*RENU SINGH * (✩ §m!ℓ!ñġ €ม€§ fℓม!ñġ ђ♪gђ✩ ) (21627 Points)
Replied 13 October 2011

Sorrry to all these a/c std notes can't be submitted . So m just pasting that here. So please save the page.

Students are hereby informed that Accounting Standards 1, 2, 3, 4, 5, 6, 7, 9, 10, 11, 12, 13,

14, 16, 19, 20 26, 29 are applicable for examination at PCC level.

Applicability of Accounting Standards:

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

Level I Enterprises:

• Enterprises whose equity or debt securities are listed of is in the process to be listed in India or outside India.

• Banks, Insurance Companies and Financial Institutions.

• All Commercial, Industrial and other Business Enterprises whose turnover exceeds Rs.50 crores

• All Commercial, Industrial and other Business Enterprises having borrowings in excess of Rs.10 crores at any time during the accounting period.

• Holding companies and subsidiaries of enterprises falling under any one of the categories mentionedabove.

Level II Enterprises:

• All Commercial, Industrial and other Business Enterprises whose turnover exceeds Rs.40 lakhs but does not exceed Rs.50 crores.

• All Commercial, Industrial and other Business Enterprises having borrowings in excess of Rs.1 crore but not in excess of Rs.10 crores at any time during the accounting period.

• Holding companies and subsidiaries of enterprise falling under any one of the categories mentioned above.

Level III Enterprises:

• Enterprises which are not covered under Level I and Level II.

AS-	Title of Accounting Standard	Scope
AS-1	Disclosure of Accounting Policies	All Levels
AS-2	Valuation of Inventories (Revised)	All Levels
AS- 3	Cash Flow Statements (Revised)	Level I
AS-4	Contingencies and Events (Occurring after the Balance Sheet Date)	All Levels
AS-5	Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies	All Levels
AS-6	Depreciation Accounting	All Levels
AS-7	Construction Contracts (Revised)	All Levels
AS-9	Revenue Recognition	All Levels
AS-10	Accounting for Fixed Assets.	All Levels
AS-11	The Effect of Changes in Foreign Exchange Rates (Revised)	All Levels
AS-12	Accounting for Government Grants	All Levels
AS-13	Accounting for Investments	All Levels
AS-14	Accounting for Amalgamations	All Levels
AS-15	Employee Benefi ts (Revised)	All Levels
AS-16	Borrowing Cost	All Levels
AS-17	Segment Reporting	Level I
AS-18	Related Party Disclosures	Level I
AS-19	Leases	All Levels
AS-20	Earnings Per Share	Level I
AS-21	Consolidated Financial Statements	Level I
AS-22	Accounting for Taxes on Income	All Levels
AS-23	Accounting for Investment in Associates in Consolidated Financial Statements	Level I
AS-24	Discontinuing Operations	Level I
AS-25	Interim Financial Reporting	Level I
AS-26	Intangible Assets	All Levels
AS-27	Financial Reporting of Interests in Joint Venture	Level I
AS-28	Impairment of Assets	All Levels
AS-29	Provisions, Contingent Liabilities and Contingent Assets	All Levels

Accounting Standard (AS) 1

Disclosure of Accounting Policies

· This statement deals with the disclosure of significant accounting policies followed in preparing and presenting financial statements.

· 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.

Q. 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 amortisation

• Treatment of expenditure during construction

• Conversion or translation of foreign currency items

• Valuation of inventories

• Treatment of goodwill

• Valuation of investments

• Treatment of retirement benefits

• Recognition of profit on long-term contracts

• Valuation of fixed assets

• Treatment of contingent liabilities.

Q. Considerations in the Selection of Accounting Policies

For this purpose, the major considerations governing the selection and application of accounting policies are:—

a. Prudence

· In viewof the uncertainty attached to future events, profits are not anticipated but recognised only when realised though not necessarily in cash. Provision ismade 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.

b. Substance over Form

· The accounting treatment and presentation in financial statements of transactions and events should be governed bytheir 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.

Disclosures-

· 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.

· All significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed.

· 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.

Accounting Standard (AS) 2

Valuation of Inventories

· A primary issue in accounting for inventories is the determination of the value at which inventories are carried in the financial statements until the related revenues are recognised. This Statement dealswith the determination of such value, including the ascertainment of cost of inventories and any write-down thereof to net realisable value.

Q. AS 2 does not applies to -

This Statement should be applied in accounting for inventories other than:

(a) work in progress arising under construction contracts, including directly related service contracts (see Accounting Standard (AS) 7, Accounting for Construction Contracts3);

(b) work in progress arising in the ordinary course of business of service providers;

(c) shares, debentures and other financial instruments held as stock-in-trade; and

(d) producers’ inventories of livestock, agricultural and forest products, and mineral oils, ores and gases to the extent that they are measured at net realisable value in accordance with

well established practices in those industries.

Some Definitions

· Inventories are assets:

(a) held for sale in the ordinary course of business;

(b) in the process of production for such sale; or

(c) in the form of materials or supplies to be consumed in the production process or in the rendering of services.

· Net realisable value is the estimated selling price in the ordinary -course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

· The cost of inventories should comprise all costs of purchase including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities), freight inwards and other expenditure directly attributable to the acquisition, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

Valuation Principle-

· Inventories should be valued at the lower of cost and net realizable value.

· The cost of inventories should be assigned by using the first-in, first-out (FIFO), or

weighted average cost formula. The formula used should reflect the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition.

· Inventories are usually written down to net realisable value on an itemby- item basis. In some circumstances, however, it may be appropriate to group similar or related items.

Q. Exclusions from the Cost of Inventories

· In determining the cost of inventories it is appropriate to exclude certain costs and recognise them as expenses in the period in which they are incurred. Examples of such costs are:

· (a) abnormal amounts of wasted 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 overheads that do not contribute to bringing the inventories to their present location and condition; and

· (d) selling and distribution costs.

Q. Disclosure

· The financial statements should disclose:

(a) the accounting policies adopted in measuring inventories, including the cost formula used; and

(b) the total carrying amount of inventories and its classification appropriate to the enterprise.

1. Raw material was purchased at Rs. 100 per kilo. 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. 10,000 kgs. of raw material is on stock at the year end. Replacement cost is Rs. 80 per kg.

ANS- As per para 24 of AS 2 (Revised) on Valuation of Inventories, materials and other supplies held for use in the production of inventories are not written down below cost if the finished product 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 net realisable value, the materials are written down to net realisable value. In such circumstances, the replacement cost of the materials may be the best available measure of their net realisable value.

Hence, in the given case, the stock of 10,000 kgs of raw material will be valued at Rs. 80 per kg. The finished goods, if on stock, should be valued at cost or net realisable value whichever is lower.

2. During the year 2001-2002, a medium size manufacturing company wrote down its inventories to net realisable value by Rs. 5,00,000. Is a separate disclosure necessary?

ANS-

Accounting Standard (AS) 3

Cash Flow Statements

MANDATORY FOR WHOM-

(i) Enterprises whose equity or debt securities are listed on a recognised stock exchange in India, and enterprises that are in the process of issuing equity or debt securities that will be listed on a recognised stock exchange in India as evidenced by the board of directors’ resolution in this regard.

(ii) All other commercial, industrial and business reporting enterprises, whose turnover for the accounting period exceeds Rs. 50 crores.

(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.

WHEN NOT MANDATORY THEN RECOMMENDATORY-

· The enterprises which do not fall in any of the above categories are encouraged, but are not required, to apply this Standard.

WHEN EXEMPTION CAN BE CLAIMED-

· Where an enterprise has been covered in any one or more of the above categories and subsequently, ceases to be so covered, the enterprise will not qualify for exemption from application of this Standard, until the enterprise ceases to be covered in any of the above categories for two consecutive years.

SUBSEQUENT APPLICATION

· Where an enterprise has previously qualified for exemption from application of this Standard (being not covered by any of the above categories) but no longer qualifies for exemption in the current accounting period, this Standard becomes applicable from the current period. However, the corresponding previous period figures need not be disclosed. An enterprise, which, pursuant to the above provisions, does not present a cash flow statement, should disclose the fact.

OBJECTIVE

· Information about the cash flows of an enterprise is useful in providing users of financial statements with a basis to assess the ability of the enterprise to generate cash and cash equivalents and the needs of the enterprise to utilise those cash flows. The economic decisions that are taken by users require an evaluation of the ability of an enterprise to generate cash and cash equivalents and the timing and certainty of their generation.

Q. WHAT ARE CASH AND CASH EQUIVALENTS AS PER AS - 3

· Cash comprises cash on hand and demand deposits with banks.

· Cash equivalents are 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.

Presentation of a Cash Flow Statement

· The cash flow statement should report cash flows during the period classified by operating, investing and financing activities.

Q. Explain the difference between direct and indirect methods of reporting cash flows from operating activities with reference to Accounting Standard 3( AS 3) revised.

(8 marks)(November, 2001)

Reporting Cash Flows from Operating Activities

· An enterprise should report cash flows from operating activities using either:

(a) the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or

(b) the 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.

Q. Cash flows arising from each of the following activities of a financial enterprise may be reported on a net basis:

(a) cash receipts and payments for the acceptance and repayment of deposits with a fixed maturity date;

(b) the placement of deposits with and withdrawal of deposits from other financial enterprises; and

(c) cash advances and loans made to customers and the repayment of those advances and loans.

Foreign Currency Cash Flows

· Cash flows arising from transactions in a foreign currency should be recorded in an enterprise’s 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 cash flow.

· A rate that approximates the actual rate may be used if the result is substantially the same as would arise if the rates at the dates of the cash flows were used. The effect of changes in exchange rates on cash and cash equivalents held in a foreign currency should be reported as a separate part of the reconciliation of the changes in cash and cash equivalents during the period.

INTEREST AND DIVIDENDS

· Cash flows from interest and dividends received and paid should each be disclosed separately. 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. In the case of other enterprises, 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.

Q. Taxes on Income

Cash flows arising from taxes on income should be separately disclosed and should be classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities.

Non-cash Transactions

Investing and financing transactions that do not require the use of cash or cash equivalents should be excluded from a cash flow statement. Such transactions should be disclosed elsewhere in the financial statements in a way that provides all the relevant information about these investing and financing activities.

Components of Cash and Cash Equivalents

An enterprise should disclose the components of cash and cash equivalents and should present a reconciliation of the amounts in its cash flow statement with the equivalent items reported in the balance sheet.

Accounting Standard (AS) 4

Contingencies And Events Occurring After Balance Sheet Date

This Statement deals with the treatment in financial statements of

(a) contingencies , and

(b) events occurring after the balance sheet date.

· A contingency is a condition or situation, the ultimate outcome of which, gain or loss, will be known or determined only on the occurrence, or non-occurrence, of one or more uncertain future events.

· Events occurring after the balance sheet date are those significant events, both favourable and unfavourable, that occur between the balance sheet date and the date on which the financial statements are approved by the Board of Directors in the case of a company, and, by the corresponding approving authority in the case of any other entity.

Q. Two types of events can be identified:

(a) those which provide further evidence of conditions that existed at the balance sheet date; and

(b) those which are indicative of conditions that arose subsequent to the balance sheet date.

Accounting Treatment of Contingent Gains

Contingent gains are not recognised in financial statements since their recognition may result in the recognition of revenue which may never be realised. However, when the realization of a gain is virtually certain, then such gain is not a contingency and accounting for the gain is appropriate.

Determination of the Amounts at which Contingencies are included in Financial Statements

The amount at which a contingency is stated in the financial statements is based on the information which is available at the date on which the financial statements are approved. Events occurring after the balance sheet date that indicate that an asset may have been impaired, or that a liability may have existed, at the balance sheet date are, therefore, taken into account in identifying contingencies and in determining the amounts at which such contingencies are included in financial statements.

Events Occurring after the Balance Sheet Date

· Events which occur between the balance sheet date and the date on which the financial statements are approved, may indicate the need for adjustments to assets and liabilities as at the balance sheet date or may require disclosure.

· Adjustments to assets and liabilities are required for events occurring after the balance sheet date that provide additional information materially affecting the determination of the amounts relating to conditions existing at the balance sheet date. For example, an adjustment may be made for a loss on a trade receivable account which is confirmed by the insolvency of a customer which occurs after the balance sheet date.

· There are events which, although they take place after the balance sheet date, are sometimes reflected in the financial statements because of statutory requirements or because of their special nature. Such items include the amount of dividend proposed or declared by the enterprise after the balance sheet date in respect of the period covered by the financial statements.

Accounting Standard - Contingencies

· The amount of a contingent loss should be provided for by a charge in the statement of profit and loss if:

(a) it is probable that future events will confirm that, after taking into account any related probable recovery, an asset has been impaired or a liability has been incurred as at the balance sheet date, and

(b) a reasonable estimate of the amount of the resulting loss can be made.

· The existence of a contingent loss should be disclosed in the financial statements if either of the conditions in paragraph 10 is not met, unless the possibility of a loss is remote.

· Contingent gains should not be recognised in the financial statements

Events Occurring after the Balance Sheet Date

· Assets and liabilities should be adjusted for events occurring after the balance sheet date that provide additional evidence to assist the estimation of amounts relating to conditions existing at the balance sheet date or that indicate that the fundamental accounting assumption of going concern (i.e., the continuance of existence or substratum of the enterprise) is not appropriate.

· Dividends stated to be in respect of the period covered by the financial statements, which are proposed or declared by the enterprise after the balance sheet date but before approval of the financial statements, should be adjusted.

· Disclosure should be made in the report of the approving authority of those events occurring after the balance sheet date that represent material changes and commitments affecting the financial position of the enterprise.

Q. Disclosure

· If disclosure of contingencies is required by paragraph 11 of this Statement, the following information should be provided:

(a) the nature of the contingency;

(b) the uncertainties which may affect the future outcome;

(c) an estimate of the financial effect, or a statement that such anestimate cannot be made.

· If disclosure of events occurring after the balance sheet date in the report of the approving authority is required by paragraph 15 of this Statement, the following information should be provided:

(a) the nature of the event;

(b) an estimate of the financial effect, or a statement that such an

estimate cannot be made.

Accounting Standard (AS) 5

Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies

Objective

The objective of this Statement is to prescribe the classification and disclosure of certain items in the statement of profit and loss so that all enterprises prepare and present such a statement on a uniform basis. This enhances the comparability of the financial statements of an enterprise over time and with the financial statements of other enterprises.

Definitions

· Ordinary activities are any activities which are undertaken by an enterprise as part of its business and such related activities in which the enterprise engages in furtherance of, incidental to, or arising from, these activities.

· Extraordinary items are income or expenses that arise from events or transactions that are clearly distinct from the ordinary activities of the enterprise and, therefore, are not expected to recur frequently or regularly.

· Q. Prior period items are income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods.

· Q. Accounting policies are the specific accounting principles and the methods of applying those principles adopted by an enterprise in the preparation and presentation of financial statements.

Net Profit or Loss for the Period

· All items of income and expense which are recognised in a period should be included in the determination of net profit or loss for the period unless an Accounting Standard requires or permits otherwise. This includes extraordinary items and the effects of changes in accounting estimates.

· The net profit or loss for the period comprises the following components, each of which should be disclosed on the face of the statement of profit and loss:

(a) profit or loss from ordinary activities; and

(b) extraordinary items.

Extraordinary Items

· “Extraordinary items should be disclosed in the statement of profit and loss as a part of net profit or loss for the period. The nature and the amount of each extraordinary item should be separately disclosed in the statement of profit and loss in a manner that its impact on current profit or loss can be perceived.”

Profit or Loss from Ordinary Activities

· “When items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately.”

· Q. Circumstances which may give rise to the separate disclosure of items of income and expense in accordance with paragraph 12 include:

(a) the write-down of inventories to net realisable value as well as the reversal of such write-downs;

(b) a restructuring of the activities of an enterprise and the reversal of any provisions for the costs of restructuring;

(c) disposals of items of fixed assets;

(d) disposals of long-term investments;

(e) legislative changes having retrospective application;

(f) litigation settlements; and

(g) other reversals of provisions.

Prior Period Items

· “The nature and amount of prior period items should be separately disclosed in the statement of profit and loss in a manner that their impact on the current profit or loss can be perceived.”

Changes in Accounting Estimates

· As a result of the uncertainties inherent in business activities, many financial statement items cannot be measured with precision but can only be estimated. The estimation process involves judgments based on the latest information available. Estimates may be required, for example, of bad debts, inventory obsolescence or the useful lives of depreciable assets. The use of reasonable estimates is an essential part of the preparation of financial statements and does not undermine their reliability.

Ø The effect of a change in an accounting estimate should be included in the determination of net profit or loss in:

(a) the period of the change, if the change affects the period only; or

(b) the period of the change and future periods, if the change affects both.

· The nature and amount of a change in an accounting estimate which has a material effect in the current period, or which is expected to have a material effect in subsequent periods, should be disclosed. If it is impracticable to quantify the amount, this fact should be disclosed.

· Q.WHEN ACCOUTING POLICY CAN BE CHANGED

“A change in an accounting policy should be made only if the adoption of a different accounting policy is required by statute or for compliance with an accounting standard or if it is considered that the change would result in a more appropriate presentation of the financial statements of the enterprise.”

· Any change in an accounting policy which has a material effect should be disclosed.

Accounting Standard (AS) 6

Depreciation Accounting

· Q. This Statement 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.

· 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.

· Any addition or extension to an existing asset which is of a capital nature and which becomes an integral part of the existing asset is depreciated over the remaining useful life of that asset. As a practical measure, however, depreciation is sometimes provided on such addition or extension at the rate which is applied to an existing asset. Any addition or extension which retains a separate identity and is capable of being used after the existing asset is disposed of, is depreciated independently on the basis of an estimate of its own useful life.

· 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.

· There are several methods of allocating depreciation over the useful life of the assets. Those most commonly employed in industrial and commercial enterprises are the straight line method and the reducing balance method.

· Q. “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. Where the management’s estimate of the useful life of an asset of the enterprise is shorter than that envisaged under the provisions of the relevant statute, the depreciation provision is appropriately computed by applying a higher rate. If the management’s estimate of the useful life of the asset is longer than that envisaged under the statute, depreciation rate lower than that envisaged by the statute can be applied only in accordance with requirements of the statute.”

Q. General Disclosures

· The following information should be disclosed in the financial statements:

(i) the historical cost or other amount substituted for historical cost of each class of depreciable assets;

(ii) total depreciation for the period for each class of assets; and

(iii) the related accumulated depreciation.

· The following information should also be disclosed in the financial statements along with the disclosure of other accounting policies:

(i) depreciation methods used; and

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

· If any depreciable asset is disposed of, discarded, demolished or destroyed, the net surplus or deficiency, if material, should be disclosed separately.

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

· Where the historical cost of a depreciable asset has undergone a change due to increase or decrease in long term liability on account of exchange fluctuations, price adjustments, changes in duties or similar factors, the depreciation on the revised unamortised depreciable amount should be provided prospectively over the residual useful life of the asset.

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

Accounting Standard (AS) 7

Construction Contracts

· The objective of this Statement is to prescribe the accounting treatment of revenue and costs associated with construction contracts. Because of the nature of the activity undertaken in construction contracts, the date at which the contract activity is entered into and the date when the activity is completed usually fall into different accounting periods. Therefore, the primary issue in accounting for construction contracts is the allocation of contract revenue and contract costs to the accounting periods in which construction work

· 1. This Statement should be applied in accounting for construction contracts in the financial statements of contractors.

Definitions

· A construction contract is a contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use.

· A fixed price contract is a construction contract in which the contractor agrees to a fixed contract price, or a fixed rate per unit of output, which in some cases is subject to cost escalation clauses.

· A cost plus contract is a construction contract in which the contractor is reimbursed for allowable or otherwise defined costs, plus percentage of these costs or a fixed fee.

Contract Costs

15. Contract costs should comprise:

(a) costs that relate directly to the specific contract;

(b) costs that are attributable to contract activity in general and can be allocated to the contract; and

(c) such other costs as are specifically chargeable to the customer under the terms of the contract.

· Costs that cannot be attributed to contract activity or cannot be allocated to a contract are excluded from the costs of a construction contract. Such costs include:

(a) general administration costs for which reimbursement is not specified in the contract;

(b) selling costs;

(c) research and development costs for which reimbursement is not specified in the contract; and

(d) depreciation of idle plant and equipment that is not used on a particular contract.

· The recognition of revenue and expenses by reference to the stage of completion of a contract is often referred to as the percentage of completion method. Under this method, contract revenue is matched with the contract costs incurred in reaching the stage of completion, resulting in the reporting of revenue, expenses and profit which can be attributed to the proportion of work completed. This method provides useful information on the extent of contract activity and performance during a period.

· Under the percentage of completion method, contract revenue is recognised as revenue in the statement of profit and loss in the accounting periods in which the work is performed. Contract costs are usually recognised as an expense in the statement of profit and loss in the accounting periods in which the work to which they relate is performed. However, any expected excess of total contract costs over total contract revenue for the contract is recognised as an expense immediately in accordance with paragraph 35.

Recognition of Expected Losses

When it is probable that total contract costs will exceed total contract revenue, the expected loss should be recognised as an expense immediately.

Disclosure

· An enterprise should disclose:

(a) the amount of contract revenue recognised as revenue in the period;

(b) the methods used to determine the contract revenue recognised in the period; and

(c) the methods used to determine the stage of completion of contracts in progress.

· An enterprise should disclose the following for contracts in progress at the reporting date:

(a) the aggregate amount of costs incurred and recognised profits (less recognised losses) upto the reporting date;

(b) the amount of advances received; and

(c) the amount of retentions.

· An enterprise should present:

(a) the gross amount due from customers for contract work as an asset; and

(b) the gross amount due to customers for contract work as a liability.

PRACTICAL QUESTIONS

A firm of contractors obtained a contract for construction of bridges across river Revathi. The following details are available in the records kept for the year ended 31st March, 1997.

	(Rs. in lakhs)
Total Contract Price	1,000
Work Certified	500
Work not Certified	105
Estimated further Cost to Completion	495
Progress Payment Received	400
To be Received	140

The firm seeks your advice and assistance in the presentation of accounts keeping in view the requirements of AS 7 (Revised) issued by your institute. (15 marks) (November, 1997)

Answer

(a)	Amount of foreseeable loss	(Rs in lakhs)
	Total cost of construction (500 + 105 + 495)	1,100
	Less: Total contract price	1,000
	Total foreseeable loss to be recognized as expense	100

According to para 35 of AS 7 (Revised 2002), when it is probable that total contract costs will exceed total contract revenue, the expected loss should be recognized as an expense immediately.

(b)	Contract work-in-progress i.e. cost incurred to date are Rs. 605 lakhs	(Rs in lakhs)
	Work certified	500
	Work not certified	105
		605
	This is 55% (605/1,100 ´ 100) of total costs of construction.

(c) Proportion of total contract value recognised as revenue as per para 21 of AS 7 (Revised).

55% of Rs. 1,000 lakhs = Rs. 550 lakhs

(d) Amount due from/to customers = Contract costs + Recognised profits – Recognised

losses – (Progress payments received + Progress

payments to be received)

= [605 + Nil – 100 – (400 + 140)] Rs. in lakhs

= [605 – 100 – 540] Rs. in lakhs

Amount due to customers = Rs. 35 lakhs

The amount of Rs. 35 lakhs will be shown in the balance sheet as liability.

(e) The relevant disclosures under AS 7 (Revised) are given below:

	Rs. in lakhs
Contract revenue	550
Contract expenses	605
Recognised profits less recognized losses	(100)
Progress billings (400 + 140)	540
Retentions (billed but not received from contractee)	140
Gross amount due to customers	35

Accounting Standard (AS) 9

Revenue Recognition

Q. WHICH ITEMS ARE EXCLUDED FROM REVENUE as PER AS -9 ?

· 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.

Q. WHEN IS REVENUE RECOGNISED IN CASE OF SALE OF GOODS

Sale of Goods

A key criterion for determining when to recognise 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.

Q. Write short note on Effect of Uncertainties on Revenue Recognition.

(10 marks) (May, 1997)

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 reasonably certain that the ultimate collection will be made.Where there is no uncertainty as to ultimate collection, revenue is recognised at the time of sale or rendering of service even though payments are made by instalments.

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.

Q. WHEN TO RECOGNISE REVENUES?

These revenues are recognised on the following bases:

(i) Interest : on a time proportion basis taking into account the amount outstanding and the

rate applicable.

(ii) Royalties : on an accrual basis in accordance with the terms of the relevant agreement.

(iii) Dividends from : when the owner’s right to receive payment investments in is established

· 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.

Q. The Board of Directors decided on 31.3.1996 to increase the sale price of certain items retrospectively from 1st January, 1996.

In view of this price revision with effect from 1st January, 1996, the company has to receive Rs. 15 lakhs from its customers in respect of sales made from 1st January, 1996 to 31st March, 1996 and the Accountant cannot make up his mind whether to include Rs. 15 lakhs in the sales for 1995-96. (3 marks) (May, 1996)

ANS= Price revision was effected during the current accounting period 1995-1996. As a result, the company stands to receive Rs. 15 lakhs from its customers in respect of sales made from 1st January, 1996 to 31st March, 1996. If the company is able to assess the ultimate collection with reasonable certainty, then additional revenue arising out of the said price revision may be recognised in 1995-96 vide Para 10 of AS 9.

Accounting Standard (AS) 10

Accounting for Fixed Assets

Q. AS 10 DOES NOT DEAL WITH WHICH ASSETS?

This statement does not deal with accounting for the following items to which special considerations apply:

(i) forests, plantations and similar regenerative natural resources;

(ii) wasting assets including mineral rights, expenditure on the exploration for and extraction of minerals, oil, natural gas and similar non-regenerative resources;

(iii) expenditure on real estate development; and

(iv) livestock.

Definitions

· 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.

· 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.

· Gross book value of a fixed asset is its historical cost or other amount substituted for historical cost in the books of account or financial statements. When this amount is shown net of accumulated depreciation, it is termed as Net Book Value.

· Stand-by equipment and servicing equipment are normally capitalised. Machinery spares are usually charged to the profit and loss statement as and when consumed. However, if such spares can be used only in connection with an itemof fixed asset and their use is expected to be irregular, itmay be appropriate to allocate the total cost on a systematic basis over a period not exceeding the useful life of the principal item.

Components of Cost

a) “The cost of an item of fixed asset comprises its purchase price, including import duties and other non-refundable taxes or levies and any directly attributable cost of bringing the asset to itsworking condition for its intended use; any trade discounts and rebates are deducted in arriving at the purchase price.” Examples of directly attributable costs are:

(i) site preparation;

(ii) initial delivery and handling costs;

(iii) installation cost, such as special foundations for plant; and

(iv) professional fees, for example fees of architects and engineers.

The cost of a fixed asset may undergo changes subsequent to its acquisition or construction on account of exchange fluctuations, price adjustments, changes in duties or similar factors.

· “Financing costs relating to deferred credits or to borrowed funds attributable to construction or acquisition of fixed assets for the period up to the completion of construction or acquisition of fixed assets are also sometimes included in the gross book value of the asset to which they relate.

· “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.”

· 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 Fixed Assets

Included in the gross book value are costs of construction that relate directly to the specific asset and costs that are attributable to the construction activity in general and can be allocated to the specific asset. Any internal profits are eliminated in arriving at such costs.

Q. Non-monetary Consideration

· When a fixed asset is acquired in exchange for another asset, its cost is usually determined by reference to the fair market value of the consideration given. Itmay be appropriate to consider also the fair market value of the asset acquired if this is more clearly evident. An alternative accounting treatment that is sometimes used for an exchange of assets, particularly when the assets exchanged are similar, is to record the asset acquired at the net book value of the asset given up; in each case an adjustment is made for any balancing receipt or payment of cash or other consideration.

· When a fixed asset is acquired in exchange for shares or other securities in the enterprise, it is usually recorded at its fair market value, or the fair market value of the securities issued, whichever is more clearly evident.

Q. Valuation of Fixed Assets in Special Cases

· In the case of fixed assets acquired on hire purchase terms, although legal ownership does not vest in the enterprise, such assets are recorded at their cash value, which, if not readily available, is calculated by assuming an appropriate rate of interest. They are shown in the balance sheet with an appropriate narration to indicate that the enterprise does not have full ownership thereof.

· Where an enterprise owns fixed assets jointly with others (otherwise than as a partner in a firm), the extent of its share in such assets, and the proportion in the original cost, accumulated depreciation and written down value are stated in the balance sheet.

· Where several assets are purchased for a consolidated price, the consideration is apportioned to the various assets on a fair basis as determined by competent valuers.

Fixed Assets of Special Types

· “Goodwill, in general, is recorded in the books only when some consideration in money or money’s worth has been paid for it.”

PUNCH LINES--

· “When a fixed asset is acquired in exchange or in part exchange for another asset, the cost of the asset acquired should be recorded either at fair market value or at the net book value of the asset given up, adjusted for any balancing payment or receipt of cash or other consideration. For these purposes fair market value may be determined by reference either to the asset given up or to the asset acquired, whichever is more clearly evident. Fixed asset acquired in exchange for shares or other securities in the enterprise should be recorded at its fair market value, or the fair market value of the securities issued, whichever is more clearly evident.”

· Losses arising from the retirement or gains or losses arising from disposal of fixed asset which is carried at cost should be recognised in the profit and loss statement.

· When a fixed asset is revalued upwards, any accumulated depreciation existing at the date of the revaluation should not be credited to the profit and loss statement.

· An increase in net book value arising on revaluation of fixed assets should be credited directly to owners’ interests under the head of revaluation reserve, except that, to the extent that such increase is related to and not greater than a decrease arising on revaluation previously recorded as a charge to the profit and loss statement, it may be credited to the profit and loss statement. A decrease in net book value arising on revaluation of fixed asset should be charged directly to the profit and loss statement except that to the extent that such a decrease is related to an increase which was previously recorded as a credit to revaluation reserve and which has not been subsequently reversed or utilised, it may be charged directly to that account.

Q. Disclosure

· The following information should be disclosed in the financial statements:

(i) gross and net book values of fixed assets at the beginning and end of an accounting period showing additions, disposals, acquisitions and other movements;

(ii) expenditure incurred on account of fixed assets in the course of construction or acquisition; and

(iii) revalued amounts substituted for historical costs of fixed assets, the method adopted to compute the revalued amounts, the nature of indices used, the year of any appraisal made,

and whether an external valuer was involved, in case where fixed assets are stated at revalued amounts.

Q. On 1.4.97 E Ltd. had sold some of its fixed assets for Rs.100 lakhs [written down value Rs. 250 lakhs]. These assets were revalued earlier. As on 1.4.97 the revaluation reserve corresponding to these assets stood at Rs. 200 lakhs. The profit on sale of property as shown in the profit and loss statement represented the transfer of this amount. Loss on sale of the asset was included in the cost of goods sold etc.

ANS= As per para 14.4 and para 32 of AS 10 on Accounting for Fixed Assets, on disposal or a previously revalued item of fixed asset, the difference between net disposal proceeds and the net book value is normally charged or credited to the profit and loss statement except that to the extent such a loss is related to an increase which was previously recorded as a credit to revaluation reserve and which has not been subsequently reversed or utilised, it is charged directly to that account. The amount standing in revaluation reserve following the retirement or disposal of an asset which relates to that asset may be transferred to general reserve.

Accordingly, the following journal entries are to be passed.

(Rs. in lakhs)

Profit on Sale of Property	Dr. 200
To Loss on Sale of Fixed Assets		150
To General Reserve		50

[Alternatively, these entries can be passed through Revaluation Reserve Account. That is, 'Profit on Sale of Property' can be credited first to Revaluation Reserve Account and then, this Reserve will be debited with loss on sale of fixed assets (included in 'Cost of Goods Sold etc.') and the balance will be transferred to General Reserve.]

Accounting Standard (AS) 11*

The Effects of Changes in Foreign Exchange Rates

Scope

· This Statement should be applied:

(a) in accounting for transactions in foreign currencies; and

(b) in translating the financial statements of foreign operations.

· This Statement also deals with accounting for foreign currency transactions in the nature of forward exchange contracts.

Definitions

i. Average rate is the mean of the exchange rates in force during a period.

ii. Closing rate is the exchange rate at the balance sheet date.

iii. Exchange difference is the difference resulting from reporting the same number of units of a foreign currency in the reporting currency at different exchange rates.

iv. Exchange rate is the ratio for exchange of two currencies.

v. Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.

vi. Foreign currency is a currency other than the reporting currency of an enterprise.

vii. Foreign operation is a subsidiary4 , associate5 , joint venture6 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.

viii. Forward exchange contract means an agreement to exchange different currencies at a forward rate.

ix. Forward rate is the specified exchange rate for exchange of two currencies at a specified future date.

x. Integral foreign operation is a foreign operation, the activities of which are an integral part of those of the reporting enterprise.

xi. Monetary items are money held and assets and liabilities to be received or paid in fixed or determinable amounts of money.

xii. Net investment in a non-integral foreign operation is the reporting enterprise’s share in the net assets of that operation.

xiii. Non-integral foreign operation is a foreign operation that is not an integral foreign operation.

xiv. Non-monetary items are assets and liabilities other than monetary items.

xv. Reporting currency is the currency used in presenting the financial statements.

Financial Statements of Foreign Operations

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 enterprise’s operations.

· 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 non-integral foreign operation or the reporting enterprise. The change in the exchange rate affects the reporting enterprise’s net investment in the non-integral foreign operation rather than the individual monetary and nonmonetary items held by the non-integral foreign operation.

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 operation’s 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 operation’s products or services are primarily paid or settled in the local currency rather than in the reporting currency;

(e) the foreign operation’s 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 operation’s 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 operation’s products, although there also might be significant amounts of exports.

Reporting at Subsequent Balance Sheet Dates

11. At each balance sheet date:

(a) foreign currency monetary items should be reported using the closing rate. However, in certain circumstances, the closing rate may not reflect with reasonable accuracy the amount in reporting currency that is likely to be realised from, or required to disburse, a foreign currency monetary item at the balance sheet date, e.g., where there are restrictions on remittances or where the closing rate is unrealistic and it is not possible to effect an exchange of currencies at that rate at the balance sheet date. In such circumstances, the relevant monetary item should be reported in the reporting currency at the amount which is likely to be realised from, or required to disburse, such item at the balance sheet date;

(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; and

(c) non-monetary items which are carried at fair value or other similar valuation denominated in a foreign currency should be reported using the exchange rates that existed when the values were determined.

Net Investment in a Non-integral Foreign Operation

· Exchange differences arising on a monetary item that, in substance, forms part of an enterprise’s net investment in a nonintegral foreign operation should be accumulated in a foreign currency translation reserve in the enterprise’s financial statements until the disposal of the net investment, at which time they should be recognised as income or as expenses in accordance with paragraph 31.

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.

· Any goodwill or capital reserve arising on the acquisition of a nonintegral foreign operation is translated at the closing rate in accordance with paragraph 24.

· A contingent liability disclosed in the financial statements of a nonintegral foreign operation is translated at the closing rate for its disclosure in the financial statements of the reporting enterprise.

Disposal of a Non-integral Foreign Operation

· On the disposal of a non-integral foreign operation, the cumulative amount of the exchange differences which have been deferred and which relate to that operation should be recognised as income or as expenses in the same period in which the gain or loss on disposal is recognised.

Disclosure

· 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.

PRACTICAL QUESTIONS

Q. E Ltd. purchased fixed assets costing Rs. 1,825 lakhs on 1.4.97 and the same was fully financed by foreign currency loan [i.e. US Dollars] repayable in five equal instalments annually. [Exchange rate at the time of purchase was 1 US Dollar = Rs. 36.50]. As on 31.3.98 the first instalment was paid when 1 US Dollar fetched Rs. 41.50. The entire loss on exchange was included in cost of goods sold etc. E Ltd. normally provides depreciation on fixed assets at 20% on WDV basis.

ANS= As per para 13 of AS 11 (Revised 2003) ‘The Effects of Changes in Foreign Exchange Rates’, exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets are recognized as incomes/expenses in the period in which they arise.

Calculation of Exchange loss:

Exchange loss = 50 lakhs US dollars ´ (41.50 – 36.50) = Rs. 250 lakhs

(including exchange loss on payment of first instalment)

Thus exchange loss of Rs. 250 lakhs should be recognized as expense in the profit and loss account for the year ended 31st March, 1998.

A company had imported raw materials worth US Dollars 6,00,000 on 5th January, 2007, when the exchange rate was Rs.43 per US Dollar. The company had recorded the transaction in the books at the above mentioned rate. The payment for the import transaction was made on 5th April, 2007 when the exchange rate was Rs.47 per US Dollar. However, on 31st March, 2007, the rate of exchange was Rs.48 per US Dollar. The company passed an entry on 31st March, 2007 adjusting the cost of raw materials consumed for the difference between Rs.47 and Rs.43 per US Dollar.

In the background of the relevant accounting standard, is the company’s accounting

treatment correct? Discuss.

As per AS 11 (revised 2003), ‘The Effects of Changes in Foreign Exchange Rates’, monetary items denominated in a foreign currency should be reported using the closing rate at each balance sheet date. The effect of exchange difference should be taken into profit and loss account. Sundry creditors is a monetary item, hence should be valued at the closing rate i.e, Rs.48 at 31st March, 2007 irrespective of the payment for the same subsequently at lower rate in the next financial year. The difference of Rs.5 (48-43) per US dollar should be shown as an exchange loss in the profit and loss account for the year ended 31st March, 2007 and is not to be

adjusted against the cost of raw- materials. In the subsequent year, the company would record an exchange gain of Re.1 per US dollar, i.e., the difference between Rs.48 and Rs.47 per Us dollar. Hence, the accounting treatment adopted by the company is incorrect.

Accounting Standard (AS) 12

Accounting for Government Grants

· It is generally considered appropriate that accounting for government grant should be based on the nature of the relevant grant. Grants which have the characteristics similar to those of promoters’ contribution should be treated as part of shareholders’ funds

Non-monetary Government Grants

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

Presentation of Grants Related to Specific Fixed Assets

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.

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

· Under the other method, grants related to depreciable assets are treated as deferred income which is recognised in the profit and loss statement on a systematic and rational basis over the useful life of the asset. Such allocation to income is usually made over the periods and in the proportions in which depreciation on related assets is charged. Grants related to non-depreciable assets are credited to capital reserve under this method, as there is usually no charge to income in respect of such assets.

Refund of Government Grants

· Government grants sometimes become refundable because certain conditions are not fulfilled. A government grant that becomes refundable is treated as an extraordinary item (see Accounting Standard (AS) 5, Prior Period and Extraordinary Items and Changes in Accounting Policies5).

· The amount refundable in respect of a government grant related to revenue is applied first against any unamortised deferred credit remaining in respect of the grant. To the extent that the amount refundable exceeds any such deferred credit, orwhere no deferred credit exists, the amount is charged immediately to profit and loss statement.

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

· Where a grant which is in the nature of promoters’ contribution becomes refundable, in part or in full, to the government on non-fulfillment of some specified conditions, the relevant amount recoverable by the government is reduced from the capital reserve.

Disclosure

· The following should be disclosed:

(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 recognised in the financial statements, including grants of non-monetary assets given at a concessional rate or free of cost.

Top & Top Limited has set up its business in a designated backward area which entitles the company to receive from the Government of India a subsidy of 20% of the cost of investment. Having fulfilled all the conditions under the scheme, the company on its investment of Rs. 50 crore in capital assets, received Rs. 10 crore from the Government in January, 2005 (accounting period being 2004-2005). The company wants to treat this receipt as an item of revenue and thereby reduce the losses on profit and loss account for the year ended 31st March, 2005.

Keeping in view the relevant Accounting Standard, discuss whether this action is justified or not. ( 4 + 4 + 4 = 12 marks)(May, 2005)

As per para 10 of AS 12 ‘Accounting for Government Grants’, where the government grants are of the nature of promoters’ contribution, i.e. they are given with reference to the total investment in an undertaking or by way of contribution towards its total capital outlay (for example, central investment subsidy scheme) and no repayment is ordinarily expected in respect thereof, the grants are treated as capital reserve which can be neither distributed as dividend nor considered as deferred income.

In the given case, the subsidy received is neither in relation to specific fixed asset nor in relation to revenue.Thus it is inappropriate to recognise government grants in the profit and loss statement, since they are not earned but represent an incentive provided by government without related costs. The correct treatment is to credit the subsidy to capital reserve. Therefore, the accounting treatment followed by the company is not proper.

Accounting Standard (AS) 13

Accounting for Investments

· This Statement deals with accounting for investments in the financial statements of enterprises and related disclosure requirements.

· This Statement does not deal with:

(a) the bases for recognition of interest, dividends and rentals earned

(b) operating or finance leases;

(c) investments of retirement benefit plans and life insurance enterprises; and

(d) mutual funds and venture capital funds4 and/or the related asset management companies, banks and public financial institutions formed under a Central or State Government Act or so declared under the Companies Act, 1956.

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 realisable 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.

Classification of Investments

· 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.

Cost of Investments

· The cost of an investment includes acquisition charges such as brokerage, fees and duties.

· 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.

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. Valuation of current investments on overall (or global) basis is not considered appropriate.

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 recognise the decline. Indicators of the value of an investment are obtained by reference to its market value, the investee’s assets and results and the expected cash flows from the investment. The type and extent of the investor’s 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.

Disposal of Investments

· On disposal of an investment, the difference between the carrying amount and the disposal proceeds, net of expenses, is recognised 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.

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:

(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.

Investment Properties

· An enterprise holding investment properties should account for them as long term investments.

An unquoted long term investment is carried in the books at a cost of Rs. 2 lakhs. The published accounts of the unlisted company received in May, 1998 showed that the company was incurring cash losses with declining market share and the long term investment may not fetch more than Rs. 20,000.

Investments classified as long term investments should be carried in the financial statements at cost. However, provision for diminution shall be made to recognise a decline, other than temporary, in the value of the investments, such reduction being determined and made for each investment individually. Para 17 of AS 13 ‘Accounting for Investments’ states that indicators of the value of an investment are obtained by reference to its market value, the investee's assets and results and the expected cash flows from the investment. On these bases, the facts of the given case clearly suggest that the provision for diminution should be made to reduce the carrying amount of long term investment to Rs. 20,000 in the financial statements for the year ended 31st March, 1998.

Accounting Standard (AS) 14

Accounting for Amalgamations

· This statement deals with accounting for amalgamations and the treatment of any resultant goodwill or reserves.

· Amalgamation in the nature of merger is an amalgamation which satisfies all the following conditions.

(i) All the assets and liabilities of the transferor company become, after amalgamation, the assets and liabilities of the transferee company.

(ii) Shareholders holding not less than 90%of the face value of the equity shares of the transferor company (other than the equity shares already held therein, immediately before the amalgamation, by the transferee company or its subsidiaries or their nominees) become equity shareholders of the transferee company by virtue of the amalgamation.

(iii) The consideration for the amalgamation receivable by those equity shareholders of the transferor company who agree to become equity shareholders of the transferee company is discharged by the transferee company wholly by the issue of equity shares in the transferee company, except that cash may be paid in respect of any fractional shares.

(iv) The business of the transferor company is intended to be carried on, after the amalgamation, by the transferee company.

(v) No adjustment is intended to be made to the book values of the assets and liabilities of the transferor company when they are incorporated in the financial statements of the transferee company except to ensure uniformity of accounting policies.

· Amalgamation in the nature of purchase is an amalgamation which does not satisfy any one or more of the conditions specified in sub-paragraph (e) above.

· Consideration for the amalgamation means the aggregate of the shares and other securities issued and the payment made in the form of cash or other assets by the transferee company to the shareholders of the transferor company.( excludes payment made to debenture holders )

Accounting Standard

· An amalgamation may be either –

(a) an amalgamation in the nature of merger, or

(b) an amalgamation in the nature of purchase.

The Pooling of Interests Method

· In preparing the transferee company’s financial statements, the assets, liabilities and reserves (whether capital or revenue or arising on revaluation) of the transferor company should be recorded at their existing carrying amounts and in the same form as at the date of the amalgamation. The balance of the Profit and Loss Account of the transferor company should be aggregated with the corresponding balance of the transferee company or transferred to the General Reserve, if any.

· If, at the time of the amalgamation, the transferor and the transferee companies have conflicting accounting policies, a uniform set of accounting policies should be adopted following the amalgamation. The effects on the financial statements of any changes in accounting policies should be reported in accordance with Accounting Standard (AS) 5 ‘Prior Period and Extraordinary Items and Changes in Accounting Policies’.

· The difference between the amount recorded as share capital issued (plus any additional consideration in the form of cash or other assets) and the amount of share capital of the transferor company should be adjusted in reserves.

The Purchase Method

· In preparing the transferee company’s financial statements, the assets and liabilities of the transferor company should be incorporated at their existing carrying amounts or, alternatively, the consideration should be allocated to individual identifiable assets and liabilities on the basis of their fair values at the date of amalgamation. The reserves (whether capital or revenue or arising on revaluation) of the transferor company, other than the statutory reserves, should not be included in the financial statements of the transferee company except as stated in paragraph 39

· Any excess of the amount of the consideration over the value of the net assets of the transferor company acquired by the transferee company should be recognized in the transferee company’s financial statements as goodwill arising on amalgamation. If the amount of the consideration is lower than the value of the net assets acquired, the difference should be treated as Capital Reserve.

· The goodwill arising on amalgamation should be amortized to income on a systematic basis over its useful life. The amortization period should not exceed five years unless a somewhat longer period can be justified.

· Where the requirements of the relevant statute for recording the statutory reserves in the books of the transferee company are complied with, statutory reserves of the transferor company should be recorded in the financial statements of the transferee company. The corresponding debit should be given to a suitable account head (e.g., ‘Amalgamation Adjustment Account’) which should be disclosed as a part of ‘miscellaneous expenditure’ or other similar category in the balance sheet. When the identity of the statutory reserves is no longer required to be maintained, both the reserves and the aforesaid account should be reversed.

Disclosure

· For all amalgamations, the following disclosures should be made in the first financial statements following the amalgamation:

(a) names and general nature of business of the amalgamating companies;

(b) effective date of amalgamation for accounting purposes;

(c) the method of accounting used to reflect the amalgamation; and

(d) particulars of the scheme sanctioned under a statute.

Accounting Standard (AS) 16

Borrowing Costs

· The objective of this Statement is to prescribe the accounting treatment for borrowing costs.

Definitions

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

· A qualifying asset is an asset that necessarily takes a substantial period of time3 to get ready for its intended use or sale.

Q. Briefly indicate the items, which are included in the expression “borrowing cost” as explained in AS 16. (6 marks) (May, 2001)

· Borrowing costs may include:

(a) interest and commitment charges on bank borrowings and other short-term and long-term borrowings;

(b) amortisation of discounts or premiums relating to borrowings;

(c) amortisation of ancillary costs incurred in connection with the arrangement of borrowings;

(d) finance charges in respect of assets acquired under finance leases or under other similar arrangements; and

(e) exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest Costs.

· Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalised as part of the cost of that asset. The amount of borrowing costs eligible for capitalisation should be determined in accordance with this Statement. Other borrowing costs should be recognised as an expense in the period in which they are incurred.

· To the extent that funds are borrowed specifically for the purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for capitalisation on that asset should be determined as the actual borrowing costs incurred on that borrowing during the period less any income on the temporary investment of those borrowings.

Commencement of Capitalisation

The capitalisation of borrowing costs as part of the cost of a qualifying asset should commence when all the following conditions are satisfied:

(a) expenditure for the acquisition, construction or production of a qualifying asset is being incurred;

(b) borrowing costs are being incurred; and

(c) activities that are necessary to prepare the asset for its intended use or sale are in progress.

Suspension of Capitalisation

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

Cessation of Capitalisation

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

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

Disclosure

23. The financial statements should disclose:

(a) the accounting policy adopted for borrowing costs; and

(b) the amount of borrowing costs capitalised during the period.

A company obtained term loan during the year ended 31st March, 2002 in an extent of Rs. 650 lakhs for modernisation and development of its factory. Buildings worth Rs. 120 lakhs were completed and Plant and Machinery worth Rs. 350 lakhs were installed by 31st March, 2002. A sum of Rs. 70 lakhs has been advanced for Assets the installation of which is expected in the following year. Rs. 110 lakhs has been utilised for Working Capital requirements. Interest paid on the loan of Rs. 650 lakhs during the year 2001 – 2002 amounted to Rs. 58.50 lakhs. How should the interest amount be treated in the Accounts of the Company?

(6 marks) (November, 2002)

Answer

The treatment for total interest amount of Rs. 58.50 lakhs can be given as follows:

Purpose

Nature

Interest to be capitalized

Interest to be charged to profit and loss account

Rs. in lakhs

Buildings

Qualifying asset

Plant and machinery

Qualifying asset

Advance to suppliers for additional assets

Qualifying asset

Working capital

Not a qualifying asset

____

48.6

9.9

For details of para 6 of AS 16 ‘Borrowing Costs’, Qualifying asset, Substantial Period of Time, refer Question 3(b).

Accounting Standard (AS) 19

Leases

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.

Definitions

· 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 lease is classified as a finance lease if it transfers substantially all the risks and rewards incident to ownership. Titlemay ormay 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.”

Leases in the Financial Statements of Lessees = Finance Leases

· At the inception of a finance lease, the lessee should recognise the lease as an asset and a liability. Such recognition should be at an amount equal to the fair value of the leased asset at the inception of the ease. However, if the fair value of the leased asset exceeds the present value of the minimum lease payments from the standpoint of the lessee, the amount recorded as an asset and a liability should be the present value of the minimum lease payments from the standpoint of the lessee. In calculating the present value of the minimum lease payments the discount rate is the interest rate implicit in the lease, if this is practicable to determine; if not, the lessee’s incremental borrowing rate should be used.

· A finance lease gives rise to a depreciation expense for the asset as well as a finance expense for each accounting period. The depreciation policy for a leased asset should be consistent with that for depreciable assets which are owned, and the depreciation recognised should be calculated on the basis set out in Accounting Standard (AS) 6, Depreciation Accounting. If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset should be fully depreciated over the lease term or its useful life, whichever is shorter.

Operating Leases

Lease payments under an operating lease should be recognised as an expense in the statement of profit and loss on a straight line basis over the lease term unless another systematic basis is more representative of the time pattern of the user’s benefit.

Leases in the Financial Statements of Lessors- Finance Leases

· “The lessor should recognise assets given under a finance lease in its balance sheet as a receivable at an amount equal to the net investment in the lease.”

· “The recognition of finance income should be based on a pattern reflecting a constant periodic rate of return on the net investment of the lessor outstanding in respect of the finance lease.”

· The manufacturer or dealer lessor should recognise the transaction of sale in the statement of profit and loss for the period, in accordance with the policy followed by the enterprise for outright sales. If artificially low rates of interest are quoted, profit on sale should be restricted to that which would apply if a commercial rate of interest were charged. Initial direct costs should be recognised as an expense in the statement of profit and loss at the inception of the lease.

Operating Leases

The lessor should present an asset given under operating lease in its balance sheet under fixed assets.

Lease income from operating leases should be recognised in the statement of profit and loss on a straight line basis over the lease term, unless another systematic basis is more representative of the time pattern in which benefit derived from the use of the leased asset is

diminished.

Sale And Lease Back Transactions

i. A sale and leaseback transaction involves the sale of an asset by the vendor and the leasing of the same asset back to the vendor. The lease payments and the sale price are usually interdependent as they are negotiated as a package. The accounting treatment of a sale and leaseback transaction depends upon the type of lease involved.

ii. If a sale and leaseback transaction results in a finance lease, any excess or deficiency of sales proceeds over the carrying amount should not be immediately recognised as income or loss in the financial statements of a seller-lessee. Instead, it should be deferred and amortised over the lease term in proportion to the depreciation of the leased asset.

iii. If a sale and leaseback transaction results in an operating lease, and it is clear that the transaction is established at fair value, any profit or loss should be recognised immediately. If the sale price is below fair value, any profit or loss should be recognised immediately except that, if the loss is compensated by future lease payments at below market price, it should be deferred and amortised in proportion to the lease payments over the period for which the asset is expected to be used. If the sale price is above fair value, the excess over fair value should be deferred and amortised over the period for which the asset is expected to be used.

iv. If the leaseback is an operating lease, and the lease payments and the sale price are established at fair value, there has in effect been a normal sale transaction and any profit or loss is recognised immediately.

v. For operating leases, if the fair value at the time of a sale and leaseback transaction is less than the carrying amount of the asset, a loss equal to the amount of the difference between the carrying amount and fair value should be recognised immediately.

Q. Net profit for the current year Rs. 1,00,00,000

No. of equity shares outstanding 50,00,000

Basic earnings per share Rs. 2.00

No. of 12% convertible debentures of Rs. 100 each 1,00,000

Each debenture is convertible into 10 equity shares

Interest expense for the current year Rs. 12,00,000

Tax relating to interest expense (30%) Rs. 3,60,000

Compute Diluted Earnings per Share

ANS=>Adjusted net profit for the current year (1,00,00,000 + 12,00,000 – 3,60,000) = Rs.

1,08,40,000.

No. of equity shares resulting from conversion of debentures = 10,00,000 Shares.

No. of equity shares used to compute diluted EPS: (50,00,000 + 10,00,000) =

60,00,000 Shares

Diluted earnings per share= (1,08,40,000/60,00,000) = Rs. 1.81

X Co. Ltd. supplied the following information. You are required to compute the basic earning per share:

(Accounting year 1.1.2002 – 31.12.2002)
Net Profit	: Year 2002 : Rs. 20,00,000
	: Year 2003 : Rs. 30,00,000
No. of shares outstanding prior to Right Issue	: 10,00,000 shares
Right Issue	: One new share for each four outstanding i.e., 2,50,000 shares.
	Right Issue price – Rs. 20
	Last date of exercise rights – 31.3.2003.
Fair rate of one Equity share immediately prior to exercise of rights on 31.3.2003	: Rs. 25

(a) Computation of Basic Earnings Per Share

(as per paragraphs 10 and 26 of AS 20 on Earnings Per Share)

	Year 2002	Year 2003
	Rs.	Rs.
*EPS EPS for the year 2002 as originally reported*
=
= (Rs. 20,00,000 / 10,00,000 shares)	2.00
*EPS EPS for the year 2002 restated for rights issue*
= [Rs. 20,00,000 / (10,00,000 shares ´ 1.04*)]	1.92 (approx.)
*EPS EPS for the year 2003 including effects of rights issue*

		2.51 (approx.)

Working Notes:

1. Computation of theoretical ex-rights fair value per share

2. Computation of adjustment factor

Accounting Standard (AS) 26

Intangible Assets

Objective

The objective of this Statement is to prescribe the accounting treatment for

intangible assets that are not dealt with specifically in another Accounting

Standard.

Scope

1. This Statement should be applied by all enterprises in accounting for intangible assets, except:

(a) intangible assets that are covered by another Accounting Standard;

(b) financial assets;

(c) mineral rights and expenditure on the exploration for, or development and extraction of, minerals, oil, natural gas and similar non-regenerative resources; and

(d) intangible assets arising in insurance enterprises from contracts with policyholders.

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.

An asset is a resource:

(a) controlled by an enterprise as a result of past events; and

(b) from which future economic benefits are expected to flow to the enterprise.

Monetary assets are money held and assets to be received in fixed or determinable amounts of money.

Non-monetary assets are assets other than monetary assets.

An intangible asset should be recognised if, and only if:

(a) it is probable that the future economic benefits that are attributable to the asset will flow to the enterprise; and

(b) the cost of the asset can be measured reliably.

An intangible asset should be measured initially at cost.

Internally generated goodwill should not be recognised as an asset.

Amortisation Period

The depreciable amount of an intangible asset should be allocated on a systematic basis over the best estimate of its useful life. There is a rebuttable presumption that the useful life of an intangible asset will not exceed ten years from the date when the asset is available for use.

Amortisation should commence when the asset is available for use.

Accounting Standard (AS) 29

Provisions, Contingent Liabilities

And Contingent Assets

· The objective of this Standard is to ensure that appropriate recognition criteria and measurement bases are applied to provisions and contingent liabilities and that suffi cient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount.

· This standard is not applicable to:

_ Financial instruments carried at fair value

_ Insurance enterprises

_ Contract under which neither party has performed any of its obligations or both parties have partially performed their obligation to an equal extent

_ AS 7,AS 15,AS 19 and AS 22.

· 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 outfl ow from the enterprise of resources embodying economic benefi ts.

· A contingent liability is:

(a) 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

(b) 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 nonoccurrence of one or more uncertain future events not wholly within the control of the enterprise.

· Present obligation - 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.

· Possible obligation - an obligation is a possible obligation if, based on the evidence available, its existence at the balance sheet date is considered not probable.

· Disclosure:

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.

· An enterprise should disclose the following for each class of provision:

(a) a brief descripttion 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 addressee in paragraph 41; and

(c) the amount of any expected reimbursement, stating the amount of any asset that has been recognised for that expected reimbursement.

ACCOUNTS THEORY

a) B List Contributories?

The shareholders who transferred partly paid shares (otherwise than by operation of

law or by death) within one year, prior to the date of winding up may be called upon

to pay an amount (not exceeding the amount not called up when the shares were

transferred) to pay off such creditors as existed on the date of transfer of shares.

Their liability will crystalize only (i) when the existing assets available with the

liquidator are not sufficient to cover the liabilities; (ii) when the existing shareholders

fail to pay the amount due on the shares to the liquidator.

b) Explain Garner v/s Murray rule applicable in the case of partnership firms. State,

when is this rule not applicable.

Garner vs Murray rule requires-

1. That the solvent partners should bear the loss arising due to insolvency of a partner in their capital ratio after making adjustments for past accumulated reserves, profits or losses, drawings, interest on drawings/capitals, remuneration to partners etc, to the date of dissolution but before making adjustment for profit or loss on realization in case of fluctuating capital. In case of fixed capital no such adjustments required.

2. That the solvent partners should bring in cash equal to their respective shares of the loss on realization.

This rule is not applicable when:

1. Only one partner is solvent.

2. All partners are insovent.

3. The Partnership deed provides for a specific method to be followed in case of insolvency of a partner, then the conditions in the deed would prevail.

c) Briefly explain the qualitative characteristics of Financial Statements.

(8 marks) (November, 1998)

Answer

Qualitative characteristics are the attributes that make the information provided in the financial statements useful to the users. The four principal qualitative characteristics are: (i) Understandability, (ii) Relevance, (iii) Reliability and (iv) Comparability.

(i) Understandability: An essential, quality of the information provided in the financial statement is that it is readily understandable by the users. For this purpose, users are deemed to have reasonable knowledge of business and economic activities. However, information about complex matters should be included in the financial statements which is relevant to the users of accounts for their economic decision making although this may be too difficult for certain users to understand.

(ii) Relevance: To be useful, information must be relevant to the decision making needs of all the users. Information has the quality of relevance when it influences the economic decisions of users by helping them to evaluate past, present or future events or confirming, or correcting their past evaluations.

Relevance of an information is affected by its nature and materiality. In some cases, the nature of information alone is sufficient to determine its relevance. In other cases, both the nature and materiality are important:

(iii) Reliability: To be useful, information must also be reliable. Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which, it either purports to represent or could reasonably be expected to represent.

(iv) Comparability: Users must be able to compare the financial statements of an enterprise through time in order to identify trends in its financial position and performance. An important implication of this qualitative characteristic is that users should be informed of the accounting policies employed in the preparation of the financial statements, any changes in those policies and the effects of such changes.

d)

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