Articles On Accounting Standards

FOREWORD
Dear all, First of all I welcome all of you to AksharabhyaS A Journey through Accounting Standards, the Accounting Standards Workshop to be held from 20th June to 02nd July 2011. It is indeed a joyous moment to note that the workshop has received a tremendous response among the students. An in depth analysis of each and every standard is done by a student speaker and icing on the cake is provided in the form of very learned and experienced Chartered Accountants who will be present as chairman of every session. CA. Srinivasa Raghavan, Executive Manager, Simpson & Co. Ltd. inaugurated the workshop on Monday, the 20th June 2011. We have devised this workshop for a period of two weeks in order to provide sufficient time for both speakers and participants to discuss the subject in detail. I wish the speakers all the best for their presentation. They have put in lots of effort to make this workshop more educative and informative. I thank all the chairpersons for accepting my invitation to chair the sessions. I sincerely thank CA. L. Venkatesan, Course Director for all the support, guidance and encouragement given to conduct this workshop. I should also thank the SIRC Chairman, my council colleagues in SIRC and also the staff of SIRC for extending their kind support for the workshop. I also thank all the firms who have sponsored their articles for this workshop. Lastly I take this opportunity to appreciate the generosity bestowed by the sponsors on us to make this workshop more meaningful and attractive. CA. C.S. Srinivas Chairman SICASA SIRC of ICAI
Accounting Standards issued by ICAI

AS 1 2 3 4 5 6 7 9 10 11 12 13 14 15 16 17 18 19 20 Name Disclosure of Accounting Policies Valuation of Inventories (Revised) Cash Flow Statements(Revised) Contingencies and events occurring after the Balance date Net Profit/Loss for the period prior period items & changes in Accounting Policies(Revised) Depreciation Accounting (Revised) Accounting for Construction Contracts(Revised) Revenue Recognition Accounting for Fixed Assets Accounting for effects of changes in Foreign Exchange Rates(Revised) Accounting for Government Grants Accounting for Investments Accounting for Amalgamations Employee Benefits Borrowing Costs Segment Reporting Related Party Disclosures Leases Earnings Per Share All level All level Level I All level All level All level All level All level All level All level All level All level All level All level All level Level I Level I All level Level I Scope Effective date 1.4.1993 1.4.1999 1.4.2001 1.1.1998 1.4.1996 1.4.1995 1.4.2002 1.4.1993 1.4.1993 1.4.2004 1.4.1994 1.4.1995 1.4.1995 1.4.1995 1.4.2000 1.4.2001 1.4.2001 1.4.2001 1.4.2001 Status Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Only for those enterprises which prepare consolidated statements
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Consolidated Financial Statements
Enterprises preparing Cash Flow Statements
1.4.2001
SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI
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Accounting for Taxes on Income
Listed Companies Other Companies All Enterprises
1.4.2001 1.4.2002 1.4.2006 1.4.2002 1.4.2004 1.4.2002 1.4.2003 1.4.2002 1.4.2004 1.4.2006 1.4.2008 1.4.2004
Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory
23 24 25 26 27 28
Accounting for Investments in Associates in Consolidated Financial Statements Discontinuing Operations Interim Financial Statement Intangible Assets Financial Reporting of Interests in Joint Ventures Impairment of Assets
Enterprises preparing Cash Flow Statements Level I Level I All Enterprises Enterprises preparing Cash Flow Statements Level I Level II Level III
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30
Provisions, Contingent Liabilities and Contingent Assets Financial Instruments: Recognition and Measurement and Limited Revisions to AS 2, AS 11(revised 2003), AS 21, AS 23, AS 26, AS 27, AS 28, AS 29.
All Level
All (except to a SME)
1.4.2009
Recommendatory
1.4.2011 31 Financial Instruments: Presentation All (except to a SME) 1.4.2009 1.4.2011 32 Financial Instruments: Disclosure and Limited Revision to AS 19 All (except to a SME) 1.4.2009 1.4.2011
Mandatory Recommendatory Mandatory Recommendatory Mandatory
AS 1 DISCLOSURE OF ACCOUNTING POLICIES

- Anand Kumar V. (v_anand90@yahoo.co.in)
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. Accounting Standard 1 issued by the Accounting Standards Board, The Institute of Chartered Accountants of India on 'Disclosure of Accounting Policies'. The Standard deals with the disclosure of significant accounting policies followed in preparing and presenting financial statements. In the initial years, this accounting standard will be recommendatory in character. During this period, this standard is recommended for use by companies listed on a recognized stock exchange and other large commercial, industrial and business enterprises in the public and private sectors.
Introduction
Disclosure of Accounting Policies: Accounting Policies refer to specific accounting principles and the method of applying those principles adopted by the enterprises in preparation and presentation of the financial statements. 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. 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. In recent years, 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. Explanation: Fundamental Accounting Assumptions 9. Certain fundamental accounting assumptions underlie the preparation and presentation of financial statements. They are usually not specifically stated because their acceptance and use are assumed. Disclosure is necessary if they are not followed. 10. The following have been generally accepted as fundamental accounting assumptions: a. Going Concern:The enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations. b. Consistency:It is assumed that accounting policies are consistent from one period to another. c. Accrual:Revenues and costs are accrued, that is, recognized as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate. (The considerations affecting the process of matching costs with revenues under the accrual assumption are not dealt with in this Statement.) Nature of Accounting Policies 11. 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.
12. 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 principles in the specific circumstances of each enterprise calls for considerable judgement by the management of the enterprise. 13. 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 14. The following are examples of the areas in which different accounting policies may be adopted by different enterprises. Methods of depreciation, depletion and amortization 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 Treatment of contingent liabilities. 15. The above list of examples is not intended to be exhaustive. Considerations in the Selection of Accounting Policies 16. 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 represent a true and fair view of the state of affairs of the enterprise as at the balance sheet date and of the profit or loss for the period ended on that date. 17. For this purpose, the major considerations governing the selection and application of accounting policies are: a. Prudence: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.
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b. Substance over Form:The accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form. c. Materiality:Financial statements should disclose all "material" items, i.e. items the knowledge of which might influence the decisions of the user of the financial statements. Disclosure of Accounting Policies 18. To ensure proper understanding of financial statements, it is necessary that all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. 19. Such disclosure should form part of the financial statements. 20. 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. 21. 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. 22. Any change in an accounting policy 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. 23. Disclosure of accounting policies or of changes therein cannot remedy a wrong or inappropriate treatment of the item in the accounts. ACCOUNTING STANDARD (The Accounting Standard comprises paragraphs 2427 of this Statement. The Standard should be read in the context of paragraphs 123 of this Statement and of the 'Preface to the Statements of Accounting Standards'.) 24. All significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. 25. 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. 26. 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. 27. 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. Section 211 of the Companies Act, 1956, deals with the form and contents of balance sheet and profit and loss account. The Companies (Amendment) Act, 1999 has inserted new sub-sections 3A, 3B and 3C to Section 211, with a view to ensure that the financial statements are prepared in accordance with the Accounting Standards. The new sub-sections as inserted are reproduced below: Section 211 (3A): Every profit and loss account and balance sheet of the company shall Comply with the accounting standards Section 211 (3B): Where the profit and loss account and the balance sheet of the company do not comply with the accounting standards, such companies shall disclose in its profit and loss account and balance sheet, the following, namely:a) The deviation from the accounting standards; b) The reasons for such deviation; and c) The financial effect, if any, arising due to such deviation Section 211 (3C): For the purposes of this section, the expression accounting standards means the standards of accounting recommended by the Institute of Chartered Accountants of India, constituted under the Chartered Accountants Act, 1949 (38 of 1949), as may be prescribed by the Central Government in consultation with the National Advisory Committee on Accounting Standards established under sub- section (1) of section 210A: Provided that the standards of accounting specified by the Institute of Chartered Accountants of India shall be deemed to be the Accounting Standards until the accounting standards are prescribed by the Central Government under this sub-section.
AS 2 - VALUATION OF INVENTORIES
- Subhashini Srinivasan (subasvasan@gmail.com)
Contents Applicability & Nature Objective Definitions Inclusions and Exclusions Techniques of Measurement Disclosures Exam Problems -At a glance Applicability of Nature Applicable Nature Objective A primary issue of accounting for inventories is the determination of the value at which inventories are carried in the financial statements units the related revenues are recognized. This statement deals with the determination of such value, including the ascertainment of cost of inventories and any write-down thereof to net realizable value. Definitions 01.04.1999 Onwards Mandatory (Compulsory)
Inventories are assets which are :

(a) held for sale in the ordinary course of business (Finished Goods); or (b) in the process of production of such sale (WIP); or (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services (Raw material, Consumables etc.) . However, this standard does not apply to the valuation of following inventories: (a) (b) (c) (d) WIP arising under construction contract (Refer AS 7); WIP arising in the ordinary course of business of service providers; Shares, debentures and other financial instruments held as stock in trade; and Producers inventories of livestock, agricultural and forest products, mineral oils, ores and gases. Such inventories are measured at net realizable value. (Inventories should be valued at the lower of cost and net realizable value.)
Inclusions and Exclusions The Cost of Inventories includes: (a) All costs of purchase (b) Cost of conversion (c) Other costs (incurred in bringing the inventories to their present location and condition). Cost of inventory does not include. (a) Abnormal Loss (waste of materials, labour or other production costs; (b) Storage costs, unless those costs are necessary in the production process prior to a further production stage; (c) Administrative, Selling and Distribution costs. (d) Interest and other borrowing costs
The costs of purchase consist of

(a) the purchase price (b) duties and taxes ( other than those subsequently recoverable by the enterprise from the taxing authorities like CENVAT credit) (c) freight inwards and other expenditure directly attributable to the acquisition. Trade discounts (but not cash discounts), rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase. The costs of conversion include direct costs (Direct Material, Direct Labour & Direct Exps.) and systematic allocation of fixed and variable production overhead.
Allocation of overheads
Overhead Recovery Rate = Production Overhead Normal/Actual Production (whichever is higher)
Joint or by products:
In case of joint products, the costs incurred up to the stage of split off should be allocated on a rational and consistent basis. The basis of allocation may be sale value at split off point or sale value at the completion of production. In case of the by products, scrap or waste material, they are valued at net realizable value. The cost of main product is then joint cost minus NRV of by product or waste
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Techniques for the Measurement
Cost Formula:
Specific identification method for determining cost of inventories Specific identification method means directly linking the cost with specific item of inventories. Where Specific Identification method is not applicable The cost of inventories is valued by the following methods; FIFO ( First In First Out) Method Weighted Average Cost
Net Realisable Value means the estimated selling price less estimated cost of completion and
estimated cost necessary to make the sale. (e.g. selling exps) NRV is estimated on the basis of most reliable evidence at the time of valuation. (e.g Firm Contracts ) NRV of Raw material to be used in Finished Goods: Higher of Incremental revenue or Replacement cost
Comparison between NRV and cost of inventory

The comparison between cost and net realizable value should be made on item-by-item basis. (In some cases, it may be appropriate to group similar or related item ) For Example: Item A Item B Total Disclosure Requirements Inventory valuation policy Basis of valuation (FIFO, Weighted Average) Classification of inventories ( Raw Material, WIP, Finished goods etc.) Cost 100 100 200 NRV 90 115 205 Inventory Value as per AS-2 90 100 200 190
Exam Problems-At a glance 1. The company deals in three products A, B and C, which are neither similar nor interchangeable. At the time of closing of its account for the year 2007-2008, the historical cost and net realisable value of the items of closing stock are determined as follows.
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Items A B C
Historical cost (Rs. in Lakhs) 40 32 16
Net Realisable value (Rs. in Lakhs) 28 32 24
What will be the value of closing stock? Answer: As per para 5 of AS 2 on Valuation of Inventories, inventories should be valued at the lower of cost and net realisable value. Inventories should be written down to net realisable value on an item by item basis in given case. ITEMS HISTORICAL COST (Rs. in lakhs) 40 32 16 88 NET REALISABLE VALUE (Rs. in lakhs) 28 32 24 84 VALUATION OF CLOSING STOCK (Rs. in lakhs) 28 32 16 76
A B C
Hence the closing stock will be valued at Rs.76 Lakhs. 2. X Co Limited purchased goods at the cost of Rs. 40 lakhs in october, 2005. Till March, 2006, 75% of the stocks were sold. The company wants to disclose closing stock at Rs. 10 Lakhs. The expected sale value is Rs.11 Lakhs and a commission at 10% on sale is payable to the agent. Advise, what is the correct closing stock to be disclosed as at 31.03.2009 (May-2004) Solution: As per AS-2, inventories are valued at cost or net realisable value whichever is lower. Cost of inventories comprises cost of purchase , cost of conversion and other cost incurred in bringing the inventories to their present position and location. Net Realisable value (NRV) is the estimated selling price in ordinary couse of business less estimated cost of completion and cost necessary to make the sale. Here, the closing stock is Rs.10 Lakhs (25% of Rs.40 Lakhs) and NRV is Rs.9.9 Lakhs (i.e Rs. 11 Lakhs 10% of 11 Lakhs for commission on sale). So, X Co Ltd. Should disclose the closing stock at Rs. 9.9 Lakhs.Commission is to be deducted as it is necessary to make sale. 3. Problem. (i) Direct material cost/ kg (ii) Direct wages cost /Kg. (iii)Variable production overhead /Kg.
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Rs.120 Rs. 20 Rs. 10
(iv) Fixed production overhead for the year based on normal capacity of 100,000 kg. Rs.10,00,000/-. Compute the cost per kg. finished stock- in hand lying unsold (assumed production at normal capacity). Solution: The fixed overhead should be absorbed on the basis of normal capacity. The computationis as shown below Cost of unsold stock per kg.: Direct material cost Conversion cost Direct wages Production overhead Variable Fixed (10,00,000/100,000) Rs. 120 Rs. 20 Rs. 10 Rs. 10 Rs. 40 Rs. 160
So, the cost of the finished item should be taken at Rs.160/- per kg. 4. Raw material was purchased at Rs. 100 per kg. Price of raw material is on the decline. The finished goods in which the raw material is incorporated is expected to be sold at below cost. 5,000 kg. of raw material is on stock at the year end. Replacement cost is Rs. 90 per kg. At what rate it should be valued ? Solution Valuation of iventory. (cost or Realisable value) As per para 24 of AS 2, materials and other supplies held for use in the production of inventories are not written down below cost if the finished products in which they will be incorporated are expected to be sold at or above cost. However, when there has been a decline in the price of materials and it is estimated that the cost of the finished products will exceed the net realisable value, the material are written down to net realisable value. However, when there has been a decline in the price of materials and it is estimated that the cost of the finished products will exceed net realisable value, the material are written down to net realisable value. In such cases the replacement cost of material may be the best available measure of their net realisable value. (i) (ii) In view of this raw material stock of 5,000 kg. should be valued at Rs. 90 per kg Finished goods, if in stock, should be valued at lower of cost and net realisable value.
5. In a production process, normal waste is 5 % of input. 5,000 MT of input were put in process resulting in a wastage of 300 MT. Cost per MT input is Rs. 100. The entire quantity of waste is on stock at the year end. Realisable value of waste is nil. Compute the cost per unit.
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Solution As per AS-2, abnormal amounts of waste materials, labour or other production costs are excluded from cost of inventories and such costs are recognised as expenses in the period in which they are incurred. (i) In this case normal waste is 250 MT (ii) Abnormal waste is 50 MT
The cost of 250 MT will be included in determining the cost of inventories (finished goods) at year end. The cost of abnormal waste amounting to Rs. 5,000 will be charged to Profit and loss A/c. Accordingly, the cost per unit is (5000*100/4750) (i.e) Rs. 105.26. So the cost per unit is Rs. 105.26 per kg. 6. Direct material Direct labour Fixed production overhead Fixed administration overhead Normal capacity Actual production Closing stock Rs. 400 per unit Rs. 250 per unit Rs. 20,00,000 p.a Rs. 10,00,000 p.a 1,00,000 units 40,000 units 10,000 units
Compute value of closing stock of finished goods. Solution: The fixed production overhead should be absorbed on basis of normal Capacity. Administration overhead of Rs. 10,00,000/- should not be included in production cost. The computation is shown below: Cost per unit of finished goods Direct material Direct Labour Fixed production overhead 20,00,000/1,00,000
Rs. 400 Rs. 250 Rs. 20 Rs.670
(i) (ii) 7.
Closing stock of finished goods 10,000 *Rs.670 (i.e) Rs. 67,00,000/So out of Rs. 20,00,000/- of Fixed production overhead only 40,000 *20 =8,00,000 is absorbed. Balance Rs.12,00,000 would be charged to P& L A/c. Administration overhead of Rs. 10,00,000 should not be included in production cost. Raw material cost /unit Direct wages cost/unit Direct Expenses / unit Rs. Rs. Rs. 2 110 40
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Production overhead (40% is fixed) Sales (in units) Closing stock (in units) Normal capacity (in units)
Rs.20,00,000 9,00,000 1,00,000 5,00,000
Solution The fixed overhead should be as per actual capacity. The variable observed should be as per actual capacity (exceeding normal capacity) . The computation is shown below : Cost /unit of finished goods Raw material cost Direct wages Direct expenses Production overhead Fixed: Variable 20,00,000*40% 5,00,000 20,00,000*60% (9,00,000+1,00,000) Rs. 1.60 Rs. 1.20 Rs. 110.00 Rs. 40.00 Rs 2.00
Total Rs.154.80 Closing stock 1,00,000 *Rs.154.80 i.e Rs.154.80Lakhs. The finished item cost is Rs. 154.80 per unit. 8. (a) Normal level of production (b) Fixed production overheads 1,00,000 units Rs.5,00,000
Compute the overhead recovered rate, overhead recovered and overhead Charged to Profit & Loss A/c in the following cases: Case 1. Actual production: 1,00,000 units, Case 2. Actual production: 80,000 units, Case 3. Actual production : 1,25,000 units Solution In case of production at normal or above normal level (cases 1&3) the fixed overhead would be recovered at a rate based on normal production level.
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Case I : Actual production 1,00,000 units (a) Fixed overhead recovery rate Rs.5,00,000/1,00,000 i.e Rs.5 per unit (b) Overhead recovered 1,00,000* Rs. 5 i.e Rs. 5 per unit (c) Overhead written off as an expense Nil In case of production below normal level (case 2) fixed overhead would be recovered on actual production, balance amount of fixed overhead would be changed to Profit & Loss A/c. The computation details are as given below: Case II : Actual production 80,000 units (a) Fixed overhead recovery rate Rs.5 (b) Fixed overhead recovered 80,000*Rs.5 i.e Rs. 4,00,000 (c) Overhead written off to P&L A/c Rs.5,00,000-.40,000 i.e Rs. 100,000 Case III : Actual production 1,25,000 units (a) Fixed overhead recovery rate Rs.5 (b) Fixed overhead at recovery rate Rs.1,25,000*5 i.e Rs. 6,25,000 Therefore fixed overhead recovery rate is Rs. 5,00,000/ 1,25,000=Rs.4/unit 9. The closing stock under retail method from the following data Sale value (a)Opening stock (b) Purchase (c) Sales (net) Solution Steps involved in solving the above problem Step: 1- Computation of value of sales value of closing stock Step:2- Computation of gross profit ratio Step:3- Computation of cost of closing stock. 1. Opening stock (at sales price) Add: Net purchase (at sale price) Less: Net sales Closing stock (sale price)
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Cost (ii) Rs. 50,000 (ii)Rs.1,30,000
(i) Rs. 70,000 (i)Rs. 1,50,000 Rs. 2,30,000
Rs. 70,000 1,50,000 2,20,000 1,30,000 90,000
2. Gross profit ratio . ` (a)Sale value of op.stock (b) Sale value of purchase Total (c) Less : Cost price of (i) Op. stock Rs.50,000 (ii) Purchases Rs.1,30,000 (d) Gross profit (e) Gross profit ratio Rs.70,000 Rs.1,50,000 Rs.22,00,000 Rs.1,80,000
Rs. 40,000 (Rs.40,000*100)/22,00,000 = 18.182 %
3. Cost of Closing Stock ` (a) Closing stock (at sale price) (b) Less Gross profit 18.182% of Rs.90,000 (c) Closing stock at cost Rs. 90,000 Rs.16,364 Rs. 73,636
10. A. Ltd supplied equipment during 2006-07 as per customers design and drawing. However due to a liquidity crunch, the customer requested the company for postponement in delivery schedule, withhold the delivery of finished goods products and suspend the production of remaining items . The details of customer balance and the goods held by the company as work in progress and finished goods as on 31.03.2008 are given below: (i) (ii) (iii) Debtors balance Rs. 60 Lakhs Finished goods Rs. 140 Lakhs (WIP) Rs. 95 Lakhs. The petition for winding up against the customer has been filed during 2007-08 by A Ltd. Auditors of A Ltd. Have qualified the accounts stating non provision of Rs. 295 lakhs included in debtors, finished goods and work in progress.
Solution As per AS 2 Inventory should be valued at lower of cost and net realisable value. In this case, the net realisable value of the inventory cannot be readily available as there is no ready market for the specific order inventory Since the company has filed a winding up petition against the customer, there is sufficient evidence that realisable value of the specific order will be negligible. As regards debtors of Rs. 60 lakhs, there is sufficient evidence of non realisation. Hence, qualification by auditors appears to be in order.
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AS 3 CASH FLOW STATEMENTS

- Arjun Dhanush (darjun@kpmg.com)
Cash flow statement reflects historical changes in the cash and cash equivalents of an enterprise by classifying the inflows and outflows of cash and cash equivalents during a period into operating (principal revenue-producing activities), investing (acquisition and disposal of long-term assets and other investments) and financing activities (activities that result in changes in the size and composition of owners capital). Thus, helps assess the ability of an enterprise to generate cash flows and make appropriate estimates for the future. Cash equivalents include short term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value. This standard became mandatory to all non-SMCs in case of corporate entities and only to Level I entities in case of non-corporate entities. CASH FLOW STATEMENT OF.. FOR.. Cash flow from operating activities* Cash flow from investing activities@ Cash flow from financing activities$ Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period Rs. XXX XXX XXX XXX XXX XXX
*OPERATING ACTIVITIES Operating activity are the principal revenue-producing activity that are not investing or financing activities. They help determine the ability of an entity to maintain its operating capability, to pay dividends, to repay loans and to make new investments without recourse to external source of financing. Enterprises should represent cash flow from operating activities using either direct method (whereby major classes of gross cash receipts and gross cash payments are disclosed) or indirect method (whereby net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows). E.g, cash receipts from the sale of goods and the rendering of services, cash payments to suppliers for goods and services, cash receipts from royalties, fees, commissions and other revenue, cash payments or refunds of income taxes (unless they can be specifically identified with financing and investing activities). Presentation Direct Method Cash sales Collection from Customers Cash payment to suppliers
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Rs. XXX XXX XXX
Indirect Method Net profit before taxation and extraordinary items ADJUSTMENTS (non-cash and non-operating
Rs. XXX
Cash payment to employees Cash from operations Income taxes paid Cash flow before extraordinary items Extraordinary item Net cash from operating Activities
XXX XXX XXX XXX XXX XXX
items) Depreciation Forex exchange loss Interest income Dividend Income Interest Expense Operating profit before working capital changes Increase in sundry debtors Decrease in inventories Decrease in sundry creditors Cash generated from operations Income taxes paid Cash flow before extraordinary items Extraordinary item Net cash from operating activities
XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
@INVESTING
ACTIVITIES
Acquisition and disposal of long term assets and other investments not included in cash equivalents are reflected in investing activities. These help portray the extent to which an entity incurs expenditure towards resources that intend to generate future income and cash flows. E.g., cash receipts from disposal of fixed assets or payments from acquisition of fixed assets (including intangibles), cash payments to acquire shares, warrants or debt instruments of other enterprises and interests in joint ventures
$FINANCING
ACTIVITIES
These activities result in changes in the size and composition of owners capital and borrowings of the enterprise. E.g., cash proceeds from issuing shares, loans, notes, bonds, and other short or long-term borrowings or other similar instruments. SPECIFIC CASES Foreign Currency cash flows should be recorded in the enterprises reporting currency by applying the exchange rate applicable on the date of cash flow. However, unrealized foreign exchange gains and loses resulting from fluctuations in forex rates are not cash flows. The effect of such change in exchange rates on foreign currency held as cash and cash equivalents should be reported separately forming part of the reconciliation of the changes in cash and cash equivalents. Taxes on income should be classified as cash flow from operating activities and separately disclosed unless the same can be identified directly with any financing or investing activity. Extraordinary items are to be classified either as operating, financing or investing as appropriate and separately disclose to enable users to understand their nature and effect on the present and future cash flows of the enterprise.
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Cash flows from interest and dividends received and paid should each be disclosed separately. Cash flows arising from interest paid should be classified as cash flows from financing activities while interest and dividends received should be classified as cash flows from investing activities. Dividends paid should be classified as cash flows from financing activities (Note: Cash flows arising from interest paid and interest and dividends received in the case of a financial enterprise should be classified as cash flows arising from operating activities). Investment in an associate or a subsidiary or a joint venture, the reporting is restricted generally to the cash flows between itself and the investee/joint venture, for example, cash flows relating to dividends and advances. Acquisitions and from disposals of subsidiaries or other business units Aggregate cash flows arising from such activities during the period should be presented separately and classified as investing activities reflecting: (a) The total purchase or disposal consideration; and (b) The portion of the purchase or disposal consideration discharged by means of cash and cash equivalents. This helps to distinguish those cash flows from other regular cash flows. The cash flow effects of disposals are not deducted from those of acquisitions. Non-cash transactions Certain investing and financing activities although capable of affecting the capital and asset structure of a company does not however, impact its current cash flows. Since these non-cash items do not involve cash flows in the current period, they are specifically excluded from the cash flow statement in order to ensure consistency with the objective of cash flow statement. E.g, (a) The acquisition of assets by assuming directly related liabilities; (b) The acquisition of an enterprise by means of issue of shares; and (c) The conversion of debt to equity. ADVANTAGES: Enables users to evaluate changes in net assets of an enterprise, its financial structure (including its liquidity and solvency). Cash flow information is useful in appraising the ability of the enterprise to generate cash and cash equivalents and enables users to develop models to assess and compare the present value of the future cash flows of different enterprises. It also helps users assess an enterprises ability to affect the amounts and timing of cash flows in order to adapt to changing circumstances and opportunities. Enhances comparability in reporting of operating performance of different enterprises, as it eliminates the effects of using different accounting treatments for the same transactions and events, Historical cash flow information is often used as an indicator of the amount, timing and certainty of future cash flows. It is also useful in checking the accuracy of past assessments of future cash flows and in examining the relationship between profitability and net cash flow and the impact of changing prices.
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DISCLOSURE: Cash and cash equivalents Reconciliation of amount in its cash flow with equivalent items The enterprise should also disclose, together with a commentary by management, the amount of significant cash and cash equivalent balances held by the enterprise that are not available for use by it.
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AS 4 CONTINGENCY AND EVENTS OCCURRING AFTER THE BALANCE SHEET DATE

- Mythili Venkatesh (myth_zest@yahoo.com)
Contents of the Standard:
The Standard on Contingencies and Events Occurring After Balance Sheet Date was originally issued on November 1982 and revised Standard came into effect from April 1, 1995. The Standard covers two distinct and independent aspects, Contingencies Events occurring after Balance Sheet date The provisions of this Standard to the extent it deals with treatment of Contingencies stand withdrawn effective from April 1, 2004. The same is to be dealt with as per AS 29 Provisions, Contingent Liabilities and Contingent Assets w. e. f. April 1, 2004. Therefore AS 4 deals with treatment of Events Occurring after Balance Sheet date in Financial Statements. Events Occurring after Balance Sheet date are those significant post balance sheet events both favourable and unfavourable that occur between the Balance Sheet date and the date on which Financial Statements are approved. These events could be broadly classified into Adjusting events and Non-Adjusting events. Adjusting events are those events which necessitate adjustment of assets and liabilities as on balance sheet date. Adjustment could be made when any of the following three conditions are fulfilled,

Additional information materially affecting the determination of amounts in Balance Sheet is found available. The fundamental accounting assumption of Going Concern is affected. Due to statutory requirements and special nature events.
And Non-Adjusting events are the other events whose financial impact requires disclosure of the fact. Disclosure shall be made when there is an occurrence of,

Events that do not relate to conditions existing at the balance sheet date Events that do not affect the figures stated in the Financial Statements Events that representing material changes and commitments affecting the financial position of enterprise.
Disclosure:
Events occurring after Balance Sheet date that represent material changes and commitments affecting the Financial Statements of the enterprise, together with nature of the event and an estimate of the financial effect or a statement that such an estimate cannot be made to be disclosed in the Directors Report.
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AS 5 - NET PROFIT OR LOSS FOR THE PERIOD, PRIOR PERIOD ITEMS & CHANGES IN ACCOUNTING POLICIES
- Mythili Venkatesh (myth_zest@yahoo.com)
Contents of the Standard: The Standard on Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies was originally issued on November 1982 and the revised Standard came into effect from April 1, 1997. The Standard covers four distinct and independent segments, Net profit or loss for the period Prior period items Changes in accounting estimates Changes in accounting policies Net Profit or loss for the Period To determine the appropriate net profit or loss for the period all the income and expense pertaining to that period are to be recognized in the Profit and Loss statement. The net profit or loss shall comprise of profit or loss from ordinary activities, extraordinary items, prior period items, changes in accounting policies and accounting estimates. Activities of significant size, nature, or incidence are to be disclosed separately. Ordinary activities are those activities which form part of day to day business and related activities. Extraordinary items are those which arise from events and transactions which are clearly distinct from those of ordinary activities and not expected to recur frequently or regularly. Prior Period Items Prior period items are those which arise in current period as the result of errors and omissions in preparation of Financials of one or more prior periods. Prior period items include errors and omissions and exclude changes in accounting estimates, changes with retrospective effect etc. Coverage under prior period items does not include corrections of accounting estimates made in previous years. Changes in Accounting Estimates: Accounting estimate is appropriation of an amount of an item in the absence of proper means of measurement. Subject to adequate skill and care being exercised, quantifying an amount on an estimated basis is an essential part of process of preparation of financials. This exercise involves judgement. It is undertaken in a manner as would not undermine the reliability of financials. Changes in Accounting Policies: Accounting Policies refers to specific accounting principles and methods of applying those principles and adopted by an enterprise in the preparation and presentation of Financials. For the purpose of compliance with Statue, compliance with Accounting Standards and for appropriate presentation of Financial Statements
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accounting policies can be changed. Any new adoptions of accounting policies for events and transactions that differ in substance from previously occurring events or transactions do not result in change in accounting policies. Also, new policies developed for those transactions which did not occur previously do not result in change in accounting policies. Disclosure: Items and expense falling under ordinary activities should be disclosed separately in all cases, keeping the materiality aspect in view, which mean the size, nature and its incidence. This would be helpful in better understanding of the financials and also for making future projections. Extraordinary Items should be disclosed in income statement in a manner that, its impact on current profit or loss can be perceived. Prior Period Items are disclosed separately in a manner that the impact of item on current year profit is perceived. Disclosed requirements of Changes in accounting estimates are the nature and amount of change in the estimate with its impact on later periods quantifying the impact where determinable. Any material change in accounting policy that materially impacts on the financial position, performance or cash flow, should be disclosed that the adjustments from such a change is clearly brought out. Not only the changes which affect the current year but also the changes which affect the later periods need to be disclosed if material. And if quantification of the effect of change is not possible the fact of change is to be disclosed.
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AS 6 DEPRECIATION ACCOUNTING
- Rashida Siamwala (rashida.siamwala@yahoo.com)
INTRODUCTION In common parlance depreciation can be viewed as A process by which a company allocates an asset's cost over the duration of its useful life. Each time a company prepares its financial statements, it records a depreciation expense to allocate a portion of the cost of the buildings, machines or equipment it has purchased to the current fiscal year. The purpose of recording depreciation as an expense is to spread the initial price of the asset over its useful life. Different accounting policies for depreciation are adopted by different enterprises. Disclosure of accounting policies for depreciation followed by an enterprise is necessary to appreciate the view presented in the financial statements of the enterprise. BRIEF BACKGROUND ON AS 6 DEPRECIATION ACCOUNTING Accounting Standard (AS) 6, Depreciation Accounting, was issued by the Institute of Chartered Accountants of India in November 1982. Subsequently, in the context of insertion of Schedule XIV in the Companies Act in 1988, the Institute brought out a Guidance Note on Accounting for Depreciation in Companies which came into effect in respect of accounting periods commencing on or after 1st April, 1989. Council of the Institute at its 168th meeting, held on May 26-29, 1994, decided to bring AS 6 in line with the Guidance Note which deferred from the AS 6 in respect to (a) change in the method of depreciation, and (b) change in the rates of depreciation. AS 6 is mandatory in respect of accounts for periods commencing on or after 1.4.1995. LIST OF DEPRECIABLE ASSETS TO WHICH AS 6 DOES NOT APPLY AS 6 deals with Depreciation Accounting and applies to all depreciable assets, except the following items to which special considerations apply(i) forests, plantations and similar regenerative natural resources; (ii) wasting assets including expenditure on the exploration for and extraction of minerals, oils, natural gas and similar non-regenerative resources; (iii) expenditure on research and development; (iv) goodwill; (v) live stock. This statement also does not apply to land unless it has a limited useful life for the enterprise.
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PROCESS OF DEPRECIATION ACCOUNTING
DETERMINATIO N OF DEPRECIABLE ASSET AND RESIDUAL
METHOD OF COMPUTING AND ALLOCATING DEPRECIATION
DISCLOSURE REQUIREMENTS
TERMINOLOGIES DEFINED AS PER AS 6 Before going into the accounting aspects of depreciation let us familiarize with certain terms for better understanding. DEPRECIATION Depreciation is a measure of - the wearing out, - consumption or other - loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes. Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. Depreciation includes amortisation of assets whose useful life is predetermined. DEPRECIABLE ASSETS Depreciable assets are assets which (i) are expected to be used during more than one accounting period; and (ii) have a limited useful life; and (iii) are held by an enterprise for use in the production or supply of goods and services, for rental to others, or for administrative purposes and not for the purpose of sale in the ordinary course of business. USEFUL LIFE Useful life is either (i) the period over which a depreciable asset is expected to be used by the enterprise; or (ii) the number of production or similar units expected to be obtained from the use of the asset by the enterprise. DEPRECIABLE AMOUNT Depreciable amount of a depreciable asset is its - historical cost, or other amount substituted for historical cost in the financial statements, - less the Estimated residual value
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RESIDUAL VALUE AND ITS DETERMINATION - It is the estimated value at the end of its useful life. - 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 residual value is likely to be significant, it is estimated at the time of acquisition/installation, or at the time of subsequent revaluation of the asset. - One of the bases for determining the residual value would be the realisable 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. FACTORS TO BE CONSIDERED WHILE ASSESSING AND CHARGING DEPRECIATION 1. Historical Cost or other amount substituted for the historical cost of the depreciable asset when the asset has been revalued. 2. Expected useful life of the depreciable asset and 3. Estimated residual value of the depreciable asset. METHODS OF COMPUTING AND ALLOCATING DEPRECIATION There are several methods like straight line method, reducing balance method, annuity method, sinking fund method, machine hour method, production units method, of allocating depreciation over the useful life of the assets. Those most commonly employed in industrial and commercial enterprises are the 1. Straight line method and 2. Reducing balance method. The management of a business selects the most appropriate method(s) 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. In respect of depreciable assets which do not have material value, depreciation is often allocated fully in the accounting period in which they are acquired. Example A ltd purchased an existing bottling unit. The method of charging depreciation on 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 con acquired unit, in the method followed earlier by them and which was not consistent with their own method. The ICAIs Guidance Note on Accounting for Depreciation in Companies provide that a company may adopt or follow different methods of depreciation, for different types of assets, provided the same methods are consistently adopted every year in terms of Sec. 205(2) of the companies act. The company can continue in this case to follow the previous method of charging depreciation for the acquired bottling unit, even if not in agreement with the other method presently followed in its other units. SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI 27
IMPACT OF RATES OF DEPRECIATION PROVIDED IN GOVERNING STATUE The statute governing an enterprise may provide the basis for computation of the depreciation. For example, the Companies Act, 1956 lays down the rates of depreciation in respect of various assets. The impact can be analyzed as under Management's estimate of useful life is Computation of Depreciation Shorter than prescribed under Statute At a higher rate, i.e. as estimated by Management Equal to those prescribed under Statute At the rates prescribed under the Statute Higher than prescribed under Statute At the rates prescribed under the Statute. [Lower rates can be adopted only if allowed under law] Example XYZ Ltd has set up its main plant on coastal land. In view of the corrosive climate the company felt that its machine life was reducing faster. Can the company charge a higher rate of depreciation? The company can charge depreciation based on its useful life of machinery, provided that such estimate is not less than the rate prescribed by the Companies Act, for that class of assets.
CHANGE IN METHOD OF PROVIDING DEPRECIATION 1. The method of depreciation should be applied consistently to facilitate comparability of the results of operations of the enterprise from period to period. 2. The method of depreciation can be changed only for
or Compliance with Statutory Requirement
or Compliance with an Accounting Standard
Consideration that the change would result in a more appropriate preparation or presentation of the Financial Statements of the enterprise.
3. Change in method of depreciation is always applied with retrospective effect. Hence, depreciation is recalculated in accordance with the new
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ACCOUNTING FOR DEPRECIATION AMOUNT WHEN THERE IS CHANGE IN HISTORICAL COST, REVISION IN ESTIMATED USEFUL LIFE OF AN ASSET AND WHEN ASSETS ARE REVALUED TREATMENT OF DEPRECIATION WHEN
There is change in Historical Cost The depreciation on revised unamortized depreciable amount is provided prospectively over the residual useful life.
Revision in estimated useful life of an asset The unamortized depreciable amount should be charged over the revised remaining useful life.
Assets are revalued
The provision of depreciation should be based on the Revalued amount and on estimate useful life.
DISCLOSURE REQUIREMENTS Matters to be disclosed 1. Effect on any change in method of depreciation. 2. Amount of Depreciation in case of Revaluation of Depreciable Assets, if Revaluation has a material effect on the amount of depreciation. 3. Net Surplus or Deficiency (if material), in case if any depreciable asset is disposed of, discarded, demolished or destroyed. 4. Historical costs or other amount substituted for Historical Cost of each class of depreciable asset, 5.Total Depreciation for the period for each class of asset and 6.Related Accumulated Depreciation 7. Depreciation method used, and 8.Depreciation rates or the useful lives of the assets, if they are different from the principal rates specified in the statue governing the enterprise. Place of Disclosure P & L and Notes
P & L Notes
P&L
P&L and B/Sheet
P&L, B/Sheet and Notes
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FEW EXPERT ADVISORY COMMITTEE (EAC) OPINION IN AS 6 1. Individual items below ` 5,000/- but total if such items are material When the total of such items is less than 10% of the total actual cost of Plant and Machinery, 100% depreciation (full write off of low value items) is permissible. Otherwise the rate as per Schedule XIV should be adopted. The accounting policy in this regard should be disclosed under AS - 1 2. Depreciation under the Units of Production Method Under Circular 12/2003 dated 21.02.2003, the dept. of Company Affairs, has clarified that WDV/SLM may be used. Companies should not use the units of production method. 3. Buildings, etc. constructed on leasehold land Useful life of assets construed on leasehold land = period of lease of the land, including the expected period of extension which is reasonably certain at the inception of the lease. The depreciation rate should be worked out on the above basis. If rate so worked out is lower than specified in Schedule XIV, Schedule XIV rates should be adopted. 4. Surplus from the disposal of rubber trees should be recognized in P&L a/c and rubber plantations should be amortised on a systematic basis. COMPARITIVE POSITION OF IFRS, US GAAP & INDIAN GAAP
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IFRS Depreciation rates are based on the useful economic lives of the assets (i.e useful lives are prescribed and depreciation rates are to be derived from there)
US GAAP Same as IFRS requirements
INDIAN GAAP AS 6 (Revised) requires depreciation to be allocated over an asset's useful life. Lives of assets are not prescribed by the Companies Act but can be derived from depreciation rates. Where applicable, higher depreciation based on useful life of the asset is required to be provided. upward Additional depreciation on revaluation of fixed assets (in case of upward revaluation) can be credited to the profit and loss account from revaluation reserve. Estimate of residual value are not reviewed. So far as useful life is concerned the same can be reviewed but it is not mandatory to do so.
Additional depreciation on revalued assets can be credited to retained profits from revaluation Reserve
Not Applicable revaluation is not permitted)
(as
Residual value and useful life of the No such guidance is available asset to be reviewed atleast at each financial year end. Changes to be Accounted for as change in an accounting estimate Variety if depreciation methods Similar to IFRS Requirements permitted such as SLM, WDM, Units of production method, etc.
Only SLM and WDV are permitted
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AS 7 CONSTRUCTION CONTRACTS
- S. Ruban (ruban.s@mca.co.in)
An overview: Prescribes PRINCIPLES of Accounting for Construction Contracts Principles of REVENUE RECOGNITION by the contractors Applies to all enterprises in respect of construction contracts entered Construction contracts generally long term to complete. Hence it prescribes revenue recognition principles. Construction Contract It is a contract in which a Contractor agrees to build some asset for his customer. Contractors Profit = Contract Price Construction cost In general,
Contracts
Fixed price contracts
Cost Plus Contracts
Combining and Segmenting Construction Contracts: The requirements of this Statement are usually applied separately to each construction contract. However, in certain circumstances, it is necessary to apply the statement to the separately identifiable components of a single contract or to a group of contracts together in order to reflect the substance of a contract or a group of contracts. When it is treated as a Separate Construction Contract When separate proposals have been submitted for each asset; Separate negotiation for each asset The cost and revenues of each asset can be identified.
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When it is treated as a Single Construction Contract The group of contracts is negotiated as a single package; The contracts are so closely interrelated The contracts are performed concurrently or in a continuous sequence. Can revenue be treated as turnover? The issue is whether the revenue so recognised in the financial statements of contractors as per the requirements of AS 7 can be considered as 'turnover'. The amount of contract revenue recognised as revenue in the statement of profit and loss as per the requirements of AS 7 should be considered as 'turnover'.
Paragraphs stated in AS 7 Para 10 Contract revenue should comprise of the following: Initial amount of revenue agreed in the contract & Variations in contract work, claims and incentive payments i. To the extent that it is probable that they will result in revenue & ii. They are capable of being reliably measured. Para 11 Contract revenue is measured at the consideration received or receivable. The amount of contract revenue may increase or decrease from one period to next. Para 12 A variation is an instruction by the customer for a change in the scope of the work to be performed under the contract. It may lead to an increase or decrease in contract revenue. Such changes may be in the nature of change in duration of contract or change in specifications or designs. A variation is included in contract revenue only when it is probable that the customer will approve the variation and the amount of revenue arising from the variation. & The amount of revenue can be reliably established. Para 13 A claim is an amount that the contractor seeks to collect from the customer or another party as reimbursement for costs not included in the contract price. Claims may arise where delays are caused by customer action, or errors in specification or design and disputed variations in contract work. As measurement of amounts of revenue arising from claims is subject to a high level of uncertainty and depends on outcome of negotiations. Hence these are included in contract revenue only when : Negotiations have reached advanced stage such that it is probable that the customer will accept the claim & that this claim can be reliably estimated. Para 14 Incentive payments are additional amounts payable to the contractor if specified performance standards are met or exceeded. Incentive payments are included in the contract revenue when: the contract is sufficiently advanced that it is probable that the specified performance standards will be met or exceeded &
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the amount of incentive payment can be measured reliably.
Contract Costs: Para 15 Contract costs should comprise: Costs that relate directly to the specific contract Costs that are attributable to the contract activity in general and can be allocated to the contract & Such other costs that are specifically chargeable to the customer under the terms of the contract. Para 16 Costs that relate directly to a specific contract include: (a) site labour costs, including site supervision; (b) costs of materials used in construction; (c) depreciation of plant and equipment used on the contract; (d) costs of moving plant, equipment and materials to and from the contract site; (e) costs of hiring plant and equipment; (f) costs of design and technical assistance that is directly related to the contract; (g) the estimated costs of rectification and guarantee work, including expected warranty costs; and (h) claims from third parties. These costs may be reduced by any incidental income that is not included in contract revenue, for example income from the sale of surplus materials and the disposal of plant and equipment at the end of the contract. Para 17 Costs may be attributable to contract activity in general and can be allocated to specific contracts include: Insurance Cost of design and technical assistance that is not directly related to the specific contract. Construction overheads.
Such costs to be allocated using systematic and rational methods which are applied consistently to all costs having similar characteristics. This allocation is based on normal level of construction activity. Such costs that may be allocated include borrowing costs as specified in AS 16 also.
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Para 19 Costs that cannot be attributed to the contract activity or cannot be allocated to the contract are excluded from the costs of the construction contract. Such costs include: general administration costs for which reimbursement is not specified in the contract; Selling costs, R&D costs for which contract does not provide of reimbursement. Depn. Of idle plant and equipment that is not used on a particular contract.
Para 20 Contract costs include costs attributable to the contract from the date of securing the contract to the final completion of the contract. However, costs that relate directly to a contract & which are incurred in securing the contract are also considered as contract costs if The costs can be separately identified and measured reliably. & It is probable that the contract will be obtained. Where the above given costs are recognized in the period in which they are incurred, they are not included in contract costs when the contract is obtained in a subsequent period. Paragraphs 21 and 31 of AS 7 provide as follows: "21. When the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract should be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date. An expected loss on the construction contract should be recognised as an expense immediately in accordance with paragraph 35." "31. When the outcome of a construction contract cannot be estimated reliably: a. revenue should be recognised only to the extent of contract costs incurred of which recovery is probable; and b. contract costs should be recognised as an expense in the period in which they are incurred.
An expected loss on the construction contract should be recognised as an expense immediately in accordance with paragraph 35." From the above, it may be noted that the recognition of revenue as per AS 7 may be inclusive of profit (as per paragraph 21 reproduced above) or exclusive of profit (as per paragraph 31 above) depending on whether the outcome of the construction contract can be estimated reliably or not. When the outcome of the construction contract can be estimated reliably, the revenue is recognised inclusive of profit and when the same cannot be estimated reliably, it is recognised exclusive of profit. However, in either case it is considered as revenue as per AS 7. 'Revenue' is a wider term. For example, within the meaning of AS 9, Revenue Recognition, the term 'revenue' includes revenue from sales transactions, rendering of services and from the use by others of enterprise resources yielding interest, royalties and dividends. The term 'turnover' is used in relation to the source of
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revenue that arises from the principal revenue generating activity of an enterprise. In case of a contractor, the construction activity is its principal revenue generating activity. Hence, the revenue recognised in the statement of profit and loss of a contractor in accordance with the principles laid down in AS 7, by whatever nomenclature described Court Decisions: Revised AS 7 Construction Contract is applicable to only contractors and not to builders and real estate consultants Court : Mumbai bench of the Income-tax Appellate Tribunal Brief : Revised Accounting Standard 7 Construction Contract is applicable to onlycontractors and not to builders and real estate consultants. Accordingly, the Project CompletionMethod consistently followed by the taxpayer for recognising revenue in the books of accounts cannot be regarded as an unreasonable. Recently, the Mumbai bench of the Income-tax Appellate Tribunal (the Tribunal) has held that the Accounting Standard (AS) 7 Construction Contract (revised) issued by the Institute of Chartered Accountants of India(ICAI) is applicable only to contractors and not to builders and real estate developers. Accordingly, the Project Completion Method followed by the taxpayer for recognising revenue in the books of accounts cannot be regarded as an unreasonable. Further, the tax department cannot change the method of accounting as any change would be a tax neutral. Citation : Unique Enterprises v. ITO [2010-TIOL-737-ITAT-MUM] (Judgment date: 20 August 2010, Assessment Year: 2005-06) Judgement : Background:- The ICAI issued Accounting Standard (AS) 7 Construction Contract in the year 1983 which was later on revised in the year 2002. The AS 7 laid down the principles of accounting for construction contracts in the financial statements of the Contractors. As per the revised AS 7 the accounting was to be done as per percentage/progressive completion method. In response to a query rose, on applicability of revised AS 7 to a real estate developer, before the Expert Advisory Committee (EAC) formed by the ICAI, the EAC observed that the pre revised AS 7 specifically mentions about its applicability to enterprises undertaking construction activities on their own which would include real estate developer. However, the revised AS 7 is applicable only to Contractors. Facts of the Case The taxpayer was engaged in the business of redevelopment of tenanted property. The taxpayer was following the Project Completion Method of accounting since its inception in the assessment year 1995-96 and the income of the project was offered for taxation in the year of completion of the project. The expenditures incurred on a project were accumulated under the head construction work-in-progress and in the final year of completion it was taken as expenditure. For the Assessment Year 2005-06, the taxpayer computes its taxable income following Project Completion Method. However, the Assessing Officer (AO) recomputed income based on the percentage/progressive completion method prescribed by AS 7. The Commissioner of Income-tax (Appeals) [CIT(A)] uphold the AOs action and held that the revised AS 7 was applicable to taxpayer.
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Taxpayers Contentions The taxpayer relied on the opinion of the EAC and contended that revised AS 7 issued in the year 2002 was not applicable to the taxpayer since it does not apply to builders and real estate developers. Further, the same method of accounting followed in earlier years had been accepted by the tax department. The taxpayer contended that it has been consistently following the Project Completion Method of accounting since its inception and has accordingly offered to tax the entire income in the next assessment year i.e. Assessment Year 2006-07. Further, before AS 7 was issued by the ICAI, the Mumbai Tribunal in the case of Champion Construction Company v. ITO [1983] 5 ITD 495 (Mum) had accepted the Project Completion Method as an appropriate method of computing income. The taxpayer also relied on the Guidance Note on Recognition of Revenue by Real Estate Developers issued by ICAI in 2006. The taxpayer contended that Guidance Note read with the Agreement of Sale, executed by the taxpayer, it is clear that the risks and the rewards of ownership have not been transferred to the buyer and it retains effective control of the property. The reliance was also placed on the decision of the Bangalore Tribunal in the case of Prestige Estate Projects (P) Ltd. v. DCIT [2010] 33 DTR 514 (Bang). Tax departments Contentions The tax department contended that AS 7 was applicable to builders and contractors and revenue recognition has to be done as per AS 7 read with AS 9. As per the Guidance Note on Recognition of Revenue by Real Estate Developers issued by the ICAI the taxpayer is bound to declare income during the year since the Agreements to sale entered by the taxpayer was partly complete and the risks was already passed. Tribunals ruling The Tribunal observed that the pre revised AS 7 issued by ICAI in the year 1983, specifically included enterprises undertaking construction activities on their own and as such to builders and real estate developers. However, such specific inclusion is missing in the AS 7 revised in the year 2002. The Tribunal also went through the opinion given by the EAC on the applicability of AS 7 and held that the revised AS 7 does not apply to builders and real estate developers. The method followed by the taxpayer cannot be called as an unreasonable method and any change in the method is revenue neutral. Further, the tax department cannot change the method of accounting which was accepted by it over the years. The Tribunal observed that the Bangalore Tribunal in the case of Prestige Estate Projects (P) Ltd. held that the Government has not specified AS 7 in Section 145 of the Act and the taxpayer developer had been regularly, under a bonafide belief, employing Project Completion Method which is an accepted method of accounting. Accordingly, the AO cannot reject the accounts of the taxpayer under Section 145(3) of the Act. The Tribunal relied on the decision of the Mumbai Tribunal in the case of Champion Construction Co. and held that it would be appropriate to offer income tax in the year in which 80 percent of the construction was completed. Since the taxpayer admittedly completed only 53.95 percent of the construction it cannot be said SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI 37
that the taxpayer has substantially completed the project so as to recognize income under the Project Completion Method of accounting. The Tribunal also relied on the decision of the Bombay High Court in the case of CIT v. Tata Iron & Steel Co. Ltd. where it was held that the method of accounting followed by the taxpayer company cannot be said to be unreasonable, and that in such a case, even if a better method could be visualised, the method consistently followed should be accepted. Accordingly, the Tribunal allowed the taxpayers contention to follow Project Completion Method and recognise the revenue accordingly in the year of project completion. The Tribunal refrained from deciding as to whether any revenue has to be recognised in the relevant assessment year based on the Guidance Note issued by ICAI considering the agreement to sale entered into by the taxpayer. Cut-off date for capitalisation of construction cost A. Facts of the Case 1. A company incorporated under section 25 of the Companies Act, 1956, organises fairs/exhibitions in order to achieve its objective of promoting Indias trade. During the year 1998-99, the company entrusted the work of construction of a new hall to CPWD which was completed in all respects in November, 1998, including structural work and electrical installations. 2. As the hall was ready for commercial use, the company started letting out the same from November, 1998 which generated rental income of Rs. 169.33 lakh and Rs. 419.64 lakh in the years 1998-99 and 1999-2000 respectively. 3. As the hall was put to commercial use from November, 1998, the expenditure of Rs. 9.97 crore incurred on the construction of the hall was capitalised with effect from November, 1998, to depict true and fair view of the state of affairs of the company. The formal completion certificate of the hall is, however, still awaited from CPWD. 4. The government auditors are of the view that since the completion certificate of the hall is awaited from CPWD the expenditure incurred on the construction of the hall should be shown as Capital Work-in-Progress in the annual accounts of the company after deducting the income generated from the project during construction period. Accordingly, the rental income of Rs. 588.97 lakh from the letting out of the hall upto 31.3.2000 should be deducted from the construction cost of the project. 5. According to the querist, the audit observation is based on the Guidance Note on Treatment of Expenditure during Construction Period issued by the Institute of Chartered Accountants of India. The companys contention is that the hall was ready for commercial use in November, 1998 and that issuance of completion certificate by CPWD has no relevance to the actual completion of work because such certificates are issued only after rectification of all the defects by the contractors and settlement of final bills by CPWD. As per the querist, the said Guidance Note referred to by the government auditors deals with treatment of income from miscellaneous sources generated during construction period, whereas, in the case of the company, the purpose of the construction of the hall was to generate rental income. Hence, the company took the view that the Guidance Note referred to above does not apply in the instant case.
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6. The government auditors, however, dropped the above observation from their report on the assurance that the matter shall be referred to the Institute of Chartered Accountant of India for expert advise. B. Queries 7. The querist has sought the opinion of the Expert Advisory Committee as to: (a) whether the cost of construction of the hall less the rental income received in the intervening period should be capitalised on formal receipt of certificate of completion from CPWD and depreciation charged thereafter, or (b) whether depreciation should be charged in the accounts from the date the hall has been put to commercial use in November, 1998. C. Points Considered by the Committee 8. In this context, the Committee also notes that paragraph 20 of Accounting Standard (AS) 10, Accounting for Fixed Assets, provides that the cost of a fixed asset should comprise its purchase price and any attributable cost of bringing the asset to its working condition for its intended use. The Committee also notes that the intention of the construction of the hall was the generation of rental income from letting out of the same. Therefore, the Committee is of the view that the hall should be construed as ready for its intended use when it is ready to generate rental income. Consequently, the cut-off date for capitalisation of expenditure should be the date when the hall is ready for its intended use and any expenditure incurred or income generated after the cut-off date should be treated as of revenue nature. D. Opinion On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 7: (a) The cost of construction of the hall should be capitalised when the hall is ready for its intended use of letting out. The receipt of certificate of completion from CPWD is a matter of procedural formality and, will have no bearing on the capitalisation of the hall in the books of account. Accordingly, the rental income earned by the company after the cut-off date as arrived at as per paragraph 8 above would not be deducted in arriving at the construction cost of the project. (b) The depreciation should be charged from the date the hall was put to commercial use, that is from November, 1998. Opinion finalised by the Committee on 17.1.2001. Treatment of retention money in the financial statements of a contractee company is setting up an integrated iron and steel plant. The entire work for setting up the plant has been divided into several packages which have been awarded to different contractors for execution. 2. The terms of payment in various contracts are as below: (i) For civil contracts (a) 10% of total contract price as mobilisation advance shall be paid after signing of the contract, and subject to submission of pre-receipted invoice and bank guarantee. (b) 80% of the total value of work executed shall be paid on monthly pro-rata basis subject to satisfactory progress of work and on certification of work by the purchaser (i.e., the company)/its consultants and on submission of certain documents. Total value of works executed shall be arrived based on actual quantity of
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works executed as certified by the purchaser/consultant and unit rates applicable for such items of work. (c) 10% of the contract price shall be paid on issue of completion certificate by the purchaser against submission of pre-receipted invoice and bank guarantee for equal amount valid till the expiry of maintenance and guarantee period. (ii) For supply contracts (a) 10% of ex-works price towards supplies shall be paid as advance after signing of the contract. Payment shall be released only after submission of a bank guarantee for equal amount valid till sixty days after the completion of supplies and having submitted the bank guarantee towards security deposit. (b) 75% of the ex-works price of the supplies and 100% of taxes, duties and freight on pro-rata basis subject to submission of requisite documents as per despatch instructions. (c) 5% of the ex-works price after issue of preliminary acceptance certificate. (d) 5% of the ex-works price after issue of commissioning certificate and submission of a fresh bank guarantee for 5% of total contract price towards guarantee/warranty valid till the expiry of guarantee/warranty period. (e) 5% of the ex-works price after issue of final acceptance certificate. (iii) For erection and fabrication contracts (a) 5% of the contract price as advance against submission of bank guarantee for equal amount and another bank guarantee towards security deposit for 10% of the total contract price. Both the bank guarantees will be valid till sixty days after issue of commissioning certificate. (b) 5% of the contract price after mobilisation of men and material handling equipment as approved by the purchaser/consultant to commence erection work at site and establishment of site office and stores. The payment shall be released on receipt of a bank guarantee for equal value valid till sixty days after issue of commissioning certificate. (c) 75% of the contract price on monthly pro-rata basis as per approved billing schedule subject to satisfactory progress of work as per milestones fixed and duly certified by purchaser/consultant on production of requisite documents. (d) 5% of the contract price after issue of preliminary acceptance certificate. (e) 5% of the contract price on issue of commissioning certificate and submission of a performance bank guarantee for 5% of the total contract price towards guarantee/warranty valid till the expiry of guarantee/warranty period. (f) 5% of the contract price upon issue of final acceptance certificate. 3. The querist has reproduced the companys accounting policy relating to capital work-in-progress which is as below: In accounting for the capital WIP, the portion that has been retained as per terms of contract is not accounted for till it becomes due for payment/release of amounts after completion of the job. 4. Keeping the above in view, the company accounts for capital work-in-progress in the following manner: (a) For civil works: 90% of the value of work completed and certified by the principal consultant is booked as capital WIP (being 10% towards adjustment of mobilisation advance and 80% towards progress payments). (b) For supply, and erection and fabrication contracts: 85% of the value of work completed or supply made as certified by the principal consultant is booked as capital WIP (being 10% towards adjustment of mobilisation advance and 75% towards progress payments). (c) The balance (10% or 15% of the contract price, as the case may be) is not accounted for till the issuance of preliminary acceptance certificate, commissioning certificate and final acceptance certificate as provided in the contract.
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Query: Applicability of Accounting Standard (AS) 7 to an unsold site. 1. A public sector undertaking, registered under the Companies Act, 1956, undertakes as a part of its activities, construction of properties and sells the same. Following is the Accounting Policy followed by the company for accounting of profits in construction contracts: Profit is recognised on percentage of completion method which is further reduced to 80% for keeping an appropriate allowance for future unforeseeable factors in cost and sale prices till the project is fully completed. Inclusion of indirect costs in the total contract cost A. Facts of the Case 1. A consultancy and engineering company engaged in design and project management activities in the petroleum sector undertakes work in the areas of petrochemicals, oil and natural gas, pipelines, ocean engineering, ports and harbours, power, metallurgy, cement, paper, etc. 2. According to the querist, during the course of audit of accounts for the year 1996-97, government auditors have expressed certain reservations with regard to non-provision of foreseeable losses and commented that the treatment adopted by the company is not in line with paragraph 13 of Accounting Standard (AS) 7, Accounting for Construction Contracts, read with paragraph 19 of the same Standard. 3. The accounting policy of the company for recognition of revenue is as below: I. Turnover Income from services rendered is accounted for: (a) in the case of cost-plus jobs, on the basis of amount billable under the contracts; (b) in the case of lumpsum contracts, as proportion of actual direct costs of the work to latest estimated total direct costs of the work or in proportion to work estimated to have been executed, whichever is less; and (c) in the case of contracts providing for a percentage fee on equipment/project cost, on the basis of physical progress as certified; and after adjusting the obligation towards guarantees, warranties and penalties etc., provided/under negotiation in the respective contracts. However, in regard to contracts where guarantees, warranties, penalties etc. are to the extent of 100% of the contract value, the same is restricted to the exposure of the company towards such contracts by way of performance bond/guarantees etc. II. Turnover/Work-in-Progress (1) No income is taken into account in respect of jobs for which: (a) the terms of remuneration receivable by the company have not been settled and/or scope of work has not been clearly defined and, therefore, it is not possible in the absence of settled terms to determine whether there is a profit or loss on such jobs. However, in cases where minimum undisputed terms have been agreed to by the clients, income has been accounted for on the basis of such undisputed terms though the final terms are still to be settled. (b) the terms have been agreed to at lumpsum basis but: (i) the physical progress is less than 25%; (ii) supply of equipment is not complete in case of works contracts. Costs of jobs as above are carried forward as work-in progress.
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(2) While determining the work-in-progress overheads incurred at head office and other offices are not considered. 4. According to the querist, as regards cost-plus jobs, the company recognises revenue as and when the expenditure is incurred. The invoices to the clients are raised broadly under the following heads: (i) payroll cost; (ii) out-of-pocket expenses; and (iii) fee. The overheads of the company are billed to the clients at a fixed percentage of the payroll cost. This percentage is worked out on the basis of previous years data and applied in the following year. As the payroll cost, out-of-pocket expenses, fee and overheads are recovered, there is no question of having any direct losses on these jobs since these are cost-plus jobs. 5. In respect of lumpsum contracts, the company raises its invoices on the clients on the basis of milestones stated in the contract. It recognises income on lumpsum jobs in the following manner: (i) No income is recognised when the progress of job is less than 25%. While determining the work-inprogress, overheads incurred at head office and other offices are not included in work-in-progress and are charged to the profit and loss account in the respective years. (ii) Income is recognised in the same proportion which the actual direct cost of the work done bears to the latest estimated total direct cost of the work, or in proportion to the work estimated to have been executed, whichever is less. For this purpose, the company draws revised cost estimates at the end of each financial year. 6. According to the querist, the government auditors have pointed out three cases in which, according to them, the company has not provided for the foreseeable losses to the extent of Rs. 267.39 lakhs. As per the querist, the auditors, in their report, have stated that paragraph 13 of AS 7, read with paragraph 19 of the same Standard, requires that the foreseeable losses on the entire contract should be provided for in the financial statements irrespective of the amount of work done and method of accounting followed. 7. According to the querist, the government auditors, while working out the losses, have taken into account the indirect costs also besides direct costs. This, according to the querist, is not correct in the context of the accounting policy followed by the company in respect of indirect costs, viz., to charge them off to the profit and loss account in the year of incurrence. The querists contention is that there are no foreseeable direct losses on the jobs based on revised direct cost estimates. B. Queries 8. The querist has sought the opinion of the Expert Advisory Committee on the following issues: (a) Whether the treatment adopted by the company in respect of exclusion of indirect costs in computing the total contract cost as explained above is as per the generally accepted accounting principles. (b) If the treatment adopted by the company is correct, whether any further disclosure in the accounting policy of the company is called for. (c) If the treatment adopted by the company is not correct, what is the correct manner of accounting for foreseeable losses or disclosure thereof.
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D. Opinion Based on the above, the Expert Advisory Committee is of the following opinion on queries raised in paragraph 8 above: (a) If the indirect costs under reference are of the nature described in paragraph 8.6 of AS 7, their non-inclusion in contract cost is not appropriate. On the other hand, if these costs are of the nature described in paragraph 8.7 of AS 7, they should not be included in contract cost (unless they are specifically attributable to a contract). (b) See (a) above. (c) The foreseeable losses should be provided for on the basis of the estimate of total contract cost including the indirect costs of the nature described in paragraph 8.6 of AS 7.
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AS 9 REVENUE RECOGNITION
- S. Harish (harishprems@gmail.com)
Introduction 1. This Statement deals with the bases for recognition of revenue in the statement of profit and loss of an enterprise. The Statement is concerned with the recognition of revenue arising in the course of the ordinary activities of the enterprise from the sale of goods, the rendering of services, and the use by others of enterprise resources yielding interest, royalties and dividends. 2. This Statement does not deal with the following aspects of revenue recognition to which special considerations apply: (i) Revenue arising from construction contracts; (ii) Revenue arising from hire-purchase, lease agreements; (iii) Revenue arising from government grants and other similar subsidies; (iv) Revenue of insurance companies arising from insurance contracts. 3. Examples of items not included within the definition of "revenue" for the purpose of this Statement are: (i) Realised gains resulting from the disposal of, and unrealised gains resulting from the holding of, non-current assets e.g. appreciation in the value of fixed assets; (ii) Unrealised holding gains resulting from the change in value of current assets, and the natural increases in herds and agricultural and forest products; (iii) Realised or unrealised gains resulting from changes in foreign exchange rates and adjustments arising on the translation of foreign currency financial statements; (iv) Realised gains resulting from the discharge of an obligation at less than its carrying amount; (v) Unrealised gains resulting from the restatement of the carrying amount of an obligation. Definitions
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4. The following terms are used in this Statement with the meanings specified: a) 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. Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them. In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other consideration. b) Completed service contract method is a method of accounting which recognises revenue in the statement of profit and loss only when the rendering of services under a contract is completed or substantially completed. c) Proportionate completion method is a method of accounting which recognises revenue in the statement of profit and loss proportionately with the degree of completion of services under a contract. Explanation 5. Revenue recognition is mainly concerned with the timing of recognition of revenue in the statement of profit and loss of an enterprise. The amount of revenue arising on a transaction is usually determined by agreement between the parties involved in the transaction. When uncertainties exist regarding the determination of the amount, or its associated costs, these uncertainties may influence the timing of revenue recognition. 6. Sale of Goods a) A key criterion for determining when to recognize revenue from a transaction involving the sale of goods is that the seller has transferred the property in the goods to the buyer for a consideration. The transfer of property in goods, in most cases, results in or coincides with the transfer of significant risks and rewards of ownership to the buyer. However, there may be situations where transfer of property in goods does not coincide with the transfer of significant risks and rewards of ownership. Revenue in such situations is recognised at the time of transfer of significant risks and rewards of ownership to the buyer. Such cases may arise where delivery has been delayed through the fault of either the buyer or the seller and the goods are at the risk of the party at fault as regards any loss which might not have occurred but for such fault. Further, sometimes the parties may agree that the risk will pass at a time different from the time when ownership passes. b) At certain stages in specific industries, such as when agricultural crops have been harvested or mineral ores have been extracted, performance may be substantially complete prior to the execution of the transaction generating revenue. In such cases when sale is assured under a forward contract or a government guarantee or where market exists and there is a negligible risk of failure to sell, the goods involved are often valued at net realisable value. Such amounts, while not revenue as defined in this Statement, are sometimes recognised in the statement of profit and loss and appropriately described. 7. Rendering of Services Revenue from service transactions is usually recognised as the service is performed, either by the proportionate completion method or by the completed service contract method. 45
(i) Proportionate completion methodPerformance consists of the execution of more than one act. Revenue is recognised proportionately by reference to the performance of each act. The revenue recognised under this method would be determined on the basis of contract value, associated costs, number of acts or other suitable basis. For practical purposes, when services are provided by an indeterminate number of acts over a specific period of time, revenue is recognised on a straight line basis over the specific period unless there is evidence that some other method better represents the pattern of performance. (ii) Completed service contract methodPerformance consists of the execution of a single act. Alternatively, services are performed in more than a single act, and the services yet to be performed are so significant in relation to the transaction taken as a whole that performance cannot be deemed to have been completed until the execution of those acts. The completed service contract method is relevant to these patterns of performance and accordingly revenue is recognised when the sole or final act takes place and the service becomes chargeable. 8. The Use by Others of Enterprise Resources Yielding Interest, Royalties and Dividends a) The use by others of such enterprise resources gives rise to: (i) interestcharges for the use of cash resources or amounts due to the enterprise; (ii) royaltiescharges for the use of such assets as know-how, patents, trade marks and copyrights; (iii) Dividendsrewards from the holding of investments in shares. b) Interest accrues, in most circumstances, on the time basis determined by the amount outstanding and the rate applicable. Usually, discount or premium on debt securities held is treated as though it were accruing over the period to maturity. c) Royalties accrue in accordance with the terms of the relevant agreement and are usually recognised on that basis unless, having regard to the substance of the transactions, it is more appropriate to recognise revenue on some other systematic and rational basis. d) Dividends from investments in shares are not recognised in the statement of profit and loss until a right to receive payment is established. e) When interest, royalties and dividends from foreign countries require exchange permission and uncertainty in remittance is anticipated, revenue recognition may need to be postponed. 9. Effect of Uncertainties on Revenue Recognition a) Recognition of revenue requires that revenue is measurable and that at the time of sale or the rendering of the service it would not be unreasonable to expect ultimate collection. b) 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
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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 installments. c) When the uncertainty relating to collectability arises subsequent to the time of sale or the rendering of the service, it is more appropriate to make a separate provision to reflect the uncertainty rather than to adjust the amount of revenue originally recorded. d) An essential criterion for the recognition of revenue is that the consideration receivable for the sale of goods, the rendering of services or from the use by others of enterprise resources is reasonably determinable. When such consideration is not determinable within reasonable limits, the recognition of revenue is postponed. e) When recognition of revenue is postponed due to the effect of uncertainties, it is considered as revenue of the period in which it is properly recognised. ACCOUNTING STANDARD 10. Revenue from sales or service transactions should be recognised when the requirements as to performance set out in paragraphs 11 and 12 are satisfied, provided that at the time of performance it is not unreasonable to expect ultimate collection. If at the time of raising of any claim it is unreasonable to expect ultimate collection, revenue recognition should be postponed. 11. In a transaction involving the sale of goods, performance should be regarded as being achieved when the following conditions have been fulfilled: (i) 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 the goods transferred to a degree usually associated with ownership; and (ii) no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods. 12. In a transaction involving the rendering of services, performance should be measured either under the completed service contract method or under the proportionate completion method, whichever relates the revenue to the work accomplished. Such performance should be regarded as being achieved when no significant uncertainty exists regarding the amount of the consideration that will be derived from rendering the service. 13. Revenue arising from the use by others of enterprise resources yielding interest, royalties and dividends should only be recognised when no significant uncertainty as to measurability or collectability exists. These revenues are recognised on the following bases: (i) Interest (ii) Royalties : on a time proportion basis taking into account the amount outstanding and the rate applicable. : on an accrual basis in accordance with 47
the terms of the relevant agreement. (iii) Dividends from : when the owner's right to receive investments in shares payment is established. Disclosure 14. In addition to the disclosures required by Accounting Standard 1 on 'Disclosure of Accounting Policies' (AS 1), an enterprise should also disclose the circumstances in which revenue recognition has been postponed pending the resolution of significant uncertainties. Illustrations A. Sale of Goods 1. Delivery is delayed at buyer's request and buyer takes title and accepts billing Revenue should be recognised notwithstanding that physical delivery has not been completed so long as there is every expectation that delivery will be made. However, the item must be on hand, identified and ready for delivery to the buyer at the time the sale is recognised rather than there being simply an intention to acquire or manufacture the goods in time for delivery. 2. Delivered subject to conditions (a) installation and inspection i.e. goods are sold subject to installation, inspection etc. Revenue should normally not be recognised until the customer accepts delivery and installation and inspection are complete. In some cases, however, the installation process may be so simple in nature that it may be appropriate to recognise the sale notwithstanding that installation is not yet completed (e.g. installation of a factory-tested television receiver normally only requires unpacking and connecting of power and antennae). (b) on approval Revenue should not be recognised until the goods have been formally accepted by the buyer or the buyer has done an act adopting the transaction or the time period for rejection has elapsed or where no time has been fixed, a reasonable time has elapsed. (c) guaranteed sales i.e. delivery is made giving the buyer an unlimited right of return Recognition of revenue in such circumstances will depend on the substance of the agreement. In the case of retail sales offering a guarantee of "money back if not completely satisfied" it may be appropriate to recognise the sale but to make a suitable provision for returns based on previous experience. In other cases, the substance of the agreement may amount to a sale on consignment, in which case it should be treated as indicated below. (d) consignment sales i.e. a delivery is made whereby the recipient undertakes to sell the goods on behalf of the consignor
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Revenue should not be recognised until the goods are sold to a third party. (e) cash on delivery sales Revenue should not be recognised until cash is received by the seller or his agent. 3. Sales where the purchaser makes a series of installment payments to the seller, and the seller delivers the goods only when the final payment is received Revenue from such sales should not be recognised until goods are delivered. However, when experience indicates that most such sales have been consummated, revenue may be recognised when a significant deposit is received. 4. Special order and shipments i.e. where payment (or partial payment) is received for goods not presently held in stock e.g. the stock is still to be manufactured or is to be delivered directly to the customer from a third party Revenue from such sales should not be recognised until goods are manufactured, identified and ready for delivery to the buyer by the third party. 5. Sale/repurchase agreements i.e. where seller concurrently agrees to repurchase the same goods at a later date For such transactions that are in substance a financing agreement, the resulting cash inflow is not revenue as defined and should not be recognised as revenue. 6. Sales to intermediate parties i.e. where goods are sold to distributors, dealers or others for resale Revenue from such sales can generally be recognised if significant risks of ownership have passed; however in some situations the buyer may in substance be an agent and in such cases the sale should be treated as a consignment sale. 7. Subscriptions for publications Revenue received or billed should be deferred and recognised either on a straight line basis over time or, where the items delivered vary in value from period to period, revenue should be based on the sales value of the item delivered in relation to the total sales value of all items covered by the subscription. 8. Installment sales When the consideration is receivable in installments, revenue attributable to the sales price exclusive of interest should be recognised at the date of sale. The interest element should be recognised as revenue, proportionately to the unpaid balance due to the seller. 9. Trade discounts and volume rebates 49
Trade discounts and volume rebates received are not encompassed within the definition of revenue, since they represent a reduction of cost. Trade discounts and volume rebates given should be deducted in determining revenue. B. Rendering of Services 1. Installation Fees In cases where installation fees are other than incidental to the sale of a product, they should be recognised as revenue only when the equipment is installed and accepted by the customer. 2. Advertising and insurance agency commissions Revenue should be recognised when the service is completed. For advertising agencies, media commissions will normally be recognised when the related advertisement or commercial appears before the public and the necessary intimation is received by the agency, as opposed to production commission, which will be recognised when the project is completed. Insurance agency commissions should be recognised on the effective commencement or renewal dates of the related policies. 3. Financial service commissions A financial service may be rendered as a single act or may be provided over a period of time. Similarly, charges for such services may be made as a single amount or in stages over the period of the service or the life of the transaction to which it relates. Such charges may be settled in full when made or added to a loan or other account and settled in stages. The recognition of such revenue should therefore have regard to: (a) whether the service has been provided "once and for all" or is on a "continuing" basis; (b) the incidence of the costs relating to the service; (c) when the payment for the service will be received. In general, commissions charged for arranging or granting loan or other facilities should be recognised when a binding obligation has been entered into. Commitment, facility or loan management fees which relate to continuing obligations or services should normally be recognised over the life of the loan or facility having regard to the amount of the obligation outstanding, the nature of the services provided and the timing of the costs relating thereto. 4. Admission fees Revenue from artistic performances, banquets and other special events should be recognised when the event takes place. When a subscription to a number of events is sold, the fee should be allocated to each event on a systematic and rational basis. 5. Tuition fees Revenue should be recognised over the period of instruction.
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6. Entrance and membership fees Revenue recognition from these sources will depend on the nature of the services being provided. Entrance fee received is generally capitalised. If the membership fee permits only membership and all other services or products are paid for separately, or if there is a separate annual subscription, the fee should be recognised when received. If the membership fee entitles the member to services or publications to be provided during the year, it should be recognised on a systematic and rational basis having regard to the timing and nature of all services provided.
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AS 10- ACCOUNTING FOR FIXED ASSETS

- N. Raghuveer (veersimhan@yahoo.co.in)
Accounting Standards aim at enforcing uniformity, to the extent possible, in Accounting for various transactions, in order to promote; 1. Transparency in the accounting practices, 2. Consistency of the methods followed and 3. Comparability of the financial statements so prepared by the process of accounting; thereby improving the quality of financial reporting in the interest of the users of financial statements. As with any other Accounting Standard, AS 10 seeks to promote uniformity in recognition, measurement, presentation and disclosures relating to fixed assets by providing guidelines for accounting for Fixed Assets under various scenarios. What are Fixed Assets? AS 10 defines Fixed Assets as: 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. Thus Fixed Assets are the assets held by an enterprise for a long term,for operating the business i.e. to use them in producing goods are providing services, and not for resale under ordinary course of business. Generally, they constitute a major portion of the total assets of an enterprise and are hence important for the proper presentation of an enterprises financial position. Examples :Enterprises generally categorize Fixed Assets as Land and Buildings, Plant and Machinery, Furniture and Fittings, Goodwill, Patents etc. Exceptions :Although AS 10 deals with Fixed Assets as a whole, it does not apply to cases relating to Fixed Assets covered by other Accounting Standards such as AS 6 Depreciation Accounting, AS 12 Accounting for Government Grants, AS 14 Accounting for Amalgamation. However the Areas covered under this standard relating to and prior to the introduction of AS 16 Borrowing Costs, AS 19 Leases and AS 26 Intangible Assets are held withdrawn and rest being mandatory from accounting year 1-4-2000. Also AS 10 does not deal with accounting for the following items: 1. Regenerative Natural Resources such as Forests, Plantations etc.; 2. Wasting Assets including mineral rights, Expenditure on exploration and extraction of Non-Regenerative Assets such as Oil, Natural Gas etc.; 3. Livestock; and 4. Expenditure on Real Estate development. However, the expenditure on items of fixed assets that are used to develop or maintain the above mentioned assets or activities, but separable from the same have to be accounted in accordance with this accounting standard.
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Identification The definition given by this standard serves as the base for judging whether an item is to be identified as fixed asset or not. However, the criteria may be applied differently to special circumstances and specific types of enterprises. For example; if the amount of expenditure on an item which could be included as a fixed asset is not material, it may be treated as an expense. Similarly, items which are individually insignificant may be grouped and the aggregate value allotted to the fixed asset. In certain special cases wherein the useful lives of components of one fixed asset are estimated to be different and they are separable, they may be recorded as individual fixed assets. Spares, Stand-by equipments and servicing equipments :1) Stand-by and Servicing equipments are usually capitalised 2) As regards machinery spares and stand-by equipments, the standard and Accounting Standard Interpretation 2 on treatment of machinery spares hold that : a) Machinery spares which are not specific to a particular item of fixed asset but can be used generally for various items of fixed assets should be treated as inventories for the purpose of AS 2. Such machinery spares should be charged to the statement of profit and loss as and when issued for consumption in the ordinary course of operations. b) Whether to capitalise machinery spare under AS 10 or not will depend on the facts and circumstances of each case. However, the machinery spares of the following types should be capitalised being of the nature of capital spares/insurance spares i) Machinery spares which are specific to a particular item of fixed asset, i.e., they can be used only in connection with a particular item of the fixed asset, and ii) Their use is expected to be irregular. c) Machinery spares of the nature of capital spares/insurance spares should be capitalised separately at the time of their purchase whether procured at the time of purchase of the fixed asset concerned or subsequently. The total cost of such capital spares/insurance spares should be allocated on a systematic basis over a period not exceeding the useful life of the principal item, i.e., the fixed asset to which they relate. d) When the related fixed asset is either discarded or sold, the written down value less disposal value, if any, of the capital spares/insurance spares should be written off. e) The stand-by equipment is a separate fixed asset in its own right and should be depreciated like any other fixed asset. What is meant by Gross Book Value of a Fixed Asset? AS 10 defines Gross Book Value as: Gross book value of a fixed asset is its historical cost or other amount substituted for historical cost in the books of account of financial statements. When this amount is shown net of accumulated depreciation, it is termed as net book value. Historical cost of a fixed asset is the amount capitalised in the books of accounts at the time of purchase of the asset. It includes freight, duties and taxes, erection charges etc. Cost and Components of Cost Cost of a fixed asset is the total expenditure attributable to the possession of the asset and its preparation for use. It includes the purchase price, import charges and non-refundable taxes and other costs directly attributable to making the asset ready for use and excludes any discounts, rebates and refunds.
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Cost to be Capitalised :The standard provides that The Administrative or General Overheads specifically attributable to a particular project or asset must be capitalised. The expenditure incurred on start-up and commissioning of the project, including the expenditure incurred on test runs and experimental production, is usually capitalised as an indirect element of the construction cost. Costs of Revenue nature :The standard also provides that The expenditure incurred after the plant has begun commercial production 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. 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 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. Self Constructed Assets :Gross book value of Self Constructed Assets consist of 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, after the elimination of any internally generated profits. Non-Monetary Consideration :When a fixed asset is acquired in exchange for another asset or shares or other securities in the enterprise, it is usually recorded at the fair market value of the asset acquired or the fair market value of the shares or securities issued or the net book value of the asset given, whichever is more clearly evident. What is meant by Fair Market Value? AS 10 defines Fair Market Value as: 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. Improvements, Repairs and Revaluations Improvements mean any service relating to a fixed asset which increases the future benefits from that asset beyond its previously assessed standard of performance. Repairs mean any service relating to a fixed asset which helps keep the asset in working condition. Expenditure on improvements and repairs :Expenditure on improvements is to be added to the gross book value of the asset, whereas the expenditure on repairs is to be charged to the profit and loss statement. Any addition or extension to an existing asset which is of capital nature is treated as follows: 1. If it forms an integral part of the asset, its cost is added to the gross book value of the asset.
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2. If it is capable of being used separately and can be used even after the existing assets disposal, then it is accounted separately. Revaluation : Fixed assets are commonly revalued by indexation with reference to current prices or by appraisal undertaken by competent valuers. Sometimes different bases may be used to revalue separate items within each category of fixed assets or for different categories of fixed assets. In such cases, it is necessary to disclose the gross book value included in each basis. When all the assets of a class are not to be revalued, the selection of the assets to be revalued must be revalued on a systematic basis. The revaluation of a class of assets resulting in the net book value of that class being greater than the recoverable amount of the assets of that class is not appropriate. When revaluation results in an increase in the net book value of the asset, it is normally credited to the revaluation reserve and not available for distribution. When the revaluation results in a decrease in the net book value of the asset, it is charged to the profit and loss statement. However when a revaluation which results in an increase or decrease in the book value as against the previous decrease or increase on revaluation respectively, the nullifying effect to the previous treatment is carried out and the balance increase or decrease is treated as mentioned above. Valuation in special cases Hire Purchase :In case of a Fixed Asset acquired on hire purchase terms, although the legal ownership is not transferred to the buyer until the final installment is paid, in application of the principle of substance over legal form, the asset is recorded in the books of the enterprise (buyer) at its cash value and depreciated thereon. If the cash value of the asset is not readily available, it is to be calculated by assuming an appropriate rate of interest. The enterprise must make suitable disclosure in the balance sheet indicating that the enterprise does not have full ownership thereof. Joint Ownership :If the assets are jointly owned by the enterprise with others, otherwise than in the case of a partner in a partnership firm, the assets are recorded in the Balance sheet to the extent of the enterprises share in such assets, original cost, accumulated depreciation and written down value. Alternatively, the pro rata cost of those assets may be grouped together with similar fully owned assets with appropriate disclosure. Purchased for a Consolidated Price :Where several assets are purchased for a consolidated price, the consideration is apportioned to the various assets on a fair basis determined by competent valuers. Retirements and Disposals 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 net realisable value and are shown separately in the financial statements. Any expected loss is recognised immediately in the profit and loss statement. An item of fixed asset is eliminated from the financial statements on disposal. Gains or losses arising on disposal are generally recognised in the profit and loss statement.
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When a fixed asset previously revalued to be higher in value is disposed at a loss, the loss in relation to the revaluation to the extent of the increase in value is charged directly to the reserve and any further loss is charged to the profit and loss statement. The amount standing in revaluation reserve following the retirement or disposal of an asset which relates to that asset may be transferred to general reserve.
Special types of Fixed Assets Goodwill :Goodwill is recorded in the books of accounts only when some consideration in the form of money or moneys worth has been paid for it. Whenever a business is acquired for a price which is in excess of the value of the net assets of the business taken over, the excess is termed as 'goodwill'. Disclosure Requirements The standard requires disclosures to be made in accordance with the disclosure requirements on accounting for fixed assets already required by AS 1 and AS 6. Further, the standard also requires the enterprises to disclose the following: 1) Gross and net book values of fixed assets at the beginning and end of an accounting period showing additions, disposals, acquisitions and other movements; 2) Expenditure incurred on account of fixed assets in the course of construction or acquisition; and 3) Revalued amounts substituted for historical costs of fixed assets, the method adopted to compute the revalued amounts, 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. Application of AS 10 ITC Limited To state Fixed Assets at cost of acquisition inclusive of inward freight, duties and taxes and incidental expenses related to acquisition. In respect of major projects involving construction, related preoperational expenses form part of the value of assets capitalised. Expenses capitalised also include applicable borrowing costs. Capitalise software where it is expected to provide future enduring economic benefits. Capitalisation costs include license fees and cost of implementation/system integration services. The costs are capitalised in the year in which the relevant software is implemented for use To charge off a revenue expenditure all up gradation / enhancements unless they bring similar significant additional benefits. Power Finance Corporation Ltd Fixed assets are shown at historical cost less accumulated depreciation, except the assets retired from active use and held for disposal, which are stated at lower of the book value or net realizable value. The additions to Fixed Assets are being capitalized on the basis of bills approved or estimates value method, in accordance with the rates prescribed in Schedule XIV of the Companies Act, 1956. Coromandel Fertilizers Ltd Fixed assets are shown at cost or valuation less depreciation. Cost comprises of the purchase price and other attributable expenses including cost of borrowings till the date of capitalisation in the case of assets involving material investment and substantial lead time.
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AS 11 (R) - ACCOUNTING FOR THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES

- Eshwar Ramanathan (easwar.ramanathan@gmail.com)
I. Objective An enterprise may have transactions in foreign currencies or it may have foreign branches (operations). Foreign currency transactions should be expressed in the enterprise's reporting currency and the financial statements of foreign branches should be translated into the enterprise's reporting currency in order to include them in the financial statements of the enterprise. The principal issues in accounting for foreign currency transactions and foreign branches are to decide which exchange rate to use and how to recognize in the financial statements the financial effect of changes in exchange rates. II. Scope This Statement should be applied by an enterprise: (a) in accounting for transactions in foreign currencies; and (b) in translating the financial statements of foreign branches for inclusion in the financial statements of the enterprise. This statement also deals with accounting for foreign currency transactions in the nature of forward exchange contracts. III. Definitions Reporting currency is the currency used in presenting the financial statements. Foreign currency is a currency other than the reporting currency of an enterprise. Exchange rate is the ratio for exchange of two currencies. Average rate is the mean of the exchange rates in force during a period. Forward rate is the exchange rate established by the terms of an agreement for exchange of two currencies at a specified future date. Closing rate is the exchange rate at the balance sheet date. Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arms length transaction.
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Monetary items are money held and assets and liabilities to be received or paid in fixed or determinable amounts of money, e.g., cash, receivables, payables. Non-monetary items are assets and liabilities other than monetary items. e.g. fixed assets, inventories, investments in equity shares. Settlement date is the date at which a receivable is due to be collected or a payable is due to be paid. Recoverable amount is the amount which the enterprise expects to recover from the future use of an asset, including its residual value on disposal. Foreign operation is a subsidiary , associate , joint venture or branch of the reporting enterprise, the activities of which are based or conducted in a country other than the country of the reporting enterprise. Forward exchange contract means an agreement to exchange different currencies at a forward rate. Forward rate is the specified exchange rate for exchange of two currencies at a specified future date. Integral foreign operation is a foreign operation, the activities of which are an integral part of those of the reporting enterprise. Net investment in a non-integral foreign operation is the reporting enterprises share in the net assets of that operation. Non-integral foreign operation is a foreign operation that is not an integral foreign operation. IV. Foreign Currency Transactions A) Recording Transactions on Initial Recognition i) A foreign currency transaction is a transaction which is denominated in or requires settlement in a foreign currency, including transactions arising when an enterprise either: a) buys or sells goods or services whose price is denominated in a foreign currency; b) borrows or lends funds when the amounts payable or receivable are denominated in a foreign currency; c) becomes a party to an unperformed forward exchange contract; or d) otherwise acquires or disposes of assets, or incurs or settles liabilities, denominated in a foreign currency. ii) A transaction in a foreign currency should be recorded in the reporting currency by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction. iii) A transaction in a foreign currency is recorded in the financial records of an enterprise as at the date on which the transaction occurs, normally using the exchange rate at that date. This exchange rate is often
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referred to as the spot rate. For practical reasons, a rate that approximates the actual rate is often used, for example, an average rate for all transactions during the week or month in which the transactions occur. However, if exchange rates fluctuate significantly, the use of the average rate for a period is unreliable. B) Reporting Effects of Changes in Exchange Rates Subsequent to Initial Recognition At each balance sheet date: (a) monetary items denominated in a foreign currency (e.g. foreign currency notes, balances in bank accounts denominated in a foreign currency, and receivables, payables and loans denominated in a foreign currency), except for restrictions on remittances, should be reported using the closing rate. However, when the closing rate is unrealistic, reporting should be at the most likely realizable or disbursable amount. (b) non-monetary items, which are carried in terms of historical cost denominated in a foreign currency, should be reported using the exchange rate at the date of the transaction; (c) non-monetary items which are carried in terms of fair value or other similar valuation, e.g. net realizable value, denominated in a foreign currency, should be reported using the exchange rates that existed when the values were determined (e.g. if fair value is determined as on the balance sheet date, the exchange rate on the balance sheet date may be used) AS 11 (pre revision) provided for capitalisation of exchange differences attributable to outstanding, unpaid foreign exchange liability incurred for purchase of Fixed assets. This rule has been eliminated and therefore such exchange rate differential cannot any longer be capitalised. Companies (Accounting Standards) Amendment rule 2009 has been pronounced under section 211(3C) of Companies Act, in terms of which an additional Para stands inserted in the standard. This amendment Para is applicable only to companies registered under Companies Act. This Para deals with exchange differences arising from or attributable to Long Term Foreign Currency Monetary Item whose maturity period stood at 12 months or more on originating date. 1. Exchange difference relating to depreciable fixed asset will be added to or deducted from Historical cost of the asset and the revised unamortised cost will be depreciated over the remaining useful life of the asset. 2. Exchange difference not relating to depreciable fixed asset will be accumulated in a separate account called "Foreign Currency Monetary item Translation difference account" and should be amortised over the remaining life of the asset or 31st March 2011 whichever is earlier. The difference in amortisation method is - when the exchange difference is capitalised it should be amortised over useful life of asset, whereas when it is taken to a separate reserve account amortisation period shall not go beyond 31st March 2011. This alternative accounting treatment prescribed under additional Para is purely optional. But once a Company exercises this option, it is irrevocable. When a company exercised the option, the fact of exercise of option and the amount remaining unamortised shall be disclosed. SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI 59
C) Recognition of Exchange Differences 1) An exchange difference results when there is a change in the exchange rate between the transaction date and the date of settlement of any monetary items arising from a foreign currency transaction. a) When the transaction is settled within the same accounting period as that in which it occurred, the entire exchange difference arises in that period. b) However, when the transaction is not settled in the same accounting period as that in which it occurred, the exchange difference arises over more than one accounting period. i. Reporting on balance sheet date at a rate different from the rate at which it was initially recognized ii. On the date of settlement at the rate different from the rate at which it was reported in the last financial statement. 2) Exchange differences arising on foreign currency transactions should be recognized as income or as expense in the period in which they arise. 3) Where an entity has non-integral foreign operations, the exchange differential attributable to some monetary items having specific characteristics should be accumulated in Foreign Currency Transaction Reserve. V. Financial Statements of Foreign Operations a) Classification of Foreign Operations The method used to translate the financial statements of a foreign operation depends on the way in which it is financed and operates in relation to the reporting enterprise. For this purpose, foreign operations are classified as either integral foreign operations or non-integral foreign operations. A foreign operation that is integral to the operations of the reporting enterprise carries on its business as if it were an extension of the reporting enterprises operations. For example, such a foreign operation might only sell goods imported from the reporting enterprise and remit the proceeds to the reporting enterprise. In such cases, a change in the exchange rate between the reporting currency and the currency in the country of foreign operation has an almost immediate effect on the reporting enterprises cash flow from operations. Therefore, the change in the exchange rate affects the individual monetary items held by the foreign operation rather than the reporting enterprises net investment in that operation. In contrast, a non-integral foreign operation accumulates cash and other monetary items, incurs expenses, generates income and perhaps arranges borrowings, all substantially in its local currency. It may also enter into transactions in foreign currencies, including transactions in the reporting currency. When there is a change in the exchange rate between the reporting currency and the local currency, there is little or no direct effect on the present and future cash flows from operations of either the nonintegral foreign operation or the reporting enterprise. The change in the exchange rate affects the reporting enterprises net investment in the non-integral foreign operation rather than the individual monetary and non-monetary items held by the non-integral foreign operation.
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The following are indications that a foreign operation is a non-integral foreign operation rather than an integral foreign operation: a) while the reporting enterprise may control the foreign operation, the activities of the foreign operation are carried out with a significant degree of autonomy from those of the reporting enterprise; b) transactions with the reporting enterprise are not a high proportion of the foreign operations activities; c) the activities of the foreign operation are financed mainly from its own operations or local borrowings rather than from the reporting enterprise; d) costs of labour, material and other components of the foreign operations products or services are primarily paid or settled in the local currency rather than in the reporting currency; e) the foreign operations sales are mainly in currencies other than the reporting currency; f) cash flows of the reporting enterprise are insulated from the day-to-day activities of the foreign operation rather than being directly affected by the activities of the foreign operation; g) sales prices for the foreign operations products are not primarily responsive on a short-term basis to changes in exchange rates but are determined more by local competition or local government regulation; and h) there is an active local sales market for the foreign operations products, although there also might be significant amounts of exports.
The appropriate classification for each operation can, in principle, be established from factual information related to the indicators listed above. In some cases, the classification of a foreign operation as either a non-integral foreign operation or an integral foreign operation of the reporting enterprise may not be clear, and judgement is necessary to determine the appropriate classification.
b) Integral Foreign Operations The financial statements of an integral foreign operation should be translated using the principles and procedures as laid in sub-heading IV as if the transactions of the foreign operation had been those of the reporting enterprise itself. The individual items in the financial statements of the foreign operation are translated as if all its transactions had been entered into by the reporting enterprise itself. The cost and depreciation of tangible fixed assets is translated using the exchange rate at the date of purchase of the asset or, if the asset is carried at fair value or other similar valuation, using the rate that existed on the date of the valuation.
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The cost of inventories is translated at the exchange rates that existed when those costs were incurred. The recoverable amount or realizable value of an asset is translated using the exchange rate that existed when the recoverable amount or net realizable value was determined. For example, when the net realizable value of an item of inventory is determined in a foreign currency, that value is translated using the exchange rate at the date as at which the net realizable value is determined. The rate used is therefore usually the closing rate. An adjustment may be required to reduce the carrying amount of an asset in the financial statements of the reporting enterprise to its recoverable amount or net realizable value even when no such adjustment is necessary in the financial statements of the foreign operation. Alternatively, an adjustment in the financial statements of the foreign operation may need to be reversed in the financial statements of the reporting enterprise. For practical reasons, a rate that approximates the actual rate at the date of the transaction is often used, for example, an average rate for a week or a month might be used for all transactions in each foreign currency occurring during that period. However, if exchange rates fluctuate significantly, the use of the average rate for a period is unreliable. c) Non-integral Foreign Operations In translating the financial statements of a non-integral foreign operation for incorporation in its financial statements, the reporting enterprise should use the following procedures: a) the assets and liabilities, both monetary and non-monetary, of the non-integral foreign operation should be translated at the closing rate; b) income and expense items of the non-integral foreign operation should be translated at exchange rates at the dates of the transactions; and c) all resulting exchange differences should be accumulated in a foreign currency translation reserve until the disposal of the net investment. For practical reasons, a rate that approximates the actual exchange rates, for example an average rate for the period, is often used to translate income and expense items of a foreign operation. The translation of the financial statements of a non-integral foreign operation results in the recognition of exchange differences arising from: a) translating income and expense items at the exchange rates at the dates of transactions and assets and liabilities at the closing rate; b) translating the opening net investment in the non-integral foreign operation at an exchange rate different from that at which it was previously reported; and c) other changes to equity in the non-integral foreign operation.
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The resulting differences from the above should be accumulated in a Foreign Currency Translation Reserve (FCTR) until disposal of net investment of the Non-Integral Foreign operation. Any goodwill or capital reserve arising on the acquisition of a non-integral foreign operation is translated at the closing rate. A contingent liability disclosed in the financial statements of a non-integral foreign operation is translated at the closing rate for its disclosure in the financial statements of the reporting enterprise.
VII. Consolidation Procedures i) The incorporation of the financial statements of a non-integral foreign operation in those of the reporting enterprise follows normal consolidation procedures, such as the elimination of intra-group balances and intragroup transactions of a subsidiary (AS 21, Consolidated Financial Statements, and AS 27, Financial Reporting of Interests in Joint Ventures). However, an exchange difference arising on an intra-group monetary item, whether short-term or long-term, cannot be eliminated against a corresponding amount arising on other intragroup balances because the monetary item represents a commitment to convert one currency into another and exposes the reporting enterprise to a gain or loss through currency fluctuations. Accordingly, in the consolidated financial statements of the reporting enterprise, such an exchange difference continues to be recognized as income or an expense or, it is accumulated in a foreign currency translation reserve until the disposal of the net investment. ii) In cases where the financial statements of a non integral foreign operations are drawn for a different reporting period, for the purpose of consolidation, the statements of the non integral operations are prepared as at the same date as the reporting enterprise. When it is impracticable to do this, AS 21, Consolidated Financial Statements, allows the use of financial statements drawn up to a different reporting date provided that the difference is no greater than six months and adjustments are made for the effects of any significant transactions or other events that occur between the different reporting dates. In such a case, the assets and liabilities of the non-integral foreign operation are translated at the exchange rate at the balance sheet date of the non-integral foreign operation and adjustments are made when appropriate for significant movements in exchange rates up to the balance sheet date of the reporting enterprises in accordance with AS 21. The same approach is used in applying the equity method to associates and in applying proportionate consolidation to joint ventures in accordance with AS 23, Accounting for Investments in Associates in Consolidated Financial Statements and AS 27, Financial Reporting of Interests in Joint Ventures. VIII. Disposal of a Non-integral Foreign Operation (N-FO) An enterprise may dispose of its interest in a non-integral foreign operation through sale, liquidation, repayment of share capital, or abandonment of all, or part of, that operation. Write down of the carrying amount of the NFO is however not a disposal. On the disposal of a non-integral foreign operation, the cumulative amount of the exchange differences which have been deferred & kept in FCTR and which relate to that operation should be recognized as income or as expenses in the same period in which the gain or loss on disposal is recognized.
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Where an N-FO is disposed of in part, the balance in FCTR will be recognized as income or expenses on a prorata basis in addition to the gain or loss on such part-disposal. The payment of a dividend forms part of a disposal only when it constitutes a return of the investment. IX. Change in the Classification of a Foreign Operation When there is a change in the classification of a foreign operation, the translation procedures applicable to the revised classification should be applied from the date of the change in the classification. When a foreign operation that is integral to the operations of the reporting enterprise is reclassified as a nonintegral foreign operation, exchange differences arising on the translation of non-monetary assets at the date of the reclassification are accumulated in a foreign currency translation reserve. When a non-integral foreign operation is reclassified as an integral foreign operation, the translated amounts for non-monetary items at the date of the change are treated as the historical cost for those items in the period of change and subsequent periods. Exchange differences which have been deferred are not recognized as income or expenses until the disposal of the operation. X. All Changes in Foreign Exchange Rates Tax Effects of Exchange Differences Gains and losses on foreign currency transactions and exchange differences arising on the translation of the financial statements of foreign operations may have associated tax effects which are accounted for in accordance with AS 22, Accounting for Taxes on Income XI. Forward Exchange Contracts Category I An enterprise may enter into a forward exchange contract or another financial instrument that is in substance a forward exchange contract, which is not intended for trading or speculation purposes, to establish the amount of the reporting currency required or available at the settlement date of a transaction. The premium or discount arising at the inception of such a forward exchange contract should be amortized as expense or income over the life of the contract. Exchange differences on such a contract should be recognized in the statement of profit and loss in the reporting period in which the exchange rates change. Any profit or loss arising on cancellation or renewal of such a forward exchange contract should be recognized as income or as expense for the period. Category II In respect of a forward contract entered into as a speculative activity, AS-R prescribes that the contract should be marked to market, and gain or loss, computed as under, should be recognized on the reporting date.
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A gain or loss on a forward exchange contract should be computed by multiplying the foreign currency amount of the forward exchange contract by the difference between the forward rate available at the reporting date for the remaining maturity of the contract and the contracted forward rate (or the forward rate last used to measure a gain or loss on that contract for an earlier period). The gain or loss so computed should be recognized in the statement of profit and loss for the period. The premium or discount on the forward exchange contract is not recognized separately. XII. Disclosure 1) An enterprise should disclose: a) the amount of exchange differences included in the net profit or loss for the period; and b) net exchange differences accumulated in foreign currency translation reserve as a separate component of shareholders funds, and a reconciliation of the amount of such exchange differences at the beginning and end of the period. 2) When the reporting currency is different from the currency of the country in which the enterprise is domiciled, the reason for using a different currency should be disclosed. The reason for any change in the reporting currency should also be disclosed. 3) When there is a change in the classification of a significant foreign operation, an enterprise should disclose: i. ii. iii. iv. the nature of the change in classification; the reason for the change; the impact of the change in classification on shareholders funds; and the impact on net profit or loss for each prior period presented had the change in classification occurred at the beginning of the earliest period presented.
4) The effect on foreign currency monetary items or on the financial statements of a foreign operation of a change in exchange rates occurring after the balance sheet date is disclosed in accordance with AS 4, Contingencies and Events Occurring After the Balance Sheet Date. 5) Disclosure is also encouraged of an enterprises foreign currency risk management policy. Transitional Provisions On the first time application of this Statement, if a foreign branch is classified as a non-integral foreign operation in accordance with the requirements of this Statement, the accounting treatment prescribed in paragraphs of Sub-heading IX in respect of change in the classification of a foreign operation should be applied.
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IFRS There is no distinction being made between integral & nonThe Effect of changes in integral foreign operation as per Foreign Exchange Rates the revised IAS 21. IAS-21 is (Revised) based on the concept of Functional currency and presentation currency. It therefore provides guidance on what should be the functional currency of an entity. ILLUSTRATIONS: 1. Integral and Non Integral Foreign operations
Particulars
Indian GAAP AS-11 is based on the concept of integral and non-integral operations. It therefore provides guidance on what operations are integral and what are not in respect of an enterprise. There is no concept of Functional Currency in Indian GAAP.
At the end of 31st March 2011 the following ledger balances has been extracted from the books of the Australia Branch of X ltd. Debit Credit (in Australian dollar thousands) Plant & Machinery (at cost) 200 Accumulated Depreciation on P&M 130 Debtors / Creditors 60 30 Stock(01-04-2010) 20 Cash and Bank balances 10 Purchases / Sales 20 123 Goods sent to Branch 5 Wages and salaries 45 Rent 12 Office expenses 18 Commission receipts 100 Branch / HO Current account 7 390 390 The following information is also available: Goods sent by HO Rs.100,000. Branch A/c in HO Rs. 120,000. Stock at 31.03.2011 in Branch $3,125. Convert the trial balance using the following rate of exchange As on 01.04.2010 Rs.40/$, as on 31.03.2011 Rs.48/$, Avg rate Rs.44/$, For fixed assets Rs. 36/$. Sol: Integral Operation Non Integral Operation Conversio Debit Credit Conversi Debit Credit n rate on rate Plant & Machinery (at 36 7200 48 9600 cost) Accumulated 36 4680 48 6240
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Depreciation on P&M Debtors / Creditors Stock(01-04-2010) Cash and Bank balances Purchases / Sales Goods sent to Branch Wages and salaries Rent Office expenses Commission receipts Branch / HO Current account
48 40 48 44 44 44 44 44
2880 800 480 880 100 1980 528 792 -
1440 5412 4400 120
48 40 48 44 44 44 44 44
2880 800 480 880 100 1980 528 792 -
1440 5412 4400 120
15640 16052 18040 17612 Exchange Loss / Gain 412 428 In case of Integral operation, the exchange loss of Rs. 412,000 should be written off in profit and loss account for the year. For Non integral operations, the exchange gain of Rs. 428,000 would be credited to foreign currency translation reserve account. 2. Forward Exchange Contracts : A company entered into a 6 months forward contract of USD at Rs.45 on 01.10.2010. Financial Year ends on 31st December. Spot rate on date of settlement Rs.50. 01.10.2010 31.12.2010 31.03.2011 Spot rate 45 47 52 Forward rate(6 48 months) Forward rate(3 51 months) Account for the difference in exchange rates if a) The Forward contract is entered into to mitigate the exchange rate risk associated with a foreign exchange liability b) The forward contract is entered into as a speculative activity Sol: (a) To mitigate risk against loan (b) Speculative Activity Date Particulars Dr Cr Particulars Dr Cr 01.10.10 Bank A/c Dr. 45 To F Currency loan 45 Foreign Currency (FCR) Foreign Currency receivable (FCR) Dr. 45 receivable Ac Dr 48 Deferred Premium Dr. 3 To amount payable to To Amount payable to Bank 48 Bank 48 31.12.10 Premium A/c Dr. 1.5 To Deferred Premium 1.5 SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI 67
31.03.11
(Proportionate for three months) F currency loss Dr. To F Currency loan F currency receivabl Dr. To F exchange gain Premium A/c Dr. To Deferred Premium (Proportionate for next three months) F currency loss Dr. To F Currency loan F currency receivabl Dr. To F exchange gain Amount payable to bank Dr. To Bank A/c
2 2 2 2 1.5 1.5 5 5 5 5 48 48 52
FCR A/c Dr. To Exchange gain
3 3
FCR A/c Dr. To Exchange gain
1 1
Bank A/c Dr. 4 Amount payable to Bank A/c Dr. 48 To FCR A/c
52
F currency loan Dr. 52 To FCR (Loan settled using F currency received)
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AS 12 - ACCOUNTING FOR GOVERNMENT GRANTS

- Eshwar Ramanathan (easwar.ramanathan@gmail.com
I. Objective & Scope To deal with the Accounting for government grants. Government grants are sometimes called by other names such as subsidies, cash incentives, duty drawbacks, etc. 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 enterprises financial statements with those of prior periods and with those of other enterprises. II. Definitions 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. III. 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. If the government grant is in the nature of promoters contribution then credit will be given to capital reserve (as part of shareholders funds). For other types of grants it is more appropriate to follow Income approach. It is fundamental to the income approach that government grants be recognized 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. (Accounting Standard (AS) 1, Disclosure of Accounting Policies). In most cases, the periods over which an enterprise recognizes the costs or expenses related to a government grant are readily ascertainable and thus grants are taken to income in the same period as the relevant expenses are recognized. 69
IV. Recognition of Government Grants Government grants available to the enterprise are considered for inclusion in accounts: i. where there is reasonable assurance that the enterprise will comply with the conditions attached to them; and ii. 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 conditions attaching to the grant have been or will be fulfilled. An appropriate amount in respect of such earned benefits, estimated on a prudent basis, is credited to income for the year even though the actual amount of such benefits may be finally settled and received after the end of the relevant accounting period. Compliance with other standards in recognition of Government Grant: A contingency related to a government grant, arising after the grant has been recognized, is treated in accordance with Accounting Standard (AS) 4, Contingencies and Events Occurring after the Balance Sheet Date. In certain circumstances, a government grant is awarded for the purpose of giving immediate financial support to an enterprise rather than as an incentive to undertake specific expenditure. Such grants may be confined to an individual enterprise and may not be available to a whole class of enterprises. These circumstances may warrant taking the grant to income in the period in which the enterprise qualifies to receive it, as an extraordinary item if appropriate (Accounting Standard (AS) 5, Prior Period and Extraordinary Items and Changes in Accounting Policies). Government grants may become receivable by an enterprise as compensation for expenses or losses incurred in a previous accounting period. Such a grant is recognized in the income statement of the period in which it becomes receivable, as an extraordinary item if appropriate. (Accounting Standard (AS) 5, Prior Period and Extraordinary Items and Changes in Accounting Policies). 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. Nonmonetary assets given free of cost are recorded at a nominal value. V. Presentation of Grants Related to Specific Fixed Assets Grants related to specific fixed assets are generally provided with a primary condition that the qualifying enterprise should purchase, construct or otherwise acquire such assets and such other conditions for restricting the type or location of the assets or the periods during which they are to be acquired or held.
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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. In the first 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 recognized 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. In the next method, grants related to depreciable assets are treated as deferred income which is recognized in the profit and loss statement on a systematic and rational basis over the useful life of the asset. 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, e.g., Deferred government grants. 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 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. Arguments For and Against these Methods: Supporters of the first method claim that it is inappropriate to net income and expense items and that separation of the grant from the expense facilitates 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. VI. Refund of Government Grants
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Government grants sometimes become refundable because certain conditions are not fulfilled. A government grant that becomes refundable is treated as an extraordinary item (Accounting Standard (AS) 5, Prior Period and Extraordinary Items and Changes in Accounting Policies). 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. 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. VII. Disclosure The following disclosures are appropriate: (i) the accounting policy adopted for government grants, including the methods of presentation in the financial statements; (ii) the nature and extent of government grants recognized in the financial statements, including grants of nonmonetary assets given at a concessional rate or free of cost.
Particulars
IFRS In case of non-monetary assets Accounting for Government acquired at nominal/concessional Grants rate, IAS 20 permits accounting either at fair value or at acquisition cost. In respect of grant related to a specific fixed asset becoming refundable, IAS 20 requires Retrospective re-computation of depreciation and prescribes charging off the deficit in the period in which such grant becomes refundable. IAS 20 requires separate disclosure of unfulfilled conditions and other contingencies if grant
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Indian GAAP AS 12 requires accounting at acquisition cost.
AS 12 requires enterprise to compute depreciation prospectively as a result of which the revised book value is depreciated over the residual useful life. AS 12 has no such disclosure requirement.
has been recognised. Recognition of government Government grants of the nature grants in equity is not permitted. of promoters' contribution should be credited to capital reserve and treated as a part of shareholders' funds.
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AS 13 - ACCOUNTING FOR INVESTMENTS

- Eshwar Ramanathan (easwar.ramanathan@gmail.com
I. Objective & Scope To deal with the Accounting for Investments in the financial statements of enterprises and related disclosure requirements. II. Definitions Investments are assets held by an enterprise for earning income by way of dividends, interest, and rentals, for capital appreciation, or for other benefits to the investing enterprise. Assets held as stock-in-trade are not investments. A current investment is an investment that is by its nature readily realizable and is intended to be held for not more than one year from the date on which such investment is made. A long term investment is an investment other than a current investment. An investment property is an investment in land or buildings that are not intended to be occupied substantially for use by, or in the operations of, the investing enterprise. Fair value is the amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arms length transaction. Under appropriate circumstances, market value or net realizable value provides an evidence of fair value. Market value is the amount obtainable from the sale of an investment in an open market, net of expenses necessarily to be incurred on or before disposal. III. Classification of Investments i. Enterprises present financial statements that classify fixed assets, investments and current assets into separate categories. Investments are classified as long term investments and current investments. Current investments are in the nature of current assets, although the common practice may be to include them in investments. Investments other than current investments are classified as long term investments, even though they may be readily marketable.
ii.
IV. Cost of Investments The cost of an investment includes acquisition charges such as brokerage, fees and duties.
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If an investment is acquired, or partly acquired, by the issue of shares or other securities, the acquisition cost is the fair value of the securities issued (which, in appropriate cases, may be indicated by the issue price as determined by statutory authorities). The fair value may not necessarily be equal to the nominal or par value of the securities issued. If an investment is acquired in exchange, or part exchange, for another asset, the acquisition cost of the investment is determined by reference to the fair value of the asset given up. It may be appropriate to consider the fair value of the investment acquired if it is more clearly evident. Interest, dividends and rentals receivables in connection with an investment are generally regarded as income, being the return on the investment. However, in some circumstances, such inflows represent a recovery of cost and do not form part of income. For example, when unpaid interest has accrued before the acquisition of an interest-bearing investment and is therefore included in the price paid for the investment, the subsequent receipt of interest is allocated between pre-acquisition and post-acquisition periods; the pre-acquisition portion is deducted from cost. When dividends on equity are declared from pre-acquisition profits, a similar treatment may apply. If it is difficult to make such an allocation except on an arbitrary basis, the cost of investment is normally reduced by dividends receivable only if they clearly represent a recovery of a part of the cost. When right shares offered are subscribed for, the cost of the right shares is added to the carrying amount of the original holding. If rights are not subscribed for but are sold in the market, the sale proceeds are taken to the profit and loss statement. However, where the investments are acquired on cum-right basis and the market value of investments immediately after their becoming ex-right is lower than the cost for which they were acquired, it may be appropriate to apply the sale proceeds of rights to reduce the carrying amount of such investments to the market value. V. Carrying Amount of Investments Current Investments The carrying amount for current investments is the lower of cost and fair value. In respect of investments for which an active market exists, market value generally provides the best evidence of fair value. The valuation of current investments at lower of cost and fair value provides a prudent method of determining the carrying amount to be stated in the balance sheet. Practically those investments which have active market would have been quoted in more than one stock exchange. In such a situation, either highest of market value quoted on various stock exchanges on the reporting date will be considered or the market value quoted in the stock exchange where it has highest trading will be considered. In either case, the Valuation method adopted should be disclosed. Valuation of current investments on overall (or global) basis is not considered appropriate. Sometimes, the concern of an enterprise may be with the value of a category of related current investments and not with each individual investment, and accordingly the investments may be carried at the lower of cost and fair value computed category-wise (i.e. equity shares, preference shares, convertible debentures, etc.). However, the more prudent and appropriate method is to carry investments individually at the lower of cost and fair value. For current investments, any reduction to fair value and any reversals of such reductions are included in the profit and loss statement. SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI 75
Long-term Investments Long-term investments are usually carried at cost. However, when there is a decline, other than temporary, in the value of a long term investment, the carrying amount is reduced to recognize the decline. Indicators of the value of an investment are obtained by reference to its market value, the investees assets and results and the expected cash flows from the investment. The type and extent of the investors stake in the investee are also taken into account. Restrictions on distributions by the investee or on disposal by the investor may affect the value attributed to the investment. Long-term investments are usually of individual importance to the investing enterprise. The carrying amount of long-term investments is therefore determined on an individual investment basis. Where there is a decline, other than temporary, in the carrying amounts of long term investments, the resultant reduction in the carrying amount is charged to the profit and loss statement. The reduction in carrying amount is reversed when there is a rise in the value of the investment, or if the reasons for the reduction no longer exist. Investment Properties The cost of any shares in a co-operative society or 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. VI. Disposal of Investments On disposal of an investment, the difference between the carrying amount and the disposal proceeds, net of expenses, is recognized in the profit and loss statement. When disposing of a part of the holding of an individual investment, the carrying amount to be allocated to that part is to be determined on the basis of the average carrying amount of the total holding of the investment. VII. Reclassification of Investments Where long-term investments are reclassified as current investments, transfers are made at the lower of cost and carrying amount at the date of transfer. Where investments are reclassified from current to long-term, transfers are made at the lower of cost and fair value at the date of transfer. VIII. Disclosure The following disclosures in financial statements in relation to investments are appropriate:(a) the accounting policies for the determination of carrying amount of investments; (b) the amounts included in profit and loss statement for:
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i) interest, dividends (showing separately dividends from subsidiary companies), and rentals on investments showing separately such income from long term and current investments. Gross income should be stated, the amount of income tax deducted at source being included under Advance Taxes Paid; (ii) profits and losses on disposal of current investments and changes in carrying amount of such investments; (iii) profits and losses on disposal of long term investments and changes in the carrying amount of such investments; (c) significant restrictions on the right of ownership, realisability of investments or the remittance of income and proceeds of disposal; (d) the aggregate amount of quoted and unquoted investments, giving the aggregate market value of quoted investments; (e) other disclosures as specifically required by the relevant statute governing the enterprise.
Particulars Accounting for Investment
IFRS IAS 40 deals with accounting for various aspects of Investment Property in a comprehensive manner.
Indian GAAP AS 13 deals with Investment Property in a limited manner. It requires the same to be treated in the same manner as long-term investment.
Illustration Particulars Equity shares Mutual Funds Government Securities Cost 406.50 70.00 200.00 Market price 440.00 54.00 250.00 Vale to be disclosed at B/s 406.50 54.00 200.00
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AS 14 - ACCOUNTING FOR AMALGAMATIONS - M.R. Sinduja (sindujaca07@yahoo.co.in)

Introduction to the standard: The ideology behind the word amalgamation has been derived from the term amalgam which means to unite, to come together as one, to blend. Two or more elements combine together to form an Alloy, same is called amalgamation when two or more companies come together and become a single entity. Such combo may be for various reasons and not limited to the objective of effective tax savings. The accounting treatment of this so commonly called amalgamation is the main area of our todays discussion. Scope of Coverage: Amalgamation is a process where the status of two or more legal entities vanishes and a new entity emerges. For eg if A ltd and S Ltd are liquidated and a new company named AS ltd is formed and it acquires the businesses of both A and S, it is termed as amalgamation. Let us look into the areas covered and excluded with regard to amalgamation. Inclusions: The provisions of Companies act 1956 or any other statute applicable to companies. Amalgamation is meant to include absorption as well, where absorption means business by an existing company. Eg: A ltd is taken over by B ltd an existing company, it is called as absorption. Exclusions: Amalgamation does not include acquisition. The cases where one company can obtain control over another, without affecting the status of each company being an independent and separate legal entity and yet deriving the benefit of alloy by acting as one single economic entity. Accounting treatment for such situations are covered under AS 21- Consolidated Financial Statements. acquisition of a
Important Definitions: Transferor Company - The company which is amalgamated into another company. The Company selling its business is also called the Vendor Company Transferee Company - The company into which a transferor Company is amalgamated is called the Transferee company. The buying company is also called the Vendee Company. Consideration for amalgamation i.e. purchase consideration means the aggregate of
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the shares and other securities (non-cash items) issued and the payment (cash) made in the form of cash or other assets by the transferee company to the SHAREHOLDERS (equity or preference) of the Transferor company but excludes Payments made to settle external liabilities like debentures and amalgamation expenses incurred. Amalgamation
Methods of Amalgamation:
Merger Amalgamation in the nature of Merger:
Purchase
Genuine pooling of Not merely of the assets and liabilities of the amalgamating companies. But also of the interests of shareholders and of the business of these companies. AS 14 specifies 5 specific conditions to be fulfilled for a MERGER All the assets and liabilities of the Transferor Company (for brevity lets name it as SC) become the assets and liabilities of the Transferee Company(as BC) Shareholders of SC holding not less than 90% of the face value of equity shares become the shareholders of BC by virtue of amalgamation. For purpose of computing 90% the shares already held prior to amalgamation by BC in SC One or more subsidiaries of BC in the SC, and Nominees of BC in the SC Should be EXCLUDED The consideration paid to equity shareholders of the SC is in the form of equity shares in the BC, except that cash may be paid in respect of any fractional shares. The business of the SC is intended to be carried on, after the amalgamation, by the BC, and Assets and liabilities of SC are incorporated in the Financials of the BC at book values except to ensure uniform accounting policies. Thus if SC is following SLM of depreciation and the BC is following WDV, the book value of the assets of SC will be revised by applying WDV. This would ensure uniform accounting policy for the pooled assets. Amalgamation in the nature of Purchase:
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The cases where One company acquires another company And as a consequence, the shareholders of the company which is acquired normally discontinue to possess interest in the equity of the amalgamated Company in a proportion identical, to that held by them in the liquidated company. Also the business of the company which is acquired is not necessarily intended to be continued. What is not a merger is Purchase. Even if one of the above conditions listed for Merger is NOT satisfied then it leads to PURCHASE. Methods of Accounting: NATURE OF AMALGAMTION Merger Purchase Pooling of Interest Method: Two key points to be noted Assets and Liabilities The assets and liabilities of the SC are to be recorded in existing carrying amounts and in the same form as at the date of amalgamation. The balance of profit and loss account to be aggregated with that of BC or transferred to General Reserve. Exception being when, In case at that time, the companies follow different accounting policies then the book values may be adjusted so as to be in line with policies of the BC. Such changes made are to be reported in accordance with AS 5. Difference between the share capital of the SC and the purchase consideration are to be adjusted as follows: DIFFERENCE BETWEEN CONSIDERATION AND SHARE CAPITAL METHOD OF ACCOUNTING Pooling of Interest Method Purchase
WHEN CONSIDERATION
WHEN SHARE CAPITAL
IS HIGHER
IS HIGHER
DIFFERENCE IS ADJUSTED IN THE RESERVES
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i.e NO GOODWILL OR CAPITAL RESERVE will arise out of amalgamation by way of merger. Purchase Method: The purchase method is very similar to that of accounting for a normal purchase of asset. The assets and liabilities will be accounted in accordance with the purchase consideration. Key points to be noted are: The assets and liabilities EXCLUDING RESERVES are to be accounted in the books of accounts of BC on FAIR VALUE basis thereby allocating the consideration proportionately among the net assets. ONLY STATUTORY RESERVES are to be maintained in the books of accounts of BC and other reserves are to be totally IGNORED. Difference between the Net Assets of the SC and the purchase consideration are to be adjusted as follows: DIFFERENCE BETWEEN CONSIDERATION AND NET ASSETS
WHEN CONSIDERATION IS HIGHER
WHEN NET ASSETS IS HIGHER
DEBIT TO GOODWILL A/C
CREDIT TO CAPITAL RESERVE A/C
The Goodwill arising on amalgamation to be amortised on a systematic basis over its useful life. However such amortization period shall not exceed 5 years unless longer period is justified. When recording the reserves as required by any statute the following entry is made: Amalgamation Adjustment Account Dr To Statutory Reserve Account Such amalgamation adjustment account is disclosed in the balance sheet under the heading Miscellaneous Expenditure. Whenever the reserve is no longer needed at such time the above entry is reversed and the reserve is no more maintained. SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI 81
Important differences between the two methods: POOLING OF INTEREST PURCHASE Discharge of purchase ONLY Shares, cash for Shares or securities or cash consideration fractional shares Assets and Liabilities Accounted at Book Values Accounted at Fair Values Reserves Brought into books of BC ONLY Statutory Reserves that also by debit to Amalgamtion Adjustment Account (reversed whenever statutory conditions are met) Difference between NOT recorded difference is Recorded as Goodwill or consideration and net asset adjusted in reserves Capital Reserve value of assets Other points to be noted: Non-Cash Consideration When there are cash and non-cash components, non-cash components are to be valued at FAIR VALUE. The FV may be taken as either the FV or the NET BOOK VALUE of assets given up when the market value is not reliably measurable. Value fixed by Statutory authorities may also be taken as FV. Consideration may be partly or whole conditional and based on happening of future events. When such is the case, if future events are predictable and can be estimated reliably then such amount to be included in consideration Else adjustment should be considered as soon as the amount is determinable. Sometimes in a scheme of amalgamation COURT APPROVAL is obtained. In such case Court approval may specify treatment of reserves different from that in AS14. In such cases following disclosures are needed as Company has to carry out Amalgamation Procedures as directed by the Court Order
Consideration based on future events
Treatment of Reserves
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Disclosure: Common Disclosures:
Description of treatment of Reserves Reason for the same Quantified Deviations in such differed treatment of reserves i.e between treatment as per AS 14 and Treatment as per Court Order
Names, general nature of business of amalgamating companies, Effective date Method of accounting Particulars of scheme Statutorily sanctioned Amalgamation after B/S date (before issue of FS) disclose as per AS 4 BUT NOT TO BE INCORPORATED IN FS For POOLING OF INTEREST METHOD 1st Financial Statement Description and No. of shares issued Percentage of Equity shares exchanged to give effect to amalgamation Difference between Consideration and NAV; treatment For PURCHASE METHOD 1st Financial Statement Consideration paid, and contingently payable Difference between Consideration and NAV; treatment Amortisation period of goodwill (if any) Significant Differences among AS-14, IFRS 3 and US GAAP AS -14 IFRS 3 Allows both Pooling of Interest Allows ONLY Purchase and Purchase Method. Method. Value of assets and liabilities to Valuation of Assets and be taken as Carrying Value. Liabilities to be done at FAIR VALUE. Requires AMORTISATION of Requires Goodwill to be tested Goodwill. Amortization should for IMPAIRMENT. Under IFRS not exceed 5 years. useful life of Goodwill is indefinite hence not amortised.
US GAAP Allows ONLY Method.
Purchase
Goodwill is not treated as Wasteful asset and hence does not require amortization but suggests to test for impairment. FAS 142 now requires Goodwill to be written off when repaired. 83
Negative Goodwill to be taken Requires immediate to Capital Reserve. recognition of Negative Goodwill in Profit and Loss account. Does not deal with Reverse Requires acquisition is Acquisition. accounted assuming acquirer is the acquiree. No provision for valuation of Requires valuation of Financial Financial Assets. Assets to be dealt with as per IFRS/IAS 39. No provision for consideration Provisional values can be used of Provisional values. provided they are updated retrospectively within 12 months with actual values. Illustration 1: A Ltd. and B Ltd. were amalgamated on and from 1st April, 2005. A new company C Ltd. was formed to take over the business of the existing companies. The Balance Sheets of A Ltd. and B Ltd. as on 31st March, 2005 are given below: (Rs. in lakhs) Liabilities A B Assets A B Ltd Ltd Ltd Ltd Share Capital Fixed Assets Equity Shares of Rs. 100 800 750 Land and Building 550 400 each 12% Preference shares of 300 200 Plant and 350 250 Rs.100 each Machinery Reserves and Surplus Investments 150 50 Revaluation Reserve 150 100 Current Assets, Loans and Advances General Reserve 170 150 50 50 Stock 350 250 Investment Allowance Reserve Profit and Loss Account 50 30 Sundry Debtors 250 300 Bills Receivable 50 50 Secured Loan 10% Debentures (Rs.100 60 30 Cash and Bank 300 200 each) Current Liabilities and provisions Sundry Creditors 270 120 Bills Payable 150 70 2000 1500 2000 1500
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Additional Information: (1) 10% Debenture holders of A Ltd. and B Ltd. are discharged by C Ltd. issuing such number of its 15% Debentures of Rs. 100 each so as to maintain the same amount of interest. (2) Preference shareholders of the two companies are issued equivalent number of 15% preference shares of C Ltd. at a price of Rs. 150 per share (face value of Rs. 100). (3) C Ltd. will issue 5 equity shares for each equity share of A Ltd. and 4 equity shares for each equity share of B Ltd. The shares are to be issued @ Rs. 30 each, having a face value of Rs. 10 per share. (4) Investment allowance reserve is to be maintained for 4 more years. Prepare the Balance Sheet of C Ltd. as on 1st April, 2005 after the amalgamation has been carried out on the basis of Amalgamation in the nature of purchase. Solution Balance Sheet of C Ltd. as at 1st April, 2005 Liabilities SHARE CAPITAL 70,00,000 Equity Rs.10 each Amt shares of 700 Assets FIXED ASSETS Goodwill Land and Building Plant and Machinery Investments (Rs. In lakhs) Amt 20 950 600 200
5,00,000 Preference shares of 500 Rs. 100 each (all the above shares are allotted as fully paid-up pursuant to contracts without payment being received in cash) RESERVES AND SURPLUS Securities Premium Account Investment Allowance Reserve SECURED LOANS 15% Debentures CURRENT LIABILITIES AND PROVISIONS Sundry Creditors Bills Payable
1650 100 CURRENT ASSETS, LOANS AND ADVANCES Stock 60 Sundry Debtors Cash and Bank 390 220
600 550 500
Bills Receivable 100 MISCELLANEOUS EXPENDITURE (to the extent not written off or adjusted) Amalgamation Adjustment 100 Account 3620 85
3620
Working Notes: A Ltd. (1) Computation of Purchase consideration (a) Preference shareholders: (3,00,00,000/100 i.e. 3,00,000 shares) * Rs. 150 each (2,00,00,000/100 i.e. 2,00,000 shares) * Rs. 150 each (b) Equity shareholders: (8,00,00,000/100*5 i.e. 40,00,000 shares) * Rs. 30 each (7,50,00,000/100*4 i.e. 30,00,000 shares) * Rs. 30 each 1200 900 1200 450 300 (Rs. in lakhs) B Ltd.
1650 (2) Net Assets taken over A Ltd Assets taken over Land and Building Plant and Machinery Investments Stock Sundry Debtors Bills receivable Cash and bank Less: Liabilities taken over: Debentures Sundry Creditors Bills payable 550 350 150 350 250 50 300 2000 40 270 150 460 Net assets taken over Purchase consideration Goodwill Capital reserve 1540 1650 110 20 120 70 210 1290 1200 90 B Ltd 400 250 50 250 300 50 200 1500
Note: Since Investment Allowance Reserve is to be maintained for 4 more years, it is carried forward by a corresponding debit to Amalgamation Adjustment Account in accordance with AS-14.
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Illustration 2: Three subsidiary companies viz., Company A, B and C, are being merged into another company, viz., Company D. The transferor and transferee companies have received approvals for merger from respective High Courts in January and February 2010 respectively. Required: (a) What is the nature of the reserves (whether capital or general reserves) for the purpose of AS 14 (Para 35) and for the purpose of giving effect to the scheme of amalgamation of the Company D in its books of account? (b) Whether such reserves are available for the purpose of distribution to shareholders as dividends and/or bonus shares. Solution (a) The difference between the issued share capital of the transferee company and the share capital of the transferor companies should be treated as capital reserve for the purpose of Para 35 of AS 14 and for the purpose of giving effect to the scheme of amalgamation of Company D in its books of account.
(b)Reserve created on amalgamation is not available for the purpose of distribution to shareholders
as dividend and/or bonus shares.
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AS 15 EMPLOYEES BENEFITS
- S. VIGNESH (cavignesh07@yahoo.com)
AS 15 has been revised by the Institute of Chartered Accountants of India and applicable in respect of accounting period commencing on or after 1st April 2006 OBJECTIVES The objective of this accounting standard is to prescribe the accounting treatment and disclosure requirement in respect of employees benefits in the financial statements of employers. APPLICABILITY Accounting standard is made applicable to different types of enterprises as under Level 1 enterprises in an Entirety Other than level 1 enterprises - If average number of persons employed during the year is 50 or more the accounting standard is applicable to such enterprises except the provision relating to Recognition and measurement of short term accumulating compensated absence in respect of which of employee are not entitled to cash payment for unused leave at the time of leaving the service Discounting the amount payable after 12 months of balance sheet as regards defined contribution plans and termination benefits. Recognition, measurement and disclosure principles ion respect of defined benefits plans and other long term employee benefits plan. However such enterprises should provide and disclosure the accrued liability in respect of defined benefits plans and other long term employee benefits plan as per actuarial valuation based in projected unit credit method and discount rate based on yield on government. If average number of persons employed during the year is less than 50 - such enterprise can determined and provide the liability and expenses as regards defined plans and long term employee benefits by assuming the such benefits are payable to all employees at the end of the accounting years and therefore recognition, measurement and disclosure principles as laid down in this standard in respect of defined benefits plans and long term employee benefits will not apply to such enterprises. Applicability to the companies - The SMCs have been given following relaxation as regards AS 15 employees benefits . SMCs need not comply with Paras 11 to 15 of AS 15 to the extent that deal with the recognition and measurement of short term accumulated compensating absences. Discounting the amount payable after 12 months of the balance sheet as regarded defined contribution plans and termination benefits. Recognition, measurement and disclosure principles in respect of in respect of defined benefits plans and other long term employees benefits plan however such enterprises should provide and disclose the accrued liability in respect of defined benefits plan and other long term employee benefits plan as per actuarial valuation based on projected unit credit method and discount rate based on yield on government bonds.
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EMPLOYEE BENEFITS Employee benefits are all forms of consideration given by an enterprise directly to the employee ,to their spouses, children or other dependants to other such as trust, insurance companies in exchange of service rendered by employee. This standard does not include share based payment like stock option these are covered by Guidance note issued by The Institute of Chartered accountants of India. MEANING OF EMPLOYEE For the purpose of this standard Employee includes whole time directors and management personnel. This standard is applicable to all form of employer and employee relationships. There is no requirement for formal employer and employee relationship. ACCOUNTING FOR SHORT TERM EMPLOYEES BENEFITS: The short term employees benefits are:I. Wages, salaries and social security contribution II. Short term compensated absences , where the absences are expected to occur within 12 months after the end of the period in which the employees render the related employee service III. Profit sharing and bonuses payable within 12 months after the end of the period in which the employee render the related services IV. Non monetary benefits The short term employee benefits should be only recognized only if the employee renders the service and it is accepted as expenses by another standard, it is recognized as a liability if the amount paid exceeds the amount which is actually paid and it is treated as an asset when amount paid exceed the amount of short term benefits. SHORT TERM COMPENSATION ABSENCES These are of two types accumulating and non accumulating.Accumulating compensation can be carry forward if the current year entitlement was not used in full. This can be again divided into vesting and non vesting types. Vesting compensated absence means entitlement of cash payment is not conditional on future employment. In this type employee are entitled to a cash payment when they leave the employment. In the case of second type i.e. Non vesting type payment does not arise. This accounting standard also require to recognize expected cost of accumulating compensating absences, when the absences occur. In the case of cost of non accumulating type of compensated absences it is computed if the employee is on the regular payroll. If the employee are not regular payroll employee then it should calculated during the period of absence in which the absence occur. Expected cost of accumulating compensated absence is the additional amount that the enterprises have to pay as a result of the unused entitlement has accumulated at the balance sheet date. PROFIT SHARING AND BONUS PLAN Under some profit sharing plans, employees receive a share of profit only if they remain with the enterprises for a specific period .Such plans create an obligation as employees render service that increases the amount to be paid if they remain in service until the end of the specified period. The measurement of such obligations can reflect the possibility that some employees may or may not have any legal obligations to pay bonus, but it may have the practice of bonus payment. Such of these enterprises has no realistic alternative but to make the payment. An enterprises should recognize the expected cost of profit sharing and bonus payments when and only when the enterprises has a present obligation to make such payments as a result of past events and ; a reliable estimate of the obligation can be made. SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI 89
POST EMPLOYMENT BENEFITS Post employment benefits include: Retirement benefits, e.g., pension etc Other benefits , e.g., post employment life insurance etc Post employment benefits plan can be classified into contribution plan and defined benefits plans. DEFINED CONTRIBUTION PLAN Under this defined contribution plan, the enterprises obligation is limited to the amount that agrees to contribute to the fund. Thus, the amount of post employment benefits received by the employee is determined by the amount of contribution paid by the enterprises to the post employment benefits plan or to a contribution and the employer is no longer liable to pay the post employment benefits to the employee. DEFINED CONTRIBUTION PLAN is again divided into three parts; they are Multi-employer plans, state plans, and insured benefits. MULTI EMPLOYER PLANS The multi employer plans are defined contribution plan or defined benefits plan and that are pool the assets contributed by various enterprises that are not under common control and those assets to provide benefits to the employer of more than one enterprises on the basis of contribution and benefits level are determined without regard to the identity of the enterprises that employ the employees concerned. Accounting for the multi employer plan is treating it as defined contribution plan, is simple. Periodical contribution paid by the employer in multi employer plan is DEBITED in expenses account and CREDITED in bank account. If the contribution is not paid and partly paid the amount is CREDITED to payable account. STATE PLANS It was established by the legislation to cover all enterprises of a specific industry or all enterprises and is operated by national or by state government. It may be classified as defined contribution plan or defined benefits plans based on enterprise obligation under plan. Accounting for state plans is contribution paid by the employer is DEBITED to expenses account and if it is payable is CREDITED to liability account. INSURED BENEDITS Where the employer takes insurance policy from an insurance company for meeting obligations under post employment benefits and employer has no obligation to pay the benefits to the employee and the insurer has sole responsibility for paying the post employment benefits. The payment of fixed premium under such contract is in substance the settlement of the employee benefits obligation. The enterprises should treat contribution payment to defined contribution plan. If the obligation is side of employer is should be treat such payment as defined benefits plans and not defined contribution plan and accounting treatment should be done accordingly. The enterprises should DISCLOSE the amount recognized as expenses for defined contribution plan and contribution added to defined contribution plan for key management personnel.
DEFINED BENEFITS PLAN
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Defined benefits plans are retirement plans like Gratuity, pension etc, that defines an amount of benefits to be provided usually as a function of one or more factors such as years of service , salary etc. ACTUARIAL VALUATION is done by actuary an expert who can reliably estimate the amount of obligation under various uncertainties.
ACCOUNTING TREATMENT FOR DEFINED CONTRIBUTION PLAN. THE accounting treatment for defined benefits plans are:Actuarial assumption are required to measure the obligation under this plan obligations are measured on discounted basis because they are not settled now it is only accrue only after many years of employee renders his service. And actuarial loss or gain is possible.
The net total of the following amounts should be charged to profit and loss account as cost of defined benefits plan excluding the employee benefits cost which is to be capitalized as per another accounting standard. Interest cost Past service cost Current service cost Actuarial gains or losses Expected return on any plan assets The effect of any curtailment re settlement Effect of recognition of over funding of defined benefits plans at lower of over funding amount and present value of any economic benefits available in the plan or reduction in future contribution to the plan. ACCOUNTING FOR THE OBLIGATION OF BALANCE SHEET. The recognition and measurement of plant assets. Plants assets consist of assets held by long term employee benefits fund and qualifying insurance policies if the proceeds of the policy can be used only to pay pr fund employee benefits under a defined benefit plan The amount recognized as a defined benefit liability in the balance sheet should be net of total of the following amounts: The present value of the defined benefit obligation at the balance sheet date MINUS any past service cost which are not recognized MINUS the fair value at the balance sheet date of plan assets(if any) out of which the obligations may be made at intervals not exceeding three years. MEASUREMENT RECOGNITION OF PLAN ASSETS The fair value of the assets is deducted in determining the amount recognized in the balance sheet. When there is no market value is available the fair value of plan assets estimated. The plan assets should exclude unpaid contribution due from the reporting enterprise to the fund as well as any non transferable financial instruments issued by the enterprises and held by the financial instruments issued by
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the enterprise and held by the fund. Plan assets are also reduced by any liability of the fund that do not relates to employee benefits. REIMBURSEMENTS TO BE RECEIVED AS ASSETS. Only went it is virtually certain that certain that another party will reimburse some of the expenditure required to settle a defined benefits obligation an enterprise should recognize its right to reimburse as a separate asset. The enterprise should treat same way as plan assets. DISCLOSURE benefits plan An brief analysis of the defined benefits obligation and fair value of the plan assets to the assets and liabilities recognized in the balance sheet The total expenses recognized in the statement of profit and loss and the line items of the statements of profit and loss in which they are included For each major category of plan assets which should include but is not limited to equity instrument debt instrument property and all other assets the % or amount that each major category constitutes of the fair value of the total plans assets The amount included for the fair value of the plan assets A narrative explanation about the overall expected returns The actual and reimbursement of an assets The actuarial assumptions The effect of an increase of 1 % point and effect of a decrease of 1% point is assumed medical cost trend rates on expenses and obligations Employers best estimates as soon as it can be reasonably determine The disclosure about multi employer defined benefits plan that are treated as if they were defined contribution plans OTHER THAN LONG TERM EMPLOYEES BENEFITS Other than long term employees benefits it includes Long term compensated absence such as long term service Long term disability fund Deferred compensation paid 12 months or more after the end of the period in which it is earned Profit sharing and bonus payable 12 months or more the end of the period which the employee render the related service ACCOUNTING FOR LONG TERM EMOPLOYEMENT BENEFITS The accounting is similar to post employment benefits except all past service cost is recognized immediately DISCLOSURE The disclosure requirement is required by other standard that is AS 5 and AS 18
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The disclosure requirements are The enterprise accounting policies and actuarial gains and losses A general description of the type of plan A reconciliation of opening and closing balances of present value of the defined
TERMINATION BENEFITS Termination benefits are employee benefits payment on the results of an entities decision to terminate an employee before normal retirement or the employee employment voluntary retirement in exchange for those benefits. ACCOUNTING TREATMENT FOR TERMINATION BENEFITS. TERMINATION expenses are treated as an expenses immediately however if the enterprises incur the expenditure on termination on or before 31 march 2009 the enterprises may choose to follow the accounting policy of deferred and expenditure over pay back period. However the expenses so deferred cannot be carried forward to accounting period commencing from 1 April 2010
DISCLOSURE If there is any contingent liability the disclosure requirement under AS 29 and AS 5 on prior period items and also AS 18 on related parties is required. EXAMPLE:The application of AS 15 In TATA CONSULTANCY SERVICE LIMITED POST EMPLOYMENT BENEFITS PLANS Contribution to defined contribution retirement benefits schemes are recognized as an expenses when the employees have rendered service entitling them to contribution. For the defined benefits scheme the cost of providing benefits is determined using projected unit credit method with actuarial valuations being carried out at each balance sheet date. Actuarial gain or loss are recognized in full in the profit and loss account for the period in which they occur. Past service cost is recognized immediately to the extent that benefits are already vested and otherwise is amortized on a straight line basis over the average period until the benefits become vested. The retirement benefits obligation recognized in the balance sheet represents the present value of the defined benefits obligations as adjusted for unrecognized past service cost and as reduced by the fair value of scheme assets. Any assets resulting from this calculation is limited to the present value of available refunds and reductions in future contributions to the scheme. SHORT TERM EMPLOYMENT BENEFITS The undiscounted amount of short term employment benefits expected to be paid in exchange for the service rendered by the employees is recognized during the period when the employee render the service. These benefits include compensated absence such as paid annual leave, overseas social security contribution and performance incentives. LONG TERM EMPLOYMENT BENEFITS Compensated absence which are not expected to occur within 12 months after the period in which the employee render the related service are recognized as an actuarially determined liability at the present value of the defined benefits obligation at the balance sheet date.
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AS 16 BORROWING COST
- Saranya M. Krishnan (sarkricas@gmail.com)
Introduction
One of the well-accepted forms of financing is meeting of portion of business needs through borrowals. It may be for day to day operations or capital expenditure. There can be situations where the time lags between building up of an asset and subsequent creation of earnings from the property is substantially long. The amount of borrowing costs eligible for capitalization should be determined and other borrowing costs should be recognized as expenses in the period in which they are incurred. There is, therefore an imperative need to accord proper accounting treatment for recognizing and recording borrowing costs incurred during a period properly attributable to creation of relative asset.
Scope
This Standard prescribes accounting treatment for borrowing costs and does not deal with the actual or imputed cost of owners equity, including preference share capital not classified as a liability. Section 208 of the Companies Act, 1956, provides for capitalization of interest paid on funds raised by the way of share capital, subject to authorization by the articles or by a special resolution and with previous approval of the Central Government. The statutory provisions have been accorded due priority and hence excluded from AS 16.
Definition
1. Borrowing Cost
It includes interest and other costs incurred in connection with borrowed funds. Elements of borrowing costs generally include: Interest and commitment charges on bank borrowings
(Commitment charges refers to the charges which are sometimes stipulated to be payable to the lender between the date loan agreement is finalized and the date the loan or any part thereof is actually taken by the company) Discounts and premiums on borrowings to the extent amortized Other ancillary costs for arranging borrowings to the extent amortized Finance charges in respect of assets under Finance Lease or under other similar arrangements
E.g. You lease some bulldozers under finance leases. You use them for the whole year on building a stadium, a qualifying asset. Accounting for finance leases involves splitting the costs between depreciation and finance charges. The finance charges will be included as borrowing costs. Exchange rate differences relatable to foreign currency borrowings, to the extent that they are regarded as an adjustment to interest costs. (Explanation is dealt in detail with an example at the end of this standard)
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2.
Qualifying asset
It is an asset that necessarily takes substantial period of time to get ready for its intended use or sale. Examples of Qualifying assets Exclusions from Qualifying assets Manufacturing Plants Assets that are ready for their intended use or sale when acquired Power Generation Facilities Inventories that are routinely manufactured or Inventories that require a substantial period of otherwise produced in large quantities on a repetitive basis over a short period of time time to bring them to a saleable condition Investment properties Investment other than Investment Properties As per ASI 1: A period of 12 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 each case. The time that an asset takes technologically and commercially, to get ready for its intended use or sale should be considered in this regard. The following assets ordinarily take 12 months or more to get ready for its intended use or sale, unless the contrary is proved by the enterprise: Assets that are constructed or otherwise produced for an enterprises own use, Assets constructed under major capital expansions, and Assets intended for sale or lease that are constructed or otherwise produced as discrete projects e.g. ship building Inventories are said to involve substantial period of time, when time is the major factor in bringing about a change in their condition, e.g. maturing of liquor for longer periods.
Recognition Principles
Borrowing costs that are directly attributable to the acquisition, construction or production of qualifying assets should be capitalized as part of the cost of that asset. In recognizing Borrowing costs that can be capitalized, the following important attributes are to be taken cognizance of: It is probable that the qualifying asset will result in future economic benefits Costs that are to be capitalized can be measured reliably Example 1 Venugopal Ltd obtained a loan from the Bank for Rs.50 lakhs to be utilized as under: (a) (b) Construction shed Rs.20 lakhs Working capital Rs.10 lakhs (c) Purchase of Machinery Rs.15 lakhs (d) Advance to Purchase of truck Rs.5 lakhs
As at the end of financial year, construction of shed was completed and machinery installed. Delivery of truck was not received. Total interest charged by the Bank for the year was Rs.9 lakhs. Show the treatment of interest under AS-16. [P (A/c) Nov 2004] Solution
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Principle:As per AS-16, borrowing costs that are directly attributable to the acquisition, construction or production of qualifying assets should be capitalized as part of the cost of that asset. Other borrowing costs should be recognized as expenses in the period in which they are incurred. Analysis:Interest rate for the loan = Rs.9 lakhs / Rs.50 lakhs = 18%. Conclusion:The treatment for the total interest of Rs.9 lakhs is given below: Purpose Loan amount Interest amount Accounting Treatment Construction of shed Rs.20 lakhs Rs.20 lakhs x 18% = Added to Cost of shed as per ASRs.3.60 lakhs 16. Purchase of Rs.15 lakhs Rs.15 lakhs x 18% = Added to Cost of shed as per ASMachinery Rs.2.70 lakhs 16. Working capital Rs.10 lakhs Rs.10 lakhs x 18% = Written off to P&L account as per Rs.1.80 lakhs AS-16. Advance to purchase Rs.5 lakhs Rs.5 lakhs x 18% = Kept in Capital Work in Progress of truck Rs.0.90 lakhs a/c till the date of acquisition / installation of additional assets and capitalized later on asset creation. Total Rs.50 lakhs Rs.9 lakhs
Specific and General Borrowings

The amount of borrowing costs eligible for capitalization is determined as under: Nature Borrowed Specifically Borrowed Generally Situation When an enterprise borrows When the financing activity of an funds specifically for the purpose enterprise is coordinated of obtaining a particular centrally or when a range of debt Qualifying Asset. instruments are used to borrow funds at varying rates of interest and such borrowings are not readily identifiable with a specific Qualifying Asset. Direct Attribution The Borrowing costs that directly Identification of a direct relate to that Qualifying Asset can relationship between particular be readily identified. borrowings and a Qualifying Asset requires exercise of judgement. Amount to be capitalized Actual Borrowing costs on that The amount of Borrowing costs Borrowing during the period. eligible for capitalization should Less: Income on the temporary be determined by applying a investment of those borrowings, if Capitalization Rate to the any expenditure on that asset. Use of Capitalization Rate
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The Capitalization rate should be the Weighted Average of the Borrowing Costs applicable to the borrowings that are outstanding during the period, other than borrowings made specifically for the purpose of obtaining a Qualifying Asset. Weighted Average Capitalization Rate for General Borrowings Total Interest less Interest on specific borrowings Total Borrowings less Specific Borrowings
The amount of Borrowing Costs capitalized during a period should not exceed the amount of Borrowing Costs incurred during that period. Example 2 Rainbow Ltd. borrowed an amount of Rs.150 crores on 01.04.2009 for construction of boiler plant @ 11% p.a. The plant is expected to be completed in 4 years. The weighted average cost of capital is 13% p.a. The accountant of Rainbow Ltd. capitalized interest of Rs.19.50 crores for the accounting period ending on 31.03.2010. Due to surplus fund out of Rs.150 crores, an income of Rs.3.50 crores was earned and credited to profit and loss account. Comment on the above treatment of accountant with reference to relevant accounting standard. [F (A/c) May 2010] Solution Principle:As per AS-16, For Specific Borrowings, Amount to be capitalized = Actual Borrowing costs on that Borrowing during the period less Income on the temporary investment of those borrowings. Weighted average of capitalization rate will be used for borrowings made generally. Analysis:In the given case, the amount of Rs.150 crores was specifically borrowed for construction of boiler plant. Therefore, treatment of accountant of Rainbow Ltd. is not correct and the amount of borrowing costs to be capitalized for the financial year 2009-10 should be calculated as follows: Particulars Interest paid for 2009-10 (11% on Rs.150 crores) Less: Income on temporary investment from specific borrowings Borrowing costs to be capitalized during 2009-10 Rs. (in crores) 16.50 (3.50) 13.00
Conclusion:Crediting the amount of Rs.3.50 crores to P&L a/c is not proper. This amount should be used to reduce the amount of Borrowings Costs eligible for capitalization. Linkage between Carrying amount and Recoverable amount of Qualifying Asset The carrying amount of a fixed asset as reflected in the Financial Statement cannot exceed its recoverable amount or net realizable value.
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If the carrying amount or the expected ultimate cost of Qualifying Asset exceeds its Recoverable amount or Net Realizable Value, the carrying amount is written down or written off in accordance with the requirements of other Accounting Standards. In certain circumstances, the amount of write-down or write-off can also be written back in accordance with those other Accounting Standards. Example 3 Cost of an inventory item is Rs.90,000. Borrowing cost capitalized as per AS-16 is Rs.12,000. What will be the accounting treatment if the NRV of this item is: (a) (b) Rs.1,15,000 Rs.87,000
Solution Carrying amount of the inventory item: Rs.90,000 + Rs.12,000 = Rs.1,02,000. (a) (b) If NRV of this item is Rs.1,15,000, the difference will be ignored. The inventory is carried at Cost or NRV whichever is lower. Inventory will be carried at Cost Rs.1,02,000. If NRV of this item is only Rs.87,000, the difference of Rs.15,000 (Carrying amount Rs.1,02,000 NRV Rs.87,000) will be written off as per AS-2 requirements. Inventory will be carried at Rs.87,000.
Capitalization Criteria
A. Commencement of Capitalization
Capitalization of borrowing costs as part of the Cost of Qualifying asset should commence only when all the following conditions are satisfied: The expenditure is being incurred for the (a) acquisition (b) construction, or (c) production of a Qualifying Asset, Borrowing cost are being incurred, and Activities that are necessary to prepare the asset for its intended use or sale are in progress. Expenditure on qualifying assets (a) Eligible amount: Expenditure on a qualifying asset includes only such expenditure resulting in: i) Payment of Cash ii) Transfers of other assets, or iii) The assumption of interest-bearing liabilities Only these expenditure items are eligible for capitalization of borrowing costs.
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(b) Reductions: From the eligible amount, any: Progress payments received, and Grants received in connection with the asset should be deducted.
(c) Apply Capitalization Rate: The average carrying amount of the asset during a period, including borrowing costs previously capitalized, is normally a reasonable approximation of the expenditure to which the capitalization rate is applied in that period.
B.
Suspension of Capitalization
Capitalization of borrowing costs should be suspended during extended periods in which active development is interrupted. Borrowing cost incurred during such periods of suspension represents cost of holding incomplete asset and hence should not be capitalized. Capitalization of borrowing costs is not normally suspended During a period when substantial technical and administrative work is carried out. When a temporary delay is a necessary part of the process of getting an asset ready for its intended use or sale. E.g. Capitalization should continue during the extended period needed for inventories to mature. Example 4 ABC Ltd commenced construction of a flyover in Mumbai in Jan 2006 under BOLT scheme. The same was completed in Feb 2007. Due to heavy seasonal rains in July 2006 in the area, the work on the flyover had to be suspended for a month. The Company accordingly suspended capitalization of borrowing costs of Rs.12.50 lakhs for that month. Comment. [F (Aud) Nov 2005] Solution Analysis:In the instant case, it has been mentioned that the construction activity was interrupted for a month due to seasonal rain. Though the rain was heavy, the period cannot be considered as extended period leading to substantial delay in suspension of construction activities. This period can be considered as a temporary delay and hence eligible for capitalization purposes. Conclusion:Borrowing cost of Rs.12.50 lakhs incurred by ABC Ltd should be capitalized. Suspension of capitalization by the company is not a correct treatment as per AS-16.
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C.
Cessation of Capitalization
Capitalization of borrowing costs should cease when: All activities necessary for making assets ready for intended use/sale are substantially complete. Items of administrative work or finishing touches to be completed happen to be minor in nature. Where an asset is completed in parts, and completed part is capable of use when work on others is in progress, capitalization for completed part should be stopped. Example 5 Determine the dates from which capitalization should cease: Building A Completed in full in March Building B Completed in full in April but not accessible until Building C is completed Building C Completed in December Building D Completed in June but got electricity connection and was ready for intended use in July Solution Building A Building B Building C Building D March December December July
Exchange difference on foreign currency borrowing attributable to borrowing cost - (ASI 10) (a) Borrowing costs may include exchange differences arising from Foreign Currency Borrowings to the extent that they are regarded as an adjustment to interest costs. (b) Foreign currency borrowings may have lower interest rates than corresponding amount of local currency loans. In such cases, the advantage in lower loan interest rates is offset by the currency depreciation and exchange difference losses. Hence, such exchange differences should be regarded as borrowing costs, in order to reflect the economic reality. (c) Step 1 2 3 4 5 6 7
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The procedure for capitalization in such cases are as follows: Procedure Interest on Local currency borrowings (i.e. at a higher rate of interest) Interest on Foreign currency borrowings (i.e. at a lower rate of interest) Difference in interest between foreign & local currency borrowings = (1) (2) Exchange difference in Principal repayable at the end of the year Further amount to be considered as Borrowing costs = (3) or (4) whichever is less Balance exchange difference to be taken to P&L a/c as per AS-11 = (4) (5) Borrowing costs under AS-16 = (2) + (5)
Example 6 XYZ Ltd has taken a loan of USD 10,000 on April 1, 2003 for a specific project at an interest rate of 5% p.a payable annually. On April 1, 2003, the exchange rate between the currencies was Rs.45 per USD. The exchange rate, as at March 31, 2004, is Rs.48 per USD. The corresponding amount could have been borrowed by XYZ Ltd in local currency at an interest rate of 11% p.a as on April 1, 2003. Determine the amount of borrowing cost as per AS-16. Solution Step 1 2 3 4 Particulars Interest on Local currency borrowings (i.e. at a higher rate of interest) Interest on Foreign currency borrowings (i.e. at a lower rate of interest) Difference in interest between foreign & local currency borrowings = (1) (2) Exchange difference in Principal repayable at the end of the year Further amount to be considered as Borrowing costs = (3) or (4) whichever is less Balance exchange difference to be taken to P&L a/c as per AS-11 = (4) (5) Borrowing costs under AS-16 = (2) + (5) Amount (Rs.) $10,000 x Rs.45 x 11% = Rs.49,500 $10,000 x Rs.48 x 5% = Rs.24,000 Rs.49500 Rs.24,000 = Rs.25,500 $10,000 x (48 - 45) = Rs.30,000 Rs.25,500 Rs.30,000 Rs.25.500 = Rs.4,500 Rs.24,000 + Rs.25,500 = Rs.49,500
5 6 7
Disclosure Requirements
The Financial Statements should disclose (a) The accounting policy adopted for Borrowing Costs, and The amount of Borrowing Costs capitalized during the period.
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AS 17 SEGMENT REPORTING
- Ramanujam Raghavan (rama_rghv@yahoo.com)
For a quite some time, there has been an increasing pressure on ICAI to introduce standards on accounting that would make financial statements more transparent and provide users especially investors and lenders the information they rightly deserve. With the advent of US listing by Indian companies, the gap between US or International Standards and Indian Standards came very obvious. One such inadequacy in the financial statements is that segment information was not required to be provided, which is now mandatory requirement. SYNOPSIS Preamble to Standard Primary reporting Test for reportable segment Identification of segments Definitions Secondary reporting Applicability PREAMBLE Every entity as they enter multiple lines of business they expand to different geographical areas. Tata motors manufacture commercial vehicles (CV- Trucks) and passenger vehicles (PV Cars). The risk and reward of CV is significantly different from PV. Demand for CV would come only when economy mainly agro industry grows. In CV there is no need of showroom or test drive when compare to PV. While preparing statements they prepare combined Profit and Loss account and income and expenditure account and balance sheet. From user point of view it is not helpful for decision making due to risk and return for CV & PV are different. The combined information does not give any information to the users. By giving splitting up separately the user can help in decision making. AS 1 state the purpose of financial statements Understanding what happened yesterday to extrapolate. Decision will be as per the ability of the company in future and not historical performance. So financial statements should be prepared in order to achieve the purpose of decision making. In CV market saturated market growth 5% expansion, net growth increase. In combined statements, we cannot figure out the prospects. AS 17 was introduced to enhance information to users for decision making. PRIMARY REPORTING It is a report for shareholders. Information you give should be more detailed to the bottom level of information pyramid. As you go on higher in the pyramid, top information should be summarized and given to shareholders. So AS 17 has to go segment reporting with revenual segment and total column. AS 17 should give information only to reportable segment (which are large segment), while small segment should be consolidated and shown as others. The total column should tally with that of Profit and Loss account and balance sheet. SEGMENT REPORT Standard requires only major segment. Identification of major segment is done by 5 tests. You are giving information to share holders which should be summary, relevant and major segment. Cost is prohibited to be given as per AS 17. Cash flow is given because users must be aware of cash flow generated. For example Capital expenditure in three segments are 10cr, NIL, (4cr). This will enable the users to know which expansion, stagnation, contractions.
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TEST FOR REPORTABLE SEGMENT
REVENUE TEST If a segment revenue is => 10% enterprise revenue, such segment revenues will all form as segments
The segment revenue consists of both internal and external sales. But in combined profit and loss account of whole organization, we have sales only for external. So we should not take enterprise revenue as it includes only external sales and not internal sales. Therefore we need to take segment revenue of all segments. ASSET TEST If a segment assets is => 10% enterprise assets, such enterprise assets will all form as segments
This entire standard focuses on operation segment and not financial segment. Therefore only operational assets are to be included.
RESULT TEST
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STEPS Each segment Profit and Loss Ascertain total Profit and Loss Select a higher value of above two items as per absolute and not value 10% of above number verified with segment Segment - Reportable or Not reportable
S1 2
S2 18
S3 -4
S4 -12
S5 -14
TOTAL 20 -30
30 3 Not Reportable Reportable Reportable Reportable Reportable
This test structure is there because, loss making segment will escape reporting requirement. Profit making segment will be captured in other test. In order to catch the loss making segment this test structure is made. MANAGEMENT CHOICE It is a freedom given to managers to report or not. If 15 segments there and 5 segments are selected through revenue, asset result tests. The left out are ten segments. The management may feel why these segments not passed the tests. If segments expected to be material enough and wants shareholders to know about it then they may report on that segment. So as per management judgments subjected to risks and rewards, they may think that this segment will be major one in near by future. So management can select some segment and report also. They cannot show all segments since they are constrained by relevance. 75% Test This is a checking kind of balance criteria. As far as organization performance, profitability, sustainability it is essential for external sales. But we have done test of internal and external test. Profit consists of internal and external. But organization external profits are critical. At the end, external sales of these revenue segment identified under first 4 test is it greater than 75% if enterprise external sales. If it is yes, no further steps complete report. If it is no, out of leftover segment, select segment which is pre-dominance based on risk or return which is sensitive and bring them as reportable segment. IDENTIFICATION OF SEGMENTS How do you find how many segments in the business there? Eg: Operations in different geographical areas. We have to conduct sales in different way in different geographical areas. For example if there are garment sales to UK, USA, France and Germany. In US and UK there is a currency risk, good market and dynamics are different. However in France and Germany there is same currency and same market risk. UK and US are politically poking nose. While France and Germany politically silent and they away. So as per above facts AS 17 recognizes only three segments US, UK, France and Germany but prime facie there are 4 segments. Therefore for AS 17 there are criteria for enable identification segments. Organization Structure Identify what segment After identification put in test of Business segment Geographical segment currency and political risk. DEFINITIONS 1. Business Segments
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Distinct (separate) components of an enterprise dealing with products and services or group of relative products and services whose risk and rewards are different from others. Factors for identification of business segments are as follows:PARTICULARS Nature of products and services Production method Distribution method Types of customers Regulatory environment 2. Geographical Segments Distinct (separate) components of an enterprise operating in an economic environment whose risk and rewards are different from operations in other economic environments. Factors for identification of business segments are as follows:DETAILS Soap, detergents, cosmetics Steel Production Hot roll or cold roll NIIT Branches and franchise Corporate sale, Retail sale Life insurance and non-insurance fire and marine
PARTICULARS Political and economic environment Currency risk Exchange control regulation Prohibition of operations
DETAILS N.Korea/ S.Korea S.Korea politically strong
Some countries have capital control convertibility. While other countries does not have Agricultural products export to Canada, Australia and New Zealand. Due to proxibility of operations we treat one segment (Canada) and other different segment (Australia, New Zealand). On the basis of geographical segment though currency and political is same.
Within India segregation to segments is possible only when there is a special risk in a particular area, where the cost of delivery is more, then there it is segregation as a separate segment. But within country it is treated as one segment. There are certain states where there are prohibitions and choices too. They are separately treated like that of SEZs and non-SEZs. 3. Segment Revenue INCLUDES External sales Internal Sales (Sales transfer) Common income allocated on a reasonable basis Organization raise common invoice for multiple products. Eg : Shipyard designing & constitution
EXCLUDES Extra-ordinary items Income from investments unless business is finance in nature.
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4. Segment Expenses INCLUDES Expenses incurred by segment on external transactions Expenses incurred by segment on inter segment transactions Common expenses capable of reasonable allocation. Eg: Various mills located in one lease plant. Rent allocated to all mills. EXCLUDES Extra-ordinary items Income from investments unless business is finance in nature. Income tax
5. Segment Result = Segment Revenue- Segment Expense 6. Segment Assets INCLUDES Identified directly to segment Common asset capable allocation. 7. Segment Liabilities INCLUDES EXCLUDES Identified directly to segment Financial Liabilities Common liabilities capable of reasonable Corporate Liabilities (Provision for tax) allocation. 8. Segment Policy It is nothing but organizations corporate Policy SPECIFIC POLICIES in relation to segment reporting As per IND AS what ever the organization Transfer pricing policy policy the same policy should be segmented. As per US GAAP it gives freedom for choosing Basis of allocation of common items. any policy in segment reporting through different policy followed in the organization. SECONDARY REPORTING Most of organization will have only one business segment or geographical segment. But 10% to 15% will have both business and geographical operations. The standards states that where both segments there, select any one of them as primary reporting and other as secondary reporting. Selection based on pre-dominance of risk
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of
EXCLUDES Financial assets reasonable Corporate asset (Advance tax)
ENTERPRISE ACCOUNTING POLICY
and return Judgment basis. But in some cases it is difficult to make choice between geographical and business segments. In that case standard give two choices Matrix choice Go as per AS choice
MAXTRIX APPROACH
Here reporting of business in columnar and geographical in row format BS1 BS2 Revenue G1 US G1 UK G1 Europe APPLICABILITY It is applicable to Joint stock companies which are other than SMC Non Company entities which are Level I enterprises. AMENDMENT TO AS 17 3yrs OLD Suppose enterprises to which this standard is applicable, if you are operating in only one segment and dont have multiple segments then there is no question of segment reporting. Eg : Company producing bricks. Standard applies and there is only one segment. Then you should disclose notes to account that we operate in one segment, so no segment reporting. Notes to report (segment reporting) is part and parcel of segment reporting BS3
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AS 18 RELATED PARTY TRANSACTIONS

- Saranya M. Krishnan (sarkricas@gmail.com)
Introduction
Investors and users are entitled to believe that all the transactions of an entity are at arms length and are between independent parties. Where trading or borrowing transactions are not carried out at arms length, additional information is needed to ensure that users and investors can understand the financial position in its proper perspective. Transactions, which are not at arms length, are vulnerable to being altered prior to their completion, or are likely to take place on terms significantly different from the terms of normal trading, or may not even be taking place at all. Due to the above, the accounting measures may not represent what they usually would be expected to represent. Thus, related party transactions and relationships could have an effect on the financial position and operating results of the reporting enterprise.
Scope
1. Objective The objective of AS-18 is to establish requirements for disclosure of: Related party relationships, and Transactions between a reporting enterprise and its related parties.
2. Applicability AS-18 is applicable to disclosure of Related Party relationships in: The Financial Statements of each Reporting Enterprise, and The Consolidated Financial Statements presented by a Holding Company.
3. Exclusions The provisions of AS-18 are not applicable in the following cases: When disclosure under AS-18 would conflict with the Reporting Enterprises duties of confidentiality as specifically provided and is expressly prohibited in terms of Statute or by any Regulator or by similar competent authority. E.g. Banks are obliged by law to maintain confidentiality in respect of their customers transactions. Transactions between members of a Group in their Consolidated Financial Statements, since they provide information on the Group as a whole.
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State Controlled Enterprises as regards Related Party relationships with other State Controlled Enterprises and transactions with such enterprises.
Definitions
(a) Related Party Parties are considered to be related if, at any time during the reporting period one party has the ability to (i) control the other party or (ii) exercise significant influence over the other party, in making financial and / or operating decisions. The following are not deemed to be related parties for AS-18 purposes: Common directors A single customer, supplier, franchiser, distributor or general agent with whom as enterprise transacts a significant volume of business merely by virtue of the resulting economic dependence. The parties listed below, in the course of their normal dealings with an enterprise by virtue of only those dealings: (i) (ii) (iii) (iv) Providers of Finance, Trade Unions, Public Utilities, Government Departments and Government Agencies including Government Sponsored bodies.
(b) Related Party Relationships Related Party relationships between enterprises are determined by the following aspects: (i) Control: Enterprises that directly, or indirectly through one or more intermediaries, control, or are controlled by, or are under common control with, the Reporting Enterprise. As per ASI 19: The term intermediary means enterprises which are subsidiaries as defined in AS-21. (ii) Associate / Joint venture: Associates and Joint venture of the Reporting Enterprise and the Investing Party or Venturer in respect of which the Reporting Enterprise is an Associate / Joint venture. Ownership: Individuals owning, directly or indirectly, interest in voting power, giving them control or significant influence over enterprise and Relatives of any such individual. Key Management Personnel and relatives of such personnel, and Significant Influence: Enterprises over which any person described in (iii) or (iv) is able to exercise significant influence. 109
(iii) (iv) (v)
Note: The Related Party Relationship may exist at any time during the reporting period and not necessarily at the end of the reporting period. (c) Related Party Transaction refers to a transfer of resources or obligations between Related Parties, regardless of whether or not a price is charged. (d) Control Control arises from: (i) (ii) (iii) Ownership, directly or indirectly of > 50% of the voting power of an enterprise. Control of the composition of the Board of Directors in the case of a company or Governing Body in the case of any other enterprise A substantial interest in voting power and the power to direct, by statute or agreement. The control of composition of BOD of a company or Governing Body of other enterprises arises out of power that can be exercised without consent or concurrence of any other person to appoint or remove all or a majority of directors. (e) Significant Influence It refers to participation in the financial and / or operating decisions of an enterprise, but not control of those parties. Significant influence may be gained by (i) Share ownership, (ii) Statute, or (iii) Agreement. It may be exercised in several ways like: Representation on the Board of Directors Participation in the policy making process Material inter-company transactions Interchange of managerial personnel Dependence on technical information (f) Substantial Interest An enterprise/individual is considered to have a substantial interest in another enterprise if that enterprise/individual owns, directly or indirectly, 20% or more interest in the voting power of the other enterprise. When less than 20% voting power is held, it is presumed that there is no significant influence unless contrary is proved. (g) Key Management Personnel They are those persons who have the authority and responsibility for planning, directing and controlling the activities of the reporting enterprise. E.g. In a company, the Managing Director(s), Whole Time Director(s), Manager and any person in accordance with whose directions the BOD of the Company is accustomed to act, are usually considered as Key Management Personnel.
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ASI 23: Remuneration to Key Management Personnel Remuneration paid to Key Management Personnel will be related party transaction requiring disclosure under AS-18, except that remuneration paid to a Non-Executive Director merely by virtue of being a director, need not be reported unless any other provisions of AS-18 are attracted. Example 1 Rajkumar, a relative of Key Management Personnel, received remuneration of Rs.2,50,000 for his services in the Company for the period from 1st January to 30th June. On 1st July, he left the service. Should the relative be identified as at the closing date i.e. on 31st December for the purposes of AS-18? Solution Principle: Parties are considered to be related if, at any time during the reporting period one party has the ability to (i) control the other party or (ii) exercise significant influence over the other party, in making financial and / or operating decisions. Conclusion: In the above case, remuneration paid to Rajkumar should be disclosed under AS-18, even if the relationship did not exist on the Balance Sheet date.
Issues in determining Related Party Relationships
1. ASI 21: Non-Executive Director Key Management Personnel A Non-Executive Director, merely by virtue of his being a Director will not be covered within the meaning of related party, and hence AS-18 is not applicable. However, a Non-Executive Director will be considered as a Key Management Personnel when: (a) He has the authority and responsibility for planning, directing and controlling the activities of the reporting enterprise, or (b) He is in a position to exercise control or significant influence by virtue of owning an interest in the voting power. 2. Where Consolidated Financial Statements are prepared, any enterprise that may have significant influence over the subsidiary is not reckoned as a related party. 3. As Associate Company, of an associate would not be automatically deemed as a related party. 4. In Consolidated Financial Statements, intra-group transactions with Associates do not get eliminated, and accordingly disclosure provisions of AS-18 are attracted.
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Example 2 Arun Ltd owns 60% of the voting power in Baskar Ltd, which in turn owns 60% voting power in Chandru Ltd. Karuna Ltd owns the remaining voting shares in Chandru Ltd and is considered to exercise significant influence over Chandru Ltd. During the reporting period, Karuna Ltd enters into transactions with Arun Ltd. Would Karuna Ltd be a related party of Arun Ltd? Solution Analysis: Karuna Ltd is not related to Arun Ltd as it (a) neither control nor is controlled by Arun Ltd, (b) does not exercise significant influence over Arun Ltd or is not so influenced by it. Conclusion: In the Consolidated Financial Statements of Arun Ltd Group, only transactions of Chandru Ltd with Karuna Ltd should be disclosed. Intra-Group transactions between Arun Ltd, Baskar Ltd and Chandru Ltd would not require disclosure in Consolidated Financial Statements.
5. Parent (A Ltd) which owns along with its subsidiary (B Ltd) more than 50% of the voting power in an enterprise (C Ltd) will be considered as a related party of A Ltd as control comprises both direct and indirect. Example 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 view point of AS-18? [P (A/c) Nov 2007] Solution Holding: As per the holding structure given above, P Ltd has a economic interest of 26% in R Ltd. Total Holding = Direct Holding of 14% + Indirect Holding through Q Ltd, i.e. 60% of 20% = 12%. Analysis: (a) P Ltd is a majority shareholder (60%) in Q Ltd. Thus P Ltd has control over Q Ltd. (b) Q Ltd holds 20% of shares in R Ltd. So, Q Ltd has significant influence over R Ltd. (c) P Ltd and Q Ltd, together hold 14% + 20% = 34% of the shares in R Ltd. So, P Ltd has significant influence over R Ltd. Conclusion: P Ltd, Q Ltd and R Ltd are Related Parties. Hence, the disclosure requirements of AS18 are applicable in the above case.
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6. Ownership of less than 20% of voting power: XX Ltd acquires 14% shares in BB Ltd. Even though less than 20% voting power is held by XX Ltd, but by virtue of being a single largest shareholder, a Director appointed by XX Ltd in BB Ltd. In such situations, XX Ltd has the ability to exercise significant influence over BB Ltd. Hence, XX Ltd and BB Ltd are Related Parties. 7. While in some cases fellow subsidiaries (where common control exists) would be related parties, coassociates cannot be deemed so. 8. A majority of Directors in a company can at times become a majority of Directors in another company. In such situations, unless any other requirement of AS-18 is attracted, the two companies would not automatically be deemed as related parties. 9. A member of Local Advisory Board (LAB) of a Bank is not a Key Management Personnel, as generally, such persons do not enjoy substantial interest, but become members of LAB because of their professional competence and eminence.
Disclosure Requirements
1. Mandatory disclosure of names, and the nature of relationship with all parties, where control exists, irrespective of whether or not there are transactions. 2. Disclosure of names, nature of relationship, and details of transactions with parties, where significant influence exists in all cases where there are transactions during the existence of related party relationship. 3. Items of a similar nature may be disclosed in aggregate by type of related party, except when separate disclosure is necessary, for an understanding of the effect of related party transactions on the financial statements of the reporting enterprise. 4. If there have been transactions between related parties, during the existence of a related party relationship, the reporting enterprise should disclose the following: (i) The name of the transacting related party; (ii) A description of the relationship between the parties; (iii) A description of the nature of transactions; (iv) Volume of the transactions either as an amount or as an appropriate proportion; (v) Any other elements of the related party transactions necessary for an understanding of the financial statements; (vi) The amounts or appropriate proportions of outstanding items pertaining to related parties at the balance sheet date and provisions for doubtful debts due from such parties at that date; and (vi) Amounts written off or written back in the period in respect of debts due from or to related parties. 5. AS-18 does not require a specific disclosure of the basis of pricing of all transactions entered into with related parties.
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6. ASI 13: Reporting Format ICAI have provided a specimen format in which aggregated information on transactions with related parties could be presented. This is reproduced below:
Particulars Purchase of goods Sale of goods Purchase of fixed asset Sale of fixed asset Rendering of services Holding Company Subsidiary Fellow Subsidiary Associate KMP Relative of KMP Total
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AS 19 LEASES
- G. Nikitha (nikstwix@gmail.com)
Accounting Standard (AS) 19, Leases, issued by the Council of the Institute of Chartered Accountants of India, comes into effect in respect of all assets leased during accounting periods commencing on or after 1.4.2001 and is mandatory in nature from that date. Accordingly, the Guidance Note on Accounting for Leases issued by the Institute in 1995, is not applicable in respect of such assets. Earlier application of this Standard is, however, encouraged. In respect of accounting periods commencing on or after 1-4-2004, an enterprise which does not fall in any of the following categories need not disclose the information required by paragraphs 22(c), (e) and (f); 25(a), (b) and (e); 37(a), (f) and (g); and 46(b), (d) and (e), of this Standard: (i) Enterprises whose equity or debt securities are listed whether in India or outside India. (ii) Enterprises which are in the process of listing their equity or debt securities as evidenced by the board of directors resolution in this regard. (iii) Banks including co-operative banks. (iv) Financial institutions. (v) Enterprises carrying on insurance business. (vi)All commercial, industrial and business reporting enterprises, whose turnover for the immediately preceding accounting period on the basis of audited financial statements exceeds Rs. 50 crore. Turnover does not include other income. (vii) All commercial, industrial and business reporting enterprises having borrowings, including public deposits, in excess of Rs. 10 crore at any time during the accounting period. (viii) Holding and subsidiary enterprises of any one of the above at any time during the accounting period.
Objective
The objective of this Statement is to prescribe, for lessees and lessors, the appropriate accounting policies and disclosures in relation to finance leases and operating leases. Scope 1. This Statement should be applied in accounting for all leases other than: (a) lease agreements to explore for or use natural resources, such as oil, gas, timber, metals and other mineral rights; and (b) licensing agreements for items such as motion picture films, video recordings, plays, manuscripts, patents and copyrights; and (c) lease agreements to use lands. 2. This Statement applies to agreements that transfer the right to use assets even though substantial services by the lessor may be called for in connection with the operation or maintenance of such assets. On the other hand, this Statement does not apply to agreements that are contracts for services that do not transfer the right to use assets from one contracting party to the other.
Definitions
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The following terms are used in this Statement with the meanings specified: A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time. A finance lease is a lease that transfers substantially all the risks and rewards incident to ownership of an asset. An operating lease is a lease other than a finance lease. A non-cancellable lease is a lease that is cancellable only: (a) upon the occurrence of some remote contingency; or (b) with the permission of the lessor; or (c) if the lessee enters into a new lease for the same or an equivalent asset with the same lessor; or (d) upon payment by the lessee of an additional amount such that, at inception, continuation of the lease is reasonably certain. The inception of the lease is the earlier of the date of the lease agreement and the date of a commitment by the parties to the principal provisions of the lease. The lease term is the non-cancellable period for which the lessee has agreed to take on lease the asset together with any further periods for which the lessee has the option to continue the lease of the asset, with or without further payment, which option at the inception of the lease it is reasonably certain that the lessee will exercise. Minimum lease payments are the payments over the lease term that the lessee is, or can be required, to make excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor, together with: (a) in the case of the lessee, any residual value guaranteed by or on behalf of the lessee; or (b) in the case of the lessor, any residual value guaranteed to the lessor: (i) by or on behalf of the lessee; or (ii) by an independent third party financially capable of meeting this guarantee. However, if the lessee has an option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable that, at the inception of the lease, is reasonably certain to be exercised, the minimum lease payments comprise minimum payments payable over the lease term and the payment required to exercise this purchase option. This is also known as Bargain Purchase Option. Fair value is the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arms length transaction. Economic life is either: (a) The period over which an asset is expected to be economically usable by one or more users; or (b) The number of production or similar units expected to be obtained from the asset by one or more users.
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Useful life of a leased asset is either: (a) the period over which the leased asset is expected to be used by the lessee; or (b) the number of production or similar units expected to be obtained from the use of the asset by the lessee. Residual value of a leased asset is the estimated fair value of the asset at the end of the lease term. Guaranteed residual value is: (a) in the case of the lessee, that part of the residual value which is guaranteed by the lessee or by a party on behalf of the lessee (the amount of the guarantee being the maximum amount that could, in any event, become payable); and (b) In the case of the lessor, that part of the residual value which is guaranteed by or on behalf of the lessee, or by an independent third party who is financially capable of discharging the obligations under the guarantee. Unguaranteed residual value of a leased asset is the amount by which the residual value of the asset exceeds its guaranteed residual value. Gross investment in the lease is the aggregate of the minimum lease payments under a finance lease from the standpoint of the lessor and any unguaranteed residual value accruing to the lessor. Unearned finance income is the difference between: (a) The gross investment in the lease; and (b) The present value of (i) The minimum lease payments under a finance lease from the standpoint of the lessor; and (ii) Any unguaranteed residual value accruing to the lessor, at the interest rate implicit in the lease. Net investment in the lease is the gross investment in the lease less unearned finance income. The interest rate implicit in the lease is the discount rate that, at the inception of the lease, causes the aggregate present value of (a) The minimum lease payments under a finance lease from the standpoint of the lessor; and (b) Any unguaranteed residual value accruing to the lessor, to be equal to the fair value of the leased asset. The lessees incremental borrowing rate of interest is the rate of interest the lessee would have to pay on a similar lease or, if that is not determinable, the rate that, at the inception of the lease, the lessee would incur to borrow over a similar term, and with a similar security, the funds necessary to purchase the asset. Contingent rent is that portion of the lease payments that is not fixed in amount but is based on a factor other than just the passage of time (e.g., percentage of sales, amount of usage, price indices, and market rates of interest). The definition of a lease includes agreements for the hire of an asset which contain a provision giving the hirer an option to acquire title to the asset upon the fulfillment of agreed conditions. These agreements are commonly known as hire purchase agreements. Hire purchase agreements include agreements under which the property in the asset is to pass to the hirer on the payment of the last installment and the hirer has a right to terminate the agreement at any time before the property so passes.
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Classification of Leases
The classification of leases adopted in this Statement is based on the extent to which risks and rewards incident to ownership of a leased asset lie with the lessor or the lessee. Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return due to changing economic conditions. Rewards may be represented by the expectation of profitable operation over the economic life of the asset and of gain from appreciation in value or realisation of residual value. A lease is classified as a finance lease if it transfers substantially all the risks and rewards incident to ownership. Title may or may not eventually be transferred. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incident to ownership. Since the transaction between a lessor and a lessee is based on a lease agreement common to both parties, it is appropriate to use consistent definitions. The application of these definitions to the differing circumstances of the two parties may sometimes result in the same lease being classified differently by the lessor and the lessee. Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than its form. Examples of situations which would normally lead to a lease being classified as a finance lease are: (a) the lease transfers ownership of the asset to the lessee by the end of the lease term; (b) the lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable such that, at the inception of the lease, it is reasonably certain that the option will be exercised; (c) the lease term is for the major part of the economic life of the asset even if title is not transferred; (d) at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and (e) the leased asset is of a specialised nature such that only the lessee can use it without major modifications being made. Indicators of situations which individually or in combination could also lead to a lease being classified as a finance lease are: (a) if the lessee can cancel the lease, the lessors losses associated with the cancellation are borne by the lessee; (b) gains or losses from the fluctuation in the fair value of the residual fall to the lessee (for example in the form of a rent rebate equalling most of the sales proceeds at the end of the lease); and (c) the lessee can continue the lease for a secondary period at a rent which is substantially lower than market rent. Lease classification is made at the inception of the lease. If at any time the lessee and the lessor agree to change the provisions of the lease, other than by renewing the lease, in a manner that would have resulted in a different classification of the lease had the changed terms been in effect at the inception of the lease, the revised agreement is considered as a new agreement over its revised term. Changes in estimates (for example, changes in estimates of the economic life or of the residual value of the leased asset) or changes in circumstances (for example, default by the lessee), however, do not give rise to a new classification of a lease for accounting purposes.
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As per US GAAP the classification of Lease is done as follows
From the above diagram it can be known that where the economic life of the asset is more than 75% and where the Present value is more than 90% of the Fair value then the lease is classified as Finance Lease. According to the US GAAP this the basis for the classification. Sale and lease back transactions Meaning and accounting Meaning: When an asset is sold by the vendor and the same asset is leased back to the vendor, it is cal1ed sale and lease back transaction. Accounting Treatment (i) In case of finance lease: Any excess or deficiency of sale proceeds over the carrying amount is to be deferred and amortized over the lease term in proportion of depreciation on leased asset. (ii) In case of operating lease
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Note: If the fair value at the time of a sale and lease back transaction is less than the carrying amount of the asset, then loss (difference between carrying amount and fair value) should be recognized immediately. ACCOUNTING TREATMENT
Recognise as recievables at an amount equal to net investment. Recognise finance income in P&L A/c, ensure constant periodic return on net investment o/s. Reduce the lease Payments from principal and unearned finance income. Increase in unguaranteed residual value not recorded, for decrease revise income allocation. Allocate initial direct cost against finance income over lease term or recognize immediately as an expense. Record profit as per sales policy.
Recognise lease as an asset and liability at inception. Record at fair value at inception not exceeding present value of MLP (from lessees perspective). Apportion lease payments between finance charge and reduction of o/s liability (Finance charge to be calculated in a manner ensuring constant periodic rate of interest). Depreciate the asset on a systematic basis.
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Do not recognize selling profit Show asset on lease as fixed asset Recognise cost and depreciation as expense Allocate initial direct costs over the lease term in proportion to the recognition of rent income or treat them as period expense. Recognise lease income on a straight line basis, unless other basis is justified.
Recognise lease payments as an expense on straight line basis unless other basis is justified.
DISCLOSURE REQUIREMENTS
Reconciliation between gross investment and present value of MLP receivable at balance sheet date. Unearned finance income
Segregate leased asset from owned asset Net carrying amount at balance sheet date for each class of asset Reconciliation between MLP at Balance sheet date and present value Contingent rents recognized Future minimum sub-lease payments to be received under non-cancellable sub-leases. General description of significant leasing agreements AS6 (revised) and AS 10 disclosures
Unguaranteed residual value Accumulated provision for uncollectable MLP receivables Contingent rent recognized General description of significant leasing agreements Accounting Policy for Initial Direct Costs.
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For each class of asset 1) Gross carrying amount 2) Accumulated and period dep. 3) Accumulated and period impairment loss 4) Impairment loss reversed for the period Future MLP under non-cancellable lease Contingent rent recognised General description of significant leasing agreements Accounting Policy for Initial Direct Costs. AS6 (revised) and AS 10 disclosures.
Future MLP under non-cancellable lease Future minimum sub-lease payments receivable for non-cancellable sub-leases. MLP and contingent rent recognized Sub-lease payments recognized General description of significant leasing agreements.
Description of significant leasing arrangements Disclosure under AS 5 (revised), if any
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AS 20 EARNING PER SHARE

- Dhanush Arjun (darjun@kpmg.com)
Objective: The objective of the standard is to prescribe principles for the determination and presentation of earnings per share which will improve comparison of performance among different enterprises for the same period and among different accounting periods for the same enterprise A consistent method of computing earnings per share for companies enhances comparability of different companies. Various accounting policies are used to determine the earnings of a Company but a consistent denominator enhances the quality of financial reporting. Scope: Should be applied by enterprises whose equity shares or potential equity shares are listed on a recognized stock exchange. Even if the shares are not listed on a recognized stock exchange and if the enterprise chooses to disclose the earnings per share, it should be done in accordance with this Standard. In case of consolidated financial statements, the earnings per share should be disclosed on the basis of consolidated information. Definitions: Various terms including equity shares, preference shares etc are defined in the Standard. However, specific reference is being to the meaning and types of potential equity shares as below. A potential equity share is a financial instrument or other contract that entitles, or may entitle, its holder to equity shares. Examples of potential equity shares are: (a) debt instruments or preference shares, that are convertible into equity shares; (b) share warrants; (c) options including employee stock option plans under which employees of an enterprise are entitled to receive equity shares as part of their remuneration and other similar plans; and (d) shares which would be issued upon the satisfaction of certain conditions resulting from contractual arrangements (contingently issuable shares), such as the acquisition of a business or other assets, or shares issuable under a loan contract upon default of payment of principal or interest, if the contract so provides. Presentation: As per the requirements of the Standard, the Companies are required to disclose 2 types of earning per share i.e. basic EPS and diluted EPS on the face of the profit and loss account for all the periods presented.
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This statement requires an enterprise to present basic EPS and diluted EPS, even if the amounts are negative i.e. loss per share. Measurement: Basic earnings per share (BEPS): Basic earnings per share = Net profit/ loss for the period attributable to equity shareholders Weighted average number of equity shares outstanding Explanation: Net profit/ loss: For the purpose of calculating BEPS, the net profit or loss should be the net profit or loss for the period after deducting preference dividends and any attributable tax thereto for the period. If an enterprise has more than one class of equity shares, net profit or loss for the period is apportioned over the different classes of shares in accordance with their dividend rights. Number of equity shares: For the purpose of calculating BEPS, the number of equity shares should be considered as the weighted average number of equity shares outstanding during the period. It means the number of shares should be considered as at the beginning of the period, and adjusted for any shares issued or bought back during the period multiplied by the time factor. Shares are included in the weighted average number of shares from the date the consideration is receivable which can be tabulated as follows: Type Inclusion Shares issued in exchange for When cash is receivable cash Shares issued as a result of the From date of conversion conversion of debt Shares issued in lieu of interest or principal on other financial As of the date interest ceases to accrue instruments Shares issued in exchange for the Date the settlement becomes effective settlement of a liability Shares issued as consideration for the acquisition of an Date on which the acquisition is recognised asset other than cash Shares issued for the rendering of Included as the services are rendered services Partly paid shares and shares with different nominal values are to be considered to the extent they are entitled to participate in dividends relative to a fully paid equity shares.
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Illustration on calculation of weighted average number of equity shares: 1/4/11 1/9/11 1/11/11 1/2/12 31/3/12 No. of equity shares held fully paid (Rs.10) 1,800 Issue of shares for cash (Rs.5 called up & paid up per share) 600 Called up & received fully remaining Rs.5 per share on 600 shares Buy back of shares 300 Closing balance of shares 2,100
Wtd. Avg. No. of Shares = (1800*5/12) + (2100*2/12) + (2400*3/12) + (2100*2/12) = 2050 Bonus Shares In case of a bonus issue or a share split, equity shares are issued to existing shareholders for no additional consideration. Therefore, the number of equity shares outstanding is increased without an increase in resources. In such a situation, the number of shares must be adjusted as if the issue was made at the start of the earliest reported period. No weightage should be assigned for timing of the issue. Further, previous years EPS will need to be scaled down by the ration of number of shares before bonus to number of shares after bonus. This has been illustrated below: Net Profit for 2010 Rs.18 lacs Net Profit for 2011 Rs.60 lacs On 1st Oct 2011, a bonus issue was made in the ratio of two for every one existing share. On that day existing shares were 20 lacs. EPS for 2011 = Rs.60lacs = Rs.1 (20+40) Adjusted EPS for 2010 = Rs.18 lacs =Rs.0.30 (20+40) Rights Issue When rights issue is made at price below fair value, the issue can be treated as two separate issues one being a bonus issue and the other being issue at full price. The number of equity shares to be used in calculating basic earnings per share for all periods prior to the rights issue is the number of equity shares outstanding prior to the issue, multiplied by the following factor: Fair value per share immediately prior to the exercise of rights Theoretical ex-rights fair value per share
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The theoretical ex-right price is the price at which the shares ought to be quoted immediately after rights issue. The same can be calculated by adding the aggregate fair value of the shares immediately prior to the exercise of the rights to the proceeds from the exercise of the rights, and dividing by the number of shares outstanding after the exercise of the rights. N.P.for 2010 Rs. 11 lacs 2011 Rs. 15 lacs No. of shares outstanding 5,00,000 On 1st May 2011 a rights issue of one for every five is done at an exercise price of Rs. 15 per share. Last date of exercising such rights is 31.05.2011 F.V. per share on 30.5.2011 is Rs.21. Theoretical ex rights F.V. per share =(5 x 21) + (1 x 15) =Rs.20 (5+1) Adjustment Factor = 21/20=1.05 EPS of 2011 = 15,00,000.00 = Rs. 2.64 (5,00,000 x 1.05x5/12)+(6,00,000 x 7/12) Original EPS of 2010 = 11,00,000 = Rs.2.20 5,00,000 Adjusted EPS of 2010 = 11,00,000 =2.10 5,00,000 x 1.05 Diluted EPS Where change in the number of shares is anticipated, a measure is needed that will take into account the effect of those anticipated changes. Diluted EPS is a measure where EPS is readjusted as though new shares are in place. The reason being, communication of the potential dilution, shareholders could expect in the near future. After the potential equity shares are converted into equity shares, the dividends, interest and other expenses or income associatedwith those potential equity shares will no longer be incurred (or earned). Instead, the new equity shares will be entitled to participate in the net profit attributable to equity shareholders. Therefore dividends, interest and other expenses or income adjusted for any attributable taxes is adjusted with the profit/ loss and the number of shares are increased to take effect of the conversion. Options and other share purchase arrangements are dilutive when they would result in the issue of equity shares for less than fair value. The amount of the dilution is fair value less the issue price. Dilutive potential equity shares Potential equity shares should be treated as dilutive when, and only when, their conversion to equity shares would decrease net profit per share from continuing ordinary operations. When the potential equity shares increase earnings per share from continuing ordinary activities or decrease loss per share from continuing ordinary activities, they are referred to as anti-dilutive and are ignored in calculating diluted earnings per share.
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For the purpose of determining the sequence from most dilutive to least dilutive potential equity shares, the earnings per incremental potential equity share is calculated. Where the earnings per incremental share is the least, the potential equity share is considered most dilutive and vice-versa. NP for 2011 Rs.100,00,000 No. of equity shares outstanding 50,00,000 Basic EPS 1,00,00,000 / 50,00,000 = Rs.2.00 1,00,000 12% FCDs of Rs. 100 each, each convertible into 10 equity shares Corporate tax rate 30% Diluted EPS = 100,00,000 + 12,00,000 3,60,000 = Rs.1.81 50,00,000 + 10,00,000 Restatement If changes occur after the balance sheet date but before the date on which the financial statements are approved by the board of directors, the per share calculations for those financial statements and any prior period financial statements presented should be based on the new number of shares The fact of occurrence of such event after the balance-sheet date should be properly disclosed Disclosure requirements: The amounts used as the numerators and denominators in calculating basic & diluted EPS. Reconciliation of abovementioned numerators with Net Profit/Loss for the period. Reconciliation between the denominators used in the calculation of Basic EPS & Diluted EPS. The nominal value of shares alongwith EPS figures.
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AS-21 - CONSOLIDATED FINANCIAL STATEMENTS

- M.R. Sinduja (sindujaca07@yahoo.co.in)
Introduction to the standard: AS 21 comes into effect in respect of accounting periods commencing on or after 01/04/2001 The purpose of the Standard is to present financial statements of a Parent Company and its Subsidiary (ies) as a single entity. It can be simply understood as 1+1+1+1+..n=1. Confused???? When the financials of a Parent and its one or more subsidiaries are combined and consolidated together as a single financial statement, it is referred to as Consolidated Financial Statement. Consolidated Financial Statement is prepared and presented to show the Consolidate position of the total assets and liabilities and net operating results of the group as a whole. As per Companies Act, 1956 preparation and presentation of Consolidated Financial Statement is not mandatory. However if an entity opts to prepare should be prepared/presented in accordance with AS 21. CFS comprises the following: Consolidated Balance Sheet Consolidated Profit and Loss Account Notes to Accounts, other statements and explanatory material Consolidated Cash Flow Statement, if parent company presents its own cash flow statement Important Terms: Parent Company - A parent is an enterprise which has 1 or more subsidiaries. It is also called as Holding Company. Subsidiary Company - An enterprise which is controlled by another enterprise (holding company) is called Subsidiary Company. Group- A parent and its subsidiaries. Equity- It is the residual interest in the assets of an enterprise after deducting its liabilities. Control- Control in general means the POWER to make all the important decisions about the way an organization is run.Such Control can be exercised DIRECTLY or INDIRECTLY (through subsidiary) by purchasing More than 50% of the voting power of an enterprise (more popular) OR CONTROLLING composition of Board of DIRECTORS/GOVERNING BODY Scope of CFS: A holding company which has to prepare CFS should consolidate the financial statements of all its subsidiary (ies) whether domestic or foreign. Exceptions being
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The control acquired by the parent in the subsidiary is proposed to be TEMPORARY; it is to be treated as Investment because it may be disposed off in near future.
The subsidiary operates under SEVERE LONG-TERM RESTRICTIONS and due to this its ability to transfer the funds to parent is significantly weakened. In any way DISSIMILAR ACTIVITIES of Parent and subsidiaries cannot be the ground for excluding the subsidiaries from CFS.
CFS NOT a substitute for separate financial statements: CFS prepared can never be a substitute for preparation of separate financial statement for a parent or its subsidiaries. That is they are supposed to prepare individual financial statements as per their governing laws apart from the CFS. Harmonisation of Accounting Policies: CFS is prepared in a format which is followed by the Holding Company to prepare its financial statements. Along with AS21 all the other standards whichever is applicable to the Holding company should also be complied with while preparing the CFS. The parent company should follow AS 13 to account for the investment made in subsidiary company i.e it should be recorded at COST, in its separate Financial Statement. Care to be taken to see that as far as possible UNIFORM ACCOUNTING POLICIES need to be followed by the parent and subsidiary companies while preparing the CFS. If it is not practicable to use the uniform accounting policies the fact should be disclosed together with the proportions of the items in the CFS to which the different accounting policies have been applied. When the amount invested is material, proper adjustment has to be made in the CFS to reflect the items in line with the accounting policies of the parent.An illustration would give clarity for the term proportions of the items. H Ltd is the Parent company. It has four subsidiaries, M, N, O and L. Accounting Policy for Inventories adopted by H,M,N and O is FIFO method. L adopts weighted average method. Aggregate value of inventory in CFS is Rs 100 Crores, of which value of inventory of L included in consolidation is Rs 25 Crores. The disclosure may be made as under: Companies in the group, except L Ltd, adopt FIFO method for calculating inventories. L Ltd., adopts Weighted average method. Amount of inventories so valued and included in CFS is 25% i.e (Rs. 25 Crores) of total value of group inventory. During the first time consolidation, adjustments need to be made so as to harmonise the accounting policies followed by the parent and subsidiaries. It is appropriate to make the first-time adjustments to the opening balance of reserves and if there is no reserves or if they are insufficient, charge to the opening balance of accumulated losses (P&L). The logic behind this method is had the parent consolidated the financials in the previous years, the adjustments would have been made to the profit and loss account of those years and the net impact till the beginning of current year would have been reflected in the opening reserves. Consolidation Procedure: Coming to the steps for CFS, consolidation is done by combining the balance sheet and profit and loss account of the parent and its subsidiaries by adding each like item on a LINE BY LINE basis i.e. asset with asset, liability with liability, income with income and expense with expense.
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Cost of Investment in subsidiary has to be cancelled or eliminated by comparing it with the % of (Equity + Reserves and Surplus on the date of acquisition) i.e. the Parents portion of Control in the subsidiary on the date of acquisition. Here 4 things to be noted to calculate the cost of control Date of acquisition % of shareholding (Equity shares) Reserves and Surplus on the date of acquisition which are to be considered as PRE-ACQUISTION Profits or Reserves. The reserves and profits accrued after date of acquisition are not of consideration because they will be treated as INCOME. Cost of Investment i.e. Consideration paid to acquire shares in subsidiary. Now lets see how to compute Cost of Control Cost of Investment Vs Amount recorded as Investment in the holding company Less: Preacquisition Dividend (i.e. Dividend declared out of pre-acquisition profits) Share in Net Assets % of Shares held in Equity Share Capital % of Pre-Acquisition profits and Reserves Less: Unrealised profit in Inter-co transaction
Generally cost of Investment will be considered but when the carrying amount is different from the cost, carrying amount will be taken for the computation purposes. The Difference between the Cost of Control and the Share of Net Assets in the Subsidiary may result in either
Goodwill
Capital Reserve
Cost > % Share in Net Assets
%Share in Net Assets > Cost
Shown as Asset in CFS
Shown under Reserves and Surplus in CFS
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Now, Minority Interest(MI) needs to be computed: Identify: Minority Interests of different subsidiaries Segregate: their share in Share Capital and Reserves and Surplus(pre and post). Keep in mind to include the Preference shares belonging to them. Also add the subsidiarys cumulative preference dividends whether or not profits are available or dividends have been declared In short MI in the net assets is the aggregate of a) Amount of equity attributed to minorities at the date on which investment in a subsidiary is made. And Share of Movements in EQUITY of Minority since the date the parent-subsidiary relationship came into existence. Preference shares not belonging to the Parent should also be included.
b)
c)
If the Minority Interest is NEGATIVE, it should be adjusted against the Majority Interest. In other words, Negative MI will not be shown in the CFS. At the time of earning profits, all such profits should be allocated to Majority Interest to recover and nullify the previously adjusted MI share of losses. While calculating MI, share of minority in net profit of consolidated subsidiaries for the reporting period should be calculated and charged against the profit and loss a/c; consequently balance profit after MI represents the parents (holding cos) share in profit which will be shown under the head Reserves and Surplus in CFS Intra-group balances and transactions i.e. inter-company debtor/creditors inter-company purchases/sales and resulting unrealized profit shall be eliminated in full. Step by Step Acquisition: If an enterprise makes two or more investment in another enterprise at different dates, and eventually obtains control of the other enterprise, the consolidated financial statements are presented only from the date on which holding-subsidiary relationship comes in existence.(i.e when making of an investment resulting in control) If two or more investments are made over a period of time, the equity of the subsidiary at the date of investment, is generally determined on a step by step basis. Intra Group Balances and Transactions: 1) Elimination Intra group balances and intra group transactions and resulting unrealized profits should be ELIMINATED IN FULL. Unrealised losses resulting from Intra group transactions should also be eliminated unless cost cannot be recovered.
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Transactions between a Holding and subsidiary in the CFS to be eliminated. They may be grouped into
Downstream
Upstream
Sale by holding to subsidiary H S
Sale by subsidiary to holding H S
100% of the unrealized profits should be adjusted in the group reserves in CFS
unrealized profits would be eliminated proportionate to the Parents share
2) Adjusting Prior Period transactions in the first CFS of the Parent There may be transactions pertaining to prior periods. An issue may arise as to the procedure to be adopted in the first CFS of the parent, for adjusting the profits or losses arising from Intra group transaction of earlier years. ICAI have suggested the following: Such (unrealized) profits or losses ought to be given effect to by adjustment to the opening balances of Group revenue reserves, with a corresponding reduction in the values of assets.
Cross Holding: Sometimes there can be relationships which lead to cross holdings between Parent and subsidiary where both hold shares in each other. In such situations, the share of subsidiary in parent is to be determined by applying a mathematical formula of simultaneous equation. Reporting Date: The financial statements of the Parent and subsidiary are to be of same reporting date when the CFS is prepared. If it is not possible to do the same for one or more subsidiaries (because of which
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their reporting dates are varying) adjustments should be made for the effect of the significant transactions or other events that occur between those dates and the date of the Parents financial statements. However, the difference between reporting dates should not be more than 6 months. Subsidiary disposal and others: When a subsidiary ceases to exist as same, i.e. there is no controlling interest, then it needs to be accounted as INVESTMENT as per AS 13 in the CFS. AS 21 is applicable to an enterprise, which is a parent at the reporting date, or was a parent at any time during the year. In cases where the subsidiary is disposed off within the year, ICAI has suggested that the following steps need to be taken: Include income and expenses of the subsidiary for the period from the last reporting date, upto the date of disposal of the subsidiary in CFS MI in CFS, in respect of the disposed subsidiary should be ascertained after including the results of operations attributable to the MI until date of disposal. MI computed above would be adjusted against the total equity of the subsidiary (comprising carrying amounts of all individual assets and liabilities of the subsidiary on the date of disposal) to compute the share of the parent in the net assets of the subsidiary at the date of disposal. The amount so computed above, and the goodwill or capital reserve with respect to the subsidiary, would be adjusted to the consideration received on disposal of the subsidiary to ascertain the gain or loss on disposal of subsidiary. Disclosure Requirements: 1) In CFS, 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; 2) In CFS wherever applicable, 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 subsidiary; Effects of the acquisition and disposal of subsidiary on the financial position at the reporting date, the results for the reporting period and on the corresponding amounts for the preceding period; and Names of the subsidiary(ies) of which the reporting date(s) is/are different form that of the parent and the difference in reporting dates.
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Significant Differences among AS-21, IAS 27 and US GAAP AS -21 IAS 27 Control Control includes indirect Control can be defined control which may exist as the power to govern without majority holding. the financial and operating policies of an enterprise so as to obtain benefits from activities. Requirements CFS are required to be Compulsorily require prepared, in addition to preparing CFS unless it and not in lieu of, is itself a wholly owned separate financial subsidiary. statements if the enterprises are required to prepare the CFS under any statute. Listed companies are required to prepare CFS Goodwill Goodwil or Capital Reserve is determined on Historical cost basis. No prescription for amortization of goodwill Differential Period The differential period between dates of parent and subsidiary, if do not coincide should not exceed 6 months which is in line sec 212 of Companies Act, 1956. Other Statutory The Companies Act Requirements 1956 prescribes under section 212 the requirements for disclosure which are in addition to the requirements of the disclosure as per AS 21. Deferred Tax The principle for deferred tax does not apply. Goodwil or Capital Reserve is determined on Fair Value basis; amortization is also provided. The differential period between dates of parent and subsidiary, if do not coincide should not exceed 6 months
US GAAP Only majority undertakings subsidiaries.
owned
Compulsorily require preparing CFS unless it is itself a wholly owned subsidiary. Companies are not allowed to issue separate financial statements but only CFS and hence American companies give less information than companies in many other companies.
The differential period between dates of parent and subsidiary, if do not coincide should not exceed 6 months
There are no There are no corresponding statutory corresponding statutory requirements. requirements.
If income taxes have been paid on intercompany profits on assets remaining within the group-, those taxes
If income taxes have been paid on intercompany profits on assets remaining within the group-, those taxes
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Investment in subsidiary In a parents separate financial statements, investments in subsidiary should be accounted for in accordance with AS 13Accounting for Investment which is cost as adjusted for any permanent diminution in value of those investment.
Exception Consolidation
of Subsidiary should be excluded from consolidation when it operates under severe long-term restrictions which significantly impair its ability to transfer funds to the parent
are deferred until the related assets are sold in an arms-length transaction. Provides guidance for accounting for investment in a parents separate financial statements. Also requires that a parents investment in a subsidiary be accounted for in the parents separate financial statements (a) at cost, (b)using the equity method as described in IAS-28 or (c) as available for sale of financial assets as described in IAS 39. Specifically provides that consolidation is required till control is not lost for such subsidiary.
are deferred until the related assets are sold in an arms-length transaction.
Does not prescribe such condition for exclusion from consolidation, however it(FAS 94) provides that if the subdiary operates under foreign exchange restrictions, controls or other Governmentimposed uncertainities which cast significant doubt on the parents ability to control the subsidiary.(FAS 94.13)
Amendments in AS-21: As a result of limited revision the name of accounting standard the name of accounting standard has been changed to Consolidated Financial Statements and Accounting for Investments in Subsidiaries in Separate Financial Statements. The name amendment is with regards to the applicability and scope of the Standard. Now this standard will also apply in accounting for investment in subsidiaries in separate financial statements of a parent. The amended paragraphs provided as under:
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In a parents separate financial statements, investments in subsidiaries, except investments in subsidiaries, except investments in subsidiaries covered under paragraph 11 of this Statement, should be accounted for either: At cost, or In accordance with AS 30, Financial Instruments: Recognition and Measurement. The same accounting should be applied for each category of investments. Investments in subsidiaries covered under paragraph 11 of this Statement should be accounted for in accordance with Accounting Standard (AS) 30, Financial Instruments: Recognition and Measurement. This limited revision comes into effect in respect of accounting periods commencing on or after the date on which accounting standard (AS) 30, Financial Instruments: Recognition and Measurement comes into effect. AUDIT CHECKLIST FOR AS-21 1) General Is the auditee a level 1 enterprise, having shares or securities listed in a recognised stock exchange If no, has the auditee voluntarily chosen to prepare and present consolidated financial statements Has the auditee provided the list of the all its subsidiaries and partnership firm in which auditee exercises control Is the auditee presenting CFS for the time (comparatives not necessary) 2) Internal control Existence of subsidiaries, control over which arises from the fact that the auditee has control over composition of board Auditee being a partner in one or more partnership firms on which auditee exercise control 3) Accounting Policy Has the auditee in its capacity as parent, adopted an appropriate accounting policy for CFS in the group Accounting policies adopted by group are different from those adopted by parent, uniformity is brought about for purposes of consolidation 4) Inclusion and Exclusion of a subsidiary for consolidation Has one or more subsidiaries in which control ceased to exist during the current audit been excluded from consolidation If yes, has the subsidiary become associate or JV requiring compliance with AS-23 or AS-27 If no, has the investment in subsidiary been accounted for as per AS-13(accounting for investments) 5) Consolidation procedures - main Included all the subsidiaries and firms in consolidation procedure Has one or more group enterprises excluded. If yes, the reasons for such exclusion
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Do the test checks carried out indicate that consolidation procedure adopted by auditee are in conformity with AS-21 particularly in the following areas; i) cost of auditees investment in subsidiary and auditees portion of equity in the subsidiary on the date when investment is made is eliminated ii) differential in cost is recognised as GW or CR do the test check show evidence whether Minority Interest is computed after taking into account , amount of equity attributable to minority interests and minority share of net assets covering the date of investment till the date of consolidation have all the group balances and transactions been identified and eliminated have unrealised profits or losses been eliminated 6) Consolidation procedures Losses of subsidiaries Have the subsidiaries incurring losses identified If yes, minoritys share of loss in the subsidiary has exceeded its share of equity and whether the same is been adjusted against the equity interests of auditee 7) Disclosures in consolidated financial statements Has it been ensured that the auditee has properly disclosed the following i) Names, country and proportion of ownership and proportion of voting power in each of the subsidiary ii) Subsidiaries in respect of which the reporting dates are different from the reporting date of the auditee. Whether the auditee has prepared a report on performance, financials and cash flows of reportable segments based on consolidated financial statements Whether the auditee disclosed basic and diluted EPS, based on consolidated financials. Illustration 1: A Ltd. purchased 40% stake of B Ltd. for Rs. 12 per share. After two years A Ltd. decided to purchase another 40% share in B Ltd. B Ltd. has 1,00,00,000 equity shares of Rs. 10 each as fully paid up shares. The purchase deal was finalised on the following terms: Purchase price per share to be calculated on the basis of average profit of last three years capitalised at 7.5%. Profits for last three years are Rs. 35 lacs, Rs. 65 lacs and Rs. 89 lacs. Total assets of B Ltd. of Rs. 11,50,00,000. Assets to be appreciated by Rs. 40,00,000. Of the External Creditors for Rs. 2,50,00,000 one creditor to whom Rs. 10,00,000 was due has expired and nothing is to be paid to settle this liability. B Ltd. will declare dividend @ 15%. Calculate the Goodwill or Capital Reserve for A Ltd. in Consolidated Financial Statement. Solution Calculation of Purchase Consideration Particulars Rs. Profits for Last 3 years: First 8,900,000 Second 6,500,000 Third 3,500,000
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Total profits for last 3 years
18,900,000
Average Profits (1,89,00,000/3) Total value of B Ltd. (63,00,000/7.5%) Number of Shares in B Ltd. Value per Share Purchase Consideration (1,00,00,000 x 40%) x 8.4 Calculation of Goodwill/Capital Reserve Particulars Fixed Assets Add: Appreciation in value of the asset Less: Creditors Less: Amount to be written off Net Asset Share in Net Asset (9,50,00,000 x 80%) Less: Cost of Investment: Purchase Consideration Less: Dividend Received (10,00,00,000 x 40% x 15%) Add: Investment (1,00,00,000 x 40% x 12) Capital Reserve Illustration 2 :
6,300,000 84,000,000 10,000,000 8.40 3,600,000 Rs. 115000000 4000000 25000000 1000000 Rs.
119000000 24000000 95000000 76000000
33600000 6000000 27600000 48000000
75600000 400000
A Ltd. had acquired 80% share in the B Ltd. for Rs. 25 lacs. The net assets of B Ltd. on the day are Rs. 22 lacs. During the year A Ltd. sold the investment for Rs. 30 lacs and net assets of B Ltd. on the date of disposal was Rs. 35 lacs. Calculate the profit or loss on disposal of this investment to be recognised in consolidated financial statement. Solution Calculation of Profit/Loss on disposal of investment in subsidiary Particulars Net Assets of B Ltd. on the date of disposal Less: Minority Interest (35 lacs x 20%) A Ltd.'s Share in Net Assets Proceeds from the sale of Investment Less: A Ltd.'s share in net assets Rs. Rs.
3,500,000 700,000 2,800,000 3,000,000 2,800,000 200,000
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Less: Goodwill in the Consolidated Financial Statement Cost of investment Less: A Ltd.'s Share in net asset on the date (22 lacs x 80%) Loss on sale of investment
2,500,000 1,760,000
740,000 540,000
Illustration 3 : Following are the Balance Sheet of A Ltd. and B Ltd.: Liabilities Equity Shares 6% Preference shares General Reserve Profit & Loss Account Bills Payable Creditors Proposed Dividend All Fig, in '000 A Ltd. B Ltd. Assets 6,000 1,200 1,020 1,100 2,750 600 5,000 1,000 800 1,790 1,540 1,870 500 Goodwill Fixed Assets Investment Stock Debtors Bills Receivable Cash & Bank All Fig, in '000 A Ltd. B Ltd. 100 20 3,850 2,750 1,620 1,100 1,900 4,150 2,450 3,080 2,150 1,000 600 400 12,670 12,500
12,670 12,500
A Ltd. purchased 3/4th interest in B Ltd. at the beginning of the year at the premium of 25%. Following are the other information available: a. Profit & Loss Account of B Ltd. includes Rs. 1000 thousands bought forward from the previous year. b. The directors of both the companies have proposed a dividend of 10% on equity share capital for the previous and current year. From the above information calculate Pre and Post Acquisition Profits, Minority Interest and Cost of Control. Solution Calculation of Pre and Post Acquisition Profits Particulars Profit & Loss Account General Reserve Less: Minority Interest (1800/4) (790/4) Pre Acquisition Post Acquisition Profits Profits 1,000,000 800,000 1,800,000 450,000 197,500 139 790,000 790,000
Consolidated Balance Sheet Calculation of Minority Interest Particulars Paid up Equity Share Capital (50,00,000/4) Paid up Preference Share Capital Pre Acquisition Profits Post Acquisition Profits Minority Interest Calculation of Goodwill/Capital Reserve Particulars
1,350,000
592,500
Rs. 1,250,000 1,000,000 450,000 197,500 2,897,500
Rs.
Rs. 4,312,5000 5,100,000 787,500
Cost of Investment in Subsidiary (50,00,000 x 75% x 125%) 4,687,500 Less: Dividend Received (50,00,000 x 75% x 10%) 375,000 Less: Paid up Capital Pre Acquisition Profits Capital Reserve 3,750,000 1,350,000
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Accounting Standards 22 (Deferred taxation)

- B. Jaisudha (jaisudha04@rediffmail.com)
Objective This accounting standard prescribes the accounting treatment for taxes on income. Traditionally amount of tax payable is determined on the profit/loss computed as per income-tax laws. According to this standard tax on income is determined on the principle of accrual concept. According to this concept, tax should be accounted in the period in which corresponding revenue and expenses are accounted. In simple words, tax shall be accounted on accrual basis not on liability to pay basis. Scope Taxes on income include all domestic and foreign taxes which are based on taxable income. Taxes on income exclude tax payable on distribution of dividends and other distribution made by enterprise. Recognition and measurement As per this accounting standard the income tax expenses should be treated just like any other expenses on accrual basis irrespective of the timing of payment of tax. Tax expenses for the period to be recognized consist of current tax and deferred tax. Current tax Current tax is the amount of income tax determined to be payable (recoverable) in respect of taxable income (tax loss) for a period. Deferred tax Deferred tax is the tax effect of timing difference. Difference between the tax expenses (which is calculated on accrual income tax Act is called deferred tax (assets/liability). That is why the tax expenses = Current Tax + Deferred Tax The difference between tax expenses and current tax arises only on account of timing difference and thus creating deferred tax asset/liability. Measurement of current and deferred tax Current tax Current tax should be measured at the amount expected to be paid to (recovered from) taxation authorities using applicable tax rates and tax laws. Deferred tax Deferred tax should be measured using the rates and tax laws that have been enacted or substantially enacted by the balance sheet date. Difference in accounting profit and tax profit As we know that profit as shown in accounts differ with the profit (taxable) calculated as per income-tax Act. The reasons of difference between two profits are of two types. 1) Timing difference: These differences originate in one period and capable of reversal in one or more subsequent periods. Examples Difference due to rate of depreciation
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Difference due to method of depreciation. Expenses debited in the statement of profit & loss for accounting purpose but allowed for tax purpose in subsequent year. Like section 43B of income tax Act, 1961
2) Permanent Difference: These differences originate in one period and do not reverse subsequently in other words the difference always remains and is of permanent in nature. For example, expenses debited in the statement of profit and loss for accounting purpose but it is not allowed for tax purpose at all in any year or income credited in profit and loss account while calculating the accounting profit is exempted for tax. Deferred Tax is tax effect of timing difference
Deferred Tax Liability is recognized for timing differences that will result in taxable amounts in future years. For example, a timing difference is created between the depreciation as per the books of accounts and the depreciation claimed under the tax laws which, in initial years, higher that depreciation claimed a expenses in the financial statements. This would lead to a higher taxable income in future. Example 1: Induga Limited prepares its accounts annually on 31st March. On 1st April, 2002, it purchases a machine at a cost of Rs. 1, 50,000. The machine has a useful life of three years and an expected scrap value of zero. Although it is eligible for a 100% first year depreciation allowance for the tax purpose, the straight-line method is considered appropriate for accounting purpose. Indugo limited has profits before depreciation and taxes of Rs. 2, 00,000 each year and the corporate tax rate is 40% each year. The purchase of machine at a cost of Rs. 1, 50,000 in 2002 gives rise to tax saving of Rs. 60,000. If the cost of the machine is spread over three years of its life for accounting purpose, the amount of the tax saving should also be spread over the same period as shown below: Statement of Profit and Loss for the three years ending on 31st March, 2003, 2004 and 2005 2003 2004 2005 Profit before depreciation and taxes 200 200 200 Less: Depreciation for accounting purpose 50 50 50 Profit before taxes 150 150 150 Less: Tax expense Current tax 0.04(200-150) 20 0.40(200) 80 80 Deferred Tax Tax effect of timing differences originating during the 40 year 0.40(150-50)
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Tax effect of timing difference reversing during the year 0.40(0-50) Tax expense Profit after tax Notes: Net timing differences Deferred Tax liability
(20) 60 90 100 40 60 90 50 20
(20) 60 90 0 0
Deferred Tax Assets - is recognized for timing differences that will result in deductible amounts in future years and for carry forward. For example, timing differences created between the reported amount and the tax base of a liability for estimated expenses as for tax purpose, those estimated expenses are not deductible until a future year. Settlement of that liability will result in tax deduction in future years, and a deferred tax asset is recognized in the current year for the reduction in taxes payable in future years. Example 2: Induga Limited prepares its accounts annually on 31st March. The company has incurred a loss of Rs. 1, 00,000 in the year 2003 and made profits of Rs 50,000 and Rs. 60,000 in the year 2004 and 2005 respectively. It is assumed that under the tax laws, loss can be carried forward for 8 years and tax rate is 40% and at the end of the year 2003, it was virtually certain, supported by convincing evidence, that the company would have sufficient taxable income in the future years against which unabsorbed deprecation and carry forward of losses can be set-off. It is assumed that there is no difference between taxable income and accounting income except that set-off of loss is allowed in years 2003, 2004 and 2005 for tax purposes. Statement of Profit and Loss for the three years ending on 31st March, 2003, 2004 and 2005 2003 2004 2005 Profit (loss) (100) 50 60 Less: Current tax (4) Deferred Tax: Tax effect of timing differences originating during the year 40 Tax effect of timing differences reversing during the year (20) (20) Profit (loss) after tax effect (60) 30 36 Transitional Provision When this accounting standard of taxes on income is first time applied, the amount of deferred tax asset/liability should be created in the same way had this accounting standard been in effect from the beginning. The corresponding debit/credit to the revenue reserves subject to the consideration of prudence in case of deferred tax assets. Prudence for Recognizing Deferred Tax Asset Deferred tax asset/liability should be measured for all timing differences. But deferred tax asset should be recognized and carried forward only to the extent it is reasonably certain that there will be sufficient future income recover such deferred tax asset. In case there is no future sufficient income, deferred tax asset should be recognized only to the extent such asset can be recovered by way of tax saving. a) Unabsorbed depreciation and carry forward losses Since there is eight year time limit for carry forward of business loss and unabsorbed depreciation in Indian tax law recognition of the deferred tax
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asset should be guided by the concept whether the sufficient profit will be generated within the prescribed time period. To recognize deferred tax assets on this account there should be convincing evidence that sufficient taxable income will be available against which such deferred tax assets can be realized. In such circumstances, the nature of the evidence supporting its recognition is disclosed. b) Re-assessment of unrecognized deferred tax asset Previously unrecognized deferred tax assets re-assessed at every balance sheet date. If it becomes reasonably certain that such unrecognized deferred tax asset will be realized then unrecognized deferred tax asset is recognized now. c) Deferred tax asset and liability Should be accounted on the basis of tax rate applicable for the subsequent relevant year known at balance sheet date. When different tax rate apply to different level of taxable income average rates should be used. Example 3: If in example 1 substantially enacted tax rates for 2003, 2004 and 2005 are 40%, 35% and 38% respectively, the amount of deferred tax liability would be computed as follows: The deferred tax liability carried forward each year would appear in the Balance Sheet as under: 31st March, 2003 = 0.40 (1, 00,000) = Rs.40, 000 31st March, 2004 = 0.35 (50,000) = Rs.17, 500 31st March, 2005 = 0.40 (zero) = Rs. zero Accordingly, the amount debited/ (Credited) to the profit and loss account (with corresponding credit or debit to deferred tax liability) for each year would be as under: = Rs. 40,000 31st March, 2003 Debit 31st March, 2004 (Credit) = Rs. (22,500) 31st March, 2005 (Credit) = Rs. (17,500) d) Review of deferred tax asset - The carrying amount of deferred tax asset would be reviewed at each balance sheet date. If it is evident that any portion of the deferred tax asset is not recoverable because of uncertainty of future income. The deferred tax asset should be written down. Any such written down amount may be reversed in subsequent period to the extent that it becomes reasonable certain that sufficient future taxable income will be available. Deferred tax assets and liabilities should not be discounted to their present value. Disclosure The break-up of deferred tax asset/liability should be disclosed. In case of deferred tax asset arises out of unabsorbed deprecation or loss, evidence supporting recognition should be disclosed. Deferred tax asset/liability should be disclosed separately from current asset/liabilities. They should also be distinguished from advance tax/tax provision/tax refund due. As per the explanation to para30 of AS-2 deferred tax liability should be shown after the head Unsecured Loan and deferred tax asset after the head Investment with a separate heading. Deferred tax asset and liability should be set off if permissible under the tax laws but to be shown separately if not permissible.
Example 4 of policy as regard taxes on income Provision for tax consists of current tax and deferred tax. Current tax provision is computed for current income based on the tax liability after considering allowances and exemptions. Deferred tax assets and liabilities are computed on the timing differences at the balance sheet date between the carrying amount of assets and liabilities and their respective tax
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bases. Deferred tax assets are recognized based on management estimates of available tax liability and assessing its certainty. Example of break-up of deferred tax asset/liability Particulars Deferred Tax Current liability/(asset deferred s) year as at Tax 1-4-2002 1487 8 1495 (46) (38) (45) (5) (1) (1) (1) (137) 1358 128 1 129 (54) 8 (16) (1) (33) 0.50 (3) 0.50 (98) 31 Liability/(a sset) as at 31-3-2003
Deferred Tax Liability (i) Difference between book and tax depreciation (ii) Prepaid Expenses (A) Deferred Tax Assets (i) Early Separation Scheme (ii) Wage Provision (iii) Provision for doubtful debts & advances (iv) Disallowances under section 43B (v) Provision for leave Salary (vi) Euro Issue Expenses (vii) Provision for Retiring Gratuity (viii) Other Deferred Tax Assets (B) Deferred Tax Liability (Net) (A-B)
1615 9 1624 (100) (30) (61) (6) (33) (0.50) (4) (0.50) (235) 1389
Pursuant to AS-22, the company has recorded a net cumulative deferred tax liability of Rs. 1,358 crores upto 31-3-2002 as reduction in General Reserve. Further, the impact of Deferred Tax Liability of Rs. 31 Crores for the period ended on 31-3-2003 has been debited to profit and loss account. AS-22 and Income tax Act 1) Tax on dividend distribution u/s 115-O to 115Q AS22 does not cover the tax on distribution of income i.e. dividend tax under sections 115-O to 115Q of Income-tax Act, as this tax is on distribution of income rather than tax on income 2) AS-22 and sec 80IA and sec 80IB The deferred tax in respect of timing differences which reverse during the tax holiday period, should not be recognized to the extent the gross total income of the enterprise is subject to such deductions. The deferred tax in respect of timing difference which reverse after the tax holiday period, should be recognized in the year in which the timing differences originate, subject to consideration of prudence. Timing differences which originate first should be considered as reversing first. 3) AS-22 and capital gain Timing differences by way of losses that arise under the capital gain should be recognized, as a deferred tax asset and carried forward subject to consideration of prudence. A deferred tax asset in respect thereof will be recognized only if there is a reasonable certainty that sufficient future taxable income will be available under the head Capital gain. SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI 145
Where an entity has a carry forward depreciation or carry forward loss, and timing differences by way of losses also arise in relation to capital gain, a deferred tax asset in respect thereof will be recognized only and only if there is virtual certainty that sufficient future taxable income will be available and such a conclusion is supported by consideration of prudence. Where there is a difference between the amounts of losses recognized for accounting purpose and tax purposes, because of cost indexation under the income tax Act, in respect of long-term capital assets, the deferred tax asset should be recognized and carried forward, on the amount that can be carried forward and set off under the Income-tax Act, subject of course, to consideration of prudence.
4) AS-22 and sections 10A and 10B The deferred tax in respect of timing differences which originate during the tax holiday period, and reverse during the tax holiday period, should not be recognize to the extent the gross total income of the enterprises is subject to such deductions. The deferred tax in respect of timing differences which originate during the tax holiday period, but reverse after the tax holiday period, should be recognized in the years which the timing differences originate, subject to consideration of prudence. Timing difference, which originate first, should be considered as reversing first. 5) AS-22 and Sec. 115JB MAT The payment of tax under section 115JB of the Income-tax Act is a current tax for the period. In a period in which a company pays tax under section 115JB of the Act, the deferred tax assets and liabilities in respect of timing differences arising during the period, tax effect of which is required to be recognized under AS-22, should be measured using the regular tax rates and not the tax rate under section 115JB of the Act. In case an enterprise expects that the timing difference arising in the current period would reverse in a period in which it may pay tax under section 115JB of the Act, the deferred tax assets and liabilities in respect of timing differences arising during the current period, tax effect of which is required to be recognized under AS-22, should be measured using the regular tax rates and not the tax rate under section 115B of the Act. 6) Tax effect of expenses/income adjusted directly against the reserves and/or Securities Premium Account It has been noticed that some companies are charging certain expenses, which are otherwise reserves and/or Securities Premium Account pursuant to the court orders. In such a case, while the expenses are charged to reserves and/or Securities Premium Account. Such a situation may also arise where an enterprise adjusts its reserves to give effect to a change, if any, in accounting policy consequent upon adoption of an Accounting Standard, in accordance with the transitional provision contained in the standard. Further, a company may adjust an expense against the Securities Premium Account as allowed under the provisions of section 78 of the Companies Act, 1956. A similar situation may arise where, pursuant to a court order or under transitional provisions prescribed in an accounting standard, an income, which should have otherwise been credited to the profit and loss account in accordance with the requirements of generally accepted accounting principles, may have been directly credited to a reserve account or similar account and the tax effect thereof is not recognised in the reserve account of a similar account.
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It is clarified by the Institute of Chartered Accountants that any item of income or expense adjusted directly to reserves and/or Securities Premium Account should be net of its tax effect to make it in compliance with Generally Accepted Accounting Principles. 7) Presentation of MAT in Financial Statement As per the Guidance Note issued by the Institute of Chartered Accountants of India, where a company recognises MAT credit as an asset on the basis of prudence, the same should be presented under the head Loans and Advances since, there being a convincing evidence of realization of the asset, it is of the income-tax during the specified period. The asset may be reflected as MAT credit entitlement. In the year of set-off credit, the amount of credit availed should be shown as a deduction from the Provision for Taxation on the liability side of the balance sheet. The unavailed amount of MAT credit entitlement, if any, should continue to be presented under the head Loans and Advances if it continues to meet the considerations of prudence and realisability. According to Explanation to para 21 of Accounting Standard Accounting for Taxes on income in context of section 115JB of the Income-tax Act, 1961. Issued by the Institute of Chartered Accountants of India, MAT is the current tax. Accordingly, the tax expenses arising on account of payment of MAT credit becomes eligible to be recognised as an asset in accordance with the recommendations contains in this Guidance Note, the said asset should be created by was of a credit to profit and loss account and presented as a separate line item therein. AS-22 and AS-28 Impairment loss calculated as per AS-28 is not deductible loss and therefore result in timing difference and finally result in creation of deferred tax asset which shall be recognized on the basis of prudence.
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AS 23 - ACCOUNTING FOR INVESTMENTS IN ASSOCIATES IN CFS

- Ayushi Jain (ayuprash@gmail.com)
Objective: The objective of this Standard is to set out principles and procedures for recognizing, in the consolidated financial statements, the effect of the investments in associates on the financial position and operating results of a group. Scope: This standard deals only with the Investments in associates in preparation and presentation of consolidated financial statements. This standard doesnt deal in preparation and presentation of separate financial statements. Applicability Only when the investor prepares consolidated financial statements this standard is applicable or else its not applicable. For separate financial statements prepared by the investor AS-13 applicable NOW IT IS AS30. Non - Applicability The Investment is acquired and held exclusively for its subsequent disposal in the near future. When there is no significant influence in an associate or ceases to have significant influence. AS-23 is applicable only when investor has significant influence and not Control. Merely on purchasing 20% or more shares by the investor, the investee doesnt become associate. FAMILIARITY WITH THE TERMS ASSOCIATE An enterprise in which the investor has significant influence which is neither a subsidiary nor a joint venture of the investor SIGNIFICANT INFLUENCE Significant influence means the power to participate in the financial and operating decisions of the associate however doesnt mean to control the associate. Control means to govern the financial and operating policies of an associate. Test of Significance Influence Accounting for Investments in Associates Investment in associate should be accounted as per Equity Method in preparation and presentation of consolidated financial statements. From the date of cessation of significant influence, the investment in associate should be accounted as per AS-13. I Equity Method of Accounting Equity is the residual interest in the assets of an enterprise after deducting all its liabilities.(Equity +Reserves). Equity method of accounting is as follows; The Investment is recorded at cost, identifying Goodwill/capital reserve during the time of acquisition; The carrying amount is adjusted for the post acquisition change in the Investors share of Net assets of the investee. Distributions received from an investee reduce the carrying amount of the investment. Other adjustments which are not included in the P&L such as Revaluation of fixed assets,amalagamation differences. II Application of Equity Method Goodwill/Capital reserve arising on the acquisition of an associate included in the carrying amount of investment in the associate.
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Unrealized profits and losses resulting from transactions between the investor and the associate should be eliminated to the extent of the investors interest in the associate III Losses on account of investment in associates Ordinarily discontinue recognizing share of further losses and the investment is reported at NIL value Additional losses are provided for; to the extent the investor has incurred obligations or made payments on behalf of the associates. If the associate subsequently reports profit, the investor resumes including its share of profits only after its share of profits equals its share of net losses that have not been recognized. Contingencies In accordance with Accounting standard (AS-4), contingencies and Events occurring after the balance sheet date, the investor discloses in the consolidated financial statements: a) Its share of contingencies and capital commitments of an associate for which it is also contingently liable; b) Those contingencies that arise because the investor is severally liable for the liabilities of the Associate. Interpretation by ICAI Proposed Dividend by the Associate ASI -16 If the associate has made a provision in its financial statements, the investors share of results of operations of the associate should be computed without taking into consideration the proposed dividend. Disclosure Investor should disclose in its consolidated financial statements the following: Description of associate including the proportion of ownership interest should be disclosed. Difference in reporting dates of financial statements of associates and of the investor should be disclosed. Investments should be classified as Long term investments. In case an associate uses accounting policies other than those adopted for the consolidated financial statements and if its not feasible to make appropriate adjustments to the associate financial statements, the fact should be disclosed along with the description of the differences in the accounting policies.
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AS 24 - DISCONTINUING OPERATION
- M. Sathish Kumar (lmsathishkumar@gmail.com)
Applicability Enterprise whose equity or debt securities are listed whether in India or outside India or Enterprise which are in the process of listing their equity or debt securities. Enterprise whose turnover exceeds Rs 50 Crores and Turnover does not include Other Income Enterprise having borrowings including public deposits exceeds Rs 10 Crores Banks Insurance Companies Financial Institutions Holding and subsidiary enterprises of any one of the above Objective To establish principle for reporting information about discontinuing operations Discontinuing Operation It is a component of an enterprise that: 1) The enterprise pursuant to a single plan is a) Disposing of substantially in its entirety b) Disposing of piecemeal c) Terminating through abandonment 2) Represent a separate major line of business or geographical area of operation and 3) That can be distinguished operationally and for financial reporting purposes Initial Disclosure Event Initial disclosure event is the occurrence of one of the following, whichever occurs earlier: a) An enterprise entered in to binding sale agreement or b) Board of directors or similar governing body approved plan for disposal and public announcement of the same. Recognition and Measurement An enterprise should apply the principles of recognition and measurement that are set out in other Accounting Standards for the purpose of deciding as to when and how to recognize and measure the changes in assets and liabilities and the revenue, expenses, gains, losses and cash flows relating to a discontinuing operation. Initial Disclosure 1) A description of the discontinuing operation(s); 2) The business or geographical segment(s) in which it is reported as per AS 17, Segment Reporting; 3) The date and nature of the initial disclosure event; 4) The date or period in which the discontinuance is expected to be completed if known or determinable;
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5) The carrying amounts, as of the balance sheet date, of the total assets to be disposed of and the total liabilities to be settled; 6) The amounts of revenue and expenses in respect of the ordinary activities attributable to the discontinuing operation during the current financial reporting period; 7) The amount of pre-tax profit or loss from ordinary activities attributable to the discontinuing operation during the current financial reporting period, and the income tax expense related thereto; and (Note: This information should be presented on the face of the statement of profit and loss) 8) The amounts of net cash flows attributable to the operating, investing, and financing activities of the discontinuing operation during the current financial reporting period Other Disclosures When an enterprise disposes of assets or settles liabilities attributable to a discontinuing operation or enters into binding agreements for the sale of such assets or the settlement of such liabilities, it should include, in its financial statements, the following information when the events occur: a) for any gain or loss that is recognized on the disposal of assets or settlement of liabilities attributable to the discontinuing operation, (i) the amount of the pre-tax gain or loss and (ii) income tax expense relating to the gain or loss; and (Note: This information should be presented on the face of the statement of profit and loss) b) the net selling price or range of prices (which is after deducting expected disposal costs) of those net assets for which the enterprise has entered into one or more binding sale agreements, the expected timing of receipt of those cash flows and the carrying amount of those net assets on the balance sheet date. Updating the Disclosures An enterprise should include, in its financial statements, for periods subsequent to the one in which the initial disclosure event occurs, a description of any significant changes in the amount or timing of cash flows relating to the assets to be disposed or liabilities to be settled and the events causing those changes. Such disclosures should continue in financial statements for a period up to and including period in which the discontinuance is completed. A dis-continuance is completed when the plan is substantially completed or abandoned, though full payments from buyer may not have been received. If an enterprise abandons or withdraws from a plan that was previously reported as a discontinuing operation, that fact, reasons therefor and its effect should be disclosed. Any disclosures required by this Standard should be presented separately for each discontinuing operation.
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AS 25- INTERIM FINANCIAL REPORTING

- Radhakrishna Das (rkdasinbox@gmail.com)
BACKGROUND AND INTRODUCTION OF THE STANDARD: Accounting Standard (AS) 25, 'Interim Financial Reporting', issued by the Council of the Institute of Chartered Accountants of India, comes into effect in respect of accounting periods commencing on or after 1-4-2002.The objective of this Statement is to prescribe the minimum content of an interim financial report and to prescribe the principles for recognition and measurement in complete or condensed financial statements for an interim period. 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, its financial condition and liquidity. KEY DEFNITIONS IN THE STANDARD: Interim period is a financial reporting period shorter than a full financial year. Interim financial report means a financial report containing either a complete set of financial statements or a set of condensed financial statements for an interim period. FORM AND CONTENT OF INTERIM FINANCIAL STATEMENTS: If an enterprise prepares and presents a complete set of financial statements in its interim financial report, the form and content of those statements should conform to the requirements as applicable to annual complete set of financial statements. If an enterprise prepares and presents a set of condensed financial statements in its interim financial report, those condensed statements should include, at a minimum, each of the headings and sub-headings that were included in its most recent annual financial statements and the selected explanatory notes as required by this Statement. An Enterprise should include the following information, as a minimum, in the notes to its interim financial statements, if material and if not disclosed elsewhere in the interim financial report: A statement that the same accounting policies are followed in the interim financial statements as those followed in the most recent annual financial statements or, if those policies have been changed, a description of the nature and effect of the change; Explanatory comments about the seasonality of interim operations The nature and amount of items affecting assets, liabilities, equity, net income, or cash flows that are unusual because of their nature, size, or incidence; The nature and amount of changes in estimates of amounts reported in prior interim periods of the current financial year or changes in estimates of amounts reported in prior financial years, if those changes have a material effect in the current interim period; Issuances, buy-backs, repayments and restructuring of debt, equity and potential equity shares; Material events subsequent to the end of the interim period that have not been reflected in the financial statements for the interim period. the effect of changes in the composition of the enterprise during the interim period, such as amalgamations, acquisition or disposal of subsidiaries and long-term investments, restructurings, and discontinuing operations; and Material changes in contingent liabilities since the last annual balance sheet date.
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MATERIALITY: In deciding how to recognize measure, classify, or disclose an item for interim financial reporting purposes, materiality should be assessed in relation to the interim period financial data. In making assessments of materiality, it should be recognized that interim measurements may rely on estimates to a greater extent than measurements of annual financial data. RECOGNITION AND MEASUREMENT: An enterprise should apply the same accounting policies in its interim financial statements as are applied in its annual financial statements, except for accounting policy changes made after the date of the most recent annual financial statements that are to be reflected in the next annual financial statements. However, the frequency of an enterprise's reporting (annual, half-yearly, or quarterly) should not affect the measurement of its annual results. To achieve those objective, measurements for interim reporting purposes should be made on a year to- date basis. For example the principles for recognizing and measuring losses from inventory writedowns, restructurings, or impairments in an interim period are the same as those that an enterprise would follow if it prepares its 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. Another example to make it comprehensive is that 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. Amounts accrued for income tax expense in one interim period may have to be adjusted in a subsequent interim period of that financial year if the estimate of the annual income tax rate changes. REVENUES RECEIVED & COSTS INCURRED UNEVENLY IN THE FINANCIAL YEAR: Costs that are incurred unevenly during an entitys financial year shall 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. Similarly revenues that are received seasonally, cyclically, or occasionally within a financial year shall not be anticipated or deferred as of an interim date if anticipation or deferral would not be appropriate at the end of the entitys financial year. Eg. Dividend income, government grants, royalty income etc. RESTATEMENT OF PREVIOUSLY REPORTED INTERIM PERIODS: A change in accounting policy, other than one for which the transition is specified by an Accounting Standard, should be reflected by restating the financial statements of prior interim periods of the current financial year. One objective of the preceding principle is to ensure that a single accounting policy is applied to a particular class of transactions throughout an entire financial year. COMPARISION WITH IAS 34: With regard to preparation of statement of profit and loss, International Accounting Standard (IAS) 34, Interim Financial Reporting, provides option either to follow single statement approach or to follow two statement approaches. But, AS 25 allows only single statement approach. Different terminology is used in AS 25 e.g., the term balance sheet is used instead of Statement of financial position and Statement of Profit and Loss is used instead of Statement of comprehensive income.
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AS 26 INTANGIBLE ASSETS
- C. Naresh (cnaresh.ca@gmail.com)
What is an Intangible Asset? An 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 others, or for administrative purposes. o An Asset is a resource controlled by an enterprise as a result of past events, and from which future economic benefits are expected to flow to the enterprise. o Non-monetary assets are those other than monetary assets (monetary assets are money held and assets to be received in fixed or determinable amounts of money) Some examples of intangible assets are patents, copyrights, computer software, franchises, market share, brand, etc. For an asset to be recognized as intangible asset, it should satisfy certain conditions, viz definition and recognition criteria:
Definition Criteria It should be separately identifiable .i.e the asset should be able to be rented, sold or exchanged for consideration without disposing of the business as a whole. An expected future economic benefit should flow from the asset, in the form of saving of costs, or increase in revenue, or a combination of both. The asset should be controlled by the entity. Legal rights, technical knowledge, copyrights, restraint of trade agreement, etc ensures control over economic benefits.
Recognition Criteria It should be recognized only if it is probable that the future economic benefits that are attributable to the asset will flow to the enterprise the cost of the asset can be measured reliably. Measurement Criteria The principles of measurement are similar to that in AS 10.
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Intangible Asset arising from Amalgamation: The standard recognizes only intangible assets that emerge from an amalgamation in the nature of purchase. Such assets can be recognized by transferee even if not recognized by the transferor. (Although AS 14 will apply in such cases) These intangible assets are to be measured at fair value. If the fair value of the asset is not separately ascertainable, then it should be included as part of goodwill. Intangible Asset received through Government Grants: Intangible assets such as airport landing rights, access to resources which are acquired through government grants should be recognized at cost of acquisition. Internally Generated Intangible Assets: Incase of goodwill, the same should not be recognized. Incase of any other expenses, the same should be classified under either research phase or development phase. All expenses under research phase should not be recognized as intangible asset but charged as expense as and when required. E.g. activities for obtaining new knowledge, search for research findings, evaluation of alternatives, etc. All Expenses qualified under development stage can be recognized as intangible asset. Development activities can comprise costs for designing, testing methods and processes, pilot plants, etc. For an expense to be classified under development stage, the following six conditions needs to be satisfied: Technical feasibility of completing the intangible asset Intention to complete and use the intangible asset Ability to use the asset Probability of generating future economic benefits from the asset Adequate technical and financial resource available to complete the development of the asset Reliable measurability of the expenses incurred in the development.
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Thus an expenditure can be recognized as intangible asset only if meets the definition and recognition criteria. Else, it should be charged off as expense. Once an expense is charged off as expense, the same cannot be later converted into an intangible asset. Measurement subsequent to initial recognition: The intangible asset recognized in the books should be reviewed periodically and amortized, if necessary. The asset should appear in the books in its carrying amount. Carrying amount is the amount at which an asset is recognized in the balance sheet, net of any accumulated amortization and accumulated impairment losses thereon. Amortization: While the decrease in value of tangible assets is called as depreciation, the same is termed as amortization incase of intangible assets. There are three critical aspects to identify the amount to be amortized:
Pin-points: Amortization should commence only from the time the asset is available for use. In certain cases, where the period of intangible asset is defined for a finite period (e.g. license rights for 5yrs, etc.) by express agreement or implied, then the defined period should be taken as the period of amortization. Generally, the amortization amount will be charged off as expense. Marking an exception to this, some assets gets absorbed in the production process of other assets. E.g. Amortization of intangible asset used in production process is included in the carrying amount of inventories. Once a residual value of the asset, other than zero, is assigned by demonstrating with persuasive evidence, the same cannot be increased at a later date.
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During the periodical annual review of the amortization, when there is a significant change in the expected useful life or/and a significant change in the expected pattern of economic benefits, the amortization period or/and the amortization method, as the case maybe, should also be changed accordingly. However this change will be governed by AS 5.
Impairment Loss: During the periodical annual review of the intangible asset, sometimes the carrying amount of the asset may exceed its recoverable amount. Such excess amount is to be treated as loss, which is termed as impairment loss. Disposal of Intangible Assets: When an intangible asset is disposed off or no more of future economic benefits to flow from its continued use, then the asset is to be de-recognized and eliminated from Balance Sheet. The amount of difference between the net disposal proceeds and the carrying amount is to be recognized as income or expense, as the case maybe. A retired asset pending disposal should be carried at carrying amount at the date when the asset is retired. The same should be tested at each financial year for impairment.
Disclosure Requirements: Disclose the amortization amount recognized and the R&D expenses in the Profit & Loss Account. Also disclose the gain/loss on retirement or disposal or asset and the impairment losses recognized. Classify separately internally generated intangible assets and other intangible assets in the assets side of the Balance Sheet and carry the same at carrying amount net of amortization and impairment loss. Assets of similar nature should be grouped together. In Notes to Accounts, disclose the amortization method and period, specific reasons if the period taken is over ten years. Also describe the accounting policy adopted for intangible assets.
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AS 27 - FINANCIAL REPORTING OF INTEREST IN JOINT VENTURE - Ayushi Jain (ayuprash@gmail.com)

Objective The objective of this Statement is to set out principles and procedures for accounting for interests in joint ventures and reporting of joint venture Assets, liabilities, income and expenses (ALIE) in the financial statements of ventures and investors. Applicability Entities pursuant to the requirements of a Statue/regulator or voluntarily, prepares and presents consolidated financial statements they are required to be complied with the Accounting Standards AS-21, AS-23 and AS-27 which relate to Consolidation of Financial Statements. Scope Definitions For the purpose of this Statement, the following terms are used with the meanings specified : A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity, which is subject to joint control. Joint control is the contractually agreed sharing of control over an economic activity. Control is the power to govern the financial and operating policies of an economic activity so as to obtain benefits from it. A venture is a party to a joint venture and has joint control over that joint venture. An investor in a joint venture is a party to a joint venture and does not have joint control over that joint venture. Contractual Arrangement The existence of a contractual arrangement distinguishes interests which involve joint control from investments in associates in which the investor has significant influence (see Accounting Standard (AS) 23, Accounting for Investments in Associates in Consolidated Financial Statements). Activities which have no contractual arrangement to establish joint control are not joint ventures for the purposes of this Statement. In some exceptional cases, an enterprise by a contractual arrangement establishes joint control over an entity which is a subsidiary of that enterprise within the meaning of Accounting Standard (AS) 21, Consolidated Financial Statements. In such cases, the entity is not consolidated under AS 21, but is treated as a joint venture as per this Statement. The contractual arrangement may be evidenced in a number of ways, for example by a contract between the ventures or minutes of discussions between the ventures. In some cases, the arrangement is incorporated in the articles or other by-laws of the joint venture. Whatever its form, the contractual arrangement is normally in writing and deals with such matters as: The activity, duration and reporting obligations of the joint venture; The appointment of the board of directors or equivalent governing body of the joint venture and the voting rights of the ventures; Capital contributions by the ventures; and The sharing by the ventures of the output, income, expenses or results of the joint venture.
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The contractual arrangement establishes joint control over the joint venture. Such an arrangement ensures that no single venture is in a position to unilaterally control the activity. The arrangement identifies those decisions in areas essential to the goals of the joint venture which require the consent of all the ventures and those decisions which may require the consent of a specified majority of the ventures. The contractual arrangement may identify one venture as the operator or manager of the joint venture. The operator does not control the joint venture but acts within the financial and operating policies which have been agreed to by the ventures in accordance with the contractual arrangement and delegated to the operator. A. Jointly Controlled Operations The operation of joint ventures involves the use of the assets and other resources of the venture rather than the establishment of a corporation, partnership or other entity, or a financial structure that is separate from the ventures themselves. Each venture uses its own fixed assets and carries its own inventories. It also incurs its own expenses and liabilities and raises its own finance, which represent its own obligations. The joint venture's activities may be carried out by the ventures employees alongside the ventures similar activities. The joint venture agreement usually provides means by which the revenue from the jointly controlled operations and any expenses incurred in common are shared among the venture. An example of a jointly controlled operation is when two or more venture combines their operations, resources and expertise in order to manufacture, market and distributes, jointly, a particular product, such as an aircraft. Different parts of the manufacturing process are carried out by each of the venture. Each venture bears its own costs and takes a share of the revenue from the sale of the aircraft, such share being determined in accordance with the contractual arrangement. In respect of its interests in jointly controlled operations, a venture should recognize in its separate financial statements and consequently in its consolidated financial statements: a. The assets that it controls and the liabilities that it incurs; and b. The expenses that it incurs and its share of the income that it earns from the joint venture. Separate accounting records may not be required for the joint venture itself and financial statements may not be prepared for the joint venture. However, the venture may prepare accounts for internal management reporting purposes so that they may assess the performance of the joint venture. B. Jointly Controlled Assets Some joint ventures involve the joint control, and often the joint ownership, by the venture of one or more assets contributed to, or acquired for the purpose of, the joint venture and dedicated to the purposes of the joint venture. The assets are used to obtain economic benefits for the venture. Each venture may take a share of the output from the assets and each bears an agreed share of the expenses incurred. An example of a jointly controlled asset is an oil pipeline jointly controlled and operated by a number of oil production companies. Each venturer uses the pipeline to transport its own product in return for which it bears an agreed proportion of the expenses of operating the pipeline. Another example of a jointly controlled asset is when two enterprises jointly control a property, each taking a share of the rents received and bearing a share of the expenses. In respect of its interest in jointly controlled assets, a venturer should recognize, in its separate financial statements, and consequently in its consolidated financial statements: Its share of the jointly controlled assets, classified according to the nature of the assets; Any liabilities which it has incurred; Its share of any liabilities incurred jointly with the other venture in relation to the joint venture;
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Any income from the sale or use of its share of the output of the joint venture, together with its share of any expenses incurred by the joint venture; and Any expenses which it has incurred in respect of its interest in the joint venture. Because the assets, liabilities, income and expenses are already recognized in the separate financial statements of the venture, and consequently in its consolidated financial statements, no adjustments or other consolidation procedures are required in respect of these items when the venture presents consolidated financial statements. The treatment of jointly controlled assets reflects the substance and economic reality and, usually, the legal form of the joint venture. Separate accounting records for the joint venture itself may be limited to those expenses incurred in common by the venture and ultimately borne by the venture according to their agreed shares. Financial statements may not be prepared for the joint venture, although the venture may prepare accounts for internal management reporting purposes so that they may assess the performance of the joint venture. C. Jointly Controlled Entities A jointly controlled entity is a joint venture which involves the establishment of a corporation, partnership or other entity in which each venturer has an interest. The entity operates in the same way as other enterprises, except that a contractual arrangement between the venture establishes joint control over the economic activity of the entity. A jointly controlled entity controls the assets of the joint venture, incurs liabilities and expenses and earns income. It may enter into contracts in its own name and raise finance for the purposes of the joint venture activity. Each venture is entitled to a share of the results of the jointly controlled entity, although some jointly controlled entities also involve a sharing of the output of the joint venture. An example of a jointly controlled entity is when two enterprises combine their activities in a particular line of business by transferring the relevant assets and liabilities into a jointly controlled entity. Another example is when an enterprise commences a business in a foreign country in conjunction with the government or other agency in that country, by establishing a separate entity which is jointly controlled by the enterprise and the government or agency. Many jointly controlled entities are similar to those joint ventures referred to as jointly controlled operations or jointly controlled assets. For example, the venture may transfer a jointly controlled asset, such as an oil pipeline, into a jointly controlled entity. Similarly, the venture may contribute, into a jointly controlled entity, assets which will be operated jointly. Some jointly controlled operations also involve the establishment of a jointly controlled entity to deal with particular aspects of the activity, for example, the design, marketing, distribution or after-sales service of the product. A jointly controlled entity maintains its own accounting records and prepares and presents financial statements in the same way as other enterprises in conformity with the requirements applicable to that jointly controlled entity. Financial Reporting Aspects Separate Financial Statements of a Venturer In a ventures separate financial statements, interest in a jointly controlled entity should be accounted for as an investment in accordance with Accounting Standard (AS) 13, Accounting for Investments.
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Each venturer usually contributes cash or other resources to the jointly controlled entity. These contributions are included in the accounting records of the venturer and are recognized in its separate financial statements as an investment in the jointly controlled entity. Consolidated Financial Statements of a Venturer In its consolidated financial statements, a venturer should report its interest in a jointly controlled entity using proportionate consolidation except a. An interest in a jointly controlled entity which is acquired and held exclusively with a view to its subsequent disposal in the near future; and b. An interest in a jointly controlled entity which operates under severe long-term restrictions that significantly impair its ability to transfer funds to the venturer. Interest in such a jointly controlled entity should be accounted for as an investment in accordance with Accounting Standard (AS) 13, Accounting for Investments. When reporting an interest in a jointly controlled entity in consolidated financial statements, it is essential that a venturer reflects the substance and economic reality of the arrangement, rather than the joint venture's particular structure or form. In a jointly controlled entity, a venturer has control over its share of future economic benefits through its share of the assets and liabilities of the venture. This substance and economic reality is reflected in the consolidated financial statements of the venturer when the venturer reports its interests in the assets, liabilities, income and expenses of the jointly controlled entity by using proportionate consolidation. The application of proportionate consolidation means that the consolidated balance sheet of the venturer includes its share of the assets that it controls jointly and its share of the liabilities for which it is jointly responsible. The consolidated statement of profit and loss of the venturer includes its share of the income and expenses of the jointly controlled entity. Many of the procedures appropriate for the application of proportionate consolidation are similar to the procedures for the consolidation of investments in subsidiaries, which are set out in Accounting Standard (AS) 21, Consolidated Financial Statements. Under proportionate consolidation, the venturer includes separate line items for its share of the assets, liabilities, income and expenses of the jointly controlled entity in its consolidated financial statements. For example, it shows its share of the inventory of the jointly controlled entity separately as part of the inventory of the consolidated group; it shows its share of the fixed assets of the jointly controlled entity separately as part of the same items of the consolidated group. The venturer usually prepares consolidated financial statements using uniform accounting policies for the like transactions and events in similar circumstances. In case a jointly controlled entity uses accounting policies other than those adopted for the consolidated financial statements for like transactions and events in similar circumstances, appropriate adjustments are made to the financial statements of the jointly controlled entity when they are used by the venturer in applying proportionate consolidation. If it is not practicable to do so, that fact is disclosed together with the proportions of the items in the consolidated financial statements to which the different accounting policies have been applied. While giving effect to proportionate consolidation, it is inappropriate to offset any assets or liabilities by the deduction of other liabilities or assets or any income or expenses by the deduction of other expenses or income, unless a legal right of set-off exists and the offsetting represents the expectation as to the realization of the asset or the settlement of the liability.
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Any excess of the cost to the venturer of its interest in a jointly controlled entity over its share of net assets of the jointly controlled entity, at the date on which interest in the jointly controlled entity is acquired, is recognised as goodwill, and separately disclosed in the consolidated financial statements. When the cost to the venturer of its interest in a jointly controlled entity is less than its share of the net assets of the jointly controlled entity, at the date on which interest in the jointly controlled entity is acquired, the difference is treated as a capital reserve in the consolidated financial statements. Where the carrying amount of the ventures interest in a jointly controlled entity is different from its cost, the carrying amount is considered for the purpose of above computations. The losses pertaining to one or more investors in a jointly controlled entity may exceed their interests in the equity of the jointly controlled entity. Such excess, and any further losses applicable to such investors, are recognised by the venture in the proportion of their shares in the venture, except to the extent that the investors have a binding obligation to, and are able to, make good the losses. If the jointly controlled entity subsequently reports profits, all such profits are allocated to venture until the investors' share of losses previously absorbed by the venture has been recovered. A venturer should discontinue the use of proportionate consolidation from the date that: a. It ceases to have joint control over a jointly controlled entity but retains, either in whole or in part, its interest in the entity; or b. The use of the proportionate consolidation is no longer appropriate because the jointly controlled entity operates under severe long-term restrictions that significantly impair its ability to transfer funds to the venturer. From the date of discontinuing the use of the proportionate consolidation, interest in a jointly controlled entity should be accounted for: a. In accordance with Accounting Standard (AS) 21, Consolidated Financial Statements, if the venturer acquires unilateral control over the entity and becomes parent within the meaning of that Standard; and b. In all other cases, as an investment in accordance with Accounting Standard (AS) 13, Accounting for Investments, or in accordance with Accounting Standard (AS) 23, Accounting for Investments in Associates in Consolidated Financial Statements, as appropriate. For this purpose, cost of the investment should be determined as under: The ventures share in the net assets of the jointly controlled entity as at the date of discontinuance of proportionate consolidation should be ascertained, and The amount of net assets so ascertained should be adjusted with the carrying amount of the relevant goodwill/capital reserve (see paragraph 37) as at the date of discontinuance of proportionate consolidation. Transactions between a Venturer and Joint Venture When a venturer contributes or sells assets to a joint venture, recognition of any portion of a gain or loss from the transaction should reflect the substance of the transaction. While the assets are retained by the joint venture, and provided the venturer has transferred the significant risks and rewards of ownership, the venturer should recognise only that portion of the gain or loss which is attributable to the interests of the other venture. The venturer should recognise the full amount of any loss when the contribution or sale provides evidence of a reduction in the net realisable value of current assets or an impairment loss. When a venturer purchases assets from a joint venture, the venturer should not recognise its share of the profits of the joint venture from the transaction until it resells the assets to an independent party. A venturer should recognise its share of the losses resulting from these transactions in the same way as profits except that losses should be recognised immediately when they represent a reduction in the net realisable value of current assets or an impairment loss.
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To assess whether a transaction between a venturer and a joint venture provides evidence of impairment of an asset, the venturer determines the recoverable amount of the asset as per Accounting Standard on Impairment of Assets. In determining value in use, future cash flows from the asset are estimated based on continuing use of the asset and its ultimate disposal by the joint venture. The separate financial statements of the venturer, the full amount of gain or loss on the transactions taking place between the venturer and the jointly controlled entity is recognised. However, while preparing the consolidated financial statements, the ventures share of the unrealized gain or loss is eliminated. Unrealized losses are not eliminated, if and to the extent they represent a reduction in the net realisable value of current assets or an impairment loss. The venturer, in effect, recognises, in consolidated financial statements, only that portion of gain or loss which is attributable to the interests of other venture. Reporting Interests in Joint Ventures in the Financial Statements of an Investor An investor in a joint venture, which does not have joint control, should report its interest in a joint venture in its consolidated financial statements in accordance with Accounting Standard (AS) 13, Accounting for Investments, Accounting Standard (AS) 21, Consolidated Financial Statements or Accounting Standard (AS) 23, Accounting for Investments in Associates in Consolidated Financial Statements, as appropriate. Operators of Joint Ventures Operators or managers of a joint venture should account for any fees in accordance with Accounting Standard (AS) 9, Revenue Recognition. One or more venture may act as the operator or manager of a joint venture. Operators are usually paid a management fee for such duties. The fees are accounted for by the joint venture as an expense. Disclosure The aggregate amounts of each of the ALIE related to its interest in the jointly controlled entity. Any contingency that has been incurred in relation to its interest in joint Venture. Its share of contingencies that has been incurred jointly with other venturer. A list of all joint venturer description of interest in significant joint venture.
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AS 28 IMPAIRMENT OF ASSETS
- M. Sathish Kumar (lmsathishkumar@gmail.com)
Applicability Scope All Enterprises All Assets other than: 1) Inventories 2) Assets arising from Construction Contracts 3) Financial Assets 4) Deferred Tax Assets
Key Definitions: Recoverable amount is the higher of an assets net selling price and its value in use. Value in use is the present value of estimated future cash flows expected to arise from the continuing use of an asset and from its disposal at the end of its useful life. An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount. A cash generating unit is the smallest identifiable group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows from other assets or groups of assets. Identifying an Asset that may be Impaired An asset is impaired when the carrying amount of the asset exceeds its recoverable amount. An enterprise should assess at each balance sheet date whether there is any indication that an asset may be impaired. If any such indication exists, the enterprise should estimate the recoverable amount of the asset. External Indication a) during the period, an assets market value has declined significantly more than would be expected as a result of the passage of time or normal use b) significant changes with an adverse effect on the enterprise have taken place during the period, or will take place in the near future, in the technological, market, economic or legal environment in which the enterprise operates or in the market to which an asset is dedicated; c) market interest rates or other market rates of return on investments have increased during the period, and those increases are likely to affect the discount rate used in calculating an assets value in use and decrease the assets recoverable amount materially; d) the carrying amount of the net assets of the reporting enterprise is more than its market capitalization
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Internal Indication a) evidence is available of obsolescence or physical damage of an asset b) significant changes with an adverse effect on the enterprise have taken place during the period, or are expected to take place in the near future, in the extent to which, or manner in which, an asset is used or is expected to be used. These changes include plans to discontinue or restructure the operation to which an asset belongs or to dispose of an asset before the previously expected date; and c) Evidence is available from internal reporting that indicates that the economic performance of an asset is, or will be, worse than expected. Net Selling Price The best evidence of an assets net selling price is a price in a binding sale agreement in an arms length transaction, adjusted for incremental costs that would be directly attributable to the disposal of the asset If there is no binding sale agreement but an asset is traded in an active market, net selling price is the assets market price less the costs of disposal. The appropriate market price is usually the current bid price. When current bid prices are unavailable, the price of the most recent transaction may provide a basis from which to estimate net selling price, provided that there has not been a significant change in economic circumstances between the transaction date and the date at which the estimate is made. If there is no binding sale agreement or active market for an asset, net selling price is based on the best information available to reflect the amount that an enterprise could obtain, at the balance sheet date, for the disposal of the asset in an arms length transaction between knowledgeable, willing parties, after deducting the costs of disposal. In determining this amount, an enterprise considers the outcome of recent transactions for similar assets within the same industry. Net selling price does not reflect a forced sale, unless management is compelled to sell immediately. Costs of disposal, other than those that have already been recognized as liabilities, are deducted in determining net selling price. Value in Use Estimating the value in use of an asset involves the following steps: (a) estimating the future cash inflows and outflows arising from continuing use of the asset and from its ultimate disposal; and (b) applying the appropriate discount rate to these future cash flows. Composition of Estimates of Future Cash Flows Estimates of future cash flows should include:
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1. Projections of cash inflows from the continuing use of the asset; 2. Projections of cash outflows that are necessarily incurred to generate the cash inflows from continuing use of the asset (including cash outflows to prepare the asset for use) and that can be directly attributed, or allocated on a reasonable and consistent basis, to the asset; and 3. Net cash flows, if any, to be received (or paid) for the disposal of the asset at the end of its useful life. Estimates of future cash flows should not include: 1. cash inflows or outflows from financing activities; or 2. Income tax receipts or payments. Future cash flows should be estimated for the asset in its current condition. Estimates of future cash flows should not include estimated future cash inflows or outflows that are expected to arise from: 1. A future restructuring to which an enterprise is not yet committed; or 2. Future capital expenditure that will improve or enhance the asset in excess of its originally assessed standard of performance. Discount Rate The discount rate(s) should be a pre-tax rate(s) that reflect(s) current market assessments of the time value of money and the risks specific to the asset. The discount rate(s) should not reflect risks for which future cash flow estimates have been adjusted. The enterprise may take into account the following rates: The enterprises weighted average cost of capital determined using techniques such as the Capital Asset Pricing Model; The enterprises incremental borrowing rate; and Other market borrowing rates.
Recognition and Measurement of an Impairment Loss If the recoverable amount of an asset is less than its carrying amount, the carrying amount of the asset should be reduced to its recoverable amount. That reduction is an impairment loss. An impairment loss should be recognized as an expense in the statement of profit and loss immediately, unless the asset is carried at revalued amount in accordance with another Accounting Standard (see Accounting Standard (AS) 10, Accounting for Fixed Assets), in which case any impairment loss of a revalued asset should be treated as a revaluation decrease under that Accounting Standard. When the amount estimated for an impairment loss is greater than the carrying amount of the asset to which it relates, an enterprise should recognize a liability if, and only if, that is required by another Accounting Standard.
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After the recognition of an impairment loss, the depreciation (amortization) charge for the asset should be adjusted in future periods to allocate the assets revised carrying amount, less its residual value (if any), on a systematic basis over its remaining useful life. Identification of the Cash-Generating Unit to Which an Asset Belongs If there is any indication that an asset may be impaired, the recoverable amount should be estimated for the individual asset. If it is not possible to estimate the recoverable amount of the individual asset, an enterprise should determine the recoverable amount of the cash-generating unit to which the asset belongs (the assets cash-generating unit). If an active market exists for the output produced by an asset or a group of assets, this asset or group of assets should be identified as a separate cash-generating unit, even if some or all of the output is used internally. If this is the case, managements best estimate of future market prices for the output should be used: a) In determining the value in use of this cash-generating unit, when estimating the future cash inflows that relate to the internal use of the output; and b) In determining the value in use of other cash-generating units of the reporting enterprise, when estimating the future cash outflows that relate to the internal use of the output. The carrying amount of a cash-generating unit should be determined consistently with the way the recoverable amount of the cash-generating unit is determined. Goodwill In testing a cash-generating unit for impairment, an enterprise should identify whether goodwill that relates to this cash-generating unit is recognized in the financial statements. In case if it is recognized, Enterprise shall perform Bottom up test or top down test if required. Impairment Loss for a Cash-Generating Unit The impairment loss should be first allocated to goodwill then to the other assets of the unit on a pro-rata basis based on the carrying amount of each asset in the unit. In allocating an impairment loss, the carrying amount of an asset should not be reduced below the highest of a. its net selling price (if determinable); b. its value in use (if determinable); and c. zero Reversal of an Impairment Loss An impairment loss recognized for an asset in prior accounting periods should be reversed if there has been a change in the estimates of cash inflows, cash outflows or discount rates used to determine the assets recoverable amount since the last impairment loss was recognized. If this is the case, the carrying amount of the asset should be increased to its recoverable amount. SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI 167
However ,the increased carrying amount of an asset due to a reversal of an impairment loss should not exceed the carrying amount that would have been determined (net of amortization or depreciation) had no impairment loss been recognized for the asset in prior accounting periods. A reversal of an impairment loss for an asset should be recognized as income immediately in the statement of profit and loss, unless the asset is carried at revalued amount in accordance with another Accounting Standard (see Accounting Standard (AS) 10, Accounting for Fixed Assets) in which case any reversal of an impairment loss on a revalued asset should be treated as a revaluation increase under that Accounting Standard. Reversal of an Impairment Loss for a Cash-Generating Unit A reversal of an impairment loss for a cash-generating unit should be first allocated to asset other than goodwill and such reversal should not be increased above the lower of: a) its recoverable amount and b) carrying amount that would have been determined (net of amortization or depreciation) had no impairment loss been recognized for the asset in prior accounting periods. Reversal of an Impairment Loss for Goodwill An impairment loss recognized for goodwill should not be reversed in a subsequent period unless: (a) the impairment loss was caused by a specific external event of an exceptional nature that is not expected to recur; and (b) subsequent external events have occurred that reverse the effect of that event. Impairment in case of Discontinuing Operations Enterprise sells discontinuing substantially and in its entirety operation Recoverable amount is determined for the discontinuing operation as a whole
Enterprise disposes discontinuing operation on Recoverable amount is determined for individual piece meal basis assets Enterprise abandons discontinuing operation Recoverable amount is determined for individual assets
It may be noted that the carrying amount of a discounting operation includes carrying amount of goodwill. Disclosure For each class of assets, the financial statements should disclose
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The amount of impairment losses recognized in the statement of profit and loss The amount of reversals of impairment losses recognized in the statement of profit & loss The amount of impairment losses recognized directly against revaluation surplus and The amount of reversals of impairment losses recognized directly in revaluation surplus The event and circumstances that led to the recognition or reversal of the impairment loss For an individual asset: a) The nature of the asset and b) Reportable segment to which asset belongs (as per AS 17) For CGU: a) Description of CGU (whether it is related to business segment or geographical segment as per AS 17) b) Amount of impairment loss recognized or reversed by reportable segment based on entitys primary format. Computation of recoverable amount
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AS 29- PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS

- Radhakrishna Das (rkdasinbox@gmail.com)
INTRODUCTION The object of introduction of any 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. Realizing the fact, the Institute of Chartered Accountants of India took so many initiatives and has also completed drafting the Indian accounting standards converged with the IFRS. Ive discussed a few matters that relate to Accounting Standard 29 Provisions, Contingent liabilities and Contingent assets. BACKGROUND OF ACCOUNTING STANDARD 29: Going concern, consistency and accrual principles are the backbone of the accounting principles. Other principles include Prudence, matching etc. If anybody were to look at these concepts, one would find that the so called accounting standards designed and drafted by the experts are nothing but the magnification of the basic principles outlined above and solution for every situation in the business that which relates to maintaining books of accounts. AS 29 is no exception and it too centers on the same basic principles. The objective of this Standard is to ensure that appropriate recognition criteria and measurement bases are applied to provisions and contingent liabilities and that sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount. The objective of this Standard is also to lay down appropriate accounting for contingent assets. APPICABILITY OF THE STANDARD: This statement should be applied in accounting for provisions and Contingent liabilities and in dealing with Contingent assets except: Those resulting from financial instruments that are carried at fair value. Those resulting from executory contracts. Those arising in insurance companies from contracts with policy holders. Those covered by other Accounting Standards. KEY DEFNITIONS USED IN THE STANDARD A provision is a liability which can be measured only by using a substantial degree of estimation. A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an out flow from the enterprise of resources embodying economic benefits. An obligating event is an event that creates an obligation that results in an enterprise having no realistic alternative to settling that obligation.
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Contingent liability is a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; Or A present obligation that arises from past events but is not recognized because: (i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or (ii) a reliable estimate of the amount of the obligation cannot be made. A contingent asset is a possible asset that arises from past events the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise. An obligation is a present obligation if, based on the evidence available, its existence at the balance sheet date is considered probable, i.e., more likely than not. An obligation is a possible obligation if, based on the evidence available, its existence at the balance sheet date is considered not probable. Now for simplicity, lets break up the standard in to three and then in detail look in to the aspects of the standard. First of all provisions, PROVISION A provision should be recognized when: (a) An enterprise has a present obligation as a result of a past event; (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 recognized. Present Obligation In almost all cases it will be clear whether a past event has given rise to a present obligation. In rare cases, for example in a lawsuit, it may be disputed either whether certain events have occurred or whether those events result in a present obligation. In such a case, an enterprise determines whether a present obligation exists at the balance sheet date by taking account of all available evidence, including, for example, the opinion of experts. The evidence considered includes any additional evidence provided by events after the balance sheet date. On the basis of such evidence: (a) Where it is more likely than not that a present obligation exists at the balance sheet date, the enterprise recognizes a provision (if the recognition criteria are met); and
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(b) Where it is more likely that no present obligation exists at the balance sheet date, the enterprise discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote.
Past Event: A past event that leads to a present obligation is called an obligating event. It is only those obligations arising from past events existing independently of an enterprise's future actions (i.e. the future conduct of its business) that are recognized as provisions. Examples of such obligations are penalties or clean-up costs for unlawful environmental damage, both of which would lead to an outflow of resources embodying economic benefits in settlement regardless of the future actions of the enterprise. An event that does not give rise to an obligation immediately may do so at a later date, because of changes in the law. Where details of a proposed new law have yet to be finalized, an obligation arises only when the legislation is virtually certain to be enacted. In many cases it will be impossible to be virtually certain of the enactment of a law until it is enacted. Probable Outflow of Resources Embodying Economic Benefits: For a liability to qualify for recognition there must be not only a present obligation but also the probability of an outflow of resources embodying economic benefits to settle that obligation. For the purpose of this Standard, an outflow of resources or other event is regarded as probable if the event is more likely than not to occur, i.e., the probability that the event will occur is greater than the probability that it will not. Where it is not probable that a present obligation exists, an enterprise discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote. Where there are a number of similar obligations (e.g. product warranties or similar contracts) the probability that an outflow will be required in settlement is determined by considering the class of obligations as a whole. Although the likelihood of outflow for any one item may be small, it may well be probable that some outflow of resources will be needed to settle the class of obligations as a whole. If that is the case, a provision is recognised (if the other recognition criteria are met). Reliable Estimate of the Obligation The use of estimates is an essential part of the preparation of financial statements and does not undermine their reliability. This is especially true in the case of provisions, which by their nature involve a greater degree of estimation than most other items. Except in extremely rare cases, an enterprise will be able to determine a range of possible outcomes and can therefore make an estimate of the obligation that is reliable to use in recognizing a provision. In the extremely rare case where no reliable estimate can be made, a liability exists that cannot be recognised. That liability is disclosed as a contingent liability (see paragraph 68). CONTINGENT LIABILITIES: An enterprise should not recognize an contingent liability. It is only disclosed unless the possibility of the outflow is remote. 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. The enterprise recognizes a provision for the part of the obligation for which an outflow of resources embodying economic benefits is probable. They 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, a provision is recognized in accordance with this standard.
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CONTINGENT ASSETS: An enterprise should not recognize a contingent asset. This is in consonance with the prudence concept, where we had earlier indicated that most of the accounting standards revolves around the same underlying principles and their presence has strongly commended for the principles to be followed. A contingent asset is not disclosed in the financial statements. It is usually disclosed in the report of the approving authority where an inflow of economic benefits is probable. Contingent assets are assessed continually and if it has become virtually certain that an inflow of economic benefits will arise, the asset and the related income are recognized in the financial statements of the period in which the change occurs. Changes and use of provisions: Provisions should be reviewed at each balance sheet date and adjusted to reflect the current best estimate. If it is no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation, the provision should be reversed. A provision should be used only for expenditures for which the provision was originally recognized. Only expenditures that relate to the original provision are adjusted against it. Adjusting expenditures against a provision that was originally recognized for another purpose would conceal the impact of two different events. APPLICATION OF THE RECOGNITION AND MEASUREMENT RULES Future Operating Losses: Provisions should not be recognized for future operating losses as they do not meet the definition of liability indicated above. An expectation of future operating losses is an indication that certain assets of the operation may be impaired. An enterprise tests these assets for impairment under Accounting Standard (AS) 28, Impairment of Assets. Reimbursements & Restructuring: Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement should be recognized when, and only when, it is virtually certain that reimbursement will be received if the enterprise settles the obligation. The reimbursement should be treated as a separate asset. The amount recognized for the reimbursement should not exceed the amount of the provision. In the statement of profit and loss, the expense relating to a provision may be presented net of the amount recognized for a reimbursement. A provision for restructuring costs is recognized only when the recognition criteria for provisions set out in paragraph 14 are met. No obligation arises for the sale of an operation until the enterprise is committed to the sale, i.e., there is a binding sale agreement. An enterprise cannot be committed to the sale until a purchaser has been identified and there is a binding sale agreement. Until there is a binding sale agreement, the enterprise will be able to change its mind and indeed will have to take another course of action if a purchaser cannot be found on acceptable terms. Also a restructuring provision should include only the direct expenditures arising from the restructuring. DISCLOSURES For each class of provision, an enterprise should disclose: (a) The carrying amount at the beginning and end of the period; (b) Additional provisions made in the period, including increases to existing provisions; (c) Amounts used (i.e. incurred and charged against the provision) during the period; and (d) Unused amounts reversed during the period:
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An enterprise should disclose the following for each class of provision: (a) A brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits; (b) An indication of the uncertainties about those outflows. Where necessary to provide adequate information, an enterprise should disclose the major assumptions made concerning future events, as addressed in paragraph 41. (c) The amount of any expected reimbursement, stating the amount of any asset that has been recognized for that expected reimbursement. Unless the possibility of any outflow in settlement is remote, an enterprise should disclose for each class of contingent liability at the balance sheet date a brief description of the nature of the contingent liability and, where practicable: (a) An estimate of its financial effect, measured (b) An indication of the uncertainties relating to any outflow; and (c) The possibility of any reimbursement. COMPARISION WITH IAS 37 - PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS: Discounting of provision: IAS 37 requires that where the effect of the time value of money is material, the amount of provision should be the present value of the expenditure expected to settle that obligation. Our Accounting Standard centers around the historical cost concept and discounting is not allowed.
Provision for Onerous contracts excluded: Onerous contract are those in which the unavoidable costs of meeting the obligation under the contracts exceed the benefits expected to be received. Present obligation of onerous contracts is not required to be recognized as it amounts to recognition of loss of future periods in the current year income statement. Contingent Assets: Contingent assets in both AS and IAS have no place in the financial statements. But as per IAS 37 disclosure is required for contingent assets in the financial statements where the inflow of economic benefits is probable.
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SUMMARY OF THE STANDARD:
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AS 30 - FINANCIAL INSTRUMENTS: RECOGNITIION AND MESUREMENT

- M.P. Shankar Ganesh (shankar@sandbca.com)
1. OBJECTIVE 2. APPLICABILITY 3. SCOPE 4. DEFINITIONS 5. DERIVATIVES 6. RECOGNITION 7. MEASUREMENT 8. IMPAIRMENT 9. DERECOGNITION 10. HEDGE ACCOUNTING 11. TYPES AND CRITERIA FOR HEDGE ACCOUNTING 12. COMPARISON WITH IAS AND IFRS Financial Instrument is a document which has a monetary value such as draft, cheques, bills of exchange and promissory notes. However for the purpose of AS -30, Financial instruments includes wide spectrum of assets and liabilities of entities and is not limited to investments or merely capital market instruments. OBJECTIVE The objective of this standard is to prescribe the principles for recognising and measuring the financial assets and financial liabilities. The principles for presentations of financial assets and liabilities in the financial statements are prescribed in AS -31 Financial Instruments: Presentation. Another Accounting Standard namely Financial Instruments : Disclosures (AS 32) prescribes the requirement for disclosing information about financial instruments through notes and policies to financial statements. APPLICABILITY AS 30, AS 31 and AS 32 will be applicable to all commercial, industrial and business entities other than small and medium sized entities (SMEs). SCOPE This standard should be applied by all entities to all types of instruments except: Interest in subsidiaries(AS 21), in associates ( AS 23) and in Joint ventures (AS 27) Items of assets and liabilities such as employee benefits, leases, Insurance contracts. Contracts and obligations under share based payment transaction etc. which are specifically dealt with by other standards are excluded from the coverage Rights to receive reimbursements against provisions already made to meet certain obligations as per AS 29 Commodity derivatives
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Contract between an acquirer and vendor in a business combination to buy or sell an acquire at a future date. But includes derivative contracts, financial contracts, certain loan commitments and any contract to buy or sell a non financial item that can be settled net or if such a contract bears the characteristics of a financial instrument, would be covered. DEFINITIONS: A financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. FINANCIAL ASSETS : Cash. Equity instrument of another entity. Contractual right to receive cash or another financial asset or to exchange .financial assets or liabilities under potentially favourable conditions. Certain contracts settled in the entitys own equity. FINANCIAL LIABILITIES: Contractual obligation to deliver cash or another financial asset or to ex-change financial asset or liabilities under potentially unfavourable conditions Certain contracts settled in the entitys own equity EQUITY INSTRUMENTS: Contract evidencing a residual interest in the assets of an entity after deducting all of its liabilities FOUR CATEGORIES OF FINANCIAL INSTRUMENTS Category Financial assets at fair value through profit or loss Definition Financial assets held for trading Derivatives, unless accounted for as hedges Financial asset designated to this category under the fair value option
Loans and receivables
Non-derivative financial assets with fixed or determinable payments that are not quoted in an active market Non-derivative financial assets with fixed or determinable payments and fixed maturity that the entity has the positive intent and ability to hold to maturity All financial assets that are not classified in another category are classified as available-for-sale Any financial asset designated to this category on initial recognition
Held-to-maturity investments
Available-for-sale financial assets
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CATEGORIES OF FINANCIAL LIABILITIES Category Financial liabilities at fair value through profit or loss Definition Financial liabilities held for trading Financial liability designated as at fair value through profit or loss on initial recognition (fair value option)
Other financial liabilities at amortised cost
All financial liabilities that are not classified at fair value through profit or loss
FINACIAL GUARENTEE CONTRACTS A contract that requires the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payments when due in accordance with the original or modified terms of a debt instrument DERIVATIVES: A Derivative is a financial instrument, or other contract within the scope of this standard with all the following characteristics: Fair value changes in response to the change in underlying Interest rate, Security price, Commodity price, Foreign exchange rate, Credit rating, or Other index. It requires no or little initial net investment. Settled at a future date. EMBEDDED DERIVATIVES An embedded derivative is a component of a hybrid instrument that combines the derivative and a non derivative host contract, with the effect that some of the cash flows of the combined instrument vary in a way similar to a stand alone derivative instrument. It would also include contracts whose values are linked to movements in certain indices or variables such as an inflation related index, equity index, movements in foreign exchange etc. The standard stipulates that subject to certain conditions being met, an entity is required to separate the derivatives from the host contract and account for that derivative by treating it as an independent financial instrument. RECOGNITION: All financial assets and financial liabilities, including derivatives, should be recognised on the balance sheet when the entity becomes party to the contractual provisions of the instrument. Financial Assets should be recognised at the fair value of the consideration given while the financial liability should be recognised at the fair value of the consideration received. MEASUREMENT: INITIAL MEASUREMENT: Measured at fair value on initial recognition.
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Transaction costs are included in the initial measurement of financial instruments that are not measured at fair value through profit or loss. Applies to all financial instruments whether or not negotiated on an arms length basis (e.g., lowinterest or interest-free loans by a shareholder or government). VALUE CHANGES P&L Not relevant (unless impaired) Not relevant (unless impaired) Equity (unless impaired) P&L Not relevant P&L
SUBSEQUENT MEASUREMENT: INSTRUMENT MEASUREMENT Financial assets at fair value Fair value through profit or loss Held-to-maturity investments Amortised cost (effective interest rate) Loans and receivables Amortised cost (effective interest rate) Available-for-sale Fair value Financial liabilities at fair value Fair value through profit or loss or designated as such Other liabilities Amortised cost Derivatives Fair value
FAIR VALUES: The fair value of a financial instrument in the different cases is as follows: Active Market: Unadjusted published price quotations. No Active Market: valuation techniques using maximum market input and minimum entity specific input. Fair values of equity instruments: in the absence of market quotation are to be based on estimates or cost less impairment (as a last resort and only if impossible to make reliable estimates). IMPAIRMENT: A financial asset or a group of financial assets is impaired if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after initial recognition; and the loss event has an impact on estimated future cash flows. An impairment loss is measured as the difference between: the assets carrying amount and the present value of estimated future cash flows - for loans and receivables or held-to-maturity investments; and the acquisition cost (net of any principal repayment and amortisation) and current fair value, less any impairment losses previously recognised for available-for-sale financial assets. At each balance sheet date, the entity should assess whether there is objective evidence of impairment for an asset or group of financial assets. Significant financial difficulty of the issuer/obligor. Default or breach of contract. Granting of a concession by the lender. Bankruptcy or financial reorganisation of the borrower. Disappearance of an active market for the assets concerned. Measurable decrease in the estimated future cash flows.
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DERECOGNITION: De-recognition of financial instrument means removal of an asset or a liability from the books as a result of sale payment, re- negotiation or default by the counter party. De- recognition is the end of the life cycle of an asset or liability that begins with its recognition. An enterprise derecognises its financial asset only when: The contractual rights to the cash flow from the financial asset expire. It transfers the financial asset and the transfer qualifies for de-recognition. An enterprise transfers a financial asset only if, it does either of the following: Transfers the contractual rights to receive the cash flows of the financial asset. Retains the contractual rights to receive the cash flows of the financial asset but assumes a contractual obligation to pay the cash flows to one or more recipients, subject to certain conditions. AS 30 prescribes the principles for A. Complete de-recognition of financial asset. B. Partial de-recognition. C. De-recognition combined with recognition of new liability. HEDGE ACCOUNTING: Entities face many business risks and most significant risk is financial risk. Different companies are exposed to different types of financial risks such as risks related to interest rates or exchange rates. Entities use a risk management technique called hedging, whereby the entity tries to reduce the impact of the future potential costs or losses. Hedging is shelter ones self from danger, risk, duty, responsibility etc. In financial sense also hedge stands for defence against financial risk using derivative or non derivative instruments. HEDGED ITEM: To qualify for designation the hedged item should create an exposure to risk that ultimately affects profit or loss. The following can be designated as hedged items: A single or group of assets/liabilities. Firm commitments or highly probable forecast transactions. Non-financial assets/liabilities for foreign currency risk or the entire risk. A portion of the cash flows on any financial asset/liability. Net investments in foreign operations. Net positions cannot be designated as hedged items. HEDGING INSTRUMENT: The following can be designated as hedging instruments: All derivatives with third parties. Non-derivatives for a hedge of foreign currency risk. Combination of two or more derivatives or non-derivatives, except for net written options. Hedging instrument cannot be designated for a portion of its life. TYPES OF HEDGES: FAIR VALUE HEDGES: Hedge of exposure to changes in fair value of: a recognised asset or liability; an unrecognised firm commitment; or an identified portion of any of the above two; that is attributable to a particular risk; and could affect P&L.
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CASH FLOW HEDGES: Hedge of exposure to variability in cash flows that is: attributable to a particular risk associated with a recognised asset or liability or a highly probable forecast transaction (also an inter-company one); and could affect P&L. HEDGES OF A NET INVESTMENT IN FOREIGN OPERATIION Must meet requirements for hedge accounting. Accounting treatment similar to that of a cash flow hedge. Effective portion of gain or loss on hedging instrument recorded in the same manner as the foreign currency translation gain or loss i.e., in equity. Ineffective portion of gain or loss on hedging instrument recorded in P&L. Release to P&L when the net investment is sold. CRITERIA FOR HEDGE ACCOUNTING: Exposure must be due to specific hedge able risk that ultimately affects earnings. At inception, the hedge must be expected to be highly effective and effectiveness must be reliably measurable. The hedge must remain highly effective during the whole period of the hedge. The hedging relationship should be formally designated. Formal documentation is required at the inception of the hedge and must include: o Identification of the hedging instrument and the hedged item or transaction. o The nature of the risk being hedged. o The risk management objective and strategy for undertaking the hedge. o How effectiveness will be assessed. The rules are strict, thus costs/benefits of hedge accounting should be considered. COMPARISON WITH IAS AND IFRS: As 30 Financial Instruments: Recognition and measurements is based on International Accounting standard (IAS) 39: Financial Instruments: Recognition and measurement and Incorporates IFRIC- 9, re-assessment of embedded derivative issued by the International Financial reporting interpretation committee. There are no material changes between AS 30 and IAS 39 and IFRIC 9.
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AS 31 FINANCIAL INSTRUMENTS PRESENTATION

- S. Deepika Jain (deepika@sandbca.com)
TABLE OF CONTENTS 1. APPLICABILITY 2. STATUTORY REQUIREMENTS VS AS31 3. OBJECTIVES 4. SCOPE 5. DEFINITIONS 6. EXAMPLES OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES 7. PRESENTATION OF LIABILITIES AND EQUITY 8. PRESENTATION REQUIREMENTS WHERE THERE IS NO CONTRACTUAL OBLIGATION TO DELIVER CASH OR ANOTHER FINANCIAL ASSET 9. PRESENTAION REQUIREMENTS IN CASE OF SETTLEMENT IN ENTITYS OWN EQUITY INSTRUMENTS 10. PRESENTATION OF CONTINGENT SETTLEMENT PROVISIONS 11. PRESENTATION OF SETTLEMENT OPTIONS 12. PRESENTATION REQUIREMENTS IN THE CASE OF CONSOLIDATED FINANCIAL STATEMENTS 13. PRESENTATION REQUIREMENTS IN THE CASE OF TREASURY SHARES 14. PRESENTATION REQUIREMENTS IN THE CASE OF INTEREST, DIVIDENDS, LOSSES AND GAINS 15. PRESENTATION OF OFFSETTING A FINANCIAL ASSET AND A FINANCIAL LIABILITY Applicability: Same as AS30 Statutory Requirements Vs AS 31: Where an entity is required to present any financial instrument say as an asset or a liability or an income or an expense, and the entity complies with the statutory requirements of the governing law, it shall be said to meet the requirements of the Standard. Objective: The objective of the standard is to establish principles for presenting financial instruments as liabilities or equity and for offsetting financial assets and financial liabilities. Classification of the financial instrument is to be made from the perspective of the issuer into 3 categories financial assets, financial liabilities and equity instruments; the classification of related interest, dividends, losses and gains and the circumstances in which FA and FL should be offset. The standard also complements the Recognition and Measurement principles and the Disclosure requirements as per AS30 and AS 32 respectively. Scope: Same as AS30. The standard is applied to buy or sell a non financial item that can be settled net in cash or by exchanging with financial instruments, in the same way as a financial instrument is traded, except that the contract was entered into and held for the purpose of receipt or delivery of a non financial item in accordance with the entitys purchase, sale or usage requirements. The standard also gives an inclusive list of the transactions that will be regarded as settlement net in cash or by exchanging financial instruments.
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Definitions: Same as explained under AS30. The standard provides definitions for the following terms: a. Financial Instruments b. Financial Asset c. Financial Liability d. Equity Instrument e. Fair Value Contracts and contractual means the agreement between 2 parties having a clear economic consequence thereby the parties have little or no discretion to avoid the agreement usually because the agreement is not enforceable by law. Contracts and financial instruments can take various forms and therefore always need not be in writing. Entity includes individuals, partnerships, incorporated bodies, trusts and government agencies. Examples of Financial Assets and Financial Liabilities: a. Currency (Cash) Financial Asset since it is a medium of exchange and therefore the basis on which all transactions are measured and recognized in the financial statements b. Cash Deposit with Bank/Financial Institutions- Financial Asset-As the depositor has a contractual right to obtain cash from the institution/bank or draw a cheque/similar instrument in the favor of the creditor in payment of the financial liability for the balance standing at the account. c. Common examples of Financial Assets: i. Contractual right to receive cash in future and corresponding financial liabilities representing a contractual obligation to deliver cash in future such as: Trade accounts receivable and payable Bills receivable and payable Loans receivable and payable Bonds receivable and payable Deposits and advances. In each of the cases the parties contractual right to receive cash is matched with the other parties obligation to pay against the same. d. An instrument will be called a financial instrument even where the economic benefit to be received or given up is a financial asset other than cash. For example, a promissory note payable in government bonds gives the holder the contractual right to receive and the issuer the obligation to deliver government bonds and not in cash. These bonds are treated as financial assets as they represent the obligation on the part of the government to receive cash. Since the promissory note is the basis of receipt of the financial asset, it is also to be treated as a financial asset of the promissory note holder and a financial liability of the promissory note issuer. e. Perpetual Debt instruments normally provides the holder the contractual right to receive payments on account of interest at fixed dates extending into an indefinite future either with or without the right to receive the principal. Say an entity issues a perpetual financial instrument in the form of perpetual bond. i.e. say an entity issues a perpetual bond to Mr.X , with principal payment on the part of Mr.X being Rs.1000/- @8% interest paid perpetually. Here the holder of the instrument holds it as a financial asset and the issuer holds it as a financial liability as the instrument creates an obligation on the part of the issuer. f. A contractual right/obligation to receive, deliver or exchange financial instruments is a financial instrument in itself. Therefore, a chain of contractual rights and obligations meet the definition of financial instrument, if it will ultimately lead to receipt/acquisition or payment/issue of cash/equity instruments, respectively. g. A contractual right to exercise a contractual right of requirement to satisfy a contractual obligation may be absolute/contingent on the occurrence of a future event. For example, When A gives a SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI 183
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guarantee to B that in case of default in payment by C, B shall pay A. The contract is a clear case of financial guarantee. Here the contract assumes the form of a financial instrument because; Bs payment to A shall take place on default by C obligation arising on account of some past event. Such guarantee takes the form of contingent financial asset on the part of A and Contingent financial liability on the part of B, even though such assets and liabilities are not always recognized in the financial statements. Under financial lease, the lessor passes on the leased asset to the lessee, who in turn pays a series of streamlined payments which includes payments towards principal and the interest. The lessor accounts for amounts receivable under the lease contract rather than recording the asset itself. Under operating lease, the lessor provides the lessee the right to use the asset upon the payment of a fee. The lessor therefore continues to account for the leased asset itself rather than recording the receivables under the same. Therefore a financial lease is regarded as a financial instrument and an operating lease is not a financial instrument. Physical assets such as inventories, plant and equipment, leased assets and intangible assets are not regarded as financial assets. As control of such physical and intangible assets creates an opportunity to generate cash or another financial asset but such assets cannot be presented to receive cash or another financial instrument. Assets such as prepaid expenses where the future economic benefit is the right to receive goods or services rather than receiving cash/financial asset are not financial assets. Similarly deferred revenue and warranty obligations are not financial assets as the outflow of benefits associated with them is delivery of goods and services rather than a contractual obligation to pay cash or another financial asset. Liabilities/assets that are created due to statutory requirements rather than contractual requirements are neither financial assets nor financial liabilities. Equity instruments include non puttable equity shares, some classes of preference shares, warrants and written call options that allow the holder to subscribe for or purchase of fixed number of non puttable equity shares in the issuing entity in exchange of fixed amount of cash or another financial asset. A contract by an entity that gives right to reacquire a fixed number of equity instruments in exchange of fixed number of own equity instruments for delivering fixed amount of cash/another financial asset is not a financial asset of the entity. Instead the consideration paid is deducted from equity. Financial instruments can be classified into 2 types: Primary instruments (such as receivables, payables and equity instruments) and derivative instruments (such a financial options, futures, forward, interest rate swaps and currency rates swaps) Contracts to buy or sell non financial items do not constitute a financial asset as the contractual right of one party to receive a non financial asset/service and the corresponding obligation of the other party do not create a present obligation to receive, deliver or exchange a financial asset. A contract involving receipt or delivery of physical asset does not give rise to a financial asset of one party and a financial liability of another party unless the payment is deferred past the date on which the physical assets are transferred; for example goods sold on credit. Certain contracts are commodity linked but settlement does not take place through commodity, rather it takes place through cash. The settlement price of such contracts is price determined based on the commodity prices though the actual settlement takes place through cash. Such contract constitutes a financial instrument.
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r. Financial instrument comprises of a financial and non financial asset, as well as, a financial and non financial liability. Such financial instrument gives the option to one party to exchange a financial asset for a non financial asset. For example, an oil linked bond may give the holder the right to receive a stream of interest payments (fixed) along with repayment of principal on maturity with an option to exchange the same with fixed quantity of oil. The option exercised by the holder shall be based on the relative price of oil. Presentation Liabilities and Equity The issuer of the financial instrument should classify the instrument or its parts, on initial recognition, into financial liability, financial asset or an equity instrument in accordance with the definitions of the terms and the substance of the contractual obligation. When the issuer applies the definitions to differentiate a financial liability from an equity instrument, the instrument is an equity instrument if and only if the conditions given in the definitions are satisfied. Presentation requirements where there is no contractual obligation to deliver cash or another financial asset: a. For differentiating a financial liability from an equity instrument, existence of a contractual obligation needs not be in existence. For example a holder of financial instrument may be eligible to receive a pro rate share of any dividends or other distributions of equity although there is no obligation on the part of the issuer of the instrument to deliver in such a manner. b. The substance of the financial instrument governs the classification rather than its legal form. Some financial instruments assume legal form as equity but are liabilities in substance. For example: i. A preference share that provides for mandatory redemption by the issuer for a fixed amount or gives the holder the right to redeem the financial instrument on or after a particular date for a fixed amount is called a financial liability. ii. A financial instrument that gives the holder the right to put it back to the issuer for cash or another financial asset is a financial liability. c. If an entity has a conditional right to avoid delivering cash or another financial asset to settle a contractual obligation, the obligation meets the definition of a financial liability. d. A financial instrument that does not explicitly establish a contractual obligation to deliver cash or another financial asset may establish obligation indirectly through its terms and conditions and is therefore a financial liability. e. Preference shares may be issued with various rights therefore they can be either a financial liability or an equity instrument. When preference shares are not redeemable, the appropriate classification is determined by the other rights attached to them. If the distributions to the holder of preference shares are at the discretion of the issuer, the shares are equity instruments. f. The contractual right of the holder of the financial instruments to request redemption of preference shares does not by itself require that the instrument is classified as financial liability. g. Members shares in a cooperative society are equity if the entity has an unconditional right to refuse redemption of the members shares or if the governing laws, statute, bye laws, etc prohibit the redemption of the members shares. h. Unconditional prohibition of redemption of members shares can be absolute, if the redemption reduces the number of members/paid up capital below minimum i. Equity is the residual interest in the assets after deducting its financial liabilities for redemption at fair value. j. Distributions to the holders of the equity instruments are recognized directly as revenue reserves and surplus. Interest, dividends and other returns relating to financial liabilities are classified as expenses, regardless of whether the payment is towards interest, dividends or otherwise. SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI 185
Presentation requirements in case of settlement in entitys own equity instruments a. A contractual right/obligation to receive or deliver a number of its own equity shares against the amount receivable/payable, does not make it a equity instrument; It still takes the form of a financial liability/asset. b. On the other hand a contract that will be settled by the entity receiving or delivering a fixed number of its own equity instrument for a fixed amount of cash or another financial instrument is an equity instrument. c. A contract that contains a obligation for an entity to purchase its own equity instruments for cash or another financial asset gives rise to a financial liability for the present value of the redemption amount. d. A contract that involves settlement of fixed number of entitys own equity instruments in exchange of the variable amount of cash/financial asset is a financial asset or a financial liability. Presentation of Contingent Settlement Provisions: A financial instrument might require the delivery of cash or another financial asset, to settle it towards a financial liability, in the event of occurrence/non occurrence of a uncertain future event that are beyond the control of both the issuer and the holder of the instrument. It is a financial liability of the issuer unless: i. The part of the contingent settlement agreed upon is not genuine. Thus a contract requiring a settlement in cash/variable number of entitys own equity instruments on the occurrence of a highly abnormal event is an equity instrument. ii. The issuer can be required to settle the obligation in cash or financial asset only in the event of liquidation of the issuer. Presentation of Settlement Options: When a derivative financial instrument gives one party a choice over how it is being settled (the modecash/own equity instruments), it assumes the proposition of a financial asset or a financial liability unless all the settlement alternatives result in it satisfying the definition of the equity instrument. Presentation requirements in the case of consolidated financial statements: When classifying a financial instrument in the consolidated financial statements, the entity considers all terms and conditions agreed upon between the members and the holders of the instruments, in determining whether the group as a whole has an obligation to deliver cash or another financial asset, to settle it in such a manner that it results in a liability classification and vice versa. Presentation requirements in the case of treasury shares: If an entity reacquires its own equity instruments those instruments should be deducted from equity. No gain or loss should be recognized in the statement of profit and loss on the purchase, sale or cancellation of the entitys own instruments. Such shares are called as treasury shares may be acquired and held by the entity or by other members of the consolidated group. Consideration paid or received should be directly recognized in equity. Presentation requirements in the case of interest, dividends, losses and gains: Interests, dividends, losses or gains should be treated as an income/expense in the statement of profit and loss. Distributions to the holders of the equity instruments should be debited to the appropriate equity account by the entity, after netting off any related income tax benefit. Transaction costs of an equity transaction should be deducted from equity after netting off any related income tax benefit. Presentation for offsetting a financial asset and a financial liability: A financial asset and a financial liability should be offset and the net amount should be presented in the balance sheet if and only if: i. The entity has a legally enforceable right to set off the recognized amounts. ii. The entity intends to settle the amount on a net basis, or to realize the asset and settle the liability simultaneously.
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AS 32 FINANCIAL INSTRUMENTS DISCLOSURE

- S. Deepika Jain (deepika@sandbca.com)
TABLE OF CONTENTS 1. APPLICABILITY 2. WHY AS 32? 3. STATUTORY REQUIREMENTS VS AS 32 4. OBJECTIVES 5. SCOPE 6. CLASSIFICATION OF THE INSTRUMENTS 7. RECLASSIFICATION 8. DERECOGNITION 9. DISCLOSURE REQUIREMENTS FOR COLLATERAL 10. DISCLOSURE OF ALLOWANCE ACCOUNT FOR CREDIT LOSSES 11. DISCLOSURE OF COMPOUND FINANCIAL INSTRUMENTS WITH MULTIPLE EMBEDDED DERIVATIVES 12. DISCLOSURE REQUIREMENTS FOR DEFAULTS AND BREACHES 13. DISCLOSURE REQUIREMENTS IN STATEMENT OF PROFIT AND LOSS AND EQUITY 14. OTHER DISCLOSURES 15. DISCLOSURE OF FAIR VALUE 16. DISCLOSURE OF NATURE AND EXTENT OF RISKS ARISING FROM FINANCIAL INSTRUMENTS 17. QUALITATIVE DISCLOSURES 18. QUANTITATIVE DISCLOSURES 19. DISCLOSURE REQUIREMENTS OF CREDIT RISKS 20. DISCLOSURE REQUIREMENTS OF LIQUIDITY RISKS 21. DISCLOSURE REQUIREMENTS OF MARKET RISKS Applicability: Same as AS 30 Why AS 32: The requirement of this standard is met with when the entity discloses such information that enables the users of the financial statements to evaluate the significance of the financial instruments for ascertaining its financial position and performance. Statutory Requirements Vs AS 32: Where an entity is required to disclose any financial instrument say as an asset or a liability or an income or an expense, and the entity complies with the statutory requirements of the governing law, it shall be said to meet the requirements of the Standard. Objective: The objective of this standard is to require entities to provide disclosures in their financial statements, which will enable the users of the Financial Statements to evaluate: a. The importance of the financial instruments in ascertaining the financial position and performance ; and b. The nature, exposure and the extent of risks from financial instruments the entity faces as at the reporting date and during the period and how the entity manages the risks. The Standard also complements the recognition measurement and presentation requirements of AS 30 and AS 31 respectively. Scope:
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Same as AS 30. Additional scope covered is that the standard is applicable to recognized and derecognized financial instruments within the meaning of AS30. It also includes contracts to buy or sell a non financial item which are within the meaning of AS30. Classification of the instruments: Disclosure requirements of this standard state that the entity groups the financial instruments into classes that are appropriate to the nature and characteristics of the information required. The Standard also requires the entity to provide sufficient information that would aid reconciliation of the line items presented in the Balance Sheet. For Balance Sheet: The carrying amount of each of the following categories should be disclosed either in the Balance sheet or in the notes: a. Financial assets at fair value through profit or loss account showing separately those instruments that are designated upon initial recognition and those instruments that are held for trading. b. Held to maturity investments c. Loans and receivables d. Available for sale financial assets e. Financial liabilities at fair value through profit or loss showing separately those instruments that are designated upon initial recognition and those instruments that are held for trading. f. Financial liabilities measured at amortized cost. In case of financial assets/financial liabilities at fair value through profit or loss account, it should disclose a. The amount of change in the fair value of the financial asset or financial liability during the period and cumulatively owing to the changes in the credit risk, determined as: i. The amount of change in its value is not owing to market risk owing to changes in the market conditions such as changes in the benchmark interest rates, commodity price, foreign exchange rate or index of price or rates. ii. The entity believes that using an alternative method would represent the amount of change in the fair value due to credit risk being associated with it. b. Additionally, the financial assets at fair value through profit or loss should indicate i. The maximum exposure to credit risk as at the reporting date. ii. The amount by which any related credit derivatives/similar instruments mitigate that maximum exposure t the credit risk iii. The amount of change In the Fair value of any related credit derivatives/similar instruments has occurred during the period/cumulatively since the loan or receivable was designated. c. Additionally, the financial liability at fair value through profit or loss should indicate i. The difference between the carrying amount and the amount the entity would be contractually liable to pay at maturity to the holder of the obligation. The entity should also disclose a. The methods used to comply with the above mentioned requirements b. If the entity believes that the disclosures it has given to comply with the above requirements is not giving a true representation of the change in the fair value of the financial asset or financial liability owing to the changes in the credit risk, the reasons for reaching such conclusions and the relevant factors. Reclassification: If the entity has reclassified a financial asset in either of the following ways via, a. At cost or amortized value rather than at fair value or b. At fair value rather than at cost or amortized cost, it should disclose the amount reclassified into or out of each of the category and the reasons for such a reclassification.
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Derecognition: An entity may have transferred financial assets in such a way that a part or the whole of the financial assets do not qualify for Derecognition. Therefore, the entity should disclose for each class of financial assets: a. The nature of the assets; b. The nature of the risks and rewards to which the entity remains exposed; c. Had the entity continued to recognize all of the assets, the carrying amounts of such assets and all associated liabilities; d. If the entity continues to recognize the assets to the extent they are having a continuing involvement, the total carrying amount of the original assets, the amount of the assets the entity continues to recognize and the carrying amount of the liabilities. Disclosure requirements for Collateral: a. Collateral issued by the entity: An entity should disclose the carrying amount of the financial assets pledged as collateral for liabilities/contingent liabilities including such amounts to the extent of reclassification and the terms and conditions of the pledge. b. Collateral issued to the entity: if the entity holds a collateral (financial/non financial assets) and is permitted to sell or repledge the collateral even in the absence of default by the owner of the collateral, it should disclose: i. The fair value of the collateral held; ii. The fair value of the collateral sold or repledged and the obligation of the entity to return the same iii. The terms and conditions associated with the use of its collateral. Disclosure of Allowance account for credit losses: When the financial assets are impaired with credit losses and the entity records such impairment in a separate account called allowance account (for individual impairments or collectively for all impairments in the same account), instead of reducing it from the carrying value of the asset, it should disclose a reconciliation of changes in the account during the period for each class of such financial assets. Disclosure of compound financial assets with multiple embedded derivatives: If an entity has an instrument that contains both liability and an equity component in it and the instrument holds such multiple embedded derivatives whose values are interdependent, it should disclose the existence of such features. Disclosure requirements for defaults and breaches: a. For loans payable recognized at the reporting date, the entity should disclose: i. The details of defaults in principal, interest, sinking fund or redemption terms of the loans payable; ii. The carrying amount of the loans payable in default at the reporting date; iii. Whether the default was remedied or the terms of the loans payable were renegotiated before the financial instruments were authorized for issue. b. For any other breaches of loan agreement, the entity should disclose the information given in a, b, c above provided the breach has permitted the lender to demand accelerated repayment. No such disclosure is required if the breaches were remedied/terms were negotiated before the reporting date. Disclosure requirements in Statement of profit and loss and equity: Items of income, expense, gains and losses: An entity should disclose the following items of income, expenses, gains or losses either on the face of the financial instruments of in the notes: a. Financial assets or financial liabilities at fair value through profit and loss, showing separately those assets or liabilities that are designated upon initial recognition and those that are held for trading as per AS 30; SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI 189
b. Available for sale financial assets, showing separately the amount of gain or loss recognized directly in the equity or such amounts that are removed from equity and are recognized in the statement of profit and loss for the period; c. Held to maturity instruments; d. Loans and receivables; e. Financial liabilities measured at amortized cost. The entity should also disclose the total interest income and the total expense using effective interest method for such financial assets and liabilities that are not fair value through profit and loss account. Fee income and other expense (that are not included in the effective interest computation) arising from: a. Financial assets or liabilities that are not at fair value through profit or loss; b. Trusts and other fiduciary activities that result in the holding or investing of assets on behalf of individuals, trusts, and retirement benefit plans and other institutions. Interest income for impairment loss for each class of financial assets need to be disclosed. The amount of impairment loss for each class of financial assets needs to be disclosed separately. Other Disclosures: Accounting Policies: The entity should summarize the significant accounting policies used, the measurement basis, used in preparation of the financial statements and other accounting policies used which are relevant to the understanding of the financial statements. Hedge Accounting: An entity should disclose the following separately for each type of hedge: a. Description of each type of hedge; b. Description of financial instruments designated as hedging instruments and their fair values as at the reporting dates; c. The nature of the risks. For cash flow hedge in particular the entity should disclose, a. The periods when the cash flows are expected to occur and when they are expected to affect profit and loss; b. Description of forecast transaction for which hedge accounting has been used earlier and is not expected to occur in the future; c. To check if the amount was recognized in the appropriate equity account; d. The amount that was removed from the appropriate equity account and included in the statement of profit and loss for the period; e. The amount that was removed from the appropriate equity account during the period and included in the initial cost of other carrying amount of a non financial asset or a non financial liability, whose incurrence was a hedged and a highly probable forecast transaction. For all categories of hedges, the entity should also disclose the gains or losses on the hedging instrument and on the hedged item attributable to hedged risk. Financial statements should also disclose the ineffectiveness recognized in the statement of profit and loss arising from cash flow hedge and from net investments from foreign operations. Disclosure of Fair Value: a. For each class of financial asset/financial liabilities, an entity should disclose the fair value in a way that permits it to be compared with its carrying amount. b. In disclosing its fair values, the entity should group the financial assets/financial liabilities into classes, c. An entity should also disclose the methods, the valuation techniques used, assumptions applied in determining the fair value.
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d. Whether the fair value is determined based on the published price quotations in the active market or are estimated using a valuation technique. If fair values are determined on any other means other than the observable market data, if changing one or more assumptions would change the fair value significantly, the entity should state this fact and disclose the effect of such changes. Also to determine the total amount of change in fair value estimated using a valuation technique recognized in the statement of profit and loss. e. If the market for a financial asset is not active the entity establishes fair value using a valuation technique. For fair value at initial recognition, the best price is the transaction price. If there is a difference between the fair value at initial recognition and the amount determined at the valuation technique, then the entity should disclose: i. The accounting policy for recognizing the difference in the statement of profit and loss ii. The aggregate difference yet to be recognized in the statement at the beginning and end of the period and a reconciliation of the changes in the balance of this difference. Disclosure of fair value when not required? a. When the carrying amount is reasonable approximation of fair value, as in the case of short term trade receivables and payables; b. For an investment in equity instruments that do not have quoted market price in an active market, that is measured at cost in accordance with AS30, due to the reason that the fair value cannot be measured reliably; c. For contract containing discretionary participation feature if the fair value cannot be measured reliably. Also for b and c described above, the entity should disclose the difference between the carrying amount and their fair value including: a. The fact that the fair value has not been disclosed because fair value could not be measured reliably b. The description of the financial instruments, carrying amount, and the reasons as to shy their fair value cannot be measured accurately c. Information about the market for the instruments d. Information about the disposal of the financial instruments shall be carried out by the entity e. If financial instruments whose fair value could not be recognized earlier are derecognized, the fact, the carrying amount on Derecognition and the amount of gain or loss recognized. Disclosure of the nature and the extent of risk arising from financial instruments: The entity is required to disclose information that shall enable the users to evaluate the nature and the extent of risk (including credit risk, liquidity risk and market risk) arising from the financial instruments to which the entity is exposed at the reporting date. Qualitative Disclosures: For each type of risk the entity should disclose the a. The exposures to risk and how they arise; b. Its objectives, policies and processes for managing the risk and the methods used to measure the risk and; c. Changes in a and b mentioned above. Quantitative Disclosures: For each type of risk, the entity should disclose: a. Summary quantitative data about its exposure to risk at reporting date b. The disclosures with regard to credit risks, liquidity risks and market risks except when they are immaterial c. If risk is not apparent in a and b, concentrations of the risks to be disclosed. SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI 191
d. If the risks is not representative the entity should provide further information to show that its representative. Disclosure requirements for Credit Risks: For disclosing credit risks, an entity should disclose: a. The amount that represents the maximum exposure to credit risk at the reporting date without considering the collateral held or other credit enhancements; Also the entity is required to disclose the amount of collateral security held and other credit enhancements b. Information about the credit quality of the financial assets that are neither past due nor impaired; c. The carrying amount of such financial assets that are past due or impaired, provided the terms are renegotiated. Disclosure requirements for liquidity risks: An entity should disclose: a. A maturity analysis for financial liabilities that shows the remaining contractual maturities; and b. Description of how it manages the risk inherent in point a above. Disclosure requirements for market risks: If an entity prepares a sensitivity analysis, in such a way that the value at risk represents the interdependencies between the various risk variables, the entity should disclose: a. An explanation to the method used in preparing the analysis and the main parameters and assumptions used; b. An explanation of the method used and the limitations due to which the assets and liabilities are not fully recorded at its fair value. Unless an entity complies with the provisions above, is should disclose, a. Sensitivity analysis of each type of market risk exposed on the reporting date b. The methods and the assumptions used to prepare sensitivity analysis and c. Changes from the previous periods in the method and assumptions used and the reasons for such changes.
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DISCLOSURES IN FINANCIAL REPORTING AND THE UNDERLYING ACCOUNTING STANDARDS

- CA. Srinivas Swaminathan
"The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions." Financial statements should be understandable, relevant, reliable and comparable. Reported assets, liabilities, equity, income, expenses, financial and non financial information are directly related to an organization's financial position and indicative future performance. My topic on disclosures in financial reporting and the underlying accounting standards. What is the importance surrounding this?. The answer goes to why we have accounting standards and disclosure rules in the first place. What are we trying to accomplish?. We want companies to present their business and financial condition based on current knowledge and expectations for the future. We want accurate reports of companies' operating results and cash flows. We also want financial statements to reflect economic and business reality because, ultimately, this helps investors formulate their investment decisions. If the financial statements distort economic and business reality, capital will be deployed sub-optimally; resources will be misallocated; investors will pay a huge opportunity cost by investing in companies with unrealistic, inflated values; and better investments will get bypassed. Customers and suppliers would make important business and strategic decisions based on a flawed picture of economic reality. Lenders would not be able to price loans consistent with the real risk assumed. Competitors would strive to achieve unrealistic goals. Employees would make career, retirement and investment decisions based on a false picture of their employer's financial prospects. This parade of horribles should sound familiar - these were the very painful consequences of the Enron and other scandals. Whether financial statements are inaccurate because of fraud or complex financial standards, the result can be the same - an erosion of confidence in the disclosure that fosters investment, and adverse effects on the economy and people's financial wellbeing. Considering this background and the maturity in economies there has been a global change in the modalities of accounting which has also reflected in disclosures to be made by Companies in preparing its financial statements. For example the SEC and other global regulators have focused heavily on deterring accounting fraud through enforcement actions and rulemaking. Even before the scandals at Enron, WorldCom and Satyam but increasingly so afterwards, the SEC / IASB and other regulators have been relentless in taking enforcement action against companies and company executives that have engaged in financial fraud. The regulators have used all of the weapons in its enforcement arsenal - injunctions, disgorgement, penalties and accounting bars and suspensions - to punish those responsible for fraudulent conduct and to deter others from engaging in similar activity. The scandals raised investor concerns about the veracity of the company disclosures, and they became more apt to question whether companies' operating results and financial condition were accurately reflected in their financial statements. To restore investor confidence, the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley) was passed, and the Commission promulgated a myriad of new regulations designed to improve corporate governance, enhance auditor independence, and elicit more meaningful and accurate corporate disclosure. While the Commission
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continued its aggressive enforcement activity after Sarbanes-Oxley, the regulatory focus expanded to include corporate governance and the processes and procedures necessary to further induce public companies to provide reliable financial statements and other disclosures. But what makes disclosure useful? The ultimate purpose of disclosure requirements is to elicit full and accurate disclosure of material information. Information is material where there is a substantial likelihood that a reasonable person would consider it important in the total mix of available information to formulating an investment decision. The financial statements are the building blocks of valuation. Whether an investor applies a comparable company or transaction analysis, or a discounted cash flow or liquidation analysis, financial statements of the company or other companies are key to valuation and thus, to making an investment decision. The importance of financial reporting and disclosures also increase as the economy continues to evolve at a rapid pace, while reporting standards and mechanisms are in a "catch-up" mode. Globalization and the emergence of new economies and capital markets have increased dramatically. Advances in technology, including the emergence of the Internet, faster and more ubiquitous communication and other technological developments, have changed the way companies do business, as well as changing the types of financial arrangements and instruments that businesses utilize. As the business world has become more complex, so have financial reports and accounting standards. Globally, over the past several years, we have also witnessed a transformation in the convergence of accounting standards, increase in accounting guidance and extent of disclosures. These disclosures have increased to the extent that there are now reportings on carbon credits, impact of change in the financial statements on account of change in market risk, credit risk, sensitivity analysis, capital management in the financial statements. Considering, India transition to IND-AS (Equivalent to IFRS) we would see on IND-AS adoption, increased transparency and disclosures in financial statements.
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FOREWORD

Accounting Standards issued by ICAI

Consolidated Financial Statements

Enterprises preparing Cash Flow Statements

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

Accounting for Taxes on Income

Listed Companies Other Companies All Enterprises

All (except to a SME)

Mandatory Recommendatory Mandatory Recommendatory Mandatory

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

AS 1 DISCLOSURE OF ACCOUNTING POLICIES

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

Inventories are assets which are :

The costs of purchase consist of

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

Techniques for the Measurement

Comparison between NRV and cost of inventory

Historical cost (Rs. in Lakhs) 40 32 16

Net Realisable value (Rs. in Lakhs) 28 32 24

Rs.120 Rs. 20 Rs. 10

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

Rs. 400 Rs. 250 Rs. 20 Rs.670

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

Rs.20,00,000 9,00,000 1,00,000 5,00,000

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

Cost (ii) Rs. 50,000 (ii)Rs.1,30,000

(i) Rs. 70,000 (i)Rs. 1,50,000 Rs. 2,30,000

Rs. 70,000 1,50,000 2,20,000 1,30,000 90,000

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

Rs. 40,000 (Rs.40,000*100)/22,00,000 = 18.182 %

AS 3 CASH FLOW STATEMENTS

Rs. XXX XXX XXX

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

XXX XXX XXX XXX XXX XXX

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

AS 4 CONTINGENCY AND EVENTS OCCURRING AFTER THE BALANCE SHEET DATE

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

PROCESS OF DEPRECIATION ACCOUNTING

DETERMINATIO N OF DEPRECIABLE ASSET AND RESIDUAL

METHOD OF COMPUTING AND ALLOCATING DEPRECIATION

or Compliance with Statutory Requirement

or Compliance with an Accounting Standard

Assets are revalued

P&L and B/Sheet

P&L, B/Sheet and Notes

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

US GAAP Same as IFRS requirements

Not Applicable revaluation is not permitted)

Only SLM and WDV are permitted

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

Fixed price contracts

Cost Plus Contracts

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

the amount of incentive payment can be measured reliably.

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI

SOUTHERN INDIA CHARTERED ACCOUNTANTS STUDENTS' ASSOCIATION, CHENNAI