accounting standards 32

8/7/2019 Accounting Standards 32

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379Financial Accounting

STUDY NOTE - 6

ACCOUNTING STANDARDS

This Study N ote includes

Accounting Standards - Applicability, Interpretation , Scope and Compliance

IntroductionAccoun ting standa rds ar e wr itten , policy d ocum ents issued by expert accounting

body or by Governm ent or other regu latory authorities covering the aspects of recog-

nition, measurement, treatm ent, presentation and disclosure of accoun ting transactionin the financial statement.The main purpose of formulating accounting standard is to standardize the di-

verse accoun ting policies with a view to eliminate to the extent possible the incompara-bility of information p rovided in finan cial statements and ad d reliability to such finan -cial statements. To d iscuss on wh ether such stand ards are necessary in p resent days itwill be beneficial to go through the advantages and disadvan tages which they are saidto provide.

ADVA NTAGES :

1. It provides the accoun tancy profession w ith useful w orking rules.2. It assists in imp roving quality of work p erformed by accoun tant.

3. It strength ens the accountan ts resistance against the pressu re from d irectors to useaccounting policy which may be suspect in that situation in which they performtheir work.

4. It ensu res the various u sers of finan cial statements to get comp lete crystal informa-tion on more consistent basis from period to period .

5. It helps the users comp are the finan cial statemen ts of two or m ore organisaitonsengaged in same type of business operation.

DISADVANTAGES :

1. Users are likely to think that said statements prepared using accoun ting standardare infallible.

2. They have been d erived from social pressures which m ay redu ced freedom .3. The working ru les may be rigid or bu reaucratic to some user of finan cial statemen t.4. The more stand ard s there are, the more costly the financial statements are to pro-

duce.


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Financial Accounting380


Accounting Title of Accounting StandardStandard N o.

AS-1 Disclosure of Accounting Policies

AS-2 Valuat ion of Inventor ies (Revised)AS- 3 Cash Flow Statemen ts (Revised )

AS-4 Contingencies and Events (Occurring after the Balance Sheet Date)

AS-5 Net Profit or Loss for the Period, Prior Period Items and Changesin Accounting Policies (Revised )

AS-6 Dep reciation Accou nting

AS-7 Const ruction Contract s (Revised)

AS- 8 Accounting for Research and Development (stands withdrawn af-ter introduction of AS-26)

AS-9 Revenu e Recognition

AS-10 Accounting for Fixed Assets.

AS-11 The Effect of Changes in Foreign Exchange Rates (Revised)

AS-12 Accounting for Government Grants

AS-13 Accounting for Investmen ts

AS-14 Accounting for Amalgamations

AS-15 Employee Benefit s (Revised)AS-16 Borrow ing Cost

AS-17 Segm ent Rep orting

AS-18 Related Par ty Disclosu res

AS-19 Leases

AS-20 Earnings Per Share

AS-21 Consolidated Financial Statements

AS-22 Accounting for Taxes on Income

AS-23 Accounting for Investment in Associates in Consolidated Finan-cial Statements

AS-24 Discon tinuing Operations

AS-25 In ter im Financia l Repor ting

AS-26 Intangible Assets

AS-27 Financial Reporting of Interests in Joint Venture


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AS-28 Im pairm ent of Assets

AS-29 Provisions, Contingent Liabilities and Contingent Assets

AS-30 Finan cial Instru men ts: Recognition and Measurem ent

AS 31 Financial Instruments: Presentat ionAS 32 Financial Instruments: Disclosures

Applicability of Accounting Stand ard s:

A three tier classification has been framed to ensure compliance of accounting standards forreporting enterprises.

Level I Enterprises:

Enterprises whose equ ity or debt secu rities are listed wh ether in India or outsid e Ind ia.

Enterprises wh ich are in th e process of listing their equ ity or d ebt secur ities as evidencedby the Board r esolut ion in this regard .

Banks includ ing co-operative ban ks

Finan cial institu tions

Enterprises carrying insu rance business

Enterprises whose tu rnov er exceeds Rs.50 crores

Enterprises having borrow ings in excess of Rs.10 crores at any time d u ring th e accoun t-ing period.

Hold ing companies and su bsidiaries of enterp rises falling under any one of the catego-ries mentioned above.

Level II Enterprises:

Enterprises whose tu rnover exceeds Rs.40 lakhs bu t d oes not exceed Rs.50 crores.

Enterp rises hav ing borrowings in excess of Rs.1 crore but no t in excess of Rs.10 crores atany time du ring the accoun ting period.

Holding companies and subsidiaries of enterprise falling under any one of the catego-ries mentioned above.


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Level III Enterprise s:

Enterprises wh ich are not covered u nd er Level I and Level II.

Accoun ting Stand ard App licability (Based on the three tier classification)

AS1,2,4-16,22,26,28 All Enterprises

AS 3,17,18,24, Not applicable to Level II and Level III enterprises in their entirety.

AS 19,20,29 All enterprises but relaxation given to Level I and Level II enterpr ises for certain d isclosure requ irements.

AS 21,23,27 Not applicable to Level II and Level III enterprises

AS 25 Not mandato rily app licab le t o Level II and Level III en terp rises

AS 30,31,32 W.e.f. accounting periods commencing on or after 1-4-2009 and willbe recomm endatory in natu re for an initial period of two years.

It will be man datory for on or after 1-4-2011 for all comm ercial, ind ustr ial and businessentities except to a Small and Med ium -sized Entity.

AS-1: DISCLOSURE OF ACCOUNTING POLICIES

This stand ard deals w ith d isclosure of significant accounting p olicies followed in the p repara-tion and presentation of the financial statements and is mand atory in natu re.

The accoun ting p olicies refer to the specific accounting pr inciples ad opted by the enterp rise.

Proper d isclosure w ould ensure m eaningful comparison both inter/ intra enterprise and alsoenable the users to properly app reciate the finan cial statements.

Finan cial statements ar e intend ed to p resent a fair reflection of the financial position financialperform ance and cash flows of an enterp rise.

Areas involving d ifferent accounting p olicies by different ent erprises are

Methods of depreciation, depletion and amortization

Treatment of expend iture d uring construction

Treatment of foreign currency conversion/ translation, Valuation of invento-ries


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The following are not considered as changes in accounting p olicies:

a) Accounting policies adopted for events or transactions that differ in substance at present(introducing Group Gratuity Scheme for employees in place of adhoc ex-gratia pay-men t earlier followed .)

b) Accoun ting policies pertains to events or transactions wh ich did not occur previouslyor that were imm aterial.

Fundamental Accounting Assumptions

Certain basic assumptions, in the preparation of financial statements are accepted and theiru se are assum ed, no sepa rate disclosure is requ ired except for non compliance in respect of-

a) Going Concern: continuing operation in th e foreseeable futu re and no interim n ecessityof liquid ation or wind ing up or reducing scale of operation .

b) Consistency: accoun ting p olicies are consistent from on e period to anoth er

c) Accrual:i) Revenues and costs are accrued i.e. they are earned or incurred (not actually re-

ceived or paid) and recorded in th e financial statements

ii) Extends to matching revenue against relevant costs.

PROBLEMS

1. The gross block of fixed assets are shown at the cost of acquisition, which includ es tax,du ties (net of MODVAT and set off availed) and other id entified d irect expenses. Inter-est on borrow ing to finance the fixed assets is considered as revenu e.

Answ er: The policy ap pears to be correct.

2. Compensation payable to employees un der volun tary retirement scheme has been de-ferred to be written off over a p eriod of four years as against the p ast practice of charg -ing out the same on paym ent/ d ue basis. Comm ent.

Answ er: The reason for change mu st be incorporated with n otes to accounts.

3. Sales includ es inter-dep artmental transfers, sales du ring trial run and are net of dis-coun ts. Comm ent.

Answer: The po licy is not as per AS-9, Revenu e Recognition .

AS-2: VALUATION OF INVENTORIES

At the outset AS -2 excludes the following though appears to be inventory in common par-lance:

a) Work-in-progress in construction contract and d irectly related service contract (ref: AS-2), inven tories not forming pa rt of construction w ork-in-progress w ill attract AS-2


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b) Work-in-progress arising in the ordinary course of business of service provid ers Shares,debentu res and other financial instrumen ts held as stock-in-trad e (ref: AS-13 as CurrentInvestments)

c) Livestock, agricultural and forest produ ct, mineral oil/ gasses as measured at net realiz-

able value as per trad e practices at certain stage of prod uction.AS-2 covers inv entories as an item of assets w hich are

a] held for sale in the ordinary course of business

b] in the process of prod uction for such sale

c] in the form of material or sup plies for the process of prod uction or rend ering of service

Inventories are valued at lower of cost or net realizable value (NRV)

a) Cost to includ e pu rchase price, conversion and other costs incurred in bringing the in-ventor ies to their present location and condition.

An enterprise should use the same cost formula for all inventories having similar na-ture and use - specific cost, FIFO, weighted average, standard cost, adjusted sellingprice

b) Net realizable value is the estimated selling p rice in the ord inary course of businessreduced by the estimated cost to bring the item in saleable condition, considered oneach balance sheet date, usua lly on item by item basis or un der suitable group of similaror related item.

Dis closure under AS-2

a) the accounting policy adopted in measuring inventories

b) the cost formula used

c) carrying amount (value) of inventory comm only classified un der Raw Material andComp onents, Work in Prog ress, Finished good s and Stores, Spares and Loose tools.

d) Schedu le-VI and AS-2 disclosure are at par

PROBLEMS1. Raw materials pu rchased at Rs.10 per kg . price of materials is on the d ecline. The fin-

ished good s in wh ich the raw m aterial is incorporated ar e expected to be sold at belowcost. 1,000 kgs of raw material is in stock at th e year-end . Replacement cost is Rs.8 per

kg. How w ill you value the inventory?

Answ er: As per p ara 24 of AS-2, on valuation of inven tories, material and other su p-plies 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 orabove cost. However, when there is a decline in the price of materials and it is esti-mated that th e cost of the finished p rod ucts will exceed net realizable value, the mate-rials are written d own to net realizable value.


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Hence, the value of stock of 1,000 kgs. of raw materials will be valued at Rs.8 per kg.The finished stock shou ld be valu ed at cost or net realizable value, wh ichever is lower.

2. Inventories are valued at cost except for finished goods and by prod ucts, finished goodsare valued at lower of cost of realizable values and by prod ucts are valued at realizable

value. Commen t on the accounting policy.

Answ er: The accounting policy followed by the comp any is at p ar w ith AS-2.

3. Cost of Produ ction of prod uct A is given below:

Raw mater ial per un it Rs.150

Wages per unit Rs.50

Overhead per unit Rs.50

Rs.250

As on the balance sheet d ate the replacement cost of raw material is Rs.110 per un it. There are100 units of raw ma terial on 31.3.08.

Calculate the value of closing stock of raw m aterials in th e following conditions:

(i) If finished prod uct is sold at Rs.275 per unit, wh at will be the value of closing stock of raw material?

(ii) If finished prod uct is sold at Rs.230 per un it, wh at will be the value of closing stock of raw material?

Answ er: (i) The realizable value of the p rod uct is more than the total cost of the p rod uct. Thecost of raw m aterial per u nit is more than the rep lacement cost, hence, raw materials shou ld bevalued on actual cost.

Therefore, the value of raw materials: 100 units x Rs.150 per u nit= Rs.15,000

(ii) The realizable value of the produ ct is less than the total cost of the produ ct. Thoughthe cost of raw material per u nit is more than the rep lacement cost, hence, raw ma teri-als should be valued on rep lacement cost.

Therefore, the value of raw materials: 100 units x Rs.110 per u nit= Rs.11,000

AS-3 (REVISED): CASH FLOW STATEMENT

Cash Flow Statement deals with the provision of information about the historical changes incash and cash equ ivalents of an enterpr ise by m eans of a cash flow statemen t which classifiescash flows du ring the p eriod from op erating, investing an d financing activities.


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Cash comp rises cash on hand and dem and d eposits with banks.

Cash equ ivalents are short term , highly liquid investment s that are readily convertibleinto know n am oun ts of cash an d w hich are subject to an insignificant risk of chan ges invalue.

Cash flows are inflows and ou tflows of cash and cash equivalents.

Operating activities are the p rincipa l revenue-producing activities of the enterprise andother activities that are n ot investing or financing activities.

Investing activities are the acquisition and disposal of long-term assets and other in-vestments not included in cash equivalents.

Finan cing activities are activities that resu lt in changes in th e size and composition of the ow ners capital (includ ing p reference share capital in the case of a company) andborrowings of the enterprise.

Methods of preparing Cash Flow Stateme nt:

1. Direct Method : In this meth od m ajor classes of gross cash receipts and gross cash pay -men ts are disclosed.

2. Indirect Method: Und er this method , the following adjustment to reported n et profit orloss to be mad e:

Effects of transactions of non-cash natu re.

Deferrals in accru als of past or futu re operating receipt or p ayments.

Changes in current a ssets and liabilities

Income & expenses associated w ith investing an d finan cing cash flows.

PROBLEMS1. Oriental Bank of Comm erce, received a gross Rs.4,500 crores demand deposits from

customers and customers withdraw n Rs.4,000 crores of demand dep osits du ring thefinan cial year 2007-08. How would you classify su ch cash flows?

Answ er: It w ill be treated as an Operating activity, on n et basis Rs.500 crores,inflow.

2. Consider a h ypothetical example on the p reparation of cash from operating activitiesun der both direct and indirect method of preparing cash flow statement.


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D irect Method Cash Flow Statement [Paragraph 18(a)] (Rs. 000)

Cash flow s from op erating activi ties

Cash receip ts from customers 33,150

Cash paid to suppliers and employees (29,600)Cash generated from operations 3,550

Income taxes paid (1,860)

Cash flow before extraord inary item 1,690

Proceeds from earthquake d isaster settlement 180

N et cash from operating activ ities 1,870

Indi rect Method Cash Flow Statement [Paragraph 18(b)] (Rs. 000)

Cash flow s from op erating activi ties

N et p rofit before taxation, and extraord inary item 3,350

Adjustments for:

Depreciation 450

Foreign exchange loss 40

Interest income (300)

Dividend income (200)

Interest expense 400

Op eratin g p rofit before w orking cap ital changes 3,740

Increase in sundry debtors (500)

Decrease in inventories 1,050

Decrease in sundry cred itors (740)

Cash generated from operations 3,550

Income taxes paid (1,860)

Cash flow before extraord inary item 1,690

Proceeds from earthquake d isaster settlement 180

Net cash from operating activities 1,870


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AS-4(REVISED): CONTINGENCIES AND EVENTS OCCURRINGAFTER THE BALANCE SHEET DATE

A contingency is a cond ition or situation, the u ltimate outcome of wh ich, gain or loss will be

know n or determined on ly on the occurrence/ n on-occurrence of one or m ore un certain futu reevents.

For the p urpose of AS-4 the m eaning is restricted to cond ition or situation at the Balance Sheetda te, the finan cial effect of wh ich is to be determined by futu re events wh ich m ay or m ay notoccur.

AS-4 does not d eal with th e following subjects, though m ay resu lt in contingencies in respectof:

a) Liabilities of Life and General Insu rance out of policies issued by the enterp rise.

b) Obligations u nd er retirement benefit plan/ scheme

c) Comm itment arising from long-term lease contract

Estimates are required to be made for the amounts to be stated in the financial statement formany ongoing and recurring activities of an enterprise. Distinction should be made betweenan event that is certain and that is uncertain.

Contingent losses depend on th e outcome of the contingencies. It should be provid ed by w ayof a charge in the statement of p rofit/ loss

a) if it is probable that futu re events will confirm after taking into account th e probablerecovery in this respect, that an asset has been imp aired or a liability has been incurred

as at the B/ S date, andb) a reasonable estimate of the resulting loss can be estimated otherw ise the existence of

the contingent loss shou ld be d isclosed in the financial statements.

Provisions for contii1gencies are not mad e in respect of general or u nsp ecified bu siness risk since they d o not relate to cond itions or situations existing at the B/ S date

The disclosure requ irements ap ply on ly for those contingencies or events w hich affect the fi-nan cial position of the enterp rise to a material extent stating:

a) The nature of contingency;

b) The un certainty wh ich may affect the futu re outcome;c) The estimate of the financial effect;d) A statement that such an estimate cannot be mad e;

Contingen t gains are not r ecognized because of uncertainty of realization; how ever, there is norestriction to d isclose as such in the Notes to Accoun ts in a m ann er not likely to mislead th eusers of the finan cial statements.


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Events occurring after the B/ S date or those significant events, both favou rable and u nfavou rablethat occur between the B/ S date and the date of approval of the financial statements by theappropr iate authority (e.g. Board of Directors of a company) can be of

a) Those which provide further evidence of cond ition that existed at the B/ S date adjust-ing even ts (e.g. insolvency of a custom er that occur after B/ S date)

b) Those wh ich are ind icative of cond itions that arose subsequent to the B/ S date non-adjusting events (loss d ue to earthquake, war)

Events occur ring after the B/ S date but ind icative of the enterp rise ceases to be a going concern(destruction of major p rod uction p lant by fire after B/ S date) needs to be considered and evalu-ated to justify going concern concept for p reparation of Finan cial statements.

PROBLEMS

1. The assets in a factory of a limited compan y was dam aged d ue to a fire break out on 15 th

April. The Loss is estimated at Rs. 50 crores ou t of wh ich Rs.35 crores w ill be recoverablefrom the insu rers. Explain briefly how the loss should be treated in th e final account forthe pr evious year.

Answ er: This has to be show n as a disclosure by way of note to accoun t.

2. Board of Directors of a limited comp any ap proved th e financial account for the year2007-08 on 31 st July,2008. The following events occurred before the ap proval of financialstatements by Board of Directors. State how would you d eal with these situations:

(a) The Board of Directors at their meeting on June 30, 2008 has recommended adividend of 10% to be paid to the shareholders after it is app roved at the annu algeneral meeting.

Answ er: Proposed Dividend m ust be show n in the Balance Sheet.

(b) A d ebtor, wh o w as declared insolvent on 10 th July 2008. The total ou tstand ingamou nt w as Rs.2 lacs as on 31 st March,2008.

Answer: A provision for loss shou ld be p rovided in the books.

A5-S (REVISED): NET PROFIT OR LOSS FOR THE PERIOD, PRIORPERIOD ITEMS AN D CHANGES IN ACCOUNTING POLICIES.

The statement requ ires the classification and d isclosure of extraord inary and p rior period itemsand the d isclosure of certain items with in the p rofit or loss from ord inary activities and alsoaccoun ting treatmen t for changes in the accounting estimate, and d isclosure regard ing changesin Accounting Policies in the finan cial statement.


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To ensu re prep aration of Profit or Loss statement on a un iform basis, in turn to enh ance bettercomparability of the enterp rise over time and with oth er enterpr ises.

All items of income and expense, which are recognized in a period , are normally includ ed forthe determination of the Net Profit/ Loss for the period unless otherwise permitted (AS-22

exception for deferred tax in th e income tax)Each extraordinary items, both income and expense arises from events/ transactions, whichare clearly distinct from ord inary activities and n ot ex petted to recur frequ ently or regu larly,shou ld be disclosed as apart of net profit/ loss for the period in a distinct man ner to un derstan dthe impact on cur rent p rofit/ loss

An event or transaction may be extraord inary for one enterprise but not for the other becauseof difference between their resp ective ord inary activities.

Only on rar e occasion does an event/ tran saction give rise to extraordina ry items.

Ord inary activities are those undertaken as part of business of ail enterp rise and related activi-ties for fu rtheran ce of, incidental to or ar ising from th ese activities. Frequ ency of occur rence isnot th e sole criteria to d etermine extraordinary or ordinary natu re.

How ever, when items of income or expense within p rofit/ loss from ord inary activities are of such a size, natu re or incidence that their d isclosure is relevant to exp lain th e performance forthe period the natu re and amou nt of such items shou ld be d isclosed separately as exceptionalitems (distinct from extraordina ry items) e.g.

a) wr ite off/ write back of inventor ies to Net Realizable Value, provision/ write back of cost of restructu ring

b) disposal of fixed asset/ long term investments

c) effect of legislative changes with retrospective application

d) settlement of litigation

e) other reversal of provisions

Prior period items (income/ expense) arise in the cur rent period as a result of errors/ omissionsin the p repar ation of the financial statements, in one or more pr ior period are generally infre-quent in natu re and d istinct from changes in accoun ting estimates.

Prior period items are norm ally includ ed in the d etermination of net profit/ loss for the cur rentperiod show n after determination of cur rent p eriod p rofit/ loss. The objective is to indicate theeffect of such items in th e profit/ loss. The separate d isclosure is intended to sh ow the imp acton th e cur rent p rofit/ loss. Disclosure is mad e

a) by showing the prior period items distinctively un der the relevant head of income/ expenditure

b) by pu tting und er Prior Period Adjustment A/ c either in the main statem ent of P/ L orin a schedule containing the respective details with the net figure in the P/ L A/ c of current p eriod in compliance with sched ule VI part II requ irement.


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Notes to the Accoun ts should provid e detail description with imp act on th e current p eriod andtax implication arising thereof (e.g. stock valuation not correctly made in the p revious p eriod).

The use of reasonable estimate based on then available informat ion circumstances are an es-sential part of the preparation of financial statement. There may arise a need to change the

estimate on the basis of new information more experience or subsequent development. Therevision in estimate does not bring the adjustment within the definition of an extraordinaryitem or prior period item.

The effect of change in Accounting Estimate should be included in the determination of netp rofit/ loss

a) in the period of change (if restricted for the period only)

b) in the period of chan ge and futu re period (if the chan ge affects both) (e.g. estimate of baddebt for (a) and change in estimated life of a dep reciable asset in term s of dep reciationfor (b

Classification as to ord inary or extraord inary as previously followed should be maintained tod isclose the effect of changes in accounting estimate for better comp arability.

The natu re and change in an accoun ting estimates having material effect in the current p eriodor in su bsequent p eriod shou ld be d isclosed . If quan tification is not p redictable such fact shou ldalso be d isclosed .

If it is difficult to d istingu ish between a change in Accoun ting Policy and change in Account-ing Estimate the chan ge is recognized as chan ge in Accounting Estimate with ap prop riate dis-closure.

Example of various disclosures under AS-5

1. change in depreciation method : change in accoun ting policy

2. useful life redu ced bu t no change: change in accounting estimate in dep reciation method

3. arithmetical error in dep reciation comp utation: prior period item

4. du e to oversight depreciation incorrectly comp uted : prior period item

5. fixed asset destroyed in earth quake: extraordinary item

6. major disposal of fixed items: ord inary activity (exceptional item)

7. maintenance provision no longer required since major part of the assets no longer exist:

the w rite-back. if material shou ld be d isclosed as exceptional item and not as extraord i-nary or p rior period item.


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PROBLEMS

1. Mr.Pradip an emp loyee of CCL Ltd.went on leave with a pay for 9 mon ths on 1.1.2008up to 30.9.2008. His m onth ly p ay w as Rs.25,000. While preparing th e financial statemen t

on 30.6.2002 for the year ended 31.3.08, the expense of salary of Mr.Pradip for 3 months(1.1.08 to 31.3.08) was not prov ided due to omission. When Mr.Prad ip joined on 1.10.08,the wh ole salary for 9 months w as du ly paid to him.

In this case, three month s salary of Rs.75,000 is prior period expense and following entryshould be passed:

Salary A/ c Dr. 1,50,000

Prior period expense (Salary) A/ c Dr. 75,000

To Bank A/ c 2,25,000

If Mr. Prad ip w as terminated from service on 1.1.08 and was re-instated in service by theCour t on 30.9.08 with fu ll pay p rotection(i.e. total salary w as reward ed to him). As theemp loyee was re-instated in service as per th e Cour ts Ord er as on 1.10.2008, the follow-ing entry shou ld be made:

Salary A/ c Dr. 2,25,000

To Bank A/ c 2,25,000

In such a case, there shall arise no error or omission wh ile preparing the financial statementsfor the earlier years.

AS -6 (REVISED) DEPRECIATION ACCOUN TING

Deprecation is a measure of the wearing out consumption or other loss of value of a depre-ciable asset due to u se efflux of time or obsolescence through techno logy and market changesand also includ es amortization of assets having pred etermined life.

Different accounting policies are followed by d ifferent enterp rises, hence d isclosure is n eces-sary to app reciate the view p resented in th e financial statements.

Depreciation h as a significant effect in d etermining an d presenting finan cial position and op-erating results.


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A de preciable asset must fulfil l the follow ing criteria:

a) expected to be used for more than one accoun ting period

b) limited useful life

c) held for use in the prod uction or supp ly of goods and services, for rental, for adm inistra-tive pu rposes, and not for sale in the ord inary course of business.

Specific exclusions from the scope of AS -6:

1. Forest, plan tation and similar regenerative resource

2. Wasting asset, expend iture or a exploration for and extraction of minerals, oils naturalgas and similar non -regenerative resources.

3. R&D expend iture

4. Goodw ill

5. Livestock

Depreciation charge for a period is usu ally recognized as an expense un less includ ed in carry-ing amount (e.g. dep reciation of manu factu ring p lant is includ ed in th e cost of conversion of inventor ies or depreciation of assets used for d evelopment activities may be treated as an in-tangible assets or capital redu ced )

Useful life is either:

( a) the p eriod over wh ich a d epreciable asset is expected to be used by the enterpr ise or ( b) onthe basis of pr oduction or similar un its obtainable from the u se of assets.

A change in dep reciation method w ill arise in the following situation:

a) adoption is required by the statute, orb) for comp liance with the relevant AS, or

c) it is considered that the change wou ld result in more approp riate presentation of thefinan cial statemen ts

When the change is adopted, the depreciation is reworked with reference to the date of theasset pu t to use by the enterp rise, the d eficiency/ surp lus is adjusted in the P/ L A/ c in the yearof change given effect w ith ap propr iate disclosure since as per AS 6. This is considered as achange in th e Accounting Policy.

Change in depreciation method always applies retrospectively.

Disclosure under AS-6: The following in formation should be d isclosed in the finan cial state-ment

1) Historical cost/ substituted cost of each class of depreciable asset

2) Total dep reciation for the period with respect to (1)

3) Accum ulated dep reciation: Ad d itional disclosure as par t of d isclosure of other account-ing policies


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a) Depreciation method used

b) Depreciation rate or the useful lives of the assets, if they d iffer from rates specified inthe govern ing statut e If any dep reciable asset is d isposed of, discard ed, dem olishedor d estroyed, the net surp lus or d eficiency, if material shou ld be d isclosed separately

(in contrast w ith th e concept of Block un der I.T Act 61)In case the dep reciable assets are revalued , the d epreciation shou ld be provided as the reval-ued amou nt on the estimate of remaining useful life of such assets. Disclosure shou ld be madein the year of revaluation, if the same h as a material effect on th e amou nt of depreciation.

PROBLEMS1. Plant has useful life of 10 years. Depreciable amou nt of Rs.30 lakhs. The comp any h as

charged d epreciation u nd er SLM. At the end of the 6 th year, the balance useful lifewas re-estimated at 8 years. The dep reciation w ill be charged from the 7 th year:

= 30 (30/ 10) x 6 = 1.58

2. B Ltd. Purchased certain p lant and machinery for Rs.50 lakhs. 20% of the cost net of CENVAT credit is the subsidy comp onent t o be realized from a State Governm ent forestablishing industry in a backward d istrict. Cost includ es excise Rs. 8 lakhs againstwh ich CENVAT credit can be claimed . Comp ute d epreciable amou nt.

Answ er: We shall have to determine the historical cost of the p lant and machinery.

Pu rchase Price Rs.50 lakhs

Less: Specific Excise du ty against wh ich CENVAT is available Rs. 8 lakhs

Original Cost of the machinery for accounting purposes Rs. 42 lakhsLess: Subsidy @ 20% of Rs.42 lakhs Rs. 8.4 lakhs

Depreciable Amount Rs. 33.6 lakhs

Note: As CENVAT Credit on Capital Goods can be availed u pto 50% in the first yearof acqu isition and the balance in the next year, an alternative treatment may also beconsidered.

The original cost of the plant an d m achinery can be taken at Rs. 50 lakhs and a sum of Rs.8.4 lakhs can be tr ansferred to d eferred income accoun t by w ay of subsidy reserve.The portion of unavailed CENVAT Credit is also required to be redu ced from cost.

AS-7(REVISED): ACCOUN TING FOR CON STRUCTION CONTRACTS

The statement ap plies to accoun ting for construction contracts, in th e finan cial statements of contractors,

A construction contract may be related to the constru ction of single asset or a nu mber of assetsclosely, interrelated or interd epend ent in term s of the scope of the contract.


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For the purpose of this statement construction contract covers:

a) Contracts for rend ering of services directly related to the constru ction of the asset e.g.service of project-man agers, architects etc.

b) Contracts for destruction/ restoration of assets and r estoration of environmen ts follow-ing demolition

c) Consultancy contracts in project managem ent, designing, comp uters wh ere such con-tracts are related to the constru ction of the asset.

d ) Those long-term contracts not relating to constru ction of an asset.

A construction contract may be

a) a fixed -price contract with / withou t escalationb) a cost-plus contract (provision for reimbu rsement of overhead on agreed basis in ad di-

tion to fixed p rice/ fees)

c) a mix of both (a cost-plus contract with a minimu m agreed p rice)

The statement u sually app ly to each contract separately, however, sometimes it is necessary toapply the statement to the separately identifiable comp onent s of a single contract or to a groupof contr acts together in ord er to reflect the substan ce. When a contr act covers

a) Number of assets: each asset treated as sepa rate contract when the prop osal, negotiationand cost/ revenue can be ident ified d istinctly

b) Negotiated single package of interrelated identifiable with an overall profit margin performed concurrently or continuous sequence: treated as a single contract whether a single cus-tomer or a grou p of customers.

c) Construction of an additional asset as the provision of the contract: treated as separate con-tract if there is significant change in design, technology or transaction from originalcontract in term s of the scope an d / or p rice.

Add itional asset shou ld be treated as a separate constru ction contract if there is signifi-cant change in design, technology or function from the assets covered in the originalcontract p rice.

Contract reve nue comprises o f

a) revenue agreed in the contractb) variations in the scope of contract, adverse/ favou rable

c) incentive paym ent (degree of certainty and reliability)

d) penalties due to delay in execution

Contract costs comprise of

a) d irectly related to specific contract


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b) attribut able cost relating to contract activity in general and precisely allocable to thecontract as reduced by incidental income not included in contract revenu e (sale of su r-plu s m aterial, disposal of contract sp ecific plants etc).

Contract cost and revenue are recognized for accounting only when the outcome of the con-

struction contract can be measured reliably with r egard to the stage of comp letion of the con-tracts activity at its B/ S date. All expected losses shou ld r ecognized as an expense for the con-tract.

Under the percentage completion method, contract revenue is recognized in the P/ L in theaccoun ting period in w hich th e work is performed and the related contract cost is shown as anexpense. How ever, expected excess of total contract is recognized as an expense imm ediately.Revenue earlier recognized or becoming doubtful/ uncollectable should be treated as an ex-pense.

A long-term contract is sub ject to fluctuation for various reasons in the original estimation thu slikely to affect the d etermination of contract results. It is necessary tha t an ann ual review of thecost already incur red an d fu tu re cost required to complete the project on schedu le. While esti-mating th e futu re cost care shou ld be taken for foreign exchan ge rate fluctuation, labour p rob-lem, chan ges in m aterial price etc.

Disclosure under AS -7 (on reporting dat e by an ent erprise)

A) An enterpr ise shou ld enclose

a) The amou nt of contract revenue recognized as revenue in the period

b) The method s used to determine the contract revenue recognized in the period

c) Method u sed to determine the stage of comp letion of contract in p rogress

B) An enterp rise shou ld d isclose the following for contracts in p rogress at the rep orting d ate1. The aggregate amou nt of costs incurred and recognized profit less recognized losses

up to reporting date.

2. The amou nt of adv ance received and amou nt retainedC) An enterprise should present

a) Gross amou nt du e from customer is an asset

b) Gross amou nt d ue to customer is a liability

c) Contingen cies as per AS-4 (warran ty cost, pen alties, guarantee issued by banks againstcounter ind emn ity of contractor)

PROBLEM

A Comp any un dertook to pay contract for a building for Rs.40lakhs. As on 31.3.2008, it in-curred it incurred a cost of Rs.6 lakhs and expects that there w ill be Rs.36 lakhs m ore for com-pleting the building. It has received Rs.4 lakhs as progress payment. What is the degree of completion?


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Percen tage of Com p letion = Cost to d ate x 100Cum ulative cost incurred + Estimated cost to comp lete

= 6/ (6 + 36) x 100 = 14.28%

AS-8 ACCOUNTING FOR RESEARCH & DEVELOPMENT(STAND S WITHD RAWN ON INTRODUCTION OF AS-26 INTANG IBLE ASSETS)

AS-9 REVENUE RECOGNITION

The statement covers the recognition of revenu e arising in the course of ord inary activities. of the enterp rise from

a) sale of goods

b) rendering of service

c) ou tsourcing of resources yielding interest, royalties and d ividend Specific exclusionfrom the stand ard p ertains to

a) construction contracts

b) lease/ hire pu rchase agreement

c) govt. grants/ subsidies

d) insurance contract of insurance comp anies

Essential criterion for recognition for r evenu e from ord inary activities as aforesaid is that th econsideration is reasonably d eterminable even th ough the p ayments are m ade by installments.In the event of uncertainty, the recognition is postponed and considered as revenue of theperiod in w hich it is prop erly recognized.

The standard requires, in addition to the AS- I, that an enterprise should also disclose thecircumstances in wh ich revenu e recognition has been postpon ed p end ing resolution of signifi-cant un certainties.

NOTE:

Revenue includ e the gross inflow o f economic benefits only accrued to an en terpr ise on its owne.g. sales tax, service tax, VAT etc. do n ot accrue to th e enterp rise and thu s not considered as

revenue under IAS-18 and US GAAP. Practices vary in India and tend to show larger grosstu rnov er for the en terpr ise (inciden tally section 145A of the Income Tax Act 61 requ ire pu r-chase, inventor y and tu rnov er inclusive of Tax, du ty and cess)

ICAI recommends disclosure in the mann er :

Turnover (gross) xxx

Less Excise duty xxx

Net Turnover xxx


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PROBLEMS

1. AB Ltd. Seeks you ad vise abou t the treatmen t of the following in the final statemen t of accounts for the year ended 31 st March 2008:

As a result of a recent ann ounced p rice revision, granted by the Govern men t of Ind iawith effect from 1 st July,2007, the company stands to receive Rs. 6 lakhs from its cus-tom ers in resp ect of sales mad e in 2007-08

Answ er: The comp any is p repar ing the financial statements for the year ended 31.3.08.Due to p rice revision gran ted by th e Governmen t of Ind ia, the company h as to receivean ad d itional sales revenue of Rs. 6 lakhs in respect of sales mad e du ring th e year 2007-08.

As p er AS-9, where u ncertainty exists in collection of reven ue, its recognition is post-pon ed to th e extent of uncertainty involved and it should be recognized as revenue

only w hen it is reasonably certain abou t its collection.In view of the above statem ent, if there is no uncertainty exists as to th e collect ability of Rs. 6 lakhs, it shou ld be r ecognized as revenu e in the financial statemen ts for the yearend ed 31.3.08.

2. Advise D Ltd .about the treatment of the following in the final statemen t of accoun ts forthe year ended 31 st March,2008.

A claim lodged with th e Railways in March,2006 for loss of good s of Rs.5 lakhs hadbeen passed for payment in March,2008 for Rs.4 lakhs. No entry was passed in thebooks of the company, w hen th e claim was lodged .

Answ er: The financial statemen ts of the comp any are prep ared for the year end ed 31.3.08.

There was a loss of goods of Rs.5 lakhs in 2005-06 and the claim was lodged in March2006 with the Railway authorities. No entry was passed in the books of the companywh en the claim w as lodged and the said treatm ent was correct in view of AS-9, whichstates that if un certainty exists as to collectability, the revenue r ecognition sh ould bepostponed.

Since, the claim is passed for payment of Rs.4 lakh s in March ,2008, it shou ld be recog-nized a s revenu e in the finan cial statements p repared for the year en ded 31.3.08.

As per AS-5 Revised, the claim amount received will not be treated as extraordinaryitem. AS-5 Revised furth er states that when items of income and expense with in p rofit0r loss from ord inary activities are of such size, nature, or incidence that their d isclo-sure is relevant to exp lain th e performan ce of the enterprise for the p eriod, the natu reand amou nt of such items should be disclosed separately. Accordingly, the nature andamou nt of this item shou ld be disclosed separat ely.


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AS-10: ACCOUNTING FOR FIXED ASSETSFixed assets for the pu rpose of the statement are those held by an enterp rise with th e inten tionof being used for the p urp ose of prod ucing or providing good s or services and n ot held for salein the normal course of business and applies to financial statements prepared on historical

cost/ substituted cost basis.The following items need special consideration and normally not covered under this state-ment. un less the expenditure on individu al items are separable and identified.

a) forest plantation and regenerative natural resources

b) wasting assets and n on-generative resources (mineral rights. exploration of mineral, oiland n atural gas)

c) expend iture on real estate development

d) livestock

Apart from d irect cost, all directly attribu table cost to bring th e asset concerned to their w ork-ing cond ition for intend ed u se also forms the par t of fixed asset.

Subsequen t expend iture after the initial cap italization that increases the futu re benefits fromthe existing assets beyond the p reviously assessed stan dard of performance (e.g. increase inqu ality of ou tpu t, substantial redu ction in op erating cost) is cap italized to form the gross book value.

Finan cial statements are norm ally prepa red on the basis of historical cost but som etimes a partor all of fixed assets, are restated (revalued) and substitu ted for historical cost. The comm onlyaccepted and preferred method of restating is by app raisal by a competent valuer.

As p er Sched ule VI, every B/ S subsequ ent to revaluation shall disclose the increased figurewith th e date of increase in place of the original cost for the first 5(five) years, but the fact of such revalu ation will continue to be d isclosed till such time su ch assets appear in the B/ S.

Revalua tion is made for an entire class of assets or the selection of assets on a systematic basis(fact of which should be app rop riately stated).

An increase in net book value arising on revaluation of fixed assets should be credited toOwn ers Fund u nd er Revaluation Reserve u nless the d ecrease on any previously revalua-tion recorded as a change in P/ L A/ c or Revaluation Reserve if increase in p revious occasionwas credited thereto.

All material items retired from active use and n ot disposed off shou ld be stated at the lower of net book value or net realizable value as a separate item in the Sched ule of Fixed Assets.

Depreciation as p er AS-6 shou ld be charged on th e total value of fixed assets includ ing reval-ued portion.


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Disclosure in ad d ition to AS-1 and AS-6, should be mad e un der AS-l0 in the following lines:

a) Gross and net book value of fixed assets at the beginning and end of an accoun tingperiod with ad ditions, disposals, acquisitions and other m ovements.

b) Expen d itures incur red on account of fixed assets in the course of constructional acqu i-sition

c) Revalued amou nts substitu ted for historical cost, the basis of selection for revalua tion,the method adopted, the year of appraisal, involvement of external valuer.

d ) The revalued am ounts of each class of fixed assets are presented in the B/ S separatelywithou t netting off the resu lt of revaluation of various classes of fixed assets.

PROBLEMS

1. A comp any has scrapp ed a semi-automatic part of a machine(not w ritten off) and re-

placed w ith a more expensive fully automatic part, wh ich h as dou bled the outp ut of themachine. At the same time the machine was m oved to m ore suitable place in the factory,wh ich involved th e building of new found ation in ad dition to the cost of dismantling an dre-erection. The compan y wan ts to charge the whole expend iture to revenu e. As an aud i-tor, wh at wou ld you d o in this situation?

Answer: If the subsequent expenditure increases the expected future benefits from theasset beyond its pre-assessed standard of performance then as per AS-10 it should becapitalized. Otherw ise, it shou ld be treated as an expense. In th is case, the rep lacement o f semi-autom atic part w ith a fully autom atic part h as dou bled the outp ut of the machinethu s, it has increased futu re benefits beyond the machines pre-assessed stand ard p erfor-man ce, hence this expend iture shou ld be capitalized as p art of cost of the machine. How -ever, the expenses for shifting the machine and bu ilding of a new foun dation in add itionto the cost of dismantling and re-erection do not contribute to any new future benefitsfrom the existing asset. They on ly serve to maintain p erformance of the machine. Hence,this cost should be charged to revenue.

2. A pu blishing comp any un dertook repair and ov erhauling of the machinery at a cost of Rs.5 lakhs to maintain them in good condition and capitalized the amount, as it is morethan 25% of the original cost of the machinery. Adv ice.

Answ er: The size of the expend iture is not the criteria to decide whether subsequent ex-pend iture should be capitalized. The imp ortant qu estion is whether the expend iture in-creases the futu re benefits from the asset beyond its pre-assessed stan dard of performanceas per AS-10. Only then it shou ld cap italize. Since, in th is case, only the ben efits are main-tained at existing level, the expend iture shou ld not be cap italized.


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3. Hero Ltd. pu rchased a machine of Rs.50 lakhs includ ing excise duty of Rs. 10 lakhs. Theexcise du ty is Cenvatable un der the excise laws. The enterp rise intend s to avail CENVATcredit and it is reasonably certain to utilize the same with reasonable time. How shouldthe excise du ty of Rs.10 lakhs be treated ?

Answ er: The following jour nal entries should be record ed:

In the year of acquisi tion: (Rs. Lakhs)

Machinery A/ c Dr. 40

CENVAT Credit Receivable A/ c Dr. 5

CENVAT Cred it Defer red A/ c Dr. 5

To Suppliers A/ c 50

In the next year:

CENVAT Credit Receivable A/ c Dr. 5

To CENVAT Credit Deferred A/ c 5

4. A compan y purchased a machinery in the year 2005-06 for Rs.90 lakhs. A balance of Rs. 10lakhs is still payable to the sup pliers for the same. The sup p lier waived off the balanceamou nt d ur ing the finan cial year 2007-08. The comp any t reated it as income and creditedto profit and loss account d u ring 2007-08. wh ether accoun ting treatment of the comp any

is correct?Answ er: As per p ara 9.1 of AS-10, the cost of fixed assets may u nd ergo changes subse-qu ent to its acquisition or construction on account of exchan ge fluctuation, price adjust-ments, changes in duties or similar factors. Considering para 9.1 the treatment done bythe company is not correct. Rs.10 lakhs should be deducted from the cost of the fixedassets.

5. Z Ltd.pu rchased a m achine costing Rs.5 lakhs for its manu facturing op erations and p aidtransportation costs Rs.80,000. Z Ltd. spent an additional amount of Rs.50,000 for testingand preparing the machine for use. What amou nt shou ld Z Ltd. record as the cost of themachine?

Answ er: As per Para 20 of AS-10, the cost of the fixed asset shou ld comp rise its pu rchaseprice and any attributable cost of bringing the asset to its working condition for its in-tended use. In this case, the cost of machinery includes all expenditures incurred in ac-quiring the asset and preparing it for use. Cost includes the purchase price, freight andhan d ling charges, insurance cost on the machine while in tran sit, cost of special foun da-tions, and costs of assembling, installation and testing. Therefore, the cost to be r ecord edis Rs.6,30,000(= 5,00,000 + 80,000 + 50,000)


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AS-11: THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES

The statement applies mand atorily in respect of:

a) Accounting for transaction in foreign cur rencies

b) Translating the finan cial statemen ts of foreign branches for inclusion in th e financialstatements of the reporting enterp rise.

A transaction in a foreign currency is recorded in the financial records of an enterprise nor-mally at the rate

a) On the date of transaction i.e. spot rate,

b) App roximate actual rate i.e. averaging the rates du ring the week/ mon th in wh ichtransactions occur if there is no significant fluctuations.

c) Weighted average in the above line.

How ever, for interrelated tr ansaction (by virtue of being set off against receivables and payables)it is translated w ith reference to the net amou nt on the d ate of transaction.

After initial recognition, the exchan ge d ifference on the r eporting d ate of finan cial statementshould be treated as und er:

a) Monetary items like foreign cur rency balance, receivables, pay ables, loans at closingrate (in case of restriction or remittan ce other th an tempor ary or w hen th e closing rat e isun realistic, it is repor ted at the rate likely to be realized )

b) Non -monetary items like fixed assets, which are recorded at h istorical cost, shou ld bemad e at the rate on the d ate of transaction.

c) Non -monetary items other than fixed assets are carried at fair value or net realizablevalue on the d ate wh ich they are determ ined i.e. B/ S date (inven tories, investmen ts inequity-shares)

Exchange d ifference on rep ayment of liabilities incurr ed for acquiring fixed a ssets should bead justed in the carrying amoun t of fixed assets on reporting d ate. The same concept ap plies torevaluation as w ell but in case such ad justment on revaluation shou ld result into showing theactual book value of the fixed assets/ or class of, exceeding th e recoverable amou nt, the re-maining amount of the increase in liability should be debited to Revaluation Reserve or P/ LStatemen t in case of inad equacy/ absence of Revaluation Reserve.

Except as stated above (fixed assets) other exchange d ifference shou ld be recognized as incomeor expense in th e period in w hich th ey arise or spread over to pertaining accoun ting period.

Depreciation as p er AS-6 should be provided on the u namortised carrying am oun t of depre-ciable assets (after taking into account the effect of exchan ge d ifference)


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D isclosure under AS -11: An en terprise shou ld dis close:

a) The amoun t of exchan ge difference includ ed in the net profit or loss for the period .

b) The amou nt of exchan ge difference ad justed in the carrying amoun t of fixed assetsdu ring the accoun ting period.

c) The amou nt of exchan ge difference in respect of forw ard contracts to be recognized inthe profit/ loss for one or more subsequent accoun ting period .

d ) Foreign currency risk man agemen t policy.

PROBLEMS

1. Exchange Rate

Goods purchased on 24.3.07 of US $1,00,000 Rs.46.60

Exchange rate on 31.3.2007 Rs.47.00

Date of actual payment 5.6.08 Rs.47.50

Calculate th e loss/ ga in for th e financial years 2006-07 and 2007-08.

Answ er: As per AS-11, all foreign curren cy transactions shou ld be recorded by ap plying th eexchan ge rate at the da te of transaction. Therefore, goods p urchased on 24.3.07 and corrspon d ing creditor wou ld be recorded a t Rs.46.60

= 1,00,000 x 46.60 = 46,60,000As per AS-11, at the balance sheet da te all monetary items shou ld be repor ted u sing the closingrate. Therefore, the cred itors of US $1,00,000 ou tstan d ing on 31.3.07 will be rep orted as:

1,00,000 x 47.00= 47,00,000.

Exchange loss Rs. 40,000(=47,00,000 46,60,000) shou ld be d ebited in p rofit an d loss accoun tfor 2006-07.

As per AS-11, exchan ge d ifference on settlemen t on m onetary items shou ld be tran sferred top rofit and loss account as gain or loss thereof:

1,00,000 x 47.50 = 47,50,000 -47,00,000 = Rs.50,000 shou ld be d ebited to p rofit or loss for the year2007-08.


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2. Z Ltd. acquired a machine on 1.4.2006 costing US $ 1,00,000. The sup pliers agreed to th efollwing terms of paymen t:

1.4.2006 : down payment 50%

1.4.2007 : 25%

1.4.2008 : 25%

The compan y d epreciates machinery @ 10% on th e Straight Line Method . The rate o f exchangeis steady at US $ 1= Rs.40 up to 30.9.2007. On 1.10.07, du e to an o fficial reva luat ion of rates, theexchange rate is ad justed to US $ 1= Rs.48.

Show the extracts of the relevant en tries in th e Profit and Loss Accoun t for the year end ing 31 st

March,2008 and the Balance Sheet as on that d ate, show ing su ch workings as necessary.

Working N otes:

2006-07:

1. Original Cost of the machine = $1,00,000 x Rs.40 = Rs.40,00,000

2. Depreciat ion (SLM) @ 10% = Rs.4,00,000

2007-08:

1. Original Cost of the machine upto 30/ 9/ 2007 = Rs.40,00,000

2. Revised cost of the m achine a s on 1.10.2007

Due to official revaluation of exchange rates, the US $ 1 = Rs.48. There is a foreign exchange

loss of Rs. 8 for each dollar liability. The total loss on foreign curr ency fluctuation w as $25,000x Rs.8 = Rs.2,00,000. This has to be ad ded to th e original cost of the machine. Therefore, revisedcost of the machine as on 1.10.2007 is Rs.42,00,000 (i.e. Rs.40,00,000 + Rs.2,00,000)

Th e re vi se d co st o f th e m ach in e as o n 1.10.2007 : Rs.

Original Cost on 1.4.2006 40,00,000

Less: Depreciation:

1.4.2006 to 31.3.2007 4,00,000

1.4.2007 to 30.9.2007 2,00,000 6,00,000

34,00,000

Ad d : Loss on foreign exchange fluctuation as on 1.10.2007 2,00,000

36,00,000


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Depreciation:

1.4.2007 to 30.9.2007 (40,00,000 x 10/ 100 x 6/ 12) 2,00,000

1.10.2007 to 31.3.2008 ( 36,00,000 x 6

8.5 x 12 ) 2,11,765

Total Depreciation for the year 2007-08 4,11,765

Note: As per AS-6 Revised , Depreciation Accoun ting, in case of change in histor ical cost du eto foreign exchan ge fluctuation, dep reciation on the revised un amor tized dep reciable amoun tshould be provided prospectively over the residual life of the asset. In this case, the residuallife is 8.5 years.

Prof it and Loss Account (extract)

for the year end ed 31 st March, 2008

Particu lars Rs. Particu lars Rs.

To Depreciation on Machinery 4,11,765

Balance Sheet (extract) as at 31 st March,2008

Liabilities Rs. Assets Rs.

Current Liabilities 12,00,000 Fixed Asse ts

Cred itors for Su pp ly Mach in ery (at cost) 40,00,000

of Machinery Add: Ad j.for foreign

Exchange fluctuation 2,00,000

42,00,000

Less: Accumulated

Depreciation 8,11,765

33,88,235


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AS -12: ACCOUNTING FOR GOVERNMENT GRANTS

Government refers to Union/ State, Govt. Agencies and similar bodies - Local, National orInternational.

Grants also includ e subsidies, cash incentive, and du ty dr awback either in cash or kind / ben-efits to an enterpr ise on recognition of comp liance in the past or futu re compliance with cond i-tion attached to it.

The accounting for the grant should be appropriate to reveal the extent of benefit accrued tothe enterprise du ring the reporting period.

For the pu rpose of the statement, following are not dealt w ith.

a) Effects of changing p rices or in sup plemen tary informationb) Government assistance other than grants.c) Own ership participation by government.

In order to recognize the income there shou ld be conclusive evidence that cond itions attachedto the grant have been or will be fulfilled to account for such earned benefits estimated on aprudent basis, even though the actual amount may be finally settled/ received after the ac-counting period . Mere receipt wou ld not suffice for income recognition.

AS-4 (contingencies etc) and AS-5 (Prior period etc) wou ld be app licable as the case may be.

The accounting for Govt. grants shou ld be based on the na ture of the relevant grant:

a) In the natu re of promoters contribution as shareholders fund (cap ital approach)

b) Otherwise as Income Approach to match with related cost recognizing AS-1 accrual

concept d isclosure.Governm ent gran ts in the form of non-mon etary assets e.g. land or other resou rces is accountedfor at the acquisition cost or recorded at nominal value if it is given free of cost.

Grants received specifically for fixed asset is disclosed in the financial statement either

a) by way of d edu ction from the gross block of the asset concerned, thu s grant is recog-nized in P/ L Account through red uced d epreciation (in case of fund ing of specificasset Cost entirely, the asset shou ld be stated at a nom inal value in B/ S); or

b) the grant treated as deferred revenue income and charged off on a systematic and ratio-nal basis over the useful life of the asset, until appropriated disclosed as Deferred

Govt. grant u nd er Reserve and Sur plu s in the B/ S (gran ts relating to d epreciable assetsshou ld be cred ited to Capital Reserve and su itably credited t o P/ L Account to offsetthe cost charged to income).

Disclosure under AS-12

a) the accounting p olicy, method of p resentation in the financial statements.

b) the natu re and extent of Govt. gran ts recognized in the finan cial statements, includ inggran ts of non -monetary assets given at a concessional rate or free of cost.


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PROBLEMS1. Z Ltd. has set up its business in d esignated backw ard area wh ich ent itles it to receive as

per a public scheme announced by the Government of India, a subsidy of 25% of thecost of investment. Having fulfilled the conditions laid down under the scheme, the

company on its investm ent of Rs.100 lakhs in capital assets du ring its accoun ting yearending on 31 st March,2008, received a subsidy of Rs.25 lakhs in January ,2008 from theGovernm ent of Ind ia. The Accountan t of the company w ould like to record the receiptas an item of revenue and to reduce the losses on the Profit and Loss Account for theyear ended 31 st March,2008. Is his action justified?

Answ er: As per AS-12, the Govern men t gran ts related to d epreciable fixed assets to betreated as deferred income which shou ld be recognized in th e Profit and Loss Accounton a systematic and rational basis over the u seful life of the asset. Such grants should beallocated to income over th e periods and in p roportions in w hich d epreciation on thoseassets is charged .

The comp any has received Rs.25 lakhs subsidy for investment in capital assets wh ichare dep reciable in nature. In view of the provisions un der AS-12, the subsidy am oun tRs.25 lakhs received shou ld n ot be credited to the Profit and Loss Account for the yearended 31 st March,2008. the subsidy shou ld be recognized and credited to the Profit andLoss Account in th e propor tion of dep reciation charge over th e life of the su bsidizedassets.

2. Hero Ltd. belongs to th e engineering indu stry. The Chief Accoun tant h as prepared thedraft accoun ts,taking note of the man datory accoun ting standard s.

The company pu rchased on 1.4.2007 a special pu rpose machinery for Rs.50 lakhs. Itreceived a Central Govern men t gran t for 20% of the p rice. The m achine has an effectivelife of 5 years.

Answ er: AS-12 pr escribes two methods in accounting tr eatmen t of Governm ent gran tsfor sp ecific fixed assets.

Method I: Governm ent grant s related to depreciable fixed assets to be treated as de-ferred income wh ich is to be recognized in the Profit and Loss Accoun t in proportion inwh ich d epreciation on those assets is charged over the useful life of the asset. The de-ferred income pend ing its apportionment to Profit and Loss Account to be d isclosed inthe balance sheet separately with a suitable description,e.g. Deferred Governm ent Grants,to be show n after Reserves & Surp lus bu t before Secured Loans.

AS-13: ACCOUN TING FOR INVESTMENTS

The Standard deals with accounting for investments in the financial statements of an enter-prise and relevant disclosure requirement. Investments are assets held for earning income,capital appreciation or for other benefits to the investing enterprise, obviously investmentsheld as stock-in-trade are not Investments.


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The following are ou tside the p urview of AS-13:

a) Recognition of income on investment as dealt with und er AS-9 (Revenu e Recognition)b) Operating or Finance Lease.

c) Investment of retirement benefit plans and Life Insuran ce Enterpr ise.

d ) Mutual fund , Asset Management Compan ies, Banks, Public Finan cial Institution, en-acted under specific Act/ Companies Act, 1956.

Reasons, type, purposes etc varies widely and for this the standard is set to harmonize theaccounting.

Cost of investmen t, mean s and includ es,

a) Acquisition charges e.g. brokerage, fees, dut ies etc.

b) If acquired by issue of shares/ securities, the acqu isition cost is the fair mar ket value,may be w ith reference to issue p rice determined by statutory auth orities.

Fair market value may be determined with reference to market value or net realizable value(net of expenses to be incurred) or net of recovery of cost (dividend or interest accrued andinclud ed in th e price of investmen ts).

Current i nvestment/Short term investment:

a) Readily realizable and not intended to be held for more than a year from date of invest-ment.

b) The carrying amou nt on the reporting d ate is taken at lower of cost or fair value toprudently account for the unrealized losses but not the unrealized gains, consideringind ividu al or category of investmen ts (not on overall basis).

c) Any redu ction to the fair value and any reversal to such redu ction is includ ed in the P/ L Accoun t.

Long -term inve stment:

a) Investments held otherwise even if readily marketable are long term investments

b) Intended to protect, facilitate and furtheran ce to existing operation, also know n as Tradeinvestments (not m eant to p rovide ad ditional cash resources)

c) Long-term investments are normally carried at cost un less there is a permanent d imi-nu tion in th e value wh en the same is recognized in the carrying am oun t by charging or

reversing throu gh P/ L Accoun t.d) The carrying amoun t is determined on ind ividu al investment basis.

On disposal, the difference between the carrying amount and the net proceed of dis-posal is recognized in the P/ L Account.

Investment in Property is in Land or Building, not intend ed for occup ation substan-tially for use by or in the operation of the Investing Enterprise, should be treated aslong-term investment.


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Reclassification of Investments:

1) Long term to current : Take lower of cost and carrying amou nt

2) Current to Long term: Take lower of cost and fair value

Disclosure under AS-13:

a) Accoun ting policy for determination of carrying amoun t

b) Income separately for long-term and current investments, at gross i.e. inclusive of TDS.

c) Profit or loss on disposal and changes in carrying amoun t separately for long term andcurrent investments.

d ) Significant restrictions on the right of own ership, realisability of investm ents or theremittance of income and pr oceeds of disposal.

e) The aggregate amoun t of quoted and u nquoted investments and aggregate market valueof quoted investments.

f) other specific d isclosure as requ ired by Statu te governing the enterp rise, (e.g. Schedu leVI requires classifications to be disclosed in terms of Govt. or Trust securities, shares,debentu res or bond s, investment p roperties others)

PROBLEMS

1. In preparing the finan cial statemen ts of X Ltd.for the year end ed 31 st March,2007, youcome across the following information. State with reasons, how would you deal withthem in the financial statements:

An u nqu oted long term investmen t is carried in t he books at a cost of Rs.5 lakhs. Thepu blished accoun ts of the unlisted compan y received in Jun e 2008 show ed th at the com-pan y w as incurring cash losses with d eclining m arket share and the long term investmentmay not fetch m ore than Rs.1 lakh.

Answ er: As per AS-13, the long term investmen ts shou ld be carried in th e finan cial state-men ts at cost. If there is a diminu tion in the valu e of long term investmen ts, which is nottemporary in natu re, provision should be mad e for each investment ind ividu ally. Anyredu ction in the carrying am oun t should be charged to the Profit and Loss Accoun t.

The long term investmen ts are carried at a cost of Rs.5 lakhs in th e books of accoun ts. Thevalue of investments fall down to Rs.1 lakh due to cash losses and the declining marketshare of the comp any in w hich the investments were mad e.

In view of the provision contained in AS-13, the carrying amount of long-term invest-ments shou ld be brou ght d own to Rs.1 lakh and Rs.4 lakhs should be charged to Profitand Loss Accoun t for the year end ed 31 st March,2008.

2. A comp any has invested a substantial amou nt in the shares of another comp any un derthe same managem ent. The market price of the shares of the aforesaid comp any is about


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half of that at w hich these shares were acqu ired by the comp any. The managem ent is notprepared to provide for the fall in the value of shares on the ground that the loss is onlynotional till the time th e shares are actually sold?

Answer: As per AS-13, for the purpose of determining carrying amount of shares the

investmen t has to be classified into long-term an d cu rrent; in the instant case, it app earsthat th e investment is long-term, hence it shou ld be carried at cost, un less there is a per-manent diminution in value of investment. At the market price, investment is half of itscost. The reduction ap pears to be heavy and perm anent, hence the pr ovision for p erma-nent diminution(decrease) in value of investment should be made. The contention of man agemen t is not as per AS-13.

3. MAGIC Bank has classified its total investm ent on 31.3.2008 into three categor ies: (a) heldto m atu rity (b) available for sale (c) held for trad ing.

Held to maturity investment is carried at acquisition cost less amortised amount. Availablefor sale are carried at marked to market. Held for trading investments are valued at weeklyintervals at market rates or as p er the p rices declared by FIMMDA. Net depreciation, if any, ischarged to revenue and net appreciation, if any, is ignored. Comment on the policy of thebank in accord ance with AS-13.

Answ er: As per p ara 2(d) of AS-13, the accounting stand ard is not applicable to bank , insu r-ance compan y, mu tual fun ds. In th is case, MAGIC Bank is a bank, therefore AS-13 does notapp ly here. For the banks, the RBI has issued gu idelines for classification and valuation of theinvestmen t. Therefore, the MAGIC Bank shou ld comp ly with RBI guidelines.

AS -14: ACCOUNTING FOR AMALGAMATIONS

Amalgam ation refers to an amalgam ation as per the p rovision of the Comp anies Act,1956 orany other law applicable to Com pan ies. Sections 391 to 394 if Companies Act,1956 governs th eprovisions of amalgamation.

Amalgamation may be categorized broad ly as:

I) Merger : - genu ine pooling of assets and liabilities and shareho lders interest of the amal-gamation comp anies.

II) Purchase: - the shareholder of the acquired comp any d o not continu e to have prop ortion-ate share in th e combined comp any or wh ere the business of the former is not intended to

be continued .

Amalgamation in the natu re of merger:

a) All the assets and liabilities of the transferor comp any are taken over by the transfereecompany.

b) Such assets and liabilities are incorporated w ithou t any adjustment (except to ensureun iformity of accoun ting p olicies) in th e finan cial statements of the tran sferee.


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c) At least 90 percent equity hold ers of transferor become equ ity shareholders of trans-feree by virtue of the amalgamation.

d) The consideration for the amalgamation is discharged by equity shareholders in thetransferee, except for fractional shares by cash.

e) The business of the transferor is intended to be carried on by the transferee.Amalgamation in the n ature of Purchase:

Absence/ non-fulfillment of one or more cond itions as above will make th e amalgamationin the natu re of purchase.

Accounting me thods:

1) Merger - Pooling of interest method: -

(a) In prep aring the balance sheet of the transferee comp any after ama lgamation, line

by line add ition of the resp ective assets and liabilities of the tran sferor an d transfereecompany shou ld be mad e except for share capital;

(b) If Purchase Consideration is more than Share capital(equity + preference) of thetransferor company, the d ifference will be adjusted with Reserves. No good will can becreated or recognized since there is no acquisition. If Purchase consideration is lessthan share capital, such shall be recognized as Capital Reserve, as per the Expert Ad vi-sory Committee (EAC) of the ICAI, April 2004.

2) Purchase method:

a) The transferee record th e assets and liabilities at their existing carrying am oun tor by allocating the consideration to ind ividu al identifiable assets and liabilities(even may be unrecorded in transferors financial statements) at fair value onthe d ate of amalgamation;

b) If Purchase consideration is more than the value of net asset acquired by trans-feree be recognized as Goodwill in the financial statement. (if feasible andpracticable, the goodwill is amortised over the u seful life, otherwise over a p e-riod of not exceeding 5 years). In a reverse situation it is Cap ital Reserve wh ichcannot be tran sferred to General Reserve.

c) In case of amalgam ation in the natu re of pu rchase the identity of reserves otherthan Statutory Reserve (Development Allowance/ Investment Allowance Re-serve un der I.T Act), is not p reserved.

Disclosure under AS-14 (in th e first financial statement a fter th e amalgam ation)

a) Nam es and general nature of business of the amalgamating comp anies

b) Effective date of amalgamation for accoun ting pu rpose

c) The method of accoun ting used

d) Particulars of the scheme sanctioned un der statute


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e) Add itional disclosure for merger

1. Description and nu mber of shares issued2. Percentage of each compan ys equity shares exchanged un der am algamation3. The amou nt of difference between the consideration and the value of net identi-

fiable assets acqu ired and tr eatment th ereof f) Add itional disclosure und er Purchase method

1. Consideration for the amalgamation and a description of the consideration paidor contingently payable

2. Amoun t of difference as above and th e treatment/ am ortization period for good-will

g) Where the scheme sanctioned u nd er a statute prescribes a different treatment otherthan AS-14, for better und erstand ing:

1. A description of the accounting treatment and reasons for variation with AS-14

2. Deviation in the accoun ting treatment as prescribed in he scheme un der statuteas comp ared to AS-14, if followed had there been no treatmen t prescribed by th escheme.

PROBLEMS1) X Ltd. having a share capital of Rs.20 lakhs and Y Ltd.having a share capital of Rs.30 lakhs. ZLtd. was formed to take over the business of X Ltd and Y Ltd. at a pu rchase considerat ion of Rs.25 lakhs an d Rs.28 lakhs, p ayable in shares of Z Ltd. The assets and liabilities were taken attheir carrying amou nts.Solution: Since the pu rchase consideration is payable in shares of the tran sferee comp any an dall the assets and liabilities are taken over at th eir carrying amou nts, the amalgam ation is in thenatu re of merger, i.e. pooling of interests method .For X Ltd. Pu rchase consideration = Rs.25 lakhsLess: Share cap ital of X Ltd = Rs.20 lakh sExcess of pu rchase consideration = Rs.5 lakhs. This shall have to be ad justed against the Re-serves of Z Ltd .For Y Ltd. Purchase Consideration = Rs.28 lakhsLess: Share Cap ital of Y Ltd = Rs.30 lakhssince pu rchase consideration is less than share capital of the tran sferor comp any, Rs.2 lakhsshall be treated as Cap ital Reserve.

Note: In case of amalgamation in the nature of purchase, goodwill shall have to be shown inthe Balance Sheet of the Transferee comp any. Such good will shall have to be w ritten off over amaximum period of 5 years.2) Net Assets of the Tran sferor Camp any : Rs. 20 lakhs. If Pu rchase Consideration is (i) Rs. 18lakhs (ii) Rs.23 lakhs & amalgam ation is in the natu re of pu rchase.Answ er: (i) Net Assets Rs.20 lakhs > Pu rchase Con sideration Rs.18 lakhs. So, Rs.2 lakhs will betreated as Capital Reserve.(ii) Net Assets Rs20 lakh s < Pu rchase Consid eration Rs.23 lakh s. So, Rs.3 lakhs w ill be trea tedas Goodw ill.


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AS-15: EMPLOYEE BENEFITS

The statement ap plies to benefit usu ally compr ising of Provid ent Fund , Sup erannuation/ Pen-sion Fund, Gratuity, Leave encashment or retirement, Post retirement health and welfareschemes and other benefits provided by an employer to emp loyees either in p ursu ance of legalrequ irement or otherw ise, bu t does not extend to em ployers obligation which cannot be rea-sonably estimated (e.g. ex-gratia ad -hoc on retiremen t).

There may be obligation on the part of the emp loyer either against defined contribu tion plan ordefined benefit schemes as elaborated below:

a) Defined Contribution Plans (DCP):

1) Retiremen t benefit is determined by contribution at agreed/ specified rate to theFund together with earnings thereof.

2) Contribution (e.g. PF) wh ether paid or p ayable for the reporting period is chargedto P/ L statemen t

3) Excess if any is treated as prepaym ent

b) Defined Benefit Plans (DBP):

1) Amou nt paid is usually determined with reference to employees earnings and/ or years of service (if the basis of contribu tion are d etermined , it will be treatedas defined contribution scheme)

2) How ever, if the emp loyers responsibility is subject to specified benefits or aspecified level of benefits, it is defined benefit scheme.

3) The extent of employers obligation is largely un certain and subject to estima-tion of futu re cond ition an d events beyond control.

Accounting treatment for Gratuity benefit and other defined benefit schemes depends on thearrangement mad e by the emp loyer:

a) No separate fund i.e. out of nonsp ecific own fund :1) Provision for accruing liability in the P/ L Account for the accoun ting period is

made.2) The provision is based on an actuarial method or some other rational method

(assum ption th at all emp loyers are eligible at the end of the accounting p eriod)

b) Own separate/specific fund established through Trust:The amou nt requ ired to be contributed on actuarial basis is certified by the Actuary ,and the actual contribution p lus and shortfall to m eet the actuarial amoun t is chargedto P/ L Account for the accounting period, any excess paymen t treated as pr epaym ent.

c) Fund established through Insurer: in the same mann er as in (b) above

Actual valuation may be carried out annually (cost can be easily determined for thepu rp ose of contribution as a charge to P/ L) or p eriodically (say, once in 3 years) where


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Actuarys certificate specifies contribu tion on ann ua l basis du ring int er-valuation p e-riod.

Leave encashment is an accrued estimated liability based on employers past experi-ence as to such ben efit actually availed off and probability of encashm ent in futu re and

therefore should relate to the period in which relevant service is rendered in compli-ance with section 209(3) - accrua l basis an d AS-15.

Disclosure under AS-15:

a) In view of the varying p ractices, adequate disclosure of method of accounting for anun derstand ing of the significance of such costs to an employer.

b) Disclosure separately mad e for statutory comp liance or otherwise the retirement ben-efit costs are treated as an element of employee remun eration w ithou t specific d isclo-sure.

c) Financial statements should d isclose wh ether actuarial valuation is made at the end of the accoun ting period or earlier (in wh ich case the date of actuarial valuation and themethod used for accrual period if not based on actuary report)

Treatment of Vo lun tary Retireme nt scheme paymen ts:

1) Termination benefits to be paid irrespective of the voluntary r etirement schem e i.e.balance in P.F, leave encashmen t; gratuity etc.

2) Termination benefits wh ich are payable on account of VRS i.e. mon etary paymen t onthe basis of years of comp leted service or for the ba lance period o f service whichever isless and notice pay .

Expert Advisory Committee (EAC) opines in favour of treating the costs (except g ratu ity wh ichshould have been p rovided for in the respective accoun ting period) as d eferred revenu e ex-pend iture since it is construed up on as saving in su bsequent periods, on some rational basisover a p eriod, pr eferably over 3 - 5 year. How ever, the termina l benefit is, to the extent th eseare not d eferred sh ould be treated as expense in the P/ L Account w ith d isclosure.

PROBLEMS

1. ZERO Bank has followed the policies for retirement benefits as und er:

(a) contribution to p ension fun d is made based on actuarial valuation at the year

end . In respect of emp loyees wh o have op ted for pension scheme.(b) Contribution to the gratuity fun d is made based on actuarial valuation at the

year end .

(c) Leave encashment is accoun ted for on PAY-AS-YOU-GO method .

Comm ent w hether the p olicy is in accord ance with AS-15.


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Answer:

(a) As the contribution to Pension Fund is made on actuarial basis every year,there fore the policy is as per AS-15, wh ich is based on actuarial basis of acounting.

(b) As the contribution is being made on annu al basis to gratuity fund on actuarialbasis, the policy is in accordance with AS-15.

(c) As regard leave encashmen t, wh ich is accoun ted for on PAY-AS-YOU-GObasis, it is not in accord ance with AS-15. It shou ld be accoun ted for on accrual basis.

2. In the context of relevant Accoun ting Stand ards, give your comment on the followingmatter for the financial year ending 31 st March,2008:

Increase in pension liability on account of wage revision in 2007-08 is being p rovided forin 5 instalments commen cing from th at year. The remaining liability of Rs.300 lakhs as red e-termined in actuarial valuation w ill be provid ed for in the next 2 years

Answ er: As per AS-15, the costs arising from an alteration in the retirement ben efits to em-ployees shou ld be treated as follows:

(i) The cost may relate to the current year of service or to the past years of service.

(ii) In case of costs relating to the current year, the same may be charged to Profit andLoss Account

(iii) Where the cost relates to the past years of service these should be charged to Profitand Loss Account as p rior period items in accord ance with AS-5.

(iv) Where retirement benefit scheme is amend ed in a man ner wh ich results in add i-tional benefits being provided to retired emp loyees, the cost of the add itional ben-efits shou ld be taken a s Prior Period and Extraord inary Items as per AS-5.

In view of the above, the method adopted for accoun ting the increase in p ension liability is notin consonan ce to the p rovisions ment ioned in AS-15.

AS-16: BORROWING COST

Borrow ing costs are interests and other costs incurr ed by an enterp rise in connection withthe borrowing of fun ds.

A qu alifying asset is an asset that necessarily takes substant ial period of time to get r eady forits intend ed u se of sale.


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Examp les of qualifying assets:

Any tangible fixed assets, which are in construction p rocess or acquired tangiblefixed assets, wh ich are not ready for use or resale. Such as plants and machinery.

Any intangible assets, wh ich are in development ph ase or acquired but not read y foruse or resale, such as patent.

Investment pr operty.

Inventories that requ ire a substantial period(i.e. generally more than one accountingperiod ) to bring th em to a saleable cond ition.

The Statemen t is applied in accounting for borrow ing costs wh ich includ e:

1. Interest and commitment charges on bank borrowing and other short term borrowings

2. Amortization of discounts/ premiu m relating to borrowings

3. Amortization of ancillary cost incurred in connection w ith arrangement of borrowings4. Finan ce charges for assets acqu ired un der finance lease or other similar arrangement

5. Exchange d ifference in foreign cu rrency borrow ing to the extent it relates to interestelement

Borrowing cost incurred on assets, which takes substantial period, is treated as cost of thatasset in respect of (1) above.

As per the Gu idance Note on Au dit of Miscellaneou s Expend iture issued by ICAI, defermen tfor amortization cost up to the time the asset is pu t to u se, in respect of (2) and (3), shou ld becapitalized (see below for AS-16 provision).

Finan ce charges as in (4) can be capitalized upto the time the asset is put to u se (AS-19 dealswith elaborate provision)

Conditions for capitalization of borrowing costs:

Directly attributable costs for acqu isition, constru ction o r p rod uction of qu alifying as-set, are eligible for capitalization .

Qualifying assets will render fu tu re econom ic benefit to the en terpr ise and th e cost canbe measured reliably.

Amount of borrowing costs eligible for capitalization (specific borrowing):

Amou nt of borrowing eligible for cap italization = Actual borrowing cost incur red d ur -ing the period less income generated on the temporary investment of amount borrow ed.

All other borrowing costs are charged to P/L Account:

AS-16 establishes a key test for capitalization w hich states that borrow ing costs that ar e di-rectly attribu table to the acquisition, construction or p rod uction of a qualifying asset are those


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costs that wou ld h ave been avoided if the expenditure on

accounting standards 32

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