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Accounting for Managers - Accounting Standards

A PROJECT REPORT

ON

ACCOUNTING
STANDARDS

(AS-1, AS-6, AS-10, AS-


12)

PRESENTED BY:
SUSHIL KUMAR SURANA
GEORGE JOSEPH
PALLAVI DIKXIT
ROBIN JAGWAYAN
RASIKA SATAM
ABHISEKH SINGHAL
PRAKASH BIJOUR

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Accounting for Managers - Accounting Standards

UNDER GUIDANCE OF:


PROF. ANIL TILAK

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CONTENTS

ACCOUNTING STANDARD-1 3
ACCOUNTING STANDARD-6 15
ACCOUNTING STANDARD-10 30
ACCOUNTING STANDARD-13 42
BIBLIOGRAPHY 53

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ACCOUNTING STANDARD-1
Accounting is the art of recording transactions in the best manner possible, so
as to enable the reader to arrive at judgments/come to conclusions, and in this
regard it is utmost necessary that there are set guidelines. These guidelines are
generally called accounting policies. The intricacies of accounting policies
permitted Companies to alter their accounting principles for their benefit. This
made it impossible to make comparisons. In order to avoid the above and to
have a harmonised accounting principle, Standards needed to be set by
recognised accounting bodies.

This paved the way for Accounting Standards to come into existence.
Accounting Standards in India are issued By the Institute of Chartered
Accountants of India (ICAI). At present there are 30 Accounting Standards
issued by ICAI.

INTRODUCTION

1. This statement deals with the disclosure of significant accounting policies


followed in preparing and presenting financial statements.

2. The view presented in the financial statements of an enterprise of its state of


affairs and of the profit or loss can be significantly affected by the accounting
policies followed in the preparation and presentation of the financial statements.
The accounting policies followed vary from enterprise to enterprise. Disclosure
of significant accounting policies followed is necessary if the view presented is
to be properly appreciated.

3. The disclosure of some of the accounting policies followed in the preparation


and presentation of the financial statements is required by law in some cases.

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4. The Institute of Chartered Accountants of India has, in Statements issued by


it, recommended the disclosure of certain accounting policies, e.g.,translation
policies in respect of foreign currency items.

5.A few enterprises in India have adopted the practice of including in their
annual reports to shareholders a separate statement of accounting policies
followed in preparing and presenting the financial statements.

6. In general, however, accounting policies are not at present regularly and fully
disclosed in all financial statements. Many enterprises include in the Notes on
the Accounts, descriptions of some of the significant accounting policies. But
the nature and degree of disclosure vary considerably between the corporate
and the non-corporate sectors and between units in the same sector.

7. Even among the few enterprises that presently include in their annual reports
a separate statement of accounting policies, considerable variation exists. The
statement of accounting policies forms part of accounts in some cases while in
others it is given as supplementary information.

8. The purpose of this Statement is to promote better understanding of financial


statements by establishing through an accounting standard the disclosure of
significant accounting policies and the manner in which accounting policies are
disclosed in the financial statements. Such disclosure would also facilitate a
more meaningful comparison between financial statements of different
enterprises.

OBJECTIVE OF ACCOUNTING STANDARDS

Objective of Accounting Standards is to standardize the diverse accounting


policies and practices with a view to eliminate to the extent possible the non-
comparability of financial statements and the reliability to the financial
statements.
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Accounting Standards are formulated with a view to harmonise different


accounting policies and practices in use in a country. The objective of
Accounting Standards is, therefore, to reduce the accounting alternatives in the
preparation of financial statements within the bounds of rationality, thereby
ensuring comparability of financial statements of different enterprises with a
view to provide meaningful information to various users of financial statements
to enable them to make informed economic decisions.

The Companies Act, 1956, as well as many other statutes in India require that
the financial statements of an enterprise should give a true and fair view of its
financial position and working results. This requirement is implicit even in the
absence of a specific statutory provision to this effect. The Accounting
Standards are issued with a view to describe the accounting principles and the
methods of applying these principles in the preparation and presentation of
financial statements so that they give a true and fair view. The Accounting
Standards not only prescribe appropriate accounting treatment of complex
business transactions but also foster greater transparency and market discipline.
Accounting Standards also helps the regulatory agencies in benchmarking the
accounting accuracy.

NATURE OF ACCOUNTING POLICIES

1. The accounting policies refer to the specific accounting principles and the
methods of applying those principles adopted by the enterprise in the
preparation and presentation of financial statements.

2. There is no single list of accounting policies which are applicable to all


circumstances. The differing circumstances in which enterprises operate in a
situation of diverse and complex economic activity make alternative accounting
principles and methods of applying those principles acceptable. The choice of
the appropriate accounting principles and the methods of applying those
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principles in the specific circumstances of each enterprise calls for considerable


judgement by the management of the enterprise.

3. The various statements of the Institute of Chartered Accountants of India


combined with the efforts of government and other regulatory agencies and
progressive managements have reduced in recent years the number of
acceptable alternatives particularly in the case of corporate enterprises. While
continuing efforts in this regard in future are likely to reduce the number still
further, the availability of alternative accounting principles and methods of
applying those principles is not likely to be eliminated altogether in view of the
differing circumstances faced by the enterprises.

AREAS IN WHICH DIFFERING ACCOUNTING POLICIES ARE


ENCOUNTERED

The following are examples of the areas in which different accounting policies
may be adopted by different enterprises.

• Methods of depreciation, depletion and amortisation

• Treatment of expenditure during construction

• Conversion or translation of foreign currency items

• Valuation of inventories

• Treatment of goodwill

• Valuation of investments

• Treatment of retirement benefits

• Recognition of profit on long-term contracts

• Valuation of fixed assets

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• Treatment of contingent liabilities.

The above list of examples is not intended to be exhaustive.

Accounting Standards establish rules relating to recognition, measurement and


disclosures, thereby ensuring that all enterprises that follow them are and that
their financial statements are true, fair and transparent. High quality accounting
standards are a necessary and important element of a sound capital market
system. In Public capital markets such as those in United States, high quality
accounting standards reduce uncertainty and increase overall efficiency.

ACCOUNTING STANDARDS-SETTING IN INDIA

The institute of Chartered Accountants of India, recognizing the need to


harmonize the diverse accounting policies and practices, constituted at
Accounting Standard Board (ASB) on 21st April, 1977.

The Institute of Chartered Accountants of India (ICAI) being a member body of


the IASC, constituted the Accounting Standards Board (ASB) on 21st April,
1977, with a view to harmonise the diverse accounting policies and practices in
use in India. After the avowed adoption of liberalization and globalisation as
the corner stones of Indian economic policies in early ‘90s, and the growing
concern about the need of effective corporate governance of late, the
Accounting Standards have increasingly assumed importance. While
formulating accounting standards, the ASB takes into consideration the
applicable laws, customs, usages and business environment prevailing in the
country. The ASB also gives due consideration to International Financial
Reporting Standards (IFRSs)/ International Accounting Standards (IASs) issued
by IASB and tries to integrate them, to the extent possible, in the light of
conditions and practices prevailing in India.

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COMPOSITION OF THE ACCOUNTING STANDARDS BOARD:

The composition of the ASB is broad-based with a view to ensuring


participation of all interest groups in the standard-setting process. These
interest-groups include industry, representatives of various departments of
government and regulatory authorities, financial institutions and academic and
professional bodies. Industry is represented on the ASB by their apex level
associations, viz., Associated Chambers of Commerce & Industry
(ASSOCHAM), Confederation of Indian Industries (CII) and Federation of
Indian Chambers of Commerce and Industry (FICCI). As regards government
departments and regulatory authorities, Reserve Bank of India, Ministry of
Company Affairs, Comptroller & Auditor General of India, Controller General
of Accounts and Central Board of Excise and Customs are represented on the
ASB. Besides these interest-groups, representatives of academic and
professional institutions such as Universities, Indian Institutes of Management,
Institute of Cost and Works Accountants of India and Institute of Company
Secretaries of India are also represented on the ASB. Apart from these interest
groups, certain elected members of the Central Council of ICAI are also on the
ASB.

THE ACCOUNTING STANDARDS-SETTING PROCESS

The accounting standard setting, by its very nature, involves reaching an


optimal balance of the requirements of financial information for various
interest-groups having a stake in financial reporting. With a view to reach
consensus, to the extent possible, as to the requirements of the relevant interest-
groups and thereby bringing about general acceptance of the Accounting
Standards among such groups, considerable research, consultations and
discussions with the representatives of the relevant interest-groups at different
stages of standard formulation becomes necessary. The standard-setting

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procedure of the ASB, as briefly outlined below, is designed in such a way so


as to ensure such consultation and discussions:

Identification of the broad areas by the ASB for formulating the Accounting
Standards.

Constitution of the study groups by the ASB for preparing the preliminary
drafts of the proposed Accounting Standards.

Consideration of the preliminary draft prepared by the study group by the ASB
and revision, if any, of the draft on the basis of deliberations at the ASB.

Circulation of the draft, so revised, among the Council members of the ICAI
and 12 specified outside bodies such as Standing Conference of Public
Enterprises (SCOPE), Indian Banks’ Association, Confederation of Indian
Industry (CII), Securities and Exchange Board of India (SEBI), Comptroller
and Auditor General of India (C& AG), and Department of Company Affairs,
for comments.

Meeting with the representatives of specified outside bodies to ascertain their


views on the draft of the proposed Accounting Standard.

Finalisation of the Exposure Draft of the proposed Accounting Standard


on the basis of comments received and discussion with the representatives of
specified outside bodies.

Issuance of the Exposure Draft inviting public comments.

Consideration of the comments received on the Exposure Draft and finalisation


of the draft Accounting Standard by the ASB for submission to the Council of
the ICAI for its consideration and approval for issuance.

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Consideration of the draft Accounting Standard by the Council of the Institute,


and if found necessary, modification of the draft in consultation with the ASB.

THE PRINCIPLES GOVERNING SELECTION OF AN ACCOUNTING


POLICY:

The primary consideration in the selection of accounting policies by an


enterprise is that the financial statements prepared and presented on the basis of
such accounting policies should present a true and fair view of the state of
affairs of the enterprise as at the balance sheet date and of the profit and loss for
the period ended on that date. For this purpose , the major considerations
governing the selection and application of accounting policies are :

1. PRUDENCE

In the view of the uncertainty attached to future event, profits are not
anticipated but recognised only when realised 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.

2. SUBSTANCE AND FORM

The accounting treatment and presentation in financial statements of


transactions and events should be governed by their substance and merely by
the legal form. A typical example where substance takes precedence over form
is in the case of finance leases. In finance leases, the lessee in substance is the
owner of the asset whilst the less or is merely the legal owner. The accounting
of finance leases is based on the substance rather than form of the transaction.

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3. MATERIALITY

Financial statements should disclose all “material” items, i.e. items the
statements. The concept of materiality recognizes that some matters
individually or in the aggregate, are important for the fair presentation of the
financial statements taken as a whole. The IASC (International Accounting
Standards Committee) defines audit materiality as follows: ‘Information is the
if its omission or misstatement could influence the economic decisions of users
taken on the basis of the financial statement.’ Materiality depends on the size of
the item or error judged in the particular circumstances of its omission or
misstatement. Thus materiality provides a threshold or cut-off point rather
being primary qualitative characteristics which information must have, if it is to
be useful. There are no hard and fast rules for determining materiality. What is
material is a matter of professional judgment. For example, an amount material
to the financial statements of one entity may not be material to financial
statements of another entity of a difference size or nature. Further, what is
material to the financial statements of a particular entity might change from one
period to another.

THE FUNDAMENTAL ACCOUNTING ASSUMPTIONS

Certain fundamentals accounting assumptions underlie the preparations and


presentation of financial statements. They are usually not specifically stated
because there acceptance and use are assumed. Disclosure is necessary if they
are not followed, otherwise disclosure is not required. The following have been
generally accepted as fundamental accounting assumptions:

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A. Going Concern

The enterprise is normally viewed as going concern, that is, as continuing in


operation for the foreseeable future. It is assumed the enterprise has neither the
intention nor the necessity of liquidation or of curtailing materiality the scale of
the operations.

B. Consistency

It is assumed that accounting policies are consistent from one period to another.

C. Accrual

Revenues and cost are accrued, that is, recognised as they are earned or
incurred (and not as money received or paid) and recorded in the financial
statements of the period which they relate. The accrual concept forces the
matching of revenues against relevant cost, for example, though warranty
expenses are incurred much after the turnover takes place, it has to be estimated
and provided for when the turnover is affected, as it is a cost incurred to achieve
that turnover.

PRINCIPLES FOLLOWING A “NOT GOING CONCERN”

The company should prepare the accounts on the basis that it is not a going
concern or that it will be closed in the near future. All the assets of such a
company should be valued as its net realisable value. All the liabilities should
be valued at the expected settlement price. In addition, further liabilities may
have to be provided in respect of employee termination or premature
termination of various contracts including the lease of the premises. Adequate
disclosure/adjustments should be made in financial statements about the
impending closure and the fact that accounts are prepared on the basis. Since
the accounts would be true and fair, there no need for the auditor to make a

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qualification. The auditor should however add a paragraph in his report


detailing the going situation (matter of emphasis and not qualification). If the
financial statement is not prepared on the above basis, the auditor will have to
qualify the financial statements.

DIFFERENT ACCOUNTING POLICIES FOR SIMILAR ITEMS

This is the contrary to the fundamental accounting assumptions of consistency,


which require use consistence policies year after year and also in the same year
for all similar items. In the case of depreciation, Expert Advisory Committee
(EAC) of ICAI has given an opinion that different methods of depreciation for
the for the same class of assets used in different plants of company can be
applied if the management considers it appropriate to do so after taking into
account important factors such as the type of assets, the nature of the use of
such assets and circumstances prevailing in the business. Whilst such
exceptions may be justifiable it would be difficult to justify valuing the same
type of inventory at to different factories by applying to different accounting
policies.

DISCLOSURE OF ACCOUNTING STANDARDS

To ensure proper understanding of financial statements, it is necessarythat all


significant accounting policies adopted in the preparation and presentation of
financial statements should be disclosed. Such disclosure should form part of
the financial statements. It would be helpful to the reader of financial
statements if they are all disclosed as such in one place instead of being
scattered over several statements, schedules and notes.

Examples of matters in respect of which disclosure of accounting policies


adopted will be required are contained in paragraph 14. This list of examples is
not, however, intended to be exhaustive. Any change in an accounting policy

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which has a material effect should be disclosed. The amount by which any item
in the financial statements is affected by such change should also be disclosed
to the extent ascertainable. Where such amount is not ascertainable, wholly or
in part, the fact should be indicated. If a change is made in the accounting
policies which has no material effect on the financial statements for the current
period but which is reasonably expected to have a material effect in later
periods, the fact of such change should be appropriately disclosed in the period
in which the change is adopted.

Disclosure of accounting policies or of changes therein cannot remedy a wrong


or inappropriate treatment of the item in the accounts. All significant
accounting policies adopted in the preparation and presentation of financial
statements should be disclosed.

The disclosure of the significant accounting policies as such should form part of
the financial statements and the significant accounting policies should normally
be disclosed in one place.

Any change in the accounting policies which has a material effect in the current
period or which is reasonably expected to have a material effect in later periods
should be disclosed. In the case of a change in accounting policies which has a
material effect in the current period, the amount by which any item in the
financial statements is affected by such change should also be disclosed to the
extent ascertainable. Where such amount is not ascertainable, wholly or in part,
the fact should be indicated.

If the fundamental accounting assumptions, viz. Going Concern, Consistency


and Accrual are followed in financial statements, specific disclosure is not
required. If a fundamental accounting assumption is not followed, the fact
should be disclosed

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AS- 6: DEPRECIATION
THE SCOPE AND OBJECTIVE OF AS-6 & DEPRECIABLE ASSETS

Depreciation is a measure of the wearing out, consumption or other loss of


value of a depreciable asset arising from use, efflux of time or obsolescence
through technology and market changes. Depreciation includes amortization of
assets whose useful life is pre-determined. Different accounting policies for
depreciation are adopted by different enterprises. Disclosure of accounting
policies for depreciation followed by enterprise is necessary to appreciate the
view presented in the financial statements of the enterprise. Depreciation has a
significant in determining and presenting the financial position and result of
operation of an enterprise. Depreciable assets are assets which

• Are Expected To Be Used More Than One Accounting Period


• Have a limited useful life, and
• Are held by an enterprise for use in the production or supply of goods
and services for rental and others, or for administrative purpose and not
for the purpose of sale in the ordinary course of business. To qualify as a
depreciable asset all there conditions are required to be fulfilled. Even if
a single condition is not fulfilled the same will not qualify as a
depreciable asset. For e.g. though land will fulfill two of the above
conditions, it does not fulfill the condition of a limited useful life and
therefore is not a depreciable asset AS-6 deals with depreciable
accounting and applies to all depreciable assets except the following
items to which special consideration apply:

• Forest plantation and similar regenerative natural resources

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• Wasting asset including expenditure on the exploration for


an extraction of minerals, oil, natural gases and similar non-
regenerative resources.
• Expenditure on research and development
• Goodwill
• Livestock

As already stated AS-6 does not apply to Land unless it has a limited useful life
for the Enterprise. Land and Buildings are separable assets and are dealt with
separately for accounting purposes, even when they are acquired together. Land
normally has an unlimited life and therefore is not depreciated. Building has a
limited life and therefore is depreciable asset. An increase in the value of land
on which the building stands does not affect the determination of the useful life
of the building.

DEPRECIATION CHARGES RECOGNIZED IN FINANCIAL


STATEMENTS

The depreciation charges for a period are usually recognized as an expense.


However in some circumstances, the economic benefit embodies in an asset are
absorbed by the enterprise in producing other asset rather than giving rise to an
expense. In this case, the depreciation charged comprises part of the cost of the
other asset as is included in its carrying amount. For e.g. the depreciation of
manufacturing plant and equipment is included in the cost of conversion of
inventories. Simi9larly depreciation of property plant and equipment used for
development activities may be included in the cost of an intangible asset or as a
capital research and development item.

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THE QUANTUM OF DEPRECIATION DETERMINED UNDER AS-6

Depreciation is allotted so as to charge a fair proportion of the depreciable


amount in each accounting period during the expected useful life of the asset.
Depreciable amount of a depreciable asset is its historical cost, or other amount
substituted for historical cost in the financial statement, less the estimated
residual value. Assessment of depreciation and the amount to be charged in
respect thereof in an accounting period are usually based on the following three
factors

• Historical cost or other amount substituted for the historical cost of the
depreciable asset when the asset has been revalued
• Expected useful value of the depreciable value and
• Estimated residual value of the depreciable asset.

The quantum of depreciation is provided in an accounting period involves the


exercise of judgment by management in light of technical, commercial,
accounting and legal requirements and accordingly may need periodical review.
If it is considered that the original useful life of an asset and any revision, the
unamortized depreciable amount of the asset is charged to the revenue over the
revised remaining useful life. The useful life of major depreciable assets or
classes of depreciable asset should therefore be reviewed periodically.

In the case the depreciable assets are revalued, the provision for depreciation is
based on the revalued amount on the estimate of the remaining useful life of
such assets. Depreciation is charged in each accounting period by reference of
the depreciable amount irrespective of an increase in the market value of the
asset. This is based on the concept of historical cost. Historical cost of a
depreciable asset represents its money outlay or its equivalent connection with
its acquisition, installation and commissioning as well as for additions to or
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improvement thereof. The historical cost of a depreciable asset may undergo


subsequent changes arising as a result of increase or decrease in long term
liability on account of exchange fluctuations, price adjustments, change in
duties or similar factors.

DETERMINATION OF AN USEFUL LIFE OF AN ASSET

As the economic benefits embodied in an asset is reduced are consumed by the


enterprise, the carrying amount of an asset is reduced to reflect this
consumption, normally by charging an expense for depreciation .A depreciation
charge is made even if the value of the asset exceeds its carrying amount. The
economic benefits embodied in an item of property, plant and equipment are
consumed by the enterprise principally through the use of the asset. However
other factors such as technical obsolescence and wear and tear while an asset
remains idle often result in diminution of the economic benefits that might have
been expected to be available from the assets.

Useful life is either (1) the period over which a depreciable asset is expected to
be used by the enterprise or (2) the number of production or similar units
expected to be obtained from the use of assets by the enterprise. The useful life
of a depreciable asset is shorter than its physical life and is

1. Predetermined by legal or contractual limits, such as the expiry dates of


related leases,

2. Directly governed by extraction or consumption

3. Dependent on the extent of use and physical deterioration on account of


wear and tear which again depends on operational factors such as the
number of shifts for which the asset is to be used, repair and maintenance
policy of the enterprise etc. and

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4. Reduced by obsolescence arising from such factors as:

a. Technological changes

b. Improvement in production methods

c. Change in market demand for the product or service output of the


assets

d. Legal or other restrictions.

Determination of a useful life of a depreciable asset is a matter of estimation


and is normally based on various facts including experience with similar types
of assets. Such estimation is more difficult for an asset using new technology or
used in the production of new product or in the provision of a new service but is
nevertheless required on some reasonable basis.

The useful life of an asset is defined in terms of the asset’s expected utility to
the enterprise. The asset management policy of an enterprise may involve the
disposal of assets after a specified time or after consumption of a certain
proportion of the economic benefits embodied in the assets. Therefore the
useful life of an asset may be shorter than its economic life. The estimation of
the useful life of an item of property, plant and equipment is a matter of
judgment based on the experience of the enterprise with similar assets

AS-6 OR COMPANIES ACT SHOULD BE FOLLOWED BY


COMPANIES FOR DETERMINING DEPRECIABLE AMOUNT

The statute governing an enterprise may provide the basis for computation of
the depreciation. For example the companies act 1965 lays down the rates of
depreciation in respect of various assets. Where the management’s estimate of
the useful life of an asset of the enterprise is shorter than that envisaged under
the relevant statutes, the depreciation provision is appropriately computed y
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applying a higher rate. If the managements estimate of the useful life of the
asset is longer than that envisaged under the statute, depreciation rate lower
than that envisaged by the statute can be applied only in accordance with
requirements of the statute. In a large number of cases, the rates of depreciation
under schedule 14 of companies are lowland therefore enterprises have a nose
for good corporate governance and accountant practices ,use much higher rates
than that prescribed under schedule 14.for example Infosys uses much higher
rates than that prescribed under schedule 14 on computers owned by them. It is
important for the financial statements to be true and fair that management
estimates the useful lives of assets and determines depreciation at higher rates.
If the useful lives are lower than one set out in schedule 14.

Rates higher than schedule 14 should be used provided such rates are based on
sound commercial and technical considerations. For example a factory building
situated in a coastal area may be subject to higher depreciation due to corrosion.
In such a case the auditor should broadly satisfy himself that the rates are
determined in an appropriate manner. Since the determination of commercial
life of an asset is a technical matter, the decision of the Board of Directors is
normally accepted by the auditors unless he has reason to believe that such
decision is grossly incorrect.

There could be instances where a company adopts accelerated depreciation


rates in respect class of assets i.e. depreciation rates are higher than rates
prescribed under schedule14 of the companies act. For the other assets the
company charges depreciation at the rates lower than the schedule 14 of the
companies act. However aggregate depreciation charge on all assets as per the
companies policy is higher than the aggregate depreciation had the company
followed schedule 14 rates for all the assets.

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If the managements estimate of the useful life of the asset is longer than that
envisaged, under the statute, depreciation rate lower than that envisaged by the
statute can be applied only in accordance with requirement of the statute.

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Department of Company affairs vide circular no.2/89 has clarified that:

It may be clarified that the rates as contained in schedule 14 should be


viewed as the minimum rates and therefore a company shall not be permitted to
charge depreciation at rates lower than those specified in schedule in relations
to assets purchased. After the date of applicability of the schedule.

The conclusion is:

• Compliance with AS-6 and the companies act should be viewed based on
each type of asset for example buildings, plant and machinery, furniture
etc and not on all the assets taken together.

• In the given case, accounting policy followed by the company is not in


agreement with the accounting standard 6 and provisions of the
companies act.

USEFUL LIVES OF ASSETS REQUIRED TO BE REVIEWED

The useful life of an item if property, plant and equipment should be reviewed
periodically and if expectations are significantly different from previous
estimates, the unamortised depreciable amount should be charged over the
revised remaining useful life. During the life of an asset it may become
apparent that the estimate of the useful life is inappropriate. For example the
useful life may be extended by subsequent expenditure on the asset which
improves the condition of the asset beyond its originally assessed standard of
performance. Alternatively, technological changes or changes in the market for
the products may reduce its useful life of the asset. For example due to certain
changes in the design of the finished product, a company may intend to
discontinue using the moulds much before the expiry of their useful life, the
repair and maintenance policy of the enterprise may also affect the useful life of

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an asset. The policy may result in an extension of the useful life of the asset or
an increase in its residual value. However the adoption of such a policy does
not negate the need to charge depreciation. It is important that the above
reassessment of useful does not result in depreciation lower than the required
under schedule 14, as that would result in contravention of section 205(2) of the
companies act.

ADDITION OR EXTENSION TO AN EXISTING ASSET

Any addition or extension to an existing asset which is of a capital nature and


which becomes an integral part of the existing asset is depreciated over the
useful remaining life of that asset. As a practical measure, however depreciation
is sometimes provided on such addition or extension at the rate which is applied
to an existing asset. Any addition or extension which retains a separate identity
and is capable of being used after the existing asset is disposed of, is
depreciated independently on the basis of an estimate of its own useful life.
Where the historical cost of a depreciable asset may undergo subsequent
changes arising as a result of increase or decrease in long term liability on
account of exchange fluctuations, price adjustments, changes in duties or
similar factors the depreciation on the revised unamortised depreciable amount
is provided prospectively over the residual useful life of the asset. For example
let’s say the useful life of an asset of Rs. 600000 is 5 years. In the second year
when the net value of the asset was Rs. 480000 an additional amount of Rs.
20000 nibs capitalised on account of foreign exchange difference. The revised
unamortised amount of Rs. 500000 would be depreciated over the remaining
useful life of 4 years. therefore deprecation each year for the next 4 years
would be Rs. 125000.if the company was using the written down value method
then depreciation would be provided on the revised unamortised amount of Rs.
500000 at the WDV depreciation rate.

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DEPRECIATION ON IDLE ASSETS

Sec 205 (2) of the companies act 1956 does not deal with the manner of
provision for depreciation on assets remaining idle owing to labor trouble etc.
However since depreciation also arises out of efflux of time it would be
necessary for the purpose of section 205 to provide for depreciation even in
respect of assets which are not in use during any financial year if it plans to
declare any dividend. It may be possible that due to assets lying idle the
remaining usable life is extended, in which case a reassessment of useful life
can be made. On this basis the unamortised depreciable amount should be
charged over the revised remaining useful life, which would result in a lower
annual charge of depreciation in the future years. However as cautioned above
depreciation amount should not be lower than that determined under schedule
14 for the purposes of section 205 of the companies act. Full depreciation is
provided for even if the asset is kept in the best working condition or its market
price is gone up, since depreciation is also a factor of efflux of time.

RESIDUAL VALUE

Determination of residual value of an asset is normally a difficult matter. If


such value is considered as insignificant, it is normally regarded as nil. On the
contrary, if the value is considered as insignificant, it is estimated at the time of
acquisition / installation, or at the time of subsequent revaluation of the asset.
One of the basis for determining the residual value would be the realizable
value of similar assets, which have reached the end of their useful lives and
have operated under conditions similar to those in which the asset will be used

PRINCIPLE GOVERNING TO CHOOSE THE DEPRECIATION


METHOD

There are several methods of allocating depreciation over the useful life of the
assets. Those most commonly employed in industrial and commercial
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enterprises are the straight line method and reducing balance method. The
management of a business selects the most appropriate method based on the
various important factors e.g. (i) type of asset, (ii) the nature of the use of such
asset and (iii) circumstances prevailing in the business. A combination of more
than one method is sometimes used. The method used for an asset is selected
based on the expected pattern of economic benefits and is consistently applied
from period to period unless there is a change in the expected pattern of
economic benefits from that asset. For example, a motor vehicle may provide
uniform economic benefits over several years. Therefore some enterprises may
choose to apply WDV method in the case of motor vehicle and SLM method in
the case of buildings.

DIFFERENT DEPRECIATION METHODS APPLIED FOR THE SAME


CLASS OF FIXED ASSETS

The management of a business selects the most appropriate depreciation


methods based on various important factors e.g. , (i) type of asset , (ii) the
nature of the use of such asset and (iii) circumstances prevailing in the business.
A combination of more than one method is sometimes used. It is therefore
possible that plant and machinery be depreciated on WDV basis and all the
other assets on SLM basis. Sometimes different methods of depreciation of the
same class of assets used in different plants of the company can be applied if
the management considers it appropriate to do so, after taking into account
important factors such as type of assets, the nature of the use of such assets and
circumstances prevailing in the business. For example, if an enterprise is in the
business of letting out vehicles on hire it may depreciate the hired vehicles at
higher rate than compared to the vehicles which are used by its employees fro
office purposes.

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CHANGING OF DEPRECIATION METHODS

Compliance with an accounting standard or if it is considered that the change


would result in a more appropriate preparation or presentation of the financial
statements of the enterprise. When such a change in the method of depreciation
is made, depreciation is recalculated in accordance with the new method from
the date of the asset coming into use. The deficiency or surplus arising from
retrospective recomputation of depreciation in accordance with the new method
is adjusted in the accounts in the year in which the method of depreciation is
changed. In case the change in the method results in deficiency in depreciation
in respect of past years, the deficiency is charged in the statement of profit and
loss. In case the change in the method results in surplus, the surplus is credited
to the statement of profit and loss. Such a change is treated as a change in
accounting policy and its effect is quantified and disclosed.

DEPRECAITION PROVIDED ON FIXED ASSETS ADDITION/


DELETION DURING THE YEAR

Schedule XIV to the Companies Act 1956, prescribed that “where during the
year, any addition has been made to any assets, or any asset has been sold,
discarded, demolished or destroyed, the depreciation on such assets shall be
calculated on a pro rata basis from the date of such addition or, as the case may
be, up to the date on which such asset has been sold, discarded, demolished or
destroyed”.

Depreciation should be provided when the asset is installed even though not in
use (but ready to use) for the whole or part of any financial year, due to reasons
like strike, lock-out, shortage of raw materials etc. However, if the asset is not
installed and is thus not ready for being put to use, depreciation should not be
provided on them. If the company has purchased certain equipments which are

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in capital WIP, since civil work has been delayed for along period, the company
should not provide depreciation on the equipments.

PROVISIONS FOR THE DEPRECIATION ON FIXED ASSETS ITEMS


BELOW Rs. 5000

As per the Schedule XIV of the Companies Act, individual items below rupees
five thousands (Rs. 5000) should be depreciated 100 %. An item of furniture
such as chair or table is capable of being used independently, therefore each
chair or table will have to be provided 100 % depreciation if its individual value
does not exceed Rs. 5000. The 100 % depreciation provision cannot be avoided
by arguing that the furniture can be used only as a set, for example, asset of
chairs, which cost Rs. 5000 (unless they are attached and fixed to each other
and one chair cannot be moved without simultaneously moving the other).
When these items are purchased during the year, the 100 % depreciation should
be pro- rated based on date of addition. In the case of plant and machinery
where the aggregated actual cost of individual items of plant and machinery
costing Rs. 5000 constituents more than 10 % of the total actual cost of plant
and machinery, normal Schedule XIV rates should be used.

INCOME TAX BASIS OF DETERMINING DEPRECIATION


ACCEPTABLE IN THE FINANCIAL ACCOUNTS UNDER
COMPANIES ACT 1956

After Schedule XIV coming into the force, rates higher than those under that
schedule can also be adopted on the basis of bona fide determination of the
commercial life of an asset in accordance with AS-6, which is a technical
matter. Also in such a case, proper disclosure has to be made. Therefore, a
company can follow rates prescribed under the Income Tax Act/ rules only if
these rates represent bona fide commercial depreciation.

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AS-6 and schedule XIV require pro-rata depreciation to be charged in respect of


addition/ deletion to fixed assets. Therefore for purposes of Companies Act
financial accounts, it is not appropriate to determine depreciation, after
crediting profit on sale of assets against the concerned block of assets, like it is
done for income-tax purpose. Infact profit on sale of assets needs separate
recognition and disclosure in the Companies Act financial statements.

CONTINUOUS AND NON-CONTINUOUS PRCOCESS PLANT’s


DEPRCIATION DISTINGUISH

The distinction between a continuous process and non continuous process plant
is important because the continuous plant carries a depreciation rate of 5.28 %
SLM (15.33 % WDV) without any requirement to provide extra shift
depreciation as the plant has to be continuously in operation. Non continuous
process plant carries depreciation rate of 4.75 % SLM (13.91 % WDV), plus
extra-shift depreciation. Therefore treating the plant as non continuous would
result in high depreciation where a plant has worked extra-shift. Schedule XIV,
note 7 defines continuous process plant which is required and designed to
operate 24 hours a day. Guidance note on schedule XIV issued by ICAI further
clarifies that the technical design of a continuous process plant is such that there
is a requirement to run it continuously for 24 hours a day, if it is not so run,
there are significant energy loss. It is however possible that due to various
reasons, for example, lack of demand, maintenance; etc such a plant may be
shut down for some time. The shut down does not change the inherent technical
nature of the plant , for instance a blast furnace which is required and designed
to operate 24 hours a day may be shut down due to various reasons; it would
still be considered as a continuous process plant. In contrast a textile unit may
be operated for 24 hours a day, yet they are not continuous process plant
because their technical design is not such that they have to be operated for 24
hours.

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In integrated steel plants, coke ovens, blast furnace, steel melting shops and
rolling mills are main plants of a steel mill. In coke ovens, blast furnaces, and
steel melting shops there is a technological compulsion to operate 24 hours a
day, i.e., if such plants are shut down costs also. But there is no such
technological compulsion in case of rolling mills. When this matter was
referred to the EAC for opinion, it gave the following opinion: “the committee
is of the view that whether a particular rolling mill is a continuous prices plant
should be determined on the basis of the facts and technical evaluation that
whether it is both designed and required to operate 24 hours a day. The
committee notes that the argument advanced by the querist primarily emphasize
the “technical compulsion” to operate certain mills 24 hours a day. However
apart from fulfilling the aforesaid condition the plant should also be designed to
operate 24 hours a day. Whether a plant is designed to operate 24 hours a day is
also a question of fact of a technical nature.

In case of a cement plant the process are lime stone minning, lime stone
crusher, raw mill/coal mill, klin and cement mill. The lime and stone are heated
in the klin, and the output generated is klinker (small particles). The klin is
designed to operate for 24 hours a day, as it operates under high temperature.
Any closure of the klin results in high power loss and thermal shock. The
klinker is processed in the cement mill too generate cement. The clinker and the
cement mill can be operated separately (non continuous) though since output of
one is input of the other, there capacities and operation have to be balanced.
However, such balancing can be done also by purchasing/selling clinker
from/to third parties the klin is designed to operate for 24 hours a day but not
the other plants in the cement factory, for example, the lime stone crusher,
cement mill, coal mill etc are not designed to operate 24 hours a day, though
from capacity balancing point of view it may be beneficial to operate them for
24 hours a day.

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Therefore whereas the kiln plant may satisfy the definition of a continuous
process plant the other plants in the cement fulfill ICAI’s definition of a
continuous process plant.

DISCLOSURE REQUIRED UNDER AS-6

The following information should be disclosed in the financial statements:

(i) The historical cost or other amount substituted for historical cost of each class
of depreciable assets;
(ii) Total depreciation for the period for each class of assets; and
(iii) The related accumulated depreciation.

The following information should also be disclosed in the financial statements


along with the disclosure of other accounting policies:

(i) depreciation methods used; and


(ii) depreciation rates or the useful lives of the assets, if they are different from
the principal rates specified in the statute governing the enterprise.

In case the depreciable assets are revalued, the provision for depreciation is
based on the revalued amount on the estimate of the remaining useful life of
such assets. In case the revaluation has a material effect on the amount of
depreciation, the same is disclosed separately in the year in which revaluation is
carried out.

A change in the method of depreciation is treated as a change in an accounting


policy and is disclosed accordingly.

Where depreciable assets are disposed of, discarded, demolished or destroyed,


the net surplus or deficiency, if material, is disclosed separately.

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AS-10: ACCOUNTING FOR FIXED


ASSETS
OBJECTIVE AND SCOPE OF AS-10

Fixed Assets often comprise a significant portion of the total assets of an


enterprise, and therefore are important in the presentation of financial position.
Furthermore, the determination of whether expenditure represents an assets or
an expense can have a material effect on an enterprise’s reported results of
operations. This standard is mandatory in nature. The provisions relating to
borrowing costs, intangible assets and leases that were originally contained in
this standard were withdrawn once new accounting standards were developed in
these areas. This statement does not deal with accounting for the following
items to which special consideration apply;
• Forests, plantations and similar regenerative natural resources;

• Wasting assets including mineral rights, expenditure on exploration for


and extraction of minerals, oil, natural gas and similar non-regenerative
resources;

• Expenditure on real estate development; and

• Livestock

Expenditure on individual items of fixed assets used to develop or maintain the


activities covered in (i) to (iv) above, but separable from those activities, are to
be accounted for in accordance with this statement.

WHAT ARE FIXED ASSETS?

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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. This statement deals with accounting for fixed assets such
as land, buildings, plant and machinery, vehicles, furniture and fittings,
goodwill, patens, trademarks and designs. This statement however does not deal
with specialised aspects of accounting for fixed assets that arise under a
comprehensive system reflecting the effects of changing prices but applies to
financial statements prepared on historical cost bases. It may be appropriate to
aggregate individually insignificant items, such as moulds, tools and dies, and
to apply the criteria to the aggregate value.

ACCOUNTING FOR MACHINERY SPARES

The accounting of machinery spares is done in accordance with this statement


and not in accordance with AS-2 on ‘Inventories”. Stand-by equipment and
servicing equipment are normally capitalized. Machinery spares are usually
charged to the profit and loss statement as and when consumed. However, if
such spares can be used only in connection with an item of fixed asset and their
use is expected to be irregular, it may be appropriate to allocate the total cost on
a systematic basis over a period not exceeding the useful life of the principal
item.
In certain circumstances, the accounting for an item of fixed asset may be
improved if the total expenditure thereon is allocated to its component parts,
provided they are in practice separable, and estimates are made of the useful
lives of these components. For example, rather than treat an aircraft and its
engines as one unit, it may be better to treat the engines as a separate unit if it is
likely that their useful life is shorter than that of the aircraft as a whole

COMPONENTS OF COSTS OF FIXED ASSETS

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The cost of an item of fixed asset comprise its purchase price, including import
duties and other non-refundable taxes or levies and any directly attributable cost
of bringing the asset to its working condition for its intended use; any trade
discounts and rebates are deducted in arriving at the purchase price. MODVAT
credit can be considered to be of the nature of a refundable tax. Therefore,
MODVAT credit should be reduced from the purchase cost of capital goods
concerned. Examples of directly attributable cost are
• Sites preparation;

• Initial delivery and handling costs;

• Installation costs, such as special foundation for plant; and

• Professional fees, for example fees of architects and engineers.

• The cost of a fixed asset may undergo changes subsequent to its


acquisition or construction on account of exchange fluctuations, price
adjustments, change in duties of similar factors.

Administration and other general overhead expenses are usually excluded from
the cost of fixed assets because they do not relate to a specific fixed asset.
However, in some circumstances, such expenses as are specifically attributable
to construction of a project or to the acquisition of a fixed asset or bringing it to
its working condition, may be included as part of the cost of the construction
project or as a part of the cost of the fixed asset.
The expenditure incurred on start-up 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 consumptions, is not capitalised and is
treated as revenue expenditure even though the contract may stipulate that the

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plant will not be finally taken over until after the satisfactory completion of the
guarantee period.
Amount paid for know-how for the plans, layout and designs of buildings
and/or design of the machinery should be capitalised under the relevant asset
heads such as buildings, plants and machinery, etc. Depreciation should be
calculated on the total cost of those assets, including the cost of the know-how
capitalised. Know-how related to the manufacturing process is usually expensed
in the year in which it is incurred. Where the amount paid for know-how is a
composite sum in respect of both the manufacturing process as well as plans,
drawings and designs for buildings, plant and machinery, etc., the management
should apportion such consideration into two parts on a reasonable bases. If the
said costs are not directly attributable to bringing the assets concerned to their
working condition for their intended use, it should not be capitalised as part of
the cost the asset.

SELF-CONSTRUCTED FIXED ASSETS

In arriving at the gross book value of self-constructed fixed assets, the above
principles apply. Included in the gross book value are costs of construction that
relate directly to the specific asset and costs that are attributable to the
construction activity in general and can be allocated to the specific asset. Any
internal profits are eliminated in arriving at such costs.

ACCOUNTING OF COST INCURRED DURING PROJECT DELAYS


AND WASTAGES

If the interval between the date a project is ready to commence commercial


production and the date at which commercial production actually begins is
prolonged, all expenses (other than borrowing costs) incurred during this period
are charged to the profit and loss statement. However, the expenditure incurred
during this period is also sometimes treated as deferred revenue expenditure to

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be amortised over a period not exceeding to 3 to 5 years after the


commencement of commercial production.
Normal wastages are capitalised. Abnormal wastages are not capitalised but
charged to the profit and loss account.

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NON MONETARY CONSIDERATION FOR FIXED ASSETS:

When a fixed asset is acquired in exchange for another asset, its cost is usually
determined by reference to the fair market value of the consideration given. Fair
market value is the price that would be agreed to in an open and unrestricted
market between knowledgeable and willing parties dealing at arm’s length who
are fully informed and are not under any compulsion to transact. It may be
appropriate to consider also the fair market value of the asset acquired if this is
more clearly evident. An alternative accounting treatment that is sometimes
used for an exchange of assets, particularly when the assets exchanges are
similar, is to record the asset acquired at eh net book value of the asset given up
in each case; an adjustment is made for any balancing receipt or payment of
cash or other consideration. When a fixed asset is acquired in exchange for
share or other securities in the enterprise, it is usually recorded at its fair market
value, or the fair market value of the securities issued, whichever is more
clearly evident.

SUBSEQUENT EXPENDITURE INCURRED ON FIXED ASSETS


AFTER INITIAL CAPITALISATION ACCOUNTED

Frequently, it is difficult to determine whether subsequent expenditure related


to fixed asset represents improvements that ought to be added to the gross book
value or repair that ought to be charged to the profit and loss statement. Only
expenditure that increases the future benefits from the existing asset beyond its
previously assessed standard of performance is included in the gross book
value, e.g., an increase in capacity or structural alteration to a building that
increases the strength of the building beyond its original strength. Examples of
improvements which result in increased future economic benefits include:
• Modification of an item of plant to extend its useful life, including an
increase in its capacity;

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• Upgrading machine parts to achieve a substantial improvement in the


quality of output; and

• Adoption of new production processes enabling a substantial


reduction in previously assessed operating costs

While deciding whether subsequent expenditure resulted in an increase in the


future benefits from the asset or not, recognition should be given both to the
increase in the benefits ‘per annum’ as well as increase in benefits through
extension of the life of the asset. Thus, even if there was no increase in the
annual capacity, but the life of the asset was substantially increased, it would be
taken as an increase in the future benefits from the concerned asset beyond its
previously assessed standard of performance. The expenditure on regular
overhauling only results in maintaining the previously estimated standard of
performance and it does not have the effect of improving the previously
assessed of performance. Lets consider an example, where a land right is in
dispute when it was acquired by an enterprise. The enterprise subsequently
incurred legal expenses and got all the land rights transferred in its favour. This
expenditure should be capitalised because it increases the value of the land
beyond its original assessed standard of performance. Lets consider another
example. An enterprise purchases a land on which there is not dispute.
Subsequent to the acquisition there is encroachment of land. The enterprise
incurs legal expenses to vacate the encroachers. This expenditure cannot be
capitalised because it does not increase the value of the land beyond its original
assessed standard of performance.
The cost of an addition or extension to an existing asset which is of a capital
nature and which becomes an integral part of the existing asset is usually added
to its gross books value.
Expenditure on repairs or maintenance of property, plant and equipment is
made to restore or maintain the future economic benefits that an enterprise can

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expect from the originally assessed standard of performance of the asset. As


such, it is usually recognised as an expense when incurred. For example, the
cost of servicing or overhauling plant and equipment is usually an expense
since it restores, rather than increase, the originally assessed standard
performance.

BASIS FOR REVALUATION OF FIXED ASSETS AND USE OF


REVALUATION RESERVE FOR DECLARING DIVIDENDS OR
ISSUING BONUS SHARES

Sometimes financial statements that are otherwise prepared on a historical cost


basis include part or all of the fixed assets at a valuation in substitution for
historical costs and depreciation is calculated accordingly. A commonly
accepted and preferred method of restating assets is by appraisal, normally
undertaken by competent valuer’s. Other methods are used are indexation and
reference o the current prices which when applied across checked periodically
by appraisal method. According to Schedule VI of Companies Act, every
balance sheet susbsequent to revaluation shall disclose the increased figure with
the date of increase in place of original cost for all the first 5 years. The fact of
revaluation will be disclosed in all the future balance sheets till such time the
revalued assets appear in the company’s balance sheet.
Revaluation reserve is a reserve that represents the excess of the estimated
replacement cost or estimated market values over the book values thereof. As
the revaluation reserve is a not a realized gain, it is not available for distribution
of dividends or issue of bonus shares , or writing off accumulated losses or
profit and loss debit balance or clearing backlog of depreciation of arrears etc.
SEBI also prohibits use of revaluation reserve for purpose of declaring bonus
shares.

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PRINCIPLES FOR SELECTION OF FIXED ASSETS FOR


REVALUATION

When a fixed asset is revalued in financial statements, an entire class of assets


should be revalued, or the selection of assets for revaluation should be made on
a systematic basis. This basis should be disclosed. Selective revaluation of
assets can lead to unrepresentative amounts being reported in financial
statements. Accordingly, when revaluations do not cover all assets of given
class, it is appropriate that the selection of assets to be made on a systematic
basis. e.g an enterprise may be revalued a whole class of assets within a unit.

ACCOUNTING TREATMENT FOR REVALUATION

It is not appropriate for the revaluation of a class of assets to result in the net
book value of that class being greater than the recoverable amount of the assets
of that class. Therefore revaluation would be restricted to the recoverable
amount of the fixed assets. The revalued amounts of fixed assets are presented
in financial statements either by restating both the gross book value and
accumulated depreciation so as to give a net book value equal to the net
revalued amount or by restating the net book value by adding therein the net
increase on account revaluation. An upward revaluation does not provide a
basis for crediting to the profit and loss statement the accumulated depreciation
existing at the date of revaluation.
As increase in net book value arising on revaluation of fixed assets should
credited directly to owner’s interests under the head of revaluation reserves,
except that, to the extent that such increase is related to and not greater than a
decrease arising on revaluation previously recorded as a charge to the profit and
loss statement, it may be credited to the profit and loss statement. A decrease in
net book value arising on revaluation of fixed asset should be charged directly
to the profit and loss statement except that to the extent that such a decrease is
related to an increase which was previously recorded as a credit to revaluation
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reserve and which has not been subsequently reserved or utilised, it may be
charged directly to that account.
Depreciation under AS-6 should be provided on the total value of the fixed
asset including the revalued protion. Depreciation on the revalued portion of the
fixed asset can either be charged to the profit and loss account or alternatively
charged to the profit and loss account and at the same time compensated from
the revaluation reserve such that the net charge to the profit and loss account is
nil.
ACCOUNTING OF RETIREMENTS AND DISPOSALS

Fixed asset should be eliminated from the financial statements on disposal or


when no further benefit is expected from its use and disposal. Items of fixed
assets that have been retired from active use and are held for disposal are stated
at the lower of their net book value and realisable value and are shown
separately in the financial statements. Any expected loss is recognized
immediately in the profit and loss statements. In historical cost financial
statements, gains or losses arising on disposal are recognised in the profit and
loss statement. Paragraph 24 of Accounting Standard (AS) 10, ‘Accounting for
Fixed Assets’ states that “Material items retired from active use and held for
disposal should be stated at the lower of their net book value and net realisable
value and shown separately in the financial statements.” The fixed assets which
are retired from active use and dismantled and are not actually sold off, should
be disclosed appropriately at the lower of net realisable value and net book
value in the Schedule of Fixed Assets or on the face of the balance sheet under
the head Fixed Assets. These items cannot be disclosed under the caption
‘inventories’
On disposal of a previously revalued item of fixed asset, the difference between
net disposal proceeds and the net book value should be charged or credited to
the profit and loss statement except that to the extent that such a loss is related

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to an increase which was previously recorded or utilised, it may be charged


directly to that account. The amount standing in revaluation reserve following
the retirement or disposal of an asset which relates to that asset may be
transferred to general reserves.

TREATMENT FOR JOINTLY OWNED FIXED ASSETS

Where an enterprise owns fixed assets jointly with other (otherwise than as a
part in a firm), the extent of its share in such assets, and the proportion in the
original cost, accumulated depreciation and written down values are stated in
the balance sheet. Alternatively, the pro rata cost of such jointly owned assets is
grouped together with similar fully owned assets with an appropriate disclosure
thereof. Details of such jointly owned assets are indicated separately in the
fixed assets register.

AMORTISATION/ DEPRECIATION OF GOODWILL

Goodwill, in general, is recorded in the books only when some consideration in


money or money’s worth has been paid for it. Whenever, a business is acquired
for a price (payable either in cash or in shares or otherwise) which is in excess
of the value of the net assets of the business taken over, the excess is termed as
‘goodwill’. Goodwill arises from business connections, trade name or
reputation of an enterprise or from other intangible benefits enjoyed by an
enterprises. Where several fixed assets are purchased for a consolidated price,
the consideration should be apportioned to the various assets on a fair basis as
determined by competent value. As a matter of financial prudence, goodwill is
written off over a period of 3-5 years.

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DISCLOSURES OF FIXED ASSETS

In addition to disclosures required to be made under AS-1 and AS-6, further


disclosures under AS-10 are as follows:
(i) Gross and net book values of fixed assets at the beginning and end of an
accounting period showing additions, disposals, acquisitions and other
movements;

(ii) Expenditure incurred on account of fixed assets in the course of


construction or acquisition; and

(iii) Revalued amount substituted for historical costs of fixed assets, the basis
of selection of fixed assets for revaluation, the method adopted to
compute the revalued amount, the nature of any 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.

For purposes of Schedule VI, the revalued amounts of each class of fixed assets
are presented in the balance sheet separately, by restating both the gross book
value and accumulated depreciation so as to give a net book value to a new
revalued amount. It is not correct to net off the increase/decrease in net-book
value arising from revaluation of various classes of fixed assets, for example,
machinery and building.

SIGNIFICANT DIFFERENCES BETWEEN AS-10, IAS AND US GAAP

Fixed assets are more elaborately defined under IAS and US GAAP. For
example according to IAS-16, an item of property, plant and equipment should
be recognised as an asset when (a) it is probable that future economic benefits
associated with the asset will flow to the enterprise; and (b) the cost of the asset
to the enterprise can be measured reliably. Though these provision not

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contained in AS-10 it is assumed that they would apply even in the Indian
situation.

US GAAP does not permit revaluation of fixed assets. As regards upward


revaluation of fixed assets, IAS-16 permits it as an alternative treatment.
Revaluation is also permitted under AS-10, such as (a) IAS provides more
detail guidelines than AS-10 on revaluation principles (b) Under IAS-16,
revaluations are required to be done with sufficient regularity such that their
carrying amount do not differ materially from the fair values. There is no such
requirement in AS-10. IAS-16 also states that annual revaluations are important
where fixed asset fair values are subject to significant volatility, otherwise a
revaluation every three or five year is sufficient.

Under AS-10 if the interval between the date a project is ready to commence
commercial production and the date at which commercial production actually
begins is prolonged, all expenses (other than borrowing costs) incurred during
this period are charged to the profit and loss statement. However, the
expenditure incurred during this period is also sometimes treated as deferred
revenue expenditure to be amortised over a period not exceeding 3 to 5 years
after the commencement of commercial production. Under IAS/US GAAP
deferral of expenditure is not permitted, and all expenses incurred in these
circumstances are charged to the profit and loss account.

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AS-12 : GOVERNMENT GRANTS

Accounting for Government Grants

• Capital Approach versus Income Approach

• Recognition of Government Grants

• Non-monetary Government Grants

• Presentation of Grants Related to Specific Fixed Assets

• Presentation of Grants Related to Revenue

• Presentation of Grants of the nature of Promoters’ contribution

• Refund of Government Grants

• Disclosure

Statements of Accounting Standards

The following is the text of the Accounting Standard (AS) 12 issued by the
Council of the Institute of Chartered Accountants of India on ‘Accounting for
Government Grants’.

The Standard comes into effect in respect of accounting periods commencing


on or after 1.4.1992 and will be recommendatory in nature for an initial period
of two years.

Accordingly, the Guidance Note on ‘Accounting for Capital Based Grants’


issued by the Institute in 1981 shall stand with drawn from this date. This

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Standard will become mandatory in respect of accounts for periods


commencing on or after 1.4.1994.2

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Introduction

1. This Statement deals with accounting for government grants.


Government grants are sometimes called by other names such as
subsidies, cash incentives, duty drawbacks, etc.

2. This Statement does not deal with:

• The special problems arising in accounting for government grants


in financial statements reflecting the effects of changing prices.
Accounting Standards are intended to apply only to items which are
material.

• Reference may be made to the section titled ‘Announcements of


the Council Regarding status of various documents issued by the
Institute of Chartered Accountants of India’ appearing at the
beginning of this Compendium for a detailed discussion on the
implications of the mandatory status of an accounting standard.

Definitions

The following terms are used in this Statement with the meanings Specified:

• Government refers to government, government agencies and similar


bodies whether local, national or international.

• Government grants are assistance by government in cash or kind to an


enterprise for past or future compliance with certain conditions.

• They exclude those forms of government assistance which cannot


reasonably have a value placed upon them and transactions with
government which cannot be distinguished from the normal trading
transactions of the enterprise.

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Explanation

The receipt of government grants by an enterprise is significant for Preparation


of the financial statements for two reasons. Firstly, if a government grant has
been received, an appropriate method of accounting there for is necessary.
Secondly, it is desirable to give an indication of the extent to which the
enterprise has benefited from such grant during the reporting period. This
facilitates comparison of an enterprise’s financial statements with those of prior
periods and with those of other enterprises.

Accounting Treatment of Government Grants

Capital Approach versus Income Approach

• Two broad approaches may be followed for the accounting treatment of


government grants: the ‘capital approach’, under which a grant is treated
as part of shareholders’ funds, and the ‘income approach’, under which a
grant is taken to income over one or more periods.

Those in support of the ‘capital approach’ argue as follows:

• Many government grants are in 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 and
no repayment is ordinarily expected in the case of such grants. These
should, therefore, be credited directly to shareholders’ funds.

• 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.

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Arguments in support of the ‘income approach’ are as follows:

• Government grants are rarely gratuitous. The enterprise earns them


through compliance with their conditions and meeting the envisaged
obligations. They should therefore be taken to income and matched with
the associated costs which the grant is intended to compensate.

• As income tax and other taxes are charges against income, it is logical to
deal also with government grants, which are an extension of fiscal
policies, in the profit and loss statement.

• In case grants are credited to shareholders’ funds, no correlation is done


between the accounting treatment of the grant and the accounting
treatment of the expenditure to which the grant relates.

• It is generally considered appropriate that accounting for government


grant should be based on the nature of the relevant grant. Grants which
have the characteristics similar to those of promoters’ contribution should
be treated as part of shareholders’ funds. Income approach may be more
appropriate in the case of other grants.

• It is fundamental to the ‘income approach’ that government grants be


recognised in the profit and loss statement on a systematic and rational
basis over the periods necessary to match them with the related costs.
Income recognition of government grants on a receipts basis is not in
accordance with the accrual accounting assumption.

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Recognition of Government Grants

Government grants available to the enterprise are considered for inclusion in


accounts:

• Where there is reasonable assurance that the enterprise will comply with
the conditions attached to them; and

• Where such benefits have been earned by the enterprise and it is


reasonably certain that the ultimate collection will be made.

• Mere receipt of a grant is not necessarily a conclusive evidence that


condition attaching to the grant have been or will be fulfilled.

Non-monetary Government Grants

Government grants may take the form of non-monetary assets, such as land or
other resources, given at concessional rates. In these circumstances, it is usual
to account for such assets at their acquisition cost.

Non-monetary assets given free of cost are recorded at a nominal value.

Presentation of Grants Related to Specific Fixed Assets

• Grants related to specific fixed assets are government grants whose


primary condition is that an enterprise qualifying for them should
purchase, construct or otherwise acquire such assets. Other conditions
may also be attached restricting the type or location of the assets or the
periods during which they are to be acquired or held.

• Two methods of presentation in financial statements of grants (or the


appropriate portions of grants) related to specific fixed assets are
regarded as acceptable alternatives.

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• Under one method, the grant is shown as a deduction from the gross
value of the asset concerned in arriving at its book value. The grant is
thus recognised in the profit and loss statement over the useful life of a
depreciable asset by way of a reduced depreciation charge. Where the
grant equals the whole, or virtually the whole, of the cost of the asset, the
asset is shown in the balance sheet at a nominal value.

• Under the other method, grants related to depreciable assets are treated 4
AS 5 has been revised in February 1997. The title of revised AS 5 is ‘Net
Profit or Loss for the Period, Prior Period Items and Changes in
Accounting Policies’. as deferred income which is recognised in the
profit and loss statement on a systematic and rational basis over the
useful life of the asset. Such allocation to income is usually made over
the periods and in the proportions in which depreciation on related assets
is charged. Grants related to non- depreciable assets are credited to
capital reserve under this method, as there is usually no charge to income
in respect of such assets. However, if a grant related to a non-depreciable
asset requires the fulfillment of certain obligations, the grant is credited
to income over the same period over which the cost of meeting such
obligations is charged to income. The deferred income is suitably
disclosed in the balance sheet pending its apportionment to profit and
loss account. For example, in the case of a company, it is shown after
‘Reserves and Surplus’ but before ‘Secured Loans’ with a suitable
description.

• The purchase of assets and the receipt of related grants can cause major
movements in the cash flow of an enterprise. For this reason and in order
to show the gross investment in assets, such movements are often
disclosed as separate items in the statement of changes in financial

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position regardless of whether or not the grant is deducted from the


related asset for the purpose of balance sheet presentation.

Presentation of Grants Related to Revenue

• Grants related to revenue are sometimes presented as a credit in the profit


and loss statement, either separately or under a general heading such as
‘Other Income’. Alternatively, they are deducted in reporting the related
expense.

• Supporters of the first method claimt hat it is inappropriate to net income


and expense items and that separation of the grant from the expense
facilitate comparison with other expenses not affected by a grant. For the
second method, it is argued that the expense might well not have been
incurred by the enterprise if the grant had not been available and
presentation of the expense without offsetting the grant may therefore be
misleading.

Presentation of Grants of the nature of Promoters’ contribution

• 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.

Refund of Government Grants

• Government grants sometimes become refundable because certain


conditions are not fulfilled. A government grant that becomes refundable

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is treated as an extraordinary item (see Accounting Standard (AS) 5,


Prior Period and Extraordinary Items and Changes in Accounting
Policies5).

• The amount refundable in respect of a government grant related to


revenue is applied first against any unamortised 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.

• The amount refundable in respect of a government grant related to a


specific fixed asset is recorded by increasing the book value of the asset
or by reducing the capital reserve or the deferred income balance, as
appropriate, by the amount refundable. In the first alternative, i.e., where
the book value of the asset is increased, depreciation on the revised book
value is provided prospectively over the residual useful life of the asset.

• Where a grant which is in the nature of promoters’ contribution becomes


refundable, in part or in full, to the government on non-fulfillment of
some specified conditions, the relevant amount recoverable by the
government is reduced from the capital reserve.

Disclosure

The following disclosures are appropriate:

• The accounting policy adopted for government grants, including the


methods of presentation in the financial statements; the nature and extent
of government grants recognised in the financial statements, including
grants of non-monetary assets given at a concessional rate or free of cost.

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• Government grants should not be recognised until there is reasonable


assurance that (i) the enterprise will comply with the conditions attached
to them, and (ii) the grants will be received.

• Government grants related to specific fixed assets should be presented in


the balance sheet by showing the grant as a deduction from the gross
value of the assets concerned in arriving at their book value. Where the
grant related to a specific fixed asset equals the whole or virtually the
whole, of the cost of the asset, the asset should be shown in the balance
sheet at a nominal value. Alternatively, government grants related to
depreciable fixed assets may be treated as deferred income which should
be recognised in the profit and loss statement on a systematic and rational
basis over the useful life of the asset, i.e., such grants should be allocated
to income over the periods and in the proportions in which depreciation
on those assets is charged. Grants related to non-depreciable assets
should be credited to capital reserve under this method. However, if a
grant related to a non-depreciable asset requires the fulfillment of certain
obligations, the grant should be credited to income over the same period
over which the cost of meeting such obligations is charged to income.
The deferred income balance should be separately disclosed in the
financial statements.

• Government grants related to revenue should be recognised on a


systematic basis in the profit and loss statement over the periods
necessary to match them with the related costs which they are intended to
compensate. Such grants should either be shown separately under ‘other
income’ or deducted in reporting the related expense.

• Government grants of the nature of promoters’ contribution should be


credited to capital reserve and treated as a part of shareholders’ funds.

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• Government grants in the form of non-monetary assets, given at a


concessional rate, should be accounted for on the basis of their
acquisition cost. In case a non-monetary asset is given free of cost, it
should be recorded at a nominal value.

• Government grants that are receivable as compensation for expenses or


losses incurred in a previous accounting period or for the purpose of
giving immediate financial support to the enterprise with no further
related costs, should be recognised and disclosed in the profit and loss
statement of the period in which they are receivable, as an extraordinary
item if appropriate.

• A contingency related to a government grant, arising after the grant has


been recognised, should be treated in accordance with Accounting
Standard (AS) 4, Contingencies and Events Occurring After the Balance
Sheet Date.7

• Government grants that become refundable should be accounted for as an


extraordinary item.

• The amount refundable in respect of a grant related to revenue should be


applied first against any unamortised 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 should be
charged to profit and loss statement.

• The amount refundable in respect of a grant related to a specific fixed


asset should be recorded by increasing the book value of the asset or by
reducing the capital reserve or the deferred income balance, as
appropriate, by the amount refundable. In the first alternative, i.e., where
the book value of the asset is increased, depreciation on the revised book

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value should be provided prospectively over the residual useful life of the
asset.

• Government grants in the nature of promoters’ contribution that become


refundable should be reduced from the capital reserve.

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Bibliography

• Compendium of Accounting Standards

• ICAI – Institute of Chartered Accountants of India

• Student Guide to Indian Accounting Standard & GAAP

• www.icai.org

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