FR Study Material As 18-29
FR Study Material As 18-29
FR Study Material As 18-29
17.2 Objective
The objective of this Standard is to establish requirements for disclosure of:
(a) Related party relationships and
(b) Transactions between a reporting enterprise and its related parties.
17.3 Scope
AS 18 should be applied:
• In reporting related party relationships and transactions between a reporting enterprise
and its related parties.
• Only to the related party relationships described in (a) to (e) below.
• To the financial statements of each reporting enterprise as also to consolidate financial
statements presented by a holding company.
This Standard deals only with related party relationships described in (a) to (e) below:
a. Enterprises that directly, or indirectly through one or more intermediaries, control, or are
controlled by, or are under common control with, the reporting enterprise (this includes
holding companies, subsidiaries and fellow subsidiaries).
b. Associates and joint ventures of the reporting enterprise and the investing party or venturer
in respect of which the reporting enterprise is an associate or a joint venture.
c. Individuals owning, directly or indirectly, an interest in the voting power of the reporting
enterprise that gives them control or significant influence over the enterprise, and relatives
of any such individual.
∗
Now sections 188 / 184 / 189 of the Companies Act, 2013 respectively.
Key management personnel: Those persons who have the authority and responsibility for
planning, directing and controlling the activities of the reporting enterprise.
A non-executive director of a company should not be considered as a key management person
by virtue of merely his being a director unless he has the authority and responsibility for
planning, directing and controlling the activities of the reporting enterprise.
The requirements of this standard should not be applied in respect of a non-executive director
even if he participates in the financial and/or operating policy decision of the enterprise, unless
he falls in any of the other categories.
Relative: In relation to an individual, means the spouse, son, daughter, brother, sister, father
and mother who may be expected to influence, or be influenced by, that individual in his/her
dealings with the reporting enterprise.
Joint Venture - a contractual arrangement whereby two or more parties undertake an economic
activity which is subject to joint control.
Joint Control– the contractually agreed sharing of power to govern the financial and operating
policies of an economic activity so as to obtain benefits from it.
Holding Company– a company having one or more subsidiaries.
Subsidiary - a company:
(a) in which another company (the holding company) holds, either by itself and/or through
one or more subsidiaries, more than one-half, in nominal value of its equity share capital;
or
(b) of which another company (the holding company) controls, either by itself and/or through
one or more subsidiaries, the composition of its board of directors.
Fellow subsidiary– a company is considered to be a fellow subsidiary of another company if
both are subsidiaries of the same holding company.
17.6 Disclosure
Name of the related party and nature of the related party relationship where control exists should
be disclosed irrespective of whether or not there have been transactions between the related
parties.
This is to enable users of financial statements to form a view about the effects of related party
relationships on the enterprise.
If there have been transactions between related parties, during the existence of a related party
relationship, the reporting enterprise should disclose the following:
(i) The name of the transacting related party;
(ii) A description of the relationship between the parties;
(iii) A description of the nature of transactions;
(iv) Volume of the transactions either as an amount or as an appropriate proportion;
(v) Any other elements of the related party transactions necessary for an understanding of the
financial statements;
(vi) The amounts or appropriate proportions of outstanding items pertaining to related parties
at the balance sheet date and provisions for doubtful debts due from such parties at that
date;
(vii) Amounts written off or written back in the period in respect of debts due from or to related
parties.
(viii) Items of a similar nature may be disclosed in aggregate by type of related party.
personnel is able to exercise significant influence are related parties. This includes enterprises owned
by directors or major shareholders of the reporting enterprise and enterprise that have a member of key
management in common with the reporting enterprise.
In the given case, Narmada Ltd. and Ganga Ltd are related parties and hence disclosure of transaction
between them is required irrespective of whether the transaction was done at normal selling price.
Hence the contention of Chief Accountant of Narmada Ltd is wrong.
Illustration 3
Mr. Raj a relative of key management personnel received remuneration of ` 2,50,000 for his services in
the company for the period from 1.4.2016 to 30.6.2016. On 1.7.2016, he left the service.
Should the relative be identified as at the closing date i.e. on 31.3.2017 for the purposes of AS 18?
Solution
According to para 10 of AS 18 on Related Party Disclosures, parties are considered to be related if at
any time during the reporting period one party has the ability to control the other party or exercise
significant influence over the other party in making financial and/or operating decisions. Hence,
Mr. Raj, a relative of key management personnel should be identified as relative as at the closing date
i.e. on 31.3.2017.
Illustration 4
X Ltd. sold goods to its associate Company for the 1st quarter ending 30.6.2017. After that, the related
party relationship ceased to exist. However, goods were supplied as was supplied to any other ordinary
customer. Decide whether transactions of the entire year have to be disclosed as related party
transaction.
Solution
As per para 23 of AS 18, transactions of X Ltd. with its associate company for the first quarter ending
30.06.2017 only are required to be disclosed as related party transactions. The transactions for the
period in which related party relationship did not exist need not be reported.
Reference: The students are advised to refer the full text of AS 18 “Related Party
Disclosures”.
UNIT 18 : AS 19 : LEASES
18.1 Introduction
This Standard came into effect in respect of all assets leased during accounting periods
commenced on or after 1.4.2001 and is mandatory in nature. AS 19 prescribes the accounting
and disclosure requirements for both finance leases and operating leases in the books of the
lessor and lessee. The classification of leases adopted in this standard is based on the extent
to which risks and rewards incident to ownership of a leased asset lie with the lessor and the
lessee.
A lease is classified as a finance lease if it transfers substantially all the risks and rewards
incident to ownership.
An operating lease is a lease other than finance lease.
At the inception of the lease, assets under finance lease are capitalized in the books of lessee
with corresponding liability for lease obligations as against the operating lease, wherein lease
payments are recognized as an expense in profit and loss account on a systematic basis (i.e.
straight line) over the lease term without capitalizing the asset. The lessor should recognise
receivable at an amount equal to net investment in the lease in case of finance lease, whereas
under operating lease, the lessor will present the leased asset under fixed assets in his balance
sheet besides recognizing the lease income on a systematic basis (i.e. straight line) over the
lease term. The person (lessor/lessee) presenting the leased asset in his balance sheet should
also consider the additional requirements of AS 10.
18.2 Scope
This Standard is applied in accounting for all leases other than:
a. Lease agreements to explore for or use natural resources, such as oil, gas, timber,
metals and other mineral rights and
b. Licensing agreements for items such as motion picture films, video recordings, plays,
manuscripts, patents and copyrights and
c. Lease agreements to use lands.
AS 19 applies to contracts that transfer the right to use assets even though substantial services
by the lessor may be called for in connection with the operation or maintenance of such assets.
Examples include the supply of property, vehicles and computers.
On the other hand, this Standard does not apply to agreements that are contracts for services
that do not transfer the right to use assets from one contracting party to the other.
The definition of a lease includes agreements for the hire of an asset which contain a provision
giving the hirer an option to acquire title to the asset upon the fulfillment of agreed conditions.
These agreements are commonly known as hire purchase agreements. Hire purchase
agreements include agreements under which the property in the asset is to pass to the hirer on
the payment of the last instalment and the hirer has a right to terminate the agreement at any
time before the property so passes.
payment calculation.
Economic life is either:
a. The period over which an asset is expected to be economically usable by one or more
users;
b. The number of production or similar units expected to be obtained from the asset by one
or more users.
Useful life of a leased asset is either:
a. The period over which the leased asset is expected to be used by the lessee or
b. The number of production or similar units expected to be obtained from the use of the asset
by the lessee.
Residual value of a leased asset is the estimated fair value of the asset at the end of the lease
term.
Guaranteed residual value is:
a. In the case of the lessee, that part of the residual value which is guaranteed by the lessee
or by a party on behalf of the lessee (the amount of the guarantee being the maximum
amount that could, in any event, become payable) and
b. In the case of the lessor, that part of the residual value which is guaranteed by or on behalf
of the lessee, or by an independent third party who is financially capable of discharging
the obligations under the guarantee.
Unguaranteed residual value of a leased asset is the amount by which the residual value of
the asset exceeds its guaranteed residual value.
We can say that:
Residual Value of the Assets = Guaranteed Residual Value + Unguaranteed Residual Value
Gross investment in the lease is the aggregate of the minimum lease payments under a finance
lease from the standpoint of the lessor and any unguaranteed residual value accruing to the
lessor.
Unearned finance income is the difference between:
a. The gross investment in the lease and
b. The present value of
(i) The minimum lease payments under a finance lease from the standpoint of the lessor
and
(ii) Any unguaranteed residual value accruing to the lessor, at the interest rate implicit in
the lease.
Net investment in the lease is the gross investment in the lease less unearned finance income.
The interest rate implicit in the lease is the discount rate that, at the inception of the lease,
causes the aggregate present value of
a. The minimum lease payments under a finance lease from the standpoint of the lessor and
b. Any unguaranteed residual value accruing to the lessor, to be equal to the fair value of the
leased asset.
The lessee’s incremental borrowing rate of interest is the rate of interest the lessee would
have to pay on a similar lease or, if that is not determinable, the rate that, at the inception of the
lease, the lessee would incur to borrow over a similar term, and with a similar security, the funds
necessary to purchase the asset.
Contingent rent is that portion of the lease payments that is not fixed in amount but is based
on a factor other than just the passage of time (e.g., percentage of sales, amount of usage,
price indices and market rates of interest).
a manner that would have resulted in a different classification, had the changed terms been in
effect at the inception of the lease, the revised agreement is considered as a new agreement
over its revised term. Changes in estimates or changes in circumstances, however, do not give
rise to a new classification of a lease for accounting purposes.
on that basis, unless another systematic basis is more representative of the time pattern of the
user’s benefit. For example, where the rental payments for an asset are based on the actual
usage of that asset, or are revised periodically to reflect the efficiency of the asset or current
market rates, the rentals actually payable may be an appropriate measure.
Manufacturer or dealer lessors sometimes quote artificially low rates of interest in order to attract
customers. The use of such a rate would result in an excessive portion of the total income from
the transaction being recognised at the time of sale. If artificially low rates of interest are quoted,
selling profit would be restricted to that which would apply if a commercial rate of interest were
charged and balance will be adjusted with the finance income over the lease term.
Initial direct costs, such as commissions and legal fees, are often incurred by lessors in
negotiating and arranging a lease. For finance leases, these initial direct costs are incurred to
produce finance income and are either recognised immediately in the statement of profit and
loss or allocated against the finance income over the lease term.
18.6.2 Disclosure
The lessor should make the following disclosures for finance leases:
a. Reconciliation between the total gross investment in the lease at the balance sheet date,
and the present value of minimum lease payments receivable at the balance sheet date.
In addition, an enterprise should disclose the total gross investment in the lease and the
present value of minimum lease payments receivable at the balance sheet date, for each
of the following periods:
(i) Not later than one year;
(ii) Later than one year and not later than five years;
(iii) Later than five years;
b. Unearned finance income;
c. The unguaranteed residual values accruing to the benefit of the lessor;
d. The accumulated provision for uncollectible minimum lease payments receivable;
e. Contingent rents recognised in the statement of profit and loss for the period;
f. A general description of the significant leasing arrangements of the lessor; and
g. Accounting policy adopted in respect of initial direct costs.
Illustration 1 (finance lease)
‘A’ leased a machine from ‘B’ on the following terms:
a. The ownership of the machine will be transferred to ‘A’ on expiry of the lease period at ` 8,900.
b. Installation cost of the machine ` 5,000.
c. The cost of the machine is ` 1,09,240.
d. Lease agreement is signed for 5 years.
e. Minimum Lease Payment is ` 28,000 p.a.
f. First installment is Payable on 01.04.2017.
g. Depreciation is charged @ 25% p.a. on WDV.
You are required to show the complete chart of principle amount and implicit rate of interest for 5 years
and also the journal entries in the books of ‘A and B’ for the period 01.04.2017 to 31.03.2019.
Solution
First calculate the implicit rate of return, i.e. the rate of Present Value at which the PV of Minimum Lease
Payment equals to Market Price of the Assets on the date of lease agreement.
Lease Present Value Present Value of Present Value Present Value of
Payment Factor @ 12% Lease Payment Factor @ 14% Lease Payment
(a) (b) (c= a x b) (d) (e = a x d)
28,000 1 28,000 1 28,000
28,000 0.893 25,000 0.877 24,561
28,000 0.797 22,321 0.769 21,545
28,000 0.712 19,930 0.675 18,899
28,000 0.636 17,795 0.592 16,578
8,900 0.567 5,050 0.519 4,622
118,096 114,206
Journal Entries
In the Books of Mr. A In the Books of Mr. B
Date Particulars Dr. Cr. Particulars Dr. Cr.
Purchase of Machine on Lease:
2017
01-April Machine on Lease A/c Dr. 114,240 Mr. A A/c Dr. 1,14,240
To Mr. B A/c 1,14,240 To Lease Sales A/c 1,14,240
Payment of First Installment:
Mr. B A/c Dr. 28,000 Bank A/c Dr. 28,000
To Bank A/c 28,000 To Mr. A A/c 28,000
18.6.4 Disclosures
a. For each class of assets, the gross carrying amount, the accumulated depreciation and
accumulated impairment losses at the balance sheet date; and
(i) The depreciation recognised in the statement of profit and loss for the period;
(ii) Impairment losses recognised in the statement of profit and loss for the period;
(iii) Impairment losses reversed in the statement of profit and loss for the period;
b. The future minimum lease payments under non-cancellable operating leases in the
aggregate and for each of the following periods:
(i) Not later than one year;
(ii) Later than one year and not later than five years;
(iii) Later than five years;
c. Total contingent rents recognised as income in the statement of profit and loss for the
period;
d. A general description of the lessor’s significant leasing arrangements; and
e. Accounting policy adopted in respect of initial direct costs.
Illustration 2 (Operating lease)
Geeta purchased a computer for ` 44,000 and leased out it to Sita for four years on leases basis, after
the lease period, value of the computer was estimated to be ` 3,000; which she realised after selling it
in the second hand market. Lease amount payable at the beginning of each year is ` 22,000;
` 13,640; ` 6,820 &` 3,410. Depreciation was charged @ 40% p.a. You are required to pass the
necessary journal entries in the books of both Geeta and Sita.
Solution
In the Books of Geeta In the Books of Sita
Date Particulars Dr. Cr. Particulars Dr. Cr.
Purchase of computers:
1st Computer A/c Dr. 44,000
Depreciation is provided on straight line method @ 10% per annum. Ascertain unearned financial income
and necessary entries may be passed in the books of the Lessee in the First year.
Solution
Computation of Unearned Finance Income
As per AS 19 on Leases, unearned finance income is the difference between (a) the gross investment
in the lease and (b) the present value of minimum lease payments under a finance lease from the
standpoint of the lessor; and any unguaranteed residual value accruing to the lessor, at the interest rate
implicit in the lease.
where:
(a) Gross investment in the lease is the aggregate of (i) minimum lease payments from the stand
point of the lessor and (ii) any unguaranteed residual value accruing to the lessor.
Gross investment = Minimum lease payments + Unguaranteed residual value
=(Total lease rent + Guaranteed residual value) + Unguaranteed residual value
= [(` 5,00,000 × 5 years) + ` 1,00,000] + ` 1,00,000
= ` 27,00,000
(b) Table showing present value of (i) Minimum lease payments (MLP) and (ii) Unguaranteed residual
value (URV)
Year MLP inclusive of URV Internal rate of return Present Value
(Discount factor
15%)
` `
1 5,00,000 .8696 4,34,800
2 5,00,000 .7561 3,78,050
3 5,00,000 .6575 3,28,750
4 5,00,000 .5718 2,85,900
5 5,00,000 .4972 2,48,600
1,00,000 .4972 49,720
(guaranteed residual value) ________
17,25,820 (i)
1,00,000 .4972 49,720 (ii)
(unguaranteed residual value) ________
(i) + (ii) 17,75,540 (b)
Unearned Finance Income = (a) – (b)
= ` 27,00,000–` 17,75,540 = ` 9,24,460
Journal Entries in the books of B Ltd.
` `
At the inception of lease
Working Note:
Table showing apportionment of lease payments by B Ltd. between the finance charges and the reduction
of outstanding liability.
Year Outstanding liability Lease rent Finance Reduction in Outstanding
(opening balance) charge outstanding liability (closing
liability balance)
` ` ` ` `
1 17,25,820 5,00,000 2,58,873 2,41,127 14,84,693
∗
As per para 11 of AS 19, the lessee should recognise the lease as an asset and a liability at an amount
equal to the fair value of the leased asset at the inception of lease. However, if the fair value of the
leased asset exceeds the present value of minimum lease payments from the standpoint of lessee, the
amount recorded should be the present value of these minimum lease payments. Therefore, in this case,
as the fair value of ` 20,00,000 is more than the present value amounting ` 17,25,820, the machinery
has been recorded at ` 17,25,820 in the books of B Ltd. (the lessee) at the inception of the lease.
According to para 13 of the standard, at the inception of the lease, the asset and liability for the future
lease payments are recognised in the balance sheet at the same amounts.
*The difference between this figure and guaranteed residual value (` 1,00,000) is due to approximation
in computing the interest rate implicit in the lease.
Illustration 5
Global Ltd. has initiated a lease for three years in respect of an equipment costing ` 1,50,000 with
expected useful life of 4 years. The asset would revert to Global Limited under the lease agreement.
The other information available in respect of lease agreement is:
(i) The unguaranteed residual value of the equipment after the expiry of the lease term is estimated
at ` 20,000.
(ii) The implicit rate of interest is 10%.
(iii) The annual payments have been determined in such a way that the present value of the lease
payment plus the residual value is equal to the cost of asset.
Ascertain in the hands of Global Ltd.
(i) The annual lease payment.
(ii) The unearned finance income.
(iii) The segregation of finance income, and also,
(iv) Show how necessary items will appear in its profit and loss account and balance sheet for the
various years.
Solution
(i) Calculation of Annual Lease Payment ∗
`
Cost of the equipment 1,50,000
Unguaranteed Residual Value 20,000
PV of residual value for 3 years @ 10% (` 20,000 x 0.751) 15,020
Fair value to be recovered from Lease Payment(` 1,50,000 – ` 15,020) 1,34,980
PV Factor for 3 years @ 10% 2.487
Annual Lease Payment (` 1,34,980 / PV Factor for 3 years @ 10% i.e. 2.487) 54,275
∗
Annual lease payments are considered to be made at the end of each accounting year.
Assets side ` `
I year Lease Receivable 1,50,000
Less: Amount Received 39,275 1,10,725
II year Lease Receivable 1,10,725
Less: Received (43,202) 67,523
III year :Lease Amount Receivable 67,523
Less: Amount received (47,523)
Residual value (20,000) NIL
Notes to Balance Sheet
Year 1 `
Minimum Lease Payments (54,275 + 54,275) 1,08,550
Residual Value 20,000
1,28,550
Unearned Finance Income(11,073+ 6,752) (17,825)
∗∗
` 74,275 include unguaranteed residual value of equipment amounting ` 20,000.
Reference: The students are advised to refer the full text of AS 19 “Leases”).
a. Debt instruments or preference shares, that are convertible into equity shares;
b. Share warrants;
c. Options including employee stock option plans under which employees of an enterprise
are entitled to receive equity shares as part of their remuneration and other similar plans;
and
d. Shares which would be issued upon the satisfaction of certain conditions resulting from
contractual arrangements (contingently issuable shares), such as the acquisition of a
business or other assets, or shares issuable under a loan contract upon default of payment
of principal or interest, if the contract so provides.
Share warrants or options are financial instruments that give the holder the right to acquire
equity shares.
The calculation is based on all shares outstanding during the period. Whether or not a particular
class or tranche of shares ranked for dividends in respect of the period is irrelevant (except in
the case of partly paid shares).
The time-weighting factor is:
Numbers of days the shares are outstanding
Number of days in the period
Although the Standard defines the time-weighting factor as being determined on a daily basis,
it acknowledges that a reasonable approximation of the weighted average is adequate in many
circumstances.
Depending on the relative size of share movements, this might, for example, be based on the
number of months for which shares were outstanding.
Illustration 1
Date Particulars Purchased Sold Balance
1st January Balance at beginning of year 1,800 - 1,800
31st May Issue of shares for cash 600 - 2,400
1st November Buy Back of shares - 300 2,100
Calculate Weighted Number of Shares.
Solution
Computation of Weighted Average:
(1,800 x 5/12) + (2,400 x 5/12) + (2,100 x 2/12) = 2,100 shares.
The weighted average number of shares can alternatively be computed as follows:
(1,800 x12/12) + (600 x 7/12) - (300 x 2/12) = 2,100 shares
In most cases, shares are included in the weighted average number of shares from the date the
consideration is receivable, for example:
a. Equity shares issued in exchange for cash are included when cash is receivable;
b. Equity shares issued as a result of the conversion of a debt instrument to equity shares are included
as of the date of conversion;
c. Equity shares issued in lieu of interest or principal on other financial instruments are included as of
the date interest ceases to accrue;
d. Equity shares issued in exchange for the settlement of a liability of the enterprise are included as
of the date the settlement becomes effective;
e. Equity shares issued as consideration for the acquisition of an asset other than cash are included
as of the date on which the acquisition is recognised; and
f. Equity shares issued for the rendering of services to the enterprise are included as the services are
rendered.
In these and other cases, the timing of the inclusion of equity shares is determined by the specific terms
and conditions attaching to their issue. Due consideration should be given to the substance of any
contract associated with the issue.
Equity shares issued as part of the consideration in an amalgamation in the nature of purchase are
included in the weighted average number of shares as of the date of the acquisition because the
transferee incorporates the results of the operations of the transferor into its statement of profit and loss
as from the date of acquisition. Equity shares issued as part of the consideration in an amalgamation
in the nature of merger are included in the calculation of the weighted average number of shares from
the beginning of the reporting period because the financial statements of the combined enterprise for the
reporting period are prepared as if the combined entity had existed from the beginning of the reporting
period. Therefore, the number of equity shares used for the calculation of basic earnings per share in
an amalgamation in the nature of merger is the aggregate of the weighted average number of shares of
the combined enterprises, adjusted to equivalent shares of the enterprise whose shares are outstanding
after the amalgamation.
Partly paid equity shares are treated as a fraction of an equity share to the extent that they were entitled
to participate in dividends relative to a fully paid equity share during the reporting period.
Where an enterprise has equity shares of different nominal values but with the same dividend rights,
the number of equity shares is calculated by converting all such equity shares into equivalent number of
shares of the same nominal value.
Equity shares which are issuable upon the satisfaction of certain conditions resulting from contractual
arrangements (contingently issuable shares) are considered outstanding, and included in the
computation of basic earnings per share from the date when all necessary conditions under the contract
have been satisfied.
Equity shares may be issued, or the number of shares outstanding may be reduced, without a
corresponding change in resources. Examples include:
a. A bonus issue;
b. A bonus element in any other issue, for example a bonus element in a rights issue to existing
shareholders;
c. A share split; and
d. A reverse share split (consolidation of shares).
In case of a bonus issue or a share split, equity shares are issued to existing shareholders for no
additional consideration. Therefore, the number of equity shares outstanding is increased without an
increase in resources. The number of equity shares outstanding before the event is adjusted for the
proportionate change in the number of equity shares outstanding as if the event had occurred at the
beginning of the earliest period reported.
Illustration 2
Date Particulars No. of Share Face Value Paid up Value
1st January Balance at beginning of year 1,800 ` 10 ` 10
31st October Issue of Shares 600 ` 10 `5
Calculate Weighted Number of Shares.
Solution
Assuming that partly paid shares are entitled to participate in the dividend to the extent of amount paid,
number of partly paid equity shares would be taken as 300 for the purpose of calculation of earnings per
share.
b. The weighted average number of equity shares outstanding during the period is increased
by the weighted average number of additional equity shares which would have been
outstanding assuming the conversion of all dilutive potential equity shares.
For the purpose of this Statement, share application money pending allotment or any advance
share application money as at the balance sheet date, which is not statutorily required to be
kept separately and is being utilised in the business of the enterprise, is treated in the same
manner as dilutive potential equity shares for the purpose of calculation of diluted earnings per
share.
After the potential equity shares are converted into equity shares, the dividends, interest and
other expenses or income associated with those potential equity shares will no longer be
incurred (or earned). Instead, the new equity shares will be entitled to participate in the net profit
attributable to equity shareholders. Therefore, the net profit for the period attributable to equity
shareholders calculated in Basic Earnings Per Share is increased by the amount of dividends,
interest and other expenses that will be saved, and reduced by the amount of income that will
cease to accrue, on the conversion of the dilutive potential equity shares into equity shares. The
amounts of dividends, interest and other expenses or income are adjusted for any attributable
taxes.
The number of equity shares which would be issued on the conversion of dilutive potential equity
shares is determined from the terms of the potential equity shares. The computation assumes
the most advantageous conversion rate or exercise price from the standpoint of the holder of
the potential equity shares.
Equity shares which are issuable upon the satisfaction of certain conditions resulting from
contractual arrangements (contingently issuable shares) are considered outstanding and
included in the computation of both the basic earnings per share and diluted earnings per share
from the date when the conditions under a contract are met. If the conditions have not been
met, for computing the diluted earnings per share, contingently issuable shares are included as
of the beginning of the period (or as of the date of the contingent share agreement, if later). The
number of contingently issuable shares included in this case in computing the diluted earnings
per share is based on the number of shares that would be issuable if the end of the reporting
period was the end of the contingency period. Restatement is not permitted if the conditions are
not met when the contingency period actually expires subsequent to the end of the reporting
period. The provisions of this paragraph apply equally to potential equity shares that are issuable
upon the satisfaction of certain conditions (contingently issuable potential equity shares).
Options and other share purchase arrangements are dilutive when they would result in the issue
of equity shares for less than fair value. The amount of the dilution is fair value less the issue
price. Therefore, in order to calculate diluted earnings per share, each such arrangement is
treated as consisting of:
a. A contract to issue a certain number of equity shares at their average fair value during the
period. The shares to be so issued are fairly priced and are assumed to be neither dilutive
nor anti-dilutive. They are ignored in the computation of diluted earnings per share; and
b. A contract to issue the remaining equity shares for no consideration. Such equity shares
generate no proceeds and have no effect on the net profit attributable to equity shares
outstanding. Therefore, such shares are dilutive and are added to the number of equity
shares outstanding in the computation of diluted earnings per share.
Potential equity shares are anti-dilutive when their conversion to equity shares would increase
earnings per share from continuing ordinary activities or decrease loss per share from continuing
ordinary activities. The effects of anti-dilutive potential equity shares are ignored in calculating
diluted earnings per share.
In order to maximise the dilution of basic earnings per share, each issue or series of potential
equity shares is considered in sequence from the most dilutive to the least dilutive. For the
purpose of determining the sequence from most dilutive to least dilutive potential equity shares,
the earnings per incremental potential equity share is calculated. Where the earnings per
incremental share is the least, the potential equity share is considered most dilutive and vice-
versa.
Illustration 5
Net profit for the current year ` 1,00,00,000
No. of equity shares outstanding 50,00,000
Basic earnings per share ` 2.00
No. of 12% convertible debentures of ` 100 each 1,00,000
Each debenture is convertible into 10 equity shares
Interest expense for the current year ` 12,00,000
Tax relating to interest expense (30%) ` 3,60,000
Compute Diluted Earnings Per Share.
Solution
Adjusted net profit for the current year (1,00,00,000 + 12,00,000 – 3,60,000) = ` 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) = ` 1.81
19.5 Restatement
If the number of equity or potential equity shares outstanding increases as a result of a bonus
issue or share split or decreases as a result of a reverse share split (consolidation of shares),
the calculation of basic and diluted earnings per share should be adjusted for all the periods
presented. If these changes occur after the balance sheet date but before the date on which the
financial statements are approved by the board of directors, the per share calculations for those
financial statements and any prior period financial statements presented should be based on
the new number of shares. When per share calculations reflect such changes in the number of
shares, that fact should be disclosed.
19.6 Presentation
An enterprise should present basic and diluted earnings per share on the face of the statement
of profit and loss for each class of equity shares that has a different right to share in the net
profit for the period. An enterprise should present basic and diluted earnings per share with
equal prominence for all periods presented.
AS 20 requires an enterprise to present basic and diluted earnings per share, even if the
amounts disclosed are negative (a loss per share).
19.7 Disclosure
An enterprise should disclose the following:
a. Where the statement of profit and loss includes extraordinary items (as defined is AS 5),
basic and diluted EPS computed on the basis of earnings excluding extraordinary items
(net of tax expense);
b. The amounts used as the numerators in calculating basic and diluted earnings per share,
and a reconciliation of those amounts to the net profit or loss for the period;
c. The weighted average number of equity shares used as the denominator in calculating
basic and diluted earnings per share, and a reconciliation of these denominators to each
other; and
d. The nominal value of shares along with the earnings per share figures.
If an enterprise discloses, in addition to basic and diluted earnings per share, per share amounts
using a reported component of net profit other than net profit or loss for the period attributable
to equity shareholders, such amounts should be calculated using the weighted average number
of equity shares determined in accordance with this Statement. If a component of net profit is
used which is not reported as a line item in the statement of profit and loss, a reconciliation
should be provided between the component used and a line item which is reported in the
statement of profit and loss. Basic and diluted per share amounts should be disclosed with equal
prominence.
Illustration 6
Net profit for the year 2017 ` 12,00,000
Weighted average number of equity shares outstanding during the year 2017 5,00,000 shares
Average fair value of one equity share during the year 2017 ` 20.00
Weighted average number of shares under option during the year 2017 1,00,000 shares
Exercise price for shares under option during the year 2017 ` 15.00
Compute Basic and Diluted Earnings Per Share.
Solution
Computation of earnings per share
Illustration 7
From the Books of Bharti Ltd., following information are available as on 1.4.2015 and 1.4.2016:
(1) Equity Shares of ` 10 each 1,00,000
(2) Partly paid Equity Shares of ` 10 each ` 5 paid 1,00,000
(3) Options outstanding at an exercise price of ` 60 for one equity share ` 10 each.
Average Fair Value of equity share during both years ` 75 10,000
(4) 10% convertible preference shares of ` 100 each. Conversion ratio 2 equity
shares for each preference share 80,000
(5) 12% convertible debentures of ` 100. Conversion ratio 4 equity shares for each
debenture 10,000
(6) 10% dividend tax is payable for the years ending 31.3.2017 and 31.3.2016.
(7) On 1.10.2016 the partly paid shares were fully paid up
(8) On 1.1.2017 the company issued 1 bonus share for 8 shares held on that date.
Net profit attributable to the equity shareholders for the years ending 31.3.2017 and 31.3.2016 were
` 10,00,000. Assume Tax rate at 30% for both the years.
Calculate:
(i) Earnings per share for years ending 31.3.2017 and 31.3.2016.
(ii) Diluted earnings per share for years ending 31.3.2017 and 31.3.2016.
(iii) Adjusted earnings per share and diluted EPS for the year ending 31.3.2016, assuming the same
information for previous year, also assume that partly paid shares are eligible for proportionate
dividend only.
Solution
(i) Earnings per share
Year ended Year ended
31.3.2017 31.3.2016
Net profit attributable to equity shareholders ` 10,00,000 ` 10,00,000
Weighted average
number of equity shares 2,00,000 1,50,000
[(W.N. 1) – without considering bonus issue
for the year ended 31.3.2017]
Earnings per share ` 5 ` 6.667
(ii) Diluted earnings per share
Options are most dilutive as their earnings per incremental share is nil. Hence, for the purpose of
computation of diluted earnings per share, options will be considered first. 12% convertible
debentures being second most dilutive will be considered next and thereafter convertible preference
shares will be considered (as per W.N. 2).
Year ended 31.3.2017 Year ended 31.3.2016
Net profit No. of Net Profit No. of equity Net
attributable to equity attributable shares Profit
equity shares per share (without attributa
shareholders ` considering ble per
` bonus issue) share
`
As reported (for years ended 10,00,000 2,00,000 5 1,50,000 6.667
31.3.2017 and 31.3.2016)
Options ________ 2,000 2,000
10,00,000 2,02,000 4.95 1,52,000 6.579
Dilutive Dilutive
12% Convertible debentures 84,000 40,000 40,000
10,84,000 2,42,000 4.48 1,92,000 5.646
Dilutive Dilutive
10% Convertible Preference
Shares 8,80,000 1,60,000 1,60,000
19,64,000 4,02,000 4.886 3,52,000 5.58
Anti-Dilutive Dilutive
Since diluted earnings per share is increased when taking the convertible preference shares into
account (` 4.48 to ` 4.886), the convertible preference shares are anti-dilutive and are ignored in
the calculation of diluted earnings per share for the year ended 31.3.2017. Therefore, diluted
earnings per share for the year ended 31st March, 2017 is ` 4.48.
For the year ended 31st March, 2016, Options, 12% Convertible debentures and Convertible
preference shares will be considered dilutive and diluted earnings per share will be taken as
` 5.58.
Since diluted earnings per share is increased when taking the convertible preference shares into
account (from ` 4.995 to ` 5.21), the convertible preference shares are anti-dilutive and are ignored
in the calculation of diluted earnings per share. Therefore, adjusted diluted earnings per share for
year ended 31.3.2016 is ` 4.995.
Adjusted diluted earnings per share ` 4.995
Working Notes:
1. Weighted average number of equity shares
31.3.2017 31.3.2016
No. of Shares No. of Shares
(a) Fully paid equity shares 1,00,000 1,00,000
(b) Partly paid equity shares* 50,000
Partly paid equity shares 25,000
Fully paid equity shares 50,000
(Partly paid shares converted into fully paid up on
1.10.2016)
Solution
Computation of Basic Earnings Per Share
(as per paragraphs 10 and 26 of AS 20 on Earnings Per Share)
Year Year
2016 2017
` `
EPS for the year 2016 as originally reported
Net profit of the year attributable to equity shareholders
Weighted average number of equity shares outstanding during the year
= (` 20,00,000 / 10,00,000 shares) 2.00
Working Notes:
1. Computation of theoretical ex-rights fair value per share
Fair value of all outstanding shares immediately prior to
exercise of rights + Total amount received from exercise
Number of shares outstanding prior to exercise +
Number of shares issued in the excercise
Reference: The students are advised to refer the full text of AS 20 “Earnings per Share”
∗
Refer working note 2.
20.2 Objective
The objective of this Standard is to lay down principles and procedures for preparation and
presentation of consolidated financial statements. Consolidated Financial Statement is prepared
by the holding/parent company to provide financial information regarding the economic
resources controlled by its group and results achieved with these resources. This consolidated
financial statement is prepared by the parent company in addition to the financial statement
prepared by the parent company for only its own affairs. Hence parent company prepares two
financial statements, one for only its own affairs and one for taking the whole group as one unit
in the form of consolidated financial statement. Consolidated financial statements usually
comprise the following:
♦ Consolidated Balance Sheet
♦ Consolidated Profit & Loss Statement
♦ Notes to Accounts, other statements and explanatory material
♦ Consolidated Cash Flow Statement, if parent company presents its own cash flow
statement.
While preparing the consolidated financial statement, all other ASs and Accounting Policies will
be applicable as they are applied in parent company’s own financial statement.
A parent which presents consolidated financial statements should consolidate all
subsidiaries, domestic as well as foreign. Where an enterprise does not have a
subsidiary but has an associate and/or a joint venture such an enterprise should also
prepare consolidated financial statements in accordance with Accounting Standard (AS)
23, Accounting for Associates in Consolidated Financial Statements, and Accounting
Standard (AS) 27, Financial Reporting of Interests in Joint Ventures respectively.
20.3 Scope
This standard applies to the financial statement prepared by the parent company including the
financial information of all its subsidiaries taken as one single financial unit. One should refer
to this AS for the investment in subsidiaries to be disclosed in the financial statement prepared
by the parent company separately. But this standard does not deal with:
a. Methods of accounting for amalgamations and their effects on consolidation, including
goodwill arising on amalgamation (AS 14).
b. Accounting for investments in associates (AS 13) and
c. Accounting for investments in joint ventures (AS 13).
The term ‘Near Future’ is a period not exceeding 12 months in normal case. For the above
purpose, one should note the intention at the time of making the investment, if the intention
is to continue with the equity for longer period then even though it is disposed off within 12
months, investee company would still be considered as subsidiary. On the other hand, if
intention at the time of purchase is dispose it in near future, but the parent company was
not able to dispose of the shares even after the end of 12 months, shares will continue to
be considered as inventory.
b. Or subsidiary company operates under severe long-term restrictions, which significantly
impair its ability to transfer funds to the parent.
When the parent company has some restrictions on bringing the resources of the
subsidiary company to its main resources then consolidated financial statement is not
required, as the control is not resulting in extra cash flow to parent company other than as
mere investment in share of any other company i.e. dividend, bonus shares.
Therefore, in both the above cases, investment of parent company in the share of its
subsidiary company is treated as investment according to AS 13.
Exclusion of subsidiary company will be only for any of the above reasons but a company
cannot be treated as outside the group just because the main business of the subsidiary
company is not in line with the business of parent company.
For example, A Ltd. holds 75% shares in B Ltd., then B Ltd. is subsidiary of A Ltd., in other
words A Ltd. is the parent company.
If A Ltd. is holding 25% shares in C Ltd., then there is no holding-subsidiary relationship
between them. But if along with A Ltd., B Ltd. also holds 30% shares in C Ltd., then
A Ltd. holding in C Ltd. is 55%, though indirectly, and A Ltd. is parent company of both
B Ltd. and C Ltd.
b. Or control of the composition of the board of directors in the case of a company or of the
composition of the corresponding governing body in case of any other enterprise so as to
obtain economic benefits from subsidiary company’s activities.
Point to be noted here is that, the control over composition of board or governing body is
for economic benefit. If any company is controlling the composition of governing body of
gratuity trust, provident fund trust etc., since the objective is not the economic benefit and
therefore it will not be included in consolidated financial statement.
An enterprise is considered to control the composition of the board of directors or governing
body of a company, if it has the power, without the consent or concurrence of any other
person, to appoint or remove all or a majority of directors of that company or members of
the body.
An enterprise is deemed to have the power to appoint a director/member, if any of the
following conditions is satisfied:
(i) A person cannot be appointed as director/member without the exercise in his favour
by that enterprise of such a power as aforesaid; or
(ii) A person’s appointment as director/member follows necessarily from his appointment
to a position held by him in that enterprise; or
(iii) The director/member is nominated by that enterprise or a subsidiary thereof.
If A Ltd. is proved to be a subsidiary company of B Ltd. by virtue of point (a) and also
a subsidiary of C Ltd. as per point (b), then the problem arises that which company is
liable to prepare Consolidated Financial Statement taking A Ltd. as its subsidiary. For
this purpose, both B Ltd. and C Ltd. will prepare such Consolidated Financial
Statement, group being constituted of themselves and A Ltd.
In addition to the above points, one should also consider the following points:
Determination of control in any company or organization, does not depend only on
the share in capital, many a times even when the share in capital is less than 50%
but still we consider the parent-subsidiary relationship as the voting power granted
under special circumstances is more than 50%.
For example, ICICI Bank advanced loan of ` 40 crores to A Ltd., whose share capital
is ` 10 crores only. As per the loan agreement, in case company defaults to repay
the principal or to pay the interest on due date three times, ICICI Bank will have right
to participate in the decision making of the company and this right will come to an end
with the repayment of the loan amount with all its interest. On happening of the event,
ICICI Bank got the voting right in the company meetings (Board and AGM) and as its
advances to company is 80% of shares plus advances, bank carry 80% voting right
and we can say that there exists a parent-subsidiary relationship, where A Ltd. is
subsidiary of ICICI Bank.
Control is said to come into existence from the date when the conditions of such
control are satisfied. If company does have control over the function of another
company but consolidated financial statement is not prepared for the reason that
there is restriction of impairing the resources then later, on removal of such restriction
control will be said to come into existence but not from the date of such removal but
from the date when such investments led to control.
♦ On the date of investment if the cost of investment to the parent is more than share of
equity in that particular subsidiary, the difference is taken as Goodwill in the consolidated
statement.
♦ On the date of investment if the cost of investment to the parent is less than share of equity
in that particular subsidiary, the difference is taken as Capital Reserve in the consolidated
statement.
20.11 Illustrations
Illustration 1
A Ltd. acquired 60% shares of B Ltd. @ ` 20 per share. Following are the extract of Balance Sheet of
B Ltd.:
`
10,00,000 Equity Shares of ` 10 each 1,00,00,000
10% Debentures 10,00,000
Trade payables 55,00,000
Fixed Assets 70,00,000
Investments 45,00,000
Current Assets 68,00,000
Loans & Advances 22,00,000
On the same day B Ltd. declared dividend at 20% and as agreed between both the companies fixed
assets were to be depreciated @ 10% and investment to be taken at market value of ` 60,00,000.
Calculate the Goodwill or Capital Reserve to be recorded in Consolidated Financial Statement.
Solution
Calculation of Goodwill/Capital Reserve
Particulars ` `
Fixed Assets 70,00,000
Less: Value written off (70,00,000 x 10%) (7,00,000) 63,00,000
Investments at Market value 60,00,000
Current Assets 68,00,000
Loans & Advances 22,00,000
Total Assets 2,13,00,000
Less: Total Liabilities: Trade payables 55,00,000
10% Debentures 10,00,000 (65,00,000)
Equity 1,48,00,000
Majority Share in Equity (1,48,00,000 x 60%) 88,80,000
♦ Where the carrying amount of the investment in the subsidiary is different from its cost, the carrying
amount is considered for the purpose of above computations.
♦ Goodwill and capital reserve of different subsidiaries can be adjusted to a net figure by the parent
in consolidated financial statement.
♦ Goodwill of consolidated financial statement need not be written off to consolidated profit and loss
account but test of impairment (Refer to AS 28) is made each time a consolidated financial
statement is prepared.
♦ When share application money and allotment money is paid separately on different dates, then as
per AS 21, date on which investment led to acquisition to control of subsidiary should be taken as
date of investment, i.e., date of allotment.
♦ On the basis of above discussion, if control is gained in the subsidiary by a series of investments,
then the date of the investment which led to holding-subsidiary relationship is taken into
consideration and step by step calculations are made for each following investments.
Illustration 2
A Ltd. purchased 40% stake of B Ltd. for ` 12 per share. After two years A Ltd. decided to purchase
another 40% share in B Ltd. B Ltd. has 1,00,00,000 equity shares of ` 10 each as fully paid up shares.
The purchase deal was finalised on the following terms:
♦ Purchase price per share to be calculated on the basis of average profit of last three years
capitalised at 7.5%. Profits for last three years are ` 35 lacs, ` 65 lacs and ` 89 lacs.
♦ Total assets of B Ltd. of ` 11,50,00,000. Assets to be appreciated by ` 40,00,000.
♦ Of the External Trade payables for ` 2,50,00,000 one trade payable to whom ` 10,00,000 was due
has expired and nothing is to be paid to settle this liability.
♦ B Ltd. will declare dividend @ 15%.
Calculate the Goodwill or Capital Reserve for A Ltd. in Consolidated Financial Statement.
Solution
Calculation of Purchase Consideration
Particulars `
Profits for Last 3 years: First 89,00,000
Second 65,00,000
Third 35,00,000
Total profits for last 3 years 1,89,00,000
Average Profits (1,89,00,000/3) 63,00,000
Particulars ` `
Fixed Assets 11,50,00,000
Add: Appreciation in value of the asset 4,0,00,000 11,90,00,000
Less: Trade payables 2,50,00,000
Less: Amount to be written off (10,00,000) (2,40,00,000)
Net Asset 9,50,00,000
Share in Net Asset (9,50,00,000 x 80%) 7,60,00,000
Less: Cost of Investment: Purchase Consideration 3,36,00,000
Less: Dividend Received (10,00,00,000 x 40% x 15%) (60,00,000)
2,76,00,000
Add: Investment (1,00,00,000 x 40% x 12) 4,80,00,000 (7,56,00,000)
Capital Reserve 4,00,000
Illustration 3
Following are the Balance Sheet of A Ltd. and B Ltd.
` '000 ` '000
Liabilities A Ltd. B Ltd. Assets A Ltd. B Ltd.
Equity Shares 6,000 5,000 Goodwill 100 20
6% Preference shares - 1,000 Fixed Assets 3,850 2,750
General Reserve 1,200 800 Investment 1,620 1,100
Profit & Loss Account 1,020 1,790 Inventory 1,900 4,150
Trade payables 3,850 3,410 Trade receivables 4,600 4,080
Dividend payable 600 500 Cash & Bank 600 400
12,670 12,500 12,670 12,500
A Ltd. purchased 3/4th interest in B Ltd. at the beginning of the year at the premium of 25%.
Following are the other information available:
a. Profit & Loss Account of B Ltd. includes ` 1,000 thousands bought forward from the previous
year.
b. The directors of both the companies have declared a dividend of 10% on equity share capital
for the previous and current year.
From the above information calculate Pre and Post Acquisition Profits, Minority Interest and Cost
of Control.
Solution
Calculation of Pre and Post Acquisition Profits
( `)
Particulars Pre-acquisition Post-acquisition
Profits Profits
Profit & Loss Account 10,00,000 7,90,000
General Reserve 800,000 -
18,00,000 7,90,000
Less: Minority Interest (1800/4) (4,50,000)
(790/4) (1,97,500)
Consolidated Balance Sheet 13,50,000 5,92,500
Calculation of Minority Interest
Particulars `
Paid up Equity Share Capital (50,00,000/4) 12,50,000
Paid up Preference Share Capital 10,00,000
♦ The losses applicable to the minority are deducted from the minority interest unless minority interest
is nil. Any further loss is adjusted with the consolidated group interest except to the extent that the
minority has a binding obligation to, and can make the losses good. Subsequently, when the
subsidiary makes profits, minority share in profits is added to majority share to the extent minority
interest losses were absorbed by majority share.
For example, 25% minority interest has the share in net equity ` 40 lacs and company made
cumulative losses since the date of investment ` 200 lacs. 25% of ` 200 lacs i.e., ` 50 lacs is
minority share in losses. Losses upto ` 40 lacs will be adjusted with the minority interest and
further loss of ` 10 lacs will be adjusted with the majority interest. Hence in the Consolidated
Balance Sheet for the relevant year, minority interest on the liabilities side will be NIL.
In the next year, if subsidiary company makes a profit say, ` 60 lacs. Minority interest comes to
` 15 lacs, out of these 15 lacs, first ` 10 lacs will be added to majority interest as recovery of losses
absorbed in past and balance ` 5 lacs will appear in Consolidated Balance Sheet as part of the
Minority Interest.
that the goods in question are still on hand at year end, they may be carried at an amount that
is in excess of cost to the group and the amount of the intra-group profit must be eliminated,
and assets reduced to cost to the group.
For transactions between group enterprises, unrealised profits resulting from intra-group
transactions that are included in the carrying amount of assets, such as inventories and tangible
fixed assets, are eliminated in full. The requirement to eliminate such profits in full applies to
the transactions of all subsidiaries that are consolidated – even those in which the group’s
interest is less than 100%.
Unrealised profit in inventories: Where a group enterprise sells goods to another, the selling
enterprise, as a separate legal enterprise, records profits made on those sales. If these goods
are still held in inventory by the buying enterprise at the year end, however, the profit recorded
by the selling enterprise, when viewed from the standpoint of the group as a whole, has not yet
been earned, and will not be earned until the goods are eventually sold outside the group. On
consolidation, the unrealised profit on closing inventories will be eliminated from the group’s
profit, and the closing inventories of the group will be recorded at cost to the group.
When the goods are sold by a parent to a subsidiary (downstream transaction), all of the profit
on the transaction is eliminated, irrespective of the percentage of the shares held by the parent.
In other words, the group is not permitted to take credit for the share of profit that is attributable
to any minority.
Where the goods are sold by a subsidiary, in which there is a minority interest, to another group
enterprise (upstream transaction), the whole of the unrealised profit should also be eliminated.
Unrealised profit on transfer or non-current assets
♦ Similar to the treatment described above for unrealised profits in inventories, unrealised
inter-company profits arising from intra-group transfers of fixed assets are also eliminated
from the consolidated financial statements. Intra Group Transactions: The effect of any
unrealised profits from intra-group transactions should be eliminated from consolidated
financial statement. Effect of losses from intra-group transactions need not be eliminated
only when the cost is not recoverable.
For example, A Ltd. sold goods for ` 1,25,000 to B Ltd., another subsidiary under same
group at the gross profit of 20% on sales. On the date of consolidated balance sheet, B
Ltd. has goods worth ` 25,000 as inventory from the same consignment. The unrealised
profits of ` 5,000 (25,0000 x 20%) will be deducted from the closing inventory and it will
be valued as ` 20,000 i.e. at cost to A Ltd. for the purpose of Consolidated Financial
Statement.
♦ Reporting Date: For the purposes of preparing consolidated financial statements, the
financial statements of all subsidiaries should, wherever practicable, be prepared:
• To the same reporting date; and
• For the same reporting period as of the parent.
loss account. While calculating the share of parent in the net asset of the subsidiary on the date
of disposal, adjustment is made for the minority interest calculated as above.
In order to ensure the comparability of the financial statements from one accounting period to
the next, supplementary information is often provided about the effect of the acquisition and
disposal of subsidiaries on the financial position at the reporting date and the results for the
reporting period and on the corresponding amounts for the preceding period. The carrying
amount of the investment at the date that it ceases to be a subsidiary is regarded as cost
thereafter.
Investment in the subsidiary, in the separate financial statement of the parent is recorded
according to the provisions of AS 13.
Illustration 4
A Ltd. had acquired 80% share in the B Ltd. for ` 25 lacs. The net assets of B Ltd. on the day are
` 22 lacs. During the year A Ltd. sold the investment for ` 30 lacs and net assets of B Ltd. on the date
of disposal was ` 35 lacs. Calculate the profit or loss on disposal of this investment to be recognised in
consolidated financial statement.
Solution
Calculation of Profit/Loss on disposal of investment in subsidiary
Particulars ` `
Net Assets of B Ltd. on the date of disposal 35,00,000
Less: Minority Interest (35 lacs x 20%) (7,00,000)
A Ltd.'s Share in Net Assets 28,00,000
Illustration 5
A Ltd. had acquired 80% share in the B Ltd. for ` 15 lacs. The net assets of B Ltd. on the day are
` 22 lacs. During the year A Ltd. sold the investment for ` 30 lacs and net assets of B Ltd. on the date
of disposal was ` 35 lacs. Calculate the profit or loss on disposal of this investment to be recognised in
consolidated financial statement.
Solution
Calculation of Profit/Loss on disposal of investment in subsidiary
Particulars ` `
Net Assets of B Ltd. on the date of disposal 35,00,000
Less: Minority Interest (35 lacs x 20%) (7,00,000)
A Ltd.'s Share in Net Assets 28,00,000
20.15 Disclosure
In addition to disclosures required by paragraph 11 and 20, following disclosures should be
made:
a. In the consolidated financial statement, a list of all subsidiaries including the name, country
of incorporation or residence, proportion of ownership interest and, if different, proportion
of voting power held;
b. In consolidated financial statements, where applicable:
(i) The nature of the relationship between the parent and a subsidiary, if the parent does
not own, directly or indirectly through subsidiaries, more than one-half of the voting
power of the subsidiary;
(ii) The effect of the acquisition and disposal of subsidiaries on the financial position at
the reporting date, the results for the reporting period and on the corresponding
amounts for the preceding period; and
(iii) The names of the subsidiary(ies) of which reporting date(s) is/are different from that
of the parent and the difference in reporting dates.
21.2 Need
Matching of such taxes against revenue for a period poses special problems arising from the
fact that in a number of cases, taxable income may be significantly different from the accounting
income. This divergence between taxable income and accounting income arises due to two main
reasons.
Firstly, there are differences between items of revenue and expenses as appearing in the
statement of profit and loss and the items which are considered as revenue, expenses or
deductions for tax purposes, known as Permanent Difference.
Secondly, there are differences between the amount in respect of a particular item of revenue
or expense as recognised in the statement of profit and loss and the corresponding amount
which is recognised for the computation of taxable income, known as Time Difference.
21.3 Definitions
Accounting income (loss) is the net profit or loss for a period, as reported in the statement of
profit and loss, before deducting income-tax expense or adding income tax saving.
Taxable income (tax loss) is the amount of the income (loss) for a period, determined in
accordance with the tax laws, based upon which income-tax payable (recoverable) is
determined.
Tax expense (tax saving) is the aggregate of current tax and deferred tax charged or credited
to the statement of profit and loss for the period.
Current tax is the amount of income tax determined to be payable (recoverable) in respect of
the taxable income (tax loss) for a period.
Deferred tax is the tax effect of timing differences.
The differences between taxable income and accounting income can be classified into
permanent differences and timing differences.
Timing differences are the differences between taxable income and accounting income for a
period that originate in one period and are capable of reversal in one or more subsequent
periods.
Permanent differences are the differences between taxable income and accounting income for
a period that originate in one period and do not reverse subsequently.
21.4 Recognition
Tax expense for the period, comprising current tax and deferred tax, should be included in the
determination of the net profit or loss for the period.
Permanent differences do not result in deferred tax assets or deferred tax liabilities. Taxes on
income are considered to be an expense incurred by the enterprise in earning income and are
accrued in the same period as the revenue and expenses to which they relate. Such matching
may result into timing differences. The tax effects of timing differences are included in the tax
expense in the statement of profit and loss and as deferred tax assets or as deferred tax
liabilities, in the balance sheet.
While recognising the tax effect of timing differences, consideration of prudence cannot be
ignored. Therefore, deferred tax assets are recognised and carried forward only to the extent
that there is a reasonable certainty of their realisation. This reasonable level of certainty would
normally be achieved by examining the past record of the enterprise and by making realistic
estimates of profits for the future. Where an enterprise has unabsorbed depreciation or carry
forward of losses under tax laws, deferred tax assets should be recognised only to the extent
that there is virtual certainty supported by convincing evidence that sufficient future taxable
income will be available against which such deferred tax assets can be realised.
21.6 Measurement
Current tax should be measured at the amount expected to be paid to (recovered from) the
taxation authorities, using the applicable tax rates and tax laws. Deferred tax assets and
liabilities are usually measured using the tax rates and tax laws that have been enacted.
However, certain announcements of tax rates and tax laws by the government may have the
substantive effect of actual enactment. In these circumstances, deferred tax assets and
liabilities are measured using such announced tax rate and tax laws. Deferred tax assets and
liabilities should not be discounted to their present value.
21.8 Disclosure
Statement of profit and loss
Under AS 22, there is no specific requirement to disclose current tax and deferred tax in the
statement of profit and loss. However, under company law requirements, the amount of Indian
income tax and other Indian taxation on profits, including, wherever practicable, with Indian
income tax any taxation imposed elsewhere to the extent of the relief, if any, from Indian income
tax and distinguishing, wherever practicable, between income tax and other taxation should be
disclosed.
AS 22 does not require any reconciliation between accounting profit and the tax expense.
Balance sheet
The break-up of deferred tax assets and deferred tax liabilities into major components of the
respective balance should be disclosed in the notes to accounts.
Deferred tax assets and liabilities should be distinguished from assets and liabilities
representing current tax for the period. Deferred tax assets and liabilities should be disclosed
under a separate heading in the balance sheet of the enterprise, separately from current assets
and current liabilities. The break-up of deferred tax assets and deferred tax liabilities into major
components of the respective balances should be disclosed in the notes to accounts.
The nature of the evidence supporting the recognition of deferred tax assets should be
disclosed, if an enterprise has unabsorbed depreciation or carry forward of losses under tax
laws.
An enterprise should offset assets and liabilities representing current tax if the enterprise:
a. Has a legally enforceable right to set off the recognised amounts and
b. Intends to settle the asset and the liability on a net basis.
An enterprise should offset deferred tax assets and deferred tax liabilities if:
a. The enterprise has a legally enforceable right to set off assets against liabilities
representing current tax; and
b. The deferred tax assets and the deferred tax liabilities relate to taxes on income levied by
the same governing taxation laws.
and reverse during the tax holiday period, should not be recognised to the extent deduction from
the total income of an enterprise is allowed during the tax holiday period as per the provisions
of sections 10A and 10B of the Act. Deferred tax in respect of timing differences which originate
during the tax holiday period but reverse after the tax holiday period should be recognised in
the year in which the timing differences originate. However, recognition of deferred tax assets
should be subject to the consideration of prudence as laid down in AS 22.
For the above purposes, the timing differences which originate first should be considered to
reverse first.
Accounting for Taxes on Income in the context of section 115JB of the Income Tax Act,
1961
The payment of tax under section 115JB of the Act is a current tax for the period. In a period in
which a company pays tax under section 115JB of the Act, the deferred tax assets and liabilities
in respect of timing differences arising during the period, tax effect of which is required to be
recognised under AS 22, should be measured using the regular tax rates and not the tax rate
under section 115JB of the Act. In case an enterprise expects that the timing differences arising
in the current period would reverse in a period in which it may pay tax under section 115JB of
the Act, the deferred tax assets and liabilities in respect of timing differences arising during the
current period, tax effect of which is required to be recognised under AS 22, should be measured
using the regular tax rates and not the tax rate under section 115JB of the Act.
Virtual certainty supported by convincing evidence
Determination of virtual certainty that sufficient future taxable income will be available is a matter
of judgement and will have to be evaluated on a case to case basis. Virtual certainty refers to
the extent of certainty, which, for all practical purposes, can be considered certain. Virtual
certainty cannot be based merely on forecasts of performance such as business plans. Virtual
certainty is not a matter of perception and it should be supported by convincing evidence.
Evidence is a matter of fact. To be convincing, the evidence should be available at the reporting
date in a concrete form, for example, a profitable binding export order, cancellation of which will
result in payment of heavy damages by the defaulting party. On the other hand, a projection of
the future profits made by an enterprise based on the future capital expenditures or future
restructuring etc., submitted even to an outside agency, e.g., to a credit agency for obtaining
loans and accepted by that agency cannot, in isolation, be considered as convincing evidence.
Solution
Tax as per accounting profit 6,00,000×20%= ` 1,20,000
Tax as per Income-tax Profit 60,000×20% =` 12,000
Tax as per MAT 3,50,000×7.50%= ` 26,250
Tax expense= Current Tax +Deferred Tax
` 1,20,000 = ` 12,000+ Deferred tax
Therefore, Deferred Tax liability as on 31-03-201
= ` 1,20,000 – ` 12,000 = ` 1,08,000
Amount of tax to be debited in Profit and Loss account for the year 31-03-2017
Current Tax + Deferred Tax liability + Excess of MAT over current tax
= ` 12,000 + ` 1,08,000 + ` 14,250
= ` 1,34,250
Illustration 2
Ultra Ltd. has provided the following information.
Depreciation as per accounting records =` 2,00,000
Depreciation as per tax records =` 5,00,000
Unamortised preliminary expenses as per tax record = ` 30,000
There is adequate evidence of future profit sufficiency. How much deferred tax asset/liability should be
recognized as transition adjustment when the tax rate is 50%?
Solution
Calculation of difference between taxable income and accounting income
Particulars Amount (`)
Excess depreciation as per tax ` (5,00,000 – 2,00,000) 3,00,000
Less: Expenses provided in taxable income (30,000)
Timing difference 2,70,000
Tax expense is more than the current tax due to timing difference.
Therefore deferred tax liability = 50% x 2,70,000 = ` 1,35,000
Illustration 3
XYZ is an export oriented unit and was enjoying tax holiday upto 31.3.2016. No provision for deferred
tax liability was made in accounts for the year ended 31.3.2016. While finalising the accounts for the
year ended 31.3.2017, the Accountant says that the entire deferred tax liability upto 31.3.2016 and
current year deferred tax liability should be routed through Profit and Loss Account as the relevant
Accounting Standard has already become mandatory from 1.4.2001. Do you agree?
Solution
Paragraph 33 of AS 22 on “Accounting for Taxes on Income” relates to the transitional provisions. It
says, “On the first occasion that the taxes on income are accounted for in accordance with this statement,
the enterprise should recognise, in the financial statements, the deferred tax balance that has
accumulated prior to the adoption of this statement as deferred tax asset/liability with a corresponding
credit/charge to the revenue reserves, subject to the consideration of prudence in case of deferred tax
assets.
Further Paragraph 34 lays down, “For the purpose of determining accumulated deferred tax in the period
in which this statement is applied for the first time, the opening balances of assets and liabilities for
accounting purposes and for tax purposes are compared and the differences, if any, are determined. The
tax effects of these differences, if any, should be recognised as deferred tax assets or liabilities, if these
differences are timing differences.”
Therefore, in the case of XYZ, even though AS 22 has come into effect from 1.4.2001, the transitional
provisions permit adjustment of deferred tax liability/asset upto the previous year to be adjusted from
opening reserve. In other words, the deferred taxes not provided for alone can be adjusted against
opening reserves.
Provision for deferred tax asset/liability for the current year should be routed through profit and loss
account like normal provision.
Illustration 4
PQR Ltd.'s accounting year ends on 31st March. The company made a loss of ` 2,00,000 for the year
ending 31.3.2015. For the years ending 31.3.2016 and 31.3.2017, it made profits of ` 1,00,000 and
` 1,20,000 respectively. It is assumed that the loss of a year can be carried forward for eight years and
tax rate is 40%. By the end of 31.3.2015, the company feels that there will be sufficient taxable income
in the future years against which carry forward loss can be set off. There is no difference between taxable
income and accounting income except that the carry forward loss is allowed in the years ending 2016
and 2017 for tax purposes. Prepare a statement of Profit and Loss for the years ending 2015, 2016 and
2017.
Solution
Statement of Profit and Loss
31.3.2015 31.3.2016 31.3.2017
` ` `
Profit (Loss) (2,00,000) 1,00,000 1,20,000
Less: Current tax (8,000)
Deferred tax:
Tax effect of timing differences originating during the year 80,000
Tax effect of timing differences reversed/adjusted during
the year (40,000) (40,000)
Profit (Loss) After Tax Effect (1,20,000) 60,000 72,000
Illustration 5
The following particulars are stated in the Balance Sheet of M/s Exe Ltd. as on 31.03.2016:
(` in lakhs)
Deferred Tax Liability (Cr.) 20.00
Deferred Tax Assets (Dr.) 10.00
Indicate clearly the impact of above items in terms of Deferred Tax liability/Deferred Tax Assets and the
balances of Deferred Tax Liability/Deferred Tax Asset as on 31.03.2017.
Solution
Impact of various items in terms of deferred tax liability/deferred tax asset
Transactions Analysis Nature of Effect Amount
difference
Difference in Generally, written down Responding Reversal ` 20 lakhs × 50%
depreciation value method of timing of DTL = ` 10 lakhs
depreciation is adopted difference
under IT Act which leads to
higher depreciation in
earlier years of useful life of
the asset in comparison to
later years.
Disallowances, Tax payable for the earlier Responding Reversal ` 10 lakhs × 50%
as per IT Act, year was higher on this timing of DTA = ` 5 lakhs
of earlier years account. difference
Reference: The students are advised to refer the full text of AS 22 “Accounting for Taxes
on Income” (issued 2001).
22.2 Objective
The objective of this Standard is to lay down principles and procedures for recognizing the
investments in associates and its effect on the financial operations of the group in the
consolidated financial statement. Reference to AS 23 is compulsory for the companies following
AS 21 and preparing consolidated financial statement for their group. For disclosing investment
in associates in the separate financial statement of the investor itself, one should follow AS 13.
Solution
Calculation of the carrying amount of Investment as per equity method
Particulars ` `
Equity Shares 10,00,000
Security Premium 1,00,000
Reserves & Surplus 5,00,000
Net Assets 16,00,000
45% of Net Asset 7,20,000
Add: 45% of Profits for the year 1,35,000
8,55,000
Less: Dividend Received 45,000 8,10,000
Less: Cost of Investment (15,00,000)
Goodwill 6,90,000
Consolidated Balance Sheet (Extract)
Assets ` `
Investment in B Ltd. 810,000
Add: Goodwill 690,000 1,500,000
should be accounted for in accordance with AS 13, Accounting for Investments. For this
purpose, the carrying amount of the investment at that date should be regarded as cost
thereafter.
Case 1: A Ltd. acquired 10% stake of B Ltd. on April 01 and further 15% on October 01
during the same year. Other information is as follow:
Cost of Investment for 10% ` 1,00,000 and for 15% ` 1,45,000
Net asset on April 01st` 8,50,000 and on October 01 ` 10,00,000.
Calculations for April 01:
Cost of investment ` 1,00,000
10% share in net asset ` 85,000
Goodwill ` 15,000
Calculations for October 01:
15% share in net asset ` 1,50,000
Cost of investment ` 1,45,000
Capital Reserve ` 5,000
Total goodwill (15,000 – 5,000) ` 10,000
Case 2: A Ltd. acquired 10% stake of B Ltd. on April 01 and further 15% on October 01 of
the same year. Other information is as follow:
Cost of Investment for 10% ` 1,00,000 and for 15% ` 1,55,000
Net asset on April 01st` 8,50,000 and on October 01st` 10,00,000.
Calculations for April 01:
Cost of investment ` 1,00,000
10% share in net asset ` 85,000
Goodwill ` 15,000
Calculations for October 01:
Cost of investment ` 1,55,000
15% share in net asset ` 1,50,000
Goodwill ` 5,000
Total goodwill (15,000 + 5,000) ` 20,000
Case 3: A Ltd. acquired 25% stake of B Ltd. on April 01 and further 5% on October 01 of
the same year. Other information is as follow:
Cost of Investment for 25% ` 1,50,000 and for 5% ` 20,000
Net asset on April 01st` 5,00,000.
Profit for the year ` 90,000 earned in the ratio 2:1 respectively.
Solution
Calculation of Goodwill/Capital Reserve under Equity Method
Particulars `
Equity Shares 10,00,000
Reserves & Surplus 2,00,000
Net Assets 12,00,000
40% of Net Asset 4,80,000
Less: Cost of Investment (10,00,000)
Goodwill 5,20,000
Consolidated Balance Sheet (Extract) as on April 01, 2014
Assets ` `
Investment in B Ltd. 4,80,000
Add: Goodwill 5,20,000 10,00,000
♦ As far as possible the reporting date of the financial statements should be same for
consolidated financial statement. If practically it is not possible to draw up the financial
statements of one or more enterprise to such date and, accordingly, those financial
statements are drawn up to reporting dates different from the reporting date of the investor,
adjustments should be made for the effects of significant transactions or other events that
occur between those dates and the date of the consolidated financial statements. In any
case, the difference between reporting dates of the concern and consolidated financial
statement should not be more than six months.
♦ Accounting policies followed in the preparation of the financial statements of the investor,
investee and consolidated financial statement should be uniform for like transactions and
other events in similar circumstances.
If accounting policies followed by different enterprises in the group are not uniform, then
adjustments should be made in the items of the individual financial statements to bring it
in line with the accounting policy of the consolidated statement.
The carrying amount of investment in an associate should be reduced to recognise a decline,
other than temporary, in the value of the investment, such reduction being determined and made
for each investment individually.
22.7 Contingencies
In accordance with AS 4, the investor discloses in the consolidated financial statements:
a. Its share of the contingencies and capital commitments of an associate for which it is also
contingently liable; and
b. Those contingencies that arise because the investor is severally liable for the liabilities of
the associate.
22.8 Disclosure
♦ In addition to the disclosures required above, an appropriate listing and description of
associates including the proportion of ownership interest and, if different, the proportion of
voting power held should be disclosed in the consolidated financial statements.
♦ Investments in associates accounted for using the equity method should be classified as
long-term investments and disclosed separately in the consolidated balance sheet. The
investor’s share of the profits or losses of such investments should be disclosed separately
in the consolidated statement of profit and loss. The investor’s share of any extraordinary
or prior period items should also be separately disclosed.
♦ The name(s) of the associate(s) of which reporting date(s) is/are different from that of the
financial statements of an investor and the differences in reporting dates should be
disclosed in the consolidated financial statements.
♦ In case an associate uses accounting policies other than those adopted for the
consolidated financial statements for like transactions and events in similar circumstances
and it is not practicable to make appropriate adjustments to the associate’s financial
statements, the fact should be disclosed along with a brief description of the differences in
the accounting policies.
♦ If an associate is not accounted for using the equity method the reasons for not doing the
same.
♦ Goodwill/capital reserve arising on the acquisition of an associate by an investor should
be disclosed separately though it is included in the carrying amount of the investment.
23.2 Objective
The objective of this Statement is to establish principles for reporting information about
discontinuing operations, thereby enhancing the ability of users of financial statements to make
projections of an enterprise's cash flows, earnings-generating capacity, and financial position
by segregating information about discontinuing operations from information about continuing
operations.
Reporting’, would normally satisfy criterion (b) of the above definition, that is, it would represent
a separate major line of business or geographical area of operations. A part or such a segment
may also satisfy criterion (b) of the above definition. For an enterprise that operates in a single
business or geographical segment and, therefore, does not report segment information, a major
product or service line may also satisfy the criteria of the definition.
The sales of assets and settlements of liabilities may occur over a period of months or perhaps
even longer. Thus, disposal of a component may be in progress at the end of a financial
reporting period. To qualify as a discontinuing operation, the disposal must be pursuant to a
single coordinated plan.
An enterprise may terminate an operation by abandonment without substantial sales of assets.
An abandoned operation would be a discontinuing operation if it satisfies the criteria in the
definition. However, changing the scope of an operation or the manner in which it is conducted
is not abandonment because that operation, although changed, is continuing.
Examples of activities that do not necessarily satisfy criterion of the definition, but that might do
so in combination with other circumstances, include:
a. Gradual or evolutionary phasing out of a product line or class of service.
b. Discontinuing, even if relatively abruptly, several products within an ongoing line of
business.
c. Shifting of some production or marketing activities for a particular line of business from
one location to another and
d. Closing of a facility to achieve productivity improvements or other cost savings.
An example in relation to consolidated financial statements is selling a subsidiary whose
activities are similar to those of the parent or other subsidiaries.
A component can be distinguished operationally and for financial reporting purposes - criterion
(c) of the definition of a discontinuing operation - if all the following conditions are met:
a. The operating assets and liabilities of the component can be directly attributed to it.
b. Its revenue can be directly attributed to it.
c. At least a majority of its operating expenses can be directly attributed to it.
Assets, liabilities, revenue, and expenses are directly attributable to a component if they would
be eliminated when the component is sold, abandoned or otherwise disposed of. If debt is
attributable to a component, the related interest and other financing costs are similarly attributed
to it. Discontinuing operations are infrequent events, but this does not mean that all infrequent
events are discontinuing operations.
a. The enterprise has entered into a binding sale agreement for substantially all of the assets
attributable to the discontinuing operation or
b. The enterprise's board of directors or similar governing body has both
(i) approved a detailed, formal plan for the discontinuance and
(ii) made an announcement of the plan.
a detailed, formal plan for the discontinuance normally includes:
• identification of the major assets to be disposed of;
• the expected method of disposal;
• the period expected to be required for completion of the disposal;
• the principal locations affected;
• the location, function, and approximate number or employees who will be compensated
for terminating their services; and
• the estimated proceeds or salvage to be realised by disposal.
An enterprise’s board of directors or similar governing body is considered to have made the
announcement of a detailed, formal plan for discontinuance, if it has announced the main
features of the plan to those affected by it, such as, lenders, stock exchanges, trade payables,
trade unions, etc. in a sufficiently specific manner so as to make the enterprise demonstrably
committed to the discontinuance.
e. The carrying amounts, as of the balance sheet date, of the total assets to be disposed of
and the total liabilities to be settled.
f. The amounts of revenue and expenses in respect of the ordinary activities attributable to
the discontinuing operation during the current financial reporting period.
g. The amount of pre-tax profit or loss from ordinary activities attributable to the discontinuing
operation during the current financial reporting period, and the income tax expense related
thereto and
h. The amounts of net cash flows attributable to the operating, investing, and financing
activities of the discontinuing operation during the current financial reporting period.
disclosures required by this Statement should be presented separately for each discontinuing
operation.
The disclosures should be presented in the notes to the financial statements except the following
which should be shown on the face of the statement of profit and loss:
a. The amount of pre-tax profit or loss from ordinary activities attributable to the discontinuing
operation during the current financial reporting period, and the income tax expense related
thereto and
b. The amount of the pre-tax gain or loss recognised on the disposal of assets or settlement
of liabilities attributable to the discontinuing operation.
Comparative information for prior periods that is presented in financial statements prepared
after the initial disclosure event should be restated to segregate assets, liabilities, revenue,
expenses, and cash flows of continuing and discontinuing operations in a manner similar to that
mentioned above.
Disclosures in an interim financial report in respect of a discontinuing operation should be made
in accordance with AS 25, ‘Interim Financial Reporting’, including:
a. Any significant activities or events since the end of the most recent annual reporting period
relating to a discontinuing operation and
b. Any significant changes in the amount or timing of cash flows relating to the assets to be
disposed or liabilities to be settled.
Reference: The students are advised to refer the full text of AS 24 “Discontinuing
Operations”
would include all disclosures required by this Standard as well as those required by other
Accounting Standards. Minimum components of an Interim Financial Report includes condensed
Financial Statement.
24.7 Materiality
In deciding how to recognise, measure, classify, or disclose an item for interim financial
reporting purposes, materiality should be assessed in relation to the interim period financial
data. In making assessments of materiality, it should be recognised that interim measurements
may rely on estimates to a greater extent than measurements of annual financial data. For
reasons of understandability of the interim figures, materiality for making recognition and
disclosure decision is assessed in relation to the interim period financial data. Thus, for example,
unusual or extraordinary items, changes in accounting policies or estimates, and prior period
items are recognised and disclosed based on materiality in relation to interim period data.
Illustration 1
Sincere Corporation is dealing in seasonal product sales pattern of the product, quarter wise is as follows:
1st quarter 30th June 10%
2nd quarter 30th September 10%
While preparing interim financial report for first quarter Sincere Corporation wants to defer ` 10 crores
expenditure to third quarter on the argument that third quarter is having more sales therefore third quarter
should be debited by more expenditure. Considering the seasonal nature of business and the
expenditures are uniform throughout all quarters, calculate the result of the first quarter as per AS 25.
Also give a comment on the company’s view.
Solution
Particulars (` In crores)
Result of first quarter ending 30th June, 2017
Turnover 80
Other Income Nil
Total (a) 80
Less: Changes in inventories Nil
Salaries and other cost 60
Administrative and selling Expenses (4+8) 12
Total (b) 72
Profit (a)-(b) 8
According to AS 25 the Income and Expense should be recognized when they are earned and incurred
respectively. Therefore seasonal incomes will be recognized when they occur. Thus the company’s view
is not as per AS 25.
Illustration 2
The accounting year of X Ltd. ends on 30th September, 2017 and it makes its reports quarterly. However
for the purpose of tax, year ends on 31st March every year. For the Accounting year beginning on 1-10-
2016 and ends on 30-9-2017, the quarterly income is as under:-
1st quarter ending on 31-12-2016 ` 200 crores
2nd quarter ending on 31-3-2017 ` 200 crores
3rd quarter ending on 30-6-2017 ` 200 crores
4th quarter ending on 30-9-2017 ` 200 crores
Total ` 800 crores
Average actual tax rate for the financial year ending on 31-3-2017 is 20% and for financial year ending
31-3-2017 is 30%. Calculate tax expense for each quarter.
Solution
Calculation of tax expense
1st quarter ending on 31-12-2016 200 ×20% ` 40 lakhs
2nd quarter ending on 31-3-2016 200 ×20% ` 40 lakhs
3rd quarter ending on 30-6-2016 200 ×30% ` 60 lakhs
4th quarter ending on 30-9-2016 200 ×30% ` 60 lakhs
met the definition of an asset or to smooth earnings over interim periods within a financial
year; and
c. Income tax expense is recognised in each interim period based on the best estimate of the
weighted average annual effective income tax rate expected for the full financial year.
Amounts accrued for income tax expense in one interim period may have to be adjusted
in a subsequent interim period of that financial year if the estimate of the annual effective
income tax rate changes.
Income is recognised in the statement of profit and loss when an increase in future economic
benefits related to an increase in an asset or a decrease of a liability has arisen that can be
measured reliably. Expenses are recognised in the statement of profit and loss when a decrease
in future economic benefits related to a decrease in an asset or an increase of a liability has
arisen that can be measured reliably. The recognition of items in the balance sheet which do
not meet the definition of assets or liabilities is not allowed.
An enterprise that reports more frequently than half-yearly, measures income and expenses on
a year-to-date basis for each interim period using information available when each set of
financial statements is being prepared. Amounts of income and expenses reported in the current
interim period will reflect any changes in estimates of amounts reported in prior interim periods
of the financial year. The amounts reported in prior interim periods are not retrospectively
adjusted. Paragraphs 16(d) and 25 require, however, that the nature and amount of any
significant changes in estimates be disclosed.
when preparing interim financial statements, the enterprise’s usual recognition and
measurement practices are followed. The only costs that are capitalized are those incurred after
the specific point in time at which the criteria for recognition of the particular class of asset are
met. Deferral of costs as assets in an interim balance sheet in the hope that the criteria will be
met before the year-end is prohibited.
(i) Bad debts of ` 40,000 incurred during the quarter. 50% of the bad debts have been deferred to
the next quarter.
(ii) Extra ordinary loss of ` 35,000 incurred during the quarter has been fully recognized in this quarter.
(iii) Additional depreciation of ` 45,000 resulting from the change in the method of charge of
depreciation assuming that ` 45,000 is the charge for the 3rd quarter only.
Ascertain the correct quarterly income.
Solution
In the above case, the quarterly income has not been correctly stated. As per AS 25 “Interim Financial
Reporting”, the quarterly income should be adjusted and restated as follows:
Bad debts of ` 40,000 have been incurred during current quarter. Out of this, the company has deferred
50% (i.e.) ` 20,000 to the next quarter. Therefore, ` 20,000 should be deducted from
` 7,20,000. The treatment of extra-ordinary loss of ` 35,000 being recognized in the same quarter is
correct.
Recognising additional depreciation of ` 45,000 in the same quarter is in tune with AS 25. Hence, no
adjustments are required for these two items.
Poornima Ltd should report quarterly income as ` 7,00,000 (` 7,20,000 – ` 20,000).
Illustration 4
Intelligent Corporation (I−Corp.) is dealing in seasonal products. The quarterly sales pattern of the
product is given below:
Quarter I II III IV
Ending 31st March 30th June 30th September 31st December
15% 15% 50% 25%
For the First quarter ending 31st March, 2016, I−Corp. gives you the following information:
` crores
Sales 50
Salary and other expenses 30
Advertisement expenses (routine) 02
Administrative and selling expenses 08
While preparing interim financial report for the first quarter, ‘I−Corp.’ wants to defer ` 21 crores
expenditure to third quarter on the argument that third quarter is having more sales, therefore third quarter
should be debited by higher expenditure, considering the seasonal nature of business. The expenditures
are uniform throughout all quarters.
Calculate the result of first quarter as per AS 25 and comment on the company’s view.
Solution
Result of the first quarter ended 31st March, 2016
(` in crores)
Turnover 50
Add: Other Income Nil
Total 50
Less: Change in inventories Nil
Salaries and other cost 30
Administrative and selling expenses (8 + 2) 10 40
Profit 10
As per AS 25 on Interim Financial Reporting, the income and expense should be recognised when they
are earned and incurred respectively. As per para 38 of AS 25, the costs should be anticipated or
deferred only when
(i) it is appropriate to anticipate that type of cost at the end of the financial year, and
(ii) costs are incurred unevenly during the financial year of an enterprise.
Therefore, the argument given by I-Corp relating to deferment of ` 21 crores is not tenable as
expenditures are uniform throughout all quarters.
Reference: The students are advised to refer the full text of AS 25 “Interim Financial
Reporting”: (issued 2002).
25.2 Scope
This standard should be applied by all enterprises in accounting intangible assets, except
(a) intangible assets that are covered by another AS,
(b) financial assets,
(c) rights and expenditure on the exploration for or development of minerals, oil, natural gas
and similar non-regenerative resources,
(d) intangible assets arising in insurance enterprise from contracts with policy holders,
(e) expenditure in respect of termination benefits.
Exclusions from the scope of an Accounting Standard may occur if certain activities or
transactions are so specialised that they give rise to accounting issues that may need to be
dealt with in a different way. However, this Statement applies to other intangible assets used
(such as computer software), and other expenditure (such as start-up costs), in extractive
industries or by insurance enterprises. This Statement also applies to rights under licensing
agreements for items such as motion picture films, video recordings, plays, manuscripts, patents
and copyrights. These items are excluded from the scope of AS 19.
25.3 Definitions
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.
Amortisation is the systematic allocation of the depreciable amount of an intangible asset over
its useful life.
An active market is a market where all the following conditions exist:
a. The items traded within the market are homogeneous.
b. Willing buyers and sellers can normally be found at any time and
c. Prices are available to the public.
An impairment loss is the amount by which the carrying amount of an asset exceeds its
recoverable amount.
A financial asset is any asset that is:
a. Cash,
b. A contractual right to receive cash or another financial asset from another enterprise,
c. A contractual right to exchange financial instruments with another enterprise under
conditions that are potentially favourable or
d. An ownership interest in another enterprise.
economic benefits flowing to the enterprise. If an item covered by this Statement does not meet
the definition of an intangible asset, expenditure to acquire it or generate it internally is
recognised as an expense when it is incurred. In some cases, an asset may incorporate both
intangible and tangible elements that are, in practice, inseparable. Judgement is required to
assess as to which element is predominant. If use of physical assets is possible only with the
intangible part of it, we treat them as Fixed Assets like Operating system for computers. If
physical element is just to support intangible part of it, we treat them as intangible assets.
25.5 Identifiability
The definition of an intangible asset requires that an intangible asset be identifiable. To be
identifiable, it is necessary that the intangible asset is clearly distinguished from goodwill. An
intangible asset can be clearly distinguished from goodwill if the asset is separable. An asset is
separable if the enterprise could rent, sell, exchange or distribute the specific future economic
benefits attributable to the asset without also disposing of future economic benefits that flow
from other assets used in the same revenue earning activity, though ‘separability’ is not a
necessary condition for identifiability. If an asset generates future economic benefits only in
combination with other assets, the asset is identifiable if the enterprise can identify the future
economic benefits that will flow from the asset.
25.6 Control
An enterprise controls an asset if the enterprise has the power to obtain the future economic
benefits flowing from the underlying resource and also can restrict the access of others to those
benefits. The capacity of an enterprise to control the future economic benefits from an intangible
asset would normally stem from legal rights that are enforceable in a court of law. However,
legal enforceability of a right is not a necessary condition for control since an enterprise may be
able to control the future economic benefits in some other way.
Market and technical knowledge may give rise to future economic benefits. An enterprise
controls those benefits if, for example, the knowledge is protected by legal rights such as
copyrights, a restraint of trade agreement or by a legal duty on employees to maintain
confidentiality. Future economic benefit is also flown from the skill of labour and customer loyalty
but usually this flow of benefits cannot be controlled by the enterprise. As employees may quit
the concern anytime or even loyal customers may decide to purchase goods and services from
other suppliers. Moreover these items don’t even qualify as intangible asset as per the definition
given in this AS.
If no active market exists for an asset, its cost reflects the amount that the enterprise would
have paid, at the date of the acquisition, for the asset in an arm's length transaction between
knowledgeable and willing parties, based on the best information available. The cost initially
recognised for the intangible asset in this case is restricted to an amount that does not create
or increase any capital reserve arising at the date of the amalgamation. Certain enterprises that
are regularly involved in the purchase and sale of unique intangible assets have developed
techniques for estimating their fair values indirectly. These techniques include, where
appropriate, applying multiples reflecting current market transactions to certain indicators
driving the profitability of the asset (such as revenue, market shares, operating profit, etc.) or
discounting estimated future net cash flows from the asset.
asset internally, such as salary and other expenditure incurred in securing copyrights or licences
or developing computer software.
This Statement takes the view that expenditure on internally generated brands, mastheads,
publishing titles, customer lists and items similar in substance cannot be distinguished from the
cost of developing the business as a whole. Therefore, such items are not recognised as
intangible assets.
In some cases, there may be persuasive evidence that the useful life of an intangible asset will
be a specific period longer than ten years. In these cases, the presumption that the useful life
generally does not exceed ten years is rebutted and the enterprise:
a. Amortises the intangible asset over the best estimate of its useful life.
b. Estimates the recoverable amount of the intangible asset at least annually in order to
identify any impairment loss and
c. Discloses the reasons why the presumption is rebutted and the factor(s) that played a
significant role in determining the useful life of the asset.
If control over the future economic benefits from an intangible asset is achieved through legal
rights that have been granted for a finite period, the useful life of the intangible asset should not
exceed the period of the legal rights unless the legal rights are renewable and renewal is virtually
certain. There may be both economic and legal factors influencing the useful life of an intangible
asset: economic factors determine the period over which future economic benefits will be
generated; legal factors may restrict the period over which the enterprise controls access to
these benefits. The useful life is the shorter of the periods determined by these factors.
is inappropriate. Over time, the pattern of future economic benefits expected to flow to an
enterprise from an intangible asset may change. Therefore, the amortisation period and the
amortisation method should be reviewed at least at each financial year end. If the expected
useful life of the asset is significantly different from previous estimates, the amortisation period
should be changed accordingly. If there has been a significant change in the expected pattern
of economic benefits from the asset, the amortisation method should be changed to reflect the
changed pattern. Such changes should be accounted for in accordance with AS 5.
25.24 Disclosure
The financial statements should disclose the following for each class of intangible assets,
distinguishing between internally generated intangible assets and other intangible assets:
a. The useful lives or the amortisation rates used.
b. The amortisation methods used.
c. The gross carrying amount and the accumulated amortisation (aggregated with
accumulated impairment losses) at the beginning and end of the period.
d. A reconciliation of the carrying amount at the beginning and end of the period showing:
i. Additions, indicating separately those from internal development and through
amalgamation.
ii. Retirements and disposals.
iii. Impairment losses recognised in the statement of profit and loss during the period.
iv. Impairment losses reversed in the statement of profit and loss during the period.
v. Amortisation recognised during the period and
vi. Other changes in the carrying amount during the period.
The financial statements should also disclose:
a. If an intangible asset is amortised over more than ten years, the reasons why it is presumed
that the useful life of an intangible asset will exceed ten years from the date when the asset
is available for use. In giving these reasons, the enterprise should describe the factor(s)
that played a significant role in determining the useful life of the asset.
b. A description, the carrying amount and remaining amortisation period of any individual
intangible asset that is material to the financial statements of the enterprise as a whole.
c. The existence and carrying amounts of intangible assets whose title is restricted and the
carrying amounts of intangible assets pledged as security for liabilities and
d. The amount of commitments for the acquisition of intangible assets.
The financial statements should disclose the aggregate amount of research and development
expenditure recognised as an expense during the period.
a. If the enterprise is following an accounting policy of not amortising an intangible item, the
carrying amount of the intangible item should be restated, as if the accumulated
amortisation had always been determined under this Statement, with the corresponding
adjustment to the opening balance of revenue reserves. The restated carrying amount
should be amortised over the balance of the period.
b. If the remaining period as per the accounting policy followed by the enterprise:
(i) Is shorter as compared to the balance of the period determined, the carrying amount
of the intangible item should be amortised over the remaining period as per the
accounting policy followed by the enterprise,
(ii) Is longer as compared to the balance of the period determined, the carrying amount
of the intangible item should be restated, as if the accumulated amortisation had
always been determined under this Statement, with the corresponding adjustment to
the opening balance of revenue reserves. The restated carrying amount should be
amortised over the balance of the period.
25.26 Illustrations
Illustration 1
Dell International Ltd. is developing a new production process. During the financial year
31st March, 2016, the total expenditure incurred on this process was ` 40 lakhs. The production process
met the criteria for recognition as an intangible asset on 1st December, 2015. Expenditure incurred till
this date was ` 16 lakhs.
Further expenditure incurred on the process for the financial year ending 31st March 2017, was
` 70 lakhs. As at 31-3-2017, the recoverable amount of know-how embodied in the process is estimated
to be ` 62 lakhs. This includes estimates of future cash outflows as well as inflows.
You are required to work out:
(a) What is the expenditure to be charged to the profit and loss account for the financial year ended
31st March 2016? (Ignore depreciation for this purpose)
(b) What is the carrying amount of the intangible asset as at 31st March 2016?
(c) What is the expenditure to be charged to the profit and loss account for the financial year ended
31st March 2017? (Ignore depreciation for this purpose)
(d) What is the carrying amount of the intangible asset as at 31st March 2017?
Solution
(a) ` 16 lakhs
(b) Carrying amount as on 31-3-2016 will be the expenditure incurred after 1-12-2015 = ` 24 lakhs
(c) Book cost of intangible asset as on 31-3-2017 is as follows
Total Book cost = ` (70 + 24) lakhs = ` 94 lakhs
1 It has been assumed that the company had amortized the patent at ` 10,00,000 per annum in the first two years
on the basis of economic benefits derived from the product manufactured under the patent.
It may be seen from above that from third year onwards, the balance of carrying amount i.e.,
` 60,00,000 has been amortized in the ratio of net cash flows arising from the product of Swift Ltd.
Note: The answer has been given on the basis that the patent is renewable and Swift Ltd. got it renewed
after expiry of five years.
Illustration 4
During 2016-2017, an enterprise incurred costs to develop and produce a routine, low risk computer
software product, as follows:
Amount (`)
Completion of detailed programme and design 25,000
Coding and Testing 20,000
Other coding costs 42,000
Testing costs 12,000
Product masters for training materials 13,000
Duplication of computer software and training materials, from product masters 40,000
(2,000 units)
Packing the product (1,000 units) 11,000
What amount should be capitalized as software costs in the books of the company, on Balance Sheet
date?
Solution
As per para 44 of AS 26, costs incurred in creating a computer software product should be charged to
research and development expense when incurred until technological feasibility/asset recognition criteria
has been established for the product. Technological feasibility/asset recognition criteria have been
established upon completion of detailed programme design or working model. In this case,
` 45,000 would be recorded as an expense (` 25,000 for completion of detailed program design and
` 20,000 for coding and testing to establish technological feasibility/asset recognition criteria). Cost
incurred from the point of technological feasibility/asset recognition criteria until the time when products
costs are incurred are capitalized as software cost (` 42,000 + ` 12,000 + ` 13,000) ` 67,000.
Reference: The students are advised to refer the full text of AS 26 “Intangible Assets”
(issued 2002).
26.2 Scope
This Standard should be applied in accounting for interests in joint ventures and the reporting
of joint venture assets, liabilities, income and expenses in the financial statements of venturers
and investors, regardless of the structures or forms under which the joint venture activities take
place.
The provisions of this AS need to be referred to for consolidated financial statement only when
CFS is prepared and presented by the venturer.
26.3 Definitions
A joint venture is a contractual arrangement whereby two or more parties undertake an
economic activity, which is subject to joint control.
From the above definition we conclude that the essential conditions for any business relation to
qualify as joint venture are:
♦ Two or more parties coming together: Parties can be an individual or any form of
business organization say, BOI, AOP, Company, firm.
♦ Venturers undertake some economic activity: Economic activity means activities with
the profit-making motive. Joint venture is separate from the regular identity of the
venturers, it may be in the form of independent and separate legal organization other than
regular concern of the venturer engaged in the economic activity.
♦ Venturers have joint control on the economic activity: The operating and financial
decisions are influenced by the venturers and they also share the results of the economic
activity.
♦ There exists a contractual agreement: The relationship between venturers is governed
by the contractual agreement. This agreement can be in the form of written and signed
agreement or as minutes of venturer meeting or in any other written form.
Joint control is the contractually agreed sharing of control over an economic activity.
Control is the power to govern the financial and operating policies of an economic activity so
as to obtain benefits from it.
A venturer is a party to a joint venture and has joint control over that joint venture.
An investor in a joint venture is a party to a joint venture and does not have joint control over
that joint venture.
Implementation and execution of these policies will be the responsibility of Mr. A. Here Mr. A is
acting as venturer as well as manager of the concern.
materials from his godown and Mr. C will look after the completion of construction. As per the
contractual agreement, they will share any profit/loss in a predetermined ratio. None of them
are using separate staff or other resources for the joint venture business and neither do they
maintain a separate account. Everything is recorded in their personal business only. Venturer
doesn’t maintain a separate set of books but they record only their own transactions of the joint
venture business in their books. Any transaction of joint venture recorded separately is only for
internal reporting purpose. Once all transactions recorded in venturer financial statement, they
don’t need to be adjusted for in consolidated financial adjustment.
Illustration 1
Mr. A, Mr. B and Mr. C entered into a joint venture to purchase a land, construct and sell flats. Mr. A
purchased a land for ` 60,00,000 on 01.01.2016 and for the purpose he took loan from a bank for
` 50,00,000 @ 8% interest p.a. He also paid registering fees ` 60,000 on the same day. Mr. B supplied
the materials for ` 4,50,000 from his godown and further he purchased the materials for ` 5,00,000 for
the joint venture. Mr. C met all other expenses of advertising, labour and other incidental expenses which
turnout to be ` 9,00,000. On 30.06.2016 each of the venturer agreed to take away one flat each to be
valued at ` 10,00,000 each flat and rest were sold by them as follow: Mr. A for ` 40,00,000; Mr. B for `
20,00,000 and Mr. C for ` 10,00,000. Loan was repaid on the same day by Mr. A alongwith the interest
and net proceeds were shared by the partners equally.
You are required to prepare the draft Consolidated Profit & Loss Account and Joint Venture Account in
the books of each venturer.
Solution
Draft Consolidated Profit & Loss Account
Particulars ` ` Particulars ` `
To Purchase of Land: By Sale of Flats:
Mr. A 60,00,000 Mr. A 40,00,000
To Registration Fees: Mr. B 20,00,000
Mr. A 60,000 Mr. C 10,00,000 70,00,000
To Materials: By Flats taken by Venturers:
Mr. B 9,50,000 Mr. A 10,00,000
To Other Expenses: Mr. B 10,00,000
Mr. C 9,00,000 Mr. C 10,00,000 30,00,000
To Bank Interest:
Mr. A 2,00,000
To Profits:
Mr. A 6,30,000
Mr. B 6,30,000
Mr. C 6,30,000 18,90,000
1,00,00,000 1,00,00,000
♦ Expenses on jointly held assets are shared by the venturers as per the contract.
♦ In their financial statement, venturer shows only their share of the asset and total income
earned by them along with total expenses incurred by them.
♦ Because the assets, liabilities, income and expenses are already recognised in the
separate financial statements of the venturer, and consequently in its consolidated
financial statements, no adjustments or other consolidation procedures are required in
respect of these items when the venturer presents consolidated financial statements.
♦ Financial statements may not be prepared for the joint venture, although the venturers may
prepare accounts for internal management reporting purposes so that they may assess the
performance of the joint venture.
For example, ABC Ltd., BP Ltd. and HP Ltd. having the same point of oil refinery and same
place of customers agreed to spread a pipeline from their unit to customers place jointly. They
agreed to share the expenditure on the pipeline construction and maintenance in the ratio 3:3:4
respectively and the time allotted to use the pipeline was in the ratio 4:3:3 respectively.
For the joint venture, each venturer will record his share of joint assets as classified according
to the nature of the assets rather than as an investment, and any expenditure incurred or
revenue generated will be recorded with other items similar to JCO. Following are the few
differences between JCO and JCA for better understanding:
♦ In JCO venturers uses their own assets for joint venture business but in JCA they jointly
owns the assets to be used in joint venture.
♦ JCO is an agreement to joint carry on the operations to earn income whereas, JCA is an
agreement to jointly construct and maintain an asset to generate revenue to each venturer.
♦ Under JCO all expenses and revenues are shared at an agreed ratio, in JCA only expenses
on joint assets are shared at the agreed ratio.
Illustration 2
A Ltd., B Ltd. and C Ltd. decided to jointly construct a pipeline to transport the gas from one place to
another that was manufactured by them. For the purpose following expenditure was incurred by them:
Buildings ` 12,00,000 to be depreciated @ 5% p.a., Pipeline for ` 60,00,000 to be depreciated @ 15%
p.a., computers and other electronics for ` 3,00,000 to be depreciated @ 40% p.a. and various vehicles
of ` 9,00,000 to be depreciated @ 20% p.a.
They also decided to equally bear the total expenditure incurred on the maintenance of the pipeline that
comes to ` 6,00,000 each year.
You are required to show the consolidated financial balance sheet and the extract of draft Profit & Loss
Account and Balance Sheet for each venturer.
Solution
Consolidated Balance Sheet
Note ( `)
I Equity and liabilities
Shareholders’ funds:
Share Capital 1 71,40,000
71,40,000
II Assets
Non-current Assets
Fixed assets:
Tangible assets 2 71,40,000
71,40,000
Notes to Accounts (`)
1. Share capital
A Ltd. 2,380,000
B Ltd. 2,380,000
C Ltd. 2,380,000 7,140,000
2. Tangible assets
Land & Building:
A Ltd. 380,000
B Ltd. 380,000
C Ltd. 380,000 1,140,000
Plant & Machinery:
A Ltd. 1,700,000
B Ltd. 1,700,000
C Ltd. 1,700,000 5,100,000
Computers:
A Ltd. 60,000
B Ltd. 60,000
C Ltd. 60,000 180,000
Vehicles:
A Ltd. 240,000
B Ltd. 240,000
C Ltd. 240,000 720,000
Notes to Accounts
` `
1. Land & Building 4,00,000
Less: Depreciation (20,000) 380,000
Plant & Machinery 20,00,000
Less: Depreciation (3,00,000) 1,700,000
Computers 1,00,000
Less: Depreciation (40,000) 60,000
Vehicles 3,00,000
Less: Depreciation (60,000) 240,000
23,80,000
Notes to Accounts
` `
1. Land & Building 4,00,000
Less: Depreciation (20,000) 3,80,000
Plant & Machinery 20,00,000
Less: Depreciation (3,00,000) 17,00,000
Computers 1,00,000
Less: Depreciation (40,000) 60,000
Vehicles 3,00,000
Less: Depreciation (60,000) 2,40,000
23,80,000
Notes to Accounts
` `
1. Land & Building 4,00,000
Notes to Accounts
Particulars (` )
1. Revenue from operations
Sales:
A Ltd. 7,25,000
B Ltd. 5,80,000 13,05,000
2. Purchases
A Ltd. 5,00,000
B Ltd. 4,00,000 9,00,000
3. Other expenses
A Ltd. 1,70,000
B Ltd. 1,36,000 3,06,000
4. Closing Inventory
A Ltd. 50,000
B Ltd. 50,000 1,00,000
5. Share Capital:
A Ltd. 1,96,490
B Ltd. 2,04,510 4,01,000
6. Reserves and Surplus
Profit & Loss Account:
A Ltd. 99,500
B Ltd. 99,500 1,99,000
7. Long Term Borrowings
Unsecured Loans:
A Ltd. 1,00,000
B Ltd. 1,00,000 2,00,000
8. Current Liabilities:
A Ltd. 50,000
B Ltd. 50,000 1,00,000
9. Fixed Assets:
A Ltd. 3,00,000
B Ltd. 3,00,000 6,00,000
10. Inventories
A Ltd. 50,000
B Ltd. 50,000 1,00,000
b. Venturer’s share of joint assets, liabilities, expenses and income are shown on the
separate lines in the consolidated financial statement.
For example, Mr. A enters into a joint venture with Mr. B and has contributed 33% of the
total fixed assets and has share of 40% in current assets and current liabilities. Its share
in net result is 50%. Consolidated Balance Sheet will be prepared by Mr. A as follow:
Consolidated Balance Sheet
Note (`)
No.
I Equity and liabilities
1. Shareholders’ funds:
Share Capital 1 1,00,000
2. Current Liabilities 2 50,000
1,50,000
II Assets
Non-current Assets
Fixed assets 3 75,000
Current Assets 4 75,000
1,50,000
Notes to Accounts
1. Share Capital:
A 33,000
B 67,000 1,00,000
2. Current Liabilities:
A 20,000
B 30,000 50,000
3. Fixed Assets:
A 25,000
B 50,000 75,000
4. Current Assets:
A 30,000
B 45,000 75,000
Similar to above all the items of expenses and income will also be classified line by line for
each item. The whole basis of this provision is to bring transparency in the books of
account. If there is any special clause for sharing of expenses, income or any other item
that should be clearly disclosed in the consolidated financial statement.
c. Most of the provisions of Proportionate Consolidation Method are similar to the provisions
of AS 21.
d. As far as possible the reporting date of the financial statements of jointly controlled entity
and venturers should be same. If practically it is not possible to draw up the financial
statements to such date and, accordingly, those financial statements are drawn up to
different reporting dates, adjustments should be made in joint venturer’s books for the
effects of significant transactions or other events that occur between the jointly controlled
entity’s date and the date of the venturer’s financial statements. In any case, the difference
between reporting dates should not be more than six months.
e. Accounting policies followed in the preparation of the financial statements of the jointly
controlled entity and venturer should be uniform for like transactions and other events in
similar circumstances.
If accounting policies followed by venturer and jointly controlled entity are not uniform, then
adjustments should be made in the items of the venturer to bring it in line with the
accounting policy of the joint venture.
f. Any asset or liability should not be adjusted by another liability or asset. Similarly any
income or expense cannot be adjusted with another expense or income. Such adjustment
can be made only when legally it is allowed to adjust them and such items does lead to
settlement of obligation or writing off of assets.
g. On the date when interest in joint entity is acquired, if the interest of venturer in net assets
of the entity is less than the cost of investment in joint entity, the difference will be
recognized as goodwill in the consolidated financial statement and if net asset is more than
cost of investment, then the difference is recognized as capital reserve.
In case the carrying amount of investment is different than cost of investment, we take
carrying amount for the purpose of the above calculation.
h. An investor who don’t have joint control in the entity is like associate as discussed in
AS 23, therefore the treatment of losses will be similar to AS 23. If investor’s share in loss
of the joint entity is in excess of his interest in net asset, this excess loss will be recognized
by the venturers. In future when entity starts reporting profits, investor’s share of profits
will be provided to venturer till total amount is equivalent to absorbed losses.
Illustration 4
A Ltd. entered into a joint venture with B Ltd. on 1:1 basis and a new company C Ltd. was formed for the
same purpose and following is the balance sheet of all the three companies:
Prepare the balance sheet of A Ltd. and B Ltd. under proportionate consolidation method.
Solution
Balance Sheet of A Ltd.
Note No. ( `)
I Equity and liabilities
1. Shareholders’ funds:
Share Capital 10,00,000
Reserves and Surplus 1 24,00,000
2. Non-current liabilities 2 4,00,000
3. Current Liabilities 3 4,50,000
TOTAL 42,50,000
II Assets
Non-current Assets
Fixed assets: 4 40,25,000
Current Assets 5 2,25,000
42,50,000
Notes to Accounts
5. Current Assets:
A Ltd. 2,00,000
C Ltd. 25,000 2,25,000
Notes to Accounts
1. Reserves and Surplus
A Ltd. 16,00,000
C Ltd. 6,00,000 22,00,000
2. Long Term Borrowings
Loans:
A Ltd. 4,00,000
C Ltd. 1,00,000 5,00,000
3. Current Liabilities:
A Ltd. 2,50,000
C Ltd. 50,000 3,00,000
4. Fixed Assets:
A Ltd. 26,25,000
C Ltd. 9,75,000 36,00,000
5. Current Assets:
A Ltd. 1,25,000
C Ltd. 25,000 1,50,000
26.13 Disclosures
A venturer should disclose the aggregate amount of the following contingent liabilities, unless
the probability of loss is remote, separately from the amount of other contingent liabilities:
a. Any contingent liabilities that the venturer has incurred in relation to its interests in joint
ventures and its share in each of the contingent liabilities which have been incurred jointly
with other venturers;
b. Its share of the contingent liabilities of the joint ventures themselves for which it is
contingently liable; and
c. Those contingent liabilities that arise because the venturer is contingently liable for the
liabilities of the other venturers of a joint venture.
A venturer should disclose the aggregate amount of the following commitments in respect of its
interests in joint ventures separately from other commitments:
a. Any capital commitments of the venturer in relation to its interests in joint ventures and its
share in the capital commitments that have been incurred jointly with other venturers; and
b. Its share of the capital commitments of the joint ventures themselves.
A venturer should disclose a list of all joint ventures and description of interests in significant
joint ventures. In respect of jointly controlled entities, the venturer should also disclose the
proportion of ownership interest, name and country of incorporation or residence. A venturer
should disclose, in its separate financial statements, the aggregate amounts of each of the
assets, liabilities, income and expenses related to its interests in the jointly controlled entities.
Reference: The students are advised to refer the full text of AS 27 “Financial Reporting
of Interests in Joint Ventures” (issued 2002).
27.1 Introduction
AS 28 came into effect in respect of accounting period commenced on or after 1-4-2004 and is
mandatory in nature from that date for the following:
(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 ` 50 crores.
In respect of all other enterprises, the Accounting Standard came into effect in respect of
accounting periods commenced on or after 1-4-2005 and is mandatory in nature from that date.
This standard prescribes the procedures to be applied to ensure that the assets of an
enterprise are carried at an amount not exceeding their recoverable amount (amount to be
recovered through use or sale of the asset). The standard also lays down principles for
reversal of impairment losses and prescribes certain disclosures in respect of impaired assets.
An enterprise is required to assess at each balance sheet date whether there is an indication
that an enterprise may be impaired. If such an indication exists, the enterprise is required to
estimate the recoverable amount and the impairment loss, if any, should be recognised in the
profit and loss account.
27.2 Scope
The standard should be applied in accounting for impairment of all assets except
1. inventories (AS 2),
2. assets arising under construction contracts (AS 7),
3. financial assets including investments covered under AS 13, and deferred tax assets
(AS 22).
There are chances that the provision on account of impairment losses may increase sickness
of companies and potentially sick companies may actually become sick.
Therefore, AS 28 applies to (among other assets):
• Land and buildings;
• Plant and machinery;
• Investment property;
• Intangible assets;
• Goodwill;
• Assets carried at revalued amounts under AS 10.
27.3 Assessment
An enterprise should assess at each balance sheet date whether there is any indication that
an asset may be impaired. If any such indication exists, the enterprise should estimate the
recoverable amount of the asset. An asset is impaired when the carrying amount of the asset
exceeds its recoverable amount. In assessing whether there is any indication that an asset
may be impaired, an enterprise should consider, as a minimum, the following indications:
External sources of information
a. During the period, an asset’s market value has declined significantly more than would be
expected as a result of the passage of time or normal use.
b. Significant changes with an adverse effect on the enterprise have taken place during the
period, or will take place in the near future, in the technological, market, economic or
legal environment in which the enterprise operates or in the market to which an asset is
dedicated.
c. Market interest rates or other market rates of return on investments have increased
during the period, and those increases are likely to affect the discount rate used in
calculating an asset’s value in use and decrease the asset’s recoverable amount
materially.
d. The carrying amount of the net assets of the reporting enterprise is more than its market
capitalization.
Internal sources of information
a. Evidence is available of obsolescence or physical damage of an asset.
b. Significant changes with an adverse effect on the enterprise have taken place during the
period, or are expected to take place in the near future, in the extent to which, or manner
in which, an asset is used or is expected to be used. These changes include plans to
discontinue or restructure the operation to which an asset belongs or to dispose of an
asset before the previously expected date and
c. Evidence is available from internal reporting that indicates that the economic
performance of an asset is, or will be, worse than expected.
The concept of materiality applies in identifying whether the recoverable amount of an asset
needs to be estimated.
If there is an indication that an asset may be impaired, this may indicate that the remaining
useful life, the depreciation method or the residual value for the asset need to be reviewed
and adjusted under the Accounting Standard 6, even if no impairment loss is recognised for
the asset.
Depreciable amount is the cost of an asset, or other amount substituted for cost in the
financial statements, less its residual value.
Useful life is either:
• The period of time over which an asset is expected to be used by the enterprise; or
• The number of production or similar units expected to be obtained from the asset by the
enterprise.
g. Estimates of future cash flows should not include cash inflows or outflows from financing
activities and also income tax receipts or payments.
Foreign Currency Future Cash Flows are estimated in the currency it will be generated and
after they are discounted for the time value of money, we convert them in the reporting
currency on the basis of AS 11.
Discount Rate
The discount rate(s) should be a pre-tax rate(s) that reflect(s) current market assessments of
the time value of money and the risks specific to the asset. The discount rate(s) should not
reflect risks for which future cash flow estimates have been adjusted. A rate that reflects
current market assessments of the time value of money and the risks specific to the asset is
the return that investors would require if they were to choose an investment that would
generate cash flows of amounts, timing and risk profile equivalent to those that the enterprise
expects to derive from the asset.
unit, an enterprise adjusts this information if internal transfer prices do not reflect
management’s best estimate of future market prices for the cash-generating unit’s output.
Cash-generating units should be identified consistently from period to period for the same
asset or types of assets, unless a change is justified.
27.10 Goodwill
Goodwill does not generate cash flows independently from other assets or groups of assets
and, therefore, the recoverable amount of goodwill as an individual asset cannot be
determined. As a consequence, if there is an indication that goodwill may be impaired,
recoverable amount is determined for the cash-generating unit to which goodwill belongs. This
amount is then compared to the carrying amount of this cash-generating unit and any
impairment loss is recognized. If goodwill can be allocated on a reasonable and consistent
basis, an enterprise applies the ‘bottom-up’ test only. If it is not possible to allocate goodwill
on a reasonable and consistent basis, an enterprise applies both the ‘bottom-up’ test and ‘top-
down’ test
a. If the carrying amount of the corporate asset can be allocated on a reasonable and
consistent basis to the cash-generating unit under review, an enterprise should apply the
‘bottom-up’ test only; and
b. If the carrying amount of the corporate asset cannot be allocated on a reasonable and
consistent basis to the cash-generating unit under review, an enterprise should apply
both the ‘bottom-up’ and ‘top-down’ tests.
loss should be recognized as income in the financial statement immediately. If impairment loss
was adjusted with the Revaluation Reserve; then reversal of impairment loss will be written
back to the reserve account to the extent it was adjusted, any surplus will be recognised as
revenue. But in any case the increased carrying amount of an asset due to a reversal of an
impairment loss should not exceed the carrying amount that would have been determined (net
of amortisation or depreciation) had no impairment loss been recognised for the asset in prior
accounting periods. This is mainly because any further increase in value of asset is
revaluation, which is governed by AS 10.
After a reversal of an impairment loss is recognised, the depreciation (amortisation) charge for
the asset should be adjusted in future periods to allocate the asset’s revised carrying amount,
less its residual value (if any), on a systematic basis over its remaining useful life.
(ii) The amount of the impairment loss recognised or reversed by class of assets
and by reportable segment based on the enterprise’s primary format (as defined in
AS 17); and
(iii) If the aggregation of assets for identifying the cash-generating unit has changed
since the previous estimate of the cash-generating unit’s recoverable amount (if
any), the enterprise should describe the current and former way of aggregating
assets and the reasons for changing the way the cash-generating unit is identified;
e. Whether the recoverable amount of the asset (cash-generating unit) is its net selling
price or its value in use;
f. If recoverable amount is net selling price, the basis used to determine net selling price
(such as whether selling price was determined by reference to an active market or in
some other way); and
g. If recoverable amount is value in use, the discount rate(s) used in the current estimate
and previous estimate (if any) of value in use.
If impairment losses recognised (reversed) during the period are material in aggregate to the
financial statements of the reporting enterprise as a whole, an enterprise should disclose a
brief description of the following:
a. The main classes of assets affected by impairment losses (reversals of impairment
losses);
b. The main events and circumstances that led to the recognition (reversal) of these
impairment losses.
27.20 Illustrations
Illustration 1
Ergo Industries Ltd. gives the following estimates of cash flows relating to fixed asset on
31-12-2016. The discount rate is 15%.
Year Cash Flow (` in lakhs)
2017 4000
2018 6000
2019 6000
2020 8000
2021 4000
Residual value at the end of 2021 = ` 1000 lakhs
Fixed Asset purchased on 1-1-2017 = ` 40,000 lakhs
Useful life = 8 years
Net selling price on 31-12-2016 = ` 20,000 lakhs
Calculate on 31-12-2016:
(a) Carrying amount at the end of 2016
(b) Value in use on 31-12-2016
(c) Recoverable amount on 31-12-2016
(d) Impairment loss to be recognized for the year ended 31-12-2016
(e) Revised carrying amount
(f) Depreciation charge for 2017
Solution
Calculation of value in use
Year Cash Flow Discount as per 15% Discounted cash flow
2017 4,000 0.870 3,480
2018 6,000 0.756 4,536
2019 6,000 0.658 3,948
2020 8,000 0.572 4,576
2021 4,000 0.497 1,988
2021 (residual) 1,000 0.497 497
19,025
Calculate “value in use” for plant if the discount rate is 10% and also calculate the recoverable amount
if net selling price of plant on 31.3.2017 is ` 60 lakhs.
Solution
Present value of future cash flow
Year ended Future Cash Flow Discount @ 10% Rate Discounted cash flow
31.3.2018 50 0.909 45.45
31.3.2019 30 0.826 24.78
31.3.2020 30 0.751 22.53
31.3.2021 20 0.683 13.66
31.3.2022 20 0.620 12.40
118.82
Present value of residual price on 31.3.2022 = 5 × 0.620 3.10
Present value of estimated cash flow by use of an asset and 121.92
residual value, which is called “value in use”.
If net selling price of plant on 31.3.2017 is ` 60 lakhs, the recoverable amount will be higher of
` 121.92 lakhs (value in use) and ` 60 lakhs (net selling price), hence recoverable amount is
` 121.92 lakhs.
Reference: The students are advised to refer the full text of AS 28 “Impairment of
Assets” (issued 2002).
ii. All commercial, industrial and business reporting enterprises having borrowings,
including public deposits, in excess of ` 1 crore but not in excess of ` 10 crore at
any time during the accounting period.
iii. Holding and subsidiary enterprises of any one of the above at any time during the
accounting period.
c. In its entirety, except paragraphs 66 and 67, for the enterprises, which do not fall in any
of the categories in (a) and (b) above.
Where an enterprise has been covered in any one or more of the categories in (a) above and
subsequently, ceases to be so covered, the enterprise will not qualify for exemption from
paragraph 67 of this Standard, until the enterprise ceases to be covered in any of the
categories in (a) above for two consecutive years.
Where an enterprise has been covered in any one or more of the categories in (a) or (b) above
and subsequently, ceases to be covered in any of the categories in (a) and (b) above, the
enterprise will not qualify for exemption from paragraphs 66 and 67 of this Standard, until the
enterprise ceases to be covered in any of the categories in (a) and (b) above for two
consecutive years.
Where an enterprise has previously qualified for exemption from paragraph 67 or paragraphs
66 and 67, as the case may be, but no longer qualifies for exemption from paragraph 67 or
paragraphs 66 and 67, as the case may be, in the current accounting period, this Standard
becomes applicable, in its entirety or, in its entirety except paragraph 67, as the case may be,
from the current period. However, the relevant corresponding previous period figures need not
be disclosed.
An enterprise, which, pursuant to the above provisions, does not disclose the information
required by paragraph 67 or paragraphs 66 and 67, as the case may be, should disclose the
fact.
28.2 Scope
This Standard should be applied in accounting for provisions and contingent liabilities and in
dealing with contingent assets, other than
a. Those resulting from financial instruments that are carried at fair value;
b. Those resulting from executory contracts;
c. Those arising in insurance enterprises from contracts with policy-holders; and
d. Those covered by another Accounting Standard.
Where another Accounting Standard like 7; 9; 15; 19; 22 & 24 deals with a specific type of
provision, contingent liability or contingent asset, an enterprise applies that Standard instead
of this Standard.
28.3 Definitions
Executory contracts are contracts under which neither party has performed any of its
obligations or both parties have partially performed their obligations to an equal extent.
Examples of executory contracts include:
• Employee contracts in respect of continuing employment;
• Contracts for future delivery of services such as gas and electricity;
• Obligations to pay local authority charges and similar levies; and
• Most purchase orders.
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 outflow from the enterprise of resources embodying economic
benefits.
An Obligating event is an event that creates an obligation that results in an enterprise having
no realistic alternative to settling that obligation.
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 recognised because:
(i) It is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
(ii) A reliable estimate of the amount of the obligation cannot be made.
A Contingent asset is a possible asset that arises from past events the existence of which
will be confirmed only by the occurrence or non-occurrence of one or more uncertain future
events not wholly within the control of the enterprise.
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.
A Restructuring is a programme that is planned and controlled by management, and
materially changes either:
(a) The scope of a business undertaken by an enterprise; or
(b) The manner in which that business is conducted.
28.4 Provisions
A provision should be recognised when:
(a) An enterprise has a present obligation as a result of a past event;
(b) It is probable that an outflow of resources embodying economic benefits will be required
to settle the obligation; and
(c) A reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision should be recognised.
For the purpose of this Statement, an outflow of resources or other event is regarded as
probable if the probability that the event will occur is greater than the probability that it will not.
Where it is not probable that a present obligation exists, an enterprise discloses a contingent
liability, unless the possibility of an outflow of resources embodying economic benefits is
remote.
28.14 Reimbursements
An, enterprise with a present obligation may be able to seek reimbursement of part or all of the
expenditure from another party, for example via:
• An insurance contract arranged to cover a risk;
• An indemnity clause in a contract; or
• A warranty provided by a supplier.
The basis underlying the recognition of a reimbursement is that any asset arising is separate from
the related obligation. Consequently, such a reimbursement should be recognised only when it is
virtually certain that it will be received consequent upon the settlement of the obligation.
In most cases, the enterprise will remain liable for the whole of the amount in question so that
the enterprise would have to settle the full amount if the third party failed to pay for any
reason. In this situation, a provision is recognised for the full amount of the liability, and a
separate asset for the expected reimbursement is recognised when it is virtually certain that
reimbursement will be received if the enterprise settles the liability.
In some cases, the enterprise will not be liable for the costs in question if the third party fails
to pay. In such a case, the enterprise has no liability for those costs and they are not included
in the provision.
28.17.2 Restructuring
The following are examples of events that may fall under the definition of restructuring:
(a) Sale or termination of a line of business;
(b) The closure of business locations in a country or region or the relocation of business activities
from one country or region to another;
(c) Changes in management structure, for example, eliminating a layer of management; and
(d) Fundamental re-organisations that have a material effect on the nature and focus of the
enterprise's operations.
A provision for restructuring costs is recognised only when the recognition criteria for provisions.
No obligation arises for the sale of an operation until the enterprise is committed to the sale, i.e.,
there is a binding sale agreement. Until there is a binding sale agreement, the enterprise will be
able to change its mind and indeed will have to take another course of action if a purchaser cannot
be found on acceptable terms.
A restructuring provision should include only the direct expenditures arising from the restructuring,
which are those that are both:
(a) Necessarily entailed by the restructuring; and
(b) Not associated with the ongoing activities of the enterprise.
A restructuring provision does not include such costs as:
(a) Retraining or relocating continuing staff;
(b) Marketing; or
(c) Investment in new systems and distribution networks.
These expenditures relate to the future conduct of the business and are not liabilities for
restructuring at the balance sheet date. Such expenditures are recognised on the same basis as if
they arose independently of a restructuring.
Identifiable future operating losses up to the date of a restructuring are not included in a provision.
As required by paragraph 44, gains on the expected disposal of assets are not taken into account
in measuring a restructuring provision, even if the sale of assets is envisaged as part of the
restructuring.
28.18 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.
SMCs are exempt from the disclosure requirements of AS 29
An enterprise should disclose the following for each class of provision:
(a) A brief description of the nature of the obligation and the expected timing of any resulting
outflows of economic benefits;
(b) An indication of the uncertainties about those outflows. Where necessary to provide
adequate information, an enterprise should disclose the major assumptions made
concerning future events, and
(c) The amount of any expected reimbursement, stating the amount of any asset that has
been recognised for that expected reimbursement.
SMCs are exempt from the disclosure requirements of AS 29
Unless the possibility of any outflow in settlement is remote, an enterprise should disclose for
each class of contingent liability at the balance sheet date a brief description of the nature of
the contingent liability and, where practicable:
Outcome of each case is to be taken as a separate entity. Ascertain the amount of contingent loss and
the accounting treatment in respect thereof.
Solution
According to AS 29 ‘Provisions, Contingent Liabilities and Contingent Assets’, contingent liability should
be disclosed in the financial statements if following conditions are satisfied:
(i) There is a present obligation arising out of past events but not recognized as provision.
(ii) It is not probable that an outflow of resources embodying economic benefits will be required to
settle the obligation.
(iii) The possibility of an outflow of resources embodying economic benefits is also remote.
(iv) The amount of the obligation cannot be measured with sufficient reliability to be recognized as
provision.
In this case, the probability of winning of first five cases is 100% and hence, question of providing for
contingent loss does not arise. The probability of winning of next ten cases is 60% and for remaining
five cases is 50%. As per AS 29, we make a provision if the loss is probable. As the loss does not
appear to be probable and the possibility of an outflow of resources embodying economic benefits is
remote, therefore disclosure by way of note should be made. For the purpose of the disclosure of
contingent liability by way of note, amount may be calculated as under:
Expected loss in next ten cases = 30% of ` 1,20,000 + 10% of ` 2,00,000
= ` 36,000 + ` 20,000
= ` 56,000
Expected loss in remaining five cases = 30% of ` 1,00,000 + 20% of ` 2,10,000
= ` 30,000 + ` 42,000
= ` 72,000
To disclose contingent liability on the basis of maximum loss will be highly unrealistic. Therefore, the
better approach will be to disclose the overall expected loss of ` 9,20,000 (` 56,000 × 10 + ` 72,000 × 5)
as contingent liability.
Reference: The students are advised to refer the full text of AS 29 “Provisions,
Contingent Liabilities and Contingent Assets” (issued 2003).
3. GN(A) 11 (Issued 1997) Guidance Note on Accounting for Corporate Dividend Tax.
4. GN(A) 12 (Revised 2000) Guidance Note on Accounting Treatment for Excise Duty.
5. Guidance Note on Accounting Treatment for MODVAT/ CENVAT.
6. GN(A) 18 (Issued 2005) Guidance Note on Accounting for Employee Share-base
Payments.
7. GN(A) 22 (Issued 2006) Guidance Note on Accounting for Credit Available in Respect of
Minimum Alternative Tax under the Income-tax Act, 1961.
8. GN(A) 24 (Issued 2006) Guidance Note on Measurement of Income Tax Expense for
Interim Financial Reporting in the Context of AS 25.
9. Guidance Note on Applicability of AS 25 to Interim Financial Results.
10. Guidance Note on Turnover in case of Contractors.
11. Guidance Note on Schedule III to the Companies Act, 2013.
12. Guidance Note on Accounting for Expenditure on Corporate Social Responsibility
Activities.
13. Guidance Note on Accounting for Derivative Contracts.
14. Guidance Note on Accounting for Depreciation in Companies in the context of
Schedule II to the Companies Act, 2013.
The students are advised to go through the full text of all the Guidance Notes from the
Accounting Pronouncements given along with this Study Material. Students may also
check the following link for the full text of the Guidance Notes on our Institute’s
website:
http://www.icai.org/post.html?post_id=1399
expenses, assets and liabilities. A section of the Guidance Note is devoted to the concept of
materiality vis-a-vis accrual basis of accounting. It also provides guidance to the auditor in
case a company has not maintained its accounts on accrual basis. Illustrations highlighting
application of the principles explained in the Guidance Note to certain important commercial
situations have also been given in the Guidance Note.
Certain fundamental accounting assumptions underlie the preparation and presentation of
financial statements. “Accrual” is one of the fundamental accounting assumptions. Para 27 of
the Accounting Standard on Disclosure of Accounting Policies (AS 1), issued by the Institute
of Chartered Accountants of India (ICAI), provides that if fundamental accounting
assumptions, viz., going concern, consistency and accrual are not followed, the fact should be
disclosed.
GN(A) 11 (Issued 1997) Guidance Note on Accounting for Corporate Dividend Tax
Corporate Dividend Tax (CDT) is in addition to the income-tax chargeable in respect of the
total income of a domestic company and was introduced under The Finance Act, 1997. The
Guidance Note on Accounting for Corporate Dividend Tax explains the salient features of
Corporate Dividend tax (CDT). As per the Guidance Note, CDT on dividend, being directly
linked to the amount of the dividend concerned, should also be reflected in the accounts of the
same financial year even though the actual tax liability in respect thereof may arise in a
different year. The liability in respect of CDT arises only if the profits are distributed as
dividends whereas the normal income-tax liability arises on the earning of the taxable profits.
Since the CDT liability relates to distribution of profits as dividends which are disclosed ‘below
the line’, it is appropriate that the liability in respect of CDT should also be disclosed ‘below
the line’ as a separate item. It is felt that such a disclosure would give a proper picture
regarding payments involved with reference to dividends.
GN(A) 12 (Revised 2000) Guidance Note on Accounting Treatment for Excise Duty
Excise duty is a duty on manufacture or production of excisable goods in India. Section 3 of
the Central Excise Act, 1944, deals with charge of Excise Duty. This Section provides that a
duty of excise on excisable goods which are produced or manufactured in India shall be levied
and collected in such manner as may be prescribed. The subject of accounting of excise duty
has, so far, beset with certain controversies, yet, the ICAI with the issuance of this Guidance
Note, has recommended practices which are broadly in accordance with the generally
accepted accounting principles would be well established. Subsequent to the issuance of that
Guidance Note, the nature of excise duty has been further clarified by some Supreme Court
decisions. Further, the principles to be followed for the valuation of inventories have been
explained in the Accounting Standard (AS) 2 on ‘Valuation of Inventories’ issued by the
Institute of Chartered Accountants of India. This Guidance Note recommends accounting
treatment for Excise Duty in respect of excisable goods produced or manufactured by an
enterprise. A separate Guidance Note on Accounting Treatment for MODVAT sets out
principles for accounting for MODVAT (now renamed as ‘CENVAT’). In considering the
appropriate treatment of excise duty for the purpose of determination of cost for inventory
valuation, it is necessary to consider whether excise duty should be considered differently
from other expenses. As per the recommendations given in the Guidance Note, Excise duty
the balance standing to the credit of the relevant equity account should be transferred to
general reserve.
For cash-settled employee share-based payment plans, the enterprise should measure the
services received and the liability incurred at the fair value of the liability. Until the liability is
settled, the enterprise is required to re-measure the fair value of the liability at each reporting
date and at the date of settlement, with any changes in value recognised in profit or loss for
the period.
For employee share-based payment plans in which the terms of the arrangement provide
either the enterprise or the employee with a choice of whether the enterprise settles the
transaction in cash or by issuing shares, the enterprise is required to account for that
transaction, or the components of that transaction, as a cash-settled share-based payment
plan if, and to the extent that, the enterprise has incurred a liability to settle in cash (or other
assets), or as an equity-settled share-based payment plan if, and to the extent that, no such
liability has been incurred.
Accounting for employee share-based payment plans is based on the fair value method. There
is another method known as the 'Intrinsic Value Method' for valuation of employee share-
based payment plans. Intrinsic value, in the case of a listed company, is the amount by which
the quoted market price of the underlying share exceeds the exercise price of an option. In the
case of a non-listed company, since the shares are not quoted on a stock exchange, value of
its shares is determined on the basis of a valuation report from an independent valuer. For
accounting for employee share-based payment plans, the intrinsic value may be used, mutatis
mutandis, in place of the fair value as described in paragraphs 5 to 14.
Apart from the above, the Guidance Note also deals with various other significant aspects of
the employee share-based payment plans including those related to performance conditions,
modifications to the terms and conditions of the grant of shares or stock options, reload
feature, graded vesting, earnings-per-share implications, accounting for employee share-
based payments administered through a trust, etc. The Guidance Note also recommends
detailed disclosure requirements. The appendices to the Guidance Note provide detailed
guidance on measurement of fair value of shares and stock options, including determination of
various inputs to the option-pricing models and examples to illustrate application of various
principles recommended in the Guidance Note.
GN(A) 22 (Issued 2006) Guidance Note on Accounting for Credit Available in Respect of
Minimum Alternative Tax under the Income-tax Act, 1961
The Finance Act, 2005, inserted sub-section (1A) to section 115JAA, to grant tax credit in
respect of MAT paid under section 115JB of the Act with effect from assessment year 2006-07.
This Guidance Note deals with various aspects of accounting and presentation of MAT paid
and the credit available in this regard. The Guidance Note describes the salient features of
MAT credit and its accounting treatment. MAT credit should be recognised as an asset only
when and to the extent there is convincing evidence that the company will pay normal income
tax during the specified period. MAT credit is a deferred tax asset for the purposes of AS 22.
A company should write down the carrying amount of the MAT credit asset to the extent there
is no longer a convincing evidence to the effect that the company will pay normal income tax
during the specified period. Where a company recognises MAT credit as an asset on the
basis of the considerations specified in the guidance note, the same should be presented
under the head ‘Loans and Advances’ since, there being a convincing evidence of realisation
of the asset, it is of the nature of a pre-paid tax which would be adjusted against the normal
income tax during the specified period. The asset may be reflected as ‘MAT credit
entitlement’. In the year of set-off of credit, the amount of credit availed should be shown as a
deduction from the ‘Provision for Taxation’ on the liabilities side of the balance sheet. The
unavailed amount of MAT credit entitlement, if any, should continue to be presented under the
head ‘Loans and Advances’ if it continues to meet the considerations stated in paragraph the
guidance note. According to paragraph 6 of Accounting Standards Interpretation (ASI) 6 ∗,
‘Accounting for Taxes on Income in the context of Section 115JB of the Income-tax Act, 1961’,
issued by the Institute of Chartered Accountants of India, MAT is the current tax. Accordingly,
the tax expense arising on account of payment of MAT should be charged at the gross
amount, in the normal way, to the profit and loss account in the year of payment of MAT. In
the year in which the MAT credit becomes eligible to be recognised as an asset in accordance
with the recommendations contained in this Guidance Note, the said asset should be created
by way of a credit to the profit and loss account and presented as a separate line item therein.
GN(A) 24 (Issued 2006) Guidance Note on Measurement of Income Tax Expense for
Interim Financial Reporting in the Context of AS 25
Accounting Standard (AS) 25, ‘Interim Financial Reporting’, issued by the Council of the
Institute of Chartered Accountants of India (ICAI), prescribes the minimum content of an
interim financial report and the principles for recognition and measurement in complete or
condensed financial statements for an interim period. AS 25 became mandatory in respect of
accounting periods commencing on or after 1st April, 2002. In accordance with the Accounting
Standards Interpretation (ASI) 27, ‘Applicability of AS 25 to Interim Financial Results’, the
recognition and measurement principles laid down in AS 25 should be applied for recognition
and measurement of items contained in the interim financial results presented under Clause
41 of the Listing Agreement entered into between stock exchanges and the listed enterprises.
This Guidance Note deals with the measurement of income tax expense for the purpose of
inclusion in the interim financial reports. Accounting for interim period income-tax expense is
based on the approach prescribed in AS 25 that the interim period is part of the whole
accounting year (often referred to as the ‘integral approach’) and, therefore, the said expense
should be worked out on the basis of the estimated weighted average annual effective
income-tax rate. According to this approach, the said rate is determined on the basis of the
taxable income for the whole year, and applied to the accounting income for the interim period
in order to determine the amount of tax expense for that interim period. This is in contrast to
accounting for certain other expenses such as depreciation which is based on the approach
prescribed in AS 25 that the interim period should be considered on stand-alone basis (often
referred to as the ‘discrete approach’) because expenses such as depreciation are worked out
on the basis of the period for which a fixed asset was available for use. The aforesaid
treatments are, however, consistent with the requirement contained in paragraph 27 of AS 25
∗
Now Explanation to AS 22.
that an enterprise should apply the same accounting policies in its interim financial statements
as are applied in its annual financial statements.
GN(A) 28 Guidance Note on Applicability of AS 25 to Interim Financial Results
This Guidance Note deals with the issue whether Accounting Standard (AS) 25, Interim
Financial Reporting, is applicable to interim financial results presented by an enterprise
pursuant to the requirements of a statute/regulator, for example, quarterly financial results
presented under Clause 41 of the Listing Agreement entered into between Stock Exchanges
and the listed enterprises.
The presentation and disclosure requirements contained in AS 25 should be applied only if an
enterprise prepares and presents an ‘interim financial report’ as defined in AS 25. Accordingly,
presentation and disclosure requirements contained in AS 25 are not required to be applied
in respect of interim financial results (which do not meet the definition of ‘interim financial
report’ as per AS 25) presented by an enterprise. For example, quarterly financial results
presented under Clause 41 of the Listing Agreement entered into between Stock Exchanges
and the listed enterprises do not meet the definition of ‘interim financial report’ as per AS 25.
However, the recognition and measurement principles laid down in AS 25 should be applied
for recognition and measurement of items contained in such interim financial results.
GN(A) 29 Guidance Note on Turnover in Case of Contractors
This Guidance Note deals with the issue whether the revenue recognised in the financial
statements of contractors as per the requirements of Accounting Standard (AS) 7,
Construction Contracts (revised 2002), can be considered as ‘turnover’.
The amount of contract revenue recognised as revenue in the statement of profit and loss as
per the requirements of AS 7 (revised 2002), should be considered as ‘turnover’.
Guidance Note on Schedule III to the Companies Act, 2013
The objective of this Guidance Note is to provide guidance in the preparation and presentation
of Financial Statements of companies in accordance with various aspects of the Schedule III.
However, it does not provide guidance on disclosure requirements under Accounting
Standards, other pronouncements of the Institute of Chartered Accountants of India (ICAI),
other statutes, etc.
Guidance Note on Accounting for Expenditure on Corporate Social Responsibility
Activities.
The objective of this Guidance Note is to provide guidance on recognition, measurement,
presentation and disclosure of expenditure on activities relating to corporate social
responsibility.
The Guidance Note does not deal with identification of activities that constitute CSR activities
but only provides guidance on accounting for expenditure on CSR activities in line with the
requirements of the generally accepted accounting principles including the applicable
Accounting Standards.
The Act clearly lay down that the expenditure on CSR activities is to be disclosed only in the
Board’s Report in accordance with the Rules made thereunder. In view of this, no provision for
the amount which is not spent, i.e., any shortfall in the amount that was expected to be spent
as per the provisions of the Act on CSR activities and the amount actually spent at the end of
a reporting period, may be made in the financial statements. The proviso to section 135 (5) of
the Act, makes it clear that if the specified amount is not spent by the company during the
year, the Directors’ Report should disclose the reasons for not spending the amount.
However, if a company has already undertaken certain CSR activity for which a liability has
been incurred by entering into a contractual obligation, then in accordance with the generally
accepted principles of accounting, a provision for the amount representing the extent to which
the CSR activity was completed during the year, needs to be recognized in the financial
statements.
Where a company spends more than that required under law, a question arises as to whether
the excess amount ‘spent’ can be carried forward to be adjusted against amounts to be spent
on CSR activities in future period. Since ‘2% of average net profits of immediately preceding
three years’ is the minimum amount which is required to be spent under section 135 (5) of the
Act, the excess amount cannot be carried forward for set off against the CSR expenditure
required to be spent in future.
A company may decide to undertake its CSR activities approved by the CSR Committee with a
view to discharge its CSR obligation as arising under
section 135 of the Act in the following three ways:
(a) making a contribution to the funds as specified in Schedule VII to the Act; or
(b) through a registered trust or a registered society or a company established under section
8 of the Act (or section 25 of the Companies Act, 1956) by the company, either singly or
along with its holding or subsidiary or associate company or along with any other
company or holding or subsidiary or associate company of such other company, or
otherwise; or
(c) in any other way in accordance with the Companies (Corporate Social Responsibility
Policy) Rules, 2014, e.g. on its own.
In case a contribution is made to a fund specified in Schedule VII to the Act, the same would
be treated as an expense for the year and charged to the statement of profit and loss. In case
the amount is spent in the manner as specified in paragraph10 (b) above the same will also be
treated as expense for the year by charging off to the statement of profit and loss. The
accounting for expenditure incurred by the company otherwise e.g. on its own would be
accounted for in accordance with the principles of accounting as explained hereinafter.
In case the expenditure incurred by the company is of such nature which may give rise to an
‘asset’, a question may arise as to whether such an ‘asset’ should be recognised by the
company in its balance sheet. In this context, it would be relevant to note the definition of the
term ‘asset’.
Invariably future economic benefits from a ‘CSR asset’ would not flow to the company as any
surplus from CSR cannot be included by the company in business profits in view of Rule 6(2)
of the Companies (Corporate Social Responsibility Policy) Rules, 2014.
In some cases, a company may supply goods manufactured by it or render services as CSR
activities. In such cases, the expenditure incurred should be recognised when the control on
the goods manufactured by it is transferred or the allowable services are rendered by the
employees. The goods manufactured by the company should be valued in accordance with the
principles prescribed in Accounting Standard (AS) 2, Valuation of Inventories. The services
rendered should be measured at cost. Indirect taxes (like excise duty, service tax, VAT or
other applicable taxes) on the goods and services so contributed will also form part of the
CSR expenditure.
Where a company receives a grant from others for carrying out CSR activities, the CSR
expenditure should be measured net of the grant.
Rule 6 (2) of the Companies (Corporate Social Responsibility Policy) Rules, 2014, requires
that “the surplus arising out of the CSR projects or programs or activities shall not form part of
the business profit of a company”. any surplus arising out of CSR project or programme or
activities shall be recognised in the statement of profit and loss and since this surplus cannot
be a part of business profits of the company, the same should immediately be recognised as
liability for CSR expenditure in the balance sheet and recognised as a charge to the statement
of profit and loss. Accordingly, such surplus would not form part of the minimum ‘2% of the
average net profits of the company made during the three immediately preceding financial
years in pursuance of its Corporate Social Responsibility Policy’.
It is recommended that all expenditure on CSR activities, that qualify to be recognised as
expense in accordance with paragraphs 10-14 above should be recognised as a separate line
item as ‘CSR expenditure’ in the statement of profit and loss. Further, the relevant note should
disclose the break-up of various heads of expenses included in the line item ‘CSR
expenditure’.
Guidance Note on Accounting for Derivative Contracts.
The objective of this Guidance Note is to provide guidance on recognition, measurement,
presentation and disclosure for derivative contracts so as to bring uniformity in their
accounting and presentation in the financial statements. This Guidance Note also provides
accounting treatment for such derivatives where the hedged item is covered under notified
Accounting Standards, e.g., a commodity, an investment, etc., because except AS 11, no
other notified Accounting Standard prescribes any accounting treatment for derivative
accounting. This Guidance Note, however, does not cover foreign exchange forward contracts
which are within the scope of AS 11. This Guidance Note is an interim measure to provide
recommendatory guidance on accounting for derivative contracts and hedging activities
considering the lack of mandatory guidance in this regard with a view to bring about uniformity
of practice in accounting for derivative contracts by various entities.
This Guidance Note covers all derivative contracts that are not covered by an existing notified
Accounting Standard. Hence, it does not apply to the following:
(i) Foreign exchange forward contracts (or other financial instruments which in substance
are forward contracts covered) by AS 11.
(ii) Derivatives that are covered by regulations specific to a sector or specified set of entities.
The accounting for derivatives covered by this Guidance Note is based on the following key
principles:
(i) All derivative contracts should be recognised on the balance sheet and measured at fair
value.
(ii) If any entity decides not to use hedge accounting as described in this Guidance Note, it
should account for its derivatives at fair value with changes in fair value being recognised
in the statement of profit and loss.
(iii) If an entity decides to apply hedge accounting as described in this Guidance Note, it
should be able to clearly identify its risk management objective, the risk that it is hedging,
how it will measure the derivative instrument if its risk management objective is being
met and document this adequately at the inception of the hedge relationship and on an
ongoing basis.
(iv) An entity may decide to use hedge accounting for certain derivative contracts and for
derivatives not included as part of hedge accounting, it will apply the principles at (i) and
(ii) above.
(v) Adequate disclosures of accounting policies, risk management objectives and hedging
activities should be made in its financial statements
Hedge accounting may be required due to accounting mismatches in:
• Measurement –
• Recognition
Types of hedge accounting
This Guidance Note recognises the following three types of hedging;
• the fair value hedge accounting model is applied when hedging the risk of a fair value
change of assets and liabilities already recognised in the balance sheet, or a firm
commitment that is not yet recognised.
• the cash flow hedge accounting model is applied when hedging the risk of changes in
highly probable future cash flows or a firm commitment in a foreign currency.
• the hedge of a net investment in a foreign operation.
Derivative assets and liabilities recognised on the balance sheet at fair value should be
presented as current and non-current.
Illustration
A Limited is a company incorporated under the Companies Act, 1956, engaged in the business of
manufacturing of toys. A Limited purchased a unit of machinery costing ` 60 lakhs as on April 01, 2014.
As per Schedule II the general useful life of the assets is15 years. However, as per A Ltd.’s estimation,
the useful life of the asset is 20 years supported by the technical advice.
Should the company use the useful life as 15 years or 20 years?
Solution
In this case, keeping in view the requirements under Schedule II, A Ltd. should depreciate the
machinery over its useful life of 20 years as determined by the company and not over 15 years as
indicated in Schedule II. A limited should also provide disclosures in this regard as recommended later
in this Guidance Note in the notes to accounts to justify the reason for difference between the indicative
use life and A’s estimated useful life.
Illustration
B Limited had considered the minimum rates of depreciation mentioned in Schedule XIV for
depreciating all its fixed assets till March 31, 2014. Based on the rates mentioned for SLM and WDV in
Schedule XIV, B Limited had derived the useful lives for the assets. Schedule II of the Companies Act,
2013 is now applicable to B Limited w.e.f. April 1, 2014.
Whether B Limited needs to follow the useful lives mentioned in the Schedule II or derived useful lives
considered till March 31, 2013 can be considered?
Solution
W.e.f. April 1, 2014, B limited should estimate the remaining useful lives of its assets based on the
definition of useful life in Schedule II and the factors specified in AS 6 for recognising depreciation in
the statement of profit and loss. There is no relevance of the derived useful life as per Schedule XIV.
However, if B Limited estimates useful lives different from those specified in Schedule II, it should
disclose such differences in the financial statements and provide justification in this behalf duly
supported by technical advice.
CPP is distinct from the repetitive process plant or assembly-line type plants. These plants are not
CPP since such plants do not involve significant shut-down and/or start-up costs and are not
technically required and designed to operate twenty-four hours a day, e.g., an automobile
manufacturing plant.
It is noted that extra shift depreciation does not apply to CPP and the assets which have been
marked as No Extra Shift Depreciation (NESD) under Schedule II. The concept of extra shift
depreciation applies only to those assets for which the useful life has been estimated on single shift
basis at the beginning of the year
Where a company, which estimated the useful life of an asset on single shift basis at the beginning
of the year, used the asset on double or triple shifts during the year, the depreciation expense
should be increased by 50% or 100% as the case may be for that period. Further, for such assets,
the company at the beginning of the next year should determine whether the asset used in extra
shift during the past year was on sporadic basis and is expected to be used on sporadic basis in
future also. In such a case, the useful life to be on single shift basis and if in future the asset is
used on double or triple shift then as in the past, the depreciation expense for the double or triple
shift should be increased by 50% or 100% as the case may be for the period of use. In case the
company estimates that the use of the asset for extra shift would not be on sporadic basis i.e. the
extra shift working for the asset would be on regular or continuous basis, it should reassess its
useful life considering its use on extra shift basis. The reassessed useful life should then be used
for the purpose of charging depreciation expense henceforth.
a result of application of Schedule II, a company may use UOP method, where appropriate,
keeping in view the various factors mentioned in paragraph 12 of AS 6. UOP method is generally
considered appropriate where the number of units that can be produced or serviced from the use of
the asset is the major limiting factor for the use of the asset rather than the time.
with the introduction of UOP method in Schedule II, a company may change from SLM or WDV
method to UOP method. In such cases, in accordance with AS 6, depreciation on the underlying
asset should be calculated retrospectively using the UOP method from the date the asset came
into use to the company with adjustment of any surplus or deficiency arising from change in
method to the statement of profit and loss as such change is required by the statute. However, as a
first time application of Schedule II, if a company changes its method of depreciation from WDV to
SLM or vice versa, the same cannot be justified as required by law as both the methods were
allowed under Schedule XIV and AS 6. In accordance with AS 6, a shift from WDV to SLM or vice
versa can only be applied by the company if it is considered that the change would result in a more
appropriate preparation or presentation of the financial statements of the company. In such a case
also, any surplus or deficiency arising from change in method should be adjusted to the statement
of profit and loss in accordance with AS 6. It may also be noted that in case of change in method of
depreciation, transitional provisions given under Note 7 (b) of Schedule II will not apply.
Illustration:
A Limited is a company incorporated under the Companies Act and engaged in the business of oil
exploration. Keeping in view the requirement in Schedule XIV it was depreciating its oil and gas assets on
SLM basis. In the financial year 2014-15, when A applies Schedule II it decides to depreciate the said assets
by following the UOP method.
How should change in method be accounted for?
Solution
In this case, in accordance with AS 6, A Limited should calculate depreciation on all such assets
following the UOP method since the assets came into existence and recognise any deficiency/gain in
the statement of profit and loss for the period ending on March 31, 2015.
Useful life specified in Part C of the Schedule is for whole of the asset. Where cost of a part of the
asset is significant to total cost of the asset and useful life of that part is different from the useful life
of the remaining asset, useful life of that significant part shall be determined separately. It is
commonly known as ‘component accounting’. Companies will need to identify and depreciate
significant components with different useful lives separately.
Under component accounting, companies will capitalise these costs as a separate component
of the asset and decapitalise the carrying amount of previously recognised component. A
company is required to apply component accounting (if appropriate) for all depreciable fixed
assets (existing or newly acquired) as at 1 April 2014 if a company opts to follow it voluntarily
and as at 1 April, 2015 mandatorily. However, if the carrying amount of any asset is lower than
or equal to the estimated residual value of the asset(s), company is not required to apply
component accounting for such asset(s).
The company must split the fixed asset into various identifiable parts to the extent possible.
The identified parts should be grouped together if they have the same or similar useful life for the
purpose of separate depreciation. Insignificant parts may be combined together in the remainder of
the asset or with the principal asset.
It may be noted that Schedule II does not prescribe any such requirement to provide
depreciation at the rate of hundred percent. Therefore, an issue may arise whether the earlier
requirement of providing hundred percent depreciation on assets with value less than rupees
five thousand can still be followed or not.
As the life of the asset is a matter of estimation, the materiality of impact of such charge
should be considered with reference to the cost of asset. The size of the company will also be
a factor to be considered for such policy. Accordingly, a company may have a policy to fully
depreciate assets upto certain threshold limits considering materiality aspect in the year of
acquisition.
The company may group additions and disposals in appropriate time period(s), e.g., 15 days,
a month, a quarter etc., for the purpose of charging pro rata depreciation in respect of additions
and disposals of its assets keeping in view the materiality of the amounts involved.
The use of different methods for similar assets at different geographical locations is not justified.
The cost of "converting" the raw materials into finished product amounts to ` 150 per unit of end
product of which ` 100 is "cash cost" paid immediately and ` 50 represents non-cash charge for
depreciation. There is no work in process.
Sales are effected at ` 750 per unit in respect of credit transactions and at ` 700 per unit in respect of
cash transactions. 20% of dispatches were in respect of cash transactions while the balance 80% were
in respect of credit transactions (one month credit).
You are required to:
(a) (i) Calculate MODVAT credit available, MODVAT credit availed of and balance in MODVAT
credit as on 30th April, 2017.
(ii) Show the necessary ledger accounts in respect of MODVAT.
(b) Value the inventory of:
(i) raw material
(ii) finished goods in warehouse
(iii) finished goods in finished goods godown on "first in first out" principle.
(c) Show the ledger accounts of customers, suppliers and bank, assuming that the necessary bank
balance is available at the start of the month to meet "cash" expenses of that month.
(d) Calculate the working capital as on 30th April, 2017.
(e) State the impact of 'MODVAT' on working capital requirement of the factory as on 30th April, 2017.
Solution
(a) (i) Excise duty paid on raw materials:
X Y Total
kgs. @ Amount kgs. @ Amount Amount
` ` `
Stock on
31st March, 2017 20,000 30 6,00,000 15,000 20 3,00,000 9,00,000
Purchases 50,000 30 15,00,000 50,000 20 10,00,000 25,00,000
21,00,000 13,00,000 34,00,000
Note: Normally goods are removed from factory on payment of excise duty. However, in
respect of certain goods, provision has been made to store the goods in warehouses
without payment of duty (Rule 20 of Central Excise Rules, 2002). These provisions are also
applicable to goods transferred to customs warehouse.
It is to be noted that as per para 33 of The Guidance Note on Accounting Treatment for
Excise Duty, it is necessary that a provision for liability in respect of unpaid excise duty
should be made in the accounts in respect of stocks lying in the factory or warehouse since
the liability for excise duty arises when the manufacture of the goods is completed.
(ii) MODVAT Credit Receivable Account
2015 ` 2015 `
April 1 To Balance b/d April By Excise Duty A/c 24,00,000
X 6,00,000 1 to 30
Y 3,00,000
9,00,000 April 30 By Balance c/d 10,00,000
April 1 To Suppliers A/c
to 30 X 15,00,000
Y 10,00,000
25,00,000 ________
34,00,000 34,00,000
Purchases Account
2015 ` 2015 `
April To Suppliers A/c April 30 By Balance c/d 1,02,50,000
1 to 30 X: [50,000 × (145 – 30)] 57,50,000
Y: [50,000 × (110 – 20)] 45,00,000 _________
1,02,50,000 1,02,50,000
(b) Valuation of Inventory
(i) Raw material:
X Y
(Kgs.) (Kgs.)
Opening stock 20,000 15,000
Purchases 50,000 50,000
70,000 65,000
Consumption 60,000 45,000
Closing stock 10,000 20,000
Inventory: `
X : 10,000 × (145 – 30) 11,50,000
Y : 20,000 × (110 – 20) 18,00,000
29,50,000
` `
To Balance b/d 40,00,000 By Cash Expenses (40,000 × 100) 40,00,000
To Sales (cash sales) A/c 42,00,000 By Balance c/d 42,00,000
20
× 30,000 × ` 700
100 _______
82,00,000 82,00,000
(d) Working Capital as on 30th April, 2017
Current Assets:
Inventory
(i) Raw materials
X 11,50,000
Y 18,00,000 29,50,000
(ii) Finished goods in warehouse 38,70,000
in finished goods godown 9,67,500 48,37,500
Customers 1,80,00,000
Bank balance 42,00,000
MODVAT credit receivable 10,00,000
3,09,87,500
Less: Current Liabilities
Sundry creditors (1,75,50,000)
1,34,37,500
the necessary Journal Entries explaining the treatment of CENVAT credit. You are also required to
indicate the value of plant at which it should be recorded in Fixed Asset register.
Answer
(i) Journal Entries
` in lakhs
(a) Plant and Machinery A/c Dr. 45
CENVAT credit receivable on capital goods A/c Dr. 5
To Bank A/c or Yash Ltd. 50
(Being capitalization of plant and machinery)
(b) Excise duty A/c Dr. 2.5
To CENVAT credit receivable on capital goods A/c 2.5
(Being excise duty set off available to the extent of 50% in the first
year of acquisition of capital asset)
(ii) Value of plant to be recorded in Fixed Asset Register: As per Guidance Note on "Accounting
Treatment for CENVAT", fixed assets have to be capitalised net of refundable amounts.
The plant and machinery will be recorded at ` 45 lakhs (` 50 lakhs - ` 5 lakhs) in the fixed asset
register.
Illustration 4
A Company has its share capital divided into shares of ` 10 each. On 1st April, 2016, it granted 10,000
employees’ stock options at ` 40, when the market price was ` 130. The options were to be exercised
between 16th December, 2016 and 15th March, 2017. The employees exercised their options for 9,500
shares only; the remaining options lapsed. The company closes its books on 31st March every year.
Show Journal Entries.
Solution
Journal Entries
Illustration 5
Mr. Investor buys a stock option of ABC Co. Ltd. in July, 2017 with a strike price ` 250 to be expired on
30th August, 2017. The premium is ` 20 per unit and the market lot is 100. The margin to be paid is
` 120 per unit.
Show the accounting treatment in the books of Buyer when:
(i) the option is settled by delivery of the asset, and
(ii) the option is settled in cash and the Index price is ` 260 per unit.
Solution
Accounting entries in the books of buyer ` `
July, 2017 Equity stock option premium Account Dr. 2,000
To Bank Account 2,000
(Being premium paid to acquire stock option)
Equity Stock Option Margin Account Dr. 12,000
To Bank Account 12,000
(Being initial margin paid on option)
(i) Option is setted by delivery of assets
August, 2017 Equity shares of ABC Ltd. Account Dr. 25,000
To Equity Stock Option Margin Account 12,000
To Bank Account 13,000
(Being option exercised and shares acquired. Margin
adjusted and the balance amount was paid)
Profit and loss Account Dr. 2,000
To Equity Stock Option Premium Account
(Being the premium transferred to profit and
loss account on exercise of option)
Illustration 6
H Ltd. engaged in the business of manufacturing lotus wine. The process of manufacturing this wine
takes around 18 months. Due to this reason H Ltd. has prepared its financial statements considering its
operating cycle as 18 months and accordingly classified the raw material purchased and held in stock
for less than 18 months as current asset. Comment on the accuracy of the decision and the treatment
of the asset by H Ltd., as per the Schedule III.
Solution
As per Schedule III to the Companies Act, 2013, one of the criteria for classification of an asset as a
current asset is that the asset is expected to be realised in the company’s’ operating cycle or is
intended for sale or consumption in the company’s normal operating cycle.
Further, Schedule III to the Companies Act, 2013 defines that an operating cycle is the time between
the acquisition of assets for processing and their realization in cash or cash equivalents. However,
when the normal operating cycle cannot be identified, it is assumed to have duration of 12 months.
As per the facts given in the question, the process of manufacturing of lotus wine takes around 18
months; therefore, its realisation into cash and cash equivalents will be done only when it is ready for
sale i.e. after 18 months. This means that normal operating cycle of the product is 18 months.
Therefore, the contention of the company's management that the operating cycle of the product lotus
wine is 18 months and not 12 months is correct.
Illustration 7
Combine Ltd. is a group engaged in manufacture and sale of industrial and consumer products. One of
its division deals with the real estate. The real estate division is continuously engaged in leasing of
real estate properties. The accountant showed the rent arising from leasing of real estate as ‘other
income’ in the Statement of Profit and Loss. State, whether the classification of the rent income made
by the accountant is correct or not in light of Schedule III to the companies Act, 2013?
Solution
As per para 4 of the ‘General Instructions for preparation of Statement of Profit and Loss’ given in
the Schedule III to the Companies Act, 2013, ‘other income’ does not include operating income.
However, rent income arising from leasing of real estate properties is an operating income as Real
Estate is one of the divisions of Combine Ltd. There is a separate head for operating income i.e.
‘Revenue from Operations’. Therefore, classification of rent income as ‘Other income’ in the
Statement of Profit and Loss will not be correct. It would, infact, be shown under the heading
‘Revenue from Operations’ only.
Illustration 8
Presented below is an extract of the Schedule of Secured and Unsecured Loans of Annual Report
2016-2017 of Super Star Ltd.
Particulars Schedule No As at
31st March, 2017
(`)
Loan Funds
a) Secured Loans 3 6,07,114
b) Unsecured Loans - Short Term Banks 36,112
6,43,226
Schedule 3: Secured Loans
Term Loans from:
- Banks 2,95,002
- Others 3,12,112
6,07,114
Other Information:
Current maturities of long-term loan from bank ` 30,000
Current maturities of long-term loan from other parties ` 15,376
There was no interest accrued/due as at end of the year.
Prepare appropriate note to accounts complying with the requirements of Schedule III to the
Companies Act, 2013 on the basis of available information.
Solution
Balance Sheet of Super Star Ltd.
As on 31st March, 2017
Particulars Note No Amount
Non Current Liabilities
Long term borrowings 4 5,61,738
Current Liabilities
Short term borrowings 5 36,112
Other current liabilities 6 45,376
6,43,226
Notes to Accounts
4. Long-Term Borrowings
Term loans – Secured
- from banks 2,95,002
- from other parties 3,12,112
6,07,114
It is assumed the Note 1 is for ‘Significant Accounting Policies’, Note 2 for ‘Share Capital’, Note 3 for
‘Reserves and Surplus’.
Illustration 9
Astha Ltd. has FCCBs worth ` 100 crore which are due to mature on 31st December 2016. While
preparing the financial statements for the year ending 31st March 2016, it is expected that the FCCB
holders will not exercise the option of converting the same to equity shares. How should the company
classify the FCCBs on 31st March 2016? Will your answer be different if the company expects that
FCCB holders will convert their holdings into equity shares of Astha Ltd.?
Solution
Schedule III to the companies Act, 2013 provides that:
“A liability shall be classified as current when it satisfies any of the following criteria:
(a) it is expected to be settled in the company’s normal operating cycle;
(b) it is held primarily for the purpose of being traded;
(c) it is due to be settled within twelve months after the reporting date; or
(d) the company does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting date. Terms of a liability that could, at the option of the
counterparty, result in its settlement by the issue of equity instruments and do not affect its
classification.”
In the present situation, Astha Ltd. does not have an unconditional right to defer settlement of the
liability for at least 12 months after the reporting date. The position will be same even when the FCCB
holders are expected to convert their holdings into equity shares of Astha Ltd. Expectations cannot be
called as unconditional rights. Thus, in both the situations, Astha Ltd. should classify the FCCBs as
current liabilities as on 31 March 2016.
Illustration 10
The Balance Sheet of Appropriate Ltd. as at 31st March, 2016 is as follows:
Comment on the presentation in terms of Schedule III to the Companies Act, 2013 and Accounting
Standards notified by the Central Government.
Solution
(1) Share Capital’ and ‘Reserves and Surplus’ are required to be shown under the heading
“Shareholders’ funds”, which have not been shown in the given balance sheet. Although it is a
part of ‘Equity and Liabilities’ yet it must be shown under the head “Shareholders’ Funds”. The
heading “Shareholders’ Funds” is missing in the balance sheet given in the question.
(2) Reserves & Surplus is showing zero balance, which is not correct since there is. Debit balance of
Statement of Profit & Loss. This debit balance of Profit and Loss should be shown as a negative
figure under the head ‘Surplus’. The balance of ‘Reserves and Surplus’, after adjusting negative
balance of surplus shall be shown under the head ‘Reserves and Surplus’ even if the resulting
figure is in the negative. It should be noted that Profit and Loss Debit Balance is not a part of
current assets rather debit balance of Statement of Profit and Loss shall be shown as a negative
figure under the head ‘Surplus’ as per requirement of Schedule III to the Companies Act, 2013.
(3) As per Schedule III to the Companies Act, 2013, Employee Stock Option Outstanding A/c is part
of Reserves and Surplus and should not be shown separately. Classification of Reserves and
Surplus should be reflected is ‘Notes to Accounts’ for the same.
(4) Share application money refundable shall be shown by way of note under the sub-heading “Other
Current Liabilities”. As this is refundable and not pending for allotment, hence it is not a part of
equity.
(5) Deferred Tax Liabilities has been correctly shown under Non-Current Liabilities. But Deferred tax
assets and deferred tax liabilities, both, can not be shown in balance sheet because only the net
balance of Deferred Tax Liabilities or Asset is to be shown as per para 29 of AS 22, Appropriate
Ltd. should offset Deferred Tax Asset & Deferred Tax Liabilities and the break up of Deferred Tax
Asset & Deferred Tax Liabilities into major components of the respective balance should be
disclosed in ‘Notes to Account’. Deferred Tax Asset shall be shown under Non-current Asset. It
should be the net balance of Deferred Tax Asset after adjusting the balance of deferred tax
liability.
(6) Under the main heading of Non-Current Assets, Fixed Assets are further classified as under:
(i) Tangible assets
(ii) Intangible assets
(iii) Capital work in Progress
(iv) Intangible assets under development.
Keeping in view the above, the Capital Work-in Progress shall be shown under Fixed Assets as
Capital Work in Progress. The amount of Capital advances included in CWIP shall be disclosed
under the sub-heading “Long term loans and advances” under the heading Non-Current Assets.
Reference: The students are advised to refer the full text of relevant Guidance Notes.