, Prior Period Items and
Changes in Accounting Policies 38
Chapter 7 AS-6: Depreciation Accounting 46
Chapter 8 AS-7 (Revised): Construction Contracts 53
Chapter 9 AS-9: Revenue Recognition 65
Chapter 10 AS-10: Accounting for Fixed Assets 77
Chapter 11 AS-11 (Revised): The Effect of Changes in Foreign Exchange Rates 89
Chapter 12 AS-12: Government Grants 99
Chapter 13 AS-13: Investment Accounts 106
Chapter 14 AS-14: Amalgamation and Absorption 117
Chapter 15 AS-15 (Revised): Employees Benefits 121
Chapter 16 AS-16: Borrowing Costs 138
Chapter 17 AS-17: Segmental Reporting 152
Chapter 18 AS-18: Related Party Disclosures 168
Chapter 19 AS-19: Leases 175
Chapter 20 AS-20: Earning per Share 195
Chapter 21 AS-22: Taxes on Income 210
Chapter 22 AS-24: Discontinuing Operations 226
Chapter 23 AS-25: Interim Financial Reporting 232
Chapter 24 AS-26: Intangible Assets 243
Chapter 25 AS-28: Impairment of Assets 256
Chapter 26 AS-29: Provisions, Contingent Liabilities and Contingent Assets 273
Chapter 27 AS-21: Consolidated Financial Statements (Holding Company Vs Subsidiary) 285
Chapter 28 AS-23: Accounting for Investment in Associates 291
Chapter 29 AS-27: Financial Interest in Joint Ventures 302
Chapter 30 Comprehensive Problems on CFS (AS-21 + AS-23 + AS-27) Group Consolidation 312
Schedule -III (Accounting Standards) 325
Extra Practical Problems from Past Year Papers and RTPs of Financial Reporting and Audit 327
CHAPTER 1
Accounting Standard
Introduction and Framework
Chapter Outline
vv Accounting Standard vv Applicability of AS
vv AS and Auditors vv Companies Accounting Standard
vv Is AS Mandatory Rules (CASR) (2006)
vv Procedure of Issuing AS vv NACAS (National Advisory Committee for
Accounting Standard) or NFRA (National
vv Advantage and Significance of AS
Financial Reporting Standards)
Accounting Standard
Accounting Standards are written documents or policy documents prepared by an expert body or government
body or any other regulatory body for true disclosure and presentation of financial statements. It covers the
aspects of recognition, measurement, treatment, presentation and the disclosures of accounting transactions.
In India AS are issued by the Institute of Chartered Accountants of India (ICAI). The work for preparation and
integration is entrusted by ICAI to ASB.
AS and Auditors
Auditors of every company are required to report under section 143(3)(e) of the Companies Act, 2013,
whether the Profit and Loss Account and Balance sheet are as per AS or not. Statutory auditors are required to
make qualifications in their audit report. While discharging the attest functions, it is the duty of the auditors
to report whether there is compliance of AS by the company. Compliance of AS is the prime duty of the
management and an Auditor is only required to report whether mandotory AS are complied or not.
Is AS Mandatory
Yes, they are mandatory. Following are the contentions to support our argument:
(i) Auditors of every company are required to report under section 143(3)(e) of the Companies Act,
2013 whether the Profit and Loss Account and Balance sheet are as per AS or not. Statutory auditors
are required to make qualifications in their audit report for non-compliance of accounting standards.
(ii) As per Section 134(5)(a) of the Companies Act, 2013 Directors under the ‘Directors’ Responsibility
Statement’ have to report whether or not the company has followed the applicable AS in preparing
its Financial Statements.
(iii) SEBI has made mandatory for all the listed companies to follow AS.
(iv) Financial Statements cannot be described as complying with the AS unless they comply with all the
applicable AS.
2 Accounting Standards
Procedure of Issuing AS
(i) The AS body forms a study group known as Accounting Standard Board (ASB) to handle problems
arising on any accounting transaction.
(ii) The study group comprises of experts from ICAI, SEBI, ICSI, and RBI etc.
(iii) ASB shall determine broad areas in which AS need to be formulated and the priority in regard to the
selection thereof.
(iv) The ASB thus formed will hold meetings and receives comments from the members.
(v) On the basis of the work of the Study Groups and the dialogues with the organizations referred
to above, an exposure draft copy of standard is made by the ASB and issued for comments to the
Institute.
(vi) It is finally submitted to NFRA (government body) who assist the government in laying and
formulation of AS.
(vii) ICAI may modify/amend the draft and issues a final draft in the form of Accounting Standard.
(viii) The final AS will then be explained to the professionals (including general public) through journals,
new letters and conducting seminars.
Though Accounting Standard has Received Much Importance Worldwide Now, But How it is
Criticized?
(i) Interpretation of AS is a hard nut to crack.
(ii) Many Private Limited Companies are not following AS because they say they are not answerable to
Shareholders.
(iii) Many Chartered Accountants have misinterpreted AS and made it a mess.
(iv) Many issues in AS are based on actual facts and circumstances of the cases which have led to loopholes
and manipulation.
(v) Many CA’s are following accounting practices and policies as per their whims and fancies.
(vi) AS cannot override the statutes and laws.
Accounting Standard Introduction and Framework 3
Applicability of AS
There are 2 classifications made by two different acts/statute.
(I) BY COMPANIES ACCOUNTING STANDARD RULES 2006 (CASR) – SMCs and Non SMCs.
(II) BY ICAI – (i) Level I, (ii) Level II, (iii) Level III Enterprises
Note: Consequent upon the issue of Companies (Accounting Standards) Rules, 2006, the applicability of the
Accounting Standards as announced by the Institute of Chartered Accountants mentioned above is only for
the entities other than companies. For the companies the applicability of Accounting Standards is as per
Companies (Accounting Standards) Rules, 2006.
Problem 1: Comment whether the following Companies can be classified as a Small and Medium Sized
Company (SMC) per the Companies (AS) Rules, 2006.
(a) A Private Limited, a Subsidiary of a Multinational Company listed on London Stock Exchange. It has
a turnover of `12 Crores and borrowings of ` 5 Crores.
(b) B Private Limited has turnover of ` 45 Crores, Other Income of `7 Crores and Bank Borrowings of
` 9 Crores.
(c) C Limited has appointed Merchant Bankers to prepare a Red-Herring Prospectus for the purpose of
filing the same with SEBI. (CA Final Audit Nov. 2008)
Solution: As per the Companies (Accounting Standards) Rules 2006, “Small and Medium Sized Company”
(SMC) means/a company :
(i) Whose equity or debt securities are not listed or are not in the process of listing on any stock exchange,
whether in India or outside India; (ii) Which is not a bank, financial institution or an insurance
company; (iii) Whose turnover (excluding other income) does not exceed rupee; fifty crore in the
immediately preceding accounting year, (iv) Which does not have borrowings (including public
deposits) in excess of rupees ten crore at any time during the immediately preceding accounting
year; and (v) which is not a holding or subsidiary company of a company which is not a small and
medium-sized company.
(a) Since A Pvt. Ltd. is a subsidiary of another Company which is listed, on London Stock Exchange
(and is therefore not a SMC), A Pvt. Ltd. cannot be a SMC. The turnover and borrowings are not
relevant in this case.
6 Accounting Standards
(b) As per the definition of SMC, point (iii), a company will be a SMC if it’s turnover does not exceed
` 50 crores or borrowings do not exceed `10 crore. For calculating this turnover, other income
is not to be included. Since B Pvt. Ltd. has a turnover of ` 45 crores and borrowing; of ` 9 crores,
it will satisfy the definition and can be classified as SMC.
(c) As per the definition of SMC, point (i) a company will be a SMC if it is not listed or in the process
of listing. Since C Pvt. Ltd. has appointed merchant bankers to prepare a Red Herring Prospectus
for the purpose of filling the same with SEBI, it is in the process of listing on a Stock Exchange.
Hence C Ltd. cannot be classified as a SMC.
Problem 2: A Company which satisfies the conditions of a Small and Medium sized Company (SMC) as per
Companies (Accounting Standards) Rules, 2006 has represented that it does not require to give disclosures
required by AS-3 “Cash Flow Statements” and AS-18 “Related Party Disclosures” in its Financial Statements.
Comment.
Solution: AS-3 is not mandatory for SMCs, but there is no exemption/from AS-18 disclosure requirement
the company should ensure compliance with AS-18 and also state that it has availed the exemption given to
SMCs in respect of AS-3.
Problem 3: XYZ Ltd. with a turnover of `35 lakhs and borrowings of `10 lakhs during any time in the
previous year, wants to avail the exemptions available in adoption of Accounting Standards applicable to
Companies for the year ended 31.3.08. Advice the Management the exemptions that are available as per
Companies (AS) Rules, 2006.
Solution: XYZ company is a SMC company as defined in AS rules no 2 (f) of the companies act.
The exemptions applicable for Small and Medium sized company (SMC) are as follows:
(a) Need not disclose certain information and this fact shall be conveyed by way of a note to financial
statement.
(b) If XYZ becomes a non-SMC, then the previous year’s information need not be disclosed, but the
information of this fact shall be disclosed by way of a note.
(c) In case XYZ opts not to avail exemptions applicable to SMC for any or some of the ASs, it shall disclose
the AS in respect of which it has availed the exemption.
(d) In case XYZ desires to disclose the information not required to be disclosed pursuant to the exemptions
availed, it shall disclose that information in compliance with the relevant accounting standard.
(e) XYZ may opt for availing certain exemptions from compliance with the requirements prescribed in an
Accounting Standard. Provided that such a partial exemption and disclosure shall not be permitted
to mislead any person.
If XYZ is a partnership firm, the applicability of this Act cannot be extended at all. The question of
application of AS to such firms will not arise and therefore there is no room for exemptions as well as
additional exemptions.
CHAPTER 2
AS-1: Disclosure of
Accounting Policies
Chapter Outline
vv Accounting Policies vv Selection of AP or Principles of AP or Points
vv Requirements of Accounting Policies – AS - 1 to be Considered While Selecting AP
vv Fundamental Accounting Assumptions vv Are Changes in Accounting Policies Allowed?
Accounting Policies
Accounting Policies are rules/principles and methods to adopt such principles in financial accounts for true
and fair recording, and presentation of financial statements.
As per IAS 8, Accounting Policies are the specific principles, bases, conventions, rules and practices applied
by an entity in preparing and presenting the Financial Statement.
Example: A Company may have an option of charging depreciation as per Straight Line Method, Written
Down Value, Sinking Fund method. If among the methods Straight Line Method is chosen, then we say
company’s policy to charge depreciation is Straight Line Method. Accounting Policies are part of Financial
Statements (FS).
A company following any Accounting Policies has to choose Accounting Policies according to the nature
of the business. Choosing of a correct Accounting Policy is very important because it affects Profit and Loss
Account, Balance sheet etc. As different companies operate under different circumstances, Accounting
Policies has to be applied accordingly.
Thus Accounting Policies mean:
◘◘ Specific Principles (Example: Value of stock at Cost/MV whichever is less)
◘◘ Methods to apply such Principles (Example: Cost formulae FIFO, WAC).
Example: Investment are valued at cost or market value whichever is less. However, the exercise of
prudence does not allow:
◘◘ The creation of hidden reserves.
◘◘ Understatement of assets or income.
◘◘ Overstatement of liabilities.
(ii) Substance over form: One should see the economic reality of a transaction and not the legal form. Legal
form is to be ignored and the substance is to be considered.
Example: By legal form lessor is the owner during the lease period but actually speaking lessee bears the
risks and rewards relating to the asset. So, one should see the economic reality of the transaction.
Hence lessee is the owner who uses the asset and not the lessor.
(iii) Materiality: If the decision of the investors changes by assessing the transaction then the transaction is
material. In other words, financial statements should disclose all facts, which may influence the mind of the
shareholders. SA – 320 on Materiality has explained in detail the concept of Materiality.
AS-1: Disclosure of Accounting Policies 9
Chapter Outline
vv Objective and Scope of AS-2 vv Joint Product and By-products
vv Meaning of Inventory vv Cost Formulae
vv Valuation of Inventory (on the B/S Date) vv Net Realizable Value
vv Absorption Costing – For Fixed Overheads vv Disclosure in the Financial Statement
vv Highlights of Cenvat Credit and
Excise Duty (Guidance Note)
Meaning of Inventory
Inventories Consists of the Following:
◘◘ Goods purchased and held for resale → (Merchandise purchased by retailers).
◘◘ Held for sale in the ordinary course of business → (Finished goods).
◘◘ In the process of production → (WIP).
◘◘ Materials and supplies awaiting production → (Raw-materials, stores, loose tools, consumables).
AS-2 (Revised): Valuation of Inventories 11
DO YOU KNOW
AS-2 (Rev.) is not applicable to WIP of Service Companies, but any unconsumed material attracts AS-2.
Ex: Services of Saloon/Beauty Parlour is Service Industry but materials kept for use is inventory.
DO YOU KNOW
Income Tax follows gross approach and AS-2 follows net approach, but the overall impact of CENVAT/EXCISE
remains the same.
Allocation as per physical units method or relative sales method at the separation point is the most
acceptable basis for apportionment of joint costs.
Allocation for by-products: By-products incidentally results from the common process. The value of such
by-products or waste or scrap is very insignificant. Thus, such by – products or waste etc. are valued at Net
Realizable Value (NRV) and this NRV is deducted from the costs of main product.
Formulae
Common cost for (product A+ product B + by-product X) XXX
Less: NRV of byproducts/waste/scrap (XXX)
Net joint cost to be apportioned between products A and B XXX
Note: Why Interest and storage cost not included in valuation of stock?
As per AS-2 interest and storage costs are not to be included in the cost of the inventories. The reason being
such costs is not incurred for the bringing of inventories to its present location and condition. However,
if one refers to AS-16 (Borrowing Costs) few exceptions are given. AS-16 states that if an asset takes a
very long time to get manufactured then in such case costs of storage etc. is to be included in the costs of
inventories because such long period is necessary for the intended use or sale of the asset.
Normal/Abnormal Losses: In determining the cost of inventories a company may incur some normal or
abnormal losses. Accounting treatment for such losses is as follows:
(i) Normal loss: Normal loss always forms part of cost of production. It means good units will have to
bear the cost of normal loss.
(ii) Abnormal loss: Abnormal loss is an expense which should be charged to Profit and Loss Account. It
means abnormal losses have to be written off in Profit and Loss Account.
Cost Formulae
An enterprise should use different cost formulae according to the nature of product and its operations scale.
Following are some of the cost formulae as permitted by AS-2.
(i) Specific identification method: In this method specific costs are assigned to specific items of
inventories. Costs can be properly appropriated to the finished products. Specific identification
method can be followed only when the items are not ordinarily interchangeable or in case of goods
or services produced and segregated for specific project.
14 Accounting Standards
Example: CNP Ltd. is a consumer durable company and has different products. As the products are
specifically identifiable and not interchangeable in terms of use/size/brands/value etc we have to
assign costs to each product separately.
(ii) FIFO method: We are very conversant with FIFO method, as we have done in our earlier class. This
method is used only when goods are ordinarily interchangeable. Here we assume that the items,
which were purchased, first will be consumed or sold first. This means the items remaining in stock
will be nothing but latest purchases. Thus one can say to the items of materials that “you are in
queue”.
(iii) Weighted Average method: Under this method total cost is divided by total units with every fresh
purchases or periodically say month or weekly etc. This method very well takes care of changes in
prices.
Following technique is to be used only when it is impossible to calculate cost by the above three
methods. But the following techniques are to be used if it approximates the actual cost.
(iv) Standard Costing: Standard Costing (SC) is a pre-determined cost which takes into account normal
level of consumption of materials, labour and indirect services. It is used widely in industries
having non-repetitive process like manufacturer of automobile, boilers, heavy electrical equipment.
Standard costing is to be updated and revised periodically.
(v) Retail Method: Retail or Adjusted selling price method is used in the following circumstances:
(1) Large number of innumerable different items in the stock (Example: Cutlery Retail Shop)
(2) Unit cost of such items is very low.
(3) Detailed records of such stock is not kept.
(4) All the items having similar margins.
(5) It is impossible to use any other method.
Procedure used to compute cost:
(1) Determine normal retail (selling) price of the year-end stock.
(2) Find the Gross margin
(3) Cost of end inventory = Normal retail price – Gross margin.
Note: The above formula for NRV is applicable to WIP (intermediate products). For finished goods we should
not consider the cost to complete the goods.
Other points for NRV:
(1) NRV should be based on most reliable evidence at the time of valuation.
(2) NRV is to be estimated at every balance sheet date.
(3) If NRV > Cost, then stock is to be valued at Cost.
(4) If NRV < Cost, then stock is to be valued at NRV. (In short stock is to be valued at Cost or NRV
whichever is less).
Problem 2: X Limited is engaged in manufacture of Cement. In the P/L account for the year ended
31/3/2007, it discloses its revenue from sales transactions (turnover) net of excise duty. The excise duty
collected and paid on sales transaction and that related to difference between Closing and Opening stock is,
however disclosed in the “Notes to Accounts”. (Audit CA Final)
Solution: As per Accounting Standard Interpretation – ASI 14 ‘Disclosure of Revenue from Sales Transactions’
(Revised) issued by ICAI in Aug 2006, turnover should be disclosed as follows on the face of the statement of
Profit & Loss:
Turnover (Gross) XX
Less : Excise duty XX
Turnover (Net) XX
Further, the excise duty shown above should be the total duty except the duty related to the difference between
closing stock & opening stock which should be recognized separately in the statement of profit and loss, with an
explanatory note in the notes to accounts to explain the nature of the two amounts of excise duty. Even as per Revised
Schedule VI Excise duty should be deducted from Sales and Services.
Since the company, X Ltd has not followed the above ASI 14, the auditor would have to qualify his report
accordingly.
Problem 3: In a manufacturing process of Vijoy Limited, one by-product BP emerges besides two main
products MP1 and MP2 apart from scrap. Details of cost of production process is here under:
Average market price of MP1 and MP2 is `80 per unit and `50 per unit respectively, by-product is sold
@ `25 per unit. There is a profit of `5,000 on sale of by-product after incurring separate processing charges
of `4000 and packing charges of `6,000. `6,000 was realized from sale of scrap. Calculate the value of Closing
Stock of MP1 and MP2 as on 31-3-2012. (CA Final Nov 2012)
Solution: As per para 10 of AS-2 (Rev), allocation as per physical units method or relative sales method at the
separation point is the most acceptable basis for apportionment of joint costs. The value of such by-products or
waste or scrap is very insignificant. Thus, such by – products or waste etc. are valued at Net Realizable Value (NRV)
and this NRV is deducted from the costs of main product.
Total joint cost = ` 1,60,000 + ` 8,2000 + ` 58,000 + ` 40,000 = ` 3,40,000
NRV of By–product = Sale Price ` 40,000 (1,600 × 25) – Further Cost ` 10,000 = ` 30,000
NRV of By–product and Scrap = ` 30,000 + ` 6,000 = ` 36,000
Net Joint Cost = ` 3,40,000 – ` 36,000 = ` 3,04,000.
Production Quantity of MP1 and MP2 is 6,250 : 5,000
Apportionment of Joint Cost based on sale value (80 × 6,250) : (50 × 5,000) or 2:1 = 2,02,667 : 1,01,333 =
` 3,04,000.
Average Joint Cost per unit = ` 32.43 for M1 and ` 20.27 for M2.
Closing Stock valuation = 800units x 32.43 = ` 25,944 and 200 units × 20.27 = ` 4,054
Problem 4:
Particulars 2005 2006
Actual units produced (Kgs.) 40,000 50,000
Normal production at normal capacity (Kgs.) 48,000 48,000
Fixed production overheads (`) 60,000 60,000
Closing Stock (Kgs.) 3,600 4,000
Cost of Closing Stock per unit excluding FPOH (`) @7.2/- @7.5/-
You are required to: (i) Value Closing Stock. (ii) Find the amount debited to P/L A/C.
Solution: Let Actual production be (AP) and Normal production be (NP).
First lets find FPOH allocation per unit = 60,000/48,000 = ` 1.25/-.
For 2005: It is a Case of AP < NP. As per AS-2 if AP < NP (40,000 < 48,000) then FPOH remains same
(i.e. 1.25/-). FPOH is recovered only 40000 × 1.25 = 50,000. Unallocated FPOH will be written-off = 60000
incurred – 50000 = 10,000
Hence, Value of Closing Stock = 3,600 units × (7.20+1.25) = ` 30,420.
Amount written off to Profit & loss account = ` 10,000(Unabsorbed).
For 2006: It is a AP > NP case. As per AS-2 if AP > NP (50,000 > 48,000) then FPOH per unit allocation should
not be 1.25/-. It should be reduced to @1.20/ otherwise inventory will be valued at above cost. FPOH are fully
absorbed.
* 1.20/- = FPOH (60,000)/AP (50,000).
Hence, Value of Closing Stock = 4,000 units × (7.50+1.20) = ` 34,800.
Amount written off to Profit & loss account = Nil.
Problem 5: In all the cases assume Cost of inventories = ` 50/- and Future estimated costs = ` 2
Closing Stock Contract Stock Contract Price General Selling price
(1) 10000 units 8000 units 55/- 56/-
(2) 10000 units 8000 units 49/- 53/-
(3) 10000 units 14000 units 49/- 54/-
(4) 10000 units 14000 units 49/- 50/-
18 Accounting Standards
such cases, when sale is assured under forward contract or a government guarantee or when market exists
and there is a negligible risk of failure to sell, the goods invoiced are often valued at Net-realisable value.”
Terry Towels do not fall in the category of agricultural crops or mineral ores. Accordingly, taking into
account the facts stated, the closing stock of finished goods (Fancy terry towel) should have been valued at
cost and not at net realisable value (including profits). Further, export incentives are recorded only in the
year the export sale takes place. Therefore, the policy adopted by the company for valuing its closing stock of
inventories of finished goods is not correct.
Problem 9: Night Ltd. sells beer to customers. Some of the customers consume the beer in the bars run by
Night Limited. While leaving the bars, the Consumers leave the empty bottles in the bars and the Company
takes possession of these empty bottles. The Company has laid down a detailed internal record procedure
for accounting for these empty bottles which are sold by the Company by calling for tenders. Keeping this in
view:
(a) Decide whether the Stock of Empty Bottles is an Asset of the Company.
(b) If so, whether the Stock of Empty Bottles existing as on the date of Balance Sheet is to be considered as
Inventories of the Company and valued as per AS–2, or to be treated as scrap and shown at realizable
value with corresponding credit to ‘Other Income’? (CA Final Nov 2010)
Solution: (i) Irrespective of the fact whether the asset is tangible or intangible one has to get the benefit from
it. Night Ltd sells these bottles by calling tenders (earns revenue). Therefore Night Ltd has to record the stock
of empty bottles as assets. (ii) Normally scrap materials/waste are never valued in detail i.e. they are just
valued @NRV and reduced from cost of main products or it may be even shown as a separate income in the
profit/loss account. But Night Ltd has a detailed inventory checking and controlling system. Hence inventory
of empty bottles are to be valued as per AS-2 and not to be treated as scrap.
Problem 10: Calculate the value of raw materials and closing stock based on the following information:
Raw material X
Closing balance 500 Units
`per unit
Cost price including excise duty 200
Excise duty (Cenvat credit is receivable on the excise duty paid) 10
Freight inward 20
Unloading charges 10
Replacement cost 150
Finished goods Y
Closing Balance 1200 units
`per unit
Material consumed 220
Direct labour 60
Direct overhead 40
Total fixed overhead for the year was `2,00,000 on normal capacity of 20,000 units.
Calculate the value of the closing stock, when
(i) Net Realizable Value of the Finished Goods Y is `400.
(ii) Net Realizable Value of the Finished Goods Y is `300.
20 Accounting Standards
Solution:
Statement showing valuation of Raw Material and Finished Goods at cost
Raw Material X `
Cost Price 200
Less: CENVAT credit (10)
Add: Freight Inward 190
Unloading charges 20
Cost 10
220
Raw Material X `
Materials consumed 220
Direct labour 60
Direct overhead 40
Fixed overheads (2,00,000/20,000) 10
Cost 330
(i) When Net Realisable Value (NRV) of the Finished Goods Y is `400
NRV is greater than the cost of Finished Goods Y i.e. `330
Hence, Raw Material and Finished Goods will be valued at cost
Accordingly, value of closing stock will be:
Note: It has been assumed that Raw Material X is used for production of Finished Goods Y.
P roblem 11: T Ltd. commenced its manufacturing activities from 1st April 2012. In the course of
production, the Company generated certain by–products. As at 31st March 2013, the Company did not value
the by–products considering the value as insignificant. The Auditor of the Company is of the opinion that
the by–products are inventory of the Company and it should be valued and brought into books of account.
Comment.
(5 Marks)
Solution: As per AS-2 the net realisable value of by – product is required to be reduced from the cost of main
product. If it is a joint product then NRV of by – product will be reduced from cost of joint product and then
the balance cost of joint product will be apportioned on a consistent and rational manner.
AS-2 (Revised): Valuation of Inventories 21
Problem 12:
From the following information, value the Inventories as on 31st March, 2015: Raw Material has
been purchased at ` 125 per kg. Prices of Raw Material are on the decline. The Finished Goods being
manufactured with the Raw Material is also being sold at below Cost. The Stock of Raw Material is of
15,000 kg and the Replacement Cost of Raw Material is ` 100 per kg. Cost of Finished Goods per kg
is as under: Particulars ` per kg
Material Cost 125
Direct Labour Cost 20
Direct Variable Production Overhead 10
Fixed Production Overhead for the year for a normal capacity of 1,00,000 kgs of production is `
10 Lakhs. At the year end, there were 2,000 kgs of Finished Goods in stock. Net Realisable Value of
Finished Goods is ` 140 per kg.
Solution:
Valuation of Finished goods: Cost or NRV whichever is less:
Cost = 125+20+10+10 = 165. Also NRV = 140
Valuation of Finished goods = 140 × 2000 = ` 280000
If the price of raw material is on decline and the finished goods are sold below cost then the materials
are valued at replacement cost.
Valuation of raw materials = 15000 × 100 = ` 1500000
Total Value of inventory = 280000+1500000 = 17,80,000
CHAPTER 4
AS-3 (Revised):
Cash Flow Statement
Chapter Outline
vv Introduction vv Reporting Cash Flows on Net Basis
vv Cash and Cash Equivalents vv Foreign Currency Cash Flows
vv Classification of Cash Flows vv Extraordinary Items
vv Presentation of Cash Flows from vv Taxes on Income
Operating Activities vv Investments in Subsidiaries,
vv Presentation of Cash Flows from Associates and Joint Ventures
Investing and Financing Activities
Introduction
AS-3, Cash Flow Statements recommends that an enterprise should prepare a cash flow statement and
present it in addition to the balance sheet and profit and loss account. The cash flow statement assists a
reader in assessing the ability of an enterprise to generate sufficient cash flows, for its different needs. A
cash flow statement also assists the reader in comparing the operating performance of different enterprises
because it is free from the effects of using different accounting policies for the same transactions (selection
and adoption of accounting policies is inherent in accrual-based financial statements, i.e., balance sheet and
profit and loss account).
Extraordinary Items
The cash flows associated with extraordinary items are disclosed separately as arising from operating,
investing or financing activities in the cash flow statement, to enable users to understand their nature and
effect on the present and future cash flows of the enterprise. These disclosures are in addition to the separate
disclosures of the nature and amount of extraordinary items required by Accounting Standard (AS)-5, Net
Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies.
Taxes on Income
Taxes on income arise on transactions that give rise to cash flows that are classified as operating, investing or
financing activities in a cash flow statement. While tax expense may be readily identifiable with investing or
financing activities, the related tax cash flows are often impracticable to identify and may arise in a different
period from the cash flows of the underlying transactions. Therefore, taxes paid are usually classified as
cash flows from operating activities. However, when it is practicable to identify the tax cash flow with an
individual transaction that gives rise to cash flows that are classified as investing or financing activities,
the tax cash flow is classified as an investing or financing activity as appropriate.
Note: Remember that CFIA and CFFA remains the same for both Direct and Indirect Method.
Problem 1: Following is the Trading Profit and loss Account of New India Ltd. for the year ended 31.03.2005.
Particulars ` Particulars `
To Opening Stock 400,000 By Sales 4,032,000
To Purchases 2,802,000 By Closing Stock 520,000
To Gross Profit 1,350,000
4,552,000 4,552,000
To Operating Expenses 6,70,000 By Gross Profit b/d 1,350,000
To Interest expense 15,000 By Compensation for loss of goodwill 100,000
To Depreciation 2,70,000 By Interest recd. from customers 5,000
To Taxation 2,50,000 from investments (40% Short term) 30,000
To Net Profit 3,70,000 By Dividend received 40,000
By Profit on sale of fixed assets 50,000
1,575,000 1,575,000
AS-3 (Revised): Cash Flow Statement 27
Problem 2: Arrange and redraft the following Cash Flow Statement in proper order keeping in mind the
requirements of AS-3:
` (in lacs) ` (in lacs)
Net Profit 60,000
Add: Sale of Investments 70,000
Depreciation on Assets 11,000
Issue of Preference Shares 9,000
Loan raised 4,500
Decrease in Stock 12,000
1,66,500
AS-3 (Revised): Cash Flow Statement 29
Solution: As per para 25 exchange gains/losses should be shown as a part of reconciliation. Foreign CF are
recorded at prevailing rate on the date of cash flow.
(i) Debtors (10000 × 40) ...Dr. 4,00,000
To Sales 4,00,000
Bank (8000 × 42) ...Dr. 3,36,000
To Debtors 3,20,000
To Exchange gain (AS-11) 16,000 (P/L)
Debtors (2,000 × 3) ...Dr. 6,000
To Exchange gain (AS-11) 6,000 (P/L)
Total Profit and Loss credit due to forex gain is 22,000 out of which 16000 is realized and 6000
unrealized. But unrealized gain can be ignored because 6000 will increase Net Profit on one side and
Debtors on other side.
(ii) Increase in foreign bank balance is an unrealized gain ($1,00,000 x 3) = ` 3,00,000. First effect will
be to eliminate ` 3,00,000 from Net Profit and then show ` 3,00,000 as an addition to the opening
balance of cash and cash equivalents.
Problem 4: Bellhop LLC submits the following information pertaining to year 2011. Using the data, you are
required to find the ending cash and Bank balances given an opening figure thereof was` 1.55 million.
(` millions)
Additional shares issued 6.50
CAPEX (Capital expenditure) 9.90
Proceeds from Assets sold 1.60
Dividends declared 0.50
Loss from disposal of Assets (1.20)
Net Income 3.30
Increase in Accounts Receivable 1.50
Redemption of 4.5% debentures 2.50
Depreciation & Amortization 0.75
(CA Final May 2012 Marks 4)
Solution:
Cash Flow Statement (Indirect Method)
(` In Millions)
Problem 5: Money Ltd., a non financial company has the following entries in its Bank Account. It has sought
your advice on the treatment of the same for preparing Cash Flow Statement.
(i) Loans and Advances given to the following and interest earned on them:
(1) to suppliers
(2) to employees
(3) to its subsidiaries companies
(ii) Investment made in subsidiary Smart Ltd. and dividend received
(iii) Dividend paid for the year
(iv) TDS on interest income earned on investments made
(v) TDS on interest earned on advance given to suppliers
(vi) Insurance claim received against loss of fixed asset by fire
Discuss in the context of AS 3 Cash Flow Statement.
Solution: Treatment as per AS 3 ‘Cash Flow Statement’
(i) Loans and advances given and interest earned
(1) to suppliers Cash flows from operating activities
(2) to employees Cash flows from operating activities
(3) to its subsidiary companies Cash flows from investing activities
(ii) Investment made in subsidiary company and dividend received Cash flows from investing activities
(iii) Dividend paid for the year Cash flows from financing activities
(iv) TDS on interest income earned on investments made Cash flows from investing activities
(v) TDS on interest earned on advance given to suppliers Cash flows from operating activities
(vi) Insurance claim received against loss of fixed asset by fire Extraordinary item to be shown
under a separate heading as ‘Cash
inflow from operating activities’.
CHAPTER 5
AS-4: Events Occuring After
the Balance Sheet
Chapter Outline
vv Introduction vv Exceptions to General Rule
vv Events Occurring after the Balance Sheet Date
i) Adjusting events
ii) Non-adjusting events
SIGNIFICANT EVENTS
DO YOU KNOW
Events are different as compared to transactions.
Some more notes and explanation regarding Adjusting and Non – Adjusting Events:
Example: Adjusting Events
Patly Pourri Limited whose accounting year ends on 31.03.2009, agreed in principle to sale plot of land on
20.03.2009 for ` 5 crores. Upto 31.03.2009 the company has not recorded the event. But on 24.04.2009 the
company received the valuation report and immediately signed the agreement for sale of land. The Financial
Statement was approved on 16.06.2009.
Analysis of Adjusting Events:
◘◘ Subsequent Event: Sale of Land.
◘◘ Subsequent Event (period): 1.4.2009 – 16.6.2009.
◘◘ Conditions existed on the Balance Sheet date: Yes, Condition, which led to the sale of Land existed on
the Balance Sheet
◘◘ Subsequent Event provides further evidence: Evidence of signing the agreement.
◘◘ Effect: Record the Sale of Land.
34 Accounting Standards
Problem 1: Explain as to how you would treat the following events occurring after the balance sheet date
in the financial statements:
a) A major fire has damaged the assets in the factory on April 2, two days after the closure of accounts.
The loss is estimated at ` 20 crores out of which ` 12 crores would be recoverable from the insurers.
b) The dispute for bonus to employees was before the arbitrator and he gave the award in favour of
workmen for ` 3 lacs.
c) A contract for civil construction was performed during the accounting year. The client has gone on
appeal for damages of low quality works and was awarded an amount of ` 1.5 lacs.
Solution:
(a) AS 4 provides that a deterioration in operating and financial position, or unusual changes affecting
the existence of the enterprise after the Balance Sheet, date may indicate a need to consider whether
it is proper to use the fundamental accounting assumption of going concern in the preparation of the
financial statements.
Taking note of the facts of the case, it is to be decided whether a net loss of ` 8 crores (over all loss
` 20 crores, of which ` 12 crores recoverable from insurers) affects the sub-stratum of the enterprise,
and whether the going concern assumption is appropriate.
In the present case it appears from the phrase “the factory” that the operations are carried out in
a “single factory”. Since insurance claim will not be sufficient to recommence operations, the going
concern assumption is likely to get affected. If this were the case, adjustments to the financial
statements would be necessary.
Nevertheless, If the size, nature and complexity of operations of the enterprise is such that this
loss will not materially affect the substratum of the enterprise, a disclosure In Directors’ report is
appropriate.
(b) Condition obtained on the Balance Sheet date relates to a dispute, and about which additional
evidence has emerged after Balance Sheet date. Accordingly, it is necessary to make adjustments, by
way of a provision for ` 3 lacs towards bonus payment for the year just ended.
(c) The award of ` 1.5 lacs by the arbitrator is an adjusting event within the meaning of AS-4. Accordingly,
a provision of ` 1.5 lacs ought to be made.
AS-4: Events Occuring After the Balance Sheet 35
Problem 2: For the 2 companies whose FY ended on 31st Dec. 2016, the financial statements were approved
by their respective directors on 25th March 2017.
During 2017, the following material events took place:
a. Keswani Ltd. sold a property which was included in the balance sheet at ` 2,00,000 and for which
contracts had been exchanged on 15th Dec. 2016. The sale was completed on 10th Feb. 2017 at a
price of ` 4,00,000. (CA Final, Nov 2010)
b. On 2nd March 2017, the mail order activities of S Ltd. (a retail trading group) were shut down with
closure costs amounting to ` 75 lakhs.
You are required to state, with reasons, how each of the above items numbered (a) and (b) should be dealt
with in the financial statements for the year ended 31st Dec. 2016.
Solution:
(a) Keswani Ltd.: The sale of property should be treated as an adjusting event since contracts had been
exchanged prior to the year-end. The effect of the sale would be reflected in the financial statements
to 31.12.2016 including the profit on sale to be reflecting for the year end..
(b) S Ltd.: A closure not anticipated at the year-end would be treated as a non-adjusting event. Disclosure
would be required since non-disclosure would affect a user’s ability to reach a proper understanding
of the financial statements.
P roblem 3: The accounts of АВС Ltd., for the year ended 31st March. 2015, was approved by the BOD of
the Co. on 19th May 2016. The Directors recommended a Dividend @ 10%. However, the Directors feel that
this need not be disclosed in the account for the year ended 31st March 2015 since it does not provide any
additional Information to the condition prevailing on the date of Balance Sheet i.e. on 31st March 2015. Do
you agree with the BOD of ABC Ltd.? (Final C.A. Audit Nov. 2012)
Solution: If an item is statutorily required to be shown in the financial statements, assets and liabilities are
adjusted for such events occurring after the balance sheet dale. For example, proposed dividend is shown in
the profit and loss account and balance sheet although such an item is approved only in the Annual General
Meeting. Under the New Schedule III dividends are required to be disclosed in the notes. But as AS-4 is superior
to any provision to Schedule III hence at present Dividend proposed by a company should be recorded by the
declaring company for the previous year under audit.
P roblem 4: A Limited Company closed its accounting year on 30.6.2016 and the accounts for that period
were considered and approved by the board of directors on 20th August, 2016. The company was engaged in
laying pipeline for an oil company, deep beneath the earth. While doing the boring work on 1.9.2016, 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 will be dealt with in the financial statements for the year
ended 30.6.2016. (Final C.A. May 1999)
Solution: Para 3.2 of AS-4 (Revised) on 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 given in Paras 13-15 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. It was not an ‘event occurring after the balance sheet date’ at the all. For events occring….AS-4
the event should take place between year ending till accounts approval date.
P roblem 5: While preparing its final accounts for the year ended 31st March, 2016 a company made a
provision for bad debts @ 5% of its total debtors. In the last week of February, 2003 a debtor for ` 2 lakhs had
suffered heavy loss due to an earthquake; the loss was not covered by any insurance policy. In April, 2016 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, 2016?
(Final C.A. Nov. 1993, Nov. 1995, Nov. 2003, June 2009)
36 Accounting Standards
Solution: As per paras 8.2 and 13 of Accounting Standard-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 ` 2 lakhs should be made to cover the loss arising due to the
insolvency in the Final Accounts for the year ended 31st March, 2016. It is because earthquake took place
before the balance sheet date.
Had the earthquake taken place after 31st March, 2016, then mere disclosure required as per para 15,
would have been sufficient.
P roblem 6: Subsequent to the balance sheet date State Bank of India have granted a remission of liability to
KF Limited (a sick Co.) of ` 40,00,000 under a BIFR package. If the conditions of remission were existing on
the Balance Sheet date should both the Banks record the remissions of liability?
Solution: Yes, the remission of liabilities to a sick company under BIFR package, should be recognized on the
Balance Sheet Date as the conditions typically existed on the balance sheet date. The sick company would
have been registered with the BIFR, incapable of fulfilling its repayment obligations, negotiations between
the sick company, financial institution and the Board would have been on going on the Balance Sheet date.
P roblem 7: Aaksha Limited made investments of ` 20,00,000 in the month of April 2017 in the acquisition
of another company the negotiations for which had started during the financial year end 31st March, 2017.
Advise on accounting for the year ended 31st March, 2017. (CA Final Nov 2009)
Solution: If investments were purchased before March and payments made after March then it is a purchase
of investments. In the present case the investments are purchased in April. This means the investments in
the books of investor company get registered in the month of April only. The negotiations do not entitle the
investor the shareholder before March. Therefore it is not the event occurring after the balance sheet date.
P roblem 8: After the close of the accounting year of XYZ Co. Ltd., there was a severe earthquake. As a result
of which a portion of the building and the rolling mill was destroyed. The extent of the damage was beyond
repair. The company’s resources were inadequate to find the replacement of the assets so destroyed.
(C.A. Final May 1995)
Solution: The event is a non-adjusting event since it occurred after the year-end and does not concern
conditions existing at the year-end. However, it is necessary to consider the validity of the going concern
assumption having regard to the extent of insurance cover. If the going concern basis is still valid, full
disclosure of the event should be provided.
Problem 9: A company deals in petroleum products. The government fixes the sale price of petrol.
After the Balance Sheet date, but before the finalization of the companies accounts, the government
unexpectedly increased the price retrospectively. Can the company record for the additional revenue at the
close of the year? Discuss? (C.A. Final)
Solution: Unexpected increase in the selling price of petrol by the govt after the Balance Sheet date cannot be
adjusted at the Balance Sheet date since it does not represent a condition on the Balance Sheet date (as very
much clear from the wording ‘unexpected rise in prices’). The event is a non-adjusting even since it occurred
after the year-end and does not concern conditions existing at the year-end. However, disclosure may be
made if the amount is material. The increase in the revenue due to the increase in Sales Price should be
recorded in the subsequent year under the head exceptional item.
Problem 10: Neel Limited has its Corporate Office in Mumbai, and sells its products to Stockists all over
India. On 31st March 2013, the Company wants to recognize receipt of cheques bearing date 31st March
2013 or before, as “Cheques in Hand”, by reducing “Trade Receivables”. The “Cheques in Hand” is shown
in the Balance Sheet as an item of Cash and Cash Equivalents. All Cheques are presented to the Bank in the
month of April 2013 and are also realized in the same month in normal course after deposit in the bank. State
with reasons, whether each of the following is an Adjusting Event, and how this fact is to be disclosed by the
Company, with reference to the relevant Accounting Standard.
AS-4: Events Occuring After the Balance Sheet 37
(i) Cheques collected by the Marketing Personnel of the Company from the Stockists on or before 31st
March 2013. (ii) Cheques sent by the Stockists through courier on or before 31st March 2013.
Solution: Cheques collected by the Marketing Personnel of the Company from the Stockists on or before 31st
March Marketing Personnel, being employees of the Company, have collected the amount before 31st March,
and it constitutes a “receipt” by the Company, before the B/s date. Subsequent realization in April provides
additional evidence of the matter, and hence the Company can consider this as an “Adjusting Event” and
account for such items as “Cheques in Hand”. As per AS-4 it is to be recorded as an adjusting event.
Cheques sent by the Stockists by through Courier on or before 31st March, the Company has not “received”
the Cheques before 31st March, and hence, mere sending of the cheques by the Stockists through Courier
does not pertain to conditions prevailing on the B/s date. This amount should not be adjusted in the accounts.
AS-5 (Revised):
CHAPTER 6
Net Profits or Loss for the Period,
Prior Period Items and Changes in
Accounting Policies
Chapter Outline
vv Objective vv Changes in Accounting Policies
vv Components of Net Profit vv Comparison between Prior Period Items,
vv Prior Period Items (PPI) Changes in Accounting Estimates and
Changes in Accounting Policies
vv Accounting Estimates (AE)
Objective
The objective of this standard is to prescribe the classification and disclosures of various components of
Net profit. By adopting this standard, the whole company will have uniformity in accounts.
Example: Profits and loss on sale of assets, Litigation settlement, writing down stock at NRV, Reversal of
provisions, restructuring expenses, litigation settlements, embezzlement of cash, profit/loss on sale of
long-term investments.
DO YOU KNOW
All ordinary items may not be exceptional, but all exceptional items are ordinary items.
Note: As per the New Schedule III Profit/loss on sale of long or current investments should be disclosed in the
notes under the head “Other income” or “Other expenses” based on profit/loss. As per AS-5 profit or loss on
sale of long-term investments should be disclosed as exceptional items. Its only a difference of presentation,
hence we should follow New Schedule III.
Example: Attachment of a property by the government, losses due to earthquake, Government refund as
per AS-12, two exceptions referred to in AS-12 for grants.
Examples of PPI: Casting Error, Capital expenditure treated as revenue, Finance lease treated as operating
lease, Omitting any particular income or expenditure in some past year, Applying incorrect rate of Depreciation
etc.
Note: As per the New Schedule III disclosure of PPI is not mentioned hence we should include it in the other
income/expenses, with some details in the footnote about the nature of PPI.
as assessed found to be different, then such difference is due to change in accounting estimates. Even the
developments in such estimates year to year have to be monitored. It has to be updated with the experience
and new information collected. Changes in Accounting Estimates are also to be disclosed separately. The use
of reasonable estimates is an essential part of preparation of financial statements and does not undermine
their reliability.
Examples of AE:
i) Useful life of assets (of course it relates to depreciation)
ii) Provision for bad debts
iii) Income Tax provision.
iv) Provision for inventory obsolescence.
Disclosures: Amount and nature of change. If the quantification of amount is not possible then fact of such
change in accounting estimate is to be disclosed.
Examples of AP: Change in the method of Depreciation, Change in the method of Stock Valuation, Change in
the approach of accounting for Government Grants, Revenue recognition policy etc.
To sum up, the following are to be shown separately including their (nature and amounts)
(1) Ordinary items (only exceptional items),
(2) Extra - ordinary items,
(3) Prior period items,
(4) Changes in Accounting Estimates,
(5) Changes in Accounting Policies.
DO YOU KNOW
Occasionally it may be difficult to distinguish between changes in measurement bases (i.e., Accounting Policies)
and Changes in Estimate. In such cases, the change is treated as a change in estimate.
Problem 1: Revision of Wages from 1st January 2017 would costs additional liability of ` 2,50,000 per
annum. Advise about the treatment in the final accounts for the year ending 31.03.2019.
(C.A. Final Nov. 1993, May 1995, May 2002)
Solution: Additional liability for salaries of ` 2,50,000 should be included in the salaries of the current year
i.e. 2018-2019. It may be noted that additional salaries are an expense arising from the ordinary activities
of the enterprise. Although infrequent in occurrence, such an expense does not qualify as an extra-ordinary
item (Para 6.2 of AS-5). One can show the item as excpetional but not extraordinary.
Problem 2: It was found that value of stock costing ` 50,000 had been included twice in the stock sheet as
on 31st March 2020. Advise about the treatment in the final accounts for the year ending 31.03.2021.
(C.A. Final Nov. 1993, May 1995, May 1999, Nov. 2003)
Solution: Rectification of error in stock valuation is a Prior Period Item vide para 3.1 of AS-5. It is necessary
to deduct ` 50,000 from opening stock in the Profit and Loss Account for the year ended on 31st March, 2011.
It is also necessary to charge ` 50,000 as prior period adjustment in the Profit and Loss Account below the
line. It may be mentioned that para 9 of AS-5 requires separate disclosure of Prior Period Items.
42 Accounting Standards
Problem 3: How would you deal with the following in the annual accounts for the year ending 31/03/2015
of ABC Ltd.:
i) The company has to pay delayed cotton clearing charges, over and above the negotiated price, for
taking late delivery of cotton from the suppliers godown. Upto the last year the company use to add
such charges in closing stock valuation. But for the current year the company wants write off the
charges against revenue as the charges are in the nature of interest.
(C.A. Final May 1996, May 2002, Nov 2012)
ii) Fuel surcharge is billed by State Electricity Board at provisional rates. The Final bill for fuel surcharge
for ` 5,30,000 for the period October 2010 – September 2014, has been received and paid in February
2015. (C.A. Final May 1996)
iii) There was a major theft of stores valued at ` 10,00,000 last year which was identified in the current
year. (C.A. Final May 1998)
iv) During the year 2014 – 15 stock was written down to its NRV. (C.A. Final May 2002)
v) ABC Ltd. was making provision for non-moving stocks based on no issues for the last 12 months upto
31.3.2015.
The company wants to provide during the year ending 31.3.2016 based on technical evaluation:
for non-moving stocks should be made. The method of estimating the amount of provision may be
changed in case a more prudent estimate can be made.
In the given case, considering the total value of stock, the change in the amount of required provision
of non-moving stock from ` 3.5 lakhs to ` 2.5 lakhs is also not material. The disclosure can be made
for such change in the following lines by way of notes to the accounts in the annual accounts of ABC
Ltd. for the year 2002-03:
“The company has provided for non-moving stocks on the basis of technical evaluation unlike
preceding years. Had the same method been followed as in the previous year, the profit for the year
and the corresponding effect on the year end net assets would have been higher by ` 1 lakh”.
P roblem 4: In the context of relevant Accounting Standards, give your comments on the following matters
for the financial year ending on 31.3.2012:
While preparing its final accounts for the year ended 31st March, 2012 Rainbow Limited created a provision
for Bad and Doubtful debts are 2% on trade debtors. A few weeks later the company found that payments
from some of the major debtors were not forthcoming Consequently the company decided to increase the
provision by 10% on the debtors as on 31st March, 2012 as the accounts were still open awaiting approval of
the Board of Directors. Is this to be considered as an extra ordinary item or prior period item?
(C.A. Final Nov. 2002)
Solution: It is an adjusting item as per AS-4 (Rev). The revision in doubtful debts improves the position of
financial statements where information is collected after the balance sheet date. It is not a change in accounting
estimates because the provision has not elapsed year. Also it is not prior period item (no error took place in the
preparation of financial statmeents) or even extraordinary item (debtors are operating assets).
P roblem 5: As an auditor state your views on the following situations:
(a) Y Ltd. provided ` 25 lacs for inventory obsolescence in 2017-18. In the subsequent year, it was
determined that 50% of such stocks was usable. The company wants to adjust the same, through
prior-period adjustment account, as the provision was made in the earlier years.
(C.A. Final Nov. 2007)
(b) In the previous year ‘Y’ Ltd. has made a provision of 10% of the contract value on ongoing projects.
The actual loss on completion of the contract in the subsequent year was 11%. The management
adjusted the difference in the previous year’s account. (C. A. Final May 1997)
(c) A suit for damages of ` 1 lakh for breach of contract of sale (breach occurred in 2015) was decreed
in favour of May Ltd. in March, 2017. The company has included the amount in its turnover for the
financial year 2017. (C. A. Final May 1998)
Solution:
(a) As per AS-5 on “Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting
Policies”, prior period items are income or expenses which arise in the current period as a result
of errors or omissions in the preparation of the financial statements of one or more prior periods.
The write-back of provision made in respect of inventories in the earlier year does not constitute
prior period adjustment since it neither constitutes error nor omission but it merely involves making
estimates based on prevailing circumstances when financial statement were being prepared. It is a
mere estimate process involving judgment based on the latest information available. An estimate may
have to be revised if changes occur regarding the circumstances on which the estimate was based,
or as a result of new information, more experience or subsequent developments. The revision of
the estimate, by its nature, does not bring the adjustment within the definitions of an extraordinary
item or a prior period item. In this case, T Ltd. provided ` 25 lakhs for inventory obsolescence in
2017-2018. In the subsequent year due to changed circumstances, it was determined that 50% of such
stock was usable. Revision of such an estimate does not bring the resulting amount of ` 12.5 lakhs within
the definition either of a prior period item or of an extra-ordinary item. The amount, however, involved
is material and requires separate disclosure to understand the financial position and performance of an
enterprise. Accordingly, the accounting treatment followed by the company is not proper.
(b) The provision of loss of 10% of the contract value by Y Ltd. in previous year is in the nature of
accounting estimate since due to uncertainties inherent in any business activity, it is difficult to
measure such item in a precise manner. Accordingly, adjusting the difference in the previous years’
44 Accounting Standards
account is not correct. AS-5 on Net Profit or loss for the Period, Prior Period Items and Changes in
Accounting Policies, states that the effect of a change in an accounting estimate should be included
in determination of net profit or loss in the period of the change, if the change affects the period
only. Thus, the management should adjust the difference in the current period only. Alternatively, the
auditor should quality his report.
(c) Amount should not be included in turnover. It is an ordinary activity but is to be disclosed separately
as per AS -5 as exceptional item. The expression “turnover” normally implies the amount for which
the sales are effected or services rendered by an enterprise. Thus, apparently as per this definition,
the amount received on account of breach of contract of sales would not form part of the turnover.
Now question may arise whether such amount is to be disclosed either as a prior period item or
extraordinary item as a separate item in the financial statements. As per the AS-5 on Net Profit or
Loss for the “Period, Prior Period Items and Changes in Accounting Policies”, it is not a prior period
item as the suit was decreed only during the current financial year. Securing damages for breach of
contract cannot be treated as an extraordinary item also since it forms part of ordinary activities of
the business. The separate disclosure of such an item should be called for as per AS-5 in case having
regard to nature, size or incidence of the item concerned and that the separate disclosure is relevant
to explain the performance of the enterprise for the period. Thus, having regard to the materiality
of the amount received it may be considered whether the same may be disclosed separately the
profit and loss account. Alternatively, a separate disclosure may be made in the notes to financial
statements. If the company does not comply with the AS the auditor may qualify his report.
P roblem 6: XYZ Ltd., as part of overall cost cutting measure announced voluntary retirement scheme (VRS)
to its employees, to reduce the employee strength. During the first half year ended 30.9.2002 the company
paid a compensation of ` 72 lakhs to those who availed the scheme. The Chief Accountant has reflected this
payment as part of regular salaries and wages paid by the company. Is this correct? (CA Final May 2003)
Solution:
Accounting Treatment of Payment on account of VRS: As per AS 5, “Net Profit or Loss for the Period, Prior Period
items and Changes in Accounting Policies” the payment made to its employees on account of VRS as an overall cost
cutting measure would fall in the ambit of ordinary activities connected with the business of the enterprise. AS-5
requires that 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. In fact an activity like VRS can very well be
treated as restructuring exercise carried by the enterprise. Though this is not an extraordinary item, AS 5 requires
that items of income and expense which are not extraordinary items, the nature and amount of such items may be
relevant to users of financial statements in understanding the financial position and performance of an enterprise
and in making projections about financial position and performance. Disclosure of such information is sometimes
made in the notes to the financial statements. Considering the above, the compensation of ` 72 Lakhs paid towards
VRS availed by employees should be shown separately in the profit and loss account of XYZ Ltd., so that the effect
of it on the operating results of the Company during the previous year can be perceived. Therefore, clubbing of `
72 lakhs with the regular salaries and wages of the company by the Chief Accountant is not appropriate and, thus,
the separate disclosure is necessary.
P roblem 7: During the course of the last three years, a company owning and operating Helicopters lost
four Helicopters. The company’s Accountant felt that after the crash, the maintenance provision created in
respect of the respective helicopters was no longer required, and proposed to write back to the Profit and
Loss account as a prior period item.
Is the Company’s proposed accounting treatment correct? Discuss. (C.A. Final May 2007)
Solution: It is not a PPI because it is not a mistake/omission of past year. It is a normal operating item and
should be credited to P/L account. But the helicopter provision write back is a special operating item. It
requires a separate disclosure (exceptional item). Loss related to accident is an extra ordinary activity.
AS-5 (Revised): Net Profits or Loss for the Period, Prior Period Items and Changes in Accounting Policies 45
Problem 8: Z Ltd. sustained loss during the year due an enemy combat.
(C.A. Final May 1998 Audit)
Solution: Extraordinary activity. Similar to loss due to an earthquake. Situations/events on which
management has no control. (Please define Extra-ordinary activities)
Problem 9: Finished Goods costing `10 lacs were damaged due to flood in July 2013. These goods were
included in Closing Stock as on March 31, 2014 at an estimated realizable value of `4.00 lacs.
These goods could be ultimately sold for `3 lacs only in August 2014. The difference of f 1 lac was debited
as prior period expenditure in financial year 2014-15. As an auditor please comments in the light of provisions
of accounting standards. 4 Marks
Solution: The difference of `100000 cannot be a prior period item as no error took place in the preparation
of financial statement of past period. The estimated write off of the inventory `6,00,000 (10-4) is revised to
`7,00,000. This is change in Accounting Estimates as per AS-5. Many items in the financial statement cannot
be exactly calculated but can only be estimated. Estimation changes because of change in circumstances,
more development in the case. In the given case the company is required to just disclose the change in a/c
estimate in the financial statement.
CHAPTER 7
AS-6 & Schedule II:
Depreciation Accounting
Chapter Outline
vv Depreciation vv The Effects of Change in Historical Cost and
vv Depreciable Assets Estimated Life of the Asset on Depreciation
vv Exclusions from AS-6 vv Second Hand Asset/Acquired in
Amalgamation Vs Depreciation
vv How to Calculate Amount of Depreciation
vv Disclosures in AS-6
vv Methods of Depreciation
Depreciation
It is the wear and tear of asset – Economics. In accounting, it is defined as a distribution of total cost over the
useful life of the asset. Depreciation is nothing but amortization of cost of assets over its useful life.
DO YOU KNOW
Under IAS, Fixed assets and Depreciation is combined in a single standard IAS-16.
Depreciable Assets
To bring an asset under depreciation chargeable asset, one has to satisfy all the conditions given below:
Condition 1: Assets should have been held for production of goods and services and not for sale.
Condition 2: Assets should be of limited life.
Condition 3: Assets used for more than 1 year- it means assets used for less than 1 year- should be charged
to revenue.
If any one of the above definitions is not satisfies it is not a depreciable fixed asset. Example: Land has all
the features of a depreciable fixed asset except condition 2, hence, Land is not depreciated.
*Estimated life can be either useful life (physical life) or economic life (number of productions one can reap from the assets)
Key highlights
◘◘ Instead of % of depreciation now it is useful life of the asset. Remembering rate is difficult but life is
easy. Example: 9 years is easy to recall but 11.11% is tough!
◘◘ Maximum cap on salvage value.
◘◘ Other than SLM, WDV even units of production can be applied.
◘◘ Component accounting is now mandatory.
◘◘ Schedule II is almost adhering to the principles of IFRS – IAS : 16 (Thanks Central Government to keep
policies akin to global guidelines)
PART A : Deals with main provisions relating to depreciation of tangible and intangible assets.
PART B : Deals with provisions relating to depreciation of assets covered by the act of the parliament.
PART C : Its provides the list of the useful life of an asset. It also provides some relevant notes related to the
calculation of depreciation.
DO YOU KNOW
(i) AS-6 states that depreciated should be calculated as per the rates given under special act / statute?
Example: Electricity Act, Companies Act 1956. But now Schedule II overrides all the acts / statutes.
(ii) Useful life is inversely proportion to Rate of depreciation. Higher the rate lower the useful life.
Depreciation amount will be (Cost – residual value). Can we say that Depreciation as per Schedule II is the
systematic allocation of depreciation amount over the useful life.
Useful life: Schedule II does not provides rates but has provided the maximum useful life. The useful life
given in PART ‘C’ is the maximum life (minimum rates of depreciation) .
Residual Value: The New Schedule related to depreciation casts a cap on the RV to be 5% on original cost.
Different Useful life and Residual Value: The useful life of an asset shall not be longer than the useful life specified
in Part ‘C’ and the residual value of an asset shall not be more than 5% of the original cost of the asset:
Provided that where a company uses a useful life or residual value of the asset which is different from the
above limits, justification for the difference shall be disclosed in its financial statement.;
5) Component Accounting - Note No 4 of Schedule II : (supported by Ind AS-16 as well as IAS – 16)
(a) Useful life specified in the Schedule II to the Companies Act is for whole of the asset. Where
cost or a part of the asset is significant to the total cost of the asset and useful life of that part
is different from the useful life of the remaining asset, useful life of that significant part will be
determined separately
(b) This paragraph talks about the ‘component approach’, which is in line with international
practices. It requires companies to separately depreciate parts of an asset that are significant
and have a useful life different from the useful life of the asset as a whole
(c) The component approach is already allowed in current Accounting Standard 10 – “Accounting
for Fixed Assets” in Paragraphs 8.3, but it seems to be a choice of matter. Now it seems as per the
note 4 it is mandatory in Companies Act, 2013.
(d) Previously companies use to charge component replacement to profit / loss account. But now it
will be separately capitalised.
Example: Building and its Elevator can be treated as a separate component. Also Aircraft body
and its engine can be treated as 2 separate assets.
(d) Effect of Schedule II on Revaluation of assets:
Schedule II has no effect on Revaluation provisions. Lets see what it was:
Whenever an asset is upward revalued the depreciation on the excess portion is charged to the
Revaluation Reserves Account.
(e) Transitional Effect of Schedule II – Very Important provision at the date of applicability of
Schedule II of Companies Act, 2013
From the date of the Companies Act coming into effect, the carrying amount of the asset as on
that date:
(i) Shall be depreciated over the remaining useful life of the asset according to the Act .This
means shifting from the old provisions to the new one the remaining carrying amount is
to be just spread over the remaining useful life as per the new provisions on a systematic
basis.
(ii) After retaining the residual value, shall be recognized in the opening balance of retained
earnings where the remaining useful life of an asset is nil. It means if the remaining
useful life as per the new provisions is Nil, then the balance in the asset after keeping aside
5% on original cost is adjusted in the opening reserves (free reserves).
(f) Disclosures in Schedule II
The following information shall also be disclosed in the accounts, namely:
(i) Depreciation methods used; and
(ii) The useful lives of the assets for computing depreciation, if they are different from the life
specified in the Schedule
(g) Amortization of Service Concession Arrangement:
In certain countries construction or maintenance of infrastructure for public services (roads,
bridges, water distribution facilities) is contracted out to private-sector operators. The private
sector operators are usually paid for their services over the term of the arrangements. Such
arrangements are often described as “build-operate-transfer” (“BOT”) or a “public-to-private
service concession arrangement.”
Consideration given by the grantor to the operator: If the operator renders construction or
upgrade services, the consideration received or receivable by the operator shall be recognized
at its fair value. The consideration may be treated as an intangible asset.
Recognizing an “intangible asset”—the operator shall recognize an intangible asset to the extent
that it receives a right or a licence to charge users of the public service.
50 Accounting Standards
Disclosures in AS-6
◘◘ Total cost of each class of asset.
◘◘ Total depreciation on each class of asset.
◘◘ Accumulated depreciation.
◘◘ Method of depreciation.
◘◘ A change in method of depreciation.
◘◘ Effect of the revaluation of the fixed asset on the amount of depreciation.
Problem 1: As an auditor, state your views on the following situation: Y Ltd. Purchased an existing bottling
unit. The method of charging depreciation of machinery of the acquired unit was different from that followed
by the company in its other units. The company wants to continue to charge depreciation for the acquired
unit, in the method followed earlier by them and which was not consistent with their own method.
(CA Final Audit, Nov. 1997, Nov. 2013)
Solution: If a company has two class of assets and method of depreciation varies in the two cases then in
such case different method of depreciation is allowed. But such different method is required to be followed
consistently every year. Hence the view of the Chief Accountant that the company cannot follow SLM method
of depreciation at the newly acquired unit is not correct and the company can follow the SLM method of
depreciation at the newly acquired unit.
Problem 2: The company procured ocean going dredgers which were cleared by the Customs without levy
of customs duty in the year 2010. However, in 2013, the Customs authorities alleged willful misstatement
and suppression of facts. The company disputed the allegations but believes that the liability will fructify.
Therefore, the amount of custom duty sought to be levied on the respective dredgers has been capitalized and
a provision for custom duty was made in the books. Advise your client on how to charge depreciation on the
addition to fixed asset in 2013 caused by capitalization of the customs duty.
Solution: Any change in the historical cost of an asset like price fluctuation, govt. grant etc. should be given
prospective effect. But Custom duty is a case of asset escaping duty. This means the asset initially would
have been more by customs duty. Such additions are to be given retrospective effect. Also such additions will
attract AS-5 as the proportionate depreciation relating to the customs duty will be charged to P/L as a prior
period item.
Problem 3: Cost of the asset = 5,00,000, Scrap value ` 25,000, Estimated life = 4 years. Compute Depreciation
rate as per SLM and WDV method?
Solution:
Depreciation as per SLM = (500000 – 25000)/4 = 118750
Depreciation rate SLM = 118750/500000 = 23.75%
Depreciation as per WDV
25000
Depreciation % = 1 – 4 = 52.71%
500000
AS-6 & Schedule II: Depreciation Accounting 51
Solution:
First for Single shift:
SLM
Annual depreciation = 60lakhs x 95%/ 15 = 3.8 lakhs p.a.
Depreciation % = 3.8 / 60 = 6.33%
Double shift:
Depreciation % = 6.33% x 1.5 = 9.50%. Depreciation = 60 lakhs x 9.5% = ` 5.7 lakhs
Triples shift:
Depreciation % = 6.33% x 2 = 12.67%. Depreciation = 60 lakhs x 12.67% = ` 7.60 lakhs
Problem 8: Revenue based amortisation:
Buddhi Developers entered into a contract with the government to construct a highway under the BOT
system. Buddhi Dev construct the infrastructure for 2 years and will acquire the rights to collect toll charges
from the vehicles running on the highway. Construction costs estimated including profits is ` 5000 lakhs
Suppose the service construction period is 6 years. Estimated revenue is given:
# is actual revenue (` in lakhs)
Year Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
1 #1000
2 1000 #1050
3 1100 1050 #1100
4 1100 1050 1100 #1105
5 1100 1050 1100 1105 #1110
6 1100 1050 1100 1100 1110 #1120
Chapter Outline
vv Objective vv Contract Costs
vv Meaning and Scope vv Recognition of Revenues and Costs
vv Types of Construction Contracts vv Accounting for Expected Loss
vv Contract Revenues vv Disclosures as per AS-7 (Revised)
Objective
In case of accounting for inventories are concerned purchasing raw – materials, manufacturing them and
then ultimately selling the finished products requires approximately 2 months to 1 year. This means accrual
of cost and revenues are well covered within one financial year. But a contract generally commences in one
year and ends in different financial year. The execution of work is spread over two or more financial year.
Here unlike inventories (AS-2) allocation of costs and revenue becomes difficult. Also long range contracts
carries with it risks and uncertainties. Many a times a contractor works on many contracts in a particular
financial year. Therefore the primary issue in studying AS- 7 is to know the proper allocation of costs and
revenue for a particular financial year. How a contractor should recognize profit/loss for one financial year
for each contract out of so many contracts is guided by AS-7 (Revised)?
DO YOU KNOW
AS -7 (R) is an exception to the general rule set out in AS-2 which does not permit recognition of profit on
inventories.
not construction contracts but are related to construction contracts. Following are the contracts which are
also covered by AS-7(Revised):
i) Contracts involving rendering of services or which are assisting or related to a construction contract.
Example: Services rendered by an architect.
ii) Contracts for destruction of assets like demolition of buildings.
iii) Restoration of assets or restoration of environment. Example: leveling of land or removal of garbage.
Illustration: A contract for building a super market is given to X Ltd. but before building the structure, it
requires land leveling and removal of debris etc. which was handed over to Y Ltd. Here there are two separate
contracts one construction of super market and second leveling of land etc.
DO YOU KNOW
We are not going by the mere form of the contracts but we are going by the real substance in the contract/
contracts for segmenting contracts and combining contracts ……….Principle of Substance over form.
Illustration: Universal Builders Inc. is well known for its expertise in building flyovers and maintaining these
structures. Impressed with Universal’s track record, the local municipal authorities have invited them to
submit a tender for a two-year contract to build a super flyover in the heart of the city (the largest in the
region) and another tender for maintenance of the flyover for 10 years after completion of the construction.
Required: Evaluate whether these two contracts should be segmented or combined into one contract.
Solution: The two contracts should be combined and treated as a single contract because
◘◘ The two contracts are very closely related to each other and, in fact, are part of a single contract with
an overall profit margin.
◘◘ The contracts have been negotiated as a single package.
◘◘ The contracts are performed in a continuous sequence.
Contract Revenues
It is the Gross Revenue Income accounted for construction contracts. Following are the elements of Contract
Revenues:
A Claim – It is the amount, which the contractor seeks to • Negotiations should have been reached reasonably at
collect from the contractee or any third party. Such claim an advanced stage.
was not included in the original contract price. • Claim should be accepted by the customer/third.
Example: Price Escalations for materials, labour has to • Amount should be measured reliably.
be reimbursed to the contractor by the contractee, cost
overruns because of clear site is not provided to the
contractor.
Incentives – It is extra amount payable for meeting the set • Performance of the contract should have been reached
out standards or exceeding the standards. reasonably at an advanced stage.
Example: Early completion of the contract can attract • It is probable that the contractor will meet the set out
incentives to the contractor. standards or may exceed the standards.
• Amount should be measured reliably.
Penalties – Penalties levied by the contractee reduces • Reduction of the contract revenue.
the contract revenue. Penalties may be levied for late
completion of the contract.
Contract Costs
Following are the elements of Contract Costs:
Exclusions from Contract Costs: Following are to be excluded from contract costs:
i. Administrative expenses not reimbursed
ii. Selling expenses (excluded even if they are reimbursed)
iii. R and D costs
iv. Abnormal losses on contract. Such costs have to be expensed in General Profit and Loss account.
AS-7 (Revised): Construction Contracts 57
DO YOU KNOW
Percentage completion method is applied on a cumulative basis year after year. Also percentage completion
method works on the accrual basis of accounting….Fundamental Accounting Assumption.
Steps to solve the problem on recognition of revenue and costs: Costs to costs basis.
Steps Particulars Amount
Step 1: Compute actual costs incurred upto date = (Actual costs incurred – Closing stock of materials xxx
unused)
Step 2: Ascertain estimated future costs to complete the contract xxx
Step 3: Ascertain Total Estimated Costs (Step 1 + Step 2) xxx
Costs incurred to date
Step 4: Determine the stage of completion =
Estimated total costs xxx
Step 5: Ascertain total contract revenue = xxx
Total Contract price x % of Completion + Escalation claims
Step 6: Ascertain contract revenue for the year = (Total contract revenue – Revenue already recognised
in previous years) xxx
Step 7: Ascertain contract costs for the year = (Contract costs incurred upto date – Costs already
recognised in previous years) xxx
Step 8: Profit for the year (Contract profit) = (Step 6 – Step 7) xxx
DO YOU KNOW
Stage of completion method (%) is calculated without taking into effect the inflation. In other words Stage of
completion method (%) is calculated based on original estimates.
Some important points:
yy Estimated costs to complete require a proper adjustment to be made for expected increase/decrease in
prices or changes in foreign exchange rates. Adjustment should also be made for any delay that may arise
out of labour problems. Estimated costs have to be updated quarterly in case of listed companies.
yy Revenue is not based on progress payments or advances received.
yy Any contract costs which are not utilized at the balance sheet date (closing stock of materials) should not
be expensed but shown as an asset. It is also known as contract costs for future activity (WIP).
DO YOU KNOW
AS -7 (R) is one of the example of Onerous Contract covered defined by ASI-30.
Problem 1: Western Developers undertook a contract for improvement and development of chains of
godowns for government. Information about the project is given below: Year I: Basic initial agreed price
` 500 lakhs, construction costs incurred ` 130 lakhs, expenses not related to contract ` 2 lakhs, Prudent
estimates for the expenditure is ` 270 lakhs. Year II: Claim accepted by contractee (all conditions are fulfilled)
` 10 lakhs, incentives ` 10 lakhs (not yet certain), construction costs already spent upto date ` 200 lakhs,
costs yet to be incurred ` 205 lakhs. Contractee has given the contractor advances at the beginning of the
contract of ` 60 lakhs. It will be adjusted equally over 4 years against progress billings. Cash payments
made by contractee to Western Developers is: 95 lakhs (yr1), 45 lakhs (yr2) and remaining in 4th year of
completion after adjusting advances. The Progress billings are 120 lakhs and 200 lakhs (cumulative) in the
first and second year respectively.
Draw P/L, Contract A/C and balance sheet for 2 years only (in extract form).
Solution:
Steps Particulars Year I Year II
Step 1 Costs to date 130 200
Step 2 Future Costs 270 205
Step 3 Total Costs 400 405
Step 4 % of Completion 32.50% 49.38%
Step 5 Contract Price × % 162.50 (500 × 32.5%) 215.84 (510 × 49.38%)
Step б Revenue for the year 162.50 89.34 (215.84 – 162.5)
Step 7 Cost for the year 130 70
Step 8 Profit/Loss 32.50 19.34
60 Accounting Standards
Contract Account
Yr1 Yr2 Yr1 Yr2
To Contracts exps 130 70 By Contract revenue 162.50 89.34
To P/L 32.50 19.34
General P/L
To Expenses 2 – By Contract P/L b/d 32.50 19.34
To Net P/L c/f 30.50 19.34
Problem 2: Pakshatru engineering Company, undertook a contract for construction of a small cannel.
Following are the expenses incurred and other details for the year 2005 provided to you:
Compute Cost of the contract for the year 2005 and also state the amount transferred to General profit and
loss account.
AS-7 (Revised): Construction Contracts 61
Solution:
Particulars ` Reason for inclusion
Opening Work in progress 65,00,000 Opening Cost b/d.
Materials Consumed (See WN) 12,96,000 Direct Cost
Overheads 10,50,000 Direct Cost
Direct Labour 12,00,000 Direct Cost
Depreciation 7,00,000 Direct Cost
Administrative Expenses 4,50,000 Allocated and identified expenses
Supervisors Salary 42,000 Allocated and identified expenses
Total 1,12,38,000
* Materials Consumed = 2,00,000 + 14,00,000 – 25,000 – 4000 – 2,75,000 = ` 12,96,000
Problem 3: Ummagudu Limited provides the following details related to a construction of project:
2013-14 2014-15 2015-16
Cost incurred till date 20,00,000 27,00,000 57,00,000
Estimated cost on prudent basis 30,00,000 27,00,000 -
Revenue
Initial agreed price 66,00,000 - -
Claims - 4,00,000 -
Incentives - - 2,00,000
Progress billings 22,00,000 39,00,000 70,00,000
Cash receipts 11,00,000 30,00,000 68,00,000
Adjustments: Claims raised were immediately accepted by the contractee. The probability of receiving the
incentives was very low as the work was not completed on time.
Calculate Profit / Loss every year. Also list the disclosures as per AS-7 (Rev)
Solution:
Profit / loss:
2013-14 2014-15 2015-16
Cost incurred till date.............a 20,00,000 27,00,000 57,00,000
Estimated cost on prudent basis......b 30,00,000 27,00,000 -
Total Costs = ...................a+b = c 50,00,000 54,00,000 57,00,000
Stage of Completion % = a / c 40% 50% 100%
Revenue 66,00,000 70,00,000 70,00,000
Cumulative Revenue = 26,40,000 35,00,000 70,00,000
Less: Revenue already recognised Nil (26,40,000) (35,00,000)
62 Accounting Standards
Retention:
Progress billings 22,00,000 39,00,000 70,00,000
Less: Cash received (11,00,000) (30,00,000) (68,00,000)
Net Retentions 11,00,000 9,00,000 2,00,000
Problem 4: On 01.12.2005 Vishwakarma Construction Co. Ltd. undertook a contract to construct a building
for ` 85,00,000. On 31.03.2006 the company found that it had already spent ` 64,99,000 on the construction.
Prudent estimates of additional cost for completion was for ` 32,01,000. What is the additional provision
for foreseeble loss, which must be made in the final accounts for the year ended 31.03.2006 as per AS-7
(Revised)? Also draw extract of P/L?
(C. A. Final Nov. 2003, May 2010, May 2011) (Advanced Accounts Marks 5)
Solution: When it is probable that the total contract costs exceeds contract revenue the difference of expected
loss has to be charged to P/L account. 100% expected loss has to be accounted for. Such expected loss has to
be expensed irrespective of:
◘◘ progress payments received, % of work completed, profits on other contracts.
Expected loss to be expensed = (Cost incurred to date + Estimated cost to complete) – Total Revenue
= (64,99,000 + 32,01,000) – 85,00,000 = ` 12,00,000.
Hence Vishwakamia Construction Co. Ltd. should expense loss of ` 12,00,000 for the year 31.03.2006. Out
of which Current Year loss = 8.04 lakhs and Provision = 3.96 lakhs. (See note below)
Cost to date 6499000
+ Estimated costs + 3201000
Total Costs 9700000
Stage of completion 67%
Total Contract Revenue 8500000
Contract Revenue for the year 5696000
Contract Costs for the year (6499000)
Loss = 804000
AS-7 (Revised): Construction Contracts 63
Problem 5: Gas Ltd. has won a contract to construct and operate a gas pipeline. Gas Ltd. will construct the
pipeline and the associated infrastructure necessary to operate it. It will then operate it for 20 years. Gas Ltd.
will receive fess under the contract over 20 years. It will receive reimbursement of construction costs over
the five years following construction plus annual fee over 20 year period. Consequently, the profit that Gas
Ltd. will earn for the construction of pipeline is included in the annual fees it will receive. How should Gas ltd.
recognize the fees it will receive?
Solution: Gas Ltd has to split up the income received into two: (i) Construction of pipe line and (ii) Operation
of pipe line. The income earned from Construction of pipe line will be accounted as per AS-7 and the income
earned from Operation of pipe line will be accounted as per AS-9 over the period of 20 years.
Problem 6: Your client a contractor has just entered into a contract with the local municipal body for
building a flyover. As per the contract terms, your client will receive an additional ` 5 million if the flyover is
constructed within a period of two years. Your client wants to recognize this revenue since in the past it has
been able to meet these targets very easily. Advise your client keeping the revised AS 7 in mind.
(CA Final May 2007 Advanced Accounts)
Solution: According to para 14 of AS 7 (Revised) ‘Construction Contracts’, incentive payments are additional
amounts payable to the contractor if specified performance standards are met or exceeded. For example, a
contract may allow for an incentive payment to the contractor for early completion of the contract. Incentive
payments are included in contract revenue when: (i) the contract is sufficiently advanced that it is probable
that the specified performance standards will be met or exceeded; and (ii) the amount of the incentive
payment can be measured reliably. In the given problem, the contract has not even begun and hence the
contractor (Mr. X) should not recognize any revenue of this contract.
P roblem 7: Regal reconstruction Co undertook a contract on 1/4/2009. The contract revenue was decided
as reimbursable costs plus 20%. Costs incurred during the year 2009-10 was ` 3,25,000, of which ` 3,00,000
was reimbursable. Show P/L A/C.
Solution:
Contract Account for 2009-10
Particular ` Particular `
To Contract exp 3,25,000 By Contract Revenue 3,60,000
To Contract profit 35,000
Problem 8: PRZ &Sons Ltd are Heavy Engineering contractors specializing in construction of dams. From
the records of the company, the following data is available pertaining to year ended 31st March, 2017. Using
this data and applying the relevant Accounting Standard you are required to;
(i) Compute the amount of profit/loss for year ended 31st March, 2017.
(ii) Arrive at the contract work in progress as at the end of financial year 2016-17.
(iii) Determine the amount of revenue to be recognized out of the total contract value.
(iv) Work out the amount due from/to customers as at year end.
(v) List down relevant disclosures with figures as per relevant Accounting Standard.
(` Crore)
Total Contact Price 2,400
Work Certified 1,250
Work pending certification 250
Estimated further cost to completion 1,750
Stage wise payments received 1,100
Progress payments in pipe line 300
(CA Final May 2012)
64 Accounting Standards
Chapter Outline
vv Objective and Scope vv Disclosures in Revenue Recognition
vv Revenue Recognition in Case of Sales of Goods vv Few Important Points in AS-9
vv Principles of Revenue Recognition in
Case of Rendering of Services:
Applicability
Revenue recognition (AS-9) is not applicable to the following areas (as they are covered by another accounting
standard):
◘◘ Revenue from Construction contracts,
◘◘ Hire purchase
◘◘ Leasing
◘◘ Government grants and subsidies
◘◘ Insurance Contract
◘◘ Realized and unrealized gains on sale of fixed assets
Definition of Revenue
It is the gross inflow of cash or any other consideration to be received or receivables in the ordinary course
of business in the form of:
(i) Sales of goods.
(ii) Services rendered.
(iii) Employment of resources by company yielding dividend, interest etc.
Only gross inflow is revenue. Savings in cost is not revenue.
66 Accounting Standards
Example: Trade Discounts are savings in costs and cannot be disclosed separately. Such discounts have to be
deducted from the purchases. For a Commission agent revenue is the commission on the sales and not the
gross inflow.
that period then the seller can assume the sales. Sometimes installation process may be very simple, in that
case revenue can be recognized when goods are delivered to the buyers place (ex: unpacking a television and
connecting power).
Case 2: Consignment Sale: Date of transfer of stock is not important but sale made by agent is important.
Case 3: Warranty Sales: In case of warrantee sales, the revenue is to be recognized after making warrantee
provisions. Such provision is based on the past experience of trend of cost of returns and repairs.
Case 4: Guarantee Sales: In case of unlimited right of return (money back if not completely satisfied) the
revenue is to be recognized after making a suitable provision for returns based on past experience.
Case5: Cash on delivery: Revenue is recognized when the seller or his agent receives cash. Ex: A Grocery
delivers goods at the door step of the buyer against cash.
Case 6: Special order shipment: These are fixed readymade contracts in which revenue is to be recognized
on the date of goods are manufactured and ready for delivery of goods and not on the date of goods reached
the buyers place.
Case 7: Subscription for Publications: In case of publication one has to see whether the publication is
repetitive or of different sale value. If it is repetitive then recognize the sale as per SLM basis. And if it is
fluctuating in nature then recognize on sale value method.
Case 8: Delivery delayed at buyer’s request: Revenue is to be recognised if all the conditions are satisfied:
◘◘ Goods are delayed at the buyers request and not at the seller’s request.
◘◘ Goods are ready for delivery.
◘◘ Buyers accepts the billing and title of goods is transferred by the seller to the buyer.
Case 9: Repo Agreements: Repo agreements are agreements where the seller repurchases the goods at
a later date. Such agreements are not covered by AS – 9 because it is a finance transaction (Substance over
form). Hence the sales realisation is to be treated as an advance (liability).
Case 10: Installment sales: Only sales part is to be recognized as revenue on the date of sale and not the
interest. Interest is to be spread over the unpaid balance in the ratio of unpaid balance.
Case 11: Goods are delivered only when final payment is received: Revenue is not to be recognized
until the final payment is received. But if a significant portion of deposit is received then revenue may be
recognized based on past experience.
DO YOU KNOW
If consultancy services like project manager services not related to construction contracts then they are
covered by AS-9, but completely devoted to the projects are covered by AS-7.
` 12,000 as revenue. But Royalty income is subject to a condition then such condition should get fulfilled to
recognise revenue.
Case 3 - Dividend: When the owners right to receive dividend is established (AGM held is a enough evidence
for recognizing revenue). If the right to receive dividend is established subsequent to the balance sheet
date the dividend income is recognized in the subsequent year. In case of interim dividend actual receipt of
dividend is the date of recognition of revenue.
Problem 1: Total sales of a company included a sum of `4,00,000 representing royalty receivable for the
supply of know – how. The amount is payable in dollars. However, exchange permission denied the remittance
of currencies due to some problems among inter – countries. Comment.
Solution: The basic condition for RR is that no uncertainty should prevail at the time of recognising the
revenue. In the current case ` 4,00,000 which is a royalty income is received in $. The nature of uncertainty
has to be studied and based on the fact the revenue should be recorded. In the present case there is a problem
in the inter – countries and not inter-companies hence the nature of the problem has to be studied.
In the present case the amount of ` 4,00,000 is already included in the revenue. This means when the
revenue accrued was recorded there was no uncertainty. A provision now is to be made for covering the
uncertainty.
Problem 2: M Ltd. deals in manufacture parts for Steel Plants. It quotes prices in various tenders issued
by Steel plant companies. As per terms of contract, full price of machinery is not released by the steel plants
companies, but 10% is retained. The company accounts for 90% of the invoice value as revenue and balance
10% on receipt basis. Advise.
(Final C.A. May 2002) (5 Marks)
Solution: AS-9 on ‘Revenue Recognition’, states that revenue from sale of goods should be recognised when
the seller of goods has transferred to the buyer the property in the goods for a price or all significant risks
and rewards of ownership have been transferred to the buyer and the seller retains no effective control of
70 Accounting Standards
the goods transferred to a degree usually associated with ownership and no significant uncertainty exists
regarding the amount of consideration. In the case of M Ltd., the goods as well as the risks and rewards of
ownership have been transferred to the steel plants. The invoice raised by M Ltd. is for the full price, but 10%
less is received as the same is kept as ‘Retention Money’. In this case, therefore, revenue has to be recognised
at the full invoice price, i.e., 100% has to be accounted as Sales Income. Depending on the past experience of
recovering the balance 10% from the steel plants, M Ltd., can, however, make a provision for sales income
which is not likely to realised. In the absence of the above, the auditor will have to qualify his report.
Problem 3: Advise to Pentagon
st
Ltd. about the treatment of the following in the final statement of account
for the year ended on 31 March, 2016.
A claim lodged with the Railways in March 2000 for loss of goods of ` 2,00,000 had been passed for
payment in March 2016 for `1,50,000. No entry was passed in the books of the company, when the claim was
lodged. (Final C.A. Nov. 1993) (2 Marks)
Solution: The company has not recorded the revenue in March 2000 when the loss took place because the
claim was not certain to receive. The company was correct by not recording the claim. Now in March 2003 the
company has received the claim (ultimate collection is certain) and revenue/claim can be recorded.
Problem 4: Due to price revision with effect from 1st October 2005 the company has to receive ` 4,75,000
from its customers in respect of sales made in 2005-06. Give the treatment in the final accounts for the year
March 2006.
(Final C.A. Nov. 1993/May 1995) (2/4 Marks respectively)
*
Solution: If the claim is certain to receive the company can record the income.
Problem 5: A Ltd. is a manufacturer of readymade garments. It sells its products to franchisees located across the
country. Readymade garment industry is subject to change in trends of fashion and as such, some of the goods are
returned and A Ltd. accepts them back as sales returns. On the basis of past trends such returns are estimated to be
at 20% of the sales of any year. For the financial year 2011-12. A Ltd. had accounted for the actual sales return made
upto 31st March 2012 but has not reversed the possible expected return that are likely to happen after 31st March
2012, in respect of the sale made for the FY 11-12. Mr. X the auditor of A Ltd wants this to be considered in the accounts
for the year ended on 31st March 2012 but the company is of the opinion that although there is a probability of some
goods being returned by the franchisees, there is no significant uncertainty regarding the amount of consideration
that will be derived from the sale of goods, since the goods are not in the possession of the company and risk and
rewards of ownership still lie with the franchisees and the company cannot record sales returns in its books of
account in respect of goods that are likely to be received after the date of balance sheet. Comment.
(CA Final Audit May 2012) (Marks 5)
Solution: The basic issue raised in the query relates to accounting for sales returns that occur after the
date of balance sheet in a situation where franchisees have a right to return the goods. The committee also
presumes that franchisee is neither acting as an agent of the company nor as a consignee as covered under
paragraph A(2)(c) of the Appendix to AS 9. Further, it is presumed that the company has complied with
revenue recognition criteria as per AS 9.
There is a right of return by the franchisees and such right would give rise to a present obligation on the
company. The committee is of the view that obligation in respect of sales return can be estimated reliably
on the basis of past experience and other relevant factors such as fashion trend etc. Therefore, considering
the definition of provision as per Accounting Standard 29‐ ‘Provisions, Contingent Liabilities and Contingent
Asset’ (AS 29), provision in respect of sales returns should be recognised in the present case.
The provision should be measured at the best estimate of loss expected to be incurred in respect of expected
sales returns including incremental selling cost that would be necessary to resell the goods returned. Further,
provision should be reviewed at each balance sheet date and if necessary, should be adjusted to reflect current
best estimate (paragraph 52 of AS 29). Committee is of the view that necessary adjustments should be made
in the amount of provisions for actual sales returns that occur between the balance sheet date and the date
of approval of financial statements.........AS-4.
The present policy of the company regarding recognition of sales return after the date of balance sheet
in the books of account only upon receipt of goods from the franchisees is not correct. The company should
recognize a provision in respect of sales returns at the best estimate of the loss expected to be incurred by
the company in respect of such returns including any incremental cost that would be necessary to resell
the goods expected to be returned. Necessary adjustment to the provisions should be made for actual sales
returns. Also provisions should be reviewed at each balance sheet date and if necessary should be adjusted
to reflect the current best estimates.
Problem 6: The BOD decided on 31/03/2006, to increase the SP of certain items retrospectively from
Jan 1 2006. In view of this price revision, with effect from 1/1/2006, the company has to receive `15,00,000 from
its customers, in respect of the sales made between the 3 months. Give the treatment in the final accounts for the
year March 2006. Final C.A. May 1996) (3 Marks)
*Solution: If the claim is certain to receive the company can record the income.
Problem 7: Y Limited used certain resources of X Limited in return, X company Limited received
` 10,00,000 and `15,00,000 as interest and royalties respectively from Y Limited during the year 2005 – 06.
On what basis these revenues can be recognised by X Limited.
(Final C.A. May 1999) (3 Marks)
Solution: The income received by X Limited is covered by Employment of Resources yielding Royalty, Dividend
and Interest.
Case 1: Interest : It is based on time proportion. It is simply the rate of interest applied on the outstanding
balance of the principal amount. But as per AS-30 now interest is accounted for as per effective cost method.
Case 2: Royalty : It is the charges for use of assets. Recognition of revenue is based on agreement entered into.
Problem 8: TVSM company has taken a Transit Insurance Policy. Suddenly in the year 2012-13 the
percentage of accident has gone up to 7% and the company wants to recognise insurance claim as revenue in
2012-13 in accordance with relevant Accounting Standards. Do you agree?
(Final C.A. May 2003) (4 Marks)
Solution: AS 9 on Revenue Recognition defines revenue as ‘gross inflow of cash, receivables or other
consideration arising in the course of the ordinary activities of the enterprise from the sale of goods, from
the rendering of services and from the use by others of enterprise resources yielding interest, royalties and
dividends.
To recognise revenue AS 9 requires that revenue arises from ordinary activities and that it is measurable
and there should be no uncertainty. As per para 9.2 of the Standard, where the ability to assess the ultimate
collection with reasonable certainty is lacking at the time of raising any claim, revenue recognition is postponed
to the extent of uncertainty involved. In such cases, it may be appropriate to recognise revenue only when it is
reasonably certain that the ultimate collection will be made.
In the given case, TVSM company wants to suddenly recognise Insurance claim because it has increased
over the previous year. But, there are uncertainties involved in the settlement of the claim. Also, the claim
does not seem to be in the course of ordinary activity of the company.
Hence, TVSM company is not advised to recognise the Insurance claim as revenue.
Problem 9: SCL Ltd. Company sells agriculture products to dealers. One of the condition of sale is that
interest is payable at the rate of 2% p.m., for delayed payments. Percentage of interest recovery is only 10%
on such overdue outstanding due to various reasons. During the year 2002-2003 the company wants to
recognise the entire interest receivable. Do you agree? (Final C.A. May 2003) (4 Marks)
Solution: As per para 9.2 of AS 9 on Revenue Recognition, where the ability to assess the ultimate
collection with reasonable certainty is lacking at the time of raising any claim, e.g. for escalation of price,
export incentives, interest etc, revenue recognition is postponed to the extent of uncertainty involved.
In such cases, it may be appropriate to recognise revenue only when it is reasonably certain that the ultimate
collection will be made. Where there is no uncertainty as to ultimate collection, revenue is recognised at the
time of sale or rendering of service even though payments are made by instalments.
Thus, SCL Ltd. cannot recognise the interest amount unless the company actually receives it. Hence, the
company is advised to recognise interest receivable only on receipt basis.
Problem 10: Victory Ltd. purchased goods on credit from Lucky Ltd. for ` 250 crores for export. The export
order was cancelled. Victory Limited decided to sell the same goods in the local market with a price discount.
Lucky Limited was requested to offer a price discount of 15%. The chief Accountant of Lucky Ltd. wants to
adjust the sales figure to the extent of the discount requested by Victory Ltd. Discuss whether this treatment
is justified. (Final C.A. Audit May 2000, FR May 2006, May 2015)
Solution: Lucky Ltd. had sold goods to Victory Ltd on credit worth for `250 crores and the sale was completed
in all respects. Victory Ltd s decision to sell the same in the domestic market at a discount does not affect
the amount recorded as sales by Lucky Ltd. The price discount of 15% offered by Lucky Ltd. after request of
Victory Ltd. was not in the nature of a discount given during the ordinary course of trade because otherwise
the same would have been given at the time of sale itself. Now, as far Lucky Ltd is concerned, there appears
to be an uncertainty relating to the collectability of the debt, which has arisen subsequent to the time of
sale therefore, it would be appropriate to make a separate provision to reflect the uncertainty relating to
collectability rather than to adjust the amount of revenue originally recorded. Therefore, such discount
should be written off to the profit and loss account and not shown as deduction from the sales figure.
Problem 11: Decide when and how much revenue can be recognised in the following situations.
1. AMC sells goods to XYZ every month. In May 2013, when AMC was about to deliver the monthly
consignment of goods, XYZ informs that Quick and Fast who provide delivery services to XYZ ceases
business. XYZ requests AMC to store the goods, at his risk, until he can find alternative transport.
2. Sabu Ltd. sold accounting software to Babu Ltd. via internet for ` 55,000. It was agreed that Babu Ltd.
can make payment on receipt of the software.
3. Solomon Cables gets a contract from a local telephone exchange for installing a telephone network in
10 identical buildings.
4. In September, Chinki decorators sell tickets for an exhibition for ` 7,00,000. The exhibition will take
place in December.
5. Ferrari Drive is a car club. To become a member of this club, a client has to pay ` 2,000 registration
fees and 3,000 annual membership fees. How should F Drive recognise its revenue?
Solution:
1. The goods are not physically delivered but the risk and returns in the goods are transferred by AMC
to XYZ. Hence AMC can record the revenue for the month.
2. Revenue can be recorded only on the receipt of `55,000 cash.
3. Solomon Cables can record 10% of revenue with every completion of work (it is a case of rendering
of services)
4. The revenue will be recorded in the month of December when the exhibition takes place. Entry to be
recorded in the month of September:
Cash ...Dr 7,00,000
To Advance revenue 7,00,000
Entry in December:
Advance revenue ...Dr 7,00,000
To Sales 7,00,000
5. Registration fees of `2,000 will be added in the corpus (Capital a/c.) and 3,000 annual membership
fees will be amortised equally over each month as revenue.
AS-9: Revenue Recognition 73
Problem 12: Excel Limited is a manufacturing company in consumer durable goods with an annual turnover
of ` 1,000 lakhs. The company receives orders from its commission agents all over the country, but goods are
dispatched directly to the customers. The documents including the transport bills are sent through the bank
for collection. At the end of 5th year, it is found that documents covering despatch of goods worth `20 lakhs
were still lying with the banks not cleared by the customers even though the normal collection period of
20 days from the date of dispatch has expired. Should revenue be recognized? (CA Final)
Solution: Revenue can be recognized if the seller of the goods has transferred to the buyer all the significant
risks and rewards attached to the ownership. Seller should not have any effective control over the goods. Also
there should not be any uncertainty for the ultimate collection.
In the given case since transport bills were sent through the bank for collection, it may be said that the
seller has retained effective control over the ownership. Further since the documents were not cleared by the
customers even after the expiry of the normal period of collection, there is an uncertainty in the realization
of sale proceeds. Hence, revenue should not be recognized.
Problem 13: Satyam Computechnique Limited appointed some franchisees to conduct training.
The institute earns franchisee fees of ` 7 crores in exchange of its brand name and technical assistance.
The company wants to recognize full franchisee fees upfront?
Solution: The franchisee fee is in the nature of royalty in exchange of a right to use an asset (brand) over
defined period of time. Such fees should be recognized on time proportion basis. However recognizing entire
fees upfront is unreasonable.
Problem 14: Media advertisers obtained rights for one day world cup cricket tournament to be held in
May/June 2009 for ` 250 lakhs. By 31/3/2009 they have paid ` 150 lakhs to secure these advertisement
rights. The balance of ` 100 lakhs was paid in April 2009. By 31/3/2009 they procured advertisement for
70% of the available for 350 lakhs. The advertisers paid 60% of the amount by that date. The balance 40%
was received in April 2009. Advertisement for the balance 30% time was procured in April 2009 for `150
lakhs. The advertisers paid the full amount while booking the advertisement. 25% of the advertisement time
is expected to available in May 2009 and the balance 75% in June 2009.
You are asked to pass journals for the month of: March, April, May and June 2009.
Solution:
31.3 Adv right bought Dr. 250 31.5 P/L A/c. Dr. 62.5
To Cash 150 To Adv right bought 62.5
To payable 100 (Expenses recognized)
(adv right bought) 250 x 25%
31.3 Cash Dr. 210 31.5 Adv right sold Dr. 125
Receivable Dr. 140 To P/L A/c. 125
To Adv right sold 350 (Income recognized)
(Collection of contract receipts) (350 +150) 25%
30.4 Payable 100 30.6 P/L A/c. Dr. 187.5
To Cash 100 To Adv right bought 187.5
(Balance paid) (Expenses recognized)
250 - 62.5
30.4 Cash Dr. 150 30.6 Adv right sold Dr. 375
To Adv. right sold 150 To P/L 375
(balance collections) (Income recognized)
500 - 125
30.4 Cash Dr. 140
To receivable 140
(Remaining balance rights
collected)
74 Accounting Standards
Problem 15: Gold Eagle Ltd, has been a successful jewellers for the past 100 years and sales are against
cash only. The Company diversified into apparels. A young senior executive was put in charge of Apparels
business and sales increased 5 times. One of the conditions for sales that dealers can return the unsold stocks
within one month of the end of season. Sales return for the year was 25% of sales. Suggest a suitable Revenue
Recognition Policy with references to AS-9. (CA Final Nov 08)
Solution : Revenue from jewellery business:
(a) Revenue from sale of jewellery article is recognized in the book as and when sold to buyers against receipt
of cash. b) sales return is recognized/recorded against cash refund, if any, as and when it arises.
(b) General revenue from sale of apparels is recognized in the books as and when sold, subject to the
following condition - Create a provision of 25% of the value of goods for one month.
Goods supplied on sale or on return basis: revenue is recognized in respect of such supply if and only if-
The buyer of the goods has communicated his acceptance of the goods so supplied, or the buyer of the goods
has not returned the goods within 1 month from the date of supply.
Problem 16: A Ltd prepared an invoice for an export consignment on FOB basis on 30th March 2010.
The goods were dispatched from the factory on 30th March 2010 and bill of lading was made on 3rd April
2010. A Ltd had booked the invoice in the Sales Register for March 2010.
(CA Final Audit May 2010 marks 5)
Solution: As per AS-9 Revenue Recognition revenue on sale of goods should be recognized only when
significant risk and rewards of ownership have been transferred to the buyer. Normally in FOB sales, the risk
passes on from the seller to the buyer at the point when the goods have been loaded and placed on board the
ship at the shipping port. At this point, the bill of lading is prepared.
Since in the given case the bill of lading has been made out only on 3 rd April 2010 the risk has been
passed only on that date. As such, sales should be booked only for 2010 – 11 and not 2009-10.
Problem 17: B Ltd., entered into an agreement on 1st March, 2013 to buy computer spares from S Ltd.
at prevailing market price for ` 1200 lakh on which S Ltd made a profit of 20% and received full advance
payment. The transaction was concluded on 15th March,2013. On the same day S Ltd. agrees to buy on
15th Sept, 2013 the same goods from B Ltd. at 20% over cost. The 20% mark up compensates B Ltd for its
inventory holding cost till sale date. You are required to show how both the buyer & seller account for the
above transaction in the year 2012-13 explaining in brief the justification for your treatment and also draft
the Notes on account on disclosure if any required in the annual accounts of year ended 31st March, 2013.
(CA Final Nov 2013 marks 5)
Solution: In case of Repo transactions AS-9 treats both the sale and buy back transaction as one and the
same part of the whole package. The first transaction negates the impact of the second one.
Problem 18: AQ Ltd, an Investment Company, is finalizing its account for the Financial Year ending 2013 in
the month of August 2013.
How will the following incomes to accounted for in the books of AQ Ltd?
(1) X Ltd has declared Interim Dividend which has not been received till 31–03–2013 but received on
25–04–2013.
(2) Y Ltd has declared dividend on 8th May 2013 for the year ending 31–03–2013, which has been
approved by the Shareholders of the Company on 30th June 2013.
(3) Z Ltd, a Subsidiary of AQ Ltd, has declared dividend for the year ended 31–03–2013 on 25th May
2013 the AGM for which is to be held on September 2013. (CA Final May 2014 marks 4)
Solution:
(a) Operating cycle of Kay Ltd. will be computed as under:
Raw material stock holding period + Work-in-progress holding period + Packing Materials
holding period+ Finished goods holding period + Debtors collection period
= 1 + 1 + 3 + 1 + 2 = 8 months
Classification of liability to suppliers: Revised Schedule VI provides that:
“A liability shall be classified as current when it satisfies any of the following criteria:
(i) it is expected to be settled in the company’s normal operating cycle;
(ii) it is held primarily for the purpose of being traded;
(iii) it is due to be settled within twelve months after the reporting date; or
(iv) the company does not have an unconditional right to defer settlement of the liability for at
least twelve months after the reporting date. Terms of a liability that could, at the option of the
counter party, result in its settlement by the issue of equity instruments and do not affect its
classification.”
There are two situations:
(a) When credit period given by supplier is 12.5 months: The nature of classification of liability is to
be seen with reference to the reporting date. Hence all liabilities except those that arise in the last
fortnight of the accounting period will be “Current” as this will have to be settled within 12 months of
the reporting date. Thus, all liabilities that do not arise in the last fortnight of the accounting period
will be “Non - Current”.
(b) When credit period given by suppliers is 330 days (i.e. 11 months approx): If the creditors are settled
in 330 days i.e. within 11 months. This satisfies the third condition i.e. it is due to be settled within
twelve months after the reporting date and there is no option to defer it. Hence, in the case it will be
treated as current liability.
Problem 19: A Company sells the goods with right to return. The following pattern has been observed:
Time frame of Return from date of purchase % of Cumulative Sales
Within 10 days 5%
Between 11 days and 20 days 7%
Between 21 days and 30 days 8%
Between 31 days and 45 days 9%
The Company has made Sales of ` 30 Lakhs in the month of February 2015 and of ` 36 Lakhs in the
month of March 2015. The Total Sales for the Financial Year have been ` 450 Lakhs and the Cost of
Sales was ` 360 Lakhs. Determine the amount of Provision to be made and Revenue to be recognized
in accordance with AS–9. A year may be considered of 360 days. (CA Final May 2015 Marks 5)
76 Accounting Standards
Note: The above solution is on the basis of the facts given in the question.
The heading of Column 1 is “the time frame of sales return from the date of purchase”. However, the
time ranges given in three out of four rows in column 1 is not reckoned from the date of purchase
but from the date after the close of the previous range. Further, the heading of column 2 is “% of
cumulative sales”. However, they are standalone ranges commencing from the date after the close of
the previous range. The two sets of data which are not exactly in line with each other may give rise
to alternative computation of amount of provision.
CHAPTER 10
AS-10: Accounting for
Fixed Assets
Chapter Outline
vv Some Definitions vv Special Discussions on Few
vv Valuation Aspect Important Aspects of AS-10
vv Disclosures in AS-10
Some Definitions
Fixed Asset
Fixed Asset is an asset held with the intention of being used for the purpose of producing or providing good
or services and is not held for sale in the normal course of business.
Example: Land and Building, Plant and Machinery, Furniture and Fitting; etc.
Fair Market Value: It is the price at which knowledgeable and willing parties deals at arm’s length price who
are fully informed and are not under any compulsion to transact.
DO YOU KNOW
The provisions relating to borrowing costs, intangible assets and leases that were originally contained in this
standard were withdrawn once new AS were developed in these areas?
Historical Cost
Cost of an item of fixed asset comprises of its purchase price, including import duties and other non refundable
taxes or levies and any directly attributable cost of bringing the assets to its working condition (even trial run
expenses are to be added).’
78 Accounting Standards
Particulars Amount
Purchase Price XXX
(+) Carriages XXX
(+) Professional fees XXX
(+) Import Duties (always as a % of Purchase price) XXX
(+) Site preparation costs XXX
(+) Professional Fees (fees of architect) XXX
(+) Handling charges XXX
(+) % of Allocated cost XXX
(Administration & general expense) XXX
(+) Designs & know how XXX
(+) Interest costs (if allowed by AS – 16) XXX
GROSS VALUE: XXX
(-) Government grants (AS-12) (XXX)
(-) Trade Discount (%) (XXX)
(-) Modvat credit (refundable taxes) (XXX)
CURRENT COST: XXX
(+)/(-) Price fluctuation adjustment XXX
(+)/(-) Forex Adjustment (AS-11) XXX
HISTORICAL COST XXX
XXX
Notes:
• Cost incurred after the asset is put to use is to be excluded.
• In case of assets manufactured in house all direct costs incurred are to be taken excluding internal
profits included in the cost.
• Administrative and selling expenses are to be excluded.
(iii) Asset acquired on hire purchase basis: Such assets are recorded at their cash price. Interest
element is to be apportioned over the period of the life of asset.
Separately Identifiable
Any addition or extension, which has a separate identity and is capable of being used after the existing asset
is disposed of, is accounted for separately e.g: Body of an aircraft and its engine.
If Assets are carried at revalued price: But, if asset was previously revalued then the profit and loss on
sale should be first adjusted against revaluation reserves and then the balance is to be transferred to profit
and loss account. Balance in revaluation reserve after the sale of asset shall be closed by transferring it to the
general reserve account.
Valuation Aspect
Valuation of Fixed Assets Retired from Active use and held for Disposal
Such asset is stated at the lower of net book value and the net realizable value in the financial statement.
DO YOU KNOW
Assets held for disposal under the new Schedule VI will be disclosed under the head current assets (other
current assets).
ii. Revaluation profit is not revenue profit hence it cannot be used for declaring dividend or issue of
bonus shares (SEBI Guidelines).
iii. Whenever fixed assets are revalued, such fixed assets are shown at revalued price in the financial
statement:
ww Competent valuers do valuation
ww For entire class of asset/s selected on systematic basis, the basis should be disclosed
ww Revaluation of fixed assets should be restricted to the Net Recoverable Amount.
iv. Accounting treatment on revaluation
First time revaluation: (Upward revaluation)
Asset A/c ...Dr.
To Revaluation Reserve A/c
First time revaluation: (Downward revaluation)
Profit and Loss A/c ... Dr.
To Asset A/c
First time Upward revaluation and then subsequently downward
At the time of Upward revaluation initially pass entry as discussed above:
Then for subsequent downward revaluation pass the entry as:
Revaluation Reserve A/c ... Dr. (Utilise fully)
Profit and loss A/c ... Dr. (balancing figure)
To Asset A/c
First time downward revaluation and then subsequently upward revaluation
At the time of downward revaluation initially pass entry as discussed above
Then for subsequent upward revaluation pass the entry as:
Asset A/c ... Dr.
To Profit and loss A/c Dr. (restricted to the amount debited previously)
To Revaluation Reserve A/c Dr. (balancing figure)
Disclosures in AS-10
The following information should be disclosed in the financial statements:
(i) Gross and net book value of fixed assets at the beginning and end of an accounting period showing
additions, disposals, acquisition and other movements
(ii) Expenditure incurred on account of fixed assets in the course of construction or acquisition; and
(iii) Revalued amounts substituted for historical costs of fixed assets, the method adopted to compute
the revalued amounts, the nature of indices used, the year of any appraisal made, and whether an
external valuer was involved, in case where fixed assets are stated at revalued amounts.
Problem 1: A Computerised Machinery was purchased by two companies jointly. The price was shared
equally. It was also agreed that they would use the machinery equally. They decided to show in their Balance
Sheets 50% of the value of the machinery and charge 50% of the depreciation in their respective books of
accounts. Comment? (C.A. Final Nov. 1997) (5 Marks)
Solution: As per para 15 where an enterprise owns fixed assets jointly with others the extent of its share in
such assets and the proportion in the original cost, PFD and WDV is to be stated in the balance sheet. At least
details of jointly owned assets are to be indicated separately in the fixed assets register.
Problem 2: During the current year 2006-07, X Limited made the following expenditure relating to its plant
building:
Particular ` in lakhs
Routine Repairs 4
Repairing 1
Partial replacement of roof tiles 0.5
Substantial improvements to the electrical wiring system which will increase efficiency 10
Problem 3: Amna Ltd. contracted with a supplier to purchase a specific machinery to be installed
in Department A in two months time. Special foundations were required for the plant, which were to be
prepared within this supply lead time. The cost of site preparation and laying foundations were `47,290.
These activities were supervised by a technician during the entire period, who is employed for this purpose
for `15,000 per month. Technician’s services were given to Department A by Department B, which billed the
services at `16,500 per month after adding 10% profit margin.
The machine was purchased at `52,78,000. Sales tax was charged at 4% on the invoice, `18,590
transportation charges were incurred to bring the machine to the factory. An Architect was engaged at a fee
of `10,000 to supervise machinery installation at the factory premises. Also, payment under the invoice was
due in 3 months. However, the Company made the payment in 2nd month. The company operates on Bank
Overdraft @ 11%.
Ascertain the amount at which the asset should be capitalized under AS 10.
Solution:
Calculation of Cost of Fixed Asset (i.e. Machine) as per AS 10
Particulars `
Purchase price Given 52,78,000
Add: Sales tax at 4% `52,78,000 × 4% 2,11,120
AS-10: Accounting for Fixed Assets 83
Note:
(i) Interest on bank overdraft for earlier payment of invoice is not relevant under AS 10.
(ii) Internally booked profits should be eliminated in arriving the cost of fixed assets as per para 10 of AS
10 ‘Accounting for Fixed Assets’.
(iii) It has been assumed that the purchase price of `52,78,000 excludes amount of sales tax.
Problem 4: The company has written up its fixed asset by ` 50 lacs. The total depreciation of ` 10lacs stands
transferred to P/L accounts. The BOD seeks your advice in the finalisation of accounts for the year ended
June 2005. (C.A. Final Audit Nov. 1999) (3 Marks)
Solution: The companies treatment is not correct for accumulated depn. As it is a case of upward revaluation
of ` 50,00,000. The PFD should be kept in the Fixed asset schedule. Also the depreciation for the current year
should be credited to PFD account. The depn relating to Revaluation figure should be charged to revaluation
reserve account and the balance is to be charged to P/L.
Problem 5: As at the beginning of the year, the company has a capital of ` 2.50 crores, free reserves of
` 0.50 crores and Revaluation Reserve of ` 4.50 crores. In the relevant year under audit the company has
incurred a loss of ` 4 crores. The company proposes to adjust the loss with the Revaluation Reserve.
(C.A. Final Audit May 2001) (6 Marks)
Solution: Guidance note on Revaluation reserve as well as AS-10 states that revaluation reserves should not
be used for any purpose except for the fixed asset for which such revaluation reserves is created. Even SEBI
prohibits revaluation reserves for declaring bonus. Only revenue reserves can be used for written off past
losses and not revaluation reserves. It is an unrealized profit.
Problem 6: J Ltd. purchased machinery from К Ltd. on 30.09.2007. The price was `370.44 lakhs after charging
8% Sales-tax and giving a trade discount of 2% on the quoted price. Transport charges were 0.25% on the quoted
price and installation charges come to 1% on the quoted price.
A loan of ` 300 lakhs was taken from the bank on which interest at 15% per annum was to be paid.
Expenditure incurred on the trial run was Materials ` 35,000, Wages `25,000 and Overheads ` 15,000.
Machinery was ready for use on 1.12.2007. However, it was actually put to use only on 1.5.2008. Find out the
cost of the machine and suggest the accounting treatment for the expenses incurred in the interval between
the dates 1.12.2007 to 1.5.2008. The entire loan amount remained unpaid on 1.5.2008.
(C.A. Final Nov. 2003, Nov 2010 NS + CA Final May 2013) (7/5/5 Marks)
Solution:
(i) Let the quoted price be ` P. Therefore (P – Trade Discount) + S Tax = ` 370.44 lacs
Solving the equation we get P = ` 350.00lacs
Particulars ` In lacs
Quoted Price 350
Trade Discount (7)
343
+ Sales tax 27.44
Net Price 370.44
84 Accounting Standards
Borrowing costs on loan outstanding for the period of installation can be assumed to be charged to
Profit and Loss account and not to be capitalized because 2 months cannot be taken as substantial
period as per AS-16. Alternatively it can be taken as substantial period of time which ICAI has taken
a view in its solution.
(ii) The expenses incurred in between 1.12.2007 to 1.5.2008 should be charged to Profit and Loss
account because machine is ready for use as on 1.12.2007.
Problem 7: Yours client is purchasing its fixed assets from indigenous and overseas sources. On these fixed
assets, rebate and discounts are sometimes allowed by the supplier. In other situations, the client also deducts
at the time of payment, liquidated damages because of late delivery of the machines. Advice your client on
accounting for rebates, discount and liquidated damages?
Solution: Cost of assets excludes trade discount and rebates i.e. they are deducted from the cost of fixed
asset……..Para 9 of AS-10. Liquidated damages are in the nature of penalty which is recovered by the purchaser
from the supplier of the asset. LD is not to be deducted from the asset but has to be shown separately in
profit/loss account as an income.
Problem 8: Your client is in the process of setting up a production line for manufacturing a new product.
Based on trial runs conducted by your client, it was noticed that the production lines output was not of the
desired quality. However, your client has taken a decision to manufacture and sell the sub-standard product
over the next one-year due to huge investment involved.
Advise your client on the cut-off date for the purpose of capitalization. (CA Final May 2007) (Marks 4)
Solution: As per provisions of AS 10 ‘Accounting for Fixed Assets’, expenditure incurred on startup and
commissioning of the project, including the expenditure incurred on test runs and experimental production,
is usually capitalized as an indirect element of the construction cost. However, the expenditure incurred after
the plant has begun commercial production i.e., production intended for sale or captive consumption, is not
capitalized and is treated as revenue expenditure even though the contract may stipulate that the plant will
not be finally taken over until after the satisfactory completion of the guarantee period. In the present case,
the company did stop production even if the output was not of the desired quality, and continued the sub-
standard production due to huge investment involved in the project. Capitalization should cease at the end of
the trial run, since the cut-off date would be the date when the trial run was completed.
Problem 9: Welcome Ships Limited incurred dry-docking of its ship (major repairs and overhaul expenses)
of ` 2 crores for the year 2006-07. Advise WS Ltd. on the treatment of the dry – docking expenses?
Solution: As per para 12 of AS-10 expenditure that increases the future benefits from the existing asset beyond
its previously assessed standard of performance is to be capitalized. Dry docking expenses/overhauling
expenses are heavy expenses incurred on periodic basis say 2-3 years for the ships/air craft’s. Under Indian
GAAPs such expenditure is charged to P/L as major repairs. But under IFRS such heavy expenditure is
capitalized and written over the period till the next overhaul expense.
Problem 10: An old car of a company having a nominal book value has found a buyer, who is willing to pay
` 1 lakh for it. The company proposes not to sell the car, but to neglect its valuation in its accounts at ` 1 lakh
should the auditor permit the company to do so? (CA Final Audit Nov. 2003) (Marks 8)
Solution: In the present case car can be either retired from active use or in use. If it is in use then it should be
included in the block of assets. But if it is retired from active use then it should be valued at lower of WDV or
AS-10: Accounting for Fixed Assets 85
net realizable value under the head fixed assets only…..para 14 of AS-10. If the car is in use then revaluation
on such car can be possible. But revaluation should not be done for single car but all the cars. The company
has neglected the valuation of ` 1,00,000 is correct.
Problem 11: Shivaji Ltd. purchased Fixed assets worth `90,00,000 on 1st April 2002. The lifestof the assets
is 10 years and they are to be depreciated on straight line basis. The assets were revalued on 1 April, 2004
when 50% of the assets were assessed at 10% less than the book value, and the remaining assets were
revalued at 15% higher than book value. The assets were ultimately sold on 1.4.2006 for ` 54,80,000. Excess
depreciation on revaluation, if any, should be charged to Revaluation Reserve.
Show Fixed Assets A/c., Depreciation A/c. and Revaluation Reserve A/c. supported by working wherever
necessary. (C.A. Final Nov. 2007) (Marks 8)
Solution:
In the books of Shivaji Ltd.
Fixed Assets Account
Dr Cr
Date Particular ` Date Particular `
1.4.2015 To Bank 90,00,000 31.3.2016 By Depreciation 9,00,000
By Balance c/d 81,00,000
90,00,000 90,00,000
1.4.2016 To Balance b/d 81,00,000 31.3.2017 By Depreciation 9,00,000
By Balance c/d 72,00,000
81,00,000 81,00,000
1.4.2017 To Balance b/d 72,00,000 1.4.2017 By Revaluation Reserve (WN2) 3,60,000
To Revaluation Reserve (WN1) 5,40,000 31.3.2018 By Depreciation (WN3) 9,22,500
77,40,000 77,40,000
1.4.2018 To Balance b/d 64,57,500 31.3.2019 By Depreciation 9,22,500
By Balance c/d 55,35,000
64,57,500 64,57,500
1.4.2019 To Balance b/d 55,35,000 1.4.2019 By Bank 54,80,000
By Revaluation Reserve (loss) 55,000
55,35,000 55,35,000
Depreciation Account
Dr Cr
Date Particular ` Date Particular `
31.3.2016 To Fixed assets 9,00,000 31.3.2016 By Profit and Loss Account 9,00,000
31.3.2017 To Fixed assets 9,00,000 31.3.2017 By Profit and Loss Account 9,00,000
31.3.2018 To Fixed assets 9,22,500 31.3.2018 By Profit and Loss Account 9,00,000
By Revaluation Reserve Account 22,500
(WN4)
9,22,500 9,22,500
86 Accounting Standards
Workings Notes:
1. Calculation of Revaluation amount to be shown in revaluation reserve account:
Downward revision of 50% of fixed assets = (`72,00,000 × ½) × 10% = `3,60,000
Upward revision of remaining 50% of fixed assets = (`72,00,000 × ½) × 15% = `5,40,000
2. Value of Fixed assets after revaluation as on 1.4.17:
[(72,00,000 × ½) – 3,60,000] + {(72,00,000 × ½) + 5,40,000} = `32,40,000 + 41,40,000 = `73,80,000
3. Depreciation per annum for remaining 8 years
Value of Fixed Assets = `73,80,000 (W.N.2)
Remaining life of the asset = 8 years
New Depreciation = `73,80,000/8 = `9,22,500
4. Depreciation to be charged to Revaluation Reserve Account
= `9,22,500 – `9,00,000 = `22,500
Students can alternatively transfer downward revaluation to P/L also instead of revaluation reserve and
accordingly the answer will change.
Problem 12: A conveyor system was capitalized on 01-01-2015 with value of ` 41.37 crores.
The break-up of the capital cost was as follows:
Civil & Mechanical structure 11.72
Driving units and pluming 05.4
Rope 02.83
Belt 11.17
Safety and electrical equipments 06.15
Other accessories 04.10
41.37
During the financial year 2019-2020 due to wear and tear, the rope used in the conveyor system was
replaced by a new one at cost of ` 8 crores. As new rope did not increase the capacity and is a component
of the total assets. The company charged the full cost of the new rope to repairs and maintenance. Old rope
continues to appear in the books of account and is charged with depreciation every year.
AS-10: Accounting for Fixed Assets 87
Whether the above accounting treatment is correct? If not, give the correct accounting treatment with
explanation.
Solution: As per Para 23 of AS-10 - Subsequent expenditure relating to an item of fixed asset should be
added to its book value only if it increases the future benefits from the existing asset beyond its previously
assessed standard of performance. In the instant case, the new replaced rope does not increase the future
benefits from the assets beyond their previously assessed performance, therefore the cost of replacement of
rope should be charged to revenue, however in doing so the estimated scrap value of the old rope should be
deducted from the cost of new rope. The old rope will be continued to be depreciated over the balance life.
Problem 13: On 01.04.2015 a machine was acquired at `4,00,000. The machine was expected to have a
useful life of 10 years. The residual value was estimated at 10% of the original cost. At the end of the 3rd year,
an attachment was made to the machine at a cost of `1,80,000 to enhance its capacity. The attachment was
expected to have a useful life of 10 years and zero residual value. At the beginning of the 4th year, the original
machine was revalued upwards by `90,000 and remaining useful life was reassessed at 9 years and residual
value was reassessed at NIL value. Find depreciation for the year 2018-19, if
(i) attachment retains its separate identity.
(ii) attachment becomes integral part of the machine.
Solution:
1. Depreciation of Original Machine
`
Original cost of Machine as on 01.04.2015 4,00,000
Less: Residual Value @ 10% (40,000)
Depreciable Value (a) 3,60,000
Useful life is 10 years
Depreciation per year 36,000
Depreciation for 3 years (36,000 x 3) (b) 1,08,000
Written down value at the end of 3 years (as on 31.03.2018)
[4,00,000 – 1,08,000] 2,92,000
Add: Revaluation 90,000
Total book value after revaluation 3,82,000
Remaining useful life was reassessed as 9 years
Depreciation per year from 2018-19 42,444
2. Depreciation of Attachment
Original cost of Attachment as on 01.04.2018 1,80,000
Useful life is 10 years
Depreciation per year from 2018-19 18,000
Chapter Outline
vv Need and Objective vv Part II: Translation of Financial
vv Part I: Accounting for Foreign Statements of Foreign Operations
Exchange Transactions
Scope
AS – 11 (Revised 2003) issued by ICAI within its ambit covers the following:
PART I → Accounting of foreign exchange transactions and
PART II → Converting the financial statements of the foreign operations.
IMPORTANT TERMS
(a) Reporting Currency: It is the currency of the country whose financial statements are reported.
Example: ` is the reporting currency of India.
(b) Foreign Currency: It is the currency other than the reporting currency of an enterprise.
(c) Exchange Rate: It is the ratio for exchange of two currencies. Example: US $ 1 = ` 60.
(d) Average Rate: It is the mean of exchange Rates in force during a period.
(e) Forward Rate: It is the predetermined exchange rate for settlement at a future specified date.
(f) Closing Rate: Rate of exchange that exists on the date of Balance Sheet.
(g) Monetary items: Monetary items are money held, assets to be received and liabilities to be paid which are
fixed and determinable. Example: Cash, bank balance, debtors, creditors, Loan etc.
(h) Non-Monetary items: Non-monetary items are assets and liabilities other than monetary items.
Example: Fixed assets, Inventories, Investments is equity shares, prepaid expenses etc.
90 Accounting Standards
DO YOU KNOW
Under the New Schedule III forex gain/loss will be disclosed under “Other Income or Other Expense”.
Exception: If the investor invests in a non-integral foreign operation in Monetary item, the exchange
difference is accumulated in Foreign Currency Translation Reserve Account instead of transfer to
income and expense account. When such investments are sold then the exchange difference accu-
mulated in foreign reserve account is to be transferred to income and expense account (refer special
problem number 3)
One can conclude that Integral operations are in substance reporting enterprises activities only and
Non–Integral operations are set up as a net investments in foreign countries.
All the above indications are only illustrative and not exhaustive. Due weightage is to be given to actual
facts and circumstances and even exercising proper judgment. Hence the issue whether a foreign operation
is integral or non – integral is still a bone of contention.
Note: Average rate may be used only when there is not significant violation in exchange rates and subject
to materiality.
◘◘ Profit and Loss account gives shelter to all the above exchange differences.
Consolidation Procedures
In case of non – integral foreign operation having a foreign subsidiary or JV then following consolidation
procedure is to be followed:
(i) Goodwill or Capital Reserve arising on acquisition should be translated at closing rate.
(ii) Usual consolidation procedures such as elimination of intra-group transactions of a subsidiary,
associate, JV, etc., should be applied.
(iii) Exchange difference arising out of consolidation will have to be accumulated in foreign translation
reserve account.
(iv) Share of Minority in translation reserves is to be proportionately accounted.
AS-11 (Revised): The Effect of Changes in Foreign Exchange Rates 93
Note: Exchange difference arising out of consolidation in case of integral foreign operations will have to be
passed through profit and loss account.
Change in Classification
Translation procedure shall be applicable from the date of reclassification.
For integral foreign operation to Exchange difference arising for non–monetary assets at the date of reclassification is
non-integral foreign operation to be accumulated in foreign translation reserve account.
For non-integral foreign The translation amount of non-monetary items at the date of reclassification is treated
operation to integral foreign at historical cost. Exchange difference accumulated in foreign currency translation
operation reserve should not be recognized as profit and loss till the disposal of operation even
if the foreign operations becomes integral.
◘◘ Question of exchange difference arising for monetary asset does not arise because treatment for
monetary asset is same irrespective of integral foreign operation or non-integral foreign operation.
Transactional Provisions
If a foreign branch of the reporting enterprises applies the revised standard i.e. non-integral operation for the
first time, the treatment will be same as if “Change in the classification of a foreign operation”.
Disclosures Requirements
◘◘ Amount of exchange difference included in the profit and loss account.
◘◘ Amount accumulated in the foreign exchange reserve account (in case of non-integral operation)
◘◘ Reconciliation between opening and closing balance the said reserve account.
◘◘ If the reporting currency is different from the currency of the country in which entity is domiciled, the
reason for such difference if any.
◘◘ A change in classification form Integral to Non–Integral and vice–versa following are the disclosures- Nature
of change in classification, Reasons, Impact of such change on shareholders funds, Effect on change in
net profit or loss for each prior period presented, Disclosure is very much appreciated for enterprises
foreign exchange risk management.
94 Accounting Standards
COMPANIES ACCOUNTING STANDARD RULES VS AS -11 (Revised). Exchange difference on long term
foreign currency monetary item:
Note: The notification dated 31.03.2009 and amended from time to time by the Ministry of Corporate
Affairs seeks to insert paragraph 46A after paragraph 45 in the Accounting Standard (AS) 11 relating to the
“The Effects of Changes in Foreign Exchange Rates”. The renewal of notification was inserted by MCA on
29th December 2011.
Problem 1: Mr Choksi an agent of Balwas total Limited purchased goods 500 units costing $10 each on
1/3/2013. The exchange rates on 1/3/2016 was 1$ = `55.33 and on 31/3/2016 it was 1$ = `55.24. Pass
journals in the books of Balwas Limited as per AS 11 (R) assuming the net realisable value of the inventories
on 31/3/2013 is (i) $12, (ii) $9.
Solution: Inventories originally costs = 500 × 10 × 55.33 = `2,76,650
On 31/3/2016: $12 or $10 whichever is less. Then inventories will be valued @ $10 (cost). As per AS-11
(R) if non monetary item is carried at cost then exchange rate will be the original rate. Valuation of inventories
= `2,76,650.
On 31/3/2016: $9 or $10 whichever is less. Then inventories will be valued @ $9 (nrv). As per AS-11
( R ) if non monetary item is carried at fair value then exchange rate will be the closing rate. Valuation of
inventories = 500 x 9 x 55.24 = ` 2,48,580.
Journals:
Loss on inventories Dr 28,070 (trf to p/l)
To Stock 28,070
AS-11 (Revised): The Effect of Changes in Foreign Exchange Rates 95
Problem 2: A company had imported raw materials worth US Dollars 6,00,000 on 5th January, 2015, when
the exchange rate was ` 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, 2015, when the exchange
rate was ` 47 per US Dollar. However on 31st March. 2015, the rate of exchange was ` 48 per US dollar. The
company passed an entry on 31st March, 2015 adjusting the cost of raw materials consumed for the difference
between ` 47 and ` 43 per US Dollar.
In the background of the relevant accounting standard, is the company’s accounting treatment correct?
Discuss. (CA Final Nov. 2006) (4 Marks)
Solution: The A/c treatment given by the company is incorrect. Creditors are Monetary item, hence as per
valuation principle Monetary items should be valued at Closing rate existing on the date of B/S i.e. 48 per $.
Also the exchange loss/gain should be adjusted in income statement and not in the cost of raw materials. The
Auditor should qualify the report.
Problem 3: Derivatives Ltd. has a subsidiary Option Inc. in USA. Derivatives Ltd. has advanced $10,000 on
1.3.2015 as a part of long term investment. The exchange rates prevailing on the respective dates are: 1.3 - 1$
= ` 48, 31.3.- 1$ = ` 48.50.
Pass necessary journals to record the above transaction.
Solution: Normally forex exchange difference is transferred to Profit/Loss A/C. But para 15 of AS-11 (Rev.)
makes an exception to the general rule. As per para 15 exchange difference arising on a monetary item, that in
substance, forms part of an enterprise’s net investment in a non – integral foreign operation, are accumulated
in foreign currency translation reserve account.
1.3.2012 Loan to Option Inc. Dr. 4,80,000
To Bank 4,80,000
31.3.2012 Loan to Option Inc. Dr. 5,000
To Exchange gain 5,000
31.3.2012 Exchange gain Dr. 5,000
To Foreign Exchange Reserve 5,000
Problem 4: Value Ltd has taken a loan of $ 40 lakhs on 1/4/2011. Exchange rates on various dates were :
1/4/2011 : 1$ = ` 60.45, 31.3.2012- 1$ = ` 59.55, 31.3.2013 1$ = ` 61.23. The Loan will be repaid by the end
of 31/3/2019. Pass Journals in the books of the Value Limited for 2011-12; 2012-13 assuming:
(1) Loan was used for the purpose of acquiring Depreciable Fixed Assets (Value Limited follows MCA
circular para 46 (A).
(2) Loan was used for other purpose i.e. other than Depreciable Fixed Assets (Value Limited follows MCA
circular para 46 (A).
(3) If Value Limited goes for the option for AS-11 (Rev) what would be your answer in question (1) and
(2) above.
(4) If Value Limited is a co-operative society what would be your answer in question (1), (2) and (3) above.
96 Accounting Standards
Solution: (` in lakhs)
Companies Act (1) Companies Act (2) AS-11 (Rev) (3) & (4)
1/4/2011 1/4/2011 Same as column 1 or 2
Fixed Assets Dr 2,418 Bank Dr 2,418
To Loan a/c 2,418 To Loan a/c 2,418
31/3/2012 31/3/2012 31/3/2012
Loan Dr 36 Loan Dr 36 Loan Dr 36
To Fixed Asset 36 To FCMR a/c Dr 36 To Forex gain 36
(60.45-59.55)40 (60.45-59.55)40 (60.45-59.55)40
FCMR a/c 4.5 Forex gain a/c 36
To Profit / loss a/c 4.5 To Profit / loss a/c 36
(` 36 lakhs w-off over 8 years)
31/3/2013 31/3/2013 31/3/2013
Fixed Asset Dr 67.2 FCMR a/c Dr 67.2 Forex loss Dr 67.2
To Loan a/c 67.2 To Loan 67.2 To Loan 67.2
(59.55-61.23)40 Profit / loss a/c 5.1 Profit / loss a/c 67.2
To FCMR a/c 5.1 To Forex loss 67.2
(36- 4.5 - 67.2) / 7
You are required to prepare translated Accounts for consolidation purpose of the UK Branch. Assume both
IFO and NIFO.
Solution:
IFO NIFO
GBP @ ₹ lakhs @ ₹ lakhs
Debit items
Fixed Assets 200000 74.5 149 80 160.00
Closing Inventory 100000 79 79.00 80 80.00
Cash / Bank 60000 80 48.00 80 48.00
Trade debtors 18000 80 14.40 80 14.40
Chapter Outline
vv Meaning, Objective and Scope of Government Grants vv Treatment of Grants Received for Carbon Credits
vv Types of Government Grants vv Disclosures Under AS-12
vv Treatment of Refund of Government Grants
Objective
One should know what should be the proper treatment of Government Grants and how much the company is
benefited from such grants.
Mere receipt of a grant is not the conclusive evidence that grant has to be immediately recorded. Following
points has to be considered:
(i) Where the grant is in the nature of compensation for any past losses (sick companies) or immediate
financial support (flood affected company) then such grant should be treated as per AS – 5 (Extra-
ordinary activity).
(ii) After receipt of grant, if there is any contingency then it is to be governed by AS – 4 (now AS – 29).
Note: Deferred grants a/c. will be disclosed under the line item “Other long term liabilities” as per the New
Schedule VI. Also the 1 year deferred portion will be disclosed under the “Other current liabilities”
(iii) Grants related to revenue:
Such grants can be for sale of products to government agencies at concessional price, expenses incurred by
the company for quality control, training expenses, high costs incurred for a creation of a product etc. Such
grants has to be recognize on systematic basis to profit and loss account to match revenue against cost. It can
be recorded as “Other income” or reduced from the concerned expenses.
(iv) Grants towards promoter’s contributions:
Promoters contribution means major investments in the project is made by the government. No repayment
of such grants is ordinarily expected. Such receipt is always a huge amount so it is credited to Capital Reserve
Account under the head Shareholders Funds. Such amounts credited to Capital Reserve should not be utilized
for any purpose like dividends/writing off losses.
Treatment of Refund
(i) If the grant received was treated as deferred income: If the grant received was treated as deferred
income the refund cost is to be (–) from the unamortised deferred income and the balance is to be
charged to profit and loss account.
(ii) If the grant received was transferred to Capital Reserve: If the grant received was transferred to
Capital Reserve, refund is to be deducted from such Capital Reserve.
(iii) If the grant received was deducted from GBV of the Asset: If the grant received was deducted
from fixed asset then in such case the refund cost is to be added back to the NBV of the asset and
depreciation is to be charged on the revised value henceforth.
(iv) If the grant received was credited to Profit and Loss Account: If the grant received was adjusted
in revenue account, then such refund cost is to be debited to the revenue account (extraordinary
activities).
Problem 3: Fantastic Ltd. has received ` 50,00,000 as grant towards Land purchased on 1.4.2007. Cost of Land is
` 5 crores. The operating cost in the area is likely to be higher due to lack of adequate infrastructures facilities. The
factory commences production on 1.4.2007. The projects for building necessary infrastructure are expected to be
completed by the end of 2009- 2010. The incremental costs incurred due to lack of infrastructures facilities were
` 50 lacs, ` 50 lacs, ` 25 lacs.
Show the accounting treatment as per AS-12 for all the years.
Solution: As the expenses for non – depreciable asset (Land) is going to be incurred in future, but the grant
is already received by the company hence grant has to be deferred:
(CONDITIONAL GRANT)
Bank A/C. Dr. 50,00,000
To Deferred Grant A/C. 50,00,000
Ratio of deferment is calculated below:
AS-12: Government Grants 103
For 2007-2008:
= 50 = 40%
50+50+25
Grant transferred to Profit and Loss from Deferred Grant = 50,00,000 × 40% = ` 20,00,000
For 2008-2009: = 50 = 40%
50+50+25
Grant transferred to Profit and Loss from Deferred Grant = 50,00,000 × 40% = ` 20,00,000
For 2009-2010: = 50 = 20%
50+50+25
Grant transferred to Profit and Loss from Deferred Grant = 50,00,000 x 20% = ` 10,00,000
Problem 4: Top & Top Limited has set up its business in a designated backward area which entitles the
company to receive from the Government of India a subsidy of 20% of the cost of investment. Having fulfilled
all the conditions under the scheme, the company on its investment of ` 50 crore in capital assets, received
` 10 crore from the Government in January, 2015(accounting period being 2014-2015). The company wants
to treat this receipt as an item of revenue and thereby reduce the losses on profit and loss account for the year
ended 31st March, 2015.
Keeping in view the relevant Accounting Standard, discuss whether this action is justified or not.
(C.A. Final Nov. 1995 & May 2005) (3/4 Marks respectively)
Solution: As per para 10 of AS 12 ‘Accounting for Government Grants’, where the government grants are of the
nature of promoters’ contribution, i.e. they are given with reference to the total investment in an undertaking
or by way of contribution towards its total capital outlay (for example, central investment subsidy scheme)
and no repayment is ordinarily expected in respect thereof, the grants are treated as capital reserve which
can be neither distributed as dividend nor considered as deferred income.
In the given case, the subsidy received is neither in relation to specific fixed asset nor in relation to revenue.
Thus it is inappropriate to recognise government grants in the profit and loss statement, since they are not
earned but represent an incentive provided by government without related costs. The correct treatment is
to credit the subsidy to capital reserve. Therefore, the accounting treatment followed by the company is not
proper.
Problem 5: Dark Ltd. has received grant of ` 20 lacs under the Government Subsidy Scheme for acquiring
imported machinery for setting up an oil exploration plant and the entire grant received is credited to profit
and loss account. (C.A. Final Nov. 2006 Audit)(4 Marks)
Solution: The treatment given is wrong, because when we received grant against machine then it called
capital grant. So it should be reduced from the cost of machinery (capital approach) or transfer to Balance
Sheet on liabilities side as deferred income (income approach). It is incorrect to transfer the grant to profit
and loss a/c.
Problem 6: A Company receives a grant from the State Government as compensation for loss of stocks due
to unseasonal floods. The entire grant received is credited to “Capital Reserve”. Comment on the accounting
treatment. (CA Final Audit)
Solution: Where the grant is in the nature of compensation for any past losses (sick companies) or immediate
financial support (flood affected company) then such grant should be treated as per AS – 5 (Extra-ordinary
activity). In the present case the company has to show such govt receipt as extraordinary receipt.
Problem 7: Primus hospitals Ltd. had acquired 40 units of Doppler scan machines from Holiver USA at a
cost of US$ 1,65,100 per unit in the beginning of Financial Year 2008-09. The prevailing rate of exchange was
` 50 to the US$. The acquisition was partly funded out of a government grant of ` 5 crores. The grant relating
to such machines was given with a rider that in the event of a change in management, the entity is bound
104 Accounting Standards
to return the grant. In April 2011, 51% control in the company was taken over by an overseas investor. The
expected productive period of such an asset is normally reckoned at 5 years. The depreciation rate adopted
was 20% p.a. S.L.M. basis. The company had incurred expenditure of US$ 4,000 towards bank charges and
` 7,500 per unit as sea freight. You are also informed that neither capital reserve nor deferred income account
has been maintained by the company. You are required to suggest the accounting treatment as a result of the
return of the grant, in the light of the relevant AS. (CA Final Nov 2011 Marks 5)
Solution: The grant is received towards fixed asset. Capital approach is adopted: (` in lakhs)
Cost of asset (dopler machines) 165100 × 40 @50 3,302
Add: Freight and other charges 4000 @50 + 7500 × 40 5
Total 3,307
Less: Grants received –500
Cost as per AS-10 2,807
Less: Depreciation for 3 years 2807 × 20% × 3 –1684.2
Carrying amount as on 1/4/2011 1,123
Add: Grant refunded 500
Revised carrying amount 1,623
Problem 8: Grant Medicare Ltd acquired 5 units of Brain Scan Equipments for US$ 5,00,000 in April 2010,
incurring ` 20,00,000 on Sea Freight and US$ 12,000 per unit towards Transit Insurance, Bank Charges,
etc. The purchase was partly funded out of the Company’s internal accruals and from Government Grant
of ` 94 Lakhs. The prevailing Exchange Rate to the US$ was ` 50. The Company estimated the useful life of
the Equipment at 4 years with an estimated Salvage Value of 13% (approx). The Grant was considered as
Deferred Income up to 2012–2013 and in April 2013, the Company had to return the entire Grant received
due to non–fulfillment of certain conditions. You are required to show the Depreciation and the Grant that is
to be recognized in the Profit & Loss Accounts for the period commencing 2010–2011 onwards and also draw
up the entry that is passed in April 2013 for the return of the Grant. The Company follows the Written Down
Value Method for depreciating its Assets. (Marks 4)
Solution: (` in lakhs)
The grant is received towards Depreciable Fixed Asset. Deferred approach is adopted by the Company.
Cost of asset (1/4/2010) $500000 × 50 250
Add: Freight and other charges 20 lakhs + $12000 × 50 × 5 50
Cost as per AS-10 300
Less: Depreciation for 2010-2011 40% (120)
Carrying amount as on 1/4/2011 180
Less: Depreciation for 2011-2012 (72)
Carrying amount as on 1/4/2012 108
Less: Depreciation for 2012-2013 (43.2)
Carrying amount as on 1/4/2013 64.8
Less: Depreciation for 2013-2014 (25.92)
38.88
Deferment of Grant:
Ratio for deferment will be ratio of depreciation: 120: 72: 43.2: 25.92 = Total of ratio = 261.12
Chapter Outline
vv Scope and Objective vv Investments in Variable Income Bearing Securities
vv Meaning of Investments vv Valuation of Investments in Various Cases
vv Types of Investments vv Sale of Investments
vv Cost of Investments vv Reclassification of Investments
vv Investments in Fixed Income Bearing Securities vv Disclosures
Meaning of Investments
It is an asset held for earning income by way of a) Dividend, b) Interest, c) Rentals, d) Capital Appreciation. It
can be Shares, Debentures and Investments in Properties. Assets held in stock in trade are not investments.
Investments are broadly classified into Current investments and Long-term investments. Further
classification can be:
(a) Investments in Government Securities
(b) Investments in Shares, Debentures or Bonds
(c) Investments in Investment properties
(d) Others
AS-13: Investment Accounts 107
DO YOU KNOW
The New Schedule III has a welcome and broad disclosure of Investments in terms of equity, preference, debt,
investments in trust, investments in govt securities, partnership firms, quoted, unquoted etc.
Types of Investments
(i) Current Investments: Such investments are: readily realizable in the market, and held for less than
1 year from the date of investments made. Investments in marketable securities are normally current
investments. Such investments are made out of surplus cash. Purpose of Current Interest is to tide up
with the working capital of the business.
(ii) Long Term Investments: Investments other than current investments are Long-term investments.
Intention of long-term investments is to gain significant influence or control. Investments held
primarily to protect, facilitate or further existing business or trading relations are often called as trade
investments. Trade investments are held for a longer period of time; hence they are in the nature of
Long Term Investments. Example: Investments made by a holding company in its subsidiary.
(iii) Property Investments: Fixed assets like land and building kept as investments not for running
own business or self occupied and it is held for earning Rent or Capital Appreciation are Investment
Properties. They are held for a number of years to generate income and capital gain. As they are
permanently held for earning income, they are also classified as Long Term Investment.
Cost of Investments
Cost of Investments = Purchase Cost + Brokerage + Transfer Fees + Stamp duty + Service taxes – Pre Interest/
Dividend. It even includes fees paid to SEBI and merchant bankers and advertisement costs if incurred for
acquiring shares. Further legal costs incurred to acquire shares and any fees paid to CLB/High Court is also
capitalized.
The total Interest received after the acquisition of Debentures (on respective due dates) are to be
allocated between pre acquisition and post acquisition Interest.
Total Interest received
ii) Ex - Interest: In case of Ex – Interest transaction the price paid by the buyer to the seller is itself
the pure cost of investment. Interest accrued up to the date of purchase is not included in the cost
of Investment. But the buyer of the investment has to pay for the interest accrued up to the date of
purchase separately.
(i) Original Shareholder (ii) Any person other than the original Shareholder
Simple Purchase Cost Purchase Cost of Acquisition
+
Premium paid to the original Shareholder
for the right shares
Sale of Rights
As a general rule sale proceeds of rights should be transferred to Profit and Loss Account.
◘◘ Exception:
When both the following conditions are satisfied then treatment of sale proceeds of rights differs:
(i) Original shares on which the shareholder gets the right shares was acquired on cum-right basis
(recent purchase after announcement of rights).
AS-13: Investment Accounts 109
(ii) Market Value after the original shares becomes ex-right is lower than the cost of acquisition
◘◘ Sale proceeds then will be first applied towards reduction of carrying amount of investments to its
market value and balance sale proceeds is to be transferred to Profit and Loss Account..........(Para 13)
Sale of Investments
(I) Computation of Profit and loss on Sale of Investments:
ww Profit = Net Sale proceeds – Carrying Cost (such profit or loss as per AS-13 is transferred to
profit and loss account)
ww Net Sales proceeds = Sale value – Expenses incurred on sale
ww Carrying Cost of Investments = Costs of Investments - Diminution in the value of shares
(II) Computation of Net Cost on Sale of Investments when only a portion of Investments are sold:
ww As per AS 13 when sale of investment takes place Average Cost method is to be followed for
determining Cost of Investments.
ww Other methods for determining Cost of Investments are 1) FIFO method, 2) Specific Identification
method. But such methods are useful for Income Tax purposes and not for accounting purpose.
110 Accounting Standards
Reclassification of Investments
Sometimes a Company may classify its Investments from Current into Long term Investments & vice versa.
For such reclassification Special Resolution at the Board Meeting has to be passed.
Following are the provisions made by AS 13 with respect to Reclassification of Investments.
i) Long term Investments are reclassified as Current Investments:
If Long term Investments are reclassified as Current Investments then transfer has to be made at
Cost or Carrying Amount whichever is less on the date of transfer. Difference is to be transferred to
Profit and Loss Account in the name of Diminution in the value of Shares.
ii) Current Investments are reclassified as Long Term Investments:
If Current Investments are reclassified as Long Term Investments then transfer has to be made at
Lesser of Cost or Fair Value on the date of transfer. Difference is to be transferred to Profit and Loss
Account in the name of Diminution in the value of Shares.
Disclosures
In addition to providing guidance for accounting treatment, AS 13 also gives a list of disclosure to “Notes to
Accounts” which are attached to and form part of Financial Statements. The disclosures as per AS 13 are:
a) The accounting policies for determination of carrying amount of investments.
b) Classification of investments (whether Current/Long Term or Shares or Governments securities or
Inv. Properties etc.)
c) The amount included in the Profit and Loss Statement for:
ww interest, dividends(showing separately dividend received from subsidiary companies), and
rentals from long term as well as current investments separately.
ww profit and loss on sale of current investments and changing in carrying cost on such investments.
ww profit and loss on sale of long term investments and changing in carrying cost on such investments.
ww gross Income received, T.D.S. and Net Income thereof.
d) Tax deducted at source to be shown under Advance Taxes Paid.
e) Significant restrictions on the right of ownership, reliability of investments or remittance of income
and proceeds of disposal.
f) The aggregate amount of quoted or unquoted investments, giving the aggregate market value of
quoted or unquoted investments.
DO YOU KNOW
Till MCA will not mandate AS-30/31/32, companies are required to follow AS-13 and not AS-30/31/32.
DO YOU KNOW
In IFRS, AS-13 type of standards are abolished. They adopt standards similar to AS-30/31/32. For Property
Investments IFRS have a seperate Standard IAS-40.
AS-13: Investment Accounts 111
Problem 1: Shri Gajab acquired 2,000 Shares of Acme Products Ltd. from a broker @229/-. The Broker
charged him 1%. Service tax 5% on brokerage and stamp duty ` 500. Compute Cost of Investments as per
AS-13.
Solution:
Basic Cost (2,000 × 229) 4,58,000
+ Brokerage 4,580
+ Service Tax (5% on 4,580) 229
+ Stamp Duty 500
4,63,309
Problem 2: COSA Ltd. gives an offer of 2,000 Equity Shares on Right basis @160/- to Shree. Shree renounces
30% of the right shares to Hamd by charging a premium of ` 12 per share. Compute Cost of Right Shares
acquired by Shree &Hamd.
Solution:
Cost of Right Shares
(i) For Shree = 2,24,000 (2,000 Shares × 70% × 160/-)
(ii) For Hamd = 1,03,200 (2,000 Shares × 30% × {160 + 12})
Problem 3: Natrajan is expected to get 5,000 shares on right basis at ` 90. He sells all the rights @ ` 55. How
to account for the sale proceeds. Please advice.
Solution: In the absence of any information full sale proceeds of rights sold is to be credited to profit and loss
account. Hence ` 2,75,000 is to be credited to Profit and Loss Account.
Problem 4: Maazaa Limited’s Share Capital of 40,000 ` 100 equity shares. Maazaa Limited offered 1 right
share for every 4 held at 135/-.Immediately after the offer, an investor Mr. Mehta purchased 1,000 such shares
cum – right @150/-. Mr. Mehta renounced all the rights offered to him. The market value of MaazaaLimited
shares came down to ` 148/- immediately after the offer. The sale proceeds of rights were `3,000.
Show the entries in the books of Mr. Mehta.
Solution: As per para 13 of AS-13 where the investments are acquired cum right basis and the Market Value
of investments after right is lower than the cost of acquisition, then sale proceeds of rights should be applied
towards the Cost of investments to bring down it to the market value.
Ex – right (after right) actual market value of investments = 1,000 x 148 = ` 1,48,000
Cost of acquisition, = 1,000 x 150 = ` 1,50,000
Difference = ` 2,000 i.e. sale proceeds applied towards cost of investments.
Problem 5: Gajini Ltd has 25% shares in Rajini Ltd acquired in the year 2006-07 @24/-. On 31/3/2009
shares of Rajini Ltd valued at stock exchange @20. Gajini Ltd wants to value investments in Rajini at ` 20/-.
Please advice.
Solution:
Valuation of Investments : AS 13 on “Accounting for Investments” requires investments to be classified
as long term and current investments distinctly in its financial statements. The investments in shares of
associate companies can very well be considered as trade investments since they would not be intended to
be liquidated within a period of one year from its acquisition. Hence they would be classified as long term
investments.
Investments in associates 25% is enough. They are LTI. Temporary fluctuations should not affect
investments made by G Ltd in R Ltd. Therefore LTI held by G Ltd in R Ltd is c/f @COST.
Problem 6: On 1.07.2007, A Ltd. acquired 2,000 shares in B Ltd. at cum-dividend price of ` 50,000. B Ltd.
declared and distributed 20% dividend on 30/09/07 in respect of year 2006-07 on its Share Capital, which
consisted of 20,000 shares of ` 10 each. On the same day, B Ltd. declared and distributed 10% interim dividend
for half year ended 30/09/07. Pass journal entries.
Solution:
1.7.2007 Investments in B Ltd Dr. 50,000
To Bank 50,000
30.9.2007 Bank Dr. 6,000 (20000 × 20% + 20000 × 10%)
To Dividend 6,000
31.3.2008 Dividend Dr. 6,000
To Investments in B Ltd 5,000
To P/L a/c. 1,000
(final dividend is full pre and interim dividend is ½ pre and ½ post)
Problem 7: Following is the Investment made by Ranka Ltd. as on 31.03.2005.
Type of Share Quantity Cost Market Value
(i) Equity Shares:
X Ltd. 250 124 175
Y Ltd. 400 106 156
Z Ltd. 200 97 95
(ii) Preference Shares:
F Ltd. 400 102 88
M Ltd. 10 115 149
R Ltd. 55 116 121
Value the investments as per Global/Category/Individual method.
Solution:
(I) Global Method: In case of global method, cost column & market value column are totaled up and
then Cost & M. V. are compared, whichever is less is shown in Balance Sheet. In the given problem
global method cannot be applied because there are various types of Investments. Thus, Category or
Individual method may be applied.
As per Para 31 of AS- 13 Global method should not be followed. Companies can use either Category
or Individual investment method.
AS-13: Investment Accounts 113
Problem 8: As a Statutory auditor of a Public, how would you deal with the following:
The company had subscribed to shares of associate company amounting to ` 5 crores. These associate
companies have incurred substantial losses and have been referred to BIFR for being declared as sick
companies. The company does not want to provide for the loss.
(C.A. Final –May 1998, May 2001) (Marks 5)
Solution:
Valuation of Investments : AS 13 on “Accounting for Investments” requires investments to be classified
as long term and current investments distinctly in its financial statements. The investments in shares of
associate companies can very well be considered as trade investments since they would not be intended to
be liquidated within a period of one year from its acquisition. Hence they would be classified as long term
investments.
AS 13 states, “long-term investments should be carried in the financial statements at cost. However,
provision for diminution shall be made to recognise a decline, other than temporary, in the value of the
investments, such reduction being determined and made for each investment individually”. In the instant
case, these associate companies have incurred substantial losses and have been referred to BIFR for being
114 Accounting Standards
declared as sick companies. The net worth of these companies would have been wiped out resulting in a fall
in the value of the investments. Therefore, such fall cannot be merely temporary as the companies could take
a long time to turn around (if at all) and again have a positive net worth. The auditor would therefore have to
qualify his report by saying that no provision for diminution for fall in the value of investments as required
by AS 13 has been made and to that extent the profits and reserves have been overstated.
Problem 9: During the year 31.03.2002, Natal Ltd. have acquired following shares of Beetel Ltd.
Date of Acquisition No. of Shares Cost per Share (`)
10.05.2001 200 50.00
16.06.2001 500 70.00
22.08.2001 6,000 75.00
11.01.2002 100 Bonus
03.03.2002 500 75.00
As per AS 13:
Total Cost 5, 32, 500
Average Cost = = = 72.95/-
Total Quantity 7, 300
1) Profit & Loss of Shares sold:
Sale Value of 2,000 Shares (Sales) ` 1,88,000 (2,000 × 94/-)
Less: Cost of Shares sold ` 1,45,900 (2,000 × 72.95/-)
Profit on Shares sold ` 42,100
2) Cost of unsold Shares:
Total Cost of all Shares ` 5,32,500
Less: Cost of Shares sold ` 1,45,900
Cost of unsold Shares ` 3,86,600
Problem 10: Lacto Ltd. held following investments of Zed Ltd. as Long term Investments.
Equity Shares: Cost ` 52,000, Carrying Cost ` 51,000, Market Value ` 56,600.
As on 30.09.2005 the Directors want to reclassify the Long term Investments as Current Investments.
(CA Final May 2010 OS)
AS-13: Investment Accounts 115
Solution: If Long term Investments are reclassified as Current Investments then transfer has to be made at
Cost or Carrying Amount whichever is less on the date of transfer. Difference is to be transferred to Profit and
Loss Account in the name of Diminution in the value of Shares.
In the present problem Carrying Amount = ` 51,000 & even lesser of Cost or Carrying Amount is also
` 51,000, Hence no adjustment is to be done.
P roblem 11: Lacto Ltd. held following investments of Zed Ltd. as Current Investments.
Equity Shares: Cost ` 52,000, Carrying Cost ` 51,000, Market Value ` 56,600.
As on 30.09.2005 the Directors want to reclassify the Current Investments as Long Term Investments.
(CA Final May 2010)
Solution: If Current Investments are reclassified as Long Term Investments then transfer has to be made at
Lesser of Cost or Fair Value on the date of transfer. Difference is to be transferred to Profit and Loss Account
in the name of Diminution in the value of Shares.
Carrying amount = ` 51,000
Valuation = Lesser of FV or Cost = Lesser of 56,600 or 52,000 = ` 52,000
Value of investments is to be increased by ` 1,000
P roblem 12: On 01.01.2007 Bevan Limited purchase a flat in Ratnajar Co-op. Soc. Limited for ` 30 lakhs.
However for purchasing the flat, it was necessary to obtain membership of the society priced at ` 1 lakh. The
company acquired shares ` 50,000 as per the bye laws of co-operative societies act. The company charged off
the membership price of ` 1 lakh to P/L account and disclosed the cost of shares as separate investments?
Comment?
Solution: The treatment of charging membership ` 1,00,000 is incorrect. Also the cost of shares should be
capitalized to the cost of property. Any cost incurred to acquire the investment property is to be added to the
Cost of Property. The total cost of investment property = ` 31,50,000.
P roblem 13: Happy Limited acquired 20,000 equity shares of Pretty Limited of FV ` 10 by issuing 25,000
equity shares of its own company. FV and MV of Happy Limited is` 10 and ` 40 respectively. Compute Cost of
Investments as per AS-13.
Solution:
Investments in Pretty Limited Dr. 10,00,000
To Equity Share Capital 2,50,000 (25,000 × 10)
To Securities Premium 7,50,000 (25,000 × 30)
(Costs of investments acquired for non – cash consideration should be taken as the value of shares issued
Para 10 of AS-13)
P roblem 14: X Limited on 1.1.2012 had made an investment of ` 600 lakhs in the equity shares of Y limited
of which 50% is made in the long term category and the rest as temporary investment. The realisable value
of all such investment on 31.3.2012 become ` 200 lakhs as X Limited lost a case of copy right. How will you
recognize the reduction in financial statements for the year ended on 31.3.2012?
(CA Final May 2012 Marks 4)
Solution: Current Investments are always valued at Cost or M.V. (market value) whichever less is. Since long
term Investments are not intended for disposal in the near future, the market values of such investments are
not relevant. For this reason LTI is to be shown at “Cost” only. However a provision for diminution in value of
shares can be made if the decline in shares is other than temporary.
Accordingly loss of ` 100 relating to Current investment should be debited to Profit and Loss. The
loss amounting to Long Term Interest ` 100 should not be written-off. Hence the carrying amount of the
investments as on 31-3-2012 is: [`600 lakhs – `200 lakhs] = `400 lakhs.
116 Accounting Standards
Problem 15: K Ltd., has 5 Subsidiaries as at 31st March 2013, and the Investments in Subsidiaries are
considered as Long–Term and valued at cost. Two of the Subsidiaries’ Net Worth eroded as at 31st March
2013, and the prospects of their recovery are very bleak and other three Subsidiaries are doing exceptionally
well. The Company did not provide for the decline in the value of investments in Two Subsidiaries,because
the overall investment portfolio in Subsidiaries did not suffer any decline, as the other three Subsidiaries are
doing exceptionally well. Comment. (5 Marks)
Solution: In the stand alone accounts investments made by holding company in its subsidiary is Trade
investments and further classified as Long Term Investments. AS 13 states, “long-term investments should
be carried in the financial statements at cost. However, provision for diminution shall be made to recognise
a decline, other than temporary, in the value of the investments, such reduction being determined and made
for each investment individually”. Therefore provision for loss should be made for individual subsidiaries.
Profit making subsidiary should be carried at Cost. As per revised schedule VI holding company is required
to disclosed provision for losses of its subsidiary company. If the company do not follow AS-13 then the Audit
Reports will be qualified.
Problem 16: JVR Limited has made investments of `97.84 Crores in equity shares of QSR Limited in
pursuance of Joint Venture agreement in 2001-02. The investment has been made at par. QSR Limited has
been m continuous losses for the last 2 years. JVR Limited is willing to re-assess the carrying amount of its
investment in QSR Limited’ and wish to provide for diminution in value of investments. However, QSR Limited
has a futuristic and profitable business plans and projection for the coming years. Discuss whether the
contention of JVR Limited to bring down the carrying amount of investment in QSR Limited is in accordance
with Accounting Standard. 4 Marks
Solution: Valuation of Investments: AS 13 on “Accounting for Investments” requires investments to be
classified as long term and current investments distinctly in its financial statements. The investments in
shares in a Joint Venture can very well be considered as trade investments since they would not be intended
to be liquidated within a period of one year from its acquisition. Hence they would be classified as long term
investments.
AS 13 states, “long-term investments should be carried in the financial statements at cost. However,
provision for diminution shall be made to recognize a decline, other than temporary, in the value of the
investments, such reduction being determined and made for each investment individually”. In the instant
case, the decline in the value of investment seems to be temporary and the company has profitable plans in
the coming years. Also investments in LTI are never valued at MV but even cash flows are considered.
Conclusion: No diminution required.
CHAPTER 14
AS-14: Amalgamation
and Absorption
Chapter Outline
vv Meaning of Amalgamation vv Purchase Consideration
vv Types of Amalgamation vv Treatment of Reserves Specified in
vv Accounting treatment of Amalgamation a Scheme of Amalgamation
in the Nature of Merger vv Disclosures
vv Accounting Treatment of Amalgamation
in the Nature of Purchase
Meaning of Amalgamation
The ‘term amalgamation is defined as “an amalgamation pursuant to the provisions of the Companies Act,
1956, or any other statute which may be applicable to companies”
An amalgamation is an arrangement whereby a company (called ‘transferor Company) is amalgamated
into another company (called ‘Transferee Company’) and loses its existence. In some amalgamation, there
may be more than one Transferor Company.
Types of Amalgamation
The practice of amalgamation of business enterprises has been in existence for a very long time. Earlier, most
amalgamation used to be principally a means by which one company acquired the net assets of another’
company. The company whose assets were acquired lost its existence, its shareholders were paid off out of
the consideration received from the acquiring company, and they ceased to have any further stake in the risks
and rewards of the business of the acquired company. However, in recent times, amalgamation has often been
used principally as a means by which the resources of two (or more) companies are pooled together. In such-
cases, even though one of the companies loses its corporate existence, the business of the acquired company is
continued by the acquiring company. Moreover, the shareholders of the acquired company are allotted shares
in the acquiring company. As such, they have a continuing interest in the risks and benefits of the acquiring
company Thus, the substance of such amalgamation is that the businesses of the acquired and the acquiring
companies continue to be run as before, but under a single corporate name. AS 14 recognizes the fact that
amalgamation may be of different nature - some of them may be really in the nature of purchase while the
others represent a genuine pooling of shareholders. From this angle, AS 14 classifies amalgamation into two
categories: (a) amalgamation in the nature of merger, and (b) amalgamation in the nature of purchase.
118 Accounting Standards
An amalgamation in the nature of merger is one, which satisfies all the following conditions.
(a) All the assets and liabilities of the transferor company (i.e., the company which is amalgamated into
another company, the latter being called the transferee company) become, after amalgamation, the
assets and liabilities of the transferee company.
(b) Shareholders holding not less than 90% of the face value of the equity shares of the transferor
company (other than, the equity shares already held therein, immediately before the amalgamation,
by the. transferee company or its subsidiaries or their nominees) become equity shareholders of the
transferee company by virtue of the amalgamation.
(c) The consideration for the amalgamation receivable by those equity share holders of the transferor
company who agree to become equity shareholders of the transferee company is discharged by the
transferee company wholly by the issue of equity shares in the transferee company except that cash
may be paid in respect of any fractional shares.
(d) The business of the transferor company is intended to be carried on, after the amalgamation, by the
transferee company.
(e) No adjustment is intended to be the made to the book values of the assets and liabilities of the
transferor company when they are incorporated in the financial statements of the transferee
company except to ensure uniformity of accounting policies.
From the above, it can be seen that in an amalgamation in the nature of merger, there is a genuine
pooling not merely of the assets and liabilities of the amalgamation companies but also of the
shareholders of both the transferee and the transferor companies.
DO YOU KNOW
Merger method is now no more acceptable/adopted under IFRS – 3.
Purchase Consideration
Purchase consideration for an amalgamation (whether in the nature of merger or purchase) means the
aggregate of the shares and other securities issued and the payment made in the form of cash or other assets
by the transferee Company to the shareholders of the transferor Company. It should include any non-cash
element at fair value. In case of issue of securities, the value fixed by the statutory authorities may be taken
to be the fair value. In the case of other assets, the fair value may be determined by reference to the market
value of the assets given-up. Where the market value of the assets given up cannot be reliably assessed, such
assets may be valued at their respective net book values.
Disclosures
The standard requires the following disclosures to be made in the financial statements.
1. For all amalgamations, the following disclosures should be made in the first financial statements
mowing the amalgamation.
(a) Names and general nature of business of the amalgamating companies;
(b) Effective date of amalgamation for accounting purpose;
(c) The method of accounting used to reflect the amalgamation; and
(d) Particulars of the scheme sanctioned under a statute.
2. Amalgamations accounted for under the pooling of interests method, the following additional
disclosures should be made in the first financial statements following the amalgamation.
(a) Description and number of shares issued, together with the percentage of each company’s
equity shares exchanged to effect the amalgamation; and
(b) The amount of any difference between the consideration and the value of net assets acquired,
and the treatment thereof.
3. For amalgamations accounted for under the purchase method, the following additional disclosures
should be made in the first financial statements following amalgamation.
(a) Consideration for the amalgamation and a description of the consideration;
(b) The amount of any difference between the consideration and the value of net assets acquired,
and the treatment there of including the period of amortization of any goodwill arising on
amalgamation.
CHAPTER 15
AS-15 (Revised):
Employees Benefits
Chapter Outline
vv Basic objective of AS-15 (Revised) vv Accounting Entries for Retirement Benefits
vv Accounting for Short Term Benefits
vv Termination Benefits
◘◘ Employee may provide services to an enterprise on a full-time, part time, permanent, casual or tempo-
rary basis.
◘◘ Employees include whole-time directors and other management personnel.
Which Discounting Rate has to be Used for Discounting Long Term Payments?
As per AS-15 discounting rate to be used for payments made after 12 months period will be as per the yield
on Government bonds existing on the balance sheet date.
But as per IAS it can be even on high level quality corporate bonds.
Past service cost. The increased present value of a defined benefit obligation for employee service in
previous periods that has arisen because of the introduction of changes to the benefits payable to employees.
Past service costs may be positive or negative depending on whether the benefits are improved or reduced.
DO YOU KNOW
Most of the investments made in plan assets are in fixed income securities like corporate bonds, govt securi-
ties, LIC policies.
Note: Negative result will mean asset and will be so recognized but this value not to exceed the present
value of economic benefit available in the form of refund from plan or reduction in future contribution.
In Profit and Loss Account: Net total of following should be recognized as an expense, unless some other
accounting std requires its inclusion as cost of some asset.
Current service cost —
+ Interest cost —
- Expected return on plan asset and on any reimbursement right —
+ Actuarial gain and losses —
- Past service cost to the extent required to be recognized —
+ Effect of curtailment/settlement —
+ Effect of amount not recognized as asset in case of negative result referred above —
Amount to be recognized as expense —
Above is as per Para 61 of AS 15 (Rev) which states that net total of the following be recognised as an
expense whereas para 118 states that AS doesn’t specify whether various components be shown as a
single item of income or expense on the face of Profit and Loss Account. It is desirable that ICAI clarifies
this.
(vii) Interval for Measurement: Detailed actuarial calculation for ascertaining present value of Defined
Benefits Obligation may be made at intervals not exceeding three years.
Fair value of plan assets should be ascertained at each Balance sheet date.
Present Value of Defined Benefit Obligation and Current Service Cost:
As these benefits are payable after a very long period, determination of its cost and its allocation over service
periods requires application of actuarial method and making actuarial assumption like, Year of service, rate
of increments, final salary, expected premature termination, Death rate, cost of Medical benefits, return
on investment etc. This is the responsibility of the management of the enterprise, who can take help of
professional actuaries.
126 Accounting Standards
Termination Benefits
◘◘ Termination benefits are payable as a result of :
ww Termination before the normal retirement date; or
ww Employees decision to accept VRS.
◘◘ Recognition, Measurement and Disclosure:
The benefit payable due to premature termination of employment either on the insistence of employer
or voluntarily by employee are known as termination benefit. Termination Benefits are usually
lumpsum payments payable under scheme, statutory regulations, under contractual requirement or
otherwise. It is immediately recognized as an expense. When this falls due more than 12 months after
the balance sheet date then the same are discounted.
128 Accounting Standards
Problem 1: Tata Cosmetics Limited has 300 employees as on 31/3/2013. 5 days leaves are allowed in a
year which can be carried forward till next year only. The company adopts LIFO method of utilizing leaves
(first current year leave will be used and then last year). As on 31/3/2013, the average unutilized leaves per
employee are 2 days. Based on the past experience it is expected that out of 300 employees, 210 will take a
leave of 5 days in next year and remaining 90 employees will take 6 ½ days leave in the next year. You are
required to calculate the amount of liability to be provided as on 31/3/2013 based on number of days?
Solution: For 210 employees 5 days leave as per LIFO will be consumed for March 2014. Leave of 31/3/2013
will lapse.
For 90 employees 5 days leave as per LIFO will be consumed for March 2014. But the actual leave estimated
to be 6 ½ which means for 31/3/2013 the company has to provide 1 ½ x 90 employees = 135 days salary.
Problem 2: Kumar Ltd is an engineering industry. The company received an actuarial valuation for the first
time for its pension scheme which revealed as surplus of `6 lakhs. It wants to spread the same over the next
2 years by reducing the annual contribution to `2 lakhs instead of `5 lakhs. The average remaining life of the
employee is estimated to be 6 years.
You are required to advise the company. (C.A. Final May 2011) (Marks 4)
Solution: According to Para 92 of AS – 15, any actuarial gains and losses should be recognized immediately
in the Statement of Profit & Loss Account as income or expenses.
In the given case, the amount of surplus from pension scheme of ` 6 Lakhs is an actuarial gain, which
should be recognized as income in the Profit & Loss Account of the current year and not to be adjusted from
the amount of annual contribution.
Disclosure: The change relating to actuarial valuation for its pension scheme should be treated as a change
in an Accounting policy and disclosed in accordance with AS – 5. Disclosure required by AS – 15 should also
be made in the Financial Statements.
Problem 3: An actuary has made some changes in his assumptions for retirement benefits e.g. changes in
medical costs to be paid, changes in discounting rate etc. Are these changes in the assumptions changes in
accounting policy or changes in accounting assumption?
Solution: A number of actuarial valuation methods have been developed by the actuarial profession to
estimate employer’s obligations under defined benefit schemes. While these methods are primarily designed
to calculate funding requirements, they are also frequently used to determine retirement benefit costs for
accounting purposes. The actuarial method selected for determining accrual of liability and the assumptions
made can have a significant effect on the expense to be recorded in each accounting period. Therefore, in
carrying out a periodical valuation, an actuary chooses a suitable valuation method and, in consultation
with the employer, makes appropriate assumptions about the elements affecting the computations. The
assumptions relate to the expected inflow from future contributions and from investments as well as to the
expected outgo for benefits. In making an actuarial valuation, the actuary may sometimes effect a change in
the actuarial method used or in the assumptions adopted for determining the retirement benefit costs. Any
alterations in the retirement benefit costs so arising are charged or credited to the statement of profit and
loss for the year. Accordingly, a change in the actuarial method used for determining the retirement benefit
costs constitutes a change in an accounting estimate and thus, the auditor would have to ensure that the same
is disclosed and impact on accounts is expressed in quantitative terms.
130 Accounting Standards
Problem 4: Zodiac Enterprsies pays salary/wages per day = ` 200. Leaves utilized during the year say 300
days. Leaves unutilized at Balance sheet date are non-accumulating 200 days and accumulating are 500 days
out of which 40% are vesting. 60% of the non – vesting leaves are expected to be utilized in future years.
Calculate relevant figures.
Solution:
1) 300 days are paid leave hence it will be paid through normal salary/wage paymeny =
300 × @200 = ` 60,000.
2) Non – accumulating leaves means that leaves which is not utilized and will not be c/f. Therefore
these leaves will lapse. Hence no provision is required.
3) Accumulating leaves = 500 days = 40% vesting (cash entitlement) + 60% (c/f with adjustment in
future years) = 200 + 300.
Accumulating leaves = Vesting (cash entitlement) = 200days @200 = ` 40,000.
Non - Accumulating leaves = 300 days x 60% utilization factor @200 = ` 36,000.
Entry for payment and provision for paid leaves c/f:
PAID LEAVES UTILISED:
Employees cost A/C Dr. 60,000 (transfer to Profit/Loss A/C )
To Cash/Bank A/C 60,000
PAID LEAVES UNUTILISED:
Employees cost A/C Dr. 76,000 (transfer to Profit/Loss A/C )
To Provision for Employees Benefits A/C 76,000
Problem 5: Wage of Mr A, an employee of Grasim Ltd is ` 200 per day. He was on leave from 26/3/2009 to
31/3/2009. Show accounting entries in the books of Grasim Ltd to record the compensated absence in each
of the following cases:
(i) Mr. A is entitled to 8 days of compensated absence, which is non – accumulating.
(ii) Mr. A is entitled to 8 days of compensated absence, which is accumulating.
Solution: Mr A has taken 6 days actual leave during the year (leave utilized). But he is entitled to 8 days leave
during the year in both the cases given in Qt 7 (i) and (ii).
i) Non – accumulating leaves means that leaves which is not utilized and will not be c/f. Therefore
these leaves will lapse. Hence no provision is required.
PAID LEAVES UTILISED:
Employees Benefits A/C Dr. 1,200 (transfer to Profit/Loss A/C )
To Cash/Bank A/C 1,200 (6days @200).
ii) PAID LEAVES UTILISED:
Employees Benefits A/C Dr. 1,200 (transfer to Profit/Loss A/C )
To Cash/Bank A/C 1,200
PAID LEAVES UNUTILISED:
Employees Benefits A/C Dr. 400 (transfer to Profit/Loss A/C )
To Provision for Employees Benefits A/C 400 (2days @200).
Problem 6: Gross wage bill of Ferrous Limited for the month of April 2009 is ` 30,00,000. PF contribution
(employers share) is 8% of gross wage. The employees make a matching contribution to PF. Ferrous Ltd.
deposited a total sum of ` 4,50,000 on 30/4/2009 towards PF obligations for April 2009. Show accounting
entries to record the above transactions.
AS-15 (Revised): Employees Benefits 131
Solution:
Employees Benefits A/C Dr. 32,40,000 (30lakh + 8% of 30lakh) (transfer to Profit/Loss A/C )
To PF Contribution A/C 4,80,000 (16% x 30lakh)
To Cash/Bank A/C 27,60,,000 (16,20,000 – 2,40,000)
PF Contribution A/C Dr. 4,80,000
To Bank A/C 4,50,000
To Liability for PF 30,000
Problem 7: Calculate FV of Plan Assets at the end:
FMV (beginning) = ` 7,00,000, Employers Contribution = ` 1,00,000, Benefits paid = ` 40,000, Actual
return = ` 50,000.
Solution: FV of plan assets = 7,00,000 + 1,00,000 – 40,000 + 50,000 = ` 8,10,000 (For explanation refer
further problems).
Problem 8: Nature of benefit payable is Lumpsum - gratuity
Basis of payment 1 % of final salary for each year of service
Salary for current year ` 10,000
Increase each year 7% compounding
Number of years of service = 5
Discount rate = 10% (Quality Bonds YTM)
Expected return on plan assets = 11%.
Investments in Plan Assets: Yr 1: ₹ 86, Yr. 2: ₹ 96, Yr. 3: ₹ 106, Yr. 4: ₹ 118, Yr. 5: ₹131.
Draw ledgers for all the years for Gratuity a/c and plan assets a/c
Solution:
Step 1) Calculation of Final Salary at the 5th year = 10,000 x (1.07)4 ,= ` 13100 (app).
Step2) Gratuity = 13,100 x 1% = ` 131 every year.
Step3) Gratuity for 5 years = 131 x 5 = ` 655.
To pay 131 at the end 5th year we have to provide ` 131 × 1 for 5th year = ` 131
To pay 131 at the end 5th year we have to provide ` 131 × 0.909 for 4th year (@10%) = ` 119
To pay 131 at the end 5th year we have to provide ` 131 × 0.826 for 3rd year (@10%) = ` 108
To pay 131 at the end 5th year we have to provide ` 131 × 0.751 for 2nd year (@10%) = ` 98
To pay 131 at the end 5th year we have to provide ` 131 × 0.683 for 1st year (@10%) = ` 89
` 89, ` 98, ` 108, ` 119 and ` 131 are known as Current Service Cost charged to Profit and Loss.
Lets now build up GRATUITY of obligation as per Projected Unit Credit Method (PUCM):
DO YOU KNOW
Closing obligation for any year = n × Current Service Cost
Example: Closing obligation for year 1 = 1 × 89 = 89, year 2 = 2 × 98 = 196 and so on.
132 Accounting Standards
Lets us now build up growth in investments for paying obligations at the end
To receive 131 at the end 5th year we have to invest ` 131 × 1 for 5th year = ` 131
To receive 131 at the end 5th year we have to invest ` 131 × 0.901 for 4th year = ` 118
To receive 131 at the end 5th year we have to invest ` 131 × 0.811 for 3rd year = ` 106
Similarly for 2nd and 1st year also.
` 86, ` 96, ` 106, ` 118 and ` 131 are known as Contribution towards Plan investments.
Similarly we can go for the fourth and the fifth year. At the end of fifth year Gratuity payable a/c and Plan
assets a/c get canceled as it is a payment towards retirement benefits.
AS-15 (Revised): Employees Benefits 133
Problem 9: Following information is given about a funded benefit plan. The PV of obligation and the FV of
assets planned were both ` 1,000 as on April 2009.
In year 2, the plan was amended to provide additional benefits effective from year 1. The PV at the end of
year 1 for additional benefits is ` 50 vested and ` 30 non - vested benefits. As on 1/4/2010 the enterprise
estimated that the avg period until non -vested benefits would become vested was 3 years; the past service
cost arising from non vesting benefit should be w-off on SLM basis over 3 years. The past service cost arising
from vesting benefit should be immediately w-off.
You are required to:
Complete the following table, Also calculate the amount charged to P/L Account as per AS-15 and draw
Balance Sheet disclosure.
Solution:
BUILDING UP PV OF OBLIGATION 2009-10 2010-11 2011-12
Opening PV of obligation 1000 1141 1197
Interest cost 100 103 96
Current service cost 130 140 150
Past service cost (non vested benefits) — 30 —
Past service cost (vested benefits) — 50 —
Benefits paid (150) (180) (190)
SUBTOTAL 1080 1264 1253
Actuarial gain/(loss) à (a) (61) +87 (42)
Closing PV of obligation (actuarial valuation) 1141 1197 1295
BUILDING UP FV OF PLAN ASSETS 2009-10 2010-11 2011-12
FV of plan assets as on ¼ 1000 1092 1109
Expected return on plan assets 120 121 114
Contributions paid 90 100 110
Benefit paid (150) (180) (190)
SUB TOTAL 1060 1133 1143
Actuarial gain/(loss)à (b) 32 (24) (50)
FV of plan assets as on 31/3 (market valuation) 1092 1109 1093
Net Actuarial gain/(loss) a+b (29) 63 (92)
DO YOU KNOW
Closing PV of obligation and FV of plan assets is to be calculated by Actuary and hence students are not al-
lowed to analyze the valuation work on 31/3. It is even applicable in practice.
Problem 10: At 01.04.2009 the FV of plan assets was ` 10,000. On 30.09.2009, the plan paid benefits of
` 1,900 and received contributions of ` 4,900. At 31.03.2010, the FV of the plan assets was ` 15,000 and the
PV of the defined benefit obligation was ` 14,792. Actuarial losses on the obligation for 2009-2010 were ` 60.
At 01.04.2009, the reporting enterprise made the following estimates, based on the market prices at that date:
Interest and dividends (after tax by the fund) 9.25%
Realized and unrealized gains on plan assets (after tax) 2.00%
Administration costs (1.00)%
Expected rate of return 10.25%
estimation. In estimating the obligation, assumptions may need to be made regarding future conditions and
events, which are largely outside the company’s control.
Thus, (1) Settlement allowance payable by the company is a defined retirement benefit, covered by AS
I5 (Revised). (2) A provision should be made every year in the accounts for the accruing liability on account
of settlement allowance. The amount of provision should be calculated according to actuarial valuation. (3)
where, however, the amount of provision so determined is not material, the company can follow some other
method of accounting for settlement allowances.
Problem 12: A pension plan of a company provides a pension of 1.5% of final salary for each year of service.
The benefits are vested after 4 years of service. However on 1/1/2010 the company changes the pension to
1.25% of final salary for each year of service starting from 1/1/2003. The present value of the differential
benefits for service from 1 January 2003 to 1 January 2010 at the date of changes as follows:
Employees with more than 4 years of service on 1/1/2010 ` 1,25,000
Employees with less than 4 years of service on 1/1/2010 ` 1,21,000
(Average period until vesting – four years) Determine the amounts recognized in respect of past service
costs.
Solution: Past service cost which is already vested is written off immediately. Unvested past service cost is
written off over the period until vesting on straight line basis. Such unrecognized past service cost is deducted
while recognizing net employee benefit obligation in the balance sheet.
Employees with more than 4 years of service on 1/1/2010 ` 1,25,000 should be immediately w-off
Employees with less than 4 years of service on 1/1/2010 ` 1,21,000 should be charged to Profit and Loss
Account on SLM basis till balance period on vesting.
Problem 13: P Ltd. has three business segments which are FMCG, Batteries and Sports Equipment. The
Battery segment has been consistently underperforming and P Ltd. after several discussion with labour unions
have finally decided on closure of this segment. Under the agreement with the labour union the employees
of the Battery Segment will earn no further benefit as the arrangement is a curtailment without settlement
wherein the employees of the discontinued segment will continue to receive benefits for services rendered
when segment was functioning. As a result of the curtailment, the company’s obligation that was arrived on
the basis of actuarial valuations before the curtailment have come down. The following is also furnished:
(i) The value of gross obligations before the curtailment calculated on actuarial basis was ` 4,000 lakhs.
(ii) The value of Unamortized past service costs is ` 100 lakhs.
(iii) The Curtailment will bring down gross obligations by ` 500 lakhs and P Ltd. anticipate a proportional
decline in the value of unamortized past service costs also.
(iv) The fair value of plan assets on date is estimated at `3,250 lakhs.
You are required to calculate the gain from curtailment and also show the liability to be recognized in the
Balance Sheet of P Ltd. after the curtailment. (CA Final Nov. 2013, Marks 5)
Solution: This is a case of Curtailment without Settlement
Particulars Before Curtailment Curtailment gain After Curtailment
PV of obligation 4000 (500) 3500
FV of plan assets (3250) - (3250)
750 (500) 250
Unrecognised Past Service Cost (100) (12.5) (87.5)
Net liability in B/S 650 487.5 162.5
Note: Proportional Decline in Unamortised Past Service Costs = 500 ÷ 4,000 = 12.5%
All the above Rupees in lakhs.
Journal Entry for Curtailment:
AS-15 (Revised): Employees Benefits 137
Chapter Outline
vv Meaning of Borrowing Costs (BC) vv Treatment of Borrowing Costs Incurred
vv Elements of Borrowing Costs or vv Meaning of Expenditure Incurred
Scope of AS-16: Para 4 on Qualifying Asset: Para 15
vv Conditions for Borrowing Costs vv Types of Borrowings/BC Eligible for Capitalization
vv What are Qualifying Assets (Q. A.) vv Disclosures
compensated by gains due to reduced amount of interest. It does not deal with gains in exchange differences.
If the exchange difference, on principal amount is not borrowing cost as per AS-16, then is to be taken care
off by AS – 11/Companies Act.
Exclusions in Borrowing Costs: (i) Cost of Equity (Ke), (ii) Cost of Preference Share Capital (Kp), (iii)
Imputed cost of equity (Kr).
DO YOU KNOW
Borrowing Costs includes not only interest on long term loans but also on working capital loans. Had the cash
generated from operations would have been used for repaying working capital loans, the borrowing costs
would have been lower. Hence Interest on working capital is also to be capitalised.
DO YOU KNOW
Qualifying assets covers fixed assets (lathe machine under construction) as well as stock in trade (wine, genetic
seeds).
Other Examples
◘◘ A toll bridge that takes a couple of years to construct before it is ready for use and is opened to the
public.
◘◘ A power plant that takes a substantial period of time to get ready for its intended use.
◘◘ A hydroelectric dam that services the needs of a village and takes a considerable period of time to
construct
The following are not Qualifying assets:
(i) Inventories routinely manufactured.
(ii) Inventories produced in large quantities and for short term.
(iii) Assets are ready for use/sale.
140 Accounting Standards
Substantial period of time: The issue as to what constitutes a substantial period of time primarily
depends on the facts and circumstances of each case. However, ordinarily, a period of twelve months is
considered as substantial period of time unless a shorter or longer period can be justified on the basis of
facts and circumstances of the case. In estimating the period, time which an asset takes, technologically and
commercially, to get it ready for its intended use or sale should be considered.
The following assets ordinarily take twelve months or more to get ready for intended use or sale unless
the contrary can be proved by the enterprise:
(i) assets that are constructed or otherwise produced for an enterprise’s own use, e.g., assets constructed
under major capital expansions.
(ii) assets intended for sale or lease that are constructed or otherwise produced as discrete projects (for
example, ships or real estate developments).
Borrowing specifically used for a Used in general for different Not used for any qualifying asset say
qualifying asset qualifying asset working capital loans
Borrowing cost should be fully Weighted average rate of borrowing Borrowing cost should be fully
debited to qualifying asset cost should be charged on average charged to profit & loss account
expenditure on qualifying asset. The
total amount charged should not
Borrowing cost for the period after exceed the actual borrowing cost
the completion all qualifying asset
will be charged to P & L A/c.
It means all relevant activities, which are essential for intended use or sale of qualifying assets, should be
completed. BC should be totally stopped when physical construction or production is substantially completed
though some routine administrative work may be still carried out.
If the construction of the qualifying asset is carried in parts/phase and each part/phase can be used
independently, then capitalization of borrowing cost for such phase/part will cease, but can continue for
other parts as well.
Example: A business park comprising several buildings, each of which can be used individually, is an example
of qualifying assets for which each part is capable of being used as intended while construction continues for
the other parts.
Disclosures
The financial statement should disclose:
1) The accounting policy adopted for borrowing cost.
2) The amount of borrowing cost capitalized during the period.
Problem 1: R. Ltd. has borrowed ` 25 crores from financial institution during the financial year 2004-05.
These borrowings are used to invest in shares of A Ltd., a subsidiary company, which is implementing a new
project estimated to cost 50 crores. As on 31st March, 2005 since the said project was not yet complete, the
Directors of R Ltd., resolved to capitalize the interest on the borrowings amounting to ` 3 crores and add it to
the cost of investments. As a statutory auditor, please comment.
(Final C.A. Audit, Final C.A. Nov. 2004) (4 Marks)
Solution:
Capitalisation of Interest on Borrowings in respect of investments: As per Accounting Standard 13 on
“Accounting for Investments,” the cost of investment includes acquisition charges such as brokerage, fees and
duties. In the instant case, R Ltd has used borrowed funds for making investment in shares of a subsidiary
company. For acquiring shares of a subsidiary company, apart from any fees, duties etc there are no cost
incurred for investing in shares. Hence, any borrowing costs incurred cannot be treated as part of cost of
investments and cannot be added to the cost of investments. The Accounting Standard 16 on “Borrowing
Costs” also does not consider investment in shares as qualifying assets that can enable a company to add the
borrowing costs to investments. In the instant case therefore, the statutory auditor would qualify his report
by stating that the borrowing costs have wrongly added to the cost of investments rather than charging
them to the profit and loss account. The effect of the same on the profit for the year would also have to be
mentioned in the audit report.
Problem 2: How would you, as a statutory auditor, deal with the following situation? The company deals
in purchase and sale of timber and has included notional interest charges (calculated on the paid up share
capital and free reserves) in the value of stock of timber as at the Balance Sheet date as part of cost of holding
the timber. (Final C.A. Nov. 1995) (4 Marks)
AS-16: Borrowing Costs 143
Solution: The companies accounting policy of capitalising the cost of interest to the stock is incorrect. The
cost of reserves and capital cannot be taken as BC. Even as per AS-2 the valuation of stock is incorrect, which
excludes interest as cost of inventory. Also the BC is to be capitalised only for manufacture or acquiring
Qualifying asset. BC cannot be added during the holding period of the asset. The company should exclude such
imputed cost of capital from timber stock otherwise the auditor will have to qualify the report. Practically
speaking company purchasing wet timber is kept for substantial period of time to make itself ready (dry
timber) for intended sale. In such BC would have been capitalized.
Problem 3: Palms Trees Ltd. has taken a loan of $ 10,000 on April 1, 2005, for a specific project at an interest
rate of 6% p.a.. Installment is payable annually into 5 equal installments. On April 1, 2005, the exchange
rate between the currencies was ` 45 per $. The exchange rate, as at March 31, 2006, is ` 48 per $. The
corresponding amount could have been borrowed by Palms Trees Ltd. in local currency at an interest rate of
11 % p.a. as on April 1, 2005.
1. You are required to ascertain the amount of borrowing cost incurred and to be included under:
a. Para 4(a) of AS 16
b. Para 4(e) of AS 16
2. Is AS 11 applicable in the above case?
3. What would be your answer if interest rate prevailing locally is 15% p. a.? (CA Final A/Cs May
2012)
Solution:
Step 1: Interest as per Foreign Loan = 10000x 6% × @48= ` 28,800 AS-16 para 4(a)
Step 2: Exchange Difference = ($10000 × 48-45) = ` 30,000
Step 3: Interest as per Indian Loan = $10000 × 45 × 11%= ` 49500
Step 4: Exchange Difference covered by AS – 16 para 4 (e) = 49500 – 28800 = ` 20,700
Total BC to be capitalised = Interest on Foreign Loan para 4(a) + Exchange difference para 4(e) = 28,800 +
20,700 = ` 49,500
Exchange Difference of ` 9,300 is covered by AS-11 (`30,000 – `20,700) = ` 9,300.
If interest rate prevailing in India is 15% p.a.:
Step 1: Interest as per Foreign Loan = 10000 × 6% x @48 = ` 28,800 AS-16 para 4(a)
Step 2: Exchange Difference = ($10000 × 48-45) = ` 30,000
Step 3: Interest as per Indian Loan = $10000 × 45 × 15%= ` 67,500
Step 4: Exchange Difference covered by AS – 16 para 4 (e) = ` 30,000 (Full)
Total BC to be capitalised = Interest on Foreign Loan para 4(a) + Exchange difference para 4(e) = 28,800 +
30,000 = ` 58,800
Exchange Difference covered by AS-11 is Nil.
Problem 4: XYZ Ltd., has undertaken a project for expansion of capacity as per the following details:
Plan ` Actual `
April, 2015 2,00,000 2,00,000
May, 2015 2,00,000 3,00,000
June, 2015 10,00,000 —
July, 2015 1,00,000 —
August, 2015 2,00,000 1,00,000
September, 2015 5,00,000 7,00,000
144 Accounting Standards
The company pays to its branches at the rate of 12% p.a., interest being debited on a monthly basis. During
the half year company had ` 10 lakhs overdraft upto 31st July, surplus cash in August and again overdraft of
over `10 lakhs from 1.9.2015. The company had a strike during June and hence could not continue the work
during June. Work was again commenced on 1st July and all the works were completed on 30th September.
Assume that expenditure were incurred on 1st day of each month.
Calculate: (i) Interest to be capitalized. (ii) Give reasons wherever necessary.
Assume:
(a) Overdraft will be less, if there is no capital expenditure.
(b) The Board of Directors based on facts and circumstances of the case has decided that any capital
expenditure taking more than 3 months as substantial period of time.
(Final C.A. May 2003) (8 Marks)
Solution:
Qualifying Asset A/C
2002 Particulars ` 2002 Particulars `
1 April To Bank O/D 2,00,000 1 April By Balance c/d 2,02,000
30 April To Interest 2,000
(1% × 200000)
1 May To Balance b/d 2,02,000 1 April By Balance c/d 5,07,020
1 May To Bank O/D 3,00,000
31 May To Interest 5,020
(1% × 502000)
1 June To Balance b/d 5,07,020 1 April By Balance c/d 5,07,020
1 June To Bank O/D —
30 June To Interest —
(Note 2)
1 July To Balance b/d 5,07,020 1 April By Balance c/d 5,12,090
1 July To Bank O/D —
31 July To Interest 5,070
(1% × 507020)
1 Aug To Balance b/d 5,12,090 1 April By Balance c/d 6,12,090
1 Aug To Bank O/D 1,00,000
31 Aug To Interest —
(Note 3)
1 Sep To Balance b/d 6,12,090 1 April By Balance c/d 13,22,090
1 Sep To Bank O/D 7,00,000
30 Sep To Interest 10,000
(Note 4)
Important Notes:
1) O/D is above 10lacs but expn on QA is less than 10 lacs, therefore 1% interest rate is applied on
expenditure of Q.A. As per para 15, the average carrying amount of the asset during a period, including
borrowing cost previously capitalized, is normally a reasonable approximation of the expenditure to
which the capitalization rate is applied in that period.
2) In the month of June the activities were stopped due to strike. Hence BC was suspended…….para 17
of AS-16.
3) In the month of August there is no O/D or positive cash balance. No interest cost is incurred and
hence the same is not capitalized.
AS-16: Borrowing Costs 145
4) During September, actual overdraft is ` 10 lakhs. Hence, only ` 10,000 interest has been capitalised
even though actual expenditure exceeds ` 10 lakhs. Maximum BC to be capitalized will be ` 10,000
in Sep.
Problem 5: A company obtained term loan during the year ended 31st March, 2002 to an extent of
` 650 lakhs for modernization and development of its factory. Buildings worth ` 120 lakhs were completed
and Plant and Machinery worth ` 350 lakhs were installed by 31st March, 2002. A sum of ` 70 lakhs has
been advanced for assets, the installation of which is expected in the following year. ` 110 lakhs has been
utilized for Working Capital requirements. Interest paid on the loan of ` 650 lakhs during the year 2001-2002
amounted to ` 58.50 lakhs. How should the interest amount be treated in the Accounts of the Company?
(C.A. Final Nov. 2002, Nov 2005) (6 Marks)
Solution: Building & Plant are qualifying assets because Building is being constrcuted, P & M is installed for
modernization of factory. Payments for assets is a capital advance i.e. we are contractee hence we have to
make fixed payments. Money spent on the working capital is also not for the purpose of Q.A. Hence interest
pertaining to construction of building & installation of plant is required to be capitalised and all the other
activities should be charged off to the Profit and Loss Account. In the present case, the interest amount of
` 58.50 lakhs shall be treated as follows: Capitalisation of interest ` 42.30 lakhs and interest charged to Profit
and Loss ` 16.20 lakhs.
Problem 6: On 01.04.2016 Nidhi Ltd. borrowed ` 2,00,000 @12% p. a. for construction of qualifying asset.
The construction commences on 01.06.2016 and completes on 28.02.2017. Income earned on investing the
same borrowings temporarily was ` 5,000 of which` 2,000 represents, income earned after 01.06.2016.
Ascertain the amount of borrowing cost eligible for capitalisation. (CA Final Nov. 2014) (4 Marks) (CA
Final May 2010 NS similar qt)
Solution:
Gross Interest paid = 200000 × 12% = 24,000
Interest eligible for BC as per AS-16 = 24000 × 9/12 = 18,000
Net Interest transferred to Profit and Loss = 24000 - 18000 = 6,000
Specific borrowing case:
Interest eligible for BC as per AS-16 = 18,000
Less: Interest on temporary investments = –2,000
Net Interest capitalised for BC as per AS-16 = 16,000
Problem 7 Kirloskar Ltd. had following general borrowings and investments in qualifying assets.
Source Date of raising Amount (`)
12% Debentures 01.04.2005 1,500,000
15% Term Loan 01.04.2005 600.000
18% Term Loan 01.04.2005 400,000
With the help of these details determine for the year ended 31.03.2006
1. the amount of borrowing cost incurred
2. the amount of borrowing cost to be capitalised for qualifying assets
3. the amount of borrowing cost to be charged to revenue
146 Accounting Standards
Solution:
Step 1) Calculation of BC incurred:
SOURCE BORROWINGS AVG O/S INTEREST
12% Debn. 15,00,000 15,00,000 1,80,000
15% Loans 6,00,000 6,00,000 90,000
18% Loans 4,00,000 4,00,000 72,000
Total: 25,00,000 25,00,000 3,42,000
Step 2) Calculation of Capitalisation rate for general borrowings: (Effective Interest @)
Capitalisation % = Interest/Avg O/S 13.68 % p.a.
Step 3) Calculation of Capitalisation of borrowings costs:
Q. A. EXPENDITURE INCURRED ON QA % PERIOD PRODUCT
A 6,00,000 13.68% 10/12 68,400
B 5,00,000 13.68% 11/12 62,700
C 4,00,000 13.68% 9/12 41,040
Total : 15,00,000 1,72,140
Step 4) Capitalisation of borrowing cost = Notional BC 1,72,140
Step 5) Borrowing cost charged to Profit and Loss = 3,42,000 – 1,72,140 = 1,69,860
Problem 8: X Ltd began construction of a new building on 1st January. It obtained ` 1 Lakh special loan to
finance the construction of the building on 1st January at an interest rate of 10%. The Company’s other two
outstanding non-specific loans were-
(a) ` 5,00,000 Loan at 11 % Interest, and (b) ` 9 ,00,000 Loan at 13% Interest.
The expenditure that were made on the building project were as follows -
(b) January ` 2,00,000, (b) April ` 2,50,000, (c) July ` 4,50,000, (d) Dec. `1,20,000.
Building was completed by 31st Dec 2007. Following the principles prescribed in AS-16 “Borrowing Cost,”
calculate the amount of interest to be capitalized and pass one Journal Entry for capitalizing the cost and
borrowing cost in respect of the building. (CA Final Nov 2008 Marks 10)
Solution:
Calculation of Capitalisation rate: (5,00,000 x 11% + 9,00,000 x 13%)/14,00,000 = 12.29%
Calculation of BC:
` 1,00,000 × 12/12 = ` 1,00,000
` 2,50,000 × 9/12 = ` 1,87,500
` 4,50,000 × 6/12 = ` 2,25,000
` 1,20,000 × 1/12 = ` 10,000
` 5,22,500
Journal entry
Date Particulars Dr.(`) Cr.(`)
31st Dec. Building account Dr. 10,94,189
To bank account 10,94,189
(being amount of cost of building and borrowing cost thereon capitalized)
Problem 9: On April 1, 2014, MGH constructions undertook construction of a factory building for expansion
purpose. Total cost of project was ` 3,00,00,000. The building was completed by end of March 2015 and
during the period following payments were made :
Payment made Amount
st
1 April 2014 20,00,000
30th June 2014 60,00,000
st
31 December 2014 1,80,00,000
st
31 March 2015 40,00,000
Total 3,00,00,000
MGH constructions borrowings as at March 31, 2015 were as follows :
a) 9% term loan amounting to ` 80,00,000 taken on December 31, 2013. Simple interest is payable
annually. Amount outstanding as at March 31, 2014 and during 14-15 is ` 80,00,000. The loan was
taken specifically for the project.
b) 11% debentures issued on March 31, 2013 with simple interest payable annually. Amount outstanding
for the year 14-15 is ` 1,50,00,000.
c) 10% bonds issued on December 31, 2012 amounting to ` 1,70,00,000. Simple interest payable at
annual rest. Amount outstanding for the year 14-15 is `1,60,00,000.
How much borrowing cost should be capitalized for construction of the building as per AS-16 “Borrowing
Cost”?
Solution:
Step 1) Calculation of BC incurred: (Only for GB) (` in lakhs)
SOURCE BORROWINGS AVG. O/S INTEREST
11% Debn. 150.000 150.000 16.500
10% Bonds 160.000 160.000 16.000
Total 310.000 310.000 32.500
Problem 11: Given below are expenses incurred in three phases of a project relating to construction of a
captive power plant: (`)
Facility expansion commenced on 01-06-2018 on all facilities. As of 31-03-2019, the status of completion
of these facilities was as follows:
◘◘ Plant A was completed as of 31-12-2018.
◘◘ Plant B was completed as of 30-11-2018.
◘◘ Power generation facility at Plant C is still under construction as of 31-03-2019.
◘◘ Plant D was completed as of 28-02-2019.
◘◘ Corporate offices were still under construction as of 31-03-2019.
Details of debt-equity profile of JP Ltd.
Equity: 1000 lakhs equity shares of ` 5 each fully paid.
500 lakhs 6% redeemable cumulative preference shares.
Debt:
◘◘ ` 2000 lakhs 11% p.a. secured debentures raised on 01-07-2016 redeemable in four equal install-
ments commencing 01-07-2018.
◘◘ ` 1500 lakhs secured working capital loan obtained on 01-04-2018. The loan carries an interest of
14% p.a. This loan was partially repaid on 31-12-2018 - amount repaid ` 500 lakhs.
◘◘ Loan from Financial Institutions amounting to ` 3000 lakhs bearing interest at 14% p.a. obtained for
construction of Plant A& B on 01-05-2018.
150 Accounting Standards
◘◘ Foreign currency loans from financial institutions amounting to $6 million bearing LIBOR plus 2%
obtained on 01-06-2018. The contracted LIBOR rate was 6% p.a. The exchange rate as of that date
was US$ 1 = ` 43. The exchange rate as of 31-03-2019 was US$ 1 = ` 46.50. The average exchange rate
during 2018-2019 was ` 45. None of the loans were repaid as of 31-03-2019. Debt is secured by a
paripassu first charge on all fixed assets of the company, both present and future. The working capital
loan is also secured against inventories and book debts of the company.
Calculate only the interest capitalized as borrowing costs.
Solution: This problem is of General Borrowing as well as Specific Borrowing both.
Step 1) Calculation of BC incurred: (Only GB)
SOURCE BORROWINGS AVG O/S INTEREST
11% Debt 2000 1,625 178.75
14% WC loan 1500 1,375 192.50
8% Foreign Loan $ 6million 2,250 180.00
5,250 551.25
Calculation of Avg Borrowings:
1) 11% Debt = 2000 × 3/12 + 1500 × 9/12 = 1625, 2) 14% WC Loan = 1500 × 9/12 + 1000 × 3/12 = 13753)
Foreign loan = $6m = $60lakhs → $60 × 10/12 = $50 lakhs (effective), Further conversion rate will be avg rate
= 50 $ × 45 = `2250 lakhs. (Interest can alternatively calculated on closing rate)
Capitalisation rate = 551.25/5250 = 10.50% p.a.
Statement of Capitalisation of BC
(1) PLANT A: Expn = 3400 lakh
General = 1000 lakhs Specific = 2400 lakhs Total
1000 × 10.50% × 7/12 2400 × 14% × 7/12 = 257.25
(2) PLANT B: Expn = 2000 lakh
General = 1400 lakhs Specific = 600 lakhs Total
1400 × 10.50% × 6/12 600 × 14% × 6/12 = 115.50
(3) PLANT C: Expn = 400 lakh
General = 1000 lakhs Specific = 0 Total
400 × 10.50% × 10/12 35.00
(4) PLANT D: Expn = 400 lakh
General = 1000 lakhs Specific = 0 Total
400 × 10.50% × 9/12 31.50
(5) CORPORATE OFFICE = 800 lakh
General = 1000 lakhs Specific = 0 Total
800 × 10.50% × 10/12 70.00
Total BC capitalized = 257.25 + 115.50 + 35 + 31.50 + 70 = ` 509.25 lakhs
Problem 13: AB Limited acquired at the start of the financial year, Fixed Assets from USA at a price of US$
1,25,000 and made a down payment of US$ 25,000. The Exchange Rate was ` 61.50 per Dollar at the date
of transaction. The balance amount was payable in 4 equal half–yearly installments with interest @ 8% per
annum. The Exchange Rate on the due dates of installment has been ` 61.60, ` 61.80, ` 61.90 and ` 62.10. The
Asset was under construction during the period of six months from its acquisition. Ascertain the amount to
be capitalized and the Gain or Loss to be recognised in each of the years. (CA Final May 2015, 4 Marks)
AS-16: Borrowing Costs 151
Solution:
Assumption: 1) MCA circular is not applicable. Hence no capitalisation.
2) Asset is not a qualifying asset, as the construction period is 6 months only.
This means purely AS-11 is applicable where no capitalisation is permitted.
Amount charged to P/L :
Installment Interest cost Exchange G/L Net (P/L)
1 (6 month) 2,46,400 10,000 2,56,400
1,00,000 x 4% x 61.60 1,00,000 (61.50-61.60)
2 1,85,400 15,000 2,00400
75,000 x 4% x 61.80 75,000 (61.60-61.80)
3 1,23,800 5,000 1,28,800
50,000 x 4% x 61.90 50,000 (61.80-61.90)
4 62,100 5,000 67,100
25,000 x 4% x 62.10 25,000 (61.90-62.10)
Amount charged to P/L:
Year 1: 2,56,400+2,00,400 = 4,56,800
Year 2: 1,28,800+67,100 = 1,95,900
CHAPTER 17
AS-17: Segmental Reporting
Chapter Outline
vv Scope and Objective vv Reportable Segments
vv Types of Segments vv Disclosure Requirements
Types of Segments
Business Segment:
i)
If a company is dealing in various products/services having different risk - return profile then we say
that the enterprise is having Business segments. A BS is a distinguishable component of an enterprise
that is engaged in providing an individual product or service or a group of related products or services
and that is subjected to risks and returns that are different from those of other business segments. A
coaching classes is running 3 divisions Commerce, Science and School. Risk and returns of individual
division might be different. This is an example of Business Segment.
Factors to be considered for BS:
i) Nature of product, ii) Different process involved, iii) Type or class of customers, iv) Methods of
distribution, v) Nature of regularity environment (laws, regulations).
AS-17: Segmental Reporting 153
SOME DEFINITIONS
i) Reportable Segment: An enterprise may be engaged in ‘n’ number of products/areas. But only some of
the segments need to be compulsorily disclosed in the financial statements. Such mandatory disclosed
segments are known as Reportable Segment.
ii) Segment Revenues: It represents revenue of a particular segment.
Segment Revenue = (Direct revenues from outside customers + Inter segment sales + Allocated income). As
segment revenue includes allocable income the basis for sharing common income between the segments
can be agreed between the segments, internal MIS, transfer-pricing policy.
What about other income: Other income should be included as a part of segment revenue if they do not
fall under the exclusion definition (discussed below) and if it is essentially operating in nature. For Example:
Export incentives are price subsidies for achieving exports which is indirectly a component of export
turnover and should be included in segment revenue. Some times segment assets are idle, and these may
be used to earn rentals. Such income would be operating income and consequently form part of segment
revenue.
Exclusions: (i) Income like Interest, dividend earned unless the operations of the segment are primarily of
a financial nature; (ii) Gains on Sale of investments; (iii) Extraordinary items.
154 Accounting Standards
DO YOU KNOW
If item of expense (say depreciation) is included in P & L A/C. for a particular segment, then the corresponding
asset will also go to that segment assets head.
vii) Segment Liabilities: Segment’s own operating liabilities + Share of Common liabilities. It excludes; (i)
Provision for Taxes (ii) Liabilities incurred at Head – Office level for general purpose.
viii) Segment Accounting Policies: AS-1 prescribes accounting policies at the total company level as a whole.
But segment accounting policies are specific accounting policies for the concerned segment to be reported.
Even accounting policies at the enterprise level may be passed on (allocated to) the segment. For ex.: If all
the segments use one particular Asset commonly then, depreciation charged on the enterprise level will
be allocated to different segments.
Examples of segment policies:
Policies relating to, (i) Basis of allocation of revenues/expenses between segments, (ii) Transfer pricing
policies.
Identification of Segments
Identification of Segments mostly depends upon the Organizational and Management structure. The internal
financial reporting to the BOD and CEO provides the best evidence for the basis of identification of segments.
2) The important factor for differentiation is “dominant source and nature of risks and return”.
3) If risks and returns of enterprises are largely affected by the products and services then business
segment will be the primary reporting segment. Here business segment is the dominant factor.
4) If risks and returns of an enterprise are largely affected by the operations in different areas then
geographical segment will be the primary reporting segment. Here geographical segment is the
dominant factor.
5) If suppose the risks and returns of both the business as well as geographical segment is equally
dominant then business segment will be primary segment.
However, if confusion arises as to differentiation between primary and secondary segment, one has to
understand the facts and circumstances of the case. Ultimately the financial disclosure should depict true and
fair view.
Segment in CFS
There is no such rule that a subsidiary company would constitute a reportable segment. Segments reportable
in the stand-alone financial statements may not be reported at the CFS level. If there are similar segments in
parent and subsidiary then they are treated as one segment for CFS purpose. Example: If HO and Subsidiary
have a common segment say FMCG, then they are merged at the CFS level.
Reportable Segments
An enterprise may be engaged in ‘n’ number of products/areas. But only some of the segments need to
be compulsorily disclosed in the financial statements. Such mandatory disclosed segments are known as
Reportable Segment.
However following are the tests applied to decide the Reportable Segment:
DO YOU KNOW
Total Revenue of all Segments ≠ Enterprise Revenue
Enterprise Revenue = Only external revenues of all segments (excluding inter-segment revenues).
Segment Result ≥ 10% of Higher of (Total Results of profitable segments OR Total Results of loss making
segments). Loss making segments will be considered in absolute terms.
If any of the above tests are not satisfied then management at its discretion choose Reportable Segment.
DO YOU KNOW
If ‘X’ is a Reportable Segment last year, then ‘X’ will continue to be a Reportable Segment every year irrespective
of the above tests gets satisfied or not.
Disclosure Requirements
Two styles of formats are required for reporting purposes:
ww Segment Revenues from external customers of business segment of only those segments whose
External Revenues is 10% ≥ Total Enterprises Revenues.
ww Carrying amount of segment assets, of those segment assets whose assets is 10% ≥ total assets
of business segments.
ww Tangible and Intangible assets acquired.
(iii) If Geographical Segment based on location of assets is Primary Segment: Then Geographical
Segment based on location of customers will be Secondary.
Following is to be reported by the Secondary Segments:
ww Segment Revenues from external customers of business segment of only those segments who’s
External Revenues is 10%≥ Total Enterprises Revenues.
(iv) If Geographical Segment based on location of customers is Primary Segment: Then Geographical
Segment based on location of assets will be Secondary.
Following is to be reported by the Secondary Segments:
ww Carrying amount of segment assets, of those segment assets whose assets is 10% ≥ total assets
of business segments.
ww Tangible and Intangible assets acquired.
Where primary segments are geographical segments based on location of assets (Para 50)
If locations of customers are different from location of assets, in addition to disclosures required pursuant
to paragraph 49 above, an enterprise is required to report revenue from sales to external customers for
each customer-based geographical segment whose revenue from sales to external customers is 10% more of
enterprise revenue.
Where primary segments are geographical segments based on location of customers (Para 51)
If locations of assets are different from location of customers, in addition to disclosures required pursuant
to paragraph 49 above, an enterprise is required to report the following segment information for each asset-
based geographical segment whose revenue from sales to external customers is 10% or more of enterprise
revenue or whose segment assets is 10 % or more of total enterprise assets.
a) the total carrying amount of segment assets by geographical location of the assets; and
b) The total cost incurred during the period to acquire segment assets that are expected to be used
during more than one period (tangible and intangible fixed assets) by location of the assets.
Problem 1: Mictrotech Ltd. produces batteries for scooters, cars, trucks and specialised batteries for
invertors and UPS. Are these products different business segments or a part of the same business segment.
(RTP)
Solution: As per AS-17 segments are identified based on different risk/rewards factors. The company is
basically producing batteries. But the batteries are further meant for (i) auto/vehicles and (ii) invertors/UPS
mostly useful for household purposes i.e. indoors. The risk and rewards in auto and invertors are significantly
different. Auto batteries are affected by government policy, road conditions, number of accidents etc and
batteries for invertors/UPS depends upon number of power supppliers, standard of living, corporate use or
household use etc. Hence there are two business segments for Microtech Ltd. ‘Auto batteries’ and ‘batteries
for invertors/UPS’.
160 Accounting Standards
Problem 2: If by applying the 10% thresholds, one reportable segment is identified but there are 5 other
business/geographical segments which do not meet individually any of the 10% thresholds, what should the
enterprise do in this case.
Solution: In such case the decision regarding reportable segment lies with the management. As per TEST 5
(Management Choice) if any of the previous tests are not satisfied then management at its discretion choose
reportable segment. Such segments are disclosed under unallocated column.
Problem 3: M Ltd. Group has three divisions A, B and C. Details of their turnover, results and net assets are
given below :
` (’000)
Division A
Sales to B 3050
Other Sales (Home) 60
Export Sales 4090
7200
Division B
Sales to C 30
Export Sales to Europe 200
230
Division C
Export Sales to America 180
Problem 4: Segment revenue does not include the following: (i) Indirect income like Interest, dividend,
Rent etc. (ii) Capital Gains on Sale of Assets. (iii) Extraordinary items.
Determine whether other items, such as export incentives, lease rent, interest from customers, can form
part of segment revenue as per AS – 17.
Solution:
Export incentives & Interest from customers: Both are part of operating income. Hence such operating receipts
has to be a part of segment revenue.
Lease Rent: A company may engage in leasing when it is profitable, in addition to the of sale of goods. For
example: An automobile company may be engaged both in selling the cars as well as leasing the car. In that
case leasing may be treated as a separate segment.
Problem 5: Superb Ltd. is a multinational company having registered office in Mumbai. The following details
are available from the books and other records of the company for the year ended 31st March, 2014:
` (’000) ` (’000)
Sales:
Domestic 7,625
Europe 1,676
America 2,325
Australia 766 12,392
Inter-unit sales between geographic areas (not included above)
Domestic 523
Europe 760 1,283
162 Accounting Standards
Operating profit:
Domestic 3,575
Europe 762
America 1,262
Australia 344 5,943
Other items:
General corporate expenses 362
Interest expenses 274
Income from investment 165
Identifiable assets:
Domestic 10,620
Europe 5,635
America 3,205
Australia 1,560 21,020
General corporate assets 750
Investments 675
Operating profit includes ` (’000) 62 on inter-geographical segment sales.
Prepare a statement showing financial information about the operations of Superb Ltd. in different
geographical segments.
Solution: Information about Superb Ltd.’s Operations in Different Geographical Segments
Geographical Segments
(Fig. in ` ’000)
Problem 6: The Chief Accountant of Sports Ltd. gives the following Data regarding its six segments:
` in Lakhs
Particulars M N O P Q R Total
Segment Assets 40 80 30 20 20 10 200
Segment results 50 –190 10 10 –10 30 –100
Segment Revenue 300 620 80 60 80 60 1,200
The Chief accountant is of the opinion that segments “M” and “N” alone should be reported. Is he justified
in his view? Discuss. (Final C.A. A/cs Nov 2010 OS, Audit May 2002)(Final C.A. May 2006)(5/4 marks)
Solution: As per para 27 of AS 17 Segment Reporting , a business segment or geographical segment should
be identified as a reportable segment if:s
(i) Its revenue from sales to external customers and from other transactions with other segments is
10% or more of the total revenue- external and internal of all segments; or
(ii) Its segment result whether profit or loss is 10% or more of:
(1) The combined result of all segments in profit; or
(2) The combined result of all segments in loss,
whichever is greater in absolute amount; or
(iii) Its segment assets are 10% or more of the total assets of all segments.
If the total external revenue attributable to reportable segments constitutes less than 75% of total
enterprise revenue, additional segments should be identified as reportable segments even if they do not meet
the 10% thresholds until atleast 75% of total enterprise revenue is included in reportable segments.
(a) On the basis of turnover criteria segments M and N are reportable segments.
(b) On the basis of the result criteria, segments M, N and R are reportable segments (since their results
in absolute amount is 10% or more of ` 200 lakhs).
(c) On the basis of asset criteria, all segments except R are reportable segments.
Since all the segments are covered in atleast one of the above criteria all segments have to be reported
upon in accordance with Accounting Standard (AS) 17. Hence, the opinion of chief accountant is wrong.
Problem 7: Fellicy Limited has investments (equity and debt) in the books of HO. The investments constitute
10% of total assets. There is some income of interest and dividend. Is it necessary to show this activity of the
HO as a separate segment or can it be shown as unallocated corporate assets?
Solution: As far as 10% limit is concerned it is material. If HO is actively engaged in trading in investments
and earning income out of it then it can be treated as a separate segment. But if only surplus cash in invested
and incidental income is earned then it can be taken to unallocated column.
Problem 8: A Company has an inter-segment transfer pricing policy of charging of at cost less 10%. The
market prices are generally 25% above cost. Is the policy adopted by the company correct?
(C.A. Final May 2007) (4 marks)
Solution: AS 17 ‘Segment Reporting’ requires that inter-segment transfers should be measured on the basis
that the enterprise actually used to price these transfers. The basis of pricing inter-segment transfers and any
change therein should be disclosed in the financial statements. Hence, the enterprise can have its own policy
for pricing inter-segment transfers and hence, inter-segment transfers may be based on cost, below cost or
market price. However, whichever policy is followed, the same should be disclosed and applied consistently.
Therefore, in the given case inter-segment transfer pricing policy adopted by the company is correct if,
followed consistently.
164 Accounting Standards
Problem 9: The management of Airways Ltd provides you the information related to one of its segment.
You are required to calculate Segment assets from the given information Plant, property, equipments =
` 24,00,000, Inventories = ` 7,00,000, Loans to employees = ` 4,00,000, Accounts receivable = ` 5,00,000,
DTA = ` 45,000 (C.A. Final NS) (5 marks)
Solution: Segment assets = 24,00,000 + 7,00,000 + 5,00,000 = ` 36,00,000.
Segment assets includes the operating assets employed for the operations of the segments. Any loan even
to employees also should not be considered segment assets.
Problem 10: A multinational enterprise by the name of Torrential International has business activities
located in three segments. The relevant details are as follows:
Extracts from the consolidated financial statements of Torrential International for the year ended
31st March 2015:
Required: Prepare a segment report for Torrential International for the year ended 31st March, 2015 that
complies with AS-17.
166 Accounting Standards
Solution:
Segment report for Torrential International
Amount in ` ‘000
Europe North America Asia Total
REVENUE
External Sales (60 : 20 : 20) 319,200 106,400 106,400 532,000
Inter-Segment sales 16,000 12,800 10,400 39,200
Total Revenue 335,200 119,200 116,800 571,200
RESULT
Segment Result (W1) 71,680 20,160 24,960 116,800
Unallocated corporate expenses (H O Operating cost) (8,000)
Profit from operations 108,800
Investment Income 4,800
Finance cost (20,000)
Income taxes (22,400)
Non controlling interest (6,400)
Net Profit 64,800
OTHER INFORMATION
Segment assets (W2) 168,160 168,160 84,080 420,400
Unallocated corporate assets (40,000 + 14,000*) 54,000
Consolidated assets 474,400
Segment liabilities (W3) 22,400 22,400 11,200 56,000
Unallocated corporate liabilities (140,800 + 13,600) 154,400
Consolidated liabilities 210,400
* Total bank balance – amount allocated to segments = ` 19,200 – ` 5,200 = ` 14,000 (000)
W1 Segment result
Europe North America Asia Total
Segment Revenue 335,200 119,200 116,800 571,200
Segment costs (249,120) (83,040) (83,040) (415,200)
External*
Inter-Group (Note 2 to question) (14,400) (16,000) (8,800) (39,200)
Segment Result 71,680 20,160 24,960 116,800
* Total operating costs (excluding inter-group items) are 423,200 (249,600 + 79,200 + 94,400)
Head Office costs are 8,000
So costs to be allocated are 415,200 in the ratio (60 : 20 : 20)
AS-17: Segmental Reporting 167
Problem 11: M/s XYZ Ltd. has three segments namely X, Y, Z. The total assets of the Company are ` 10.00
crs. Segment X has ` 2.00 crs., segment Y has ` 3.00 crs. and segment Z has ` 5.00 crs. Deferred tax assets
included in the assets of each segments are X- ` 0.50 crs., Y—` 0.40 crs. and Z—` 0.30 crs. The accountant
contends that all the three segments are reportable segments. Comment.
(CA Final Nov. 2014 Marks 5) (CA Final Nov 2008 Marks 5)
Solution: According to AS 17 “Segment Reporting”, segment assets do not include income tax assets.
Therefore, the revised total assets are 8.8 crores [10 crores – (0.5+0.4+0.3)]. Segment X holds total assets of
1.5 crores (2 crores – 0.5 crores); Segment Y holds 2.6 crores (3 crores – 0.4 crores); and Segment Z holds
4.7 crores (5 crores – 0.3 crores). Thus all the three segments hold more than 10% of the total assets, all
segments are reportable segments.
CHAPTER 18
AS-18: Related Party
Disclosures
Chapter Outline
vv Introduction vv Exemptions in Disclosure Requirements
vv Definition of Related Party, Control, of AS-18 [Para 5]
Significant Influence
vv Related Party Relationship to Which
AS-18 Applies. [Para 3]
Introduction
AS-18 is more of a Disclosure Standard rather than a Standard on accounting treatment. It prescribes no
accounting requirements. It only prescribes disclosure requirements. AS-18 applies to the financial statements
of each reporting enterprise as also to consolidated financial statements presented by a holding company.
Objective of AS-18
It is a normal feature in a business to have related party (RP) in any business transactions. This is because RP
are very well known and the company can place faith on such RP. But RP’s can even siphon funds and affects
the volume and decision of business of one enterprise for the benefit of the other enterprise or for own self
interest.
Following are the consequences of RP transactions:
(i) Transactions may not be at arms length price (sometimes no price is charged)
ww providing free management services.
ww providing interest free loan.
ww sales at a discounted price.
ww payment at inflated price.
ww pledging personal assets/giving guarantees.
(ii) Existence of RP affects financial and operating decisions.
(iii) Transactions would not have been taken place if there were no related party relationship.
(iv) RP may be formed to fulfill the bad desires of Management.
(v) Many frauds previously took place because of RP relationship. The parties behind the fraud were
supposed to be RP.
Thus a related party relationship could have an effect on the financial position and operating results of
the reporting enterprise. The purpose of the Standard is to make the reader of financial statements aware of
the existence of related party relationships and the extent to which an entity’s financial position, profitability,
AS-18: Related Party Disclosures 169
or cash flows may have been affected by transactions with such parties. It should be noted that this is a
disclosure Standard and does not deal with recognition or measurement issues, all of which are dealt with by
other relevant Standards. Disclosure of RP transaction is a good practice of Corporate governance reporting.
Scope of AS-18
AS-18 prescribes disclosures of:
(i) Related party relationships; and
(ii) Transactions between a reporting enterprise and its related parties.
Such disclosures convey to the users that certain RP relationship exists and RP transactions took place
during the year. Company should be fair enough to disclose the names and transaction of RP.
Exceptions to Related Party Relationships or Who are not Deemed to be RPs [Para 4]
Following are not deemed to be RP’s:
(i) Two Companies simply because they have director in common (unless the director is able to affect
the policies of both the companies in their mutual owings).
(ii) Single customer, supplier, distributor, franchise, agent etc. with whom significant volume of business is
transacted. These are those parties on which the company has economic dependency.
(iii) The parties listed below, in the course of their normal dealings with an enterprise by virtue only of
those dealings (Although they may circumscribe the freedom of action or may even participate in the
decision making process).
Providers of financers, trade unions, public utilities, government departments & government agencies.
AS-18: Related Party Disclosures 171
Details of disclosure if transactions take place during the existence of related party relationship.
1. Name of the related party. 2. Description of relationship. 3. Description of nature of transaction. 4. Volume of transaction
either as amount or as proportion. 5. Any other important element of the transaction. 6. Outstanding at balance sheet
date related to related parties and provisions for bad debts. 7. Amount written off or written back in the period in
respect of debt due from or due to related party.
Examples of related party transactions which will be covered:
a. Purchase or sale of goods, service and fixed assets
b. Agency arrangements, leasing and hire purchase arrangement
c. License agreements
d. Transfer of research and development
e. Finance including loans and equity contribution
f. Guarantees and collaterals
g. Management contracts including for deputation of employees.
h. Providing consultation services.
IMPORTANT POINTS
(1) Where purchase is made in one year and payments are made in the subsequent year then reporting for RP
is done in the first year. This is because transfer of resources takes place in previous year and in the next
year it is the consideration paid towards resources already transferred.
(2) A member of Local Advisory Board of a Bank is not a KMP.
(3) A shareholder holding less than 20% shares and is the only shareholder holding maximum shares is not an
RP.
(4) A Non – Executive director is not a KMP because he only participates in the financial and operating decisions
and does not control.
(5) AMC is the RP in case of Mutual Fund.
(6) Reimbursement of expenses incurred by KMP on behalf of the company is not a related party transaction.
172 Accounting Standards
Problem 1: NANO Limited has set up a trust for gratuity and pension fund. It transfers Funds of ` 20,00,000 in
the financial year 2009 -2010. Will the transfer of funds to the trust a Related Party transaction?
Solution: Every company who forms trusts/Gratuity Funds have full control over the trusts. Therefore such
trusts/Gratuity Funds are RP. But the trusts/Gratuity Funds is formed for the benefits of the employees,
hence such transactions are not treated as RP transactions.
Problem 2: Apple Limited has two Associates, Mango Limited and Orange Limited, owning 25 per cent of
the voting power of Mango Limited and 30% of the voting power of Orange Limited. Would Mango Limited be
considered a related party in the financial statements of Orange Limited?
Solution: As per para 3 (b) of AS-18 Associates and Joint Ventures of the reporting enterprise and the
investing party or venturers in respect of which the reporting enterprise is an associate or a joint venture;
are RP. But sub associates (associates of associates) or co – associates (fellow associates) are not covered. In
the present problem Mango is fellow associate of Orange Ltd. hence they are not RP.
Problem 3: P Ltd. has 60% voting right in Q Ltd. Q Ltd. has 20% voting right in R Ltd. Also, P Ltd. directly
enjoys voting right of 14% in R Ltd. R Ltd. is a listed company and regularly supplies goods to P Ltd. The
management of R Ltd. has not disclosed its relationship with P Ltd.
How would you assess the situation from the viewpoint of AS-18 on Related Party Disclosures?
(CA Final Nov 2007, Nov 2012)
Solution:
Investing Investee % of RP
Company Company holding
P Ltd Q Ltd 60% Yes – para 3 (a) Control
Q Ltd R Ltd 20% Yes – para 3 (b) Sig influence
P Ltd R Ltd * 34% Yes – para 3 (b) indirect Sig influence
* P is holding directly 14% and through its subsidiary Q 20% = 14+20 = 34%.
Problem 4:
60%
A B
15% 40%
C
Solution:
Investing Investee % of RP
Company Company holding
A Ltd B Ltd 60% Yes – para 3 (a) Control
B Ltd C Ltd 40% Yes – para 3 (b) Sig influence
A Ltd C Ltd * 55% Yes – para 3 (a) indirect Control
* A is holding directly 15% and through its subsidiary B 40% = 15 + 40 = 55%.
AS-18: Related Party Disclosures 173
Problem 5:
30%
A B
25%
Solution:
Investing Investee % of RP
Company Company holding
A Ltd B Ltd 30% Yes – para 3 (b) Sig influence
B Ltd C Ltd 25% Yes – para 3 (b) Sig influence
A Ltd C Ltd - Sub associates are not covered
Co. A and C are not RP.
Problem 6:
60%
A B
70%
Solution:
Investing Investee % of RP
Company Company holding
A Ltd B Ltd 60% Yes – para 3 (a) Control
A Ltd C Ltd 70% Yes – para 3 (a) Control
Co. B Ltd and C ltd is RP because they are under a common control with Company A Ltd. Refer para 3 (a).
Problem 7: Narmada Limited sold goods for ` 90 lakhs to Ganga Limited during 31.3.2006. The Managing
Director of Narmada Limited owns 100% of Ganga Limited.
Sales are made to Ganga Limited at Normal Selling Price. The Chief Accountant of Narmada Limited contends
that no disclosure is required transactions are at arm length price.
(C A Final Nov 2001/May 2006)
Solution:
M. D. of Narmada Ltd is KMP para 3(d) → RP
M. D. of Narmada Ltd is also holding 100% of Ganga Ltd 3(c) → RP
Therefore; Narmada Ltd and Ganga Ltd are RP of each other para 3(e) → RP
Therefore the contention of the chief accountant is wrong.
Problem 8: A husband and wife are controlling 34% of voting power in XY Limited. They are having a
separate partnership firm, which supplies mainly the raw-material to the company. The Management says
that the above transaction need not be disclosed.
(C.A. Final Nov. 2003)
174 Accounting Standards
Solution:
(Husband+Wife) holding 34% shares of XY Ltd is para 3(c) → RP (Sig influence)
Also. (Husband+Wife) have a separate partnership (PF) para 3(c) → RP (Control)
Therefore;
PF and XY Ltd both are RP of each other para 3(e) → RP
Therefore the contention of the management is wrong. Raw materials supplied by partnership firm to the
company should be covered as a RP transaction.
Problem 9: Heavy Limited divested 65% shares in its subsidiary Light Limited on 7/1/2009 and as such no
relationship as per AS-18 exists on the year end. Should the H Co. disclose the relationship and the related
transaction on 31/3/2009?
Solution: As per AS-18 para 23 provides that if there happens to be a RP relationship during the year
then reporting is mandatory. Holding Co is required to report it in its separate financial statement. It is not
necessary that the relationship should exist on the year end. Even if the relationship existed at any time in
the year then AS-18 is attracted. In the present case even if there would not be any transaction then also
reporting would be attracted because relationship is that of Control.
Problem 10: Mr. Rajjab KMP of Shehzadaa Limited received a cheque of ` 1,40,000 towards reimbursement
of expenses incurred on stay in hotel, conference expenses etc. visiting some meeting on behalf of the
company. You are required to guide whether the above transaction is covered under AS-18?
Solution: KMP is of course a RP to the company, but the reimbursement of expenses are not in the nature
of remuneration. Reimbursement of expenses is for business purpose. Hence such transaction will not be
disclosed in the financial reporting.
CHAPTER 19
AS-19: Leases
Chapter Outline
vv Objective and Importance of AS-19 vv Leasing Activities Undertaken
vv Types of Lease by Manufacturer/Dealer
vv Change in Classification vv Sale and Lease Back
vv Recognition Principles or Accounting vv Initial Direct Costs: para 15, 24, 31, 42.
Treatment for Leases vv Disclosure Requirements
Scope of AS-19
AS-19 applies to all types of leases except the following:
◘◘ Lease agreements entered into for the exploration or use of resources such as oil, gas timber etc.
◘◘ Motion picture, manuscripts, plays, video recordings, copyrights, patents etc. given on license.
◘◘ Lease agreements for the use of vacant lands.
◘◘ Service contracts – The reason being, one contracting party does not transfer right to use the asset to
another party.
176 Accounting Standards
176
DO YOU KNOW
Whether the lease is a finance lease or operating lease is always decided as on the Zero date.
AS-19: Leases 177
Types of Lease
Lease
Conditions for Finance lease: para 9 (Any one condition should be satisfied)
(i) Transfer of ownership of the asset to the lessee at the end of the lease term.
(ii) Lessee is given an option to purchase the asset at the end of the lease term, at a price that is sufficiently
lower than the fair value on the date of exercise of the option.
(iii) Lease term is for the major part of the economic life of the asset even if the title is not transferred.
(iv) At the inception (beginning) of the lease the PV(MLP) recovers substantially the portion of the Fair
Value of asset on the date of inception of lease. This is known as Fair value recovery test.
(v) The lease is a non-cancellable lease agreement. A non-cancellable lease agreement is that which is
cancelled only due to the following circumstances:
ww Occurrence of some remote contingency.
ww With the permission of the lessor.
ww The lessee enters into a fresh agreement for same or similar asset with the same lessor.
ww Payment made by the lessee of such an additional amount (at the inception), which shows the
continuation of lease is certain.
(vi) The Leased asset is of a specialized nature such that only the lessee can use it, without much
modifications being made.
The above factors are very important one for lease classification. Satisfaction of any one of the above
factors is enough to entitle the lease agreement to make it a finance lease. For ex. : A Co. lets its
178 Accounting Standards
Machine for 9 years. The useful life of the machine is 9yrs. Here in this case, condition number 3 gets
satisfied, other conditions remains silent or might not have been satisfied. Thus, it is a finance lease.
It is also been observed that when one condition is satisfied, then other conditions do get attracted
to classify to make the agreement a lease agreement.
However some additional conditions are also given with either individually or in combination with
other conditions may be considered as finance lease. (These are suggestive conditions only)
(vii) Lessee cancels the lease agreement, and the losses associated with the cancellation of lease are borne
by the lessee.
(viii) Gains or losses fluctuation in the residual value of the asset falls on the lessee.
(ix) Lease rentals for the secondary period of the lease are substantially low than the market rent.
DO YOU KNOW
In case of operating lease there can be multiple lessees. Even the lessor uses the asset for some time.
Change in Classification
Whether a lease is a finance lease or operating lease is decided at the very inception of the lease. If one come
across a change in the classification of the lease in future then following treatment should be given:
(a) If the change results into a different category of lease, then the lease agreement thereafter to be
treated as a totally separate agreement for the balance period.
(b) But say if some estimates go wrong like for ex. wide change in useful life of asset or default made by
the lessee etc. then the classification remains same i.e. no change in classification.
DO YOU KNOW
Many a times the interest and principal component is different for lessor and lessee. Following are the reasons
for such difference:
yy Difference due to GRV guaranteed by third party
yy Difference due to different discounting factor used by the lessor and lessee.
yy Difference due to UGRV.
Measurement of income: In case of manufacturer/dealer lease Profit on sale = FMV – Cost of goods
Finance Income = (Gross Investments in lease – FMV).
The Finance income is to be allocated as per IRR over the lease period.
Low interest rate case: Sometimes the manufacturer/dealer keeps interest rate artificially low as compared
to commercial rates in order to attract customers. Even some finance leases are sold at ‘zero interest rate’.
If this is done, then much of the portion of income will be absorbed by selling profit (at the inception). So, to
curb this, AS-19 suggests: Compute the selling profit as per the normal prevailing market interest rates.
If Operating lease: In case of operating lease there is nothing as such sale. No selling profit is to be recognized
at the inception of lease. The Lease payments received will be the sole income and no selling profit is to be
accounted.
Distinction between Direct Finance Lease and Manufacturer Lease
Direct Finance Lease Manufacturer Lease
(i) Here one party manufactures the asset and sell it to (i) Here manufacturer of the lease himself leases the asset.
a finance company. The finance company in further
leases it to the third party.
(ii) Only Finance Income is recorded as the income for the (ii) Total income of the Lessor consists of selling profit +
lessor. Finance income.
(iii) Here Fair Value at the inception of the leasing becomes (iii) Here Sale Value at the inception of the leasing becomes
the Net Investments. the Net Investments.
Problem 1: State whether the following comes within the scope of AS-19.
1. A Ltd. gives its well for extraction of oil to B Ltd. for 7 years at lease. .
2. Cola Ltd. entered into copyright agreement with Coke Ltd.
3. M Ltd. lets out its vacant land to P Ltd. at a rent of ` 50,000 p.m.
Solution:
Scope of AS – 19:
1) Not covered by AS – 19 (refer para 2)
2) Not covered by AS – 19 (refer para 2)
3) Not covered by AS – 19 (refer para 2)
Problem 2: Following are some of the cases given. Classify with reasons whether the following is Finance
or Operating lease –
(a) Y Ltd. wishes to obtain a machine tool costing ` 20 lakhs by way of lease. The effective life of the
machine tool is 12 years but the company requires it only for the first five years. It enters into an
agreement with R Ltd. for a lease rental of ` 2 lakhs p.a. The Finance Director of Y Ltd. is not sure
about the treatment of these lease rentals and hence requests your assistance in proper disclosure
of the same. For calculation purposes, the implicit rate of interest may be taken at 15%. Discount
factors : 0.87, 0,76, 0.66, 0.57 and 0.50. (C.A. Final May 2002/New syllabus June 09) (5 Marks)
(b) F Ltd. has a newly set up its pharmaceuticals business. It has installed a huge plant, which will be
used only by F Ltd. without any modifications at a monthly rent of ` 10,00,000.
(c) K Ltd. leased out its assets to R Ltd. at ` 5,000 p.m. for 6 years after which the asset will be retained
by the lessee by paying ` 30,000 at the end of 5th year. Residual value estimated at the end of 5th year
is ` 40,000.
Solution:
(a) Lets calculate the PV of MLP of the leased asset.
Cost of the asset = ` 20,00,000, Agreement period = 5 years, Rent = ` 2,00,000.
PV of MLP’s @15% = 2,00,000 x Cum. PVF@15% = 2,00,000 x 3.36 = ` 6,72,000.
PV of MLP’s is less than the FMV on the date of lease agreement. Also none of the other conditions of
FL are being satisfied.
Hence it is a Operating Lease.
(b) The Leased asset is of a specialized nature such that only the lessee can use it, without much
modifications being made. Hence it is a FL.
(c) Lessee is given an option to purchase the asset at the end of the lease term, at a price that is sufficiently
lower than the fair value on the date of exercise of the option. The FV at the end of the 5th year is `
40,000 and the lessee is given the option to purchase the asset at a price lower than the FV.
Problem 3: Lessee Ltd. acquired a machinery from Lessor Ltd. The following information is available to you:
Lease term 5 years
Fair value at the inception of lease `45,00,000
Fixed Lease Rent paid at the end of every year : Year 1 ` 11,00,000
Year 2 ` 13,00,000
Year 3 ` 16,00,000
Year 4 ` 13,00,000
Year 5 ` 11,00,000
184 Accounting Standards
The above lease payments includes ` 1,00,000 for maintenance and services to be reimbursed by lessee.
GRV (by lessee) ` 1,75,000
Estimated residual value ` 2,75,000
Lessor IRR @11.16% p.a.
Depreciation charged on similar assets (SLM) 19% p.a.
At the end of year 5 Lessee Ltd. purchased machinery @Market Value of ` 2,60,000 from the Lessor. Lessee
Ltd. immediately sold the asset at the same value.
Show the journal in the books of Lessee Ltd. and Lessor Ltd. for all the years.
Solution:
Books of Lessee (Lessee Ltd.)
(` In lakhs)
STEP I) Calculation of PV of MLP: STEP II) Calculation of Finance Charges:
Year MLP PVF @ PV(MLP) Installment = (Principal + interest) O/S.
11.16% Principal
0 — — — — — — 44.41
1 10 0.900 9.00 10 5.04 4.96 39.37
2 12 0.809 9.71 12 7.61 4.39 31.76
3 15 0.728 10.92 15 11.46 3.54 20.30
4 12 0.655 7.86 12 9.73 2.27 10.57
5 11.75 0.589 6.92 11.75 10.57 1.18 nil
(10 + 1.75)
Total 60.75 44.41 60.75 44.41 16.34
LEDGERS:
Lessor A/c
Year Particulars ` (lakh) Year Particulars ` (lakh)
1 To Bank 11.00 1 By Machine 44.41
To Balance 39.37 By Maintenance Chs 1.00
By Finance Chs 4.96
2 To Bank 13.00 2 By balance b/d 39.37
To Balance 31.76 By Maintenance Chs 1.00
By Finance Chs 4.39
3 To Bank 16.00 3 By balance b/d 31.76
To Balance 20.30 By Maintenance Chs 1.00
By Finance Chs 3.54
4 To Bank 13.00 4 By balance b/d 20.30
To Balance 10.57 By Maintenance Chs 1.00
By Finance Chs 2.27
5 To Bank 13.60 5 By balance b/d 10.57
By Maintenance Chs 1.00
By Finance Chs 1.18
By Machine 0.85
Note:
Lease payments 11,00,000
towards GRV 1,75,000
towards UGRV (2,60,000 – 1,75,000) 85,000
Payment in 5th year 13,60,000
Machinery A/c
Year Particulars ` (lakh) Year Particulars ` (lakh)
1 To Lessor 44.41 1 By Depreciation 8.44
By balance c/d 35.97
2 To Balance 35.97 2 By Depreciation 8.44
By balance c/d 27.53
3 To Balance 27.53 3 By Depreciation 8.44
By balance c/d 19.09
4 To Balance 19.09 4 By Depreciation 8.44
By balance c/d 10.65
5 To Balance 10.65 5 By Depreciation 8.44
To Lessor 0.85 By Bank 2.60
By Profit and Loss A/c 0.46
186 Accounting Standards
Lessee A/c
Year Particulars ` (lakh) Year Particulars ` (lakh)
1 To Machine 45.00 1 By Bank 11.00
To Maintenance Fees 1.00 By Balance c/d 40.02
To Finance income 5.02
2 To balance c/d 40.02 2 By Bank 13.00
To Maintenance Fees 1.00 By Balance c/d 32.49
To Finance income 4.47
3 To balance c/d 32.49 3 By Bank 16.00
To Maintenance Fees 1.00 By Balance c/d 21.11
AS-19: Leases 187
Problem 4: A. Ltd. leased a machinery to B Ltd. The following information is available to you:
Lease term 5 years
Fair value at the inception of lease (01.01.2005) ` 20,00,000
Fixed Lease Rent paid at the end of every year ` 5,00,000
GRV (by lessee) ` 1,00,000
Estimated residual value ` 2,00,000
Lessors IRR 15%
Depreciation 10% p.a.
The annual payments are determined in such a way that the present value of lease payments plus the
residual value is equal to the Cost of Asset.
You are required to work out the following for Global Limited:
i) Unearned Finance Income.
ii) Annual Lease payments.
iii) Yearly Finance income
iv) Show how the items will appear in the Profit and Loss Account and Balance Sheet for the various
years.
(Similar Qt. asked in Nov. 2013 (4 marks) + (Final C.A. May 2006 – Accounts) (8 Marks)
Solution:
Calculation of PV of MLP: (From Global Limited i.e. Lessors point of view)
Let MLP every year be ` X.
Year II:
Minimum Lease Payments 54,275
Residual Value (Estimated) 20,000
74,275
Less: Unearned Finance Income (6,752)
Lease Receivables (not later than 1year) 67,523
Year III:
Lease Receivables (including residual value) 67,523
Less: Amount Received (67,523)
NIL
Problem 6: Madhav Transport Ltd. has given 4 newly purchased fleets of trucks to Anna Services Ltd. on
lease. The lease is for 3 years only. Rentals agreed in the contract are as follows:
Year 1 = ` 2,70,000, Year 2 = ` 2,40,000, Year 3 = ` 2,10,000. The Cost of the total fleet of vehicles =
` 9,00,000. The life of the trucks may be taken as 9 years. Costs of yearly insurance borne by the lessee is
` 500 per truck for first year & thereafter 600 per truck.
How will you treat the above in the books of both lessor and lessee.
Solution: As no information regarding apportionment of Lease Rent is given, hence SLM method is to be
adopted.
Total Rent = 270000 + 240000 + 210000 = 720000
Rent p.a. = 720000/3 = 240000.
Initial Recognition:
Dr.
Lease Rent receivable 20,00,000 (Cash Price)
To Revenue A/c 20,00,000
Problem 8: Bandivli Works Ltd. own an asset of which is depreciated @10% on SLM basis. The asset was
purchased 5 years back for ` 1,00,000. The company has decided to sell the machine by the end of 5th year at
` 60,000 (being Fair Value) to Mayur Enterprises and leases it back for the remaining 5 years. Bandivli Works
Ltd. agrees to pay a lease rent of ` 15,000 p.a. for the remaining 5 years. Lessee’s incremental borrowing cost
7.93% p.a. (CA Final May 2013)
Advice on accounting in the books of Lessee.
Solution: If Sale and lease back is a Finance lease: The difference between (Sale proceeds - Carrying amount
of asset) will be either profit or loss. Such profit or loss is not recognized immediately bu is spread over the
lease term in proportion to the depreciation of the asset. As the asset is sold at the end of 5th year, carrying
amount has to be calculated:
Step 1 → Carrying Amount = 100000 – 5 × 10000 = 50,000
Selling Price = ` 60,000 (assume to be fair value)
Step 2 → Determination of Finance Lease or Operating Lease:
Standing as on the sixth year opening day on which asset is sold out on Sale – lease back basis lets
determine whether the lease is FL or OL.
PV (MLP) @7.93% = 15,000 (Rent) × Cum. [email protected]% = 15,000 × 4 = 60,000
PV of Total MLP’s = 60,000
PV of Total MLP’s is equal to the selling price and hence it is a Finance Lease
Lessee will record the asset at ` 60,000.
Step 3 → Calculation of profit and treatment:
Profit on sale = Sale proceeds – CA = 60,000 - 50,000 = 10,000 (deferred)
192 Accounting Standards
Journal Entry:
Cash/Bank A/C. Dr. 60,000
To Asset A/C. 50,000
To Deferred Income A/C. 10,000
But as per the standard such profit should not be immediately recorded but should be deferred in the ratio
of future depreciation.
Therefore Deferment = ` 2,000 (10,000/5)
Calculation of Finance Charges:
Installment = (Principal + interest) O/S. Principal
— — — 60,000
15,000 10242 4758 49758
15,000 11054 3946 38703
15,000 11931 3069 26772
15,000 12877 2123 13895
15,000 13895 1105 nil
75,000 60,000 15,000
Further entries in the books of Lessee (Bandivli Ltd) can be passed easily, just by referring question no:
3,5……
As there is no Unguaranteed RV the finance income of Lessor will be same as Finance charges for Lessee
(refer table above).
Problem 9: If Mamta Ltd. sold an asset to Samta and lease back the same asset from Samta Ltd. Assuming it
is an Operating Lease give the treatment in the following cases: (All figures are in `)
(I) Problem on Case I type i.e if SP = FV:
1) SP = 15,000, CA = 12,000, FV = 15,000
(II) Problem on Case II type i.e if SP < FV:
1) SP = 15,000, CA = 13,000, FV = 19,000. 2) SP = 15,000, CA = 17,000, FV = 16,000 assuming loss is
compensated by future lease rental equally over 2 years
(III) Problems on Case III type i.e if SP > FV:
1) SP = 15,000, CA = 12,000, FV = 13,000.
Solution:
If Sale and lease back is a Operating lease:
Case I
If Sale price of asset = Fair Value
Profit or loss on sale of asset (SP – CA) is to be recognized immediately.
(1) Cash/Bank Dr. 15,000
To Asset 12,000
To Profit and Loss 3,000
Case II
If Sale price of asset < Fair Value
Profit or loss on sale of asset (SP – CA) is to be recognized immediately.
Exception: If loss is compensated by charging future lease rentals lower than the market price, then defer and
amortize such loss in proportion to lease payments over the lease term.
AS-19: Leases 193
REMEMBER:
If in the exam, ICAI asks you problems in lease on:
(i) Immediate lease payments
(i) Semi - annual lease
You can refer chapter on Leasing in SFM module.
194 Accounting Standards
Problem 11: On 1st January, 2011 Santa Ltd sold equipment for ` 6,14,460. The carrying amount of the
equipment on the date was ` 1,00,000. The sale was part of the package under which Banta Ltd leased the
asset to Santa Ltd for 10 year term. The economic life of the asset is estimated at 10 years. The Minimum
Lease Rents payable by the Lesser has been fixed at ` 1,00,000 payable annually beginning 31st December,
2011. The incremental borrowing Interest Rate of Santa Ltd is estimated at 10% p.a. Calculate the net effect
on the Profit and Loss Account. (CA Final May, 2013, 5 Marks)
Solution: Profit on sale lease is to be deferred over lease period in the ratio of depreciation (SLM). SP – BV
= 614460 – 100000 = `5,14,460.
Present Value of MLP = 6.1446 × 100000 = `6,14,460, Also leased asset has the FV at 6,14,460. Lessee will
record the asset @ 6,14,460.
As per AS-19 para ....... the profit/loss on sale under the Sale and Lease Back method should be deferred in
the ratio of depreciation.
For the calculation of interest please refer interest table from AS-19.
CHAPTER 20
AS-20: Earning per Share
Chapter Outline
vv Scope and Objective vv Potential Equity Shares
vv Basic EPS vv Dilutive and Non – Dilutive EPS
vv Restatement vv Disclosures
vv Timing for Inclusion in WANES
Basic EPS
The standard requires an enterprise to present the Basic EPS on the face of financial statements. Basic EPS
is simply the Net Profit available to Equity Shareholders divided by the Weighted Average Number of Equity
Shares outstanding during the year (WANES).
Net Profit available to Equity Shareholders
Basic EPS =
WANES outstanding during the year
(i) Net Profit available to Equity Shareholders:
ww Concept of Net Profit available to Equity Shareholders:
Net Profit available to equity shareholders (Numerator) is the profits after all expenses and
payments to preference shareholders. It is the profits attributable to the ESH who has provided
funds for earning that profits.
ww Calculation of Net Profit available to Equity Shareholders:
Net profit/loss during the year XXX
– Tax expenses XXX
– Preference Dividend XXX
– Preference Dividend Tax XXX
Net Profit available to Equity Shareholders(Numerator) XXX
DO YOU KNOW
In case of Bonus/Share split/Consolidation the ownership percentage is not affected.
DO YOU KNOW
In case of amalgamation in the nature of purchase the amalgamated company records only the
assets and liabilities therefore the date of acquisition is the date relevant for WANES. But in
case of amalgamation in the nature of merger the amalgamated company even incorporates the
Reserves and Profit & Loss of the amalgamating company as if the amalgamated company exists
from the beginning.
• If it is Amalgamation in the nature of purchase WANES = WANES of New Co. + Shares issued to Old Co. × Time weight
• If it is Amalgamation in the nature of merger WANES = WANES of New Co. + Shares issued to Old Co. × 12/12.....para 18
Case 7 → Buy-Back:
If Buy - back takes place at the Fair Value then we have to just simply deduct the Shares buy-
backed (after time-factor adjustment) from Opening number of Shares for WANES. But Buy –
back is effected at a premium which happen in most of the cases then this will be a reverse
case to the treatment of right issue of shares i.e. inclusion of bonus element, but in a reverse
direction.
198 Accounting Standards
Restatement
From our above discussions it is clear that Bonus, Share – split, Consolidation are issued free of cost to
shareholders i.e. there is a change in the denominator, numerator remaining same. Every company is required
to report current years EPS with the last years report. Thus, last year’s accounts are also to be given effect,
otherwise the financial statements will disclose misleading information. So adjusting previous years EPS is
known as Restatement. Hence to harmonise the EPS, restatement of EPS is required by the Standard. AS-20
further carries the logic when bonus/share split etc., occurs after the year closes but before signing of the
accounts the EPS is to shown only after adjusting for the new number of shares.
Reporting requirements: Dilutive EPS is to be reported (mandatory as per AS-20 as well as New Schedule
VI). Anti – dilutive is never to be reported in the financial statements.
PES effect on Basic EPS at a glance:
Note: Dilutive is to be calculated till the PES were outstanding. Once it is converted then from that date such
converted PES enters into Basic EPS calculations.
200 Accounting Standards
Note: (a) EP: Exercise price, (b) MP: Fair Value or Market Value per share during that year.
DO YOU KNOW
Options are always dilutive: The above method of calculating Equity shares for no consideration for options
is given by IAS 33 also known as Treasury Stock method.
2) If conditions are met then equity shares will be issued and for computing Basic EPS the date will be
reckoned from the date when conditions are met upto the reporting date.
3) If conditions for Contingently equity shares are not met throughout the complete financial year then
it remains potential equity shares at the end of reporting date.
Disclosures
(a) Mandatory Disclosures:
ww Positive as well as Negative EPS.
ww Basic & Diluted EPS on the face of Profit & Loss Accounts.
ww Restatement of EPS – for post balance sheet bonus issue.
ww Numerator used for Basic & Diluted EPS – with reconciliation.
ww Denominator used for Basic & Diluted EPS – with reconciliation.
ww Nominal value of shares along with EPS figure.
(b) Additional Disclosures:
ww Terms and conditions of contracts eligible for Potential Equity Shares.
ww Composition of Net profit viz., Net Profit from ordinary activities.
Problem 1: For the year 2013-2014 Tuts Limited earns ` 3 lakhs before tax. Other details are as follows:
Opening Equity Share Capital ` 500,000
5,000 Shares issued on 01.11.2013 (`10/-).
On 1.3.2014 1,000 Shares were buy backed.
Corporate Tax 33.33%. Compute Basic EPS.
Solution:
Basic EPS = Net Profit/WANES = 2,00,000/52,000 = ` 3.85
Net Profit = 3,00,000 – 1,00,000 = ` 2,00,000
WANES = 50000+5000x5/12-1000x1/12 = 50000+2083.33-83.33 = 52,000.
202 Accounting Standards
Note: One should compare Restated EPs with Reported EPS i.e. ` 44.83 with ` 33.33.
Problem 3: Tedy Limited earns a Net Profit for the year 2005 – 2006 ` 5,00,000 before Tax. Tax @ 40%.
Transfer to Sinking Fund is ` 10,000. Transfer to General Reserves ` 2,000. Preference Dividend ` 10,000.
Equity Dividend = ` 16,000. Dividend Tax 10%. Compute Net Profit for Basic EPS.
Solution:
Net Profit for Basic EPS = 5,00,000 – 40% tax – 10,000 Pref. Div. – 1,000 CDT on Pref. Dividend = ` 2,89,000.
Trf to general reserves, sinking fund, equity dividend should be ignored.
Problem 4: COSY COMFORTS Limited earns a Net Profit for the year 2006 – 2007 ` 20,00,000 after tax. The
corresponding figure for the last year was ` 16,00,000. Its Capital Structure contains 80,000 Shares of ` 10
each. On 07.11.2006 it has decided to consolidate the shares from ` 10 each to ` 100 each. Calculate Basic
EPS and Restated EPS.
Solution:
Basic EPS 2006 – 07 (Reported) = Net Profit/WANES = 20,00,000/8,000 = `250
Basic EPS 2005 – 06 (Reported) = 1600000/80000 = ` 20
Basic EPS 2005 – 06 (Restated) = 1600000/8000 = `200
Problem 5: STAR LIMITED has three classes of shareholders in its capital structure viz ; Class A : 5,000
Shares, Class B : 1,000 Shares Class C : 3,000 Shares. Dividends rights attached to this class is 90%, 110% and
100%respectively. Net Profit for the year 2006 is ` 1,80,000.
Compute EPS for each class of shareholders for the year 2006.
Solution:
EPS per full fledge share. 180000/(5000 × 0. 9 + 1000 × 1.1 + 3000 x 1) = 180000/8600 = `20.93
Proportionate Dividend for CLASS A = `18.837 (90% X 20.93)
Proportionate Dividend for CLASS B = `23.023 (1.1 X 20.93)
Proportionate Dividend for CLASS C = `20.93.
Problem 6: As on 01.01.2006 Pistons Limited had 5,00,000 shares. It issued 1 right share for every 5 shares
held at ` 15/- on 01.03.2006. Market price per share just before the right issue is ` 21. Net profit for 2005 was
`11,00,000 and for 2006 `15,00,000.
Calculate EPS for 2006 and restated EPS for 2005.
(CA Final Nov 2014, 4 Marks) (Similar to CA Final Nov 04 8 Marks; May 2014 5 Marks)
AS-20: Earning per Share 203
Solution:
OS × MP + RI × Subscription Price 5,00,000 × 21 + 1,00,000 × 15
Theoretical Ex-right MP = = = ` 20
Total Shares 6,00,000
Irrespective of any method Theoretical Ex-right MP is required to be calculated as a first step.
Formula Method:
WANES = 5,00,000 + Right shares × 9/12 × Adjusting Factor (A.F.)
= 5,00,000 + 1,00,000 × 10/12 × 1.05 = 500000+87500
Calculation of A.F.:
Adjusting Factor = MP before rights = 21/20 = 1.05
MP ex- right
Basic EPS 2006 (Reported) = Net Profit/WANES = 15,00,000/(5,00,000+87500) = ` 2.55
Basic EPS 2005 (Reported) = 1100 000/5,00,000 = ` 2.20
Basic EPS 2005 (Restated) = 1100000/500000 × 1.05 = ` 2.10
Logical Method:
Total Right shares received = 1,00,000
Less : Shares for which proceeds are received - 75,000 (1,00,000 × 15/20)
Net RI for which proceeds not recd. OR Bonus element 25,000
Eligible RI = 75000 × 10/12 + 25000 × 1/1 = 87500
Basic EPS 2006 (Reported) = Net Profit/WANES = 15,00,000/(5,00,000+87500) = ` 2.55
Basic EPS 2005 (Reported) = 1100 000/5,00,000 = ` 2.20
Basic EPS 2005 (Restated) = 1100000/(500000 + 25000 Bonus) = ` 2.10
Problem 7: Max Ltd. takes over Zee Ltd. as on 01.04.2005.
Max Ltd. Zee Ltd.
Original Shares 200,000 1,00,000
Face Value 100 100
Share Value for P.C. 210 105
Profits (01.01.2005 –31.03.2005) 1,00,000 70,000
Profits (01.04.2005 – 31.12.2005) 4,30,000 —
Compute EPS assuming:
(a) Amalgamation in the nature of Purchase
(b) Amalgamation in the nature of Merger
Solution:
Calculation of PC = 100000 × 105 = 1,05,00,000
Number of shares issued = 10500000/210 = 50,000
Problem 8: Mohur Limited has equity capital of ` 40,00,000 consisting of fully paid up shares of ` 10 each.
Net Profit after tax for 2004 – 2005 was ` 60,00,000. It has also issued 36,000, 10% Convertible Debentures
of ` 50 each. Each debenture is convertible into 5 equity shares. Tax rate 30%. Compute diluted EPS.
(C.A. Final Nov. 2006)(Similar Problem Nov. 2009)(NS)
204 Accounting Standards
Solution:
PAT 6000000
(1) Basic EPS = = = 15
No. of share 400000
PAT 6126000
(2) Diluted EPS = = = 10.56
New No. of share 580000
Note – Adjust PAT
Net profit before conv. debenture in to share = 60,00,000
Interest saving on debenture
{36000*50*10%*70%(100-30)} = 1,26,000
Adj. PAT 61,26,000
New no share for dilution:
Old shares = 4,00,000
Convertible debenture (36000*5) = 1,80,000
5,80,000
Problem 9: Esteem Ltd. has formulated a employees stock option plan for its employees. Options were
granted on 01.04.2007 at a price of ` 30 per share. Fair Value per share on 01.04.2007 was ` 50/-. The
options would vest in 3 years. The company amortises the difference between the FV and exercise price over
3 years equally. Esteem Ltd. has 6,00,000 shares as on 31.03.2008 as well as on 31.03.2009 but on 31.03.2010
it has 6,30,000 shares. Options were of 1,50,000 shares. Fair value of equity shares on average basis as on
31.03.2008 ` 45, as on 31.03.2009 ` 47, as on 31.03.2010 ` 40. Net profits before ESOP costs is ` 55,00,000,
70,00,000 and ` 64,00,000 respectively.
Please calculate Dilutive as well as Basic EPS for all 3 years after considering the options.
Solution:
Particulars 31.03.2008 31.03.2009 31.03.2010
Profits before amortization of ESOP cost 55,00,000 70,00,000 64,00,000
Less: ESOP written off – amortised
(1/3rd of [50-30] 150000) (10,00,000) (10,00,000) (10,00,000)
Net profits available to equity share holders: 4,500,000 6,000,000 5,400,000
WANES ......... (a) 600,000 600,000 630,000
Basic EPS 7.50 10.00 8.57
Shares under options 1,50,000 1,50,000 1,50,000
Less: Equity shares for which proceeds received (100,000) (95,745) (112,500)
(1,50,000 х 30/45, 1,50,000 х 30/47, 1,50,000 х 30/40)
Less: Unamortised ESOP cost treated as proceeds received
(20.00.000/45, 10,00,000/47, 0) (44.444) (21,277) —
Shares for which no consideration recd ...... (b) 5,556 32,979 37,500
Shares eligible/or Dilutive EPS .....(a+b) 605,556 632,979 667,500
Dilutive EPS = [Net Profits/(a+b)] = 7.43 9.48 8.09
Problem 10: From the information furnished you are required to compute the Basic and Diluted EPS
(earnings per share) for accounting year 0.04.2011 to 31.3.2012 and adjusted EPS for the year 01.04.2010 to
31.03.2011.
Net profit for year ended 31.03.2011 ` 75,50,000
Net profit for year ended 31.03.2012 ` 1,00,25,000
No. of Equity shares as on 01.04.2011 50,00,250
Bonus issue on 01.01.2012 1 share for every 2 held
No. of 12% Convertible Debentures of ` 100 1,00,000
each issued on 01.01.2012
Conversion Ratio of Debentures 10 shares per debenture
Tax Rate 30 percent
(CA Final May 2012) (Marks 4)
Solution:
a) Basic EPS for the year ended 31-3-2012:-
Net Profit for 2011-12 1, 00, 25, 000 1, 00, 25, 000
= = = ` 1.33 per share
No. of equity shares 50, 00, 250 + 25, 00, 125 75, 00, 375
b) Diluted EPS:-
Net Income+Interest (Post Tax) 1, 00, 25, 000 + 0.70(3, 00, 000)
=
Weighted Average No. of equitty shares
75, 00, 375 + 100000 × 1 4 *
Solution:
Profit/Loss position is as follows :
Net profit from continuing operations 40,000
Net loss from discontinuing operations (30,000)
Net profit to the company as a whole - 10,000
Recall Potential Equity Shares are considered dilutive only when their conversion would lead to decrease
in net profit per share from “continuing operations”.
For checking purpose whether the PES are dilutive/anti-dilutive consider results of continuing operations
only. In other words results from dis-continuing operations is to be ignored.
But for the final reporting purpose consider both Continuing as well as Discontinuing operations for
computing Basic as well as Dilutive EPS.
Therefore for dilutive EPS profits of `40,000 is the control figure which is from continuing operations.
Accordingly 500 Potential equity shares are dilutive as it decreases the net profit per share from “continuing
ordinary operations” from ` 2.00 to ` 1.95.
Reporting and Disclosures :
Basic EPS = (10,000/20,000) = 0.50
Dilutive EPS = (10,000/20,500) = 0.49
Problem 13: Find out the WANES:
Date Particulars Shares
01.04.2009 Opening shares (Face value `10) 14,400
01.06.2009 Merger with A Ltd (` 6 paid up) 9,000
01.10.2009 Issued shares – assets purchased 1/7/2009 7,200
01.11.2009 Amalgamation – purchase with X Ltd
Shares issued @ 6/- 9,600
01.02.2010 25% Shares buy back from opening shares
Shares issued to X Ltd were not eligible for dividend as decided by both the companies.
Solution:
Date Particulars Shares
01.042009 Opening shares 14,400
01.06.2009 Merger with A Ltd (` 6 paid up) [9,000 × 60%] 5,400
01.10.2009 Issued shares – assets purchased 1/7/2009 [7,200 × 9/12] 5,400
01.11.2009 Amalgamation – purchase with X Ltd —
Shares issued @6/- (it will be considered in the Diluted EPS)
01.02.2010 25% Shares buy back from opening shares (600)
WANES 24,600
Problem 14: As on 31/3/2001, the equity share capital of Q Ltd. is 10 crores divided into shares of `10 each.
During the financial year 2001/02, it has issued bonus shares in the ratio of 1:1. The net profit after tax for
the years 31/3/2001 and 31/3/2002 is ` 8.50 crores and ` 11.50 crores respectively. The Earnings per share
(EPS) disclosed in the accounts for two years is ` 8.50 and ` 5.75 respectively. Comment on the Discloser as
an Auditor. (C.A. Final Nov. 2002 Audit)(5 Marks)
AS-20: Earning per Share 207
Solution: The earnings per share for both the years will have to be calculated taking the equity share capital
after the bonus issue as the denominator. If the same is done the earnings per share for 31/3/2001 will be
` 4.25 and that for 31/3/2002 will be ` 5.75. Since the above figures of earnings per share have not been
disclosed, the company has not complied with the provisions of the standard. If the same is not followed, he
would then have to qualify his report in terms of section 143 of the Companies Act, 2013.
Problem 15: From the Books of Bharati Ltd., following information is available as on 31.3.2011 and
31.3.2012.
(1) Equity shares of `10 each 1,00,000
(2) Partly paid Equity Shares of ` 10 each ` 5 paid 1,00,000
(3) Options outstanding at an exercise price of ` 60 for one equity share of `10 each. Average Fair Value 10,000
of equity share during both years ` 75
(4) 10% convertible preference shares of `100 each. Conversion ratio 2 equity shares for each preference 80,000
share
(5) 12% convertible debentures of ` 100. Conversion ratio 4 equity shares for each debenture 10,000
(6) 10% dividend tax is payable for the years ending 31.3.2013 & 31.3.2012.
(7) On 1.10.2012 the partly paid shares were fully paid up
(8) On 1.1.2013 the company issued 1 bonus share for 8 shares held on that date.
Net profit attributable to the equity shareholders for the years ending 31.3.2013 and 31.3.2012 were
`10,00,000. Tax = 30%
Calculate: EPS in accordance with AS-20. (C.A. Final May 2003) (14 Marks)
Solution:
Calculation of Basic EPS:
31/3/2013 31/3/2012
(Restated)
No of shares for no consideration for options = 10000 × (75 – 60)/75 = 2000 tax rate 30%.
208 Accounting Standards
(ii) Diluted earnings per share: Options are most dilutive as their earnings per incremental share is
nil. Hence, for the purpose of computation of diluted earnings per share, options will be considered
first. 12% convertible debentures being second most dilutive will be considered next and thereafter
convertible preference shares will be considered
Problem 16: From the following information of Beta Ltd., Calculate EPS in accordance with AS - 20 -
Particulars 31.3.2008 31.3.2007
Net Profit before Tax ` 3,00,000 ` 1,00,000
Current Tax ` 40,000 ` 30,000
Tax relating to earlier years ` 24,000 ` (13,000)
Deferred Tax ` 30,000 ` 10,000
Profit After Tax ` 2,06,000 ` 73,000
Other information:
(a) Profit of 31.03.2008 includes ` 1,00,000 compensation from Central Government towards loss on
account of earthquake in 2005 (non-taxable)
(b) Outstanding convertible 6 % Preference Shares 1,000 issued and paid on 30.9.2006. Face value `100,
Conversion ratio 15 equity shares for every preference share.
(c) 15% Convertible Debentures of `1,000 each Total Face Value `1,00,000 to be converted into 10
Equity Shares per Debenture issued and paid on 30.6.2006.
(d) Total Number of Equity Shares outstanding as on 31.3.2008, 20,000 including bonus shares issued
on 1.1.08 of 10,000 shares, face value `100. (CA Final Nov 2008) (Marks 8)
Solution:
(a) Calculation of Earnings Per Share (EPS) of Beta Ltd.
` `
Year ended Year ended
31.3.08 31.3.07
1. A. Earning before extra ordinary items (after Pref. Div) 1,00,000 70,000
B. No. of Equity Shares 20,000 20,000*
C. Basic Earnings Per Share [A/B] (EPS excluding extra-ordinary) 5.00 3.50
2. Tax Rate applicable
40,000 + 30,000/2,00,000 35%
30,000 + 10,000/1,00,000 40%
AS-20: Earning per Share 209
Ranking System
3. A. Dividend on Weighted Average Preference Shares 6,000 3,000
B. Incremental Shares 15,000 7,500
C. EPS on Incremental Shares [A/B]---------Rank I 0.40 0.40
4. Convertible Debentures
A. Increase in earnings 9,750
` (1,00,000 × 15/100 × .65)
` (1,00,000 ` 15/100 × .60 × 9/12) 6,750
B. Increase in shares 1,000 750
C. Increase in EPS [A/B]---------Rank II 9.75 9.00
It is anti-dilutive as it increases the EPS from continuing ordinary operations (Para 39, AS 20)
Calculation of Diluted EPS
Year ended Year ended
31.3.08 31.3.07
` `
A. Profit from continuing ordinary activities before Preference Dividend 1,06,000 73,000
No. of ordinary equity shares 20,000 20,000
Adjustment for dilutive potential of 6% convertible pref. shares 15,000 7,500
B. Total no. of shares 35,000 27,500
C. Diluted EPS from continuing ordinary operations [A/B] 3.02 2.65
Chapter Outline
vv Objective, Meaning and Scope vv Setting off Principles of Deferred Taxes
vv Recognition Principles for Deferred Taxes vv Transitional Provisions
vv Review of Deferred Taxes vv Some Issues Relating to Deferred Taxes
vv Measurement of Current and Deferred Taxes vv Disclosures
Scope
The Standard deals with the taxes on income (domestic as well as foreign taxes). It excludes CDT, FBT and
Wealth Tax. But FBT has been otherwise abolished.
AS-22: Taxes on Income 211
Measurement of Deferred Taxes: For the measurement of D.T. let’s say Depreciation as per I. Tax is
` 1,00,000 and Depreciation as per Companies Act is ` 70,000. Tax rate is 30%.
Then T.D = ` 30,000 and D. T. = 30% × 30,000 = ` 9,000 (DTL) → pay less today and tax authority will
recover it in subsequent year.
Other important points:
◘◘ DTA indicates assets created for the company.
◘◘ DTL indicates liability created for the company.
◘◘ Separate DTA’s/DTL’s are calculated for each timing difference.
◘◘ Once a DTA/DTL is created it should be reversed in the subsequent in years.
◘◘ Deferred taxes are created for all timing differences. Deferred taxes are not created for permanent
differences.
◘◘ Deferred taxes also arise in case of companies paying Nil taxes.
◘◘ Deferred taxes should not be discounted.
◘◘ Deferred taxes should be created for all timing differences. But for DTA the principle of prudence
should also be taken care of.
Tax Expenses = Current Tax + / - Deferred Taxes
◘◘ Journal Entry:
(1) Profit and loss A/c (tax expense) Dr. xxx
To Current Tax A/c xxx
Profit and loss A/c (tax expense) Dr. xxx
To Deferred Tax A/c (DTL) xxx
DO YOU KNOW
Current tax and deferred tax is required to be calculated, but P/L Dr (tax charge) is always the balancing figure.
head of tax laws i.e: Income from Business. DTA relating to Capital Gains and DTL relating to Depreciation
cannot be set off.
Transitional Provisions
If a company for the first item accounts for DT’s then such effect has to be given either by debiting to Opening
Reserves. Again see to it that DT’s are created only for T.D’s and P. D’s. Future in case of DTA’s Prudence and
Virtual Certainty is to be considered.
Purchase Merger
The criteria of prudence are met on the date of amalgamation. Journal:
If assets/liabilities are recorded at fair values DTA Dr.
To G/W or C Reserve Not applicable
DO YOU KNOW
AS-22 has maximum number of ASI’s.
Disclosures
◘◘ DTA/ DTL should be shown net under the New Schedule III i.e. DTA (net) will be disclosed under the
head Non Current Assets and DTL (net) under Non Current Liabilities. Net means either DTA or DTL
one will prevail i.e. either DTA – DTL or DTL – DTA.
◘◘ Nature of evidence regarding Virtual Certainty for DTA’s recognition (in notes to accounts).
DO YOU KNOW
With the disclosure requirements of New Schedule III of DTA/DTL will be disclosed under NCA/NCL respectively.
Problem 1: Trimurthy Pan Masala (P) Ltd. was incurring heavy losses in the last several years since it could
not withstand the competition in the market. The State in which the company had its registered office and
also its major sales had moved a bill in the State Assembly to ban manufacture and sale of all kinds of Pan
Masalas in the State. While finalizing the accounts for the year ended 31-03-2004, the CFO of the company
created a Deferred Tax Asset for the tax benefits that would arise in future years from the earlier years losses
that had remained unabsorbed in Income Tax. (C. A. Final Audit Nov. 2002 and Nov 2004) (Marks 5/4)
Solution: Creation of Deferred Tax Asset: Accounting Standard 22 on “Accounting for Taxes” requires that
Deferred Tax Asset (DTA) should be recognised for all timing differences, subject to the considerations of
prudence. The Standard further states that unabsorbed losses of the business can be considered for creation
of DTA provided there is virtual certainty supported by convincing evidence that sufficient future taxable
income will be available against which such DTA can be realised. In view of this, the DTA created by the CFO
of Trimurthy Pan Masala (P) Ltd. is not in order. Since the company which is in the business of manufacturing
of panmasala has been incurring heavy losses and in addition to this the State in which the company is having
its major sales is proposing the ban on sale and manufacture of pan masala, the statutory auditor would,
therefore, have to qualify his report and mention the extent of amounts of loss and reserves which are under
and overstated respectively.
216 Accounting Standards
Problem 2: Naini Limited presents you the following information for the year 2017-2018:
Net profit / loss before tax ₹ 1,33,000
Opening balance of DTA ₹ 17,000 and DTL ₹ 1,000.
Bonus under 43B disallowed by ITO ₹ 4,000
VAT disallowed last year now allowed: ₹ 18,000
Expenses incurred in the year 2015-2016 for launching new product : ₹ 75,000. ITO allows it over 5 years.
Private donations ₹ 6,000
Depreciation charged as per Accounts :₹ 10,000 and IT ₹ 12,000.
Agricultural income exempted ₹ 17,000
100% depreciation allowed by IT on special equipments bought for ₹ 1,00,000. Depreciation as per Accounts 30% p.a.
Directors spouse remuneration disallowed 50%. Remuneration paid ₹ 60,000
Rental income credited to P/L ₹ 16,000. This was already considered as income by ITO last year on receipt basis.
Show presentation of P/L and Balance Sheet as per AS-22 and Schedule III.
Consider tax rate: 30%.
Solution:
Statement of DTA / DTL:
Income As Per Co. Act & I. Tax. + Current Tax on Taxable Income
LEDGER OF DTL:
D T L A/C
2004-05 2004-05
To bal c/f 20,000 By P/L (40% x 50000) 20,000
2005-06 2005-06
To bal c/f 35,000 By bal c/d 20,000
(35% x 100000) By P/L (b.al fig) 15,000
2006-07 2006-07
To bal c/f 48,000 By bal c/d 35,000
(32% x 150000) By P/L (b.al fig) 13,000
2007-08 2007-08
To P / L (reverse) 48,000 By bal c/d 48,000
To bal c/f (30% x 0) 0
Journal:
P/L Dr. (b.f.) 40,000
To Current Tax 0
To DTA 40,000
DTA/DTL For 31.03.2016 T.D. DTA 40%
Balance loss recovered –1,00,000 –40,000 0
Total: –1,00,000 –40,000 0
Add: Opening 1,00,000 40,000 0
Closing Balance: 0 0 0
Journal:
P/L Dr. (b.f.) 48,000
To Current Tax 8,000
To DTA 40,000
Problem 6: The following particulars are submitted by the accountant of Power point Ltd. for the year
31.03.2005:
(1) Profit before taxes ` 16,00,000
(2) Details of Land sold during the year:
ww Sale of Land on : 12.01.2005
ww Sale proceeds of Land :` 14,00,000
ww Date of purchase of Land : 14.11.1979
ww Cost of acquisition of Land :` 1,00,000
ww Market Value of Land on 01.04.1981: ` 3,00,000
ww Indexation for the year 2004-2005 : 480
(3) Capital gains tax 20%.
(4) Business income taxes 40%.
Compute DTA / DTL:
Solution: Lets separate two different types of Incomes heads:
Business Incomes:
Profits before taxes 16,00,000
(-) Profit on Sale of Land
considered separately
(14,00,000 - 1,00,000) –13,00,000
Business Profits as per Income Tax = 3,00,000
Current Taxes @40% 1,20,000
Assuming there is no T.D. in Business Income, Entry will be:
P/L Dr. 1,20,000
To Current Tax 1,20,000
Capital Gains:
Sale proceeds of Land 14,00,000
(-) Cost of Acquisition -14,40,000
(3,00,000 x 480/100)
Capital Loss: 40,000
Current Taxes @20% 0
DTA on Losses @20% 8,000
DTA Dr. 8,000
To P / L 8,000
It is assumed that the company has got enough future capital gains to recover DTA.
220 Accounting Standards
Problem 7: Show P/L Account for various years of Reliance Limited from the following particulars:
2001 – 2002 2002 – 2003 2003 – 2004 2004 - 2005
Net Profit before taxes 400,000 450,000 475,000 500,000
Other particulars:
(1) Company has only one Asset.
(2) Date of purchase of Asset 01.04.2001 for ` 4,00,000.
(3) Life 4 years.
(4) Depreciation as per Books SLM with residual Value Nil.
(5) Depreciation as per I. Tax 50% WDV Method.
(6) Recognition of impairment loss on 31.03.2003 ` 60,000.
(7) Sale of asset at the end of 2004 – 2005 for ` 52,000.
(8) Tax – rate @40%.
Solution:
01-02 02-03 03-04 04-05
Net Profit before taxes 4,00,000 4,50,000 4,75,000 5,00,000
+ Depreciation as per Co. Act 1,00,000 1,00,000 70,000 70,000
+ Impairment Loss 0 60,000 0 0
– Dep. As per I. tax –2,00,000 –1,00,000 –50,000 0
– Profit on Sale of Asset 0 0 0 –52,000
(WDV – SP = 0 - 52,000)
Short term capital gains 0 0 0 2,000
(4,00,000 – 2,00,000 –
1,00,000 -50,000) – 52,000
Taxable Income 3,00,000 5,10,000 4,95,000 5,20,000
Current Tax @40% 1,20,000 2,04,000 1,98,000 2,08,000
Journal:
P / L Dr. 1,80,000
DTL Dr. 24,000
To Current Tax 2,04,000
AS-22: Taxes on Income 221
Journal
P / L Dr. 2,00,000
DTL Dr. 8,000
To Current Tax 2,08,000
Problem 8: Compute Deferred Taxes for years given below based on the information provided to you and
also show the effect of MAT Credit:
2010 – 2011 2011 – 2012 2012 – 2013 2013 - 2014
Net Profit before taxes 200,000 110,000 10,000 90,000
Depreciation as per Books 50,000 50,000 1,00,000 1,00,000
Depreciation as per I. Tax 210,000 40,000 40,000 10,000
Tax – rate @35%. MAT @20%. Company is charged under section 115JB.
Solution:
10-11 11-12 12-13 13-14
Net Profit before taxes 2,00,000 1,10,000 10,000 90,000
+ Depreciation as per Co. Act 50,000 50,000 1,00,000 1,00,000
– Dep. As per I. tax –2,10,000 –40,000 –40,000 –10,000
Taxable Income 40,000 1,20,000 70,000 1,80,000
Current Tax as per section 115JB 40,000 22,000 2,000 18,000
(Book Profit x 20%)
Current Tax as per normal tax rates 14,000 42,000 24,500 63,000
(Taxable Income x 35%)
Current tax as per Higher of 40,000 42,000 24,500 63,000
(115JB or Normal Taxes)
Problem 9: A company has paid tax under 115JB for the year ended 31/3/2017. The company wants to
claim Mat credit in the next year. (C.A. Final Audit Nov. 2007) (Marks 5) Audit
Solution: The concerned issue is discussed in the Guidance Note issued by ICAI on “Accounting for Credit
available in respect of MAT under the IT Act 1961”. As per para 6 of the said Guidance Note, Although MAT
credit is not a deferred tax asset under AS 22 , yet it give rise to expected future economic benefit in the form
of adjustment of future income tax liability arising within the specified period.
MAT paid in a year in respect of which the credit is allowed during the specified period under the Income
Tax Act is a resource controlled by the company as a result of past event, namely the payment of MAT. MAT
credit has expected future economic benefits in the form of its adjustment against the discharge of the normal
tax liability if the same arises during the specified period. Accordingly, MAT credit is an asset.
According to the framework, once an item meets the definition of the term ‘asset’, it has to meet the criteria
for recognition of an asset so that it may be recognized as such in the financial statements. Para 88 of the
Framework provides the following criteria for recognition of an asset: an asset is recognized in the balance
sheet when it is probable that the future economic benefits associated with it will flow to the enterprise and
the asset has a cost or value that can be measured reliably.
Thus, if the auditor is satisfied that the probability of the company to claim the said credit is high, it could
recognize the same as an asset. In Balance sheet it should be shown under the head “Loans & Advances” as
“MAT credit entitlement”.
Problem 10: Milton Limited is full tax free enterprise for 10 years of its existence and is in second year of
its operations. Depreciation TD resulting in DTL in years 1 and 2 is ` 200 lakhs and ` 400 lakhs respectively.
From the 3rd year onwards it is expected that the TD would reverse each year by ` 10 lakhs. Tax rate 35%.
Compute DTL in the second year and any charge to P/L. (C.A. Final May 2006) (4 Marks)
Solution:
T.D. arises in year 1 = 200 lakhs
Less: Reversed during tax holiday = (10lakhs × 8) -80 lakhs
Net : 120 lakhs
Tax 35%
DTL 42 lakhs
Entry for yr. 1 is: P/L A/c. Dr. 42 lakhs
To DTL 42 lakhs
AS-22: Taxes on Income 223
Problem 11: Omega Ltd is working on different projects those are likely to be completed within 3 Years
period. It recognizes revenue from these contracts on percentage of completion method for the financial
year 2016, 2017 and 2018 for ` 11 Lakhs, `16 Lakhs and ` 21 Lakhs respectively. However, for Income Tax
purpose, it has adopted the completed contract method under which it has recognized revenue of ` 7 Lakhs,
` 18 Lakhs and ` 23 Lakhs for the years 2016, 2017 and 2018 respectively. Income Tax rate is 35%. Compute
the amount of deferred tax asset/ liability for the years 2016, 2017 and 2018. (C.A. Final New Syllabus)
Solution:
2016 2017 2018
Revenue as per accounts (percentage of completion method) 11,00,000 16,00,000 21,00,000
Revenue as per tax (completion contract method) 7,00,000 18,00,000 23,00,000
Timing Difference 4,00,000 (2,00,000) (2,00,000)
DTL (Timing diff x 35%) 1,40,000 (70,000) (70,000)
DTL arises DTL reverse DTL reverse
Problem 12: Wonder Compliments Ltd has incurred a loss of ` (1,00,000) in the year 2012-13. The loss is an
exceptional loss and will be reversed in the next year. Items disallowed during the year amounts to ` 25,000.
The profit earned during the year 2013-14 is ` 3,40,000. Compute the amount of deferred tax asset/ liability
for the years 2012-13 and 2013-14. Tax rate is 40%.
Solution:
2012-13
Timing difference = -1,00,000 + 25000 = (75,000). Taxable income is Nil, hence Current tax = 0.
DTA = (75,000) x 40%= ` 30,000 + items disallowed 25,000 × 40% = 10,000. Total DTA = ` 40,000 2013-14
Timing difference reversal = 75,000 + 25000 = 1,00,000. Hence DTA reversed is full ` 40,000. Current tax
= 3,40,000 -75,000 – 25,000 = 2,40,000 × 40% = ` 96,000.
Problem 13: Cool mail distributors had paid the first MLP of a finance lease ` 3,90,000. The Cost of asset is
recorded at ` 15,50,000 on the signing of the lease contract. Depreciation rate is 20%. Interest rate for lessee
is 12%. Compute the net DTA / DTL during the year arising due to AS-19? Tax rate 35%.
Solution:
As per AS-19 following are the items charge to P/L by the Lessee company:
Depreciation = 15,50,000 × 20% = 3,10,000
Finance Charges = 15,50,000 × 12% = 1,86,000
Total items disallowed by I.T. = 4,96,000
Less: MLP allowed as rent (3,90,000)
Net timing difference = 1,06,000
DTA 35% 37,100
224 Accounting Standards
Problem 14: The following details are available in the books of RTP Ltd.
Particulars ` in lakhs
Provision for tax:
For 2009-10 400
For 2010-11 600
For 2011-12 500
Advance tax paid:
For 2009-10 350
For 2010-11 700
For 2011-12 540
RTP Ltd. estimates its Deferred Tax Liabilities to be ` 200 lakhs and its Deferred Tax Assets to be ` 40
lakhs. How will the above be disclosed?
Solution: Disclosure of Current and Deferred Tax balances will be on the basis of principles laid down in
AS 22. These are:
Current tax assets and liabilities can be set off, if the enterprise has a legally enforceable right to set off the
recognized amounts and intends to do settle them on a net basis.
Deferred tax assets and liabilities can be set off, it the items relates to taxes on income levied by the same
governing taxation laws.
Problem 15: What is the tax effect of sale of fixed assets, considering the block of assets approach followed
in the Income-tax Act, 1961?
A company has a block of assets with a written down value of `1,00,000 on April 1, 2012 for tax purposes.
The book value of the assets for accounting purposes is also `1,00,000. The assets are depreciated on written
down value basis at 25 percent per annum for both accounting and tax purposes. Of the entire block, assets
costing `5,000 on April 1, 2012, were sold for `10,000 on March 31, 2014. Compute the deferred tax asset/
liability assuming tax rate of 40 per cent.
Solution: In the case of a company, the following computations will be made:
2012-13
In this year, depreciation for both accounting and taxation purposes would be `25,000 (25 per cent of
`1,00,000). Accordingly, no timing difference arises on this account.
2013-14
Depreciation for the year would be `18,750 (25 percent of `75,000) as per the books of account, while for
tax purposes it would be `16,250 as sale proceeds of `10,000 would be reduced from the block of assets prior
to the computation of depreciation. Accordingly, the following timing differences arise:
• Depreciation for tax purposes is `16,250 and for accounting purposes `18,750 giving rise to a timing
difference of `2,500.
AS-22: Taxes on Income 225
• Profit on sale of fixed asset amounting to `7,188 (`10,000 - `2,812 being the WDV of the asset as on
31st March, 2014) is recognized for accounting purposes. However, for tax purposes this income is
not considered. This will result in a timing difference of `7,188.
The net timing difference would be `4,688 (`7,188 – `2,500) by which the accounting income would
exceed the taxable income, thus requiring creation of a deferred tax liability of `1,875 (4,688 X 0.4).
The difference of `4,688 would reverse in future years when depreciation for accounting purposes would
be higher as compared to depreciation for tax purposes because depreciation for accounting purposes would
be computed on higher carrying amount of fixed assets as compared to carrying amount of those assets for
tax purposes.
Problem 16: From the given information, you are required to compute the deferred tax assets and deferred
tax liability for Ramanujam Limited as on 31st March 2014. The tax rate applicable is 35%.
(i) The company has charged depreciation of( 7,42,900/- in its books of accounts while as per
income-tax computation, the depreciation available to the company is `8,65,400
(ii) The company has made provision for doubtful debts for `54,300/- during the year.
(iii) The company has debited share issue expenses of `6,23,500/- which will be available for
deduction under the Income-tax Act from the next year.
(iv) The expense of `7,84,5001- has been charged to profit and loss account which are disallowed
under the Income-tax Act.
(v) The company has made donation of `2,00.000/- which has been debited to profit and loss
account and only 50% thereof win be allowed as deduction as per Income-tax law.
(CA Final Nov. 2014, 5 Marks)
Solution:
S. No. Particulars Amount of Nature of DTA @ DTL @
difference difference 35% 35%
1. Excess allowable depreciation as per income-tax law 1,22,500 Timing - 42,875
2. Provision for doubtful debts - disallowed as per 54,300 Timing 19,005 -
ncome-tax law in the current year but reversible in
future years.
3. Share issue expenses charged in the accounting 6,23,500 Timing 2,18,225 -
books but allowed as deduction in the income-tax law
from the next year
4. Disallowed expenses as per income tax law 7,84,500 Permanent - -
5. Donation debited to Profit & Loss Account
Allowed as per income tax 1,00,000 No difference - -
Disallowed as per income tax 1,00,000 Permanent - -
2,37,230 42,875
CHAPTER 22
AS-24:
Discontinuing Operations
Chapter Outline
vv Objective & Scope vv Initial Disclosure Event
vv Discontinuing Operation (DO): Defined vv Initial Disclosure Description
DO YOU KNOW
Throughout New Schedule III Profit/Loss Statement information related to the continuing operation is consid-
ered. For discontinuing operations of an enterprise Part II of Schedule III requires single amount of presenta-
tion of profit before tax.
ii. Separate major line of business or a geographical area of operation: Segmental Reporting as
defined in AS-17 normally represents or satisfies separate major line of business or a geographical
area of operation. Even if an enterprise operates in a single business or geographical segment, a
major product or service line may also satisfy this criteria.
ii. Distinguishable component - financially and operationally distinguishable: D.O. should be
financially and operationally distinguishable for reporting purposes. This means the assets, liabilities,
and major expenses should be attributable towards such discontinuing operation. If a debt is attributed
to a component, the related interest and other financing costs are similarly attributed to it. It means had
the operation discontinued it would eliminate the related income/expenses/assets/liabilities.
#EXPLANATION: Manner of Discontinuing:
a1) Disposing of substantially in its entirety: It means a binding agreement of sale is entered with the
buyer. Actual transfer may take place at a later date.
b1) Piecemeal, selling off the component’s assets and liabilities: It means selling Assets and Settling
liabilities individually settlement of assets/lies may even take months perhaps years. There may not
be a binding sale agreement to sell the asset.
c1) Abandonment: An enterprise may terminate an operation by abandonment without substantial sale
of assets. However, changing the scope of an operation or the manner in which it is conducted is
not abandonment because that operation, although changed, is continuing. Business enterprises
frequently close facilities, abandon products, change the size of work force in response to market
forces. While those kinds of terminations generally are not, in themselves, discontinuing operations,
but they may be present in connection with a discontinuing operation.
Example of Abandonment: An event management company managing events for various nature stops
managing birthday parties and focuses on large scale events. If the birthday parties events was contributing
significant portion of the event management business and the plan of abandonment was based on a detailed
laid down pan then such a situation is covered by AS-24 as termination by Abandonment.
I llustration — Disposal of a major line of business
A company manufactures and sells 10 brands of consumer products that are grouped into five major product
lines — beauty care, health care, food, pet care and baby care. Each brand comprises operations and cash
flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of
the entity. Therefore, each brand is a component of the entity. Each product line (i.e., a group of components)
represents a major line of business that comprises a major part of the entity’s operations and financial results.
The company decides to exit the beauty care market and disposes of its related product line.
Analysis
The disposal qualifies as a discontinued operation because the beauty care product line is a group of
components of the entity that represents a major line of business that comprises a major part of an entity’s
operations and financial results (i.e., a strategic shift).
Illustration — Disposal that does not qualify for presentation as a discontinued operation:
Assume the same facts as in the above Illustration, except the company decides to dispose of one of its brands
within the beauty care product line. Following the disposal, the company will not have significant continuing
involvement or continuing cash flows with the disposed component.
Analysis
The disposal does not meet the definition of a discontinued operation because the disposed brand does not
What may not be a discontinuing operation? A restructuring transaction or event that does not
meet the definition of discontinuing operations as per AS-24 should not be called a discontinuing
operation. Examples of activities that do not necessarily on their own satisfy the discontinuing
operation definition, but that might do so in combination with other circumstances, include:……..
para 9
228 Accounting Standards
Note: If initial disclosure event occurs after balance sheet date but before approval of the financial
statements by the board of directors in case of companies, or by the corresponding governing body in case
of other enterprises, the event is treated as event occurring after the balance sheet date, and disclosures
as per AS 4 are required. It will be treated as non – adjusting event and only disclosure in the BOD report
is required.
Continuation of Disclosure
All disclosures required above, should continue in financial statements for periods up to and including the
period in which the discontinuance is completed. Discontinuance is completed when the plan is substantially
completed or abandoned, though full payments from the buyer(s) may not yet have been received.
Problem 1: Compel Ltd. is discontinuing a product segment which is not a reportable segment within the
meaning of AS-17 and reported in segment information as an unallocated reconciling item. Management
intends to sell-off the assets and settle the liabilities by piecemeal. Is it a discontinuing operation within the
meaning of AS-24?
Solution: Normally segments reportable under AS-17 are purely discontinuing operation for AS-24 also.
But what about those segments which act as unallocated reconciling item ? Reportable segment or part of
reportable segment can also be discontinuing operation. Condition for discontinuing operation is that, the
discontinuing operation should be major business line or area of operations.
In the present case C Ltd. is disposing one of the product segment through piecemeal distribution. Selling
off the attributable assets and liabilities itself indicates that some of the assets and liabilities of the business
are attributable to the segment. Hence it is a discontinuing operation.
Problem 2: Mix Ltd. is having cosmetics division, garment division and beverages division. The beverages
division accounts for 7% of total assets, 10% of enterprise revenue and 10% of combined profits of all divisions.
It is proposed to be demerged by the Board of Directors pursuant to a single plan. It is a distinguishable
component operationally and financially. Is it a discontinuing operation as per AS-24?
230 Accounting Standards
Solution: Normally segments reportable under AS-17 are purely discontinuing operation for AS-24. Mix
Ltd. wants to dispose beverages division, which is a discontinuing operation as per AS-24. Following are the
points entitling beverages division as discontinuing operation as per AS-24:
◘◘ 7% of total assets, 10% of enterprises revenue and 10% of combined profits etc. is a clear indication
of the fact that some of the assets and liabilities of the business are attributable to the beverages
segment.
◘◘ It is a distinguishable component operationally and financially.
Problem 3: Silk and Cotton Ltd. has a large network of retail shops which sell various types of clothes. It is
trading in clothes and carries on activities through retail outlets all over the country. It wishes to discontinue
a particular brand of silk sarees. The outlet will be operational even after the product is discontinued. Does it
have to report silk sarees as discontinuing operations?
Solution: The operating assets of the company is the retail outlets and not any type of cloth sold through the
outlet. The company is discontinuing the particular brand of silk sarees. The company can still continue to
operate the outlet by selling some other products through the outlet. Hence, discontinuing the silk sarees is
not discontinuing operation.
Problem 4: X Limited is presenting consolidated financial statements of X Limited and its subsidiaries. It
has sold a subsidiary XYZ Limited whose activities are similar to that of X Limited. Can the sale of XYZ Limited
be treated as discontinuing operation with reference to consolidated financial statements?
Solution: According to para 9 of AS-24 in relation to CFS is selling a subsidiary whose activities are similar to
those of the parent or other subsidiaries does not necessarily satisfy the definition of discontinuing operations.
But these might be discontinuing operations as per AS-24 in combination with other circumstances as per
the particular facts and circumstances of the case.
Problem 5: Does the fact that disposal of component is classified as discontinuing operations call into
question the enterprise’s ability to continue as a going concern?
Solution: According to para 14 of AS-24 the fact that a disposal of a component of an enterprise is classified
as a discontinuing operations does not, in itself, bring into question the enterprise’s ability to continue as a
going concern.
Circumstances under which the going concern ability gets invalid:
1) If on account of discontinuing operation the company discontinue the core operations retaining the
non - core operations then the going concern ability may be under doubt.
2) A company may have only one operation and that operation itself gets discontinued.
P roblem 6: Resource Enterprises produces a standard type of tools and equipments for industiral use.
The company carry out its production into 3 processes.. It has been found that over a period of a time cost
of production of the first process is 15% higher than the market price of the intermediate product available
freely in the market. The company has decided to close down the first process as a measure of cost saving.
Should this event be treated as a discontinuing operations?
Solution: The company has made a good decision of outsourcing the service, in respect of a single process.
This has been done by the company with a view to achieve cost reduction. The change is merely a cost –
saving endeavour. Such a change does not meet definition criteria in para 3 (a) of AS-24. Hence, this change
is not discontinuing operation.
P roblem 7: A cosmetic producing Company provides the following information -
Particulars Cold Vanishing
Cream Cream
January 2013 –September 2013 p.m. 2,00,000 2,00,000
October 2013 –December 2013 p.m. 1,00,000 3,00,000
January 2013 – March 2014 p.m. 0 4,00,000
AS-24: Discontinuing Operations 231
The Company has enforced a gradual change in product-line on the basis of an overall plan. The Board of
Directors of the Company has passed a resolution in March 2013 to this effect. The Company follows calendar
year as its accounting year. Should this be treated as a discontinuing operation? Give reasons in support of your
answer. (C.A. Final May 2008)
Solution: By gradually reducing the size of operations in the product line of Cold Cream, the company has
increased its scale of operation in Vanishing Cream. Such a change is a gradual or evolutionary phasing out of
a product line or class of services and does not meet the definition criteria namely, disposing of substantially
in its entirety, a component of the enterprise. Hence, this changeover is not a discontinuing operation.
P roblem 8: HL Ltd has 3 divisions auto products, auto lubricants and printing divisions. This is classified as
a reportable segment as per AS-17. It has decided to abandon 3 out of 5 assets of printing division and replace
it with new automated assets. Comment whether the sale of assets of printing division is a discontinuing
operation by abondonment?
Solution: It is not a termination by abandonment because only few assets have been abandoned. Changing
the scope of an operation or the manner in which it is conducted is not abandonment because that operation,
although changed, is continuing. Business enterprises frequently close facilities, abandon products, change
the size of work force in response to market forces. While those kinds of terminations generally are not, in
themselves, discontinuing operations, they can in connection with a discontinuing operation.
Problem 9: Qu Ltd is in the business of manufacture of Passenger Cars and Commercial Vehicles. The
Company is working on a strategic plan to shift from the Passenger Car segment over the coming 5 years.
However, no specific plans have been drawn up for sale of neither the Division nor its Assets. As part of its
plan, it will reduce the production of Passenger Cars by 20% annually. It also plans to commence another New
Factory for the manufacture of Commercial Vehicles and transfer surplus employees in a phased manner:
1. You are required of comment if mere gradual phasing out in itself can be considered as a “Discontinuing
Operation’ within the meaning of AS–24.
2. If the Company passes a Resolution to sell some of the assets in the Passenger Car Division and
also to transfer few other Assets of the Passenger Car Division to the factory, does this trigger the
application of AS–24?
3. Would your answer to the above be different, if the Company resolves to sell the assets of the
Passenger Car Division in a phased but time bound manner? (CA Final Nov. 2013, Marks 4)
Solution:
1. Mere gradual phasing out in itself cannot be considered as a Discontinuing Operation (DO). Gradual
or evolutionary phasing out of a product line or class of service is not DO…….para 9
2. Passing of Resolution to sell some of the assets in the Passenger Car Division and also to transfer few
other Assets of the Passenger Car Division to the factory, does not trigger the application of AS–24. It
is sale in its entirety remember and not some of the assets. Also starting the operations in the New
Factory is altogether a new business and has nothing to do with old business.
3. Resolution to sell assets of the Passenger Car Division in a phased but time bound manner will
lead to identification of a Discontinuing Operation as per AS–24. It means there is a single plan to
discontinue the operation. The manner of discontinuance seems to be piecemeal distribution.
CHAPTER 23
AS-25:
Interim Financial Reporting
Chapter Outline
vv Meaning of Interim Financial vv Problems Encountered while following AS – 25
Reporting and Its Applicability vv Integral and Discrete View
vv Minimum Financial Statements vv Recognition and Measurement
vv Merits of Interim Financial Reporting Principles as PER AS – 25
vv Meaning of Year to Date Basis
Objective
AS 25, deals with the form, contents of an interim financial report, minimum components of an interim
financial report, minimum explanatory notes to the interim financial report, periods for which interim
financial reports should be prepared, recognition and measurement and restatement of previously reported
interim periods. Timely and reliable interim financial reporting improves the ability of investors, creditors,
and others to understand an enterprise’s capacity to generate earnings and cash flows.
The recognition and measurement principles laid down in this Accounting Standard apply also to complete
financial statements for an interim period, and such statements would include all of the disclosures required
under this Accounting Standard as well as those required by other Accounting Standards.
AS-25: Interim Financial Reporting 233
Applicability
As of now, neither the standard nor any regulation in India requires any enterprise to prepare interim financial
reports. This means an enterprise can voluntarily elects to prepare interim financial report. Then what may
be the various situations where AS-25 is applicable (but not mandatory) : (i) IFR for mergers, (ii) IFR for
declaring interim dividends, (iii) IFR for IPOs, (iv) IFR for submitting to the Banks.
DO YOU KNOW
There are more estimates used in IFR as compared to annual accounts.
Example 1: Financial year of Bapu Ltd. is April 1 to 31 March. The company presents quarterly interim
reports. The interim report for second quarter of 2019-20 (01/07/09 to 30/09/19) should consist of the
following:
Balance Sheet as at 30 September 2019 31 March 2019
Profit & Loss A/c for:
3 months ending 30 September 2019 30 September 2018
6 months ending 30 September 2019 30 September 2018
Cash flow statement for
6 months ending 30 September 2019 30 September 2018
For an enterprise whose business is highly seasonal may provide financial information for twelve months
ending on interim reporting date as also comparative information for prior corresponding twelve months
period.
Example 2: Financial year of A Ltd. is April 1 to 31 March. Its business is highly seasonal. The company
presents quarterly interim reports. The interim report for second quarter of 2019-20 (01/07/19 to 30/09/19)
may consist of the following:
Balance Sheet as at 30 September 2019 31 March 2019
Profit & Loss A/c. for:
3 months ending 30 September 2019 30 September 2018
6 months ending 30 September 2019 30 September 2018
12 months ending 30 September 2019 30 September 2018
Cash flow statement for
6 months ending 30 September 2019 30 September 2018
12 months ending 30 September 2019 30 September 2018
Provisions
The principles for recognizing and measuring losses from inventory write-downs, restructurings, or
impairments in an interim period are the same as those that an enterprise would follow if it prepares only
annual financial statements. However, if such items are recognized and measured in one interim period and
the estimate changes in a subsequent interim period of that financial year, the original estimate is changed
in the subsequent interim period either by accrual of an additional amount of loss or by reversal of the
previously recognized amount. Determination of the appropriate amount of a provision (e.g. warranties
liquidated damages, etc.) may be complex and often costly and time-consuming. Enterprises sometimes
engage outside experts to assist in the annual calculations.
Contingencies
The measurement of contingencies may involve the opinions of legal experts or other advisors. Formal
reports from independent experts are sometimes obtained with respect to contingencies. Such opinions
about litigations, claims assessments, and other contingencies and uncertainties may or may not also be
needed at interim dates depending on the situation. For example, if there are significant developments in the
litigation at interim dates, one should revisit the need for making or reversing a provision for which a legal
opinion may be useful.
Inventories
Inventories are measured for interim period on the same basis as at year-end. To save time and costs,
enterprises often use estimates to measure inventories at interim period than at year-end. Full stocktaking
and valuation procedures may not be required at interim dates, hence estimations are inevitable. Inventory
AS-25: Interim Financial Reporting 237
losses from market declines should not be deferred beyond the interim period in which the decline occurs.
The standard requires the determination of net realizable value by reference to selling prices and related
costs to complete at the end of the interim period. An enterprise will reverse a write-down in a subsequent
interim period when the recoveries take place, i.e., subsequent recoveries against the losses recognized
should be treated as gains in the interim periods when the recoveries happen.
Intangible Assets
The deferment of costs incurred in developing intangible assets in an interim period in the hope that the
recognition (capitalization) criteria will be met later in the financial year is not justified. Reinstatement of
expenditure recognized as an expense in previous annual financial statements or interim financial reports
are prohibited. This means once expensed these costs cannot be later on resurrected and capitalized even if
conditions are met.
Bonus / ex - gratia
Conditions for recording bonus in interim periods:
i) the bonus is a legal obligation or past practice (no realistic alternative but to pay)
ii) a reliable estimate of the amount can be made.
Bonus based on yearly results (discretionary) = Do not recognize in interim periods.
Bonus based on yearly results (past practice to pay) = Recognize in interim periods.
There should be either legal or statutory liability for provision of bonus. In other words the bonus should
be constructive on the interim period. Bonus can also arise due to past practice, to maintain good business
relations or act in an equitable manner.
Volume Rebates
Volume rebates or discounts are anticipated in interim periods, by both the payer and the recipient, if it is
probable that they have been earned or will take effect. An intergral view has been followed. But discretionary
rebates and discounts are not anticipated / deferred even if typically experienced in earlier periods.
238 Accounting Standards
Depreciation
Depreciation for the interim period is based only on assets owned during that interim period.
Bad - debts
Provision/actual bad debts is to be recorded in the interim period when it arises. Don’t spread over the loss
over the entire year even if it is uncurred in a quarter.
DO YOU KNOW
The recognition and measurement principles laid down in AS-25 are applicable to SEBI quarterly reports by
the listed companies. But as far as the disclosure and presentation is concerned format prescribed by SEBI is
to be followed.
Problem 1: An enterprise reports quarterly. At the end of Q1 estimate of pre-tax annual profit was ` 6 lacs
and the aggregate of deductions from the GTI under I. Tax Act was estimated at ` 1 lac.
At the end of Q2 estimate of pre-tax annual profit was ` 6.30lacs and the aggregate of deductions from the
GTI under I. Tax Act was estimated at ` 84,000.
The pre-tax annual profits for Q1 & Q2 were ` 1.2 lacs and ` 1.3 lacs respectively. The tax rate is 30%.
Compute profit after tax for the quarters.
AS-25: Interim Financial Reporting 239
Solution: Estimated income pre-tax for Q1 is ` 5,00,000 and c/f. loss is ` 1,00,000, tax@40%, then Avg.
annual tax @ =
For Q1 : Annual tax liability = 30% (6-1) = ` 150000
AAET@ = 150000 / 600000 = 25%
Tax expense for Q1 = Actual earnings for Q1 x 25% = 120000 x 25% = 30000
For Q2 : Annual tax liability (reassessed) = 30% (6.3-0.84) = ` 1.638
AAET@ = 1.638 / 6.3 = 26%
Tax expense for Q2 = (Total actual earnings for Q1+Q2) x 26% - Tax expense already recognised = (120000
+ 130000) x 26% - 30000 = ` 65000 – ` 30,000 = ` 35,000.
Disclosures of P/L : Q1 Q2
PBT 120000 130000
Less: Tax (30000) (35000)
PAT 90000 95000
Problem 2: Estimated annual income ` 1,00,000 (inclusive of estimated capital gains of ` 20,000 earned
in second quarter). Assumed tax rates: Capital Gains: 10%, Other income: first 40,000 = 30% and balance
income = 40%. Assuming there is no difference between taxable income and accounting income. Income
earned every quarter is estimated to be ` 25,000 (including ` 20,000 capital gains earned in second quarter).
Solution: Total estimated income = 25,000 × 4 = ` 1,00,000 out of which ` 20,000 is capital gains which
means other income is ` 80,000
Avg. Annual tax % under capital gain = 10%
Tax on other income based on slab = 30% on first 40,000 and 40% on balance 40,000 = ` 28,000
Avg. tax rate = 28,000/80,000 = 35%
Tax expense for Q1, Q3 and Q4 = 25,000 × 35% = ` 8,750.
Tax expense for Q2 = 20,000 × 10% + 5,000 × 35% = ` 3,750.
Problem 3: Batuk Pvt. Ltd. receives dividend income of ` 4,00,000 on its investments in the third quarter.
The management wants to recognise dividend of `1,00,000 per quarter. Comment.
Solution: Dividend income is always recorded when the right to claim the dividend is established. In case
of Dividend income Discrete view has to be adopted, which means income will be recorded when accrued.
Hence full dividend of ` 4,00,000 is to be recorded in the third quarter……para 36 of AS-25
Problem 4: For the first quarter ending 31st March, 2013, Majhe Co. gives you the following information:
` crores
Sales 50
Salary and other expenses 30
Advertisement expenses (routine) 02
Administrative and selling expenses 08
While preparing interim financial report for the first quarter ‘Majhe Co.’ wants to defer ` 21 crores
expenditure to third quarter on the argument that third quarter is having more sales, therefore third quarter
should be debited by higher expenditure, considering the seasonal nature of business. The expenditures are
uniform throughout all quarters.
Calculate the result of first quarter as per AS 25 and comment on the company’s view.
(C.A. Final May 2005) (4 Marks)
240 Accounting Standards
As per AS 25 on Interim Financial Reporting, the income and expense should be recognised when they are
earned and incurred respectively. As per para 38 of AS 25, the costs should be anticipated or deferred only
when
(i) it is appropriate to anticipate that type of cost at the end of the financial year, and
(ii) costs are incurred unevenly during the financial year of an enterprise.
Therefore, the argument given by Majhe Corp. relating to deferment of ` 21 crores is not tenable as
expenditures are uniform throughout all quarters.
Problem 5: Accounts of Poornima Ltd. show a net profit of ` 7,20,000 for the third quarter of 2005 after
incorporating the following:
(i) Bad debts of ` 40,000 incurred during the quarter. 50% of the bad debts have been deferred to the
next quarter.
(ii) Extra ordinary loss of ` 35,000 incurred during the quarter has been fully recognised in this quarter.
(iii) Additional depreciation of ` 45,000 resulting from the change in the method of charge of depreciation
to be applied from next financial year.
Ascertain the correct quarterly income. (C.A. Final May 2006) (4 Marks)
Solution: In the above case, the quarterly income has not been correctly stated. As per AS 25 Interim Financial
Reporting, the quarterly income should be adjusted and restated as follows:
(1) Bad debts of ` 40,000 have been incurred during current quarter. Out of this, the company has
deferred 50% (i.e.) ` 20,000 to the next quarter. Therefore, ` 20,000 wrongly deferred should be
deducted from ` 7,20,000.
(2) The treatment of extra-ordinary loss of ` 35,000 being recognized in the same quarter is correct.
(3) Recognising additional depreciation of ` 45,000 in the same quarter is in tune with AS 25.
Poornima Ltd should report quarterly income as `7,00,000 (` 7,20,000 – ` 20,000).
Problem 6: Practice Limited provided for a loss of ` 2,00,000 being lower of (NRV or Cost) for the first
quarter but subsequently the losses are reversed due to demand in the product. The company is expecting
further rise in the NRV in the third as well as fourth quarter. Can Practice Ltd. reverse the loss of ` 2,00,000
in next quarters?
Solution: As per para 29 of AS-25 when losses are provided in one interim period and recoveries takes place
in subsequent interim period, then losses once provided can be reversed in subsequent interim period. In the
present case Practice Ltd can reverse ` 2,00,000 on account of demand in the product.
Problem 7: Your client is a listed company is in the process of preparing first quarter accounts as required
by its stock exchange. Advise your client on its following position.
Note: Problem No.: 7 and 8 are master problems in AS-25 don’t forget to revise it.
AS-25: Interim Financial Reporting 241
(a) Training expenses incurred in the first quarter will be allocated equally over the four quarters
because the benefit is spread over the entire year
(b) Training expenses expected to be incurred in the last quarter will be estimated and equally allocated
to all the four quarters
(c) A donation of ` 5 million is expected to be made in the second quarter; provision will be made in the
first quarter.
(d) Since historically there has been an immaterial variance between budgets and actual, depreciation
charge each quarter will be determined by the budgeted figures.
(e) Incentives are provided to customers if they purchase 1 million kg of urea on an annual basis, it is
expected that atleast 30 customers would be able to achieve this target before the end of the third
quarter. No provision is made for the incentive in the first quarter, since the client believes that the
provision has not yet fructified
(f) 70% of the clients revenue comes in the second quarter. The client wants to spread this revenue to
all the four quarters, else the quarterly accounts will fluctuate significantly.
(g) A major repair is planned of the plant in the fourth quarter, which is absolutely certain. The estimated
repair expenditure will be accounted for in the first quarter itself.
(h) Over the years the client has been unfailingly giving bonuses to staff in the third quarter. This has
become its constructive obligation. The client does not wish to charge a proportionate amount of
bonus in the current quarter.
Solution: Answers for all the questions are = False i.e. the company is wrong in its contention for each of the
cases for preparation of IFR.
Problem 8: Antarbarti Limited reported a Profit Before Tax (PBT) of ` 4 Lakhs for the third quarter ending
30th September 2011. On enquiry you observe the following. Give the treatment required under AS–25.
(i) Dividend Income of ` 4 Lakhs received during the quarter has been recognised to the extent of ` 1
Lakh only.
(ii) 80% of Sales Promotion Expenses ` 15 Lakhs incurred in the third quarter has been deferred to the
fourth quarter as the Sales in the last quarter is high.
(iii) In the third quarter, the Company changed depreciation method from WDV to SLM, which resulted in
excess depreciation of ` 12 Lakhs. The entire amount has been debited in the third quarter, though
the share of the third is only ` 3 Lakhs.
(iv) ` 2 Lakhs Extraordinary Gain received in third quarter was allocated equally to the third and fourth
quarter.
(v) Cumulative loss resulting from change in method of Inventory Valuation was recognized in the third
quarter of ` 3 Lakhs. Out of this loss ` 1 Lakh relates to previous quarters.
(vi) Sale of investment in the first quarter resulted in a gain of ` 20 Lakhs. The Company had apportioned
this equally to the four quarters.
Prepare the adjusted Profit before tax for the third quarter. (C.A. Final May-2015, Nov 2012) (5 Marks)
Solution:
Statement of adjusted PBT
PBT (given) 4,00,000
+ Dividend income not recorded 3,00,000
- Sales promotion expenses deferred (1500000 x 80%) (12,00,000)
+ Excess depreciation charged 9,00,000
+ Extraordinary income c/f now recorded 1,00,000
+ Excess loss on inventory write down eliminated 1,00,000
- Gain on sale of investments not related to this quarter (5,00,000)
Adjusted P B T 1,00,000
242 Accounting Standards
Problem 9: Pfizer Cosmo Limited has provided for ` 80,000 as warranty expenses for the first quarter
30/6/2009. The actual warranty claims amounted to ` 85,000. Also the warranty expenses for the second
quarter 30/9/2009 estimated at ` 70,000. Calculate the expenditure of warranty charged to profit/loss
account for the second quarter.
Also give the year to date expenditure with breakup of first and second quarter provision charged to
profit/loss a/c.
Solution: Total expenditure of warranty charged to profit/loss account for the second quarter = ` 85,000.
(includes 80,000 for second quarter and ` 5,000 change in estimate).
Year to date expenditure (cumulative) = ` 1,55,000 out of which ` 80,000 is already is charged to the first
quarter. This means 1,55,000 – 80,000 i.e. 75,000 will be net provision in the second quarter (including ‘
5,000 change in estimates)
Problem 10: A Company which has presented its quarterly results for a Limited Review Report, has
represented that expenditure incurred on heavy repairs carried in that quarter are being spread over the
entire year, since it would otherwise, distort the quarterly results Comment.
(CA Final Nov 2003 Audit) (Marks 5) (CA Final June 09 Audit) (Marks 5)
Solution: Costs that is incurred unevenly during an enterprise’s financial year should be anticipated or def
erred for interim reporting purposes. This is to be anticipated if, and only if, it is also appropriate to anticipate
or defer that type of cost at the end of the financial year.
Conclusion: Costs that are incurred unevenly during an enterprise’s financial year should be anticipated
or deferred for interim reporting purposes, if and only if, it is also appropriate to anticipate or defer that
type of cost at the end of the financial year. But, cost of major planned periodic maintenance or overhaul is
not anticipated for interim reporting purpose, unless any event has caused the enterprise have a present
obligation.
Problem 11: An enterprise reports quarterly, estimates as annual income of `10 lakhs. Assume tax rates
on 1st `5,00,000 at 30% and on the balance income at 40%. The estimated quarterly income are `75,000,
`2,50,000, `3,75,000 and `3,00,000. Calculate the tax expenses to be recognized in each quarter.
(CA final May 2011 Accounts) (Marks 4)
Solution: As per para 29(c) – Treatment of Taxes: Income Tax Expense is recognized in each interim period
based on the best estimate of the weighted average annual income tax rate expected for the full financial year.
(a) Estimated Total Income for the year: 75000 + 250000 + 375000 + 300000 = `10,00,000
(b) Estimated Total Tax Liability: Upto `5 Lakhs = 30% × `5,00,000 = `1,50,000; Next `5,00,000 = 40%
× `5,00,000 = `2,00,000. Total Liability = 1,50,000 + 2,00,000 = `3,50,000.
(c) Effective Annual Tax Rate: Total Tax Liability ÷ Total Income = `3,50,000 ÷ `10,00,000 = 35%
(d) Quarterly Tax Expense: Therefore, tax expense for each quarter —Q1, Q2, Q3, Q4 = ` 75,000 × 35% =
`26,250, ` 2,50,000 × 35% = ` 87,500, ` 3,75,000 × 35% = ` 1,31,250, ` 3,00,000 × 35% = ` 1,05,000.
Problem 12: On 30-6-2011, X Limited incurred ` 3,00,000 net loss from disposal of a business segment.
Also on 31-7-2011, the company paid ` 80.000 for Property taxes assessed for the calendar year 2011. How
should the above transactions be included in determination of net income of X Limited for the six months
interim period ended on 30-9-2011? (CA Final Nov. 2008 Marks 5) + CA Final A/Cs May 2012 Marks 5)
Solution:
Disposal of Business Segment: Net Loss of from disposal of a business segment of ` 3,00,000 should be
reported in full as the loss was incurred during the half year period.
Property Taxes: Cost charged as Expense should be allocated to interim period on accrual basis. Hence,
Property Taxes of ` 80,000 for the whole year should be apportioned as follows:
1/1/2011 – 31/3/2011 – related to last year’s prepaid ` 20,000
1/4/2011 – 30/9/2011 – 6 months quarter 1+2 ` 40,000
1/10/2011 – 31/12/2011 – prepaid for next quarter ` 20,000
CHAPTER 24
AS-26:
Intangible Assets
Chapter Outline
vv Objective and Scope vv Amortization Treatment
vv What is an Intangible Asset vv Treatment of Sale/Disposal of Intangible Asset
vv Recognition Principle of Intangible Asset vv Disclosures
DO YOU KNOW
With the introduction of AS-26 the concept of deferral (Deferred Revenue Expenditure) has been abolished…..
para 56.
244 Accounting Standards
i) Asset
An asset is an economic resource, it should be controlled by an enterprise, as a result of some past event, from
which economic benefits should flow to the enterprise.
◘◘ An economic resource - Asset should be an economic resource which gives some economic benefit.
◘◘ It should be controlled by an enterprise – Control is said to be placed only when the economic gains
flow only to the enterprise and not to others. The enterprise can restrict the access to others. There
are various ways in which case control can be exercised – by legal rights, by using passwords, or by a
legal duty on employees to maintain confidentiality.
◘◘ As a result of some past event – the asset may be either purchased or generated i.e. a past event.
◘◘ From which economic benefits should flow to the enterprise – The company should be able to reap
economic benefits from the assets. Benefits include proceeds from sale of goods, cost savings ex: use
of intellectual property reduces cost of process.
iii) Identifiable
Generally an asset is said to be identifiable if it’s separable from other assets and if enterprise could rent, sell,
exchange or distribute the specific future benefits of this assets used in revenue earning activity. For example:
If a company has got 3 brands of soap and if the company sells one of the brands without selling the business
then such sale of brand name is identifiable.
However separability is not necessary condition for identifiability, since an enterprise may be able to
identify an asset in some other way. Even if the asset is able to generate income in combination with other
assets it is enough to identify such asset as an intangible asset. For example: Where an enterprise acquires a
travel agent business and apart from paying consideration for the net assets of the business, pays ` 1 crore as
non – competing fees. Such non – compete fees can be said to be identifiable.
DO YOU KNOW
Unlike Old Schedule VI, the New Schedule III has a speical classification for Intangible Asset under the Sub –
Head Non – Current Asset as a Fixed Asset.
incurred towards generating such intangible assets cannot be capitalized. Cost incurred is divided
into two phases:
(a) Research phase: Research Phase means and includes expenses incurred to create or to invent
some new product. Research expense should not be recognized as cost because the expenses
cannot be translated into future economic benefits. As per AS – 26 expenses incurred during the
Research Phase should be expensed.
(b) Development phase: It is the activity which converts the research product into a marketable
commodity. Development cost can be capitalized if the product meets asset criteria. Otherwise
such costs are also to be expensed. The company should be able to demonstrate that the expenses
incurred towards development phase as an asset.
Expenditure on research (or the research phase of an internal project) is to be written off as an expense as
and when incurred, as it is not possible to demonstrate that an asset exists that will generate future economic
benefit. Examples include
◘◘ Activities aimed at obtaining new knowledge
◘◘ The search for, evaluation, and selection of applications of research findings or knowledge
◘◘ The search for alternatives for materials, devices, products, systems, or processes
◘◘ The formulation, design, evaluation, and selection of possible alternatives for new or improved mate-
rials, devices, products, systems, or processes
Development expenditure may be recognized as an intangible asset when, and only when, all of the
following can be demonstrated: (Para 44)
◘◘ The technical feasibility of completing the asset so that it will be available for use or sale
◘◘ The intention to complete the asset and use or sell it
◘◘ The ability to use or sell the asset
◘◘ How the asset will generate probable future economic benefit, including demonstrating a market for
the asset’s output, or for the asset itself, or the asset’s usefulness
◘◘ The availability of sufficient technical, financial, and other resources to complete the development and
to use or sell the asset
◘◘ The ability to reliably measure the expenditure attributable to the asset during its development.
Amortization Treatment
i) Amortization
It is the process of allocating cost of intangible asset over its useful life. Depreciable amount of intangible
asset should be allocated on a systematic basis over the best estimates of its useful life.
v) Residual value
Residual value is usually taken as zero. Except when active market exists for intangible assets or third party
is willing to buy at the end of its economic life.
AS-26: Intangible Assets 249
Disclosures
The financial statements should disclose the following for each class of intangible assets:
1. The useful lives or the amortization rates used
2. The amortization methods used
3. The gross carrying amount and the accumulated amortization (aggregated with accumulated
impairment losses) at the beginning and end of the period.
4. A reconciliation of the carrying amount at the beginning and end of the period showing:
(i) Additions, indicating separately those from internal development and through amalgamation
(ii) Retirements and disposals
(iii) Impairment losses recognized in the statement of profit and loss during the period, if any
(iv) Impairment losses reversed in the statement of profit and loss during the period, if any
(v) Amortization recognized during the period
(vi) Other change in the carrying amount during the period.
Problem 1: Rotex Pharma comes up with a formulation that destroys pests immediately. It is in the form
of a gel/paste, which is highly effective. The company does not have a patent for this product but it keeps
the ingredients a secret. These ingredients are not printed on the package of the product. Can the company
regard the knowhow as an intangible asset?
Solution: Yes the know – how is an intangible asset because the company has got control on the use of
intangible asset. The company can control the future economic benefits from this know-how even without
taking the patent because the ingredients of the content of the gel/paste are not printed.
Problem 2: An enterprise has a portfolio of customers and a market share and expects that, due to its efforts
in building customer relationships and loyalty, the customers will continue to trade with the enterprise. Can it
recognise portfolio customers, market shares, customer relation-ships, customer loyalty as intangible assets?
Solution: Market share, customers lists are not intangible assets because a company cannot control the
future economic benefits arising from the loyalty of customers, market share. There are enough competitors
who can share the market economic benefits. And no one can have any control on the geographical area
(market share).
Problem 3: Logifirms Pvt. Limited is developing a new production process. During the year 2006,
expenditure incurred was ` 10 lakhs, of which ` 9 lakhs was incurred before 1st December, 2006 and 1 lakh
was incurred between 1st December, 2006 and 31st December, 2006. The enterprise is able to demonstrate
that, at 1st December, 2006, the production process met the criteria for recognition as an intangible asset.
Comment? (C.A. Final May 2008)
Solution: As per AS-26 expenses incurred for R & D has to be expensed. And expenses incurred at the
development phase should be capitalised only if one is able to demonstrate that the development stage has
met the criteria for recognition of an intangible asset. In the present case only ` 1,00,000 can be capitalised
as costs of intangible and ` 9,00,000 has to be expensed.
Problem 4: Cipla Ltd. has a patent for a particular product. A case has been filed against the company
by another party claiming that it is the rightful owner to that patent and that the company has copied and
infringed its patent. The company has incurred heavy legal expenditure to the tune of ` 15 lakhs to defend the
suit the company eventually won the suit. The company has capitalized this expenditure as part of the cost of
the patent. Do you agree with this accounting treatment?
Solution: As per AS-26 subsequent expenditure incurred on intangible asset can be capitalised only when
such expenditure increases the efficiency or life of the asset. In the present case the company has incurred
` 15,00,000 to defend the suit and not to improve the earning capacity of the asset. Hence ` 15,00,000 has to
be expensed immediately.
Problem 5: An enterprise has purchased an exclusive right to generate hydro-electric power for 40 years.
The costs of generating hydro-electric power are much lower than the costs of obtaining power from
alternative sources. It is expected that the geographical area surrounding the power station will demand a
significant amount of power from the power station for at least 40 years.
Solution: As per AS-26 the life of the intangible asset is to be assumed as 10 years. But any longer or shorter
life can be justified. In the present case the company the life of the asset is taken as 60 years because there
is significant demand in the next 40 years for the electricity. Hence, amortization of cost of right to generate
electricity is to be taken as 40 years.
Problem 6: A company with a turnover of ` 250 crores and an annual advertising budget of ` 2 crore had
taken up the marketing of a new product. It was estimated that the company would have a turnover of ` 25
AS-26: Intangible Assets 251
crores from the new product. The company had debited to its Profit and Loss account the total expenditure of
` 2 crore incurred on extensive special initial advertisement campaign for the new product. Is the procedure
adopted by the company correct? (C.A. Final Nov 2003 & Nov. 2006) (4 Marks)
Solution: Advertisement expense is sales promotion expense. Such expenditure should not be capitalized
as an be capitalized as cost of asset as per AS-26. Sales expenses are to be excluded from costs of Intangible
Assets. Advertisement expense may be deferred or expensed but cannot be capitalized. But even the concept
of deferral (deferred revenue exp.) has been abolished now …..para 56.
Problem 7: B Pvt. Ltd., implements a Voluntary Retirement
st
Scheme (VRS) for its employees. It follows a
policy of amortising the expenditure over 10 years. As at 1 April, 2004, the unamortised VRS expenditure
was ` 15 lakhs. During the year 2004-05, it incurred further ` 12 lakhs as VRS. For the year ended 31st March,
2005, the company proposes to revise the period of amortisation to 5 years. It also proposes to follow the
revised period for the opening balance. (C.A. Final May 2005) (5 Marks)
Solution:
Expenditure on Voluntary Retirement Scheme: Termination benefits are employee benefits payable as a
result of either an enterprises’ decision to terminate an employee’s employment before the normal retirement
date; or an employee’s decision to accept voluntary redundancy in exchange for those benefits (voluntary
retirement). Accordingly, Voluntary Retirement Scheme (VRS) is one form of termination benefit and hence
AS 26 principles are not applicable. The same has to be, therefore, accounted as per AS-15 (Rev). But both
standards i.e. AS-26 and AS-15 (Rev) now wants VRS expenditure should be written off immediately. When
to record VRS expense is governed by AS-29.
Problem 8: Camlin Ltd. acquired assets and liabilities of Carlin Ltd. for a consideration of ` 6,00,000,
discharged in the form of 40,000 equity share ` 10 each at ` 15 per share. Following is the carrying amount
and fair value business Assets & Liabilities is as below:
Assets/Liabilities Carrying amount Fair Value
(1) Fixed Assets 8,97,000 8,90,000
(2) Current Assets 2,95,000 2,80,000
(3) Loan 5,50,000 5,50,000
(4) Creditors 50,000 50,000
Carlin Ltd. has a Patent right. The patent was not recognised because the company did not have the
resources necessary to make use of it. Record Amalgamation entries in the books of Camlin Ltd. in each of the
following 4 cases:
(A) Patent’s Fair Value = ` 25,000
(B) Fair Value of patent is not determinable.
(C) Fair Value patent is 35,000 but no active market for such patent exist.
(D) Neither Fair Value is determined nor active market exists.
Solution:
As it is a case of amalgamation PC = 40,000 × 15 = ` 6,00,000
Case A: In case of amalgamation, if the P.C. is determined/paid by net payments method – and amalgamation
is in the nature of purchase the intangible asset (ex.: patents, rights & not goodwill) has to be recorded at
fair – value if such intangible asset meets the recognition criteria.
252 Accounting Standards
Journals:
(1) Business Purchase Dr. 6,00,000
To Liquidator of Carlin Ltd. 6,00,000
(2) Fixed Assets Dr. 8,90,000
Current Assets Dr. 2,80,000
Patents Dr. 25,000
Goodwill Dr. (b.f.) 5,000
To Loan 5,50,000
To Creditors 50,000
To Business Purchase 6,00,000
(3) Liquidator of Carlin Ltd. Dr. 6,00,000
To Equity Share Capital 4,00,000
To Securities Premium 2,00,000
Case B: If the fair – value of the intangible asset cannot meet the recognition criteria then it is to be included
in the goodwill arising on amalgamation.
Journals: (Entry no. 1 and 3 remains same)
In Entry no 2 Goodwill be the balancing figure i.e. ` 30,000 and patent is a part of G/W.
Case C: If there is no active market for an intangible asset acquired in an amalgamation in the nature of
purchase, the cost initially recognized for the intangible asset is restricted to an amount that does not create
or increase any capital reserve arising at the date of the amalgamation.
Journals: (Entry no. 1 and 3 remains same)
In Entry no 2 Patent will be recorded maximum ` 30,000 to the extent it does not create Capital Reserves.
Case D: No patent will exist at all.
Problem 9: Infopark Ltd. acquired for its internal use a software on 28.01.2012 from USA for US $1,00,000.
The exchange rate on that date was ` 50 per US $. The seller allowed trade discount of 5%. The other expenditure
were: (i) Import duty : 20%, (ii) Purchase tax : 10%, (iii) Entry tax 5% (refundable), (iv) Installation expenses:
` 25,000, (v) Professional fees for Clearance from Customs: ` 20,000. Compute the cost of software as per
AS-26. (C.A. Final RTP and IPCC Nov 2012 Marks 4)
Solution:
Purchase cost $1,00,000
(–) Trade discount ($5,000)
95,000
Rupee equivalent value ($ 95,000 × ` 52) 47,50,000
(+) Import duty @20% 9,50,000
57,00,000
(+) Purchase tax 10% 5,70,000
(+) Installation expenses 25,000
(+) Professional fees for clearence 20,000
Cost of Software Capitalised (`) 63,15,000
then. The net cash flows from the product during these 5 years were expected to be ` 36,00,000, ` 46,00,000,
` 44,00,000 ` 40,00,000 and ` 34,00,000. Find out the amortization cost of the patent for each of the years.
(C.A. Final May 2006) (4 Marks)
Solution:
The whole problem is divided into three parts:
(i) Transitional provisions
(ii) Amortization period
(iii) Amortization method
(i) Transitional provisions:
Position of patents at the end of second year:
Total Cost amortized (as per the companies policy) = 10,00,000 × 2 = ` 20,00,000
Total Cost to be amortized (as per AS-26) = 16,00,000 × 2 = ` 32,00,000
Transitional adjustment = ` 12,00,000
Opening Reserves A/c. Dr. 12,00,000
To Cost of Patents 12,00,000
(ii) Amortization period: It is clearly given in the problem that the revised life of the intangible asset is yet
another 5 years. This means the costs of patents will be written off in the next 5 years.
(iii) Amortization method: If the enterprise can reasonably estimate the pattern of revenues or benefits, the
cost of intangible should be amortized on the same pattern.
Following is the apportionment of Costs of Patents:
Problem 11: Pfizer is developing a hepatitis vaccine compound. Sun Pharma is developing a measles
vaccine compound. Pfizer and Sun enter into an agreement to swap these two products. Under the terms
of the agreement, Pfizer will retain the marketing rights to its drug for all Asian countries. The fair value of
Pfizer’s compound has been assessed as 3 million, including 0.2 million relating to the Asian marketing rights.
The carrying value of the compound is 0.5 million. Pass the journal Entry for exchange of intangible assets.
Solution:
Pfizer’s management should recognise the compound received at the far value of the compound given up.
Even gain has to be recorded on sale of hepatitis vaccine compound.
Journal Entry:
Rights for Measles Vaccine Compound Dr 2.8 million
To Rights for Hepatitis Vaccine Compound a/c 0.5 million
To Profit on sale a/c 2.3 million
Profit on sale = 2.3 million = (2.8 – [0.2/3] x 0.5)
254 Accounting Standards
Problem 12: Sun Pharma Limited is engaged in research on a new process design for its product. It had
incurred an expenditure of ` 530 lakhs on research upto 31st March, 2015.
The development of the process began on 1st April, 2015 and Development phase expenditure was ` 360
lakhs up to 31st March, 2016 which meets assets recognition criteria.
From 1st April, 2016, the company will implement the new process design which will result in after tax
saving of ` 80 lakhs per annum for the next five years.
The cost of capital is 10%
Explain:
(i) Accounting treatment for research expenses.
(ii) The cost of internally generated intangible asset as per AS 26.
(iii) The amount of amortization of the assets (The present value of annuity factor of ` 1 for 5 years
@ 10% = 3.7908)
Solution:
Research expenses: As per AS-26 the expenditure on research of new process design for its products
530 lakhs is to be charged to P/L accounts. ………..para 41.
Cost of internally generated intangible asset: As per the question the development costs meet the asset
recognition criteria on 31/3/2016. As per AS-26 for measurement purpose such internally generated
intangible asset can be capitalized by discounting the cash flows:
PV of savings after tax = 80 lakhs × 3.7908 = ` 303.26 lakhs; But the cost incurred on development phase
is ` 360 lakhs. Therefore the difference of (360 – 303.26) = ` 56.74 lakhs will be charged to P/L account. After
capitalizing the cost of asset ` 303.26, the company has to amortize this cost for the next 5 years. Annual
amortization will be ` 60.65 lakhs.
Problem 13: X Ltd is engaged in the business of Newspaper and Radio Broadcasting. It operates through
different brand names. During Financial Year 2012–2013, it incurred substantial amounts on external trade,
business communication and branding expenses by participation in various Corporate Social Responsibility
initiatives. The Company expects to benefit by this expenditure by attracting new customers over a period of
time and accordingly it has capitalized the same under Brand Development Expenses and intends to amortize
the same over the period in which it expects the benefits to flow. As the Statutory Auditor of the Company, do
you concur? Give reasons. (CA Final Nov. 2013, Marks 4)
Solution:
Assumption 1:
All the Broadcasting Brands are purchased one: Yes the Brands are Intangible assets as per AS-26.
Purchased Brands are intangible assets.
Assumption 2:
All the Broadcasting Brands are internally generated: As per AS-26 internally generated brands, goodwill,
publishing titles and mastheads are not intangible assets…………….. para 50
Now let’s talk about the expenses on promotion and branding development.
Whether the brands are purchased one or internally generated in all such cases expenses on brand building
has to be charged to profit / loss account.
AS-26 has prohibited Selling and Advertisement expenses to be either deferred or capitalized. The
company is incorrect in its contention.
Problem 14: During the financial year 2014-15, Power Ltd. had the following 8 transactions:
(i) On 01.04.2014, Power Ltd. purchased a new asset of Dark Ltd. for `11,40,000. The fair value of Dark
Ltd.’s identifiable net assets was ` 8,50,000. Power Ltd. is of the view that due to popularity of Dark
Ltd. ‘s product, the life of goodwill is 10 years.
AS-26: Intangible Assets 255
(ii) On 01.05.2014, Power Ltd. purchased a franchise to operate transport service from the Government
for ` 12,00,000 and at a annual fees of 4% of transport revenues. The franchise expires after 5 years.
Transport Revenue were ` 1.20,000 for Financial Year 2014-15. Power Ltd. projects future revenue
of ` 2,40.000 in 2015-16 and ` 3,50,000 p.a. for 3 years thereafter.
(iii) On 05.07.2014, Power Ltd. was granted a patent that had been applied for by Dark Ltd. During 2014-
15. Power Ltd. incurred legal cost of ` 1,10,000 to register the patent- and an additional ` 3,00,000 to
successfully prosecute a patent infringement suit against a competitor. Power Ltd. expects the patent’s
economic life to be 10 years. Power Ltd. follows an accounting Policy to amortize all intangibles on
SLM basis over a maximum period permitted by Accounting Standard taking a full year amortization
in the year of acquisition.
Prepare:
a. A Schedule showing’ the intangible section in Power Ltd. balance sheet at 31st March, 2015.
b. A Schedule showing the related expenses that would appear in the Statement of Profit and Loss of
Power Ltd. for 2014;.15.
Solution:
(i) The excess of consideration paid over the Fair Value of identifiable Net Assets is recognized as
Goodwill. Hence, Goodwill = 11,40,000 – 8,50,000 = ₹ 2,90,000.
As per AS-14 Goodwill is written off over 5 years. But a higher period is allowed only when it can be
evidenced by robust proof.
Amortisation p.a. = 290000 / 10 = ₹ 29,000.
(ii) Franchise fee ₹12,00,000 would be recognized as Intangible Asset. The Annual Amortization should
be allocated over the assets useful life, on a systematic basis i.e. SLM basis or Ratio of Revenues to
be earned. As per AS-26 it is more appropriate to compute amortization on the basis of production /
cash flow ratio and not SLM.
In this case cash flow ratio = 120:240:350:350:350
Therefore the Amortisation will be: Year (1-5) = ₹1,02,128, ₹ 2,04,256, ₹2,97,872 each of the next 3
years.
Alternatively, Amortisation p.a. under SLM = 12,00,000 ÷ 5 = 2,40,000.
(iii) Cost of Patent as per AS – 26 = Registration + Directly attributable Cost = 1,10,000 + 3,00,000 = ₹
4,10,000. Amortisation p.a. = 4,10,000 ÷ 10 years = 41,000.
Balance Sheet as on 31/3/2015 (Extract)
Assets:
Non – Current Assets:
Goodwill (2,90,000 – 29,000) 2,61,000
Transport license (12,00,000 – 1,02,128) 10,97,872
Patents (4,10,000 – 41,000) 3,69,000
17,27,872
Chapter Outline
vv Scope and Objective vv Corporate Assets
vv Meaning of Impairment vv Reversal of Impairment Loss
vv Meaning of Some Terms Relating to Impairment vv Reversal of Impairment Loss of an Individual Asset
vv Impairment Loss vv Reversal of Impairment Loss of a CGU
vv Symptoms of Impairment of Assets vv Transitional Provisions
vv Impairment of Individual Asset vv Disclosures
vv Impairment of Cash Generating Unit
Scope
Impairment of Assets applies to which type of Assets?
Impairment of Assets specially applies to “Operating Fixed Assets”
Fixed Assets can be “Tangible/Intangible Assets”
Fixed assets can be carried at historical cost/Revalued figure
DO YOU KNOW
Intangibles gets impaired faster as compared to Tangible assets during recession.
Meaning of Impairment
Impairment of Assets means decrease in the carrying amount of the assets. It is provided only when carrying
value of asset exceeds recoverable amount. It is debited to P & L Account as a normal expense. It is a provision
of loss in addition to normal depreciation. However, one should not get confused between Depreciation and
Impairment. Following is the differentiation:
◘◘ Net Selling Price (NSP): NSP is the amount obtained from selling an asset less its costs of disposal. It
excludes finance cost and income tax. Examples of costs of disposal are legal costs, costs of removal of
assets. Termination benefits related to reorganizing a business following the disposal of asset are not
direct costs related to the disposal of assets, hence not to be included.
IAS 36 sets out how an entity should determine the fair value less costs to sell. The Standard sets out
these examples:
• Where there is a buying and selling agreement, the price in that agreement less the costs to sell can
be used.
• The price in an active market less the cost of disposal can be used.
• The fair value less costs to sell can be based on the best information available which reflects the
proceeds that could be obtained from the disposal of the asset in an arm’s-length transaction.
• As per AS-28/IAS-36 best evidence is the price in a binding sale agreement in an arm’s length
transaction adjusted for the costs of disposal
NSP = Sale Value – Cost of disposal
◘◘ Value in Use (VIU): Value in use is the sum of the present value of future cash flows from continuing
use of the asset and its residual value at the end of its useful life.
VIU = PV of Assets (Future Cash flows + Residual value)
Impairment Loss
Asset is said to be impaired when recoverable amount of the asset is less than its carrying amount. It means
that if recoverable amount of the asset is more than its carrying amount then there is no impairment.
Impairment loss = Carrying Amount – Recoverable Amount
DO YOU KNOW
Impairment loss is a timing difference as per AS-22.
◘◘ Internal factors: *Obsolescence or physical damage of an asset. For example: Devastating Fire damages
the major portion of the assets.
ww The asset is not used in the manner it is expected to be used. For example: Benches and desks
used in schools gets impaired fast than used in Offices and Halls.
ww Continued Cash losses or Budgeted losses etc.
DO YOU KNOW
Impairment loss is an exceptional item and not extra-ordinary item for AS-5
would incorporate the vehicles into the cash-generating unit to which they belong and estimate the
recoverable amount of that cash-generating unit.
Example: Cosy and comforts is in the hotel business. They have installed Sony LED in each room for elite
customers. The initial costs was ` 2,50,000 for each unit. After 1 year the carrying value is ` 2,00,000. The
market value has fallen down due to competitors coming out with similar product at a much lower price.
Hence here impairment is obvious. One has to calculate NSP of the LED’s for impairment loss.
After understanding the meaning of CGU lets see how to calculate Impairment loss for a CGU. Recognition
of Impairment loss for a CGU will depends upon whether Goodwill is allocable or unallocable. Following are
some of the situations:
Situation 1: No Goodwill stands in the books of accounts.
If a company has no Goodwill, Impairment loss of a CGU is similar to what we have seen in case of single asset.
The impairment loss of the total CGU is to be allocated between the individual assets on a pro-rata basis.
Situation 2: Goodwill stands in the books of accounts and allocable to CGU.
In this second situation where Goodwill can be allocated to CGU, Carrying Amount of Tangible Assets is to
be increased by allocating GW. Now comparing Total Carrying Amount of CGU with Recoverable Amount of
CGU will give us Impairment loss. Wipe off the Impairment loss first against GW then the balance apportion
against Tangible Assets. This approach is known as bottom-up test.
Word of caution: Ensure that; after allocating Impairment loss to individual assets the Carrying Amount of
such individual asset should not be less than the higher of {NSP, VIU, 0}.
Situation 3: Goodwill stands in the books of accounts but not allocable to CGU.
In this third situation it finds improper or impossible to allocate Goodwill to CGU. Then we have to go
for the next larger CGU in such a way that GW can be allocated. If still GW is not allocable, the search for the
next larger CGU should continue. Finally a position will come where the whole enterprise will be treated as
a CGU and GW will be totally allocable to the whole enterprise. Now the total carrying amount (CGU+GW)
will be compared to the Recoverable value. First adopt bottom up test without goodwill on all the CGU’s and
then calculate impairment at total level which includes Assets + G/W (which is unallocated). If total carrying
amount exceeds recoverable amount then impairment should be written off against unallocated goodwill.
As such CGU’s will not be impaired as they are already impaired by bottom up test (refer special problem on
Narang Ltd).
DO YOU KNOW
If a particular CGU is not impaired (i.e. Recoverable Amount > Carrying Amount), then the assets within the
CGU are also not impaired even though any one of the asset is showing impairment signs. It means provision
for impairment loss depends upon the CGU in totality and not the individual asset included in the CGU.
Corporate Assets
Corporate Assets include group or divisional assets such as the building of a headquarters, office premises,
division of an enterprise, EDP equipment or a research centre.
Features of Corporate Assets:
◘◘ They contribute towards the cash flows of CGU under review and even other CGU’s.
◘◘ Their cash flows are largely dependent on other assets or group of assets.
◘◘ Their Carrying Amount cannot be fully attributed towards the CGU under review.
◘◘ Corporate Assets do not generate separate cash inflows; the recoverable amount of an individual
corporate asset cannot be determinable unless management has decided to dispose of the asset.
262 Accounting Standards
Impairment loss for a Corporate asset is not same as Goodwill. In case of Corporate assets the loss will be
shared between the CGU and Corporate assets on pro rata basis. Yes both bottom up and top down approach
is applicable on Corporate assets also (refer special problem on Rahul Ltd).
External Factors
◘◘ Market Value of the asset may have increased. For example: The Congress Government introduces
once again the Khadi system in 2004. Definitely Khadi Industries/Machines will be in high demand.
Helmet was mandatory in 2007 which encourages the production of helmet.
◘◘ Decrease in market expectation rates of return which increases the discount rate.
Internal Factors
◘◘ Evidence that economic performance of the asset is better than expected.
◘◘ Use of the asset in a manner, which maintains the current condition of the asset in a proper manner.
One should remember the following points for the Reversal of Impairment loss of individual asset:
DO YOU KNOW
Restrictions placed on carrying amounts not to be increased as previously stated is because any increase in
carrying amounts more than the restrictions placed will give rise to recognition of unrealized gains. → Concept
of Prudence.
Disclosures
Disclosures are categorized into four forms:
(a) Disclosures for each class of Assets:
(i) Amount of impairment loss debited to profit and loss account.
(ii) Amount of impairment loss reversed back (credited) to profit and loss account.
(iii) Amount of impairment loss adjusted against revaluation reserves.
(iv) Amount of impairment loss reversed back (credited) to revaluation reserves.
◘◘ Disclosures for CGU:
Where the amount to be disclosed is material for reporting purposes then following is to disclosed:
(i) Events and circumstances, which led to impairment loss and its reversal.
(ii) Amount of impairment loss recognized or reversed.
(iii) Nature of individual asset and reportable segment to which it belongs.
(iv) Description of CGU in terms of: whether it is a product line, segment, a unit, or a plant etc.
(v) Amount of impairment loss recognized or reversed by reportable segment as per enterprise’s
primary format (as defined in AS-17).
(vi) Change in Composition of CGU.
◘◘ Disclosures for both individual asset as well as Cash Generating Unit:
264 Accounting Standards
Impairment No
No Review
condition exist
Yes
No
NSP VIU CA > NRA No Impairment
Yes
Cash Discount
Impairment =
Flows rate
[CA – NRV]
Binding Sale Active
agreement Markets
Problem 1: Venus Limited has an asset which is carried in the B/S on 31-03-2005 at ` 500 lakhs. As at the
date the value in use is ` 400 lakhs and the NSP `375 lakhs. From the above data: (a) Calculate Impairement
loss, (b) Pass Journals.
(C. A. Final Nov. 2005)
Solution:
Value in Use = ` 400 lacs, NSP = ` 375 lacs.
Recoverable amount = Higher of VIU or NSP = ` 400 lacs.
Carrying amount of asset = ` 500 lacs.
Hence Impairment loss = Carrying amount - Recoverable amount
AS-28: Impairment of Assets 265
(iii) Yes the whole multiplex is the CGU. The individual facilities are not capable of generating revenues.
The multiplex in combination with other assets can generate revenues.
(iv) Since the cash flows from the plants are inter-dependant, the enterprise itself is the smallest unit of
group of assets generating independent cash flows.
Problem 5: A publisher owns 150 magazine titles of which 70 were purchased and 80 were selfcreated.
The price paid for a purchased magazine title is recognised as an intangible asset. The costs of creating
magazine titles and maintaining the existing titles are recognised as an expense when incurred. Cash inflows
from direct sales and advertising are identifiable for each magazine title. Titles are managed by customer
segments. The level of advertising income for a magazine title depends on the range of titles in the customer
segment to which the magazine title relates. Management has a policy to abandon old titles before the end of
their economic lives and replace them immediately with new titles for the same customer segment.
What is the cash-generating unit?
Solution: It is likely that the recoverable amount of an individual magazine title can be assessed. Even though
the level of advertising income for a title is influenced, to a certain extent, by the other titles in the customer
segment, cash inflows from direct sales and advertising are identifiable for each title. In addition, although
titles are managed by customer segments, decisions to abandon titles are made on an individual title basis.
Therefore, it is likely that individual magazine titles generate cash inflows that are largely independent
one from another and that each magazine title is a separate cash-generating unit.
Problem 6: G Ltd. acquired a machine on 1st April 2005 for ` 7 crore that had an estimated useful lifest
of 7 years. The machine is depreciated on straight line basis and does not carry any residual value. On 1
April 2009 the carrying value of the machine was re-assessed at `5.10 crore and the surplus arising out
of the revaluation being credited to revaluation reserve. For the Y.E. March 2011 conditions indicating an
impairment of the machine existed and the amount recoverable ascertained to be only ` 79 lakhs. You are
required to calculate the loss on impairment of the machine and show how this loss is to be treated in the
books of G Ltd. G Ltd. had followed the policy of writing down the revaluation surplus by the increased charge
of depreciation resulting from the revaluation.
(CA final Nov 2011 A/C Marks 4, Similar problem June 2009 Marks 5,
Similar qt in May 2013 Marks 5)
Solution:
` crores
Cost of the Asset on 1/4/2005 7
(–) Depreciation for 4 years (7/7 × 4) (4)
Carrying amount on 1/4/2009 3
Revaluation of asset 5.10
Revaluation reserve 2.1
Now, Carrying amount of asset on 31/03/2011 [A] 1.70
(5.10 – [5.10/3] × 2)
Recoverable Amount (RA) [B] 0.79
Impairment loss [A – B] 0.91
Less: Revaluation reserve balance left out (2.1 – [2.1/3] × 2) (0.70)
Net charged to P/L 0.21
AS-28: Impairment of Assets 267
Problem 7: Radar Ltd. enters into an agreement to dispose one of its plant, whose carrying amount is
` 60,000 at ` 70,000. Radar Ltd. is expected to incur the following costs to effect the sale:
Repairs ` 1,500, Legal charges ` 3,000, Freight & Carriages ` 200. Capital gains tax ` 1,000. Compute NSP.
Solution:
NSP = Sale Value – *Cost of disposal = 70,000 – 4,700 = `65,300
*Cost of disposal =1,500+3,000+200 = ` 4,700. Cost of disposal includes all direct costs incurred to effect
sale except Tax expense.
P roblem 8: Goosers Limited let out land on rental basis as a parking space as a result of which there is
impairment. However, the landowner argues that an impairment provision is not required since the land
will be soon converted into a bowling alley, a highly profitable business? Is that argument acceptable for not
making an impairment provision?
Solution: As per para 36 of AS-28, future cash flows for Impairment Loss is to be calculated for the asset
under current condition. Future restructuring costs are not to be considered for calculating cash flows. Any
future use of the asset is not to be considered unless that change is fully committed to. Therefore impairment
loss is to be provided is required to be provided.
P roblem 9: United Ink and Varnish Ltd. has an ink processing machine costing ` 20,00,000 (01.04.2006). As
on 31.03.2008 the company went for impairment of the machine. The recoverable amount as on 31.03.2008 is
` 9,00,000. Depreciation rate 25%. The Company goes for SLM method of Depreciation but as per Income Tax
WDV method is allowed. Corporate Tax @35%. Calculate Impairment Loss, DTL/DTA, Future Depreciation
per annum for United Ink and Varnish Ltd.
(CA Final May 2012) (5 Marks)
Solution:
Workings:
(a) Calculation of Carrying Amount as on 31.03.2008:
As per
Books Income Tax
Cost 20,00,000 20,00,000
Less: Depreciation for 2006-2007 – 5,00,000 – 5,00,000
WDV as on 31.03.2007 15,00,000 15,00,000
Less: Depreciation for 2007-2008 – 5,00,000 – 3,75,000
WDV as on 31.03.2008 10,00,000 11,25,000
Problem 10: NARANG PVT. LTD. has 3 UNITS (CGUs) A, B, C. Goodwill appearing in the books of Narang Ltd.
is ` 40 crores. Compute Impairment Loss for CGU:
(i) Assuming goodwill is allocable
(ii) Goodwill is not allocable.
Solution:
(i) This method is known as bottom-up test . The total impairment loss is first apportioned towards
write off G/W then balance towards CGU/asset.
(ii) As the GW is not allocable we have to apply Top down approach. But first apply bottom-up test
without allocating GW.
Particulars `lakhs
Book value on 31.3.2008 = carrying amt on 31.3.2007 + expenditure in 07-08 = (28 + 80) 108
Less: Recoverable amount 72
Impairment loss to be charged to P & L A/c 36
Carrying value of intangibles as on 31.03.2008: the production process will be shown at book value `108
lakhs, or recoverable amount `72 lakhs, whichever is less, i.e. `72 lakhs. Amount charged to P/L will be
36lakhs
Problem 12: Rahul Industries Ltd. has three cash-generating units A, B and C. The carrying amount of assets
as on 31.3.2005 of A, B and C is ` 400 lacs, ` 600 lacs and` 800 lacs respectively. Due to adverse technological
changes effecting activities of the company, the company conducts an impairment test of each of its cash-
generating units on 31.3.2005.
The Company has corporate assets comprising Head Office building of ` 600 lacs and Research and
Development (R&D) Centre of ` 200 lacs. The carrying amount of building can be allocated on reasonable
basis but R&D centre cannot be allocated on reasonable basis to the cash-generating units. The remaining
useful life of CGU “A” is 10 years and B and C is 20 years. The Head Office assets are depreciated on straight-
line basis.
The Net selling price of each cash-generating unit is not determinable. Hence recoverable amount is based
on “value in use”; 15% discount rate is to be considered.
Calculate impairment loss to be recognised in financial statement for the year ended 31.3.2005 and
allocation of impairment loss. Also calculate the revised carrying amount of assets of all cash-generating
units.
Future cash flow for A, B and C and for the company as a whole at the end of 31.3.2005 is as follows :
` in lacs
Solution:
Note: The carrying amount of Head Office building can be allocated on reasonable and consistent basis to the
cash-generating units under review and hence a ‘bottom up’ test is necessary.
The carrying amount of R & D Centre cannot be allocated on a reasonable basis to the individual cash-
generating units therefore a ‘top down’ test will be applied in addition to ‘bottom up’ test.
Step 1: Allocation of carrying amount of the H.O. building ` in lacs
Year Future cash flow Annuity factor @ 15% Discounted cash flow
For CGU “A”
1 to 5 140 3.352 469
6 to 10 200 1.666 333
Value in use 802
For CGU “B”
1 to 5 100 3.352 335
6 to 10 130 1.666 215
11 to 20 82 1.239 102
Value in use 652
For CGU “C”
1 to 5 120 3.352 402
6 to 10 240 1.666 400
11 to 20 230 1.239 286
Value in use 1088
For Rahul Ltd as a whole
1 to 5 370 3.352 1240
6 to 10 650 1.666 1083
11 to 20 446 1.239 553
Value in use 2876
Note: Discounted rates are mentioned in total for 1 to 5 years as annuity factor (0.870 + 0.756 + 0.657 + 0.572 + 0.497 = 3.352)
Step 3: Impairment test - Bottom up
Year-end 31.3.2005 A B C
(a) Carrying amount (After allocation of building) 475 825 1100
(b) Recoverable amount (value in use; NSP not available) 802 652 1088
(c) Impairment loss 0 (173) (12)
Step 4: Allocation of impairment loss to cash-generating units B and C only ( ` in lacs)
Step 5: As the R & D Centre is not allocable on reasonable basis to GGU’s A, B and C, the top down test for
impairment is done by considering the carrying amount of larger cash-generating unit to which R & D Centre
can be allocated i.e. Company as a whole. (` in lacs)
Note:
The impairment loss of only ` 185 lacs is to be recognised in financial statement and allocated to B, C and
Building of `126, 9 and 50 respectively, resulting in revised carrying amount of
(i) CGU “A” - ` 400 lacs (iv) Building - ` 550 lacs
(ii) CGU “B” - ` 474 lacs (v) R & D - ` 200 lacs
(iii) CGU “C” - `791 lacs (vi) Total - ` 2415 lacs
Problem 13: JUBILEE LIMITED acquired business of LIFTINGS LIMITED as on 01.01.1999 by issuing
10,000 Equity Shares of ` 100 each. Net Assets acquired is ` 9,50,000.
On 31.12.2002 due to government reforms, which badly affected their production line, it had to carry out
impairment programme. The manufacturing plant is the only cash-generating unit for the company. Its useful
life is 10 years. The plant is so specialized that its NSP could not be determined. For Recoverable Amount, its
Value in Use is calculated @15%. Estimated VIU is ` 5,10,000.
But, in 2004 the government withdrawn the restrictions on the contrary some incentives and rebates
were provided. JUBILEE LIMITED re-estimated the recoverable amount in 2004, which was estimated at `
3,80,000.
You are required to:
(a) Compute impairment loss in 2002.
(b) Carrying Amount as on 2004 after reversal of loss.
Solution:
(a) Computation of Impairment loss in 2002.
P roblem 14: SMC Limited is having a Plant (an Asset) whose Carrying Amount as on 01–10–2012 is `
38,000 Lakhs and the Plant was having a useful life till 31–03–2020. The estimated Residual Value is ` 900
Lakhs. The Selling Price on 31st March 2015 is expected to be ` 20,000 Lakhs and the Cost of Disposal is
expected to be ` 100 Lakhs.
The Expected Cash Flows from the Plant are as under –
Financial Year 2015–2016 2016–2017 2017–2018 2018–2019 2019–2020
Cash Flow ` Lakhs 4,100 5,900 6,000 7,800 4,500
The Company expects the Discount Rate of 10%. Discount Factor at 10% for 1, 2, 3, 4 and 5 years are
0.909, 0.826, 0.751, 0.683 and 0.621 respectively. The Company provides depreciation on SLM basis.
You are required to determine as at 31st March 2015:
(i) Value in Use of the Plant
(ii) Impairment Loss, if any, to be recognized for the year.
(iii) Revised Carrying Amount for the Financial Year ending 31st March 2015. (CA Final May. 2015)
Solution: Original Cost 38,000.00
Less: Depreciation for 2012–2013, 2013–2014 and 2014–2015 (12366.68) = Carrying Amount
on 31.03.2015 before Impairment = ` 25,633.33 lakhs.
Recoverable Amount (Net Selling Price 19,900 [or] Value in Use 21,787.10, whichever is higher) = `
21,787.10
Impairment Loss = Carrying Amount Less Recoverable Amount = ` 25,633.33 – ` 21,787.10 = `.
3,846.23 lakhs.
WN: 1) Depreciation = (38000 – 900) / 7.5 = ` 4946.67. Depn for 2 ½ years = 4946.67 x 2.5 = `. 12366.68
WN: 2) Value in Use = 4100 x 0.909 + 5900 x 0.826 + 6000 x 0.751 + 7800 x 0.683 + (4500 + 900)x 0.621 =
` 21787.10 lakhs.
(i) VIU = ` 21787.10lakhs
(ii) Impairment loss = ` 3846.23 lakhs
(iii) Revised Carrying amount on 31/3/2015 = ` 21,787.10 lakhs.
CHAPTER 26
AS-29: Provisions, Contingent
Liabilities and Contingent
Assets
Chapter Outline
vv Objective vv How Should Future Operating Losses Be Treated?
vv Recognition of Provisions vv Onerous Contract
vv How to Measure the Amount of Provisions? vv Restructuring Costs
vv Recognition of Contingent Liabilities vv Disclosure Requirements Under AS 29
vv Recognition of Contingent Assets
Objective
(i) Ensure that appropriate recognition criteria and measurement bases are applied to provisions and
contingent liabilities.
Example:
1) A contracting company executes several road building and bridges contract. Most of these contracts
have liquidated damages clause built in them involving complex formula for computing the
compensation. The past experience of the company is that very often the liquidated damage clause is
not invoked, partly because the fault also lies with the contractee, e.g., payments not made on time,
clear contract site not made available to contractor, etc. and unforeseen situations like bad weather,
lack of cooperation from local authorities, etc. The company does not make any provision since a
reliable estimate cannot be made.
2) A contingent liability does not require recognition, it only requires a disclosure. Where an enterprise
is jointly and severally liable for an obligation, the part of the obligation that is expected to be met by
other parties is treated as a contingent liability.
3) Contingent liabilities are assessed continually to determine whether an outflow of resources
embodying economic benefits has become probable. If it becomes probable that an outflow of future
economic benefits will be required for an item previously dealt with as a contingent liability, it should
be recognized as a provision.
Onerous Contract
An onerous contract is a contract where the unavoidable costs of meeting the obligations > expected benefits.
As per Ind AS -37 losses arising out of owner contracts should be provided for Example In case of AS-7 if the
total Costs of construction > total revenue then provision is created for the expected loss and such contract
is known as onerous contract.
Example: An entity is bound under the terms of a franchise agreement for a local brand that it has marketed
for years. Based on market survey and a cost-benefit study, the entity decided to stop marketing the local
brand and entered into a new agreement to market an international brand. Although the entity does not
derive any economic benefit from the franchise agreement for the local brand, there is an obligation to pay a
lump-sum amount to the franchiser under the non cancellable franchise agreement for a period of two more
years. Thus the entity would need to make a provision for the commitment under the franchise agreement
(since it is an onerous contract).
AS-29: Provisions, Contingent Liabilities and Contingent Assets 277
Restructuring Costs
A restructuring is the programme that is planned and controlled by the management, and materially changes
either the scope of the business or the manner in which the business is conducted Example Demerger costs.
To provide guidance on this issue, IAS 37 provides these examples of events that may qualify as
restructuring:
◘◘ Sale or termination of a line of business
◘◘ Closure of business locations in a region or relocation of business activities from one location to
another
◘◘ Changes in management structure, such as elimination of a layer of management
◘◘ Fundamental reorganization of the entity such that it has a material and a significant impact on its
operations.
Problem 1: A furnace has a lining that needs to be replaced every five years for technical reasons. At the
balance sheet date, the lining has been in use for three years. Is a provision required to be recognised?
Solution: There is no present obligation as at the balance sheet date. Because, at the balance sheet date, no
obligation to replace the lining exists independently of the company’s future actions. Even the intention to
incur the expenditure depends on the company deciding to continue operating the furnace or to replace the
lining. In view of this, no provision for replacement is required.
Problem 2: An airline is required by law to overhaul its aircraft once every three years. This is the third year
of use. Is a provision required to be recognised? (CA Final Nov 2010 OS)
Solution: Provision for costs of overhauling aircraft are not recognised for the same reasons that the cost
of replacing the lining is not recognised as a provision as above. Even a legal requirement to overhaul does
not make the costs of overhaul a liability, because no present obligation exists to overhaul the aircraft
independently of the enterprise’s future actions. The enterprise could avoid the future expenditure by its
future actions, for example by selling the aircraft. In view of this, no provision for overhauling costs is required.
Problem 3: A manufacturer gives warranties at the time of sale to purchasers of its product. Under the terms
of the contract for sale the manufacturer undertakes to make good, by repair or replacement, manufacturing
defects that become apparent within three years from the date of sale. On past experience, it is probable
(i.e. more likely than not) that there will be some claims under the warranties. Is a provision required to be
recognised?
or
V Ltd. sold 1 Lakh vacuum pumps during the year 2006-07 with a condition to make good by repair/
replacement any manufacturing defects reported within 6 months from the date sale. Past experience in this
regard showed that there were no replacements carried out, but minor/major repairs were necessitated to
the extent of 10%/5% respectively of the units sold. The cost of such minor/major repairs would amount
to `1,000/` 6,000 respectively. While finalizing the accounts for the year, the Company does not reflect any
provision, in this regard. Comment on the above situation. (CA Final May 2008)
Solution: The obligating event is the sale of the product with a warranty. An outflow of resources embodying
economic benefits in settlement is probable for the warranties as a whole. Therefore, provision for the best
estimate of warranty costs should be made.
Problem 4: An enterprise in the oil industry causes contamination but does not clean up because there is no
legislation requiring cleaning up, and the enterprise has been contaminating land for several years. At 31st
March 2012 it is virtually certain that a law requiring a clean-up of land already contaminated will be enacted
shortly after the year end. Is a provision required to be recognised? (CA Final Nov 2012)
Solution: The obligating event is the contamination of the land because of the virtual certainty of legislation
requiring cleaning up. An outflow of resources embodying economic benefits in settlement is Probable.
Hence, a provision is recognised for the best estimate of the costs of the clean-up.
Problem 5: An enterprise operates an offshore oilfield where its licensing agreement requires it to remove
the oil rig at the end of production and restore the seabed. Ninety per cent of the eventual costs relate to
the removal of the oil rig and restoration of damage caused by building it, and ten per cent rise through the
extraction of oil. At the balance sheet date, the rig has been constructed but no oil has been extracted. Is a
provision required to be recognised?
Solution: The construction of the oil rig creates an obligation under the terms of the licence to remove the
rig and restore the seabed and is thus an obligating event. At the balance sheet date, however, there is no
AS-29: Provisions, Contingent Liabilities and Contingent Assets 279
obligation to rectify the damage that will be caused by extraction of the oil since extraction of oil has not
commenced as of the balance sheet date. An outflow of resources embodying economic benefits in settlement
is probable. A provision is recognised for the best estimate of ninety per cent of the eventual costs that relate
to the removal of the oil rig and restoration of damage caused by building it. These costs are included as part
of the cost of the oil rig. The ten per cent of costs that arise through the extraction of oil are recognised as a
liability when the oil is extracted.
Problem 6: A retail store has a policy of refunding purchases by dissatisfied customers, even though it is
under no legal obligation to do so. Its policy of making refunds is generally known. Is a provision required to
be recognised?
Solution: It is Present obligation as a result of a past obligating event. The obligating event is the sale of
the product, which gives rise to an obligation because obligations also arise from normal business practice,
custom and a desire to maintain good business relations or act in an equitable manner. An outflow of resources
embodying economic benefits in settlement is probable because a proportion of goods are returned for
refund.
A provision should be recognised for the best estimate of the costs of refunds since recognition criteria in
AS-29 is satisfied.
Problem 7: Samsung Limited has ` 4.50 crores in sales tax demand relating to previous year against which
the company has gone into appeal for the year 2013-14. The ground of appeal dealt with points covering
` 3.50 crores of demand. Show how the matter will have to be dealt with the final accounts for the year 2008-09.
(C.A. Final Nov. 2014 Accounts, 3 Marks) (C.A. Final Nov. 2009 OS Accounts, May 2010 OS Audit)
Solution: The company has gone for an appeal consisting of amount ` 3.50 i.e. there is no present obligation
but possible obligation. Therefore disputed amount of ` 3.50 crores where appeal is preferred will be shown
as a contingent liability. The balance 1 crore should be provided as actual liability (company accepts the
liability)
Problem 8: As on 31-3-2012, there was a claim for damage from one of the customers against the company
in selling of accounting software for an alleged failure to provide after-sales services in relation to the software
purchased form it. Before finalization of accounts for the year ended 31-3-2012 (the accounts were finalized
on 14th June 2012), the company won the case and had no liability whatsoever in this regard. The company
has made a provision for this contingent liability in its accounts for the year ended 31-3-2012, which it says,
will be reserved in the next year.
Solution: The case was outstanding on the balance sheet date and the case disposed off after the year ending
hence it attracts AS-4 Events Occurring after the B/S date. Accounting effect has to be given for such event
took place after the year end. The company had provided for the loss as per AS-29 which now, should be
reversed for the previous year. This is because the company is not liable to pay any amount.
Problem 9: XYZ Ltd. pays bonus every year as per the minimum bonus act. Bonus is payable in the month of
November. Is bonus required to be provided for the year ended 31/3/2015 for the rendering of the services
by that date?
Solution: The obligating event is the rendering of service by the employee, which legally entitles the
employee to bonus. Thus provision is recognized. Obligation can arise either due to legal enforcement, statute,
agreement or to maintain good business relations or to act in an equitable manner.
Problem 10: After a wedding in 2013-14, ten people died, possibly as a result of food poisoning from
products sold by the enterprise. Legal proceedings are started seeking damages from the enterprise but
it disputes liability. Up to the date of approval of the financial statements for the year 31 March, 2009 the
enterprise’s lawyers advise that it is probable that the enterprise will not be found liable. However, when the
enterprise prepares the financial statements for the year 31 March, 2015 its lawyers advise that, owing to
280 Accounting Standards
developments in the case, it is probable that the enterprise will be found liable. How this should be dealt with
in financial statement?
Solution:
(a) At 31 March, 2014
On the basis of the evidence available when the financial statements were approved, there is no
present obligation as a result of past events.
Hence no provision is recognised. The matter is disclosed as a contingent liability unless the
possibility of any outflow is regarded as remote.
(b) At 31 March, 2015
Present obligation as a result of a past obligating event - On the basis of the evidence available, there
is a present obligation.
An outflow of resources embodying economic benefits in settlement is probable. A provision is
recognised for the best estimate of the amount to settle the obligation.
Problem 11: During 2015-16, Enterprise X gives a guarantee of certain borrowings of Enterprise Y, whose
financial condition at that time is sound. During 2016-17, the financial condition of Enterprise Y deteriorates
and on 30 September, 2016 Enterprise Y goes into liquidation. How it will he dealt with by ‘X’?
Solution:
(a) At 31 March, 2016
Guarantee given by Co X, gives rise to a possible obligation.
No outflow of benefits is probable at 31 March, 2016 since financial position of Y is sound.
Hence, no provision is recognised. The guarantee is disclosed as a contingent liability unless the
probability of any outflow is regarded as remote.
(b) At 31 March, 2017
The obligating event is the giving of the guarantee, which gives rise to a legal obligation to make good
enterprise Y’s defaults.
At 31 March 2017, it is probable that an outflow of resources embodying economic benefits will be
required to settle the obligation, since enterprise Y has gone into liquidation.
A provision should be recognised for the best estimate of the obligation.
Problem 12: Gopal Company has at its financial year ended 31st March, 2004 fifteen law suits outstanding,
none of which has been settled by the time the accounts are approved by the directors. The directors have
estimated that the possible outcomes as below:
Result Probability Amount of loss
For first ten cases:
Win 0.6 —
Lose-low damages 0.3 90,000
Lose-high damages 0.1 1,60,000
For remaining five cases:
Win 0.5 —
Lose-low damages 0.3 60,000
Lose-high damages 0.2 95,000
The directors believe that the outcome of each case is independent of the outcome of all the others.
Estimate the amount of contingent loss and state the accounting treatment of such contingent loss.
(C.A. Final May 2004, May 2013)
Solution: Please refer May 2013 paper - Question 9
AS-29: Provisions, Contingent Liabilities and Contingent Assets 281
Problem 13: Mini Ltd. took a factory premises on lease on 01.04.07 for ` 2,00,000 per month. The lease is
operating lease. During March 2008, Mini Ltd. relocates its operation to a new factory building. The lease on
the old factory premises continues to be live upto 31.12.2010. The Lease cannot be cancelled and cannot be
sub-let to another user. The auditor insists that lease rent of balance 33 months upto 31.12.2010 should be
provided in the accounts for the year ending 31.3.2008. Mini Ltd seeks your advice. (CA Final May 2008)
Solution:
1. “Onerous Contract” is a contract in which the unavoidable cost of meeting the obligation under the
contract exceeds the economic benefit expected under it.
2. In the given case , the operating lease contract has become onerous, as the economic benefit of lease
contract for next 33 months upto 31.12.2010 will be nil
3. Lessee, Mini Ltd has to pay lease rent of `66,00,000 (2,00,000 p.m for next 33 months). Therefore,
provision on account of `66,00,000 is to be made in the account for the year ending 31.03.08,in
accordance with AS-29 requirements.
Total period = 45 months → 12 months current yr and 33 months future period. Do you know 12 months
period rent is expenditure but 33 months future rent is a provision (loss).
Problem 14: Sun Ltd. has entered into a sale contract of ` 5 crore with X Ltd during 2013-14 financial year.
The profit on this transaction is 1 crore. The delivery of goods to take place during the first month of 2014-15.
In case of failure to deliver goods within the schedule, a compensation of ` 1.5 crore is payable to X Ltd. Sun
Ltd decided to manufacture the goods during the last month of 2013-14. As on 31/3/2014 Sun Ltd has not
manufactured the goods and it is unlikely that Sun Ltd will be in a position to meet the contractual obligation.
(i) Should Sun Ltd provide for contingency as per AS-29?
(ii) Should provision be measured as an excess of compensation to be paid over the profit?
(CA Final May 2010)
Solution:
(i) Yes, Sun Ltd has to make a provision as per AS-29. Past event is non – production of goods.
Present obligation is to pay compensation. It is probable that there will be outflow of resources as
compensation payable.
(ii) As on 31/3/2014 the goods are not yet manufactured compensation is required to be payable. Hence
the whole compensation of ` 1.5crores is to be provided. Provision should not be measured as an
excess of compensation to be paid over the profit.
Basic condition for any provision (Check list): V V Imp
(i) there is a present obligation as a result of a past event;
(ii) it is probable that an outflow of resources embodying economic benefits will be required to settle the
obligation; and
(iii) a reliable estimate can be made of the amount of the obligation.
Problem 15: An engineering goods company provides after sales warranty for 2 years to its customers.
Based on past experience, the company has been following policy for making provision for warranties on the
invoice amount, on the remaining balance warranty period:
Less than 1 year : 2% provision
More than 1 year : 3% provision
The company has raised invoices as under:
Calculate the provision to be made for warranty under Accounting Standard 29 as at 31st March, 2014
and 31st March, 2015. Also compute amount to be debited to Profit and Loss Account for the year ended 31st
March, 2015.
Solution: Provision to be made for warranty under AS 29 ‘Provisions, Contingent Liabilities and
Contingent Assets’
As at 31st March, 2012 = ` 40,000 × .02 + ` 25,000 × .03
= ` 800 + ` 750
= ` 1,550
As at 31st March, 2013 = ` 25,000 × .02 + ` 90,000 × .03
= ` 500 + ` 2,700
= ` 3,200
Amount debited to Profit and Loss Account for year ended 31st March, 2015
`
Balance of provision required as on 31.03.2015 3,200
Less: Opening Balance as on 1.4.2014 (1,550)
Amount debited to profit and loss account 1,650
Problem 16: VV Ltd. had announced a voluntary retirement plan for its employees on January 1, 2000.
The scheme is scheduled to close on June 30, 2000. The scheme envisaged an initial lump sum payment of
maximum of ` 2 lakhs and monthly payments over the balance period of service of employees coming under
the plan. 200 employees opted for the scheme as on March31, 2000. The total lump sum payment for these
employees would be ` 250 lakhs and the aggregate of future payments to them would amount to ` 1,500
lakhs. However no payment had been made to the employees under the scheme up to March31, 2000. Nor the
company made any provision in its accounts towards any liability under the scheme.
(Final Audit C.A. May 2000)
Solution: Accounting Standard (AS)-4 (Revised) on ‹Contingencies and Events Occurring After the Balance
Sheet Date›, states that events occurring after the balance sheet date are 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, and,by the corresponding
approving authority in the case of the any other entity.
Two types of events can be identified as:
(a) those which provide further evidence of conditions that existed at the balance sheet date; and
(b) those which are indicative of conditions that arose subsequent to the balance sheet date.
It further states that assets and liabilities should be adjusted for events occurring after the balance sheet
date that provide additional evidence to assist the estimation of amounts relating to conditions existing at
the balance sheet date or that indicate that the fundamental accounting assumption of going concern (i.e., the
continuance of existence or substratum of the enterprise) is not appropriate.
As per facts of the case, a condition existed on the balance sheet date (31st March, 2000) regarding the
liability towards the Voluntary Retirement Plan (VRP) since the management started the VRP in the month
of January, 2000 and 200 employees opted for the VRP as on March 31, 2000. Since it was probable that the
future events will confirm that a liability has been incurred on the balance sheet date and that the amount
could be estimated on reasonable basis, a provision for payments under the VRP would be required to be
made for an appropriate amount for the aforesaid number of employees.
AS-29: Provisions, Contingent Liabilities and Contingent Assets 283
Problem 17: Vishnu Company has at its financial year ended 31st March, 2013 fifteen law suits outstanding,
none of which has been settled by the time the accounts are approved by the directors.
The directors have estimated that the possible outcomes as below:
Result Probability Amount of loss
For first ten cases:
Win 0.6 —
Lose-low damages 0.3 90,000
Lose-high damages 0.1 1,60,000
For remaining five cases:
Win 0.5 —
Lose-low damages 0.3 60,000
Lose-high damages 0.2 95,000
The directors believe that the outcome of each case is independent of the outcome of all the others.
Estimate the amount of contingent loss and state the accounting treatment of such contingent loss.
(CA Final May 2013, 4 Marks)
Solution: As per AS-29 Contingent liability should be disclosed in financial statements if following conditions
are satisfied:—
◘◘ There should be present obligation arising out of past event but not recognised as provision.
◘◘ It is not probable that an outflow of resources embodying economic benefits will be required to settle
the obligation.
◘◘ The possibility of an outflow of resources embodying economic benefits remote.
◘◘ The amount of the obligation cannot be measured with sufficient re” to be recognised as provision.
In this case, the probability of winning of first 10 cases is 60%and for remaining, five cases 50%. In other
words, the probability of losing is 40%or 50% respectively. As per the 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. For the purpose of the disclosure of contingent liability by way of note amount
may be calculated as under:
Expected loss in first ten cases = ` 90,000 × 0.3 + ` 1,60,000 × 0.1
= ` 43,000 × 10= ` 4,30,000
Expected loss in remaining five cases = ` 60,000 × 0.3+ ` 95,000 × 02
= ` 37,000 × 5= ` 1,85,000
Total Contingent Liability = ` 4,30,000 + ` 1,85,000 = ` 6,15,000
Problem 18: Quick Ltd is a Company engaged in the trading of spare parts used in the repair of automobiles. The
Company has been regular in depositing the tax, as such there is no liability of Income Tax, etc. for the Financial
Year 2012–2013. The figures for the year are as under:
Income chargeable to Tax `211.64 Lakhs
Total Income after Adjustments `228.48 Lakhs
Tax thereon `74.13 Lakhs
TDS deducted during the year `30.45 Lakhs
Tax paid for the year `43.68 Lakhs
The Company has prepared its Balance Sheet as per above figures. However, during the assessment proceeding held
before the finalization of the Balance Sheet, the Income Tax Officer has issued demand of `7.52 Lakhs, insisting that this
amount of TDS has not been uploaded online and thus is not acceptable as deduction.
The Company has in reply to the same filed a rectification with the Assessing Officer. The Company is trying to
collect the TDS Certificates, but `2.39 Lakhs deducted by XY Ltd, is not traceable. The rectification is lying pending
with the Assessing Officer. Please suggest the treatment of `2.39 Lakhs and `7.52 Lakhs in Balance Sheet. 5 Marks
284 Accounting Standards
Solution: There are 2 things in the problem (1) TDS of `2.39 lakhs which is not traceable, (2) TDS of `5.13 lakhs
which is being traced. However in this case the ITO should accept the TDS evidence: Under the Income Tax Act, the
credit for TDS cannot be denied on the ground that it is not reflected online in Form 26AS. In such cases, the TDS
Credit can be given on the strength of other evidences available with the Assessee.
Accounting treatment:
For TDS of `2.39 lakhs which is not traceable: It may or may not be traceable, in future. This means it is not a real but
possible obligation which means it is a contingent liability. It should be disclosed in the notes to accounts.
For TDS of `5.13 lakhs which is traceable: As the occurrence of the liability is remote no disclosure is required
either as a contingent liability nor it is a provision.
Problem 19: ABC Company files a law suit against Unlucky company for `5 crores. The Attorney of Unlucky
feels that the suit is without merit, so unlucky company merely discloses the existence of the law suit in the
notes to accounts accompanying its financial statements. As the Auditor, how would you respond to this?
Marks 5
Hint: As per AS – 29 if the probability of outflow of resources is probable then the provision has to be made.
As it is clear from the data of the problem that the Attorney of Unlucky feels that the suit is without merit the
provision should not be made. But the Auditor has to ascertain the fact regarding the legal suit filed against
the company, still whether provision is required. If provision is required then the company should make
a provision.
Problem 20: Lucky P Limited has been assessed to Income –Tax, in which a demand of ` 10 lakhs has been
made. The Company has gone in appeal. The Company has deposited ` 6.00 Lakhs against the demand, on
being pursued by the Department. The Company has been advised by its Counsel that there is 80% chance
of losing in respect of one of the ground which may end up confirming the demand of ` 4.00 Lakhs, while
on other ground, there is fair chance of winning the appeal. How the Company should treat the same while
preparing the Final Accounts for the year ending 31st March 2015?
Solution:
An enterprise should recognise a provision only when all of the following conditions are met:
(i) there is a present obligation as a result of a past event;
(ii) it is probable that an outflow of resources embodying economic benefits will be required to settle the
obligation; and
(iii) reliable estimate can be made of the amount of the obligation.
Accounting treatment:
As there is 80% chance of losing the case it is highly probable that outflow of resources will be spent
to settle the obligation. Hence Lucky Ltd should make a provision of Rs. 4,00,000. For the balance
demand the company should make a disclosure as a Contingent Liability as there is a fair chance of
winning the appeal.
Regarding Rs. 6,00,000 which is not a settlement of the Liability, it should be disclosed under the
head “Non – Current Assets” indicating that it is paid in relation to an appeal pending.
CHAPTER 27
AS-21: Consolidated Financial
Statements (Holding Company
Vs Subsidiary)
Chapter Outline
vv Applicability vv Effective Date of Consolidation
vv Consolidation Procedures vv Losses Exceeding Equity for Minority
vv Intragroup Transactions vv Disclosure
Applicability
This Statement should be applied in the preparation and presentation of consolidated financial statement for
a group of enterprises under the control of a parent
This statement should also be applied in accounting for investments in subsidiaries in the separate
financial statement of a parent.
DEFINITIONS
(i) Control
ww The ownership, directly or indirectly through subsidiary (ies), of more than one-half of the voting
power of an enterprise; or
ww Control of the composition of the board of directors in the case of a company or of the composition of
the corresponding governing body in case of any other enterprise so as to obtain economic benefits
from its activities.
(ii) Minority interest is that part of net result of operation and the net assets of a subsidiary attributable to
interest which are not owned, directly through subsidiary (ies), by the parent.
Consolidated financial statement normally include consolidated balance sheet, consolidated statement of
profit and loss, and notes, other statements and explanatory material that from an integral part thereof,
consolidated cash flow statement is presented in case a parent presents its own cash flow statements.
The consolidated financial statements are presented, to the extent possible, in the same format as that
adopted by the parent for its separate financial statement.
Exclusions
An enterprises may control the composition of the governing bodies of entities such as gratuity trust provident
fund trust etc. since the objective of control over such entities is not to obtain economic benefits from their
activities, these are not considered for the purpose of preparation of consolidate d financial statements.
286 Accounting Standards
Consolidation Procedures
In preparing consolidated financial statements, the financial statement of the parent and its subsidiaries
should be combined on a line by line basis by adding together like items of assets, liabilities, income arc
expanses. In order that the consolidated financial statement presents financial information about the group
as that of a single enterprise, the following steps should be taken.
a) the cost to the parent of its investment in each subsidiary and the parent’s portion of equity of each
subsidiary at the date on which investment in each subsidiary is made, should be eliminated;
b) any excess of the cost to the parent of its investment in a subsidiary over the parent’s portion of equity
of the subsidiary, at the date on which investment in the subsidiary is made, should be described as
goodwill to be recognized as an asset in the consolidated financial statements;
c) when the cost to the patent of its investment in a subsidiary is less than the parent’s portion of equity
of the subsidiary, at the date on which Investment in the subsidiary is made, the difference should be
treated as a capital reserve in the consolidated financial statement;
d) Minority interest in the net income of consolidated subsidiaries for the reporting period should
be Identified and adjusted against the income of the group in order to arrive at the net income
attributable to owners of the parent; and
e) Minority interests in the net assets of consolidated subsidiaries should be identified and presented in
the consolidated balance sheet separately from liabilities and the equity of the parent’s shareholders.
Intragroup Transactions
Intragroup balance and intragroup transitions, including sales, expenses and dividend, are eliminated in full.
Unrealized profits resulting from intragroup transactions that are included in the carrying amount of assets,
unrealized losses resulting from intragroup transitions that are deducted in arriving at the carrying amount
of assets are also eliminated unless cost cannot be recovered.
AS-21: Consolidated Financial Statements (Holding Company Vs Subsidiary) 287
Consolidated financial statements should be prepared using uniform accounting policies for like
transactions and other events in similar circumstances. If is not practicable to use uniform accounting policies
in preparing the consolidated financial statement, that fact should be disclosed together with the proportions
of the item in the consolidated financial statements to which the different accounting policies have been
applied.
Disclosure
Following disclosure should be made:
(a) In consolidated financial statement a list of all subsidiaries including the name, country of
incorporation or residence, proportion of ownership interest and, if different, proportion of voting
power held;
(b) In consolidated financial statement, where applicable:
(i) The nature of the relationship between the parent and a subsidiary, if the parent does not
own directly or indirectly through subsidiaries, more than one-half of the voting power of the
subsidiaries;
(ii) The effect of the acquisition and disposal of subsidiaries on the financial position at the reporting
date the results for the reporting period and on the corresponding amounts for the preceding
period; and
(iii) The names of the subsidiary (ies) of which reporting date (s) is/are different from that of the
parent and the difference in reporting dates.
288 Accounting Standards
AUTHOR’S NOTES
For Problems on AS-21 Refer Advance Account Book.
VERY VERY IMPORTANT FOR CA FINAL STUDENTS
Even if you know holding company please refer this for better practice
FOLLOWING ARE SOME CONCLUDED POINTS IN HOLDING SUBSIDIARY CONSOLIDATION
All Assets and liabilities: Just add it subject to adjustments.
Share Capital (SC) of Holding: Consolidated Financial Statements.
Reserves of Holding: Consolidated P/L as a working note. Post reserves of S will be included in reserves of
H and then consolidated reserves will be transferred to Balance sheet.
Investments in ESC by H in S: Cost of Control working note.
SC and Reserves of S Co.: Analysis of Net worth of S Co. working note.
Number of working notes: (i) Consolidated B/S, (ii) Consolidated Reserves/P/L of Holding co. (iii) Minority
interest, (iv) Cost of Control, (v) Analysis of Net worth of S Co.
1) Appropriation of Net Worth of S Co.: Net Worth of S Co is distributed into the following 3 parts (i)
Pre Net Worth, (ii) Post Net Worth, (iii) Minority Interest.
2) Can Minority Interest go negative: No
3) Mutual Owing: Between H – S: Full Cancellation, Between H – S2: Full Cancellation, Between S1-S2:
Full Cancellation. (Assume S1 is Subsidiary and S2 is sub subsidiary.)
4) Stock Reserve (Unrealised profit):Between H – S: Full Cancellation, Between H – S2: Full
Cancellation, Between S1-S2: Full Cancellation. (Assume S1 is Subsidiary and S2 is sub subsidiary.)
Entry for cancellation: Consolidated P/L A/c Dr.
To Stock Reserve A/c
5) Unrealised profit on Fixed Asset: Full Cancellation.
Entry for cancellation: Consolidated P/L A/c Dr.
To Unrealised Profit from Fixed Asset Reserve a/c
AS-21: Consolidated Financial Statements (Holding Company Vs Subsidiary) 289
9) Investment in Preference Share Capital: If H Co has investments in PSC in S Co. following are some
important points:
(i) PSC Face Value and Cost of investments in PS should be treated in the same manner as we treat E
Shares. But the analysis of PS should be separate from analysis from ES. This is because PS and
ES holdings are altogether different.
(ii) PSH do not share any reserves or profit/loss of S Co.
(iii) Treatment for Dividend paid and proposed is same as ES. But if S Co is yet to declare preference
dividend then it is not same as equity dividend. In case of PS Dividend is yet to be declared by S
Co then H Co should provide for the Preference Dividend i.e. deduct dividend from profits of S
Co and then the balance profits should be distributed to equity shareholders.
(iv) If Preference Dividends are not provided for many years let’s say 4-5 then provide such dividends
from reserves and the balance reserves will be held for H and Minority for distribution.
(v) If whole PSC is held in S Co. by outside party and not by H Co. then the whole PSC will be Minority
Interest.
10) Appropriations of Reserves: Dividend declared by S Co and General Reserve appropriated from
profits should always take colour from its nature of P/L. If Shares are acquired during the year (say
September for March ending) then General Reserve/Dividend appropriated from profits should be
½ pre and ½ post.
11) Investment in Debentures: If H Co has investments in Debentures of S Co. then just cancel as mutual
debt. But if Face value >/< then Cost then treat the difference as Goodwill/Capital Reserve.
12) Investment in Preference Share Capital/Debentures by S Co.: If S Co has investments in PSC/
debn in H Co. then cancel as Mutual Owings. It may so happen that Face value and Cost of investments
may be different then such difference should be treated gain/loss (P/L) and should be distributed
between H Co and Minority interest.
13) Share acquired more than one time: If Lot 1 is small lot and subsequent controlling interest
Lot 2 Analyze pre and post from the date of Lot 2. If Lot1 is controlling interest subsequent small
Lot 2 Analyze pre and post separately for Lot 1 and Lot 2. But remember Dividend received will be
analysed based on each Lot separately governed by AS-13.
14) Chain holding: There are 3 types of Chain holding:
(i) H having interest in 2 S → Consolidation of fellow subsidiaries
(ii) H having interest in S1 and S1 further having interest in S2 → Consolidation of Sub - subsidiaries
(iii) H having interest in S1 as well as in S2 and S1 also holds interest in S2 → H and S together holding
interest in another subsidiary.
Steps to Consolidate Chain Holding:
In case of H having interest in 2 subsidiaries, then consolidation of S Co is as usual i.e. two separate
Subsidiaries.
H having S1 and S1 further having S2, → In case of Consolidation of Sub – subsidiaries, first we have
to analyse the ultimate subsidiary. Analysis of net worth of the ultimate subsidiary is as follows:
DO YOU KNOW
Under the New Schedule III Minority Interest is a new sub-head within “Equity”.
CHAPTER 28
AS-23: Accounting for
Investment in Associates
Chapter Outline
vv Introduction vv Disclosures
vv Meaning of Associate and Significant Influence vv Interpretations Issued by the ICAI
vv Exception to Equity Method vv Transitional Provision
vv Equity Method Accounting: Para 6
Introduction
Scope: Accounting Standard 23 set out principles and procedures for recognizing effect of the investment in
associates on the financial position and operating results in consolidated financial statements prepared and
presented by an investor.
It is not applicable for separate financial statement prepared and presented by, an investor. (AS-13 applies
for separate financial statements)
20% or more of the voting power of the investee, it is presumed that the investor has significant influence,
unless it can be clearly demonstrated that this is not the case. Conversely, if the investor holds, directly or
indirectly through subsidiary(ies), less than 20% of the voting power of the investee, it is presumed that
the investor does not have significant influence, unless such influence can be demonstrated. A substantial
or majority ownership by another investor does not necessarily preclude an investor for having significant
influence.
It is clarified by ICAI that for the purpose of considering 20% of voting power, the potential equity shares
of the investee held by the investor will not be taken into account for determining the voting power of the
investor. Example of Potential equity shares are convertible debentures, convertible preference shares, stock
options.
◘◘ When the financial statements of associate and investor have different reporting date adjustment
should be made for the effects of any significant event or transaction between the investor and
associate, which occurs between the reporting dates.
◘◘ When the financial statements of associate and investor have different accounting policies for like
transactions and events adjustment should be made, if it is not practicable to do, the fact is disclosed
along with a brief description of the difference between the accounting policies.
Contingencies
In the consolidated financial statement of investor following facts should be disclosed:
◘◘ Its share of the contingencies and capital commitments of an associate for which it is also contingently
liable.
◘◘ Those contingencies that arise because the investor is severally liable for the liabilities of the associate.
294 Accounting Standards
Disclosures
Investor should disclose in its consolidated financial statement the following:—
◘◘ Description of associate including the proportion of ownership interest should be disclosed.
◘◘ Investment in associates accounted for using the equity method should be classified as long-term
investments.
◘◘ Difference in reporting dates of financial statements of associates and of the investor should be
disclosed.
◘◘ In case an associate uses accounting policies other than those adopted for the consolidated financial
statements for like transactions and events in similar circumstances and it is not practicable to make
appropriate adjustments to the associate's financial statements, the fact should be disclosed along
with a brief description of the differences in the accounting policies.
Transitional Provision
On the first occasion when investment in an associate is accounted for in consolidated financial statements
in associate with this statement, the carrying amount of investment in the associate should be brought to the
amount that would have resulted had the equity method of accounting been followed as per this statement
since the acquisition of the associate. The corresponding adjustment in this regard should be made in the
retained earnings in the consolidated financial statements.
AS-23: Accounting for Investment in Associates 295
Accounting Entries for AS-13 and AS-23 (Equity Consolidation) on Comparative Basis
Particulars Separate financial statements Consolidated financial statements
Investments in Associates Investments xx Not required (disclose at cost)
To Bank / Securities xx
Goodwill / Capital Reserves NA Just identify
Stock Reserves NA Consolidated P/L xx
To Stock Reserve xx (A->H)
To Investments xx (H->A)
Pre dividend received Bank xx No entry required if correct entry is done
To Investments xx in SFS
Share of post profits NA Investments xx
(for losses entry will be To Consolidated P/L xx
reversed)
Share of any other reserve NA Investments xx
To Concerned Reserve xx
Dividend distributed from Bank xx Consolidated P/L xx
post profits To P/L xx To Investments xx
Dividend provided Not to be recorded as governed by AS-9 Just ignore it as per ASI -16
(i.e. recorded in the year when AGM will be
held)
Investments w-off as per Diminution in the value xx NA
AS-13 To Investments xx
(charged to P/L)
Problem 1: Consolidated Balance Sheet of H Ltd. group as on 31/3/2012 before adjustment for equity
method for investment in associate A Limited is given below:
Liabilities ` Assets `
Share Capital (` 10) 8,00,000 Sundry Assets 18,50,000
Capital Reserves 20,000 Investments in A Ltd. 1,50,000
Profit/Loss A/c 4,45,000
Minority Interest 1,35,000
Sundry Liabilities 6,00,000
20,00,000 20,00,000
H Limited acquired 20% of equity shares of A Ltd. 01.04.2010 for ` 75,000. P & L A/c of A Limited as on
1.4.2010 was ` 1,00,000. The assets of A Ltd. were revalued on 31.03.2011.
Show equity adjustment and Consolidated Balance Sheet of the group as on 31.03.2012.
Solution:
Costs of Investments and G/W/CR:
Cash paid = 75000 (Cost) → Step 1
Less: Share in Net Assets 80000 (300000+100000) 20%
Capital Reserves 5000 → Step 2
Disclosure in the CFS (B/S) as on 1.4.2010
ASSETS SIDE
Investments in A Limited:
80000
Capital Reserves (5000) 75000 (Cost) (identify)
Solution:
Costs of Investments and G/W/CR:
Cash paid = 1000000 (Cost) → Step 1
Less: Share in Net Assets 900000 (3000000 + 600000) 25%
Goodwill 100000 → Step 2
Disclosure in the CFS (B/S) as on 1.4.2012
ASSETS SIDE
Investments in Helium Limited: 1000000
Goodwill (identify) = [100000]
Disclosure in the CFS (B/S) as on 31.3.2013
ASSETS SIDE
Investments in Helium Limited: 1000000
Goodwill (identify) [100000]
Less: Share of losses (625000)
(2500000 × 25%) 3,75,000
Disclosure in the CFS (B/S) as on 31.3.2014
ASSETS SIDE
Investments in Helium Limited: Nil (375000 – 4000000 × 25%)
If investors share of losses in associates equals or exceeds the carrying amount of investment, then the investor
discontinues recognizing its share of losses and investments is reported at nil value.
Problem 4: A Ltd. acquired 25% of shares in B Ltd. as on 31.3.2002 for ` 3 lakhs. The Balance Sheet of B Ltd.
as on 31.3.2002 is given below: `
Share Capital 5,00,000
Reserves and Surplus 5,00,000
10,00,000
Fixed Assets 5,00,000
Investments 2,00,000
Current Assets 3,00,000
10,00,000
During the year ended 31.3.2003 the following are the additional information available:
i. A Ltd. received dividend from B Ltd., for the year ended 31.3.2002 at 40% from the Reserves.
ii. B Ltd., made a profit after tax of ` 7 lakhs for the year ended 31.3.2003.
iii. B Ltd., declared a dividend @ 50% for the year ended 31.3.2003 on 30.4.2003.
A Ltd. is preparing Consolidated Financial Statements in accordance with AS-21 for its various subsidiaries.
Calculate:
i. Goodwill if any on acquisition of B Ltd.’s shares.
ii. How A Ltd., will reflect the value of investment in B Ltd., in the Consolidated Financial Statements?
iii. How the dividend received from B Ltd. will be shown in the Consolidated Financial Statements?
(C. A. Final May 2003) (6 Marks)
Solution: In terms of AS 23 B Ltd. will be considered as an associated company of A Ltd. as shares acquired
are more than 20%.
i. Calculation of Goodwill ` in lakhs
Cost of investment 3.00
Less: Share in the value of Equity of B Ltd. as at the date of investment
AS-23: Accounting for Investment in Associates 299
On 1.4.2010 8% Debentures were issued with face value ` 2,00,000 and collected Securities Premium
` 30,000. On 1.6.2010 12% Preference Shares were issued at a face value of ` 1,00,000 and collected Securities
Premium ` 10,000.
Calculate Carrying amount of investments for every year till 31.3.2011 as per AS-23. Assume that the final
dividends were declared in the month of September every year pertaining to previous year. Ex: 10% dividend
rate in 2005-06 pertains to appropriations from 2004-05. Also calculate G/W or Capital reserve as per AS-23.
Solution:
Carrying amt 31/3/2006 31/3/2007 31/3/2008
Opening Bal 1,00,000 1,04,000 1,10,000
(–) Pre Dividend (4,000) Nil Nil
Opening Carrying amt (a) 96,000 1,04,000 1,10,000
+ Profits/Reserves i 40,000 50,000 90,000
Less: Dividend Distributions ii Nil (20,000) (30,000)
i + ii 40,000 30000 60000
Share 20% (b) 8,000 6,000 12,000
Closing Carrying amt (a + b) 1,04,000 1,10,000 1,22,000
Carrying amt 31/3/2009 31/3/2010 31/3/2011
Opening Bal 1,22,000 1,08,000 1,16,000
(–) Pre Dividend Nil Nil Nil
Opening Carrying amt (a) 1,22,000 1,08,000 1,16,000
+ Profits/Reserves i (10,000) 40,000 *80,000
Less: Dividend Distributions ii (60,000) Nil (20,000)
i + ii (70,000) 40,000 60000
Share 20% (b) (14,000) 8,000 12,000
Closing Carrying amt (a + b) 1,08,000 1,16,000 1,28,000
Problem 9: BPL has made 25% investments in CPL. CPL is an associate of BPL. CPL sold an equipment of
` 105,000 to BPL Ltd. at ` 82,000. Assuming BPL is required to prepare the consolidated financial statement,
therefore AS-23 is applicable and equipment is still with BPL. Show the adjustment of unrealised losses if the
recoverable value of the asset is (i) 1,10,000, (ii) 75,000, (iii) 90,000.
Solution: There is an unrealized loss of `23,000 as per AS-23. Unrealized profit/loss should be eliminated to
the extent of 25% of 23,000 = 5,750, but it should be eliminated only when recoverable amount of equipment
is equal to ` 1,05,000 or more. If recoverable amount of equipment is less than 1,05,000, loss should not be
eliminated. The meaning of recoverable amount is as per AS-28, Impairment of asset.
Problem 10: A Ltd. has a share capital of 50,000 shares @ `100 per share. H Ltd. Acquired 15% shares in
A Ltd. on 1.4.2013. It also acquired all the 5,000, 12% convertible debentures of `100 each of A Ltd. These
debentures will be converted at par into equity shares of A Ltd. after 3 years. State whether A Ltd. is an
Associate of H Ltd. or not with reasons?
Solution: As per para 3 of AS 23 ‘Accounting for Investments in Associates in Consolidated Financial
Statements’, an associate is an enterprise in which the investor has significant influence and which is neither
a subsidiary nor a joint venture of the investor.
Standard further explains in para 4 that as regards share ownership, if an investor holds, directly or
indirectly through subsidiary (ies), 20% or more of the voting power of the investee, it is presumed that the
investor has significant influence, unless it can be clearly demonstrated that this is not the case. Conversely,
if the investor holds, directly or indirectly through subsidiary (ies), less than 20% of the voting power of the
investee, it is presumed that the investor does not have significant influence, unless such influence can be
clearly demonstrated.
Further as per an explanation to para 4 of the standard, for the purpose of classification of associate, the
potential equity shares of the investee held by the investor will not be taken into account for determining
the voting power of the investor. In other words the voting power should be determined on the basis of the
current outstanding securities with voting rights.
As per the information given in the question, H Ltd. presently holds indirectly 22.7% shares (with and
without voting rights) (Refer W.N.) in A Ltd. However, the current outstanding securities with voting rights in
A Ltd. is only 15% and the remaining holding is on account of potential equity shares. Since potential equity
shares do not have voting rights they will not be taken into consideration while determining the significant
influence of H Ltd. on A Ltd. Hence, A Ltd. is not an associate of H Ltd.
Working Note:
Calculation of percentage of holding of shares after conversion `
Current holding is 15% i.e. 7,500 shares of `100 each 7,50,000
Potential equity shares i.e. 5,000 shares of `100 each 5,00,000
12,50,000
Total share capital of A Ltd. after conversion of debentures into equity shares will be
= `50,00,000 + `5,00,000 = `55,00,000
Percentage of holding = `(12,50,000/55,00,000) × 100 = 22.7% approx.
CHAPTER 29
AS-27: Financial Interest
in Joint Ventures
Chapter Outline
vv Detailed Discussion on the Elements of Joint Venture vv Transactions between Venturer and Joint Venture
vv Forms of Joint Venture vv Distinction between JCO/JCA and JCE
vv Jointly Controlled Operations (JCO) vv Operators Fee
vv Jointly Controlled Assets (JCA) vv Disclosures Requirements
vv Jointly Controlled Entity (JCE)
SOME DEFINITIONS
(i) Joint Venture: Joint Venture is a contract between two or more parties to undertake an economic activity,
under joint control. Thus it is a commercial undertaking by two or more persons, which relates to disposition
of goods or completion of single project. Joint Venture are in 3 forms: (i) Jointly Controlled Operations, (ii)
Jointly Controlled Assets, (iii) Jointly Controlled Entities.
Features:
ww Agreement between two or more parties.
ww The agreement is made to execute a specific venture
ww Parties can be partnership firm, individuals, limited companies, AOP’s etc.
ww The main purpose of setting JV is to undertake business activity and earn profit.
ww Formation of JV can be same as venturers or a totally separate entity.
ww JV’s are mostly entered for business projects like chartering of ship, engineering projects, building
dams/bridges etc. JV entered between NMDC (State Owned Enterprise) and Tata Steel for extracting,
exploring and developing mines.
(ii) Venturer: Venturer is a party to the Joint Venture having joint control over the Joint Venture. A Venturer
should record investments in JV as per AS-27.
(iii) Investor: Even investor is a party to a Joint Venture but does not have joint control. An investor should
record investments in JV as per AS-13/A-S21/AS-23.
AS-27: Financial Interest in Joint Ventures 303
Nature of Contract
The nature of contractual arrangement entered between the venturers is enumerated below:
◘◘ First of all Contracts should be in black and white.
◘◘ It is the contract entered between venturers which shows existence of Joint Control.
◘◘ Contract can be in the form of general agreement, Articles, Bye-laws.
◘◘ Contract may contain all or some of the following matters:
ww Nature of Activity, Period and reporting obligations of JV.
ww Appointment of BOD or any other similar governing body.
ww Capital Contributions by Venturers.
ww Voting rights of Venturers.
ww Sharing of output, income, expenses or results of the joint venture.
◘◘ Venturer Contributes out its own Assets/inventories etc. Even it raises liabilities on their own.
◘◘ No separate accounting records are required to be maintained for the JV by the Venturer except a need
arises for internal reporting purposes.
◘◘ Agreement between the venturers explains the profit sharing norms, sharing of output, sharing of
expenses etc.
Example of JCO: A & B are engaged in construction business. C is having his own advertising agency. A, B,
and C decided to combine their assets, operations, resources and expertise to manufacture a Steamer. A & B
goes for manufacturing the Steamer. C goes for marketing and distributing activities. Each venturer incur its
own expenses and share profits as per the agreement entered into.
Possibility Effect
1) Profit to JV Venturer should recognize profit only to the extent of
other venturers share (i.e. own share of profit should be
eliminated).
2) Loss to JV Venturer should recognize loss only to the extent of other
venturersshare(i.e. own share of loss should be eliminated).
3) Loss to JV; if sale evidence reduction in NRV of current Venturer should recognize his share of loss immediately.
assets or impairment in case of fixed assets
Note: Provisions of para 41 and 42 are applicable only in case of CFS and not stand alone financial statements.
AS-27: Financial Interest in Joint Ventures 307
DO YOU KNOW
Accounting treatment of Venturer and JCE is similar to Holding and subsidiary. The difference is that in case of
H & S we adopt full consolidation and in case of H & JCE we adopt proportionate consolidation.
Operators Fee
Joint Venture may appoint any outside person or one among the venturers as the Operator or Manager. Fee is
paid for such services rendered. Accounting is as follows:
In the Books of the Operator: Operator Fee receipt for a operator is a income to be recognized as per AS-9
Revenue Recognition.
In the Books of Joint Venture: For JV Operator Fee is just like any other expense.
In the Books of Joint Venture: Para 36: Intercompany transaction will not be eliminated. Offset is possible
only when there is a legal right to offset the asset and liability.
Disclosures Requirements
Applicability of Disclosures
i) Disclosures enumerated below are to be reflected in the books of the Venturer.
ii) Disclosures are common for both separate financial statements and CFS.
iii) Disclosures are common for whether it is JCO/JCA/JCE.
Disclosures
◘◘ List of Joint Ventures.
◘◘ Description of interest in JV.
◘◘ Proportion of interest in JV.
◘◘ In case of JCE only, the proportion of ownership interest.
◘◘ A venturer should disclose the contingent liabilities, separately from other contingent liabilities.
i) Venturers share of own interest in contingent liabilities.
ii) Share of contingent liabilities incurred jointly with other co-venturers.
iii) Contingent liabilities in case of contingency i.e. in case of other venturers share.
◘◘ A venturer should disclose the capital commitments incurred.
i) Venturers share of own capital commitments pending.
ii) Share of capital commitment pending jointly with other co-venturers.
iii) Capital commitment pending for the JV as a whole and venutrers share thereof.
308 Accounting Standards
Problem 1:
Case 1) H Ltd does not have any subsidiary but have a JV @40% share.
Case 2) H Ltd have its subsidiary as well as a JV J Ltd @60% share.
Case 3) H Ltd have its subsidiary as well as a JV J Ltd @40% share.
Case 4) H Ltd have its subsidiary as well as a JV J Ltd @50% share.
Solution: Proportionate consolidate method (PCM) will be applied only when a company has its separate JV
with a different identity. But such company should have its subsidiary too. Further if share in JV is more than
50% then full consolidation will be applicable for JV as per AS-21.
Case 1) PCM is not applicable as H Ltd does not have its subsidiary.
Case 2) If H Ltd has a voting power more than 50% in JV then the holding company should adopt Full
consolidation. Here H Ltd has invested more than 50% in JV hence Full Consolidation is applicable.
Case 3) Here PCM will be applicable.
Case 4) Here PCM will be applicable.
Problem 2: Following is the Trial Balance of Monty Limited for the year ended 31/3/2013 is given below:
Dr. Balance ` in lakhs Cr. Balance ` In lakhs
Opening Stock 160 Sales 1,300
Purchases 1,040 Share Capital (` 10) 1,000
Expenses 150 Profit & Loss (31/3/2012) 80
Depreciation 70 Suspense A/C 20
Fixed Assets 630
Debtors 250
Bank 100
2,400 2,400
During the year 2012-13, Monty Ltd. entered into a JV with Ponty Ltd to buy and sell used machines. The
profits & losses of the venture are to be shared equally. The balance of Suspense a/c represents transactions
of Monty Ltd for the venture as per details given below:
` Lakhs ` Lakhs
Sold 16 machines for the venture @ 5 lakh 80
Purchased 14 machines for the venture @ 4 lakh 56
Expenses incurred on behalf of JV 4
Balance of Suspense a/c 20
Ponty Ltd purchased 18 machines @4 lakh per machine and sold 10 machines @5 lakh. Expenses incurred
on behalf of JV ` 6 lakh.
Value of closing stock of Monty Ltd excluding stock of JV was ` 168 lakhs.
Prepare profit & loss a/c for the year ended 31/3/2013 and its Balance sheet as at that date. If Monty Ltd
has a Subsidiary/Holding Co. then what additional/special entries are required to be passed for CFS.
AS-27: Financial Interest in Joint Ventures 309
Solution:
IT’S A CASE OF JCO: (Books of Monty)
1) Share of Monty Ltd in JV purchase = 50% (32 machines x 4 lakh) = ` 64,00,000
2) Share of Monty Ltd in JV sales = 50% (26 machines x 5 lakh) = ` 65,00,000
3) Share of Monty Ltd in JV expenses = 50% (4 lakh + 6 lakh) = ` 5,00,000
4) Share of Monty Ltd in JV stock = 50% (4 lakh x 6) = ` 12,00,000
5) Adjusting entry:
Purchase A/C. Dr. 64,00,000
Expenses A/C. Dr. 5,00,000
Suspense A/C. Dr. 20,00,000
To Sales A/C. 65,00,000
To Ponty Ltd (bal fig) 24,00,000
5) Total value of Closing stock of Monty Ltd = ` 168 lakhs + 12 lakhs = ` 180 lakhs
Profit and Loss Statement 31/3/2013 (` in lakhs)
`
Sales 1365
Less: Expenditure
Purchases Cost of goods (64+1040) (1104)
Changes in inventories (180-160) 20
Depreciation (70 + 0) (70)
Other expenses (150 + 5) (155)
Net Profit 56
Once Monty Ltd merges the transactions of JV with its own business then there is no need to once again
pass any separate entries for CFS with group accounts subsequently applicable to JCO.
Problem 3: On 1/4/2012 Salvi Ltd and Dalvi Ltd entered into a JV to purchase Volvo Buses and to let out
on rental basis. Cost of the total fleet of assets amounted to ` 100 lakhs. Stamp duty, Registration charges etc
amounts to 2%. Salvi and Dalvi decided to record the Jointly Controlled Asset in equal ratio. Salvi raised a
310 Accounting Standards
loan of ` 70lakhs and the balance cost was financed by Dalvi @12% p.a. Yearly hire charges collections made
by Salvi was ` 9 lakhs and Dalvi ` 21 lakhs. Expenses incurred out of pocket for JV (including AMC): Salvi `
2 lakhs and Dalvi ` 5 lakhs. Sharing of revenue and expenses is decided as 3:2 between Salvi and Dalvi. For
your further information interest on loan was outstanding and unpaid by the year end. Life of the Buses were
estimated to be 10 years. Compute the profit/loss of each coventurer for the year 2012-13. Also pass journals
in the books of accounts of each venturer.
Solution:
Interest is calculated in the ratio of Loans and Depreciation in the ratio of share of assets.
The above entries get absorbed in the separate financial statements of respective Venturer.
Problem 4:
Mapro Ltd. JCE Ltd. JCE Ltd.
closing B/S Opening B/S
Share Capital 1,00,000 50,000 50,000
Reserve & Surplus 20,000 30,000 10,000
AS-27: Financial Interest in Joint Ventures 311
Particulars ` in lacs
I. Equity and Liabilities
(1) Shareholders’ Funds
(a) Share capital 1,00,000
(b) Reserves and Surplus (20000 + 40% (30000 – 10000) – 400 27,600
(3) Non – Current Liabilities: Loans etc (30000 + 10000 × 40%) 34,000
Total 1,61,600
II. Assets
(1) Non-Current assets
(a) Fixed Tangible Assets (110000 + 40% × 60000)
(b) Goodwill 38000- 40% of (50000+10000) 1,34,000
(2) Current assets 14,000
(a) Inventories (2,000 + 40%x30,000 – 400 unrealised profit) 13,600
Total 1,61,600
Problem 5: Optimix Ltd has a share of 40% in the Share Capital of Joint Venture in the form of jointly
controlled entity. As per the agreement O Ltd does not have any joint control but can only be mere an investor.
Comment whether AS-27 is applicable to O Ltd.
Solution: Optimix Ltd has a share of 40% in the Share Capital of Joint Venture in the form of jointly controlled
entity. As per the agreement O Ltd does not have any joint control but can only be mere an investor. Here
AS-13 for standalone a/cs and AS-23 for CFS (equity method) will be applied for O Ltd. But AS-27 PCM will
not be applicable.
CHAPTER 30
Comprehensive Problems on CFS
(AS-21 + AS-23 + AS-27) Group
Consolidation
Problem 1: P Ltd. owns 80% of S, 40% of J and 40% of A. J is jointly controlled entity and A is an associate
Balance Sheet of four companies as on 31.3.2009 are: (Rs in lakhs)
Assets P Ltd. S J A
Investment in S 800 -
Investment in J 600
Investment in A 600
Fixed assets 1000 800 1400 1000
Current assets 2200 3300 3250 3650
Total 5200 4100 4650 4650
Liabilities
Share capital `1 equity share 1000 400 800 800
Retained earnings 4000 3400 3600 3600
Creditors 200 300 250 250
-
Total 5200 4100 4650 4650
P Ltd. acquired shares in S many years ago when S retained earnings was ` 520 lakhs. P Ltd. acquired
shares in J at the beginning of the year when J retained earnings was ` 400 lakhs. P Ltd. acquired shares in A
on 01.04.2008 when A retained earnings was ` 400 lakhs.
The Balance of goodwill relating to S had been written off 3 years ago. The value of goodwill in
J remains unchanged.
Prepare the consolidated Balance Sheet of P Ltd. as on 31.03.2009 as per AS-21, AS-23 and AS-27.
(CA Final Nov 2009) Marks 16
Solution:
Consolidated Balance Sheet of H Co as on 31.3.2009
Particulars ` in lacs
I. Equity and Liabilities
(1) Shareholders’ Funds
(a) Share capital 1,000
(b) Reserves and Surplus 8,800
(2) Minority Interest 760
(3) Current Liabilities
Trade Payables (200 + 300 + 40% of 250) 600
Total 11,160
Comprehensive Problems on CFS (AS-21 + AS-23 + AS-27) Group Consolidation 313
II. Assets
(1) Non-Current assets
(a) Fixed Assets
Tangible Assets [1,000 + 800 + 560 (1400 × 40%)] 2,360
Intangible Assets 120
(b) Non-Current Investments 1,880
(2) Current Assets [2,200 + 3,300 + 1,300 (3,250 × 40%)] 6,800
Total 11,160
Consolidated P/L of H
Bal of H Co 4000
+ Share from S 2304
(-) Goodwill woff -64
+ Share from JV (3600-400) × 40% 1280
+ Share from Associates (3600-400) × 40% 1280
8800
Disclosure of Investm as per Equity Method
Cost of Invesmtents in A Ltd.:
Share in Net Assets of A Ltd. 480
Goodwill (identified) 120 600 (Cash paid)
+ Share in further profits 1280
(3200 × 40%) 1880
Analysis of Networth of Subsidiary (80%)
PRE POST
SC 400
P/L 520 2880
920 3800 2880
MI(20%) = 760
H (80%)
Pre = 736
Post = 2,304
Calculation of Cost of Control
Investments (@Cost) 800
(-) Pre Share -736
Godwill 64
Less: W-off -64
Balance 0
FOR JV
Analysis of Networth OFJV (40%)
PRE POST
SC 800
P/L 400 3200
1200 4400 3200
H (40%)
314 Accounting Standards
PRE POST
480 1280
Note: O nly proportionate consolidation and not full.
No Minority interest
Calculation of Cost of Joint Control
Investments (@Cost) 600
(-) Pre Share -480
Godwill 120
Analysis of Networth of Associates (40%)
PRE POST
SC 800
P/L 400 3200
1200 4400 3200
H (40%)
PRE POST
480 1280
Note: Equity method
Calculation of G/W or C/R
Investments (@Cost) 600
(-) Pre Share -480
Goodwill 120
Problem 2: The draft Balance Sheet of three companies, W, H, O, as at 31.3.2010 is as under:
` in thousands
Assets W. H. O.
Fixed assets 697 648 349
Investments 1,60,000 shares in H 562 -- --
80,000 shares in O 184 -- --
Cash at bank 101 95 80
Trade receivables 386 321 251
Inventory 495 389 287
Total 2,425 1,453 967
Liabilities
Share Capital 600 200 200
(Nominal Value `1 per share)
Reserves 1,050 850 478
Trade payables 375 253 189
De bentures 400 150 100
Total 2,425 1,453 967
You are given the following information:
(a) W purchased the shares in H on 13.10.2005 when the balance in reserves was ` 500 thousands.
(b) The shares in O were purchased on 11.5.2005 when the balance in reserves was ` 242 thousands.
(c) The following dividend have been declared but not accounted for before the accounting year end.
W ` 65 thousands
H ` 30 thousands
O ` 15 thousands
Comprehensive Problems on CFS (AS-21 + AS-23 + AS-27) Group Consolidation 315
(d) Included in inventory figure of O is inventory valued at ` 20 thousands which had been purchased
from W at cost plus 25%.
(e) Goodwill in respect of the acquisition of H has been fully written off.
(f) On 31.3.2010 H made bonus issue of one share for every share held. This had not been accounted in
the balance sheet as on 31.3.2010.
(g) Included in trade payables of W is` 18 thousands to O, which is included in trade receivables of O.
Prepare Consolidated Balance Sheet of W as at 31.3.2010.
(CA Final New Course May 2010)(16 marks)
Solution: Consolidated Balance Sheet of W and its subsidiary as at 31.3.2010
Particulars ` in lacs
I. Equity and Liabilities
(1) Shareholders’ Funds
(a) Share capital 600.00
(b) Reserves and Surplus 1,355.80
(2) Minority Interest 210.00
(3) Non-current Liabilities
(a) Long term borrowings [Debentures] [400 + 150] 550.00
(4) Current Liabilities
(a) Trade Payables (375 + 253) 628.00
(b) Other Current Liabilities [Proposed Dividend] 65.00
Total 3,408.80
II. Assets
(1) Non-Current assets
(a) Fixed Assets (697 + 648) 1,345.00
(b) Non-Current Investment (G/W of O `7,200) 276.80
(2) Current Assets
(a) Inventories (495 + 389) 884.00
(b) Trade Receivable (386 + 321) 707.00
(c) Cash and Cash Equivalents [101 + 95] 196.00
Total 3,408.80
Note: As Associates ‘O’ is not being consolidated. Therefore, trade payable of W of ` 18 thousand which is
trade receivable of O are not cancelled.
Problem 3: Air Ltd., a listed company, entered into an expansion programme on 1st October, 2009. On that
date the company purchased from Bag Ltd. Its investments in two Private Limited Companies. The purchase
was of
(a) the entire share capital of Cold Ltd.
and
(b) 50% of the share capital of Dry Ltd.
Both the investments were previously owned by Bag Ltd. after acquisition by Air Limited, Dry Ltd. was to
be run by Air Ltd. and Bag Ltd. as a jointly controlled entity.
Air Ltd. makes its financial statements upto 30th September each year. The terms of acquisition were :
Cold Ltd.
The total consideration was based on price earnings ratio (P/E) of 12 applied to the reported profit of ` 20
lakhs of Cold Ltd. for the year 30 September, 2009. The consideration was settled by Air Ltd. Issuing 8%
debentures for ` 140 lakhs (at par) and the balance by a new issue of ` 1 equity shares, based on its market
value of ` 2.50 each.
Dry Ltd.
The market value of Dry Ltd. on first October, 2009 was mutually agreed as ` 375 lakhs. Air Ltd. satisfied its
share of 50% of this amount by issuing 75 lakhs ` 1 per equity shares (market value ` 2.50 each) to Bag Ltd.
Air Ltd. has not recorded in its books the acquisition of the above investments or the discharge of the
consideration.
The summarized statements of financial position of the three entities at 30th September, 1010 are :
(` in Thousands)
(c) Dry Ltd., the jointly controlled entity, is to be accounted for using proportional consolidation, in
accordance with AS-27 “Interests in joint venture”.
(d) Goodwill in respect of the acquisition of Dry Ltd. has been impaired by ` 10 lakhs at 30th September,
2010. Gain on acquisition, if any, will be separately accounted.
Prepare the consolidated Balance Sheet of Air Ltd. And its subsidiaries as at 30th September, 2010.
(CA Final New Course Nov. 2010) (16 marks)
Solution: (All are ` in 000)
(a) Calculation of Business consideration to Cold Lid.
PC = Earnings × P/E = 20 lakhs × 12 = ` 24,000
To be paid as under—
8% Debenture 14,000
Equity Shares (1,00 lakhs/2.5 = 40 lakhs shares) 10,000
24,000
(b) Consideration paid to Dry Ltd.
Total consideration as given 37,500
Share 50% - issued equity shares 18,750
Numbers of shares @ ` 2.50 per share (thousands) 7,500
(c) Analysis of Profit of Cold Ltd. as on 30-09-2010
Pre-acquisition Post-acquisition
Retained Earnings 7,000 8,000
Air Ltd. share 100% 7,000 8,000
(d) Calculation of goodwill or Cost of control
Amount paid 24,000
Less:
Paid up value of share 20,000
Pre-acquisition profit 7,000 27,000
Capital Reserve 3,000
(e) Calculation of Goodwill of Dry Ltd.
Amount paid 18,750
Less: Share Capital 25,000
Pre-acquisition profit + 2,500
27,500 × 50% 13,750
Goodwill 5,000
(f) Retained Earnings
Air Ltd. Own balance 20,800
Share of Cold Ltd.(100%) 8,000
Share of JV (50% post) 1,000
29,800
Less: Goodwill w/off (1,000)
28,800
(g) Consolidation of assets and liabilities - Air Ltd. plus 100% of Cold Ltd. plus 50% of Dry Ltd
Comprehensive Problems on CFS (AS-21 + AS-23 + AS-27) Group Consolidation 319
Consolidated Balance Sheet of Air Ltd. and its subsidiary and Joint Venture as on 30/09/2010
Particulars Note No. ` in 000
I. Equity and Liabilities
(1) Shareholders’ Funds
(a) Share capital 1 21,500
(b) Reserves and Surplus 2 49,050
(2) Non current liabilities
Long Term Borrowings
8% Debentures 14,000
(3) Current Liabilities
(a) Short term borrowings (O/D) 1,540
(b) Trade payables (17120+5270+50% × 14100) 29,440
(c) Short term provisions (tax) (5640+2400+760 × 50%) 8,420
Total 1,23,950
II. Assets
(1) Non-Current assets
Fixed Tangible Assets (34260+27000+50% × 21060) 71,790
Intangible assets (G/W on consolidation) 4,000
(2) Current assets
(a) Inventories (9640+7200+50% × 18640) 26,160
(b) Trade receivables (11200+5060+50% × 4620) 18,570
(c) Cash/Cash equivalents (3410+50% × 40) 3,430
Total 1,23,950
1) Share Capital:
Issued Subscribed paid up:
21,500 thousand equity shares of `1/- = 21500 thousands
(of the above, 11500 thousand equity shares have been issued for consideration other than cash)
2) Reserves and Surplus:
Issued Subscribed paid up:
Capital Reserves 3,000 (on consolidation)
Securities Premium 17,250
Surplus 28,800
49,050
Minority will not be calculated in the problem because Cold Ltd is wholly owned subsidiary and Dry
Ltd is a JCE.
Problem 4: Eagle Ltd had acquired 51% in Sparrow Ltd for `75.80 lakhs on 01/04/2010. On the date of
acquisition Sparrow’s Assets stood at `196 lakhs and liabilities at `16 lakhs The Net asset position of Sparrow
Ltd as on 31/3/2011 & 30/09/2011 were `280 lakhs & `395 lakhs respectively, the increase resulting from
profits earned during the period. On 01/10/2011 25.5% holdings were sold for `125 lakhs.
You are required to (i) Explain the nature of the relationship between the two companies on the relevant
dates, (ii) The goodwill/capital reserve that arises on change in nature of the investment, (iii) Carrying
amount of unsold investments, (iv) The profit arising on part sale of investment in consolidated as well as
separate financial statements. (CA Final Nov 2011)(Marks 8)
320 Accounting Standards
Solution:
(i) On the date of acquisition, i.e. 01/04/2010, Sparrow Ltd is a subsidiary of Eagle Ltd as it holds 51%
shares. On 1/10/2011, half of the investments was sold due to this now the relationship between
Sparrow Ltd and Eagle Ltd is of associates. Eagle Ltd. will now account for the investment in Sparrow
Ltd as per equity method in its consolidated financial statements.
Working: (` in Lakhs)
Cost of investments on 1/4/2010 75.80
(-) Share of net worth (pre) [196-16] × 51% Total net assets of (91.80)
Capital Reserves : 16
Other details:
1. Details of inter-group investment is as follows:
5. Cost of goods sold of S-F is $6 opening stock + $ 38 purchases (-) $ 4 closing stock = $40.
Solution:
Important points: S-F Subsidiary Foreign, A – associates, J – Joint Venture
1. First S-F financial statement is converted into rupees by using AS-11 then it is consolidated as per
AS-21,
2. `A’ will be considered as per AS-23 which requires identification of goodwill/capital reserve
on the date of acquisition but not recognition and thereafter applying equity method. Wherein
proportionate share in profits will be recognized. No assets, liabilities, expense income of associate
will be consolidated. Stock reserve for unrealized profit will be calculated to the extent of our holding.
3. `J’ will be consolidated by proportionate consolidation method wherein proportionate part of asset,
liabilities, expense, and incomes shall be consolidated. Hence no question of minority interest arises.
Similarly inter co. debt and unrealized profit will be eliminated proportionately only.
Conversion of Financial Statement of S-F AS-11 (Rev)
Balance sheet $ Rate ` P&L $ Rate `
Equity 10 35 350 Sales 60 38 2280
Pre-acq reserve 2 35 70 Cost of goods sold
P&L 2 — 85 Opening stock 6 37 222
322 Accounting Standards
Note:
1. Goodwill 8 and capital reserve 20 can be netted in consolidated balance sheet with details in notes
or can be shown separately.
2. Goodwill in case of associate will not be recognized separately but will be shown with investment
only.
# Sales `2280 – Cost of goods `1506 – Depn `70 – Expenses `608 – Exchange loss `11 = `85
Comprehensive Problems on CFS (AS-21 + AS-23 + AS-27) Group Consolidation 323
3. Consolidated Fixed Assets Invs in A (AS 23) Other Invs Inventories Trade Rec C/CE Loans
Balances
H Co 400.00 16.00 60.00 120.00 114.00 20.00 150.00
S – local 70.00 10.00 30.00 40.00 5.00 10.00
S Foreign 350.00 35.00 160.00 160.00 40.00 80.00
JV (*) 48.00 4.00 32.00 24.00 4.00 8.00
Total 868.00 16.00 109.00 342.00 338.00 69.00 248.00
(-) Stock reserve (0.50) (3.50)
(-) Mutual Debts
H and S (10.00)
H and JV (12)
Share of Profit 2.00
868.00 17.50 109 338.50 316.00 69.00 248.00
Trade crs = 200+20+160+12+-10-12 = 370
JV* taken proportionate assets and liabilities
Stock Reserves Unsold Goods Margin Elimination% Product Dr. Cr.
S-L 7.50 0.20 1.00 1.50 P/L Stock Res
A 10.00 0.20 0.25 0.50 P/L Investments
JV 25.00 0.20 0.40 2.00 P/L Stock Res
4.00
324 Accounting Standards
Problem 6: A Ltd. acquires 80% share in B Ltd for ` 15 lakhs. The net assets of B Ltd. on the day are ` 22
lakhs. During the year A LTd. sold the investment for ` 30 lakhs and net assets of B Ltd. on the date of disposal
was ` 35 lakhs. Calculate the profit or loss on disposal of this investment to be recognized in Consolidated
Financial Statements. (5 Marks)
Solution:
Calculation of profit or loss or disposal (` in Lakhs)
Cost of investments initially 15,00,000
+ Share of post increase in net worth [35-22] × 80% 10,40,000
Carrying amount as on the date of sale (a) 25,40,000
Proceeds from disposal of shares of subsidiary B Ltd. (b) 30,00,000
Loss on disposal in consolidated Profit and Loss A/c (a-b) 4,60,000
Problem 7: H Limited, a Company registered with SEBI, has three Subsidiaries and one Associate. While doing
the audit of Consolidated Financial Statements (CFS) of H Limited you have come to know that the Associate
Entity had made a Provision for Proposed Dividend in its Financial Statements. H Limited computed it share
of the results of operations of the Associate after taking into account the Proposed Dividend. Comment.
(Marks 4)
Solution: Proposed dividend by the Associates ASI-16
It is clarified that in case the associate has made a provision for proposed dividend in its financial
statements, the investor’s share of the results of operations of the associate should be computed without
taking into consideration the proposed dividend (also refer practical problem asked in May 2010). Carrying
Amount of Investment is reduced by the distributions (Dividends received) from Associates. However, when
the Associate has made a Provision for Proposed Dividend in its Financial Statements, the Investor’s Share
from the Associate should be computed without taking into consideration the Proposed Dividend. Accounting
treatment given by H Ltd in the above case, is not proper.
Problem 8: Parent Ltd acquired 51% Shares of Child Ltd, during the year ending 31–03–2014. During the
Financial Year 2014–2015 the 20% Shares of Child Ltd, were sold by Parent Ltd. Parent Ltd, while preparing
the Financial Statements for the year ending 31–03–2014 and 31–03–2015 did not consider the Financial
Statements of Child Ltd, for consolidation. As a Statutory Auditor how would you deal with it?
Solution:
Parent Ltd has to comply with the CFS for both the years viz: 2013–2014 and 2014–2015. At the year end the
then subsidiary company will now become the Associate company. This means last year full consolidation is
applied and in the year 2014-15 Equity Consolidated will be applied. The Auditor of the Company should also
see the Compliance of AS–21,23.
SCHEDULE -III
(ACCOUNTING STANDARDS)
Problem 1: Mr Bankim is an exporter of goods. He exported goods worth $ 20,000 on 1/1/2015 on credit
basis fors a period of 6 months. As he is worried about the changes in exchange rates he took a forward cover.
Following are the details:
Date Rate
1/1/2015 1$ = ` 65.50 Spot rate
1/1/2015 1$ = ` 64.00 Forward rate for 6 months
31/3/2015 1$ = ` 65.00 Closing rate
31/3/2015 1$ = ` 65.20 Forward rate for 3 months
30/06/2015 1$ = ` 64.90 Spot rate
Prepare ‘Notes’ accounts showing the above deposits in accordance with the requirements of Revised
Schedule VI. 5 Marks
Solution:
Assumption: Year ending: 31/3/2014
As per the revised Schedule VI disclosures are as follows:
Current Assets:
(a) Cash & Cash Equivalents: (maturity < 3 months)
Punjab National Bank FD `15,00,000
State Bank of India FD `10,00,000
(b) Other Current Assetss: (maturity > 3 months but < 12 months)
ICICI Bank FD `10,00,000
Non – Current Assets:
Other Non – Current Assets: (maturity > 12 months)
Axis Bank FD `10,00,000
EXTRA PRACTICAL PROBLEMS FROM PAST YEAR PAPERS
AND RTPs OF FINANCIAL REPORTING AND AUDIT
AS1
Problem 1: XYZ Company is engaged in the business of financial services and is undergoing tight liquidity
position, since most of the assets of the company are blocked in various claims/petitions in a Special Court.
XYZ has accepted Inter-Corporate Deposits (ICDs) and, it is making its best efforts to settle the dues. There
were claims at varied rates of interest, from lenders, from the due date of ICDs to the date of repayment. The
company has provided interest, as per the terms of the contract till the due date and a note for non-provision
of interest on the due date to the date of repayment was affected in the financial statements. On account of
uncertainties existing regarding the determination of the amount and in the absence of any specific legal
obligation at present as per the terms of contracts, the company considers that these claims are in the nature
of “claims against the company not acknowledged as debt”, and the same has been disclosed by way of a note
in the accounts instead of making a provision in the profit and loss accounts. State whether the treatment
done by the Company is correct or not.
Solution: AS 1 “Disclosure of Accounting Policies” recognises prudence as one of the major considerations
governing the selection and application of accounting policies. In view of the uncertainty attached to future
events, profits are not anticipated but recognized only when realized though not necessarily in cash. Provision
is made for all known liabilities and losses even though the amount cannot be determined with certainty and
represents only a best estimate in the light of available information.
Further, ‘accrual’ is one of the fundamental accounting assumptions as per AS 1. Irrespective of the terms
of the contract, so long as the principal amount of a loan is not repaid, the lender cannot be placed in a
disadvantageous position for non-payment of interest in respect of claim for interest from the due date to
date of repayment of loan.
From the aforesaid, it is apparent that the company should provide for the liability (since it is not waived
by the lenders) at an amount estimated or on reasonable basis based on facts and circumstances of each
case. Non-provision of the interest from the due date to the date of repayment of loan amounts to violation of
accrual basis of accounting.
AS2
Problem 2: On 31.03.2013 a Business Firm finds that Cost of a partly finished unit on that date is `530.
The unit can be finished in 2013– 2014 by an additional expenditure of `310. The finished unit can be sold
for `750 subject to payment of 4% brokerage on Selling Price. The firm seeks your advice regarding : 1) The
amount at which the unfinished unit should be valued as at 31.03.2013 for preparation of Final Accounts and
2) The desirability or otherwise of producing the finished unit.
Solution:
1) As per AS–2, WIP should be valued at actual Cost or NRV whichever is less.
NRV = 750 – 30 (brokerage) – 310 = ` 410 or Cost ` 530 whichever is less i.e. Valuation as on
31/3/2013 = ` 410.
2) Desirability of Further Production –
Particulars Amount
Expenditure incurred till date 530
Add: Additional Expenses 310
328 Accounting Standards
Problem 5: The closing inventory at cost of a Company amounted to `9,56,700. The following items were
included at cost in the total:
(i) 350 Shirts, which had cost `380 each and normally sold for `750 each. Owing to a defect in
manufacture, they were all sold after the balance sheet date at 50% of their normal price. Selling
expenses amounted to 5% of the proceeds.
(ii) 700 Trousers, which had cost `520 each. These too were found to be defective. Selling expenses for
the batch totaled `3,800. They were sold for `950 each.
What should be the closing inventory value (to the nearest rupee), after considering the above items?
Solution: Calculation of value of closing inventory:
`
Value of closing inventory (given) 956700
Less: Adjustment to bring the stock of shirts at net realizable value (W.N.1) (8313)
Revised value of closing inventory as per AS 2 948387
WN:
1) Valuation of Shirts as per AS-2
Cost price (per shirt) 380
Net realizable value per shirt :
Selling price of a shirt ` 750 × 50% = 375.00
Less: Selling expense (5% of ` 375) = (18.75)
NRV of a shirt 356.25
As per AS 2, inventories are valued at cost or NRV whichever is less. 356.25
Difference of cost and NRV 23.75
Therefore, value of inventory of shirts is to be reduced by ` 8,313
(` 23.75 × 350 shirts)
2) Valuation of Trousers
Cost price (per trouser) 520
NRV per trouser:
Selling price of a trouser ` 950.00
Less: Selling expense of a trouser (` 3,800/700) `(5.43)
NRV of a trouser ` 944.57
As per AS 2, inventories are valued at cost or NRV whichever is less.
Since, inventory of trousers is already carried at cost, no further adjustment
is required in the total value of closing inventories. 520
Problem 6: Cuba Compu Techniques Pvt. Ltd. manufactures computers, during the year ended 31st March
2005 the company manufactures 550 computers. It adopts the policy of valuing finished stock of goods at a
standard cost of `1,80,000 per computer. Details of cost is as follows:
Materials & stores `400 lakhs, Direct labour `250 lakhs, VPOH `150 lakhs, FPOH `290 lakhs. FPOH
includes interest and storage cost of `100 lakhs. Compute value of stock. (C.A. Final May 2002)
Solution: The company follows Standard Costing policy of valuing stock, but as per AS-2 valuation will be
done as per absorption costing. Valuation as per absorption costing is worked out as follows:
Materials ` 400 lakhs + Direct labour ` 250 lakhs + VPOH ` 150 lakhs + FPOH ` *190 lakhs.
= ` 990 lakhs. * FPOH is excluding interest and storage cost see para 3.1(b).
Production of goods (computers) = 550 computers (assuming to be normal production)
Cost per computer (by absorption costing) = ` 990 lakhs/550 = ` 1.80 → as per AS-2.
330 Accounting Standards
Solution:
Particulars Units Cost price of the Retail price of the
goods (`) goods (`)
Opening inventory 2,59,000 10,50,222 12,64,748
Goods purchased 12,00,000 61,20,000 78,05,923
Total Goods 14,59,000 71,70,222 90,70,671
Less: Actual Sales -8,30,456 -- -55,81,454
Closing Stock 6,28,544 ? 34,89,217
Cost to Retail ratio = 71,70,222 ÷ 90,70,671 = 79.048%.
Applying Cost/Retail ratio to Stock at retail price = 79.048% × 34,89,217 = ` 27,58,156.
Value of Closing Stock of Carvi & Sons = ` 27,58,156.
AS3
Problem 8: Garden Ltd. acquired fixed assets viz. plant and machinery for `20 lakhs. During the same year
it sold its furniture and fixtures for `5 lakhs. Can the company disclose, net cash outflow towards purchase of
fixed assets in the cash flow statement as per AS-3?
Solution: According to Para 21 of AS 3 (Revised) ‘Cash Flow Statements’, an enterprise should report
separately major classes of gross cash receipts and gross cash payments arising from investing and financing
activities, except to the extent that cash flows described in paragraphs 22 and 24 are reported on a net
basis. Acquisition and disposal of fixed assets is not prescribed in para 22 and 24 of the standard. Hence,
the company cannot disclose net cash flow in respect of acquisition of plant and machinery and disposal of
furniture and fixtures.
AS4
Problem 9: A claim for damages of `10 lakhs for breach of patents and copyrights had been served on
the company in January, 2011. The Directors sought competent legal advice on the eligibility of the claim
and were advised that the claim was highly frivolous, without any bases and would not survive even in the
first trial court. The company however anticipates a long drawn legal battle and huge legal costs. Advise the
company regarding how this should be treated in the accounts.
Extra Practical Problems from Past Year Papers and RTPs of Financial Reporting and Audit 331
Solution:
Previously this problem was covered by AS-4, but now it is covered by AS-29.
Provision: No provision is required as there is no probability of outflow of resources. The company is strong
in its contention about the case. The case is not likely to survive in the first trial court.
Contingent liability: Even no disclosure is required for the case because the settlement of the liability is very
remote.
But the company has to disclose the fact that huge expenses will be incurred on legal cases. But the
company cannot record the same because it is a future expenses.
AS5
Problem 10: Tiger Motor Car Limited signed an agreement with its employees union for revision of wages
on 01.07.2015. The revision of wages is with retrospective effect from 01.04.2012. The arrears of wages
up to 31.3.2015 amounts to `40,00,000 and that for the period from 01.04.2015 to 01.07.2015 amount to
`3,50,000. In view of the provisions of AS 5 “Net Profit or Loss for the period, Prior Period Items and Changes
in Accounting Policies”, decide whether a separate disclosure of arrears of wages is required while preparing
financial statements for the year ending 31.3.2016.
Solution: Wages related to the current year 2015 – 16 ` 7,50,000 is a normal wages under the head Employees
Cost. But wages related to past years ` 40,00,000 is an exceptional item which requires a separate disclosure.
Problem 11: Comment on the following: A Co. Ltd has not included in the Balance Sheet as on 31-3-2015
a sum of `1.50 crores being amount in the arrears of salaries and wages payable to the staff for the last
2 years as a result of successful negotiations which were going on during the last 18 months and concluded
on 30-4-2015. The auditor wants to sign the said Balance Sheet and give the audit report on 31-5-2015. The
auditor came to know the result of the negotiations on 15/5/2015.
Solution: The negotiations were concluded on 30/4/2015 which is an event occurring after the balance
sheet date. Yes it is an adjusting event for the year 2014 – 2015. The condition for such event was present on
the balance sheet date. Also as per AS-5 it is to be separately disclosed as an exceptional item to explain the
performance of the company ion a better way.
Problem 12: Discuss with reference to the Accounting Standards the nature of classification and disclosure
requirements in the statement of profit and loss of an entity in the following cases:
(a) Losses sustained as a result of enemy action.
(b) Disposal of long-term Investments of a trading entity.
(c) Setting up of group gratuity scheme where there was none.
(d) Payment of arrears of bonus for the earlier year as a result of settlement with the workers in the
current year.
Solution:
(a) Extra ordinary activity – being the event is beyond the control of the management.
(b) Exceptional item – It is necessary to explain such transaction within ordinary.
(c) Prior period item – Non-compliance of AS -15.
(d) If we assume the provision was not necessary i.e. remote liability then now a separate disclosure is
required. But if Provisions was required then it is a prior period item.
332 Accounting Standards
AS6
Problem 13: A plant was depreciated under two different methods as under –
Straight line method Diminishing Balance
1st year 3.90 10.69
2nd year 3.90 7.90
3rd year 3.90 5.84
4th year 3.90 4.32
15.60 28.75
5th year 3.90 3.19
Required: (a) If the company followed diminishing balance for first four years and decides to switch over to
SLM, what would be the amount of resultant surplus/deficiency? (b) If the company followed SLM for first
four years and decides to switch over to diminishing balance what would be amount of resultant surplus/
deficiency?
Solution: Change in the method of depreciation is change in accounting policy. Change in AP is governed by
AS-1 and AS-5. As per AS-5 any change in AP is required to be disclosed separately. Also change in AP always
has a retrospective effect.
In the present problem the retrospective effect in the books is as follows:
Asset A/C Dr 13.15
To Asset A/C 13.15
Also in the current year the depreciation will be charged as per the new method SLM ` 3.90.
Problem 14: In the Trial Balance of M/s. Sun Ltd. as on 31-3-2011, balance of machinery appears `5,60,000.
The company follows rate of depreciation on machinery @ 10% p.a. on Straight Line Method*. On scrutiny it
was found that a machine appearing in the books on 1-4-2010 at `1,60,000 was disposed of on 30-9-2010 at
`1,35,000 in part exchange of a new machine costing `1,50,000.
Required: Calculate:
(i) Total depreciation to be charged in the Profit and Loss Account.
(ii) Loss on exchange of machine.
(iii) Book value of machinery in the Balance Sheet as on 31.3.2011.
Solution:
(i) Total Depreciation to be charged in the Profit and Loss Account
Depreciation on old machinery in use [10% of (5,60,000 – 1,60,000)] ` 40,000
Add: Depreciation on new machine @ 10% for six months 7500
(1,50,000 × 10% × 6/12)
Total depreciation on machinery in use 47500
Add: Depreciation on machine disposed of (10% for 6 months) 8000
(1,60,000 × 10% × 6/12)
So, total depreciation to be charged in Profit and Loss A/c 55,500
(ii) Loss on Exchange of Machine
Book value of machine as on 1.4.2011 160000
Less: Depreciation for 6 months @ 10% (8000)
Written Down Value as on 30.9.2011 1,52,000
Less: Exchange value 1,35,000
Loss on exchange of machine 17,000
Extra Practical Problems from Past Year Papers and RTPs of Financial Reporting and Audit 333
AS7
Problem 15: Comment on the following whether they are covered under AS-7 (Revised) with reasons:
(Similar Question asked in Audit Nov 2010)
Case I: AB construction company constructs 18 residential flats during the accounting year 2004 – 2005. Out
of 18 flats 4 flats are kept for entertainment purposes and for serving the guests and the balance are sold to
the Companies Directors for accommodation.
Case II: CD construction company constructs a big MALL SHOPPING CENTRE for selling the shops and
commercial complexes. The MALL is constructed on their own to sell and not under any contract with any
contractee.
Solution:
Case I: Flats which are kept for the guests etc. is Fixed Assets for the company. As such it is not a sale
transaction at all. And even the balance Flats sold to the Companies Directors will not be covered by AS-7 but
it will be income accounted as per AS-9 (Other Income). Even there is no contractor - contractee relationship.
Hence the transactions will not be covered by AS-7.
Case II: Constructing the MALL and then selling the shops and premises on their own account, and not under
a contract does not attract AS-7. Shops and premises unsold or in process should be shown as closing stock
as per AS-2. Even the materials and equipment is to be shown under as closing stock. When the shops and
premises are sold at that point of time it will be treated as sale as per AS-9. It is a case of Real estate developers.
Problem 16: Determine whether the contracts are segmenting contracts or combining contracts from the
following situations given below:
i) Mehta Constructions has 4 contracts for construction and installation of ATM booths for Central
Bank. Each contract is a separate proposal. The contract price per contract ` 32 lakhs.
ii) Construction of super bazar for AN Ltd. was divided into the following stages: Stage1 – Leveling the
ground, Stage2 – Construction of super bazaar, Stage3 – Canteen attached to the super bazaar. All the
contracts are assigned as a package.
Solution:
i) A single contract may give so many works to be performed or a single contract may contain
combination of various assets to be constructed. Here a single gives 4 works to be performed. Then
each of the work performed is to be taken as a separate contract because :
each work performed/construction of asset is a separate proposal.
each work performed/construction of asset is subject to separate negotiation.
Contractor may accept or reject a particular work to be performed/asset to be constructed.
Costs &revenues of each work performed/completion of asset can be ascertained separately.
334 Accounting Standards
ii) Sometimes, a group of contracts may be treated as a single contract. The whole contract has been
given, as a package containing various works to be performed. Therefore, the group of contracts may
be treated as a single contract because :
group of contracts is, assigned as a single package.
all the contracts put together forms part of a single project giving an overall profit margin.
all the contracts individually are interdependent on each other.
all such contracts can be performed simultaneously (concurrently) or consequently (one after
the other). Hence construction of the total super bazaar including canteen etc. is a single contract.
Problem 17: Comment of the following: B Co. Ltd is engaged in the business of developing mass scale
housing projects including development of small commercial complexes. The flats/ commercial spaces are
booked by the public and are allotted by way of allotments letter to each allottee. Major construction activities
pertaining to buildings are undertaken after allotment is over. After completing the construction, possession
of flats/commercial spaces is given to allottees by executing legal document. The CEO of the B Co. Ltd. says
that AS 7 is not applicable to the company.
Solution: The contention of the CEO of B Ltd is correct. Any builder who constructs property on his own
and under a contract should follow AS-9 for Revenue Recognition and AS-2 for Valuation if Inventories.
Flats / premises are inventories unsold on 31/3. In 2012 ICAI came with a Guidance note on “Real Estate
Developers”, which is applicable to all the builders who construct properties on their own. The GN is based
on AS-2 and AS-9 provisions.
Problem 18: Contractors Ltd. have recognized contract revenue on a contract awarded in the financial year
2009-10. The target date of completion is 5 years. The contract provides for incentives for early completion
at the rate of`1,000 per day subject to a maximum of `3,00,000. The company has included this amount in
contract revenue (in the first year of contract) on the ground that based on the previous experience in similar
contracts, it is confident of completing the contract in 4 years. The company’s past track record shows that
company was able to complete such contracts well in time and earn incentives. Comment on the company’s
accounting policies.
Solution: The Company’s accounting policy is not in accordance with AS 7 (Revised) “Construction Contracts”.
Past track record is not the criteria for recognition of incentive payments receivable for early completion of
contract. According to AS 7 (Revised) incentives payments can be included in contract revenue only when
- the contract is sufficiently advanced that it is probable that the specified performance standards will be
met or exceeded; and - the amount of the incentive payment can be measured reliably. The contract is not
sufficiently advanced as it is in the first year and its normal time is 4-5 years. Hence, the recognition criteria
are not met and it is inappropriate to include incentive payments receivable in the current year is part of
contract revenue.
Problem 19: An amount of `9,90,000 was incurred on a contract work upto 31-03-2010. Certificates have
been received to date to the value of `12,00,000 against which `10,80,000 has been received in cash. The cost
of work done but not certified amounted to `22,500. It is estimated that by spending an additional amount
of`60,000 (including provision for contingencies) the work can be completed in all respects in another two
months. The agreed contract price of work is `12,50,000. Compute an estimate of the profit to be taken to the
Profit and Loss Account as per AS 7.
Solution:
Computation of estimate of profit as per AS 7
`
Expenditure incurred upto 31.3.2010 9,90,000
Estimated additional expenses 60,000
(including provision for contingency)
Extra Practical Problems from Past Year Papers and RTPs of Financial Reporting and Audit 335
AS9
Problem 20: M/s Moon Ltd sold Goods worth `6,50,000 to Mr. Star. Mr. Star asked for a Trade Discount
amounting to `53,000 and the same was dispatched. On receipt of Goods, Mr. Star found that Goods worth
`67,000 are defective. Mr. Star returned defective goods to M/s Moon Ltd and made payment due amounting
to `5,30,000. The Accountant of M/s Moon Ltd booked the Sale for `5,30,000. Discuss the contention of the
Accountant with reference to AS–9.
Solution: As per Para 4.1 of AS 9 “Revenue Recognition”, revenue is the gross inflow of cash, receivables or
other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods,
from the rendering of services, and from the use by others of enterprise resources yielding interest, royalties
and dividends. In the given case, Moon Ltd. should record the sales `6,50,000 less Discount of `53,000 in
price and goods returned worth `67,000 are to be adjusted by suitable provisions.
Therefore the revenue to be recorded will be `5,97,000. Suitable provision should be made for sales
return.
Problem 21: An infrastructure company has constructed a mall and entered into agreement with tenants
towards license fees (monthly rental) and variable license fees, a percentage on the turnover of the tenant
(on an annual basis). Chief Finance Officer wants to account/recognize license fee as income for 12 months
during current year under audit and variable license fees as income during next year, since invoice is raised
in the subsequent year. As an auditor, how would you deal and state in the statement of Accounting policies?
Solution: AS-9 deals with the timing of recognition of Revenue. Revenue should be recorded on accrual basis
if there is no uncertainty prevailing over revenue.
Both the fixed rentals and variable licence fees on turnover should be recorded in the same accounting
year. The year of raising invoices is immaterial. The contention of the CEO of the company is incorrect. The
Auditor should qualify the report under SA 705 indicating the understatement of income .
Problem 22: As a Statutory Auditor, how would you deal with the following?
LM Ltd. has 2 divisions L and M. The finished products of division L are transferred to division M where
further processing is carried out before sale to customers. To achieve transparency and accountability
between the divisions, division L raises an invoice on division M at cost plus normal margins. At the year
end the unrealized profits on inter-division stocks are eliminated. However, the transfers are recorded at the
invoice value as sales and purchases in the respective division for the purpose of preparing the Profit and
Loss Account. Suitable disclosure, for this are given in the ‘Notes to Accounts’.
Solution: The risks and rewards related to the ownership is not transferred by the company to another party
.i.e. the risk and rewards remains with the company only. Therefore the company cannot record the gain on
account of inter dept. transfer. It is the sales and purchases at departmental level and not at the company’s
level.
336 Accounting Standards
Problem 23: A company is engaged in the manufacture of electronic products and systems. As per Chief
Accountant a prototype system was installed at one of the customer’s locations in June 2010 for getting
acceptance on the performance of the system. The Chief Accountant has stated that as the ownership of
the system installed for field trials was vested with the company, for accounting & control purposes, the
prototype system installed at customer’s location in 2010 was capitalized in the accounts for the year 2010-
11 at its bought-out cost. State whether the accounting treatment adopted by the company is correct or not?
Solution: As per para 3 of AS-2 ‘Valuation of Inventories’, inventories mean assets held for sale in the ordinary
course of business, or in the process of production for such sale, or for consumption in the production of
goods or services for sale, including maintenance supplies and consumables other than machinery spares.
And as per para 6.1 of AS 10 ‘Accounting for fixed Assets’, fixed asset is an asset held with the intention of
being used for the purpose of producing or providing goods or services and is not held for sale in the normal
course of business.
Accordingly, the system installed by the company at customer’s site for his acceptance, based on the field
trials of the system, is an item of inventory, and is not a fixed asset. Installation of such prototype system at
customers’ sites for their acceptance is akin to sale of goods on approval basis. Therefore, the capitalization
of such prototype system at its bought-out-cost is not correct.
At the time of installation of such systems at the customers’ site, value of the same should be transferred
to a separate account such as ‘Goods sent for approval account’.
As it does not qualify the definition of fixed asset, therefore, no depreciation can be charged on it.
Problem 24: A company is engaged in the business of ship building and ship repair. On completion of
the repair work, a work completion certificate is prepared and countersigned by ship owner (customer).
Subsequently, invoice is prepared based on the work completion certificate describing the nature of work
done together with the rate and the amount. Customer scrutinizes the invoice and any variation is informed
to the company. Negotiations take place between the company and the customer. Negotiations may result in
a deduction being allowed from the invoiced amount either as a lumpsum or as a percentage of the invoiced
amount. The accounting treatment followed by the company is as follows:
(i) When the invoice is raised, the customer’s account is debited and ship repair income account is
credited with the invoiced amount.
(ii) Deduction, if any, arrived after negotiation is treated as trade discount by debiting the ship repair
income account.
(iii) At the close of the year, negotiation in respect of certain invoices had not been completed. In such
cases, based on past experience, a provision for anticipated loss is created by debiting the Profit and
Loss account. The provision is disclosed in Balance Sheet. Following two aspects are settled in the
negotiations:
(a) Errors in billing arising on account of variation between the quantities as per work completion
certificate and invoice and other clerical errors in preparing the invoice.
(b) Disagreement between the company and customer about the rate/cost on which prior agreement
has not been reached between them.
Comment:
(i) Whether the accounting treatment of deduction as trade discount is correct? If not, state the correct
accounting treatment.
(ii) Whether the disclosure of the provision for anticipated loss in Balance Sheet is correct; if not, state
the correct accounting treatment. (CA Final June 09)
Solution:
(i) As per AS 9 “Revenue Recognition”, revenue is recognized at the time when the invoice is raised to
the customers; however the treatment of deduction as trade discount is not in accordance with AS 9.
Extra Practical Problems from Past Year Papers and RTPs of Financial Reporting and Audit 337
Such deductions should be shown separately. The description of the difference as ‘trade discount’ is
not appropriate.
(ii) In respect of unsettled invoices on the B/S date provisions have to be created based on the past
experience. In the present problem company has passed accounting entry as:
Profit/loss A/c. Dr xxxx
To Provision for doubtful debts xxxx
When the debtors are unable to pay or cash discount is incurred in that case the company should charge
the loss to Profit and loss account. This is because it is a loss post sales.
AS10
Problem 25: X Ltd., paid `25 lakhs as advance to Y Ltd. towards the purchase of a printing machinery on
15.01.14 with delivery instructions to deliver the same in the last week of June, 08. Further on 02.02.14 X
Ltd. purchased two diesel generator sets from Y Ltd. for `30 lakhs on 90 days Credit term. In the accounts for
2013-14, X Ltd. intends to adjust the advance paid against Credit purchase and show the net amount of `5
lakhs as due from them. As the statutory auditor, how would you deal with this?
Solution: X Ltd. has paid advance amount to the supplier of machinery to be used in the project, such
advance amount should be grouped under the head ‘Capital Advances’ under the line item Long term loans
and advances. It is as per requirement of New Schedule III to the New Companies Act 2013. Short term credit
for 2 generators should be disclosed under Other Current liabilities. The proposal of X Ltd., to show the net
balance in the personal account of Y Ltd., is not correct. Such proposal will cancel the two material items in
the balance sheet – one, expenditure towards capital asset and the other current liability for purchase of the
generator set. Hence, the auditor should advise X Ltd., to show these two items separately. If X Ltd. does not
accept the advice, the auditor should qualify his report with suitable quantification of amount involved.
AS11
Problem 26: Option Ltd. is engaged in the manufacturing of steel. For its steel plant, it required machineries
of latest technology. It usually resorts to Long Term Foreign Currency Borrowings for its fund requirements.
On 1st April, 2011, it borrowed US $1 million from International Funding Agency, USA when exchange rate
was 1 $ = `52. The funds were used for acquiring machineries on the same date to be used in three different
steel plants. The useful life of the machineries is 10 years and their residual value is `20,00,000.
Earlier also the company used to purchase machineries out of foreign borrowings. The exchange differences
arising on such borrowings were charged to profit and loss account and were not capitalized even though the
company had an option to capitalize it as per notified AS 11 (notification issued by the MCA in 2009).
Now for this new purchase of machinery, Option Ltd, is interested to avail the option of capitalizing the
same to the cost of asset. Exchange rate on 31st March, 2012 is 1 US $ = `51. Assume that on 31st March, 2012,
Option Ltd. is not having any old Long term foreign currency borrowings except for the amount borrowed for
machinery purchased on 1st April, 2011.
Can Option Ltd. capitalize the exchange difference to the cost of asset on 31st March, 2012? If yes, then
calculate the depreciation amount on machineries as on 31st March, 2012.
Would your answer differ, if Option Ltd. was not a company and was a LLP?
338 Accounting Standards
Solution: Ministry of Corporate Affairs, Government of India, inserted paragraph 46A in notified AS 11 by
Notification dated 29th December, 2011, which is relevant for companies. It states that in respect of accounting
periods commencing on or after 1st April, 2011, for an enterprise which had earlier exercised the option
under paragraph 46 or not (such option to be irrevocable and to be applied to all such foreign currency
monetary items), the exchange differences arising on reporting of long term foreign currency monetary items
at rates different from those at which they were initially recorded during the period, or reported in previous
financial statements, in so far as they relate to the acquisition of a depreciable capital asset, can be added to
or deducted from the cost of the asset and shall be depreciated over the balance life of the asset.
Accordingly, though Option Ltd. had not earlier exercised the option as given by the notification on AS 11,
issued in 2009, yet it can avail the option to capitalise the exchange difference to the cost of machinery by
virtue of para 46A inserted in the notified AS 11 in December, 2011.
Exchange difference to be capitalised:
Cost of the asset in $ $ 10 lakhs
Exchange rate on 1st April, 2011 `52 = 1$
Cost of the asset in ` ($10 lakhs x 52) 520 lakhs
Less: Exchange differences as on 31st March, 2012 (52-51) x $ 1 million Gain (10 lakhs)
510 lakhs
Less: Depreciation for 2011-12 (510-20)/10 49 lakhs
461 lakhs
Notification number G.S.R 914(E), dated 29th December, 2011, is relevant only for companies. If Option
Ltd. is a LLP, then this notification is not applicable and it cannot capitalise the exchange difference to the cost
of the machinery. The amount recognised to Profit and Loss account would be `10 lakhs.
P roblem 27: XYZ Ltd. purchased an equipment at a price of $ 1,00,000 on 2-4-2011 upon terms of credit
the price should be settled within six months. The company capitalized the asset in terms of Indian `at a
rate of exchange prevailing as on date of purchase. When the liability is settled as per terms on 10.9.2011, it
incurs an additional amount of `3,50,000 due to exchange fluctuation the date of settlement. The said sum is
charged off to profit and loss account.
Solution: The accounting treatment is in consonance with AS-11 (Rev). All the exchange difference is
transferred to P/L account.
Problem 28: The draft Balance Sheets of A Ltd. and its American subsidiary B incorporated. As at 31st
December, 2016 are:
A (`) B (`)
Fixed Assets 18,00,000 20,000
Investments in B
Incorporated at cost 16,00,000 —
Stocks 12,00,000 30,000
Debtors 24,00,000 60,000
Cash and Bank 8,00,000 10,000
78,00,000 1,20,000
Represented by
Equity share Capital 30,00,000 30,000
Profit and Loss Account 20,00,000 40,000
Loan 12,00,000 20,000
Trade Creditors 6,00,000 10,000
Taxation 10,00,000 20,000
78,00,000 1,20,000
Extra Practical Problems from Past Year Papers and RTPs of Financial Reporting and Audit 339
A Ltd. acquired 80% of shares in B Incorporated on 1st January 2016, when the Profit & Loss Account
showed a balance of $ 15,000. The Exchange rate prevalent during the relevant dates were:
1st January, 2016 1 $ = `59.46, Average rate 1 $ = `60.25, 31st December, 2016 1 $ = `61.50,
Fixed Asset acquisition rate 1 $ = `58.00.
A Ltd received dividend of $2,400 pertaining to pre acquisition period on 10th March 2016. The exchange
rate prevailing on that date was 1$ = `59.36. Mutual debt payable by A to B is `30,055 equivalent to $500
respectively.
Required: Prepare the consolidated Balance Sheet of A Ltd. and its subsidiary at 31st December, 2016
assuming: Integral and Non–Integral operations; with reference to the provisions of AS-11 Rev.
Solution:
Conversion of Trial Balance ($ → `)[Integral Operations]
ER Dr. (`) Cr. (`)
Fixed Assets NM 58 11,60,000 –
Inventories NM 61.5 * 18,45,000
(Assumed to be out of recent purchase)
Trade Receivable M 61.5 36,90,000
Cash and Bank M 61.5 6,15,000
Equity Share Capital NM 59.46 – 17,83,800
Profit & Loss A/c NM WN – 24,00,520
Loan M 61.5 – 12,30,000
Trade Creditors M 61.5 – 6,15,000
Taxation M 61.5 – 12,30,000
Forex Gain (balancing fig) – – – 50,680
73,10,000 73,10,000
Working Note – 1
Profit & Loss Balance
$ 40,000
Opening $ 15,000
Dividend $ (3,000)
$ 12,000 $ 28,000 N.P
@ 59.46 @ 60.25
7,13,520 16,87,000 = 24,00,520
Consolidated B/S of A & its subsidiary as on 31/12/2014
Equity
1) Shareholder’s Fund
Share Capital 1 30,00,000
Reserves & Surplus 2 37,87,305
2) Minority Interest 8,47,000
3) Non-Current Liabilities
Loans and Borrowings 24,30,000
4) Current Liabilities
340 Accounting Standards
Notes to Accounts
1) Share Capital
Authorized –
Issued, Subscribed, paid up
30,000 Equity Share of `10 each fully paid 30,00,000
2) Reserves & Surplus
Profit & Loss balance 32,46,985
Capital Reserve on Consolidation 5,40,320
3) Consolidated Assets and Liabilities
Consolidated P & L
Balance b/d 20,00,000
(+) Share of Post P & L 13,90,144
(-) Stock Reserve –
(-) Dividend declared –
(-) Pre - dividend wrongly credited (1,42,464)
(-) Creditors Revaluation (695)
3,24,6985
Analysis of Net Worth of B Inc.
Extra Practical Problems from Past Year Papers and RTPs of Financial Reporting and Audit 341
Pre Post
Share Capital 17,83,800 –
Profit & Loss (WN1) 7,13,520 16,87,000
Forex gain – 50,680
24,97,320 17,37,680
A 80% 19,97,856 13,90,144
Minority 20% 4,99,464 3,47,536
@
Mutual Owings:
A = 30, 055
B = 500 $
AS12
Problem 29: Supriya Ltd. received a grant of `2,500 lakhs during the last accounting year 2012-13 from
government for welfare activities to be carried on by the company for its employees. The grant prescribed
conditions for its utilization. However, during the year 2013-14, it was found that the conditions of grants
were not complied with and the grant had to be refunded to the government in full. Elucidate the current
accounting treatment, with reference to the provisions of AS 12.
Solution: As per AS 12 ‘Accounting for Government Grants’, Government grants sometimes become
refundable because certain conditions are not fulfilled. A government grant that becomes refundable is
treated as an extraordinary item as per AS 5 “Net Profit or Loss for the Period, Prior Period Items and Changes
in Accounting Polices”.
The amount refundable in respect of a government grant related to revenue is applied first against any
unamortized deferred credit remaining in respect of the grant. To the extent that the amount refundable
exceeds any such deferred credit, or where no deferred credit exists, the amount is charged immediately to
profit and loss statement. In the present case, the amount of refund of government grant should be shown in
the profit & loss account of the company as an extraordinary item during the year 2009-10.
342 Accounting Standards
AS13
Problem 30: A manufacturing company purchased shares of another company from stock exchange
on 1st May, 2012 at a cost of `5,00,000. It also purchased Gold of `2,00,000 and Silver of `1,50,000 on
1st April, 2010. How will you treat these investments as per the applicable AS in the books of the company
for the year ended on 31st March, 2013, if the values of these investments are as follows:
`
Shares 2,00,000
Gold 4,00,000
Silver 2,50,000
Solution: As per para 32 of AS 13 on ‘Accounting for Investments’, any investment of long term period is
shown at cost. Hence, the investment in Gold and Silver (purchased on 1st April 2005) shall continue to be
shown at cost i.e., `2,00,000 and `1,50,000 respectively as their value have increased. Also as per AS 13, for
investment in shares - if the investment is for short-term period then the loss of `3,00,000 is to be charged
to profit & loss account for the year ended 31st March, 2008. If investment is of long term period then it will
continue to be shown at cost in the Balance Sheet of the company. However, provision for diminution shall
be made to recognize a decline, other than temporary, in the value of the investments, such reduction being
determined and made for each investment individually.
Problem 31: XYZ & Company has acquired 100% of the equity shares of Company ‘X’ during 2011. Company
‘X’ is a defunct company. The net worth of the Company ‘X’ is represented by land and building it owns. XYZ
& Company acquired the shares of Company ‘X’ only for the land and building owned by it. XYZ & Company
had proposed to start a software development facility at this site at the time of share purchase. The software
development facility has not yet been set up, as Company’s existing facility itself is under-utilized.
In the financials of the year 2012, the above investment was classified as fixed assets under the head ‘land
and building’ to reflect the substance of the transaction, as the intention to acquire the shares was to use the
land and building owned by Company ‘X’.
During the year 2014, the Company has decided to sell these shares and has passed a resolution authorizing
the chairman to negotiate and settle the price. As of March 2014, this investment is reflected as fixed assets in
the books. The property is prime one and is an ideal one for setting up new software units, warehouses etc.
a) Should the above shares be classified under investments or is the current treatment of grouping it
under fixed assets correct?
b) If the current treatment of disclosing the shares as land and building is correct, should we disclose
the same as assets held for disposal, with appropriate classification and disclosures?
Solution: As per para 20 of AS 13 ‘Accounting for Investments’, the cost of any shares in a company, the
holding of which is directly related to the right to hold the investment property, is added to the carrying
amount of the investment property as long term investment.
In the given case, the acquisition of shares in Company X was with the sole motive of using the land and
buildings, and not for earning income by way of dividends. The substance of the transaction is an investment
in fixed assets, though the “form” may be acquisition of shares.
In view of the foregoing, the accounting treatment so far accorded by the Company, in classifying the
shares as fixed assets is correct.
Since the original intention has undergone a change, therefore, on account of the changed intention, i.e. “to
dispose of the shares”, the accountant should reclassify the holdings in the Company X as investments, and
bring the same in the books as “current investment”.
As per para 23 of the standard when long term investments are reclassified as current investments,
transfers are made at the lower of cost and carrying amount at the date of transfer. Accordingly reclassified
current investment should be shown at cost or carrying amount whichever is less.
Extra Practical Problems from Past Year Papers and RTPs of Financial Reporting and Audit 343
AS15
Problem 32: On 01/04/12, a Mehtaab Developers engaged employees on a 6 year period for annual salary
of `6.5 lakh. The annual salary is expected to increase by `50,000 every year. The employee is entitled to
annual pension for 4 years after retirement. The annual pension is calculated as 10% of annual salary for
each of the first 3 years and 20% of annual salary for each next 3 years. Market yield on government bond is
10%. Show Provision for Pension A/c in the books of the company.
Solution:
Calculation of Annual Pension: = Calculation of Current Service Cost
Year Salary × 10%
2012-13 650000 × 10% 65000 380280 x 0.621 2,36,154
2013-14 700000 × 10% 70000 380280 x 0.683 2,59,731
2014-15 750000 × 10% 75000 380280 x 0.751 2,85,590
2015-16 800000 × 20% 160000 380280 x 0.826 3,14,111
2016-17 850000 × 20% 170000 380280 x 0.909 3,45,675
2017-18 900000 × 20% 180000 380280 x 1.000 3,80,280
720000
PV of Annuity of 720000 (for 4 years) as if the whole benefit is payable on 31/3/2018 = 720000 × 3.169
= 22,81,680
Annual amount attributable to each year of service = 2281680/6 = `3,80,280
2012-13
To balance c/f 236154 By Current Service cost 236154
2013-14
To balance c/f 519500 By balance b/d 236154
By Interest cost 23615
By Current Service cost 259731
The calculations will continue till 2016-17..............
Closing balance of Obligation = Current Service Cost × n = 345675 × 5 = 1728375
2017-18
To balance c/f 2281493 By balance b/d 1728375
By Interest cost 172838
By Current Service cost 380280
EMPLOYEE RETIRES HERE AND NOW HE WILL GET PENSION
2018-19
To Bank 720000 By balance b/d 2281493
To balance c/f 1789642
By Interest cost 228149
By Current Service cost 0
Problem 33: Vetongi Crystals Ltd engaged 100 workers for a monthly salary `5,500 on April 1, 2012. The
employees are entitled to death-cum-retirement gratuity calculated as 40% of last salary drawn for each
completed year of service. An actuary was appointed to advice the company for measuring its obligations in
respect of the gratuity. The actuary presented the following estimates at the end of 2012-13.
a) Average working life per worker = 26 years (inclusive of 2012-13)
b) Annual growth rate of monthly salary = 5%
c) Expected annual rate of return on plan assets = 10%
d) Annual market yield on government bonds of maturity period of 25 years = 8%
For acquisition of plan assets, the company contributed `1,00,000 on 31/03/13 and `1,10,000 on
31/03/14. Fair value of plan assets on 31/03/2014 was `2,19,000.
Show Gratuity payable A/c and Contribution for Plan Asset A/c in the books of the company for 2012-13
and 2013-14.
Solution:
Calculations for 2012-13 to 2013 - 14
Calculation of Final Salary = 5500 x 1.0525 = 5500 x 3.386 = `18625
Gratuity promised at the end = 18625 x 40% = `7450
Current Service Cost for 2012 – 13 = 7450 payable at the end/(1.08)25 = 7450 x 0.1460 = 1088 for 100
employees = `1,08,800
Current Service Cost for 2013-14 = 7450 payable at the end/(1.08)24 = 7450 x 0.1577 = 1175 for 100
employees = `1,17,500
Problem 34: In the above problem, consider the following additional information and hence show Gratuity
Payable A/c and contribution for plan Asset A/c for 2014-15 and 2015-16.
a) Annual market yield on government bonds = 7.2%
b) Average annual growth rate of salary re-estimated to 5.22%.
c) Fair value of Plan Asset on 31/03/15 is `4,60,000 and `6,75,000 on 31/3/16
d) Contribution to fund for acquisition of plan asset is `2,13,900 an 31/3/15 and `1,73,000 on 31/03/16
Solution: Calculations for 2014 – 15 and 2015 – 16.
Revised assumptions:
Calculation of Final Salary = 5500 x 1.0522 25 = 5500 × 3.569 = `19625
Gratuity promised at the end = 19625 × 40% = `7850
Extra Practical Problems from Past Year Papers and RTPs of Financial Reporting and Audit 345
Current Service Cost for 2014-15 = 7850 payable at the end/(1.072)23 = 7850 × 0.202 = 1586 for 100
employees = `1,58,600
Current Service Cost for 2015-16 = 7850 payable at the end/(1.072)22 = 7850 × 0.2165 = 1700 for 100
employees = `1,70,000
PV of obligation as on 31/3/2014 (2 years end) = 7850/(1.072)24 = 7850 × 01884 = 1480 for 100 employees
= `1,48,000 × 2 years = `2,96,000
Actuarial G/L = PV of obligation as on 31/3/2014 as per old rates – as per new rates = 7850/(1.072)24 =
7850 × 01884 = 1480 for 100 employees = `1,48,000 × 2 years = `2,96,000 – 2,3,5000 = `61,000
Problem 35: Elegance Limited in its 15th year of incorporation. Following is the position of the funded
gratuity plan for a group of employees.
31/03/2014
PV of obligation 37,00,000
Less: FV of Plan assets (25,00,000)
12,00,000
Less: Unrecognized Past Service Cost (70,000)
(2 years remaining for vesting benefits)
Net 11,30,000
The employees related to the above funds were expected to retire by the end of 2017-18. The concerned
employees had joined the services from 01/04/2007, the retirement plans also started from the same period.
The annual amount attributed towards the services as calculated by the actuary is `6,92,000 each year. The
yield on government bond is expected to be 7% and return on plan assets estimated to be 9.5%. By the
end of 31/3/2015 10% of the employee’s services were curtailed with the settlement of a fixed amount of
`1,40,000. The past service cost will get proportionately reduced. FV of plan assets on account of settlement
remains same. Contributions made to the plan assets were `5,00,000. The FV of the plan assets were valued
at `32,00,000. You are required to compute the following:
1) Current Service Cost, 2) Actuarial gain or loss, 3) Balance Sheet disclosure, 4) Employee Cost charged
to profit and loss a/c.
Solution:
1) Current Service Cost = `5,64,880, 2) Actuarial gain/loss = `32,660 (gain),
3) Balance Sheet Disclosure: PV of obligation 40,67,136
Less: FV of Plan Assets = (32,00,000)
Net : 8,67,136
Less: Unamortized PSC (31,500)
8,35,636
4) Employee Cost charged to P/L = `2,80,316
346 Accounting Standards
AS16
Problem 36: Parvesh Ltd. had the following borrowings during a year in respect of capital expansion:
Plant Cost of Asset (`) Remarks
Plant P 100 lakhs No specific borrowings
Plant Q 125 lakhs Bank loan of `65 lakhs at 10%
Plant R 175 lakhs 9% Debentures of `125 lakhs were issued.
In addition to the specific borrowings stated above, the Company had obtained term loans from two banks
(1) `100 lakhs at 10% from Corporation Bank and (2) `110 lakhs at 11.50% from State Bank of India, to meet
its capital expansion requirements. Determine the amount of borrowing costs to be capitalized in each of the
above Plants, as per AS-16.
Solution:
(1) Computation of actual borrowing costs incurred during the year
Note: The amount of borrowing costs capitalized should not exceed the actual interest cost.
Problem 37: On 1st April, 2012, Amazing Construction Ltd. obtained a loan of `32 crores to be utilized as
under:
(i) Construction of sea link across two cities:
(work was held up totally for a month during the year due to high water levels) : `25 crores
(ii) Purchase of equipments and machineries : `3 crores
Extra Practical Problems from Past Year Papers and RTPs of Financial Reporting and Audit 347
AS17
Problem 39: Following details are given for Cheerless Ltd. for the year ended 31st March, 2005:
`(’000) `(’000)
Sales:
Food Products 5,650
Plastic and Packaging 625
Health and Scientific 345
Others 162 6,782
Expenses:
Food Products 3,335
Plastic and Packaging 425
Health and Scientific 222
Others 200 4,182
Other items:
General corporate expenses 562
Income from investments 132
Interest expenses 65
Identifiable assets:
Food Products 7,320
Plastic and Packaging 1,320
Health and Scientific 1,050
Others 665 10,355
General corporate assets 722
Other information:
(a) Inter-segment sales are as below: `(’000)
Food Products 55
Plastic and Packaging 72
Health and Scientific 21
Others 7
(b) Operating profit includes `(’000) 33 on inter-segment sales.
(c) Information about inter-segment expenses are not available.
You are required to prepare a statement showing financial information about Cheerless Ltd.’s operations
in different industry segments.
Solution:
Industry Segments
Item Food Plastic & Health & Others Inter- Consolidated
Products Packaging Scientific segment figs.
Eliminations
`(’000) `(’000) `(’000) `(’000) `(’000) `(’000)
Revenues:
Sales to unaffiliated
Customers 5,595 553 324 155 6,627
Inter-segment sales 55 72 21 7 (155) —
Total revenue 5,650 625 345 162 (155) 6,627
Extra Practical Problems from Past Year Papers and RTPs of Financial Reporting and Audit 349
AS18
Problem 40: What are your views on the following?
i) A firm of a father and son is received `2 lakhs towards job work done for XYZ Ltd during the year
ended on 31.03.10. The total job work charges paid by XYZ Ltd. during the year are over `50 lakhs.
The father is a Managing Directors of XYZ Ltd having substantial holding. The Managing Director told
the auditor that since he is not involved in the activities of the firm and since the amount paid to it is
insignificant; there is no need to disclose the transaction. He further contended that such a payment
made in the last year was not disclosed. Is Managing Director right in his approach?
ii) Mr. Raj a relative of key Management personnel received remuneration of `2,50,000 for his services
in the company for the period from 1.4.2009 to 30.6.2009. On 1.7.2009 he left the service.
Solution:
(i) The MD is not correct in its view.
The so called individual is a KMP in XYZ Ltd and is a partner in the firm. In accordance with para 3
(e) of AS-18 Enterprises controlled by a common individual referred to in para 3 ( c ) and 3 ( d ), are
related party if they enter the transaction among themselves. Hence disclosure requirements are
applicable in the books of both the firm and XYZ Ltd. The auditor should qualify the audit report in
accordance with SA 705, SA 550 and Companies Act section 143.
(ii) According to para 10 of AS 18 on Related Party Disclosures, parties are considered to be related if at
any time during the reporting period one party has the ability to control the other party or exercise
significant influence over the other party in making financial and/or operating decisions. Hence, Mr.
Raj, a relative of key management personnel should be identified as relative as at the closing date i.e.
on 31.3.2010.
AS19
Problem 41: X Ltd. sold JCB Machine having WDV of `50 Lakhs to Y Ltd for `60 Lakhs and the same JCB
was leased back by Y Ltd to X Ltd. The lease is operating lease Comment according to relevant Accounting
Standard if:
(i) Sale price of `60 Lakhs is equal to fair value
(ii) Fair Value is `50 Lakhs and sale price is `45 Lakhs.
(iii) Fair value is `55 Lakhs and sale price is`62 lakhs
(iv) Fair value is `45 Lakhs and sale price is `48 Lakhs.
350 Accounting Standards
Solution:
(i) X Ltd should immediately record the profit of `10 lakhs.
(ii) Loss of `5 lakhs immediately charged to P/L provided loss is not compensated by future lease rentals.
(iii) Profit of 5 lakhs (55-50) is to be immediately recognized and the profit of `7 lakhs (62-55) is to
deferred over lease period.
(iv) Loss of 5 lakhs (50 -45) is to be immediately recognized and the profit of `3 lakhs (48-45) is to
deferred over lease period.
Problem 42: Lessee Ltd. has taken a machine on lease from Lessor Ltd. The following information is
available to you:
Lease term 3 years
Useful life 3 years
Fair value at the inception of lease `7,00,000
Fixed Lease Rent `3,00,000 payable at the end of each of the 3 years
GRV to be assured by lessee `22,000
IRR @15% p.a.
Since PV of MLP `6,99,054 being lower than the fair value `7,00,000, therefore, value of machine
will be taken as `6,99,054.
The difference between this figure and guaranteed residual value (`22,000) is due to approximation in
computing the interest rate implicit in the lease.
Extra Practical Problems from Past Year Papers and RTPs of Financial Reporting and Audit 351
Problem 43: The following balances are extracted from the Books of Ram Ltd., a real estate company on
31st March 2011:
Dr. Cr.
(` in ‘000) (` in ‘000)
Leasehold premises 42
Equipment, fixtures and fittings at cost on 01-04-2010 264
Depreciation on equipment fixtures and fittings on 01-04-2010 164
AS20
Problem 44: Utility Ltd. has 40,000 equity shares of `10 each and 10% 5,000 Convertible Debentures of
`100 each outstanding during 2010-11. Each Debentures got converted into 3 shares on 1/12/2011. Net
profit after tax for the year is `3,45,000. Tax rate 40%. Calculate Basic and Diluted EPS for the year 2011-12.
Solution:
345000
Calculation of Basic EPS = = `7.67
40000+(15000 ×4/12)
352 Accounting Standards
Problem 45: Calculate the Basic Earning Per Share of x Ltd. for year 2013-14 and restatement for the year
2012-13:
Solution:
3660000
Calculation of Basic EPS for 2013 – 14 = = `24.05
152178#
3480000
Calculation of Restated EPS 2012 – 13 = = `23.85
145918##
##
100000 + 16700 + 29218 = 145918
#Calculation of WANES:
AS22
Problem 46: Comment on the following: T Ltd. an Indian company, is subject to Indian Income Tax Act,
1961, discloses Advances Income-tax paid (Current asset) and Provision for Income Tax (Current tax liability),
separately in Balance Sheet for the year ended 31.3.2013, i.e. do not offset the amount.
Solution: AS-22 provides that an enterprise should offset assets and liabilities representing current tax if
the enterprise: Has a legal enforceable right to set off the recognised amount and intends to settled the asset
and liability on net basis. T Ltd should offset the advance tax paid and provision for tax for the year ended
31/3/2013.
Problem 47: SRS Ltd. has drawn the financial statement as on 31-03-11 and presented to you alongwith
additional information:
Additional Information:
(a) Entire pre-operative expenses of `7,00,000/- was charged to Profit and .Loss Account whereas for
the purpose of Income Tax, only what is allowable is claimed.
(b) Depreciation as per Books - `35,00,000/-, Depreciation as per Income tax - `50,00,000/-
(c) Losses to be carried forward as per Income Tax Act - `16,00,000/-
(d) Donation disallowed while computing tax - `50,000/-
354 Accounting Standards
Considering the additional information, can you certify that the company has complied with the Accounting
Standards and issue an unqualified report?
Solution:
Particulars Comment
Fixed Assets As per the new Schedule III one should draw a detailed Schedule of Fixed Assets in terms of
Gross block, Depn, Net Block.........
Pre operative expenses The company is correct by writing off the entire pre – operative expenses to P/L as per AS-26.
But the company has failed to create DTA on the pre operativ expenses disallowed.
Deferred tax on Depn The company has not provided any DTL for the timing difference on account of depreciation.
Donation It is a permanent difference no DTA / DTL is required.
Losses unabsorbed Assuming company has enough evidence to earn sufficient profits DTA should be provided for
the unabsorbed losses under IT Act.
Other Assets/Liabilities Advance paid / recd/ Crs / Debtors are not presented as per New Schedule III.
The Financial Statements are not in accordance to New Companies Act and AS. Th reports should be
qualified as per SA 705.
AS23
Problem 48: Tarun Ltd. had acquired 25% of the equity share capital of Varun Ltd. at `2,40,000 by 1-7-
2012. It had received `8,000 as dividend for the year 2011-12. Equity share capital of Varun Ltd. is `5,00,000.
Varun Ltd. had not provided for the dividend when the accounts for the year 2011-12 were prepared. Find out
goodwill/capital reserve against investment in Varun Ltd. as well as the value at which investment shall be
reported in consolidated financial statements to be prepared by Tarun Ltd. as on 31-3- 2013, if the balances
in profit and loss account were `84,000 and `1,92,000 respectively at the end of 2011-12 and 2012-13.
Solution:
Date of Acquisition 1-7-2009
Date of consolidation 31-3-2010
Pre-acquisition period 3 months
Post-acquisition period 9 months
% of Holding 25%
`
Investments 2,40,000
Less: Pre-Acquisition dividend 8,000
Nominal Value of shares 1,25,000
Share in Capital Profits 21,750 1,54,750
Goodwill 85,250
Investment in associate under equity method
Nominal Value of Investment 1,46,750
Goodwill 85,250
2,32,000
Add: Share of Revenue Profit 26,250
2,58, 250
Problem 49: Compute the total Stock Reserve and pass journals in respect of stock reserve in each case:
Case 1: H sold goods to A an Associate company at invoice value of `45,000 at 1/8th of cost. In the same year
A sold goods to H at an invoice value of `65,000 at 1/7th of cost. At the year end H could sell 50% of the goods
received from A and A sold 60% of the goods received from H. H holds 25% shares in A.
Solution:
When goods are sold by H to A:
Profit/Loss Dr 2000
To Investments in A 2000
(45000 × 1/9) 40%
When goods are sold by A to H:
Profit/Loss Dr 4063
To Stock Reserve 4063
(65000 × 1/8) 50%
Problem 50: Kadambari invested 2,50,000 in Shetambari an associate company on 1/7/2014 with an
interest of 20%. The Share Capital on that date was `3,00,000, P/L balance `2,00,000. Shetambari declared
dividends for 2013-14 and 2014-15 at the rate 12% and 15% respectively in the month of August. Profits
earned in the 2 years were `1,50,000 and `1,75,000 respectively. Compute the carrying amount of investments
for CFS and SFS as on 1/7/2014, 31/3/2015 and 31/8/2015.
Solution:
Calculation of Carrying Amount as per AS-23
Date 1/7/2014 31/3/2015 31/8/2015
Cost / Carrying amount 250000 250000 265600
356 Accounting Standards
AS24
Problem 51: A company enters into three sale agreements for disposing off the assets of three separate
components of the business. Can the company report the discontinuing operations on a consolidated basis?
Elucidate.
Solution: As per Para 31 of AS-24, disclosure is to be presented separately for each discontinuing operation.
Hence, reporting on an aggregated basis not permitted.
Problem 52: Hashmi Ltd. has 2 factories producing Shawls, Bed Sheets, Mats, and Curtains. It planned to
discontinue production of Mats. The company does not apply AS 17 segment Reporting since it produces
only one class of goods. The company has no related plan to increase production of other products such
that its sale gets compensated. Mats constitute 15% of the sale of the company. Does this sale qualify for
discontinuing operations.
Solution: Segmental Reporting as defined in AS-17 normally represents or satisfies separate major line of
business or a geographical area of operation. Even if an enterprise operates in a single business or geographical
segment, a major product or service line may also satisfy this criterion. Production of Mats represents a
separate major line of business. Hence the present case is covered by AS-24.
AS25
Problem 53: Fixed production overheads for the financial year is `19,200. Normal expected production
for the year, after considering planned maintenance and normal breakdown, and the future demand of the
product is 4,800 MT. It is considered that there are no quarterly/seasonal variations. Therefore, the normal
expected production for each quarter is 1200 MT and the fixed production overheads for the quarter are
`4,800.
Required:
(i) Presuming that there is no quarterly/seasonal variation, calculate the allocation of fixed production
overheads for all the four quarters as per relevant Accounting Standards.
(ii) In case there are quarterly and seasonal variation how the estimate of normal capacity to be made as
per relevant Accounting Standards.
Extra Practical Problems from Past Year Papers and RTPs of Financial Reporting and Audit 357
Solution:
(i) It is considered that there is no quarterly/seasonal variation, therefore normal expected production
for each quarter is 1200 MT and fixed production overheads for the quarter are `4,800.
Fixed production overhead to be allocated per unit of production in every quarter will be `4 per MT
(Fixed overheads/Normal production i.e. `4,800/1200 MT).
First quarter
Actual fixed production overheads = `4,800.
Fixed production overheads based on the allocation rate of `4 per unit allocated to actual production =
`4 × 1000 MT = `4,000.
Unallocated fixed production overheads to be charged as expense as per paragraph 9 of AS-2 and
consequently as per AS-25 = `800.
Second quarter
Actual fixed production overheads as per para 27 of AS 25, on year-to-date basis = `9,600.
Fixed production overheads to be absorbed on year-to-date basis
2400 MT × `4 = `9,600.
`800 was not allocated to production in the first quarter. To give effect to the entire `9,600 to be
allocated in the second quarter, as per paragraph 29(a) of AS-25, `800 is reversed by way of a credit
to the profit and loss account of the second quarter.
Third quarter
Actual production overheads on year-to-date basis = `14,400.
Fixed production overheads to be allocated on year-to-date basis
3,200 MT × `4 = `12,800
Under allocated overheads of `1600 is to be changed as expense as per para 9 of AS 2 and consequently
as per AS-25.
Fourth quarter/Annual
Actual fixed production overheads on year-to-date basis = `19,200.
Fixed production overheads to be allocated on year-to-date basis
4,600 MT × `4 = `18,400
`1600 was not allocated to production in the third quarter due to less production. However, due
to over production of 200 MT in the fourth quarter, excess allocable fixed overhead in the fourth
quarter is given effect to by reversal of previously charged amount to Profit and Loss account (i.e. in
the third quarter) to the extent of `800 (200 MT x `4). Therefore, `800, over allocable in the fourth
quarter, are to be reversed as per para 29(a) of AS-25 by way of a credit to the profit and loss account
of the fourth quarter.
Unallocated overheads for the year `800 are expensed in the profit and loss account as per para 9 of
AS-2.
The cumulative result of all the quarters would also result in unallocated overheads of `800. Hence,
the requirements of para 27 of AS-25 that the quarterly results should not affect the measurement of
the annual results has been complied with.
(ii) In a case where there are quarterly/seasonal variations, the estimates of normal capacity would
have to be made on the quarterly/seasonal basis. The enterprise will have to estimate its normal
capacity on the basis of the average of the relevant quarters/seasons of past few years, say 3 to 5
years, also considering the demand of the product during the season. (For example, a company is
having seasonal variations say, in the 3rd quarter. The estimate for the 3rd quarter should be based
on the capacity utilisation of the 3rd quarter for the past few years, say 3 to 5 years, also keeping in
mind the future demand of the product during the quarter). Once the normal capacity for a quarter
358 Accounting Standards
is determined, as aforesaid, the quarter should be considered for measurement purposes, as per
paragraph 27 of AS-25 on year –to-date basis, i.e. on cumulative basis, which would then be added
up to determine the normal capacity for the year on the basis of which the absorption rate will
be determined. The variations between the seasons would thus be considered normal and treated
accordingly.
If there is an abnormal breakdown during a period, as per AS-2, the amount of fixed production
overheads not allocated to units of production is charged to the profit and loss account. However,
the result of under allocation of overheads or over allocation of overheads should not affect the
measurement of its annual results since interim periods are parts of a financial year.
AS26
Problem 54: Government of Goa has given fishing license to Fishermen Ltd. at a nominal price of `1,000.
The market price of the license is `1,00,000. An expenditure of `2,500 has been incurred by the company in
relation to the fishing license. At what price should the license be recorded in the books of the company?
Solution: Any intangible asset acquired through government grants should be recorded at a concessional
price. But any expenditure incurred on it needs to be capitalised. Accordingly in the present case the cost of
the license fees worth `100000 will be `1000 + 2500 = `3500.
P roblem 55: Rajesh Ltd. has acquired exclusive marketing rights worth `50 lakhs from Ramkumar Ltd. in
exchange for import quotas worth `40 lakhs. Assuming that Rajesh Ltd. has not paid any other consideration
to Ramkumar Ltd, at what price should it initially record the marketing rights?
Solution: As per AS – 10 as well as AS – 26 if any asset is acquired against any other asset, the cost will be
the Fair market value of the asset given up if it is more evident otherwise, FMV of the asset acquired. Here the
cost of marketing rights can be taken as `40 lakhs which FMV of the asset given up.
P roblem 56: As a statutory auditor, how would you deal with the following: Investopia Pvt. Ltd, started
stock broking activities in 2012. For this purpose is acquires membership of a stock exchange for 200 lacs.
While finalizing the accounts, the company disclosed the above amount under the Fixed Assets schedule as
‘Stock Exchange Membership Rights”. The company also did not write off any amount since the rights would
enable the company to perpetually carry on its business.
Solution: As per para 63 of AS-26 any intangible asset acquired / generated can be amortized over its
estimated useful life or contractual life. 10 years should be considered only when estimated life cannot be
possible. In the present case as the Stock Membership Card carries a perpetual life it is to be amortised over
10 years. If the asset is not amortised then in that case the audit report needs to be qualified under SA 705.
Problem 57: As an auditor, how would you deal with the following: PQR Ltd. had acquired a Brand from
another company for `100 lakhs. PQR Ltd. contended that since the said brand is a very popular and famous
brand, no depreciation or amortization needs to be provided.
Solution: Same as problem 64.
Problem 58: An Enterprise has incurred expense for purchase of Technical know-how for manufacturing
a car. The Enterprise has paid `5 crores for the use of know-how for a period of 4 years. The Enterprise
estimates the production of cars as follows:
Year No. of Mopeds
1 25,000
2 50,000
3 75,000
4 1,00,000
(a) How will the Enterprise amortize the Technical know-how Fees as per AS 26?
Extra Practical Problems from Past Year Papers and RTPs of Financial Reporting and Audit 359
(b) Whether this amortization should be directly charged as an expense or should form part of production
cost of the cars?
Solution: Intangible Asset is an identifiable non-monetary asset without physical substance held for use in
the production or supply of goods or services for rental to other or for administrative purposes. Amortisation
is the systematic allocation of the depreciable amount of an intangible asset over its useful life. The depreciable
amount of an intangible asset should be allocated on a systematic basis over the best estimate of its useful life.
AS27
Problem 59: Holding company Limited has 45% stake in its JV (JCE). H sold goods worth 32,000 to JV and
even JV sold goods worth `10,000 to H. Profit margin is 25%. Out of the goods sold within the group H sold
50% of the goods to third party and JV could sell 1/3 rd of the goods to third party. Calculate the impact of the
above transaction on the profit and loss account.
Solution:
H sold goods to JCE JCE sold goods to H
Profit / loss Dr 1,800 Profit / loss Dr 750
To Stock Reserve 1,800 To Stock Reserve 750
(32000 x 25%) 0.50 x 45% (10000 x 25%) 2/3 x 45%
Net impact on P/L in the CFS = 2,550 (1800+750)
AS28
Problem 60: A plant was acquired 15 years ago at a cost of ` 5 crores. Its accumulated depreciation as at
31st March, 2011 was ` 4.15 crores. Depreciation estimated for the Financial year 2011-12 is ` 25 lakhs.
Estimated Net Selling Price as on 31st March, 2011 was ` 30 lakhs, which is expected to decline by 20 per cent
by the end of the next financial year.
Its value in use has been computed at ` 35 lakhs as on 1st April, 2011, which is expected to decrease by 30
per cent by the end of the Financial year.
(i) Assuming that other condition for applicability of the impairment Accounting Standard is satisfied,
what should be the carrying amount of this plant as at 31st March, 2012?
(ii) How much will be the amount of write off for the financial year ended 31st March, 2012?
(iii) If the plant had been revalued ten years ago and the current revaluation reserves against this plant
were to be ` 12 lakhs, how would you answer to questions (i) and (ii) above?
(iv) If the value in use was zero and the enterprise were to incur a cost of ` 20 lakhs to dispose of the
Plant, what would be your response to question (i) and (ii) above? (May 2010 OS) (8 Marks)
Solution:
(i) As on 31/3/2012: Carrying amount b/d = 500 lakhs – 415 lakhs – 25 lakhs = `60 lakhs; VIU = 24.5
lakhs (70% of 35); NSP = 24 lakhs (30 × 0.8). Impairment loss = CA – RV = 60 – 24.50 = `35.50.
Carrying amount after impairment loss = ` 24.5 lakhs.
360 Accounting Standards
Problem 62: Light Ltd. is a multi-product manufacturing company, having its corporate office in a big
building. As the area of building is large, Light Ltd. has let out 1/3 area of the building at a monthly rent of
`100 lakhs, the lease agreement with tenant is for next 5 years. Is the building cash-generating unit? If not
what is the cash-generating unit of the building?
Solution: As per para 66 of AS 28 ‘Impairment of Assets, the cash-generating unit is smallest group of asset
that includes the asset and that generates cash inflows from continuing use that are largely independent of
the cash inflows from other assets.
In the instant case the primary purpose of the building is to serve as a corporate office of Light Ltd., which
is engaged in multi product manufacturing activities. Therefore, the building as a whole cannot be considered
to generate cash inflows which are largely independent of the cash flows for the company as a whole. The
building is not held as an investment; therefore, it would be inappropriate to determine ‘value in use’ of the
building based on future market rent.
Hence, building is not a cash generating unit; the cash-generating unit for the building is Light Ltd., the
company as a whole.
AS29
Problem 63: A company, incorporated under Section 8 of the Companies Act, 2013, have main objective to
promote the trade by organizing trade fairs / exhibitions. When company was organizing the trade fair and
exhibitions it decided to charge 5% contingency charges for the participants/outside agencies on the income
received from them by the company, while in the case of fairs organized by outside agencies, 5% contingency
charges are levied separately in the invoice, the contingency charges in respect of fairs organized by the
company itself are inbuilt in the space rent charged from the participants. Both are credited to Income and
Expenditure Account of the company.
The intention of levying these charges is to meet any unforeseen liability, which may arise in future.
The instances of such unforeseen liabilities could be on account of injury/loss of life to visitors/ exhibitors,
etc., due to fire, terrorist attack, stampede, natural calamities and other public and third party liability. The
chances of occurrence of these events are high because of large crowds visit the fair. The decision to levy 5%
contingency charges was based on assessment only as actual liability on this account cannot be estimated.
The following accounting treatment and disclosure was made by the company in its financial statements:
1. 5% contingency charges are treated as income and matching provision for the same is also being
made in accounts.
2. A suitable disclosure to this effect is also made in the notes forming part of accounts.
Required: (i) Whether creation of provision for contingencies under the facts and circumstances of the case
is in conformity with AS 29. (ii) If the answer of (i) is “No” then what should be the treatment of the provision
which is already created in the balance sheet.
Solution:
(i) Para 14 of AS 29 “Provisions, Contingent Liabilities and Contingent Assets” states that a provision
should be recognised when (a) An enterprise has a present obligation as a result of a past event
and (b) It is probable that an outflow of resources embodying economic benefits will be required to
settle the obligation and (c) A reliable estimate can be made of the amount of the obligation. If these
conditions are not met, no provision should be recognised.
From the above, it is clear that in the contingencies considered by the company, neither a present
obligation exists as a result of past event, nor a reliable estimate can be made of the amount of the
obligation. Accordingly, a provision cannot be recognised for such contingencies under the facts and
circumstances of the case.
(ii) “Provision” is the amount retained by the way of providing for any known liability. Since the
contingencies stipulated by the company are not known at the balance sheet date, the provision in
this regard cannot be created. Therefore, the provision so created by the company shall be treated as
a ‘Reserve’.
362 Accounting Standards
Problem 66: What are your views on the following? Tarkash Ltd was under audit for the year ended
31.3.2012. an appeal filed by A Ltd. against the demand of Excise Duty of `26 crores was pending before
the Supreme Court for which neither provision was made nor was disclosed in the notes to the financial
statements. On 12th July, 2012, the auditor came to know through paper reports that the point involved in
the appeal of A Ltd was adjudicated by the Supreme Court in the case of some other assessee, which is in
favour of the department of Excise Duty. The auditor insisted that provisions is required to be made of `30
crores in the financial statements. The management was of the view that since its own case is still pending, no
provision is called for. It was also of the view that the event does not have any effect on the financial position
of the company on the date of the Balance Sheet. Is the view of the management tenable?
Solution: The management must make the provision for the excise duty of `26 crores as it very much cleared
by the recent SC decision for other assesses. Now the possibility of outflow of resources is probable. The
company should review (visit) the case of provision otherwise the audit report will be qualified for non
compliance of AS29.
AS30
Problem 67: On April 1, 2012 a metal dealer has a firm commitment to buy 1,000 tons of certain metal on
May 31, 2012. The current price of the metal is `60,000 per ton. On April 1, 2012, to cover his short position
in metal market, the dealer took a long position on 1,000 tons of metal futures at strike price `60,000 per ton.
The initial margin was `10 lakh. The settlement prices on different dates were as below:
Date Settlement price/ton (`)
10/04/12 59,500
28/04/12 59,300
08/05/12 59,400
18/05/12 59,800
31/05/12 60,100
Show accounting entries in books of the dealer in respect of above:
Solution: Its a cash flow hedge.
(` in lakhs)
1/4: Initial margins 10
To Bank 10
10/4: Hedging reserve 1,000[- 60,000 + 59,500] 5
To Bank 5
28/4: Hedging reserve 1,000[- 59,500 + 59,300] 2
To Bank 2
8/5: Bank 1
To Hedging reserve 1
18/5: Bank 4
To Hedging reserve 4
31/5: Bank 3
To Hedging reserve 3
31/5: Purchase 601
To Bank 601
31/5: Bank 10
To Initial Margin 10
31/5: Hedging reserve 1
To P & L 1
364 Accounting Standards
Problem 68: Identify the host and embedded derivative in the following cases:
(i) Entity A holds a debenture bond of entity B which is convertible into ordinary shares of entity B at
the option of entity A.
(ii) Sun Ltd. enters into a lease agreement for usage of plant and equipment, rentals in respect of which
lease rentals are payable annually. The lease includes a clause that lease rentals payable will be linked
to changes in Cost Inflation Index announced u/s 48 of Income tax Act, and contingent rentals will be
payable on the basis of Benchmark interest of PLR of SBI.
(iii) Moon Ltd. enters into a lease agreement for usage of plant and equipment, rentals in respect of
which are payable annually. The lease includes a clause that lease rentals payable will be increasing
annually by `1,20,000
(iv) A floating rate debt - (a) with no cap (b) with a cap on interest and (c) a separate agreement for a cap
on interest.
(v) Interest rate on a fixed deposit linked to fluctuation of BSE sensex.
Solution:
(i) The debenture bond is the host contract. The option to convert into shares is the embedded derivative.
(ii) The lease contract is the host contract. The adjustment linked to Cost Inflation Index is the embedded
derivative contract.
(iii) The price adjustment is not a derivative - it does not meet the definition of derivative - there is no
underlying.
(iv) a. A floating rate debt with no cap - there is no derivative.
b. A floating rate debt with a cap on interest - the cap is the derivative and the debt instrument is
the host contract.
c. Separate agreement for a cap on interest - the cap is a derivative because it is based on the
interest rate of the underlying instrument.
(v) Fixed deposit is the host contract and interest payment linked to BSE sensex is the embedded
derivative.
Problem 69: Basic entries for financial instruments:
Pass the entries in the books of labisha:
Labisha makes a forward sale 200000 of own shares to Mohsina at `400. Delivery of the shares is to be
made after 3 months. On the B/S date the price of the share is `410. On the settlement date the price of the
shares quoted at `433. Assume settlement will be done in own equity shares on net basis. Also calculate how
many shares will be issued to Mohsina on settlement?
Solution:
Initial recognition Nil Nil
Valuation on B/S date Profit/loss Dr 20,00,000 20,00,000
To Financial liability
(410-400) 200000
Valuation on settlement date Profit/loss Dr 46,00,000
To Financial liability 46,00,000
Net settlement (433-410) 200000
Financial liability Dr 66,00,000
To Equity 66,00,000
(20+46)
Labisha will issue its own 15242 variable number of equity shares. 15242 = (6600000/433)