“PREFACE” There has been a long-standing demand from students & teachers to write a separate “Hand book” which
will contain brief explanation of Topics, Terms, and Important formulas, Format. I am very happy to introduce this “Hand book” for the benefits of students & teachers This done keeping in mind that this is the 1st year (FYJC) for the study of this subject, which will lay the foundation for vast & practical subject for the future. It strictly follows a “Student – friendly” approach and has been written purely in a “Teach- yourself “style. Thus, it would essentially serve as a Tutor at Home. As I discussed the topic in brief & in simple. Straightforward & easy language to make it easy for students to understand & remember. I express the hope that the teachers as well as the students will welcome this “Hand Book”. Any criticism or suggestion for further improvement of the book will be gratefully acknowledged & highly appreciated.
Prof. Jha Nishikant (“Nishi Sir”)
I.Sc., DCA, B.Com.,ICWA
1 / 34
What is Book –Keeping? “Book” means “Books of Accounts” & “ Keeping” means “ Maintaining the books of Accounts.” It is a Scientific Method to record day-to-day “ BUSINESS TRANSACTION” in books of Accounts in such a manner that it gives us a correct and clear picture of financial position of the business. Classification of Accounts:
Personal A/c Name of the person / Institution; Outstanding & prepaid Expenses (e.g. Nitin’s A/c, Thakur College A/c, O/s salary A/c etc)
As we are knowing that, in every transaction at least two aspects / amount are affected, this two fold Real A/c Related with Tangible & Intangible Assets or Things (e.g. Cash A/c, Goods A/c, Goodwill A/c, Land Building A/c, Plant & Machinery A/c)
Nominal A/c Related to Expenses / Losses & Income / Gains (e.g. Wages / Salary A/c, Rent A/c, Loss by fire / Theft A/c etc)
of every transaction in two Accounts is know as Double Entry System of Book – Keeping. Three Golden rules for Book – Keeping & Accountancy are a follows:
For Personal A/c: “DEBIT THE RECEIVER CREDIT THE GIVER”
e.g. .1. Nihikant Pays Rs3000/- to M/s Nishi & Co. Ans: DEBIT M/s Nishi & Co. A/c (As receiver) & CREDIT Nishikant’s A/c (As giver)
For Real A/c :
“DEBIT WHAT COMES IN ; CREDIT WHAT GOES OUT”
e.g. 2. Purchase goods for Cash Rs 3000/Ans; DEBIT Goods A/c (As comes in) CREDIT Cash A/c (As goes out)
For Nominal A/c: “ DEBIT ALL LOSSES & EXPENSES CREDIT ALL INCOME &* GAINS” e.g.3. Paid Salary Rs 3000/Ans: DEBIT Salary A/c (As expenses) CREDIT Cash A/c (As goes out) JOURNAL: It is a book of Prime Entry, in which daily transactions are recorded for the first time. JOURNALIZE: it means record the transactions by passing Journal Entry; i.e. giving effects of every transaction in terms of debit and credit by applying rules of Debit & Credit of different types of Account
2 / 34
Journal of ……….. Date DD/MM/YY e.g. Particulars Name of the A/c Debit……………Dr. To Name of A/c Credited. (Narration / Explanation) 1. Nishi & Co A/c………….....Dr. To Nishikant’s A/c (Being Nishikant Pays to Nishi & Co.) 2. Good A/c…………………..Dr. To Cash A/c (Being Purchase goods for Cash) 3. Salary A/c……………….…Dr. To Cash A/c (Being Salary paid) L/F Debit Amt ** 3000 3000 3000 3000 3000 Credit Amt **
LEDGER: “A Ledger A/c contains Summary statement of all the transactions to a Person, Asset, Expenses, and Incomes etc. which have taken place during a given period of time and show their Net Effect.” LEDGER POSTING: “An act of recording the transaction in the Ledger A/c on the basis of the entry made in Journal.” RULE OF POSTING: Same Sides, Same Amount, but Opposite A/c LEDGER of……. Dr. Date DD/MM/YY Particulars To Name of the A/c Credited Name of A/c J/F Amt. Date ** DD/MM/YY Particulars By Name of the A/c Debited Cr. J/F Amt **
Ledger posting of above three e.g. Dr. Date DD/MM/YY Dr. Date DD/MM/YY Dr. Date DD/MM/YY Dr. Date DD/MM/YY Dr. Date Particulars To Nishikant’s A/c M/s Nishi & Co. A/c J/F Amt. Date 3000 DD/MM/YY Particulars J/F Cr. Amt
Nishikant’s A/c Amt. Date DD/MM/YY Goods A/c J/F Amt. 3000 Salary A/c J/F Amt. 3000
Particulars By Nishi & Co. A/c
Cr. Amt 3000 Cr. Amt
Particulars To Cash A/c
Particulars To Cash A/c
Cash A/c Date
3 / 34
By Goods A/c By Salary A/c
Notes: i. In a specific ledger that A/c can never be Debited on Credited
If ledger A/c is having an opening balance then it will start with the word “ Balance b/d” (i.e. brought down). However if the ledger A/c is having a closing balance then it will close with the word “Balance c/d” (i.e. carried down) All closing balance of ledger A/c is transfer to “Trail Balance” at the end of every Financial Year. TRIAL Balance: If a statement showing the list of A/c with they’re closing balance i.e. either Debit or Credit balance.
It shows “ ARITHMETICAL ACCURACY” of ledger Posting. It should be tallied. If there is any difference, for time being it should be transferred to “SUSPENSE A/c.” There are two types of “Trial Balance “. They are as follows: Journal Form / Statement Form of Trail Balance: Trail Balance of……………as on ……….. Sr. No Particulars Capital Assets Total L/F Debit bl. ** ** Credit bl. ** **
4 / 34
Ledger From of Trail Balance: Trail Balance of……………as on ……….. Sr. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Particulars Purchase Sales Return / Return Inward Expenses / Loss Bad Debts Stock Drawings Debtors Bills Receivable Cash / Bank Balance Prepaid Expenses Outstanding Incomes Loan given Depreciation All Assets Total J/F Debit ** ** ** ** ** ** ** ** ** ** ** ** ** ** ** Sr. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Particulars Sales Purchase Return / Return Outward Incomes/ Gain Bad Debts Recovery Gross Profit Capital Creditors Bills payable Bank Overdraft Outstanding Expenses Advance income Loan taken Reserve / Funds All liabilities Total J/F Credit ** ** ** ** ** ** ** ** ** ** ** ** ** ** **
FINAL ACCOUNT OF SOLE TRADER: Final Account and Statement are prepared by a Trader at the end of financial year in order to find out Profit or Loss and the position of total Assets & Liabilities of the Business. What will be given in the Problem? a) Trial Balance & b) Adjustments We are required to prepare final account, which consist of the following: a. Trading Account b. Profit & Loss Account c. Proprietor’s Capital Account d. Balance Sheet Trading A/c for the year ended……………. Particulars To Opening Stock To Purchase Less: Purchase Returns To Exp related to Purchase Carriage Inward Octroi Duty Freight To Manufacturing Exp To Wages To Power & Fuel To All Factory Expenses To Gross Profit c/d (Bal Fig) Rs ** ** Particulars By Sales Less: Sales Return Rs ** ** ** ** ** ** **
** ** ** ** ** ***
By Closing Stock By Goods Loss by fire or theft By goods donated or withdrawn by Proprietor By goods distributed as free sample
By Gross Loss c/d (Bal. Fig)
Profit & LOSS ACCOUNT Profit and Loss Account for the year ended……………….. Particulars Rs Particulars Rs
5 / 34
To Gross Loss b/d Office Adm Exp: To Salaries To Office Rent To Print & Stationery To Sundry Expenses Selling & Dist Exp: To Commission to Salesman To Advertisement To Packing Charges To Carriage Outward To financial Expenses To Interest on Loan To Bad Debts To Loss on Sale of Asset To Discount Allowed Depreciation: To Plant & Machinery To Land & Building To Furniture To Net Profit c/d
** ** ** ** ** ** ** ** ** ** ** ** ** ** ** ** ** ** ***
By By By By By By By By By
Gross Profit b/d Discount Recd. Commission Recd Dividend Recd Bad Debts Recovered Interest Recd Apprenticeship Prem. Sundry Income Profit on Sale of Asset
** ** ** ** ** ** ** ** **
By Net Loss c/d
Particulars To Net Loss To Drawings To Interest on Drawings To Balance c/d (Trans. To B/s Liability Side)
Proprietor’s Capital Account Rs. Particulars ** By Balance B/d ** By Net Profit ** By Interest on Capital By Balance c/d ** (Trans. To B/s Assets Side) *** OR **** ** ** ** ****
Rs. ** ** ** ** ***
Proprietor’s Capital Account Opening Balance Add: Net Profit Less: Drawings Add: Interest on Capital Less: Interest on Drawings Balance Sheet as on …………. Liability Proprietor’s Capital A/c Loans from Bank Loans from others Current Liabilities: Sundry Creditors Bills Payable Outstanding Expenses Advance Income Bank Overdraft Rs ** ** ** ** ** ** ** **
Assets Fixed Asset: Goodwill Land & building Plant & Machinery Furniture Current Assets: Closing Assets: Closing Stock Loose Tolls Bills Receivable Cash at Bank Cash at Hand Outstanding Income Prepaid Expenses Deferred Revenue Expense
Rs ** ** ** ** ** ** ** ** ** ** ** ** **
6 / 34
Advertisement Suspense A/c Miscellaneous Expenses (Fictious) Suspense A/c ** *** IMPORTANT NOTES FOR FINAL ACCOUNTS: a. All items of Trial balance will have ONLY ONE EFFECT b. Items on the Debit side of the Trail Balance will appear EITHER on Trading Account DEBIT SIDE OR on Profit & Loss Account DEBIT SIDE OR on Balance Sheet ASSET SIDE c. Items on the Credit side of the Trading Balance will appear EITHER on Trading Account CREDIT SIDE OR on Profit & Loss A/c CREDIT SIDE OR on Balance Sheet LIABLITIES SIDE d. e. f. g.
** ** ** ***
All adjustment will have two effects. Generally speaking, all items relating to the goods and direct Expenses like Freight, Wages, Custom Duties, Fuel & Power etc. will be shown under Trading Account. All items of Incomes & Expenses (other than above direct expenses) will be shown under Profit & Loss Account Items of Assets and Liabilities will be shown in Balance Sheet.
ADJUSTMENTS: Certain transactions came to our notice after Trail Balance is prepared, however have to be considered while preparing Trading A/c, Profit & Loss A/c, Balance Sheet are know as adjustment. An item in adjustments will appear at two places while item in Trial Balance at only one place. Following are some of the Adjustments and its two effects in Final Accounts Question
7 / 34
No 1 2
Adjustments Closing Stock Outstanding Expenses
One Effect (Debit) Trading a/c. Credit Side Trading a/c OR P/L a/c Debit Side add to Expenses Trading a/c OR P/L a/c Debit Side less from Expenses P/L a/c Credit Side add to Income P/L a/c Credit Side less from Income P/L a/c Debit Side P/L a/c Debit Side Add to Bad Debts P/L a/c Debit Side add to Bad Debts P/L a/c Debit Side add to Discount allowed
Second Effect (Credit) Balance Sheet Asst Side Balance Sheet – Liabilities Side
Balance Sheet Asset Side
4 5 6 7 8 9
Outstanding Income Pre Received Income Depreciation Further Bad Debts R.B.D R.D.D
Balance Sheet Asset Side Balance Sheet – Liabilities Balance Sheet less from Assets Balance Sheet less from Debtors Balance Sheet less from Debtors Balance Sheet less from Debtors (Net)
Note: If old RBD / RDD is more than total of B>D / Discount allowed and new RBD /RDD the whole thing will come on the credit side of P/L a/c 10 Goods distributed as Samples Goods Withdrawn by Proprietor Trading a/c Credit Side P/L Debit Side as Advt Expense
Trading a/c Credit Side
Balance Sheet – Add to Drawings OR Less from Capital i.e.. Capital a/c Debit Side
Goods destroyed by fire
Trading a/c Credit Side
P/L a/c Debit Side as loss by fire (our share of loss) Balance Sheet Asset Side (for Insurance Claim receivable) P/L a/c Debit Side Balance Sheet add to Creditors liabilities Side Balance Sheet add to Debtors Asset side
Goods lost by theft Credit purchase left out to be recorded Credit sales left out to be recorded R.D.C
Trading a/c Credit Side Trading a/c add to purchase
Trading a/c add to Sales
P/L a/c credit side add
Balance Sheet – liabilities to Discount recd & less from Creditors
8 / 34
Subsidiary book are the division & sub – division of journal, so that time & labor could be saved by grouping similar transactions together & providing a separate book. The subsidiary book maintain by business organization are: a. Purchase book: to record all credit purchases of goods only
b. c. d. e. f. g. h. i.
Sales book: to record all credit sales of goods only Purchase Returns Book: to record goods returned to suppliers out of credit purchase Sales Returns Book: to record goods returned by customers out of credit sales of goods. Cash Book: to record all cash transactions only Analytical Petty Cash Book: to record Petty Payments Bills Receivable Book: To record all bills of exchange which are received from Debtors Bills Payable book: to record all Bills of exchange accepted & given to Creditors Journal Proper: it is used to record only those business transactions which cannot be entered in any of above eight books
It will record following transactions: a. Opening Entries b. Adjustments Entries c. Transfer Entries d. Closing Entries e. Rectification Entries f. Dishonor of bills & Promissory note entries g. Credit Purchase of assets h. Credit Sales Assets i. Bad Debts Entries Date Name of Supplier Format of Purchase Book L/F Inward Invoice No. Amt
Name of Customer
Format of Sales Book L/F Outward Invoice No.
Format of Purchase Return Book Name of the suppliers to whom goods are returned L/F Debit Note No. Format of Sales Return Book Name of the Customer who returns the goods L/F
Credit Note No.
Sr No 1. 2. 3. 4. 5. 6.
Rules to record a Transaction in Subsidiary Book: In ledger Reasons Party’s A/c Party’s A/c Purchase A/c Sales A/c Purchase Return A/c Sales Return A/c Debit Receiver Credit Giver Debit Good comes in Credit Goods goes out Debit Goods comes in
Sales / Purchase Return Purchase / Sales Return Total of Purchase Book Total of Sales Book Total of Purchase Return Book Total of Sales Return Book
9 / 34
CASH BOOK: The cashbook is a book of original entry. Where all cash & bank Transactions relating to receipt & payments are recorded. It serves the purpose of journal as well as ledger. Since the cashbook enables the trader to find out the daily cash & bank balance, there is no need to open separate Cash A/c & Bank A/c Different Types of Cash Book: i. Simple Cash Book is single column cashbook with one cash column on each side. ii. Double column cash book viz. Cash & Discount column on each side iii. Triple column cash book viz. Cash, Discount & Bank column on each side Dr. Date Receipts Format of three columns Cash Book Discount Cash Bank Date Receipts Discount Cr. Cash bank
PETTY CASH BOOK: Petty Cashbook is a separate cashbook where we record small or Petty Cash expenses of routine nature. It is of two Types: i. Simple Petty Cashbook ii. Analytical or columnar Petty Cashbook Specimen Form Bank Reconciliation Statement as on: Rs Bank Balance as per Cash Book Add: 1) ………………….. 2) ………………….. Less: 1) …………………... 2) …………………… Bank Balance as per Pass Book Transactions for the preparation of Bank Reconciliation Statement Cash Book Less Less NO NO Add Add Add NO NO NO NO NO Pass Book NO NO Less Less NO NO NO Add Add Add Add Less ** ** ** ** ** Rs ** ** **
Cheques issued but not presented (not encashed, or dishonored or lost) ii. Cheques drawn but not actually issued to parties iii. Cheque issued but not credited in cash book iv. Direct payment by the bank or transfer to other accounts v. Cheques deposited but not cleared (not realized, not collected, not credited or dishonored) vi. Cheques discounted but dishonored vii. Cheques debited in cash book but not deposited viii. Cheques or cash directly paid in bank by others or transfer from others a/c ix. Cheques deposited but not deposited in cash book x. Interest on deposits / investment, dividends credited in pass book xi. Wrong credit in pass book for deposit of Cheque, interest xii. Interest on overdraft, bank charges, commission etc debited in pass book xiii. Wrong Debit in passbook for issue of cheque, bank changes etc. xiv. Wrong on excess credit in cashbook on payment side
10 / 34
of cashbook has been overcast. xv. Short credit in cashbook or payment side of cashbook has been under cast. xvi. Short debit in cashbook or Receipt side of cashbooks has been under cast xvii.Wrong on excess debit in cashbook on Receipt side of cash book has been overcast
NO Less Add Add Add Less NO NO NO NO
RECTIFICATION of ERRORS Errors mean “Mistake” to rectify means “to correct or make right what is wrong.” Therefore, rectification of errors is the process of correcting a mistake or mistakes made. Different types of Errors and their rectification: i. One side Errors: such errors can be rectified by giving only the rectification effect, rectification entry is not necessary. E.g. Error of partial omission Debit or Credit entries are not posted art all or posted more than once Debits are wrongly posted as credits and vice versa Wrong totally of subsidiary books. Difference in the amount posted to the Debit and Credit of the concerned account of an entry Error in calculation of balance of an account Balance of an account wrongly recorded while preparing Trail Balance Error in taking total of any items on both the columns of a Trail Balance E.g., A credit sale of Rs. 1000 from Nihikant’s has not been posted to his account Solution: Nishikant’s a/c should be credited. ii. Two Side Errors: following steps are used in order to rectify the two side errors. 1st Step: Write wrong entry 2nd Step: Write Reverse Wrong Entry 3rd Step: wirte Correct Entry From reverse wrong entry & correct entry. We will have to pass “Rectification Entry” which will nullify & cancel the wrong effect which is already caused due to some errors & will give correct effect. They are: Error of Principle Compensating errors Writing wrong amount in Journal or subsidiary book Debiting or Crediting wrong A/c in Journal or subsidiary books or Ledger Recording transaction in wrong Subsidiary book Posting of wrong amount. Posting to wrong side of an A/c. Posting of wrong amount to wrong A/c Posting of wrong amount to wrong side of an A/c Posting to wrong A/c on wrong side Double posting. E.g.,1. Goods Rs. 3000/- sold to Nishikant has been debited to M/s Nishi & co.A/c
11 / 34
Solution: Entry Wrong Entry M/s Nishi & co A/c To Sales A/c Reverse Entry Sales A/c To M/s Nishi & Co A/c Correct Entry Nishikant’s A/c To Sales A/c Rectification Entry Nishikant’s A/c To M/s Nishi & Co A/c Dr Dr. 3000 Cr 3000
E.g.2. a credit purchase of Rs 3,000 from Nishikant is posted to his A/c as Rs. 30,000 Solution: Entry Wrong Entry Purchase a/c To Nihikant’s A/c Reverse Entry Nishikant’s A/c To Purchase A/c Correct Entry Purchase A/c To Nishikant’s A/c Rectification Entry Nishikant’s A/c To Purchase A/c Dr Dr. 3000 30000 Dr. 30000 3000 Dr. 3000 3000 Dr. 3000 3000 Cr
E.g. 3. A credit purchase from Nishi & Co has been wrongly recorded in sales book Rs. 3000/Solution: Entry Wrong Entry M/s Nishi & co A/c To Sales A/c Reverse Entry Sales A/c To M/s Nishi & Co A/c Correct Entry Purchase A/c To M/s Nishi & co A/c Rectification Entry Purchase A/c Sales A/c Dr Dr. 3000 Cr 3000
12 / 34
To M/s Nishi & Co A/c RECTIFICATION of Suspense A/c:
Suspense A/c is an artificial A/c, which is used to put difference of Trial balance. In order to avoid delay in the preparation of Final A/c. When errors are detected after preparing Trail Balance & Balance of Suspense A/c is given in the problem then it is necessary to pass the rectification entry & post them in suspense A/c that must tally after making all rectification & post them into suspense ledger.
Session 2 Chapter II Accounting Standards “The changing economic trend of the world requires balance sheet and accounts to be comparable and one that would reflect the common picture. Bringing Indian Accounting Standards on par with international standards is a step which will help the investor community and the entire corporate world” –(Arun Jaitley, Former Law Minister) Format 1. 2. 3. 4. 5. 6. of each standard contains: A statement of concepts and fundamental accounting principles relating to the standards. Definition of the terms used in standard. The manner in which the accounting principles have been applied for formulating the standard Presentation and disclosure requirements. Class of enterprise to which it applies Effective date.
Accounting Standards apply only to material items. The Accounting Standard Board (ASB) of the Institute of Chartered Accountants of India has issued the following Accounting Standards that are to be followed but its members. Accounting standards are collection of generally followed accounting principles, policies and practices. These help to ensure a common basis for financial statements different originations. This means that people can understand these more easily and make useful comparisons Financial Statements are at the centre of business reporting. Financial statements usually provide users with essential information that heavily influence their decisions. The US is the leader in financial reporting, and US Securities and Exchange Commission is respected for it role in formulating and implementing US GAAP despite the general vote of confidence. In India the Statements on Accounting Standards are issued by the Institute of Chartered Accountants of India (ICAI) to establish standards that have to be complied with to ensure that financial statements are prepared with generally accepted accounting standards in India (India GAAP) The Council of ICAI constituted the Accounting Standards Board (ASB) in April 1977 to formulate Accounting Standards. While formulating the Accounting Standards, ASB takes into consideration the
13 / 34
applicable laws, usages and business environment. However, users were strongly critical about certain aspects of financial statements and they offered or supported many substantive ideas for improvement. Standard setters, regulators, and many others devote considerate resources in maintaining and improving the standards. The new accounting norms are aimed at protecting share / holders interest and recommending ways of improving corporate governance AS-1: Disclosure of Accounting Policies. Effective date April 1993 This statements deal with the disclosures of significant accounting policies followed in preparing and presenting financial statements. The purpose of this statement is to promote preparing and presenting financial statements by instituting the disclosure of significant accounting policies in the financial statements and the manner of doing it. The emphasis in AS-1 is on disclosure of accounting policies in the presentation of financial statements. These are normally to be disclosed at one place. All the companies now follow this practice. Accounting Polices refer to the specified accounting principles, adopted by the enterprise and methods of applying these principles in the preparation and presentation of financial statements. Some of the areas in which such disclosure is to be made are as under: 1. Methods of depreciation, depletion, and amortization. 2. Treatment of expenditure during construction 3. Valuation of inventories 4. Conversion or translation of foreign currency items’ 5. Treatment of goodwill 6. Valuation of investments 7. Valuation of fixed asset 8. Recognition of profits on long term contracts 9. Treatment of retirement benefits 10. Treatment of contingent liabilities It is for the management to select the accounting policy to be followed by the enterprise. However, while making this selection, it is necessary to ensure that the financial statements present a true and fair view of the state of affairs. The major considerations to be followed during the selection of accounting policies are stated in AS-1 as under. Prudence: this is a world of uncertainty. Profits are recognized only when realized. At the same time, provisions for all known liabilities and losses are made though the amount represents only the best estimate. Substance over form: the accounting treatment and presentation of transactions and events in the financial statements should be governed by their substance and not just by the legal form. For example, the accounting of finance leases is based on the substance rather than the form of transaction. The lessee capitalizes the lease equipment as fixed assets being the owner in the substance, whereas the lessor records the investment made as debtor Materiality: financial statements disclose all material facts. The IASC audit materiality as under.
“Information is material if its omission or misstatement could influence the economic decision of users taken on the basis of financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or mist statements. Thus materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic whose information should be there to be useful.” There are no hard and fast rules for determining materiality. Materiality is a matter of judgment. For instance, what is material to the financial statements of one firm may not be material to the financial statements of another firm of a different nature or size. Fundamental Accounting Assumptions As we discussed in the 1st sessions the fundamental accounting concepts underlie the preparation of financial statements. Their use is not specifically stated in the financial statements because their use is assumed. If they are not accepted and used a disclosure of such facts should be made. The following are generally accepted fundamental accounting concepts. Going concern Consistency
14 / 34
AS-2 Valuation of Inventories How to value and account for stocks? This standards was revised in June -99. Effective date: 1- Apr -99 The standard deals with the principles of valuing inventories for financial statements including the ascertainment of cost of inventories and any write – down thereof to net realizable value. Requirements: 1. 2. 3. 4. 5. 6. Inventories should be valued at lower of cost and net realizable value. The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to the present location and condition. Administrative, selling and distribution expenses, abnormal wastages should not be included in the cost of inventories The cost of inventories of items that are not ordinarily interchanged, goods, and services produced and segregated for specific projects should be assigned by specific identification of their individual costs. the costs of inventories, other than those dealt with (3) above, should be assigned by using the first – in- first out (FIFO) or weighted average cost formula. Under the weighted average formula, the cost of each item is determined from the weighted average of the cost of similar items at the beginning of the period and the cost of similar items purchased or produced during the year. Generally, inventories are written down to net realizable value on an item-by-item basis. However, similar items can be grouped wherever it is appropriate.
Disclosure: The financial statements should disclose the following: The accounting policies adopted in measuring inventories, including the cost formula The total carrying amount of inventories and its classification.
AS – 3: Cash flow Statements Preparing and presenting cash flow statements. Revised in March – 1997. Effective date: 1- Apr-2001 The statements deals with the provisions of information about the historical changes in cash and cash equivalents of an enterprise by means of cash flow statements which classifies cash flow during the period from operating, investing and financial activities. AS-4: Contingencies and events occurring after Balance Sheet date. Revised in April-1995. Effective date: 1-Apr-1995. This standard deals with Contingencies, and Events occurring after Balance Sheet date, financial statements. This statements deal with the accounting treatment of contingencies and events occurring after Balance Sheet date. The standard does not apply to the following contingencies. Liabilities of life insurance and general insurance enterprises arising from policies issued Obligations under retirement benefit plans. Commitments arising from long term lease contracts. Accounting The amount of contingent loss should be provided for by a change in the profit and loss account if: • • • • It is probable that future events will confirm that, after taking into account any related probable recovery, an asset has been impaired or a liability has been incurred as at the Balance Sheet. A reasonable estimate of the amount of the resulting loss can be made. The existence of the contingent loss should be disclosed in the financial statements if either of condition in the above paragraph is not met, unless the possibility of loss is remote. The existence and amount of guarantees, obligations arising from discounted bills of exchange and similar obligations undertaken by an enterprise are generally disclosed in financial statement by way of note, even though the possibility that a loss will occur to the enterprise is remote.
15 / 34
• • •
Provisions and contingencies are not made in respect of general or unspecified business risks since they do not relate to conditions or situation existing at the balance sheet date.] Contingent gains should not be recognized in the financial statements Assets and liabilities should be adjusted for events occurring after the balance sheet date that provide additional evidence to assist the estimation of amounts relating to conditions existing at the balance sheet date or that indicate the fundamental accounting assumption of going concern. Dividends that are stated to be in respect of the period covered by the financial statements, which are proposed or declared by the firm after the balance sheet but before approval of the financial statements, should be adjusted.
Disclosure Requirements: Disclosure should be made in the report of the approving authority of those events occurring after the balance sheet date represent material changes and commitments affecting the financial position of the firm. The following information has to be provided: The nature of the event An estimate of the financial effect or statement that such an estimate cannot be made. AS-5: Net Profit or Loss for the period, prior period items and changes in Accounting Policies. Revised in Feb-1997. Effective date: 1 Apr-1996 The objective of this statement is to prescribe the classification and disclosures of certain items in the statement of profit and loss so that all enterprises prepare and present such statement on a uniform basis Accounting Net profit or Loss for the period, prior period items and changes in accounting policies. All items of income and expenses, which are recognized in a period, should be included in the determination of net profits or loss. 1. The net profit or loss for the period comprises the following components; Profits or Loss from ordinary activities Extraordinary items The above components should be disclosed on the face of the profit and loss statement. 2. Extraordinary items should be disclosed in the statement of profit and loss as a part of net profit or loss for the period. The nature and the amount of extraordinary item should be separately disclosed in the statement of profit and loss in a manner that its impact on current profit and loss can be perceived. 3. When items of income and expenses within profits and loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise foe the period, the nature and amount of such items should be disclosed separately. Disclosure: In the financial statements, there should be disclosure of i. The amount of construction work-in-progress ii. Progress payments received and advances and retentions on account of contracts included in construction work-in-progress; and iii. The amount receivable in respect of income accrued under cost, plus contracts not included in construction work-in-progress iv. Disclosure of changes in an accounting policy used for construction contracts should be made in the financial statements giving the effect of the change and its amount. AS-6: Depreciation Accounting. Revised in Aug-1994. Effective date: 1 Apr – 1995. Depreciation should be charged on assets. Related information should be disclosed. Different enterprises adopt different accounting policies for depreciation. Disclosure of accounting polices for depreciation that are followed by an enterprises is necessary to appreciate the view presented in the financial statements of the enterprise AS-7: Accounting for Construction Contracts. Effective date: 1 Arp-1993. This standard deals with the determination of construction cost and its disclosure in accounts. A construction contract is a contract for the construction of an asset or a combination of asset, which
16 / 34
together constitute a single project. Examples of activity covered by such contracts include the construction of bridges, dams, ships, buildings and complex pieces of equipment Types of construction contracts: construction contracts are formulated in a variety of ways but generally fall into two basic types: Fixed price contracts: the contractor agrees to fixed contract price, or rate, in some cases subject to cost escalation clauses. Cost plus contracts: the contractor is reimbursed for allowable or otherwise defined costs, and is allowed a percentage of these costs or a fixed fee. Accounting Treatment of Construction Contract Costs and Revenue The methods of accounting for contracts commonly followed by contractors are as under: Percentage of completion method Completed contract method Percentage of Completion Method: Revenue is recognized based on the stage of completion reached as the contract activity progresses. The costs incurred in reaching the stage of completion are matched with the revenue, resulting in the reporting of results, which can be attributed to the proportion of work completed. Although (as per the principle of prudence) revenue is recognized only when realized, under this method the revenue is recognized with the progress of the activity even though in certain circumstances it may not be realized. Completed Contract Method: Revenue is recognized only when the contract is completed or substantially completed, that is when only minor work is expected other than warranty obligation. Costs and progress payments received are accumulated during the course of the contract but revenue is not recognized until the contract activity is substantially completed. Under both methods, provision is made for losses for the stage of completion reached on the contract. In addition, provision is usually made for losses on the reminder of the contract. It may be necessary for accounting purpose to combine contracts made with a single customer or to combine contracts made with several customers if the contracts are negotiated as a package or if the contracts are for single project. Conversely, if a contract covers a number of projects and if the costs and revenue of such individual projects can be identified within terms of the overall contract, each such project may be treated as equivalent to a separate contract. AS-8: Accounting for Research and Development: Effective date: 1 –Apr- 1993 This standard deals with the treatment of costs of research and development in the financial statements. The standard identifies items cost which compromise R&D costs lays down conditions under which R&D costs may be defined and requires specific disclosures to be made regarding R&D costs. AS-9: Revenue recognition. Effective date: 1-Apr-1993 This statement deals with the basis to recognize revenue in the statement of profits and loss of an enterprise. The statement is concerned with the recognition of revenue arising in the course of ordinary activities of the enterprises AS-10.Accounting for Fixed Assets: Effective Date: 1 Apr-1993. Financial statements disclose certain information relating to fixed assets. In many enterprises these assets are grouped into various categories, such as land, building, plant and machinery, vehicles, furniture and fitting goodwill, patents, trade marks designs. This statement deals with the accounting for such fixed assets. AS-11: Accounting for effects of changes in Foreign Exchange Rates. Effective date: 1- Apr1995 Objective: an enterprise may have transactions in foreign currencies or it may have foreign branches. Foreign currency transactions should be expressed in the enterprise’s reporting currency and the financial statements of foreign branches should be translated into the enterprise’s reporting currency in order to include financial statements of the enterprise the principle issues in accounting for foreign currency transactions and foreign branches are to take decision on the exchange rate to use and how to recognize the financial effect of changes in exchange rates in the financial statements. Scope: This statement should be applied by an enterprise: i. In accounting for transactions in foreign currencies; and
17 / 34
ii. In translating the financial statements of foreign branches for inclusion in the financial statements of the enterprise. Disclosures: An enterprise should disclose1. The amount of exchange differences included in the net profit or loss for the period. 2. The amount of exchange differences adjusted in the carrying amount of fixed assets during the accounting period; and 3. The amount of exchange differences in respect of forward exchange contracts to be recognized in the profit or loss for one or more subsequent accounting periods. AS-12: Accounting for Government Grants. Effective Date: 1 Apr- 1994. These statements deal with the accounting for government grants. Government grants are sometimes called by other names such as Subsidies, Cash incentives, Duty drawbacks etc. this statement does not deal with: 1. The special problems arising in accounting for government grants in financial statements reflecting the effects of changing prices or in supplementary information of a similar nature. 2. Government assistance other than in the form of government grants; 3. Government participation in the ownership of the enterprise. Definition: “Government” refers to government agencies and similar bodies whether local, national or international “Government Grants” are assistance by government in cash or kind to an enterprise for past or future compliance with certain conditions. They exclude those forms of government assistance which cannot reasonably have a value placed upon them and transactions with government which cannot be distinguished from the normal trading and transactions of the enterprise. Disclosure: The following disclosures are appropriate 1. The accounting policies adopted for government grants, including the methods of presentation in the financial statements; 2. The nature and extend of governments grants recognized in the financial statements, including grants of non – monetary assets given at a concessional rate or free of cost. AS-13: Accounting for investments. Effective Date: 1-Apr-1995. This statement deals with accounting for investments in the financial statements of the enterprises and related disclosure requirements. AS-14: Accounting for Amalgamations: Effective date: 1-Apr-1995. Introduction: These statements deals with accounting for amalgamation and the treatment of any resultant goodwill or reserves. This statement is directed principally at the companies although some of its requirements also apply to financial statements of other enterprises. Definitions: Amalgamation: it means an amalgamation pursuant to the provisions of the companies Act, 1956 or any other statute, which may be applicable to companies. Transferor Company: It means the company, which is amalgamated into another company. Transferee Company: It means the company into which a transferor company is amalgamated. Amalgamation in the nature of merger: an amalgamation has to satisfy all the following conditions. 1. All the assets and liabilities of the transferor company become, after amalgamation, the assets and liabilities of the transferee company. 2. Shareholders holding not less than 90% of the face value of the equity shares of the transferor company (other than the equity shares already held therein, immediately before the amalgamation, by transferee company or its subsidiaries or their nominees) will become equity shareholders of the transferee company by virtue of the amalgamation. 3. The transferee company discharges the consideration for the amalgamation receivable by those equity shareholders of the transferor company who agree to become equity shareholders of the transferee company, except that cash may be paid in respect of any fractional shares.
18 / 34
The business of the transferor company is intended to be carried on, after amalgamation, by Transferee Company. No adjustment is intended to be made to the book values of the assets and liabilities of the transferor company when they are incorporated in the financial statements of the transferee company except to ensure uniformity of accounting policies.
Amalgamation in the nature of purchase: it is amalgamation, which does not satisfy any one more of the condition specified in sub-paragraph above. Consideration: consideration for the amalgamation means the aggregate of the shares, other securities issued, and the payment made in the form of cash or other assets by the transferee company to the shareholders of the transferor company. Fair value: An asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s length transaction for the amount. Explanation Types of Amalgamation Amalgamations fall into two broad categories. In the first category are those amalgamations where there is a genuine pooling not merely of the assets and liabilities of the amalgamations companies but also of the shareholders interest and of the business of these companies. Such amalgamations are in the nature of merger and their accounting treatment should ensure that the resultant figures of Assets, liabilities, capital and reserves more or less represent the sum of the relevant figures of the amalgamation companies. In the second category are those amalgamations, which are in effect a mode by which one company acquires another company and as a consequence, the shareholders of the company which is acquired normally do not continue to have a proportionate share in the equity of the combined company, or the business of the company which is acquired is not intended to be continued. Such amalgamations are in the nature of purchase. Methods of Accounting for Amalgamations: there are two main methods of accounting for amalgamation: The pooling of interests method; and The purchase method The use of the pooling of interests method is confirmed to circumstances, which meet the criteria for an amalgamation in the nature of a merger. The object of the purchase method is to account for the amalgamation by applying the same principles as are applied in the normal purchase of assets. This method is used in accounting for amalgamation in the nature of purchase. The pooling of interest method Under the pooling of interests method, the assets, liabilities and reserves of the transferor company are recorded by the transferee company at their existing carrying amounts. The Purchase Method: Under the purchase method, the transferee company accounts for the amalgamation either by incorporating the assets and liabilities at their existing carrying amounts or by allocating the consideration to individual identifiable assets and liabilities of the transferor company based on their fair values at the date of amalgamation. The identifiable assets and liabilities may include assets and liabilities not recorded in the financial statements of the transferor company. Where assets and liabilities are restated based on their fair values, the determination of fair values may be influenced by the intentions of the transferee company. For example to other potential may have specialized use for an asset, which is not available to other potential buyers. The transferee company may intend to effect changes in the activities of the transferor company which necessitate the creation of specific provisions for the expected costs, e.g. planned employee termination and plant relocation costs. Consideration The consideration for the amalgamation may consist of securities, cash or other assets. In determining the value of the consideration, an assessment is made of the fair value of its elements. A variety of techniques is applied in arriving at fair value. For example, when the consideration includes securities, the value fixed by the statutory authorities may be taken to be the fair value. In case of other assets, the fair value may be determined by reference to the market value of the asset given up. Where the
19 / 34
market value of the assets given up cannot be reliably assessed, such asset may be valued at their respective net book values. Balance of Profit & Loss Account: In the case of an Amalgamation in the nature of merger, the Balance of the Profit & Loss Account appearing in the financial statement of the transferor company is aggregated with the corresponding balance appearing in the financial statements of the transferee company. Alternatively, it is transferred to the general reserve, if any. In the case of an Amalgamation in the nature of purchase the Balance of Profit & Loss Account appearing in the financial statements of the transferor company, whether debit or credit, loses its identity. Disclosure: For all amalgamations, the following disclosures are considered appropriate in the first financial statements following the amalgamation: Names and General nature of business of the amalgamation companies; Effective date of amalgamation for accounting purposes. The method of accounting used to reflect the amalgamation; and Particulars of the scheme sanctioned under a statue. For all amalgamation accounted for under the pooling f interest method, the following additional disclosure are considered appropriate in the first financial statements following the amalgamation. Description and number of shares issued, together with the percentage of each company’s equity shares exchanged to effect the amalgamation. The amount of any difference between the consideration and the value of net identifiable assets acquired and the treatment thereof. For amalgamation accounted for under the purchase method, the following additional disclosures are considered appropriate in the first financial statements following the amalgamation: Consideration for the amalgamation and a description of the consideration paid or contingently payable; and The amount of any difference between the consideration and the value of net identifiable assets acquired, and the treatment thereof including the period of amortization of any goodwill arising on amalgamation. AS-15: Accounting for retirement benefits in the Financial statements of Employers 1. Effective date: 1 Arp-1995. This statement deals with accounting for retirement benefits in the financial statements of the employers. Retirement benefits usually consist of; a. Provident fund. b. Superannuating / Pension. c. Gratuity d. Leave encashment benefits on retirement e. Post-retirement health and welfare schemes and f. Other retirement benefits. Accounting In respect of retirement benefits in the form of provident fund and other defined contribution schemes, the contribution payable by the employer for a year is charged to the statement of profit and loss for the year. Thus, besides the amount of contribution paid, a shortfall of the amount of contribution paid compared to the amount payable for the year is also charged to the statement of profit and loss for the year. On the other hand, if contribution paid is in excess of the amount payable for the year, the excess is treated as a pre-payment. The accounting treatment for gratuity and other schemes will depends upon the type of arrangement that the employee has chosen to make. i. If the employer has chosen to make payment for retirement benefits out of his own funds, an appropriate charge to the statement of profit & loss for the year is made through a provision for the accruing liability. The accruing liability is calculated according to actuarial valuation. However many enterprises which employ only few persons do not calculate the accrued liability by using actuarial methods. They calculate the accrued liability by using other rational methods. E.g. a method based on the assumption that such benefits are payable to all employees at the end of the accounting year. ii. In case, the liability for retirement benefits is funded through creation of a trust, the cost incurred for the year is determined actuarially. Many employers undertake such valuations every year while others undertake them less frequently, usually once in every years. Where
20 / 34
the contribution paid during the year is lower than the amount required to be contributed during the year to meet the accrued liability as certified by the actuary, the shortfall is charged to the statement of profit and loss for the year. Where the contribution paid during the year is in excess of the amount required to be contributed during the year to meet the accrued liability as certified by the actuary, the excess is treated as a pre-payment. iii. In case the liability for retirement benefits is funded through a scheme administered by an insurer, it is usually considered necessary to obtain an actuarial certificate or a confirmation from the insurer that the contribution payable to the insurer is the appropriate accrual of the liability for the year. Where the contribution during a year is lower than the amount required to be contributed during the year to meet the accrued liability as certified by the actuary or confirmed by the insurer, as the case may be, the shortfall is charged to the statement of profit and loss for the year. Where the contribution paid during the year is in excess of the amount required be contributed during the year to meet the accrued liability as certified by the actuary or confirmed by the insurer, as the case may be, the excess is treated as a pre- payment. Disclosures: The financial statements should disclose the method by which retirement benefit costs for the period have been determined. In case the costs related to gratuity and other defined benefit schemes are based on an actuarial valuation, the financial statements should also disclose whether the actuarial valuation was made at end of the period or at an earlier date. In the latter case, the date of the actuarial valuation should be specified and the method by which the accrual for the period has been determined should also be briefly described, if the same is not based on the report of the actuary. AS-16: Borrowing Costs. Effective date: 1-Apr-2000. The objective of this statement is to prescribe the accounting treatment of borrowing costs meaning thereby interest and other costs incurred by an enterprise in connection with borrowing of funds, briefly stated, it lays down that borrowing costs that are directly attributable to the acquisition, construction or production of an asset should be capitalized as a part of the cost of that asset. This statement does not deal with the actual or imputed cost of owners equity, including preference share capital not classified as a liability. Borrowing costs: Borrowing cost are interest and other costs incurred by an enterprise in connection with the borrowing of funds. Borrowing costs may include: Interest and commitment charges on bank borrowings and other short term and long term borrowings. Amortization of discounts or premiums relating to borrowings. Amortization of ancillary costs incurred in connection with the arrangement of borrowings. Finance charges in respect of assets acquired under finance leases or under other similar arrangements; and Exchange differences arising from foreign currency borrowings to the extend that they are regarded as an adjustment to interest costs. Qualifying Asset: it is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Examples of qualifying assets are manufacturing plants, power generation facilities, inventories that require a substantial period of time to bring then to a saleable condition, and investment proprieties. Other investments, and those inventories that are routinely manufactured or otherwise produced in large quantities on a repetitive basis over a short period of time, are not qualified assets. Assets that are ready for their intended use or sale when acquired are also not qualified assets. Recognition: Borrowings costs that are directly attributed to the acquisition, construction or production of a qualifying asset should be capitalized as part of the cost of that asset. The amount of borrowings costs eligible for capitalized as part of the cost of that asset. The amount of borrowing costs eligible for capitalization should be determined in accordance with this statement. Other borrowings costs should be recognized as an expense in the period in which they are incurred. Borrowing costs are capitalized as part of the cost of qualifying asset when it is probable that they will result in future economic benefits to the enterprise and the costs can be measured reliably. Other borrowing costs are recognized as an expense in the period in which they are incurred.
21 / 34
Disclosure: The financial statements should disclose: a. The accounting policy adopted for borrowing costs, and b. The amount of borrowing costs capitalized during the period. AS-17: Segment Reporting. Effective Date: 1-Apr-2001 This Standard applies to Enterprises, whose equity or debt securities are listed on a recognized stock exchange in India, and to enterprises that are in the process of issuing equity or debt securities that will be listed on recognized stock exchange in India as evidence by the board of directors’ resolution in this regard. All other commercial, industrial and business reporting enterprises, whose turnover for the accounting period exceeds Rs. 50 crore. The objective of this statement is to establish principles for reporting, financial information, about the different types of products and services an enterprise produces and the different geographical areas in which it operates. Such information helps users of financial statements to: a. Understand better the performance of the enterprises; b. Assess better the risks and returns of the enterprise; and c. Make more informed judgments about the enterprise as a whole Many enterprises provide groups of products and services or operate in geographical areas that are subject to differing rates of profitability, opportunities for growth, future prospects, and risks. Information about different types of products and services of an enterprise and its operations in different geographical areas- often called segment information – is relevant in assessing the risks and returns of a diversified or multi- location enterprise but may not be determinable from the aggregated data. Therefore, reporting of segment information is widely regarded as necessary for meeting the needs of users of financial statements. AS-18: related Party Disclosures. Effective Date: 1- Apr-2001. The objective of this statement is to establish requirements for disclosure of: a. Related party relationships; and b. Transactions between a reporting enterprise and its related parties This statement should be applied in reporting related party relationships and transactions between a reporting enterprise and its related parties. The requirements of this statement apply to the financial statements of each reporting enterprise as also to consolidate financial statements presented by holding company. This statement applies only to related party relationship described as under: 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 venture of the reporting enterprise and the investing party or venture in respect of which the reporting enterprise is an associate or a joint venture; c. Individual owning, directly or indirectly; an interest in the voting power of the reporting enterprises that gives them control or significant influence over the enterprise, and relatives of any such individual; d. Key management personnel and relatives of such personnel, and e. Enterprise over which any person described in © or (d) is able to exercise significant influence. This includes enterprise owned by directors or major shareholders of the reporting enterprise /s that have a member of key management in common with the reporting enterprise. Disclosure: The statues governing enterprise often require disclosure in financial statements of transactions with certain categories of related parties. In particular, attention is focused on transactions with the directors or similar key management personnel of an enterprise, especially their remuneration and borrowings, because of the fiduciary nature of their relationship with the enterprise. 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. Where the reporting enterprise controls or is controlled by, another party, this information is relevant to the users of financial statements irrespective of whether or not transactions have taken
22 / 34
place with that party. This is because the existence of control relationship may prevent the reporting enterprise from being independent in making its financial and /or operating decision. The disclosure of the name of the related party and the nature of the related party relationship where control exists may sometimes be at least as relevant in appraising an enterprise’s prospects as are the operating results and the financial position presented in its financial statements. Such a related party may establish the enterprise’s credit standing, determine the source and price of its raw materials, and determine to whom and at what price the product is sold. If there have been transactions between related parties, during the existence of a related party relationship, the reporting enterprise should disclose the following. 1. The name of the transacting related party; 2. a description of the relationship between the parties; 3. a description of the nature of transactions; 4. Volume of the transactions either as an amount or as an appropriate proportion; 5. Any other elements of the related party transactions necessary for an understanding of the financial statements; 6. The amounts or appropriate proportions of outstanding items pertaining to related parties at the balance sheet date and provisions for doubtful debts due from such parties at that date; and 7. Amounts written off or written back in the period in respect of debts due from or to related parties. The following are examples of the related party transactions in respect of which disclosures may be made by a reporting enterprise: Purchases or sales of goods (finished or unfinished); Purchases or sales of fixed asset; Rendering or receiving of services; Agency arrangements; Leasing or hire purchase arrangements; Transfer of research and development; License agreement; Finance (including loans and equity contributions in cash or kind); Guarantees and collaterals; and Management contracts including deputation of employees.
AS - 19: Leases. Effective date: 1-Apr-2001. Objective: the objective of this statement is to prescribe, for lessees and lessor, the appropriate accounting policies and disclosures in relation to finance leases and operating leases. A lease is an agreement whereby by the lessor conveys to the lessee in return for a payment or series of payment the right to use an asset for an agreed period of time. Financial lease: A financial lease is a lease that transfers substantially all risks and rewards incident to ownership of an asset. Operating lease: it is a lease other than a financial lease. Lease term: It is the non- cancelable period for which the lessee has agreed to take on lease the asset together with any further periods for which the lessee has option to continue the lease of the asset, with or without further payment, which option it is reasonably certain that the lessee will exercise at the inception of the lease. Fair value: It is the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm’s length transaction. Residual value: it is estimated fair value of the asset at the end of the lease term. Classification of Leases: The classification of leases adopted in this statement is based on the extend to which risks and reward incident to ownership of a leased asset; lie with the lessor or the lessee. Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in returns due to changing economic conditions. Rewards may be represented by expectation of profitable operation over the economic life of the asset and of gain from appreciation in value or realization of residual value.
23 / 34
A lease is classified as a finance lease if it transfers substantially all risks and rewards incident to ownership. Title may or may not eventually be transferred. A lease is classified as an operating lease if it does not transfer substantially all risks and rewards incident to ownership. Whether a lease is finance or an operating lease depends on the substance of the transaction rather than its form. Examples of situations, which would normally lead to a lease being classified as a finance lease, are: a. The lease transfers ownership of the asset to the lessee by end of the lease term; b. The lessee has option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable such that, at the inception of the lease, it is reasonably certain that the option will be exercised; c. The lease term is for the major part of the economic life of an asset even if title is not transferred; d. At the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and e. The leased asset is of a specialized nature such that only the lessee can use it without major modification being made. Leases in the Financial Statements of lessees: Finance Leases: At the inception of a finance lease, the lessee should be recognized the lease as an asset and a liability. Such recognition should be at an amount equal to the fair value of the leased asset at the inception of the lease. However, if the fair value of the leased asset exceeds the present value of the minimum lease payments from the standpoint of the lessee, the amount recorded as an asset and a liability should be the present value of the minimum lease payments from the standpoint of the lessee. In calculating the present value of the minimum lease payments, the discount rate is the interest implicit in the lease, if this is practicable to determine, if not the lessee’s incremental borrowing rate should be used. The lessee should, in addition to the requirements of AS 10, accounting for Fixed Asset, AS 6, and Depreciation Accounting and governing statute, make the following disclosure for finance leases: a. Assets acquired under finance lease as segregated from the asset owned. b. For each class of assets, the net carrying amount at the balance sheet date; c. Reconciliation between the total of minimum lease payments at the balance sheet date and their present value. In addition, an enterprise should disclose the total of minimum lease payments at the balance sheet date, and their present value, for each of the following periods Not later than one year Later than one year and not later than five years; Later than five years; d. Contingent rents recognized as income in the statement of profit and loss for the period; e. The total of future minimum sublease payments expected to be received under non-cancelable sublease at the balance sheet date, and; f. A general description of the lessee’s significant leasing arrangements including but not limited to, the following: The basis on which contingent rent payable are determined; The existence and term of renewal or purchase options and escalation clauses; and Restrictions imposed by lease arrangements, such as those concerning dividends, additional debt, and future leasing. Operating leases: Lease payments under an operating lease should be recognized as an expense in the statement of profit and loss on a straight-line basis over the lease term unless another systematic basis is more representative of the time pattern of the user’s benefit. The lessee should make the following disclosures for operational leases: a. The total of future minimum lease payments under non-cancelable operating leases fro each of the following periods: Not later than one year; Later than one year and not later than five year; Later than five years;
24 / 34
b. c. d.
The total of future minimum sublease payments expected to be received under non-cancelable sublease at the balance sheet date; Lease payments recognized in the statements of profit and loss for the period, with separate amounts for minimum lease payments and contingent rents; Sub-lease payments received (or receivable) recognized in the statement of profit and loss for the period.
Leases in the Financial Statements of Lessor Finance Leases: The lessor should recognize asset given under a finance lease in its balance sheet as a receivable at an amount equal to the net investment in the lease. Under finance, lease substantially all the risks and the lessor transfers rewards incident to legal ownership, and thus the lease payment receivable is treated by the lessor as repayment of principle, i.e. net investment in the lease, and finance income to reimburse and reward the lessor for its investment and services. 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: Not later than one year; Later than one year and not later than five year; Later than five years; b. Unearned finance income; c. The un-guaranteed residual values accruing to the benefits of the lessor; d. The accumulated provision for uncollectiable minimum lease payments receivable; e. Contingent rents recognized In the statements 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. Operating leases: The lessor should present an asset given under operating lease in its balance sheet under fixed assets. Lease income from operating leases should be recognized in the statement of profit and loss on a straight-line basis over the lease term, unless another systematic basis is more representative of the time pattern in which benefits derived from the use of the leased asset is diminished. The depreciation of leased assets should be on a basis consistent with the normal depreciation policy of the lessor for similar assets, and depreciation charge should be calculated on the basis set out in AS 6 Depreciation Accounting. AS-20: Earning per share. Effective date: 1 Apr – 2001. This statement is relevant only for companies with equity share capital. The objective of this statement is to prescribe principles for the determination and presentation of earning per share, which will improve comparison of performance among different enterprises for the same period and among different accounting periods for the same enterprises. The focus of this statement is on the denominator of the earning per share calculation. Even though earnings per share data has limitations because of different accounting policies used for determining ‘earnings’, a consistently determined denominator enhances the quality of financial reporting. AS- 21: Consolidated Financial Statements. Effective date: 1 Apr-2001. This standard is designed for holding companies and group companies and applies only if the group or parent company prepares consolidated statements. Some concepts are relevant to consolidation of accounts of NGOs. The objective of this statement is to lay down principles and procedures for preparation and presentation of consolidation financial statements. The parent of a group to provide financial information about the economic activities of its group presents consolidated financial statements. AS- 22: Accounting for Taxes on Income: Applies selectively from 1 Apr-2001 onwards and applies to all from 1-Apr-2003.
25 / 34
It deals with the estimation and disclosure of income tax. This statement should be applied in accounting for taxes on income. This includes the determination of the amount of the expense or savings related to taxes on income in respect of an accounting period and the disclosure of such amount in financial statements. The objective of this statement is to prescribe accounting treatment for taxes on income. Taxes on income are one of the significant items in the statement of profit and loss of an enterprise. In accordance with the matching concept, taxes on income are accrued the same period as the revenue and expenses to which they relate. Matching of such taxes against revenue for e period poses special problems that arise 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. Secondly, there are differences between the amount in respect of a particular item of revenue or expense as recognized in the statement of profit and loss and the corresponding amount, which is recognized for the computation of taxable income. 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. Deferred tax should be recognized for all the timing differences, subject to the consideration of prudence in respect of deferred tax asset. Presentation and disclosure: An enterprise should offset assets and liabilities representing current tax if the enterprise: Has a legally enforceable right to set off the recognized amounts; and Intends to settle the asset and the liability on a net basis. An enterprise will normally have a legal enforceable right to set off an asset and liability representing current tax when they relate to income taxes levied under the same governing taxation laws; and the taxation laws permit the enterprise to make or receive a single net payment. AS-23: Accounting for Investments in Associates in Consolidated Financial Statements. Effective Date: 1 Apr-2002 This standard applies only if consolidated statements are presented by the enterprise. Difference between International Accounting Standards (US GAAP) and Indian Accounting Standards. Reporting Vs Disclosure: Firstly, the accent of the Indian accounting standards is on reporting where as the accent of the US GAAP is on disclosure and transparency. . E.g. in India it is not necessary to disclose the portion of long-term debt, which has an un expired term of maturity of less than one year. This is given an erroneous picture of the period short-term liabilities of the company and the liquidity risk that the companies face in such an eventuality. The US GAAP on the country insists on the disclosing the portion of long-term debt separately, which has an un expired term to maturity of less than one year. Form Vs Substance: The accent of the Indian Accounting Standards is on form where as the accent of the US GAAP is on the substance of the transaction. E.g. while accounting of a lease in India the depreciation benefit is available to the lessor because in structure or form a lease deal is not a sale. On the contrary, I the US GAAP a lease deal confer the depreciation benefit on the lessee since the benefits of the production use of the asset rests with the lessee. Accounting Vs Analysis: The accent of the Indian accounting standards is on abiding by accounting principles whereas the accent on the US GAAP is on presenting a true and fair picture of the financial position of the company to the analysts. E.g., under assets that can be identified with each product division enabling analysts to get a true and unbiased picture of the performance and profitability of each division. According to the Indian Accounting Standards, it is not necessary.
26 / 34
Globalization Vs Localization; The other difference is that accent of Indian accounting Standards is on localization of the business while the accent of the US GAAP is on globalization of the business. The US GAAP stipulates that companies consolidate their subsidiary accounts and show the results as apart of the parent company accounts. This has provided an incentive to US corporate to expand offshore through subsidiaries and ensure its good performance. Changes in Indian Accounting Standards and their impact: Like any other listed firms, Satyam Computers is now required to consolidate its account of its subsidiaries in its balance sheet. Satyam reported a net profit of around 119 crore in the quarter ending December 2001. but, its 52.5 subsidiary, Satyam Infoway, reported a net loss of around Rs. 391.96 crore as per US GAAP. Under the new norms, Satyam Computers would be required to add the losses of its subsidiary, as it’s bottom- line after subtracting the minority interest. i.e. after subtracting 47.5 percent of net losses. If Satyam Infoway’s losses are not taken into account, the situation is very bright. However, one cannot be happy once Satyam Infoway’s losses are taken into account. However, new accounting norms do not necessarily mean losses to the companies. Some companies are going to see a jump in their profits. E.g. Reliance is likely to see a jump in net profits after consolidating the accounts of Reliance Petroleum. Similarly, there is going to be a jump in the profits of State Bank of India by 20 % after it consolidates the account of its subsidiary. Criticism of US Accounting Standards: The current standards setting process is too cumbersome and slow, Much of the recent FASB guidance is rule based and inhibits transparency. Much of the recent FASB guidance is too complex.
Accounting Standards should change: It is widely believed that rather than enforcing standards based on specific rules; if it were on it were on intent, there is a possibility of avoiding the loopholes exploited by many companies. The international accounting standards bodies like the International Accounting standards Board and the Financial Accounting Standards Boards are trying their best to change the accounting rules to benefit both the companies an the investing companies and the investing community by way of better and informed financial statements. Capital markets all over the world, particularly the US capital markets are plagued by murky accounting standards. Enron is the best example for this. All this resulted the lack of confidence in the US financial reporting standards. It may result in deterring the foreign investors’ trust on the, most revered and feared US GAAP. Many fear that the situation in US may result in many Managers around the world withdrawing their investments from US. The reason for US not to ensure with accounting standards is it negative net wroth against the world. Consider these figures: world assets in the US amount to $7.3tn; US investment outside its borders is $5.2tn. To understand the amusing aspect of the US accounting standards, consider this example. A company that owns an asset says an aircraft and finances this asset with debt, reports it as an asset and liability. Under the existing accounting standards, if the company acquires the asset under a lease structured as an operating lease, it will report neither the asset nor the liability. So this makes the situation where it is possible for a company to operate an airline without reporting any of its principle assets on the balance sheet. Thus, a balance sheet that presents an airline without showing it on the sheet is not a faithful representation of economic reality. All these make a case to harmonize global accounting standards fro benefits of both global and US investors. Amalgamation, Acquisition. Absorption, External Reconstruction Difference between Merger Method & Purchase Methods. Merger Methods Purchase Methods Recording of Assets & Liability & Reserves
27 / 34
Assets, Liability & Reserves of the Vendor company are recorded by Purchase Co.
Only those Assets & Liability, which are taken over, are recorded in the books of Purchasing Co. we also include Statutory Reserves of Vendor Co. in the books of Purchasing Co. but we exclude other reserves & Surpluses. Value at which it is recorded As per book value of Vendor Co. As per agreed value or adjustment value Adjustments of Difference. The difference between purchase The difference between purchase consideration & assets & Liability taken over consideration Assets & Liability taken over will will be transferred to P/L a/c or General be transferred to Goodwill or Capital Reserves Reserve of the Purchasing Co. of the company. Statutory Reserves It will be incorporated in Purchasing Co. along I will be incorporated in Purchasing Co under with other Reserves the a/c of ‘Amalgamation Adjustment a/c’ Absorption: When one or more small Co. is taken over by a big company this process is known as absorption. External Reconstruction: When one & only one loss making Co. (P&L a/c appear in the Balance Sheet) assets side under the head Miscellaneous expenses is taken over (only by passing book entries) by a new Co. Will be known as process of External Reconstruction. Special Notes: 1. Typical extra ordinary external Liability: Workman saving a/c Pension Funds Super Funds Employees Security deposit Provision for gratuity Provident Fund Unclaimed Fund Workman Profit Sharing Fund 2. Typical Extra Ordinary Accumulated Profit Dividend equalization Reserves Development Debit Reserves Investment Allowances Reserves Revaluation Reserves Replacement Reserves Export Profit Reserves (Statutory Reserves) Project Export Reserves (Statutory Reserves) Investments Allowance Reserves. 3. Difference types of funds Funds which is fully Funds partly profit partly accumulated profit liability • Sinking Funds • Employee’s accident compensation fund. • Debenture • Employee’s Insurance Redemption fund funds. • Dividend equalization • Contingency funds funds • Workman accident funds Given in the problem: Balance Sheet of Vendor Company Adjustment Funds fully liability • • • • Employees Provident fund Employees profit sharing fund Employees Pension Fund Employees super annuation fund
28 / 34
Required to prepare: Calculation of Purchase consideration & discharge of purchase consideration. Pass the Journal entry & prepare a/c to close the books of Vendors Company. Opening entry & opening balance in the books of Purchasing Company. Steps for solving the sum: Calculation for purchase consideration & discharge of Purchase Consideration. Purchase consideration (P.C) means net worth of the business that is asset & liability payable by purchasing company to Vendor Company there are following four methods of calculation Purchase Consideration.
Lump Sum Method: Here amount of the P.C will be given in the problem / illustration. Payment Basis Method: Rs. ** ** Mode of Payments (Pur. Co) a. Equity Share in P.Co b. Cash a. Equity Share in P Co. b. Preference Share in P Co. c. Cash a. Debenture in P Co. Rs. ** ** ** ** ** **
To whom (Of Vendor Co.) 1. Equity Share Holder (at A.V) 2. Preference Share Holders (at A.V)
3. Debenture Holder (at A.V) Amount of P.C.
Net Asset Method: Rs. ** ** ** ** ** ** Rs.
Particulars Asset taken over (Agreed Value) Fixed Assets Investment Current Asset (-) External Liabilities cover (at A.V) Secured Loan Unsecured Loan Current Liability Amount of P.C
Special Points Record only those assets & liability, which are taken over by purchasing company at Agreed Value. If nothing is specified in the problem than assume all Assets & Liability are taken over.
Intrinsic Worth Method: A Ltd ** (**) *** ** ** ** ** *** B Ltd ** (**) *** ** ** ** ** ***
Particulars Assets as per Balance sheet (-) Laiblity Amount available for Equity Share holders I.V of share = Amount available for Shareholders No of Equity Share Share Exchange Ratio Share Exchange Ratio * Total Purchase Co. Cash Amount of Purchase Consideration (P.C) Special Points
29 / 34
If amount of P.C is given in the problem than follow Lump Sum Method When amount of P.C is not given but all more of payments method is given in the problem than follow payment Basis Method When amount of P.C is not given and one more of payment is not given than follow Net Asset Method. When specially specified to follow Intrinsic worth Method than follow I.W Method
Discharge of Purchase Consideration: Rs. ** ** ** ** ** ***
Particulars Equity Share in Purchasing Co. Preference Share in Purchasing Co. Debenture in Purchasing Co. Cash Bank Amount of Purchase Consideration
Close the books of Vendor Co.
Following a/c will be prepared to close the books of Vendor Co.
Realization a/c Equity Shareholder a/c Preference Shareholder a/c Purchasing Co. a/c Equity Share purchasing Co. a/c Preference Share in purchasing Co. a/c Debenture in purchasing Co. a/c Cash & Bank a/c Other a/c if required
Transfer of balance sheet item to there respective ledger a/c at book value (Balance Sheet Value) Where to transfer Liability Side (Cr. Bal) Equity Share Capital 1. Equity shareholder’s a/c (Cr Side) Preference Share Capital 2. Preference Shareholder’s a/c (Cr Side) Reserves & Surplus 3. Equity shareholder’s a/c (Cr Side) Remaining all other liabilities 4. Realization a/c (Cr Side) (Including Debenture) Asset Side (Dr. Bal) Accumulated Losses 1. Equity Shareholder a/c (Dr Side) (Mis Expenditure) Remaining all other assets 2. Realization a/c (Dr Side)
Items of Balance Sheet 1. 2. 3. 4.
Journal entries to close the books of Vendors Co. 1. Transfer of Equity Share Capital & Reserves & surpluses Equity Share Capital a/c Reserves & Surpluses a/c To Equity Shareholder a/c 2. Transfer Preference Share Capital Preference Share Capital a/c Dr. To Preference Shareholder a/c 3. Transfer of other Liability Liability a/c Dr. Dr. Dr.
30 / 34
To Realization a/c 4. Transfer of Asset Realization a/c To Asset a/c Dr.
5. Transfer of Losses (Misc. Expenditure) Equity Shareholder a/c Dr. To Losses a/c Entries for Purchase Consideration 6. Entry for P.C Receivable Purchasing Co a/c To Realization a/c Dr.
7. Entry for P.C Receipt / Discharge of P.C Equity Share in Purchasing Co. a/c ------% Preference Share in Purchasing Co a/c Dr. ------%Debenture in purchasing Co. a/c Cash Bank a/c To Purchasing Co. a/c
Dr. Dr. Dr.
(Note: The above entry for Share Debenture will be recorded as agreed price or issue price) 8. Entry for Sale of Asset not taken over by Purchasing Co. Cash / Bank a/c Dr. To Realization a/c (Note: The above entry should be passed for selling price only & not for profit or loss of sale. Whether asset are recorded or unrecorded entry for sale remain the same.) 9. Entry for payment of Liquidation expenses (Dissolution Expense/ liabilities) • When Vendor Co pays & Vendor Co. bears Realization a/c Dr. To Bank a/c • Vendors Co pays & purchasing Co. bears i. On payment expenses by Vendor Co. Purchasing a/c (agreed Value) Dr. To Bank a/c ii. On Reimbursement of amount of Purchasing Co. Bank a/c Dr. To Purchasing Co. a/c (Note: Any difference between actual amount paid & amount received will be transfer to realization a/c) iii. Purchasing Co. pays & purchasing Co. bears No Entry 10. Entry for payment of liability not taken over by purchasing Co. Realization a/c Dr. To Bank a/c To Equity Share in purchasing Co. a/c To Preference Share in purchasing Co. a/c To Debenture in purchasing Co. a/c
31 / 34
(Note: The above entry should be passed on for actual amount paid & not for P&L on payment. Whether liabilities are recorded or un recorded the entry for payment remain the same. If nothing is specified we will assume that liability is taken over by Purchasing Co) 11. Payment to Preference Shareholder Preference Shareholders a/c Dr. To Cash a/c To Equity share in Purchasing Co. a/c To Preference Share in purchasing C. a/c To Debenture in Purchasing Co a/c 12. Close Realization a/c & transfer the balance into equity Shareholders a/c 13. Close all the other a/c & Transfer the balances sheet into equity Shareholder a/c 14. Close Equity Shareholder a/c, which must Tally 15. Entry for unrealized profit (profit of unsold stock Goodwill (Stock Reserve) a/c Dr. To Stock a/c Opening Entry of in the books of Purchasing Co. A. Purchase Method 1. Entry for fresh Issue Bank a/c Discount on issue of share a/c To Share Capital a/c To Security Premium A/c 2. Entry for Preliminary Expense Paid Preliminary expense A/c To Cash / Bank a/c
3. Entry for P.C Payable Business Purchase a/c Dr. To Liquidator of Vendor a/c 4. Entry for asset & liability taken over Asset (Taken over at Agreed Value) a/c Goodwill (Difference) a/c Dr. To Liability (Taken over at Agreed Value) To Debenture (Vendor Co) To Business Purchase (P.C Amount) To Capital Reserve (difference)
(Note: As per Accounting Standard 14 the above goodwill should be return off within 5 years) 5. Entry for Creating Statutory Reserves (if required) Amalgamation Adjustment a/c Dr. To Statutory Reserves a/c (Note: The above amalgamation adjustment well appeared under Misc. Expenditure a/c & Statutory Reserves will be under head of reserves & Surpluses. Statutory Reserves are created for export profit reserves. Development credit reserves, investment allowances reserves, Project Export reserves) 6. Entry for discharge of P.C Liquidation of Vendor Co. a/c Dr. Discount on issue of share Co. Dr. To Equity Share Capital To Preference Share Captial To Security Premium To Bank
32 / 34
7. Entry for discharge of Debenture of Vendor Co. by Issue of Debenture of purchasing Co. New Debenture (Vendor Co.) a/c Dr. Discount on issue of Debenture a/c Dr. To debenture of purchasing Co. a/c To Security Premium (of issue of Debenture) a/c 8. Entry for liquidation / realization expense paid & bears by purchasing Co. Capital Reserves / Goodwill A/c Dr. To Cash/ Bank a/c (Note: For amalgamation & external reconstruction opening balance of purchasing a/c from the prepared from above entry but for absorption opening balance sheet of purchasing Co will be prepared by following manner. Old balance sheet of purchasing Co. B. Merger Method / Pooling of interest method: 1. Entry for fresh issue Bank a/c Discount on issue of share a/c Dr. To Share Capital a/c To Security Premium a/c 2. Entry for preliminary expense paid Preliminary expense A/c To Bank a/c
3. Entry for incorporation of Asset & liability of Vendor Co. Fixed Asset a/c Dr. Investment a/c Dr. Current a/c Dr. Misc Expenditure a/c Dr. To all Liability (including Share Capital) a/c To Reserves & Surpluses (Asset general reserve) a/c To Debenture (vendor Co) a/c To Business Purchase (amount of P.C) a/c To P& L a/c or general reserve a/c(any difference) a/c (Note: Any difference in debit / credit will be transferred to general reserve a/c. or profit & loss a/c not in Goodwill & capital reserve.) 4. Entry for P.C Payable Business Purchase a/c To Liquidator of Vendor a/c Dr.
5. Entry for discharge of P.C Liquidation of Vendor Co. a/c Dr. Discount on issue of share Co. a/c Dr. To Equity Share Capital To Preference Share Capital To Security Premium To Bank (Note: Preference shareholder of vendor Co. should be allotted preference share of purchasing Co.) 6. Payment of Debenture of Vendor Co -----% Debenture a/c (Purchasing Co.) a/c To ----% Debenture a/c To Cash/ Bank a/c Dr.
7. Liquidation expense paid & bears by purchasing Co
33 / 34
P&L a/c or General Reserve a/c Dr. To Cash / Bank Opening balance sheet of purchasing Co. can be prepared from opening Journal entry which is discussed above where debit items to be reflected on Asset side & Credit items on the liability side of the Balance Sheet However if it is acquisition or external reconstruction than new balance sheet will be prepared with the help of old balance sheet and for which we should follow following rules Debit Credit Debit Credit Debit Credit Credit Debit ADD ADD LESS LESS.
Whatever is the final figure will reflect in the Balance Sheet
34 / 34