CA - INTER COURSE MATERIAL Quality Education beyond your imagination... SUBJECT CODE: 1, MATERIAL NO: 64 SUPPLEMENTARY MATERIAL ON ACCOUNTING STANDARDS_40e (APPLICABLE FOR OLD AND NEW SYLLABUS) (COVERS ACCOUNTING AND ADVANCED ACCOUNTING) N MASTER MINDS" CA « CMA « CS MEC + CEC GUNTUR | RAJAHMUNDRY | KURNOOL | VIZAG | NELLORE HYDERABAD | VIJAYAWADA | TIRUPATHI Cell: 98851 25025 / 26 Visit us @ www.mastermindsindia.com | Mail: mastermindsinfo@ymail.com Facebook Page: Masterminds For CA | Youtube Channel: Masterminds For CA Page 1No. of Problems No Chapter Name Gass Room J Sal, | Page no Problems Problems 4, | Framework for the Preparation and . . 03 Presentation of Financial Statements a AS - 1: Disclosure of Accounting Policies - 07 06 3. AS - 2: Valuation of Inventories 01 10 10 Se ese ee 08 4 AS - 5: Net Profit or Loss for the Period, a Prior Period Items and Changes in 02 03 ard Accounting Policies 6. AS - 7: Construction Contracts - 07 19 7. AS - 9: Revenue Recognition 03 04 23 8 ed Property, Plant and 07 at 28 40. a 12: Accounting for Government 02 08 40 11. AS - 16: Borrowing Costs 01 05 45 12. AS - 17: Segment Reporting - 04 49 13. AS - 18: Related Party Disclosure - 05 §2 14. AS - 19: Leases - 06 54 15. AS - 20: Earnings Per Share - 01 57 16. AS - 22: Accounting For Taxes on Income 01 04 58 17. AS - 26: Intangible Assets - 08 59 418. ea Coral en ae saa Liabilities 7 03 62 Total 20 112, -No.1 for CAICWA & MECICEC MASTER MINDS aS Ea Td ty 1. Introduction: (ASB) of ICAI issued a framework in July, 2000 which provides The fundamental basis for development of new standards and Review of existing standards. The principal areas covered by the framework are as follows: i) ii) ‘Components of financial statements; Objectives of financial statements; i) Assumptions underlying financial statements: iv) Qualitative characteristics of financial statements, v Elements of financial statements; vi) Criteria for recognition of elements in financial statements; vii) Principles of measurement of financial elements; vi Concepts of Capital and Capital Maintenance. Purpose of the Framework: a) b) °) 4) e) Status and scope of the framework. a) b) ¢) Provides assistance in applying accounting standards in preparation of Financial statements Helps in development of future Accounting Standards and in its review of existing Accounting Standards; Providing a basis for reducing the number of al fe accounting treatments permitted by Accounting Standards; Assist auditors in forming an opinion as to wh fancial statements conform with Accounting Standards; os Assist users of financial statements in intag prepared in conformity with Accounting {374 the information contained in financial statements. The framework applies to general financial statements usually prepared annually for extemal users, by all commercial, industrial and business enterprises, whether in public or private sector. The special purpose financial reports, for example computations prepared for tax purposes are outside the scope of the framework. Nothing in the framework overrides any specific Accounting Standard. In case of conflict between an Accounting Standard and the framework, the requirements of the Accounting Standard will prevail over those of the framework. ‘Components of Financial Statements: A complete set of financial statements normally consists of a) b) ¢) d) a) b) a Balance Sheet, a Statement of Profit and Loss and a Cash Flow Statement and Notes, statements and other explanatory materials that form integral parts of the financial statements. Balance Sheet portrays i) Value of economic resources controlled by an enterprise. ii) Italso provides information about liquidity and solvency of an enterprise. Statement of Profit and Loss presents i) The result of operations of an enterprise for an accounting period ii) It depicts the performance of an enterprise, in particular its profitability. CA Inter_40e_Accounting Standards_Supplementary Material98851 25025/26 www.mastermindsin c) Cash Flow Statement shows i) The way an enterprise has generated cash and ‘The way they have been used in an accounting period and i) Helps in evaluating the investing, financing and operating activities during the reporting period. d) Notes and other statements presents i) Supplementary information explaining different items of financial statements. ii) Other disclosures such as disclosure of accounting policies, segment reporting, related party disclosures, earings per share, etc, 5. Objectives and Users of Financial Statements: The objective of financial statements is to provide information about a) the financial position, b) performance and ¢) Cash flows of an enterprise that is useful to a wide range of users. The framework identifies seven broad groups of users of financial statements. ¥ ¥ ¥ ¥ v [lavestors] [Employees] (Lenders } [Suppliers & K{Customers] (_ Govt} (_Public_} Creditors 19 Assumptions: As per the framework, there are three fung oe accounting assumptions: 6. Fundamental Account Going Concern’ Accrual (Consistency a) Going Concern: Financial statements are normally prepared on the assumption that an enterprise will continue in operation in the foreseeable future and neither there is an intention, nor there is a need to materially curtail the scale of operations. b) Accrual Basis: Under this basis of accounting, transactions are recognised as soon as they ‘occur, whether or not cash or cash equivalent is actually received or paid. Accrual basis ensures better matching between revenue and cost and profit! loss obtained on this basis reflects activities of the enterprise during an accounting period, rather than cash flows generated by it ¢) Consistency: The principle of consistency refers to the practice of using same accounting policies for similar transactions in all accounting periods. The consistency improves comparability of financial statements. 7. Qualitative Characteristics of Financial Statements: The framework suggests that the financial statements should observe and maintain the following four qualitative characteristics as far as possible within limits of reasonable cost benefit, Qualitative Characteristics of Financial Statements Relevance Understandability ‘Comparability Reliability CA Inter_40e_Accounting Standards_Supplementary MaterialNo.1 for CA/CWA & MECICEC MASTER MINDS These attributes can be explained as: a) Understandability: The financial statements should present information in a manner as to be readily understandable by the users with reasonable knowledge of business and economic activities and accounting. b) Relevance: The financial statements should contain relevant information only. Information, which is likely to influence the economic decisions by the users, is said to be relevant. ¢) Reliability: To be useful, the information must be reliable: that is to say, they must be free from material error and bias. The information provided are not likely to be reliable unless: i) Transactions and events reported are faithfully represented Transactions and events are reported in terms of their substance and economic reality not merely on the basis of their legal form. iii) The reporting of transactions and events are neutral, ie. free from bias, iv) Prudence is exercised in reporting uncertain outcome of transactions or events v) The information in financial statements must be complete d) Comparability: Comparison of financial statements is one of the most frequently used and most effective tools of financial analysis. The financial statements should permit both inter-firm and intra-firm comparison 8, ELEMENTS OF FINANCIAL STATEMENTS: The framework classifies items of financial statements in five broad groups depending on their economic characteristics, represent a right generating futule economic benefit, e.g. patents, copyrights, debtors and bills receivable. An asset without physical substance can be either intangible asset, e.g. patents and copyrights or monetary assets, e.g. debtors and bills receivable. ii) An asset is a resource controlled by the enterprise. This means it is possible to recognise a resource not owned but controlled by the enterprise as an asset, ie., legal ownership may or may not vest with the enterprise, To be considered as an asset, it must be probable that the resource generates future economic benefit. If the economic benefit from a resource is expected to expire within the current accounting period, itis not an asset. iv) To be considered as an asset, the resource must have a cost or value that can be measured reliably. b) Liability: A liability is a present obligation of the enterprise arising from past events, the settlement ‘of which is expected to result in an outflow of a resource embodying economic benefits. The following points may be noted! i) A liability is a present obligation, ie. an obligation the existence of which, based on the evidence available on the balance sheet date is considered probable. ii) It may be noted that certain provisions, e.g. provisions for doubtful debts, depreciation and impairment losses, represent diminution in value of assets rather than obligations. These provisions are outside the scope of AS 29 and hence should not be considered as liability ili) A liability is recognised only when outflow of economic resources in settlement of a present obligation can be anticipated and the value of outflow can be reliably measured. Otherwise, the liability is not recognised. CA Inter_40e_Accounting Standards_Supplementary Material98851 25025/26 www.mastermindsin om ¢) Equity: Equity is defined as residual interest in the assets of an enterprise after deducting all its liabilities. Equity is the excess of aggregate assets of an enterprise over its aggregate liabilities, d) Income: i) Income is ‘+ _ increase in economic benefits during the accounting period in the form of inflows or ‘+ enhancement of assets and should be measured reliably or ‘+ Decreases jn liabilities that result in increase in equity other than those relating to contributions from equity participants. ii) Revenue is an income that arises in the ordinary course of activities of the enterprise, e.g sales by a trader. i) Gains are income, which may or may not arise in the ordinary course of activity of the enterprise, .g. profit on disposal of fixed assets. Gains are showed separately in the statement of profit and loss because this knowledge is useful in assessing performance of the enterprise. iv) Income eamed is always associated with either increase of asset or reduction of liability. This means, no income can be recognised unless the corresponding increase of asset or decrease of liability can be recognised. For example, a bank does not recognise interest earned on non-performing assets because the corresponding asset (increase in advances) cannot be recognised, as flow of economic benefit to the bank beyond current accounting period is not probable. Thus, Balance sheet of an enterprise can be written in form of: A-L=E ‘Where: Ge A= Aggregate value of asset S Aggregate value of liabilities SS E = Aggregate value of equity & e) Expense: S i) An expense is ¥ * decrease in economic beriefits during the accounting period in the form of outflows or + depletions of assets or ‘+ Incurrence of liabilities that result in decrease in equity other than those relating to distributions to equity participants. ii) The definition of expenses encompasses expenses that arise in the ordinary course of activities of the enterprise, e.9. wages paid, i) Losses may or may not arise in the ordinary course of activity of the enterprise, e.g. loss on disposal of fixed assets. Losses are separately showed in the statement of profit and loss because this knowledge is useful in assessing performance of the enterprise. iv) Expenses are always incurred simultaneously with either reduction of asset or increase of liability. Thus, expenses are recognised when the corresponding decrease of asset or increase of liability are recognised by application of the recognition criteria stated above. OBA Pte sy PROBLEMS FOR SELF PRACTICE 1. ABC Ltd. was making provision for non-moving inventories based on issues for the last 12 months up 10 31.03.2016. ‘The company wants to provide during the year ending 31.03.2017 based on technical evaluation: Total value of inventory Rs. 100 lakhs Provision required based on 12 months issue Rs. 3.5 lakhs CA Inter_40e_Accounting Standards_Supplementary MaterialNo.1 for CA/CWA & MECICEC MASTER MINDS Provision required based on technical evaluation _—Rs. 2.5 lakhs Does this amount to change in Accounting Policy? Can the company change the method of provision? (New sm) Solution: The decision of making provision for non-moving inventories on the basis of technical evaluation does not amount to change in accounting policy. Accounting policy of a company may require that provision for non-moving inventories should be made. The method of estimating the amount of provision may be changed in case a more prudent estimate can be made. In the given case, considering the total value of inventory, the change in the amount of required provision of non-moving inventory from Rs. 3.5 lakhs to Rs. 2.5 lakhs is also not material. The disclosure can be made for such change in the following lines by way of notes to the accounts in the annual accounts of ABC Ltd. for the year 2016-17: “The Company has provided for non-moving inventories on the basis of technical evaluation unlike preceding years. Had the same method been followed as in the previous year, the profit for the year and the corresponding effect on the year end net assets would have been lower by Rs. 1 lakh.” 2. Jagannath Ltd. had made a rights issue of shares in 2017. In the offer document to its members, it had projected a surplus of Rs. 40 crores during the accounting year to end on 31st March, 2017. The draft results for the year, prepared on the hitherto followed accounting policies and presented for perusal of the board of directors showed a deficit of Rs. 10 crores. The board in consultation with the managing director, decided on the following: i) Value year-end inventory at works cost (Rs. 50 crores) instead of the hitherto method of valuation of inventory at prime cost (Rs. 30 crores). ii) Provide depreciation for the year on straight line basis on account of substantial additions in gross block during the year, instead of on the reducing balange method, which was hitherto adopted. As a consequence, the charge for depreciation at Rs. res is lower than the amount of Rs. 45 crores which would have been provided had the lod been followed, by Rs. 18 crores. Not to provide for “after sales expenses” during sranty period. Till the last year, provision at 2% of sales used to be made under the cor “matching of costs against revenue” and actual expenses used to be charged against, vision. The board now decided to account for expenses as and when actually incur fS during the year total to Rs. 600 crores. iv) Provide for permanent fall in the y investments - which fall had taken place over the past five years - the provision being Rs res. As chief accountant of the company, you are asked by the managing director to draft the notes on accounts for inclusion in the annual report for 2016-2017 (NEW SM) Solution: As per AS 1, any change in the accounting policies which has a material effect in the current period or which is reasonably expected to have a material effect in later periods should be disclosed, In the case of a change in accounting policies which has a material effect in the current period, the amount by which any item in the financial statements is affected by such change should also be disclosed to the extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact should be indicated, Accordingly, the notes on accounts should properly disclose the change and its effect. Notes on Accounts: i) During the year inventory has been valued at factory cost, against the practice of valuir prime cost as was the practice til last year. This has been done to take cognizance of the more Capital intensive method of production on account of heavy capital expenditure during the year. As a result of this change, the year-end inventory has been valued at Rs. 50 crores and the profit for the year is increased by Rs. 20 crores. ii) In view of the heavy capital intensive method of production introduced during the year, the ‘company has decided to change the method of providing depreciation from reducing balance method to straight line method. As a result of this change, depreciation has been provided at Rs. 27 crores which is lower than the charge which would have been made had the old method and the old rates been applied, by Rs. 18 crores. To that extent, the profit for the year is increased So far, the company has been providing 2% of sales for meeting “after sales expenses during the warranty period. With the improved method of production, the probability of defects occurring in the products has reduced considerably. CA Inter_40e_Accounting Standards_Supplementary Material98851 25025/26 www.mastermindsin om Hence, the company has decided not to make provision for such expenses but to account for the same as and when expenses are incurred. Due to this change, the profit for the year is increased by Rs. 12 crores than would have been the case if the old policy were to continue, iv) The company has decided to provide Rs. 10 crores for the permanent fall in the value of investments which has taken place over the period of past five years. The provision so made has reduced the profit disclosed in the accounts by Rs. 10 crores. 3. State whether the following statements are ‘True’ or ‘False’. Also give reason for your answer. i) Certain fundamental accounting assumptions underline the preparation and presentation of financial statements. They are usually specifically stated because their acceptance and use are not assumed. ii) If fundamental accounting assumptions are not followed in presentation and preparation of financial statements, a specific disclosure is not required iii) All significant accounting policies adopted in the preparation and presentation of financial statements should form part of the financial statements. iv) Any change in an accounting policy, which has a material effect should be disclosed. Where the amount by which any item in the financial statements is affected by such change is not ascertainable, wholly or in part, the fact need not to be indicated, v) There is no single list of accounting policies which are applicable to all circumstances. mte(0) -4M) Solution: i) False: As per AS 1 “Disclosure of Accounting Policies’, certain fundamental accounting assumptions underlie the preparation and presentation of financial statements. They are usually not specifically slated because their acceptance and@uge are assumed. Disclosure is necessary if they are not followed, RS ii) False: As per AS 1, if the fundamental accoug@assumptions, viz. Going Concem, Consistency and Accrual are followed in financial st&@Wents, specific disclosure is not required. If a fundamental accounting assumptions oh ed, the fact should be disclosed, ) True: To ensure proper understand 6x0 financial statements, it is necessary that all significant accounting policies adopted in the ate tion and presentation of financial statements should be disclosed. The disclosure of thgUntficant accounting policies as such should form part of the be disclosed in one place. iv) False: Any change in the accounting policies which has a material effect in the current period or which is reasonably expected to have a material effect in later periods should be disclosed. Where ‘such amount is not ascertainable, wholly or in part, the fact should be indicated v) True: As per AS 1, there is no single list of accounting policies which are applicable to all circumstances. The differing circumstances in which enterprises operate in a situation of diverse and complex economic activity make altemative accounting principles and methods of applying those principles acceptable financial statements and they sh 4, Om Ltd. purchases goods on behalf of its customers for execution of work under a works contract against which it receives full payment and necessary declaration form under Central Sales Tax Act to be passed on to the supplier. The company follows the practice of treating the same as its purchases and accordingly debits to its Profit and Loss Account. Give your views on the above. (RTP N16) Solution: AS-1 "Disclosures of Accounting Policies”, states that the accounting treatment and presentation in Financial Statements of transactions should be governed by their substance and not merely by the legal form. The treatment in the given case would depend on the terms of the Works Contract and also the substance of the agreement. Accordingly, there can be two possibilities in the instant case, viz. Situation 1: The Company acts as the agent of the customer. Disclosure should be made to this effect that the material purchased belongs to the customer. Where ownership of goods vests with the customers and the company merely purchases goods on behalf of its customers, it acts in the capacity of an agent for execution of works under a works contract for which it receives full payment. CA Inter_40e_Accounting Standards_Supplementary MaterialNo.1 for CA/CWA & MECICEC MASTER MINDS Hence, these purchases cannot be treated as the purchases of the Company and so, the debit to its P&L Accis not correct uation 2: The Company is the owner of the materials purchased in substance and has the right, (though a restricted one) to use the materials, for all practical purposes. If the terms of Works Contract provide for factor linked payment by customer and in substance the materials acquired by the Company belongs to the company only, irrespective of the legal form of ‘ownership, the Company is justified in debiting its P&L A/c. 5. Company follows the following policy for retirement benefits: Contribution to pension fund is made based on actuarial valuation at the year-end in respect of employees who have opted for pension scheme. Contribution to the gratuity fund is made based on actuarial valuation at the year-end. Leave encashment is accounted for on Pay AS YOU GO Method. Comment. Solution: As per AS-1, The “Accrual” is fundamental accounting assumptions, therefore, any accounting policy cannot be contrary to fundamental accounting assumption. Policy followed for leave encashment on the basis of PAY AS YOU GO’ is not in accordance with accrual assumptions. Therefore, the accounting policy as regards leave encashment is not correct, in fact itis contrary to AS-15 “Employee Benefits” 6. Induga Ltd, manufactures a special type of computer. The company has a software division for developing programme with respect to specialized area such as medical imaging. During the year ended 31% March, 2010 the company manufactured a prototype computer to be used for demonstrating the medical imaging software programme and not for sale. The cost of manufacturing of prototype computer was Rs. 50 lakhs. The amount was included in fixed production overheads of hardware division. Comment. Solution: Cost of prototype computer, which is manuf: sale, should not be included in fixed production over the cost of these prototype computers and same t by the Induga Ltd. and is not meant for “Accounting policy is necessary to write off ‘closed, ‘ancial statement for the following items: a) Revenue recognition - sales of goods. b) Depreciation ¢) Impairment of assets d) Foreign currency translation e) Inventories Sol a) Sales are recognised when goods are invoiced and dispatched to customers and are recorded inclusive of excise duty and net of trade discounts and sales tax. b) Depreciation is charged on straight line method based on useful life specified In Schedule Il of the Companies Act, 2013 except for the following assets in respect of which depreciation is charged at the rates mentioned below: i) _Kutcha Roads 47.50% i) Enabling Works 20% ¢) At each balance sheet date, the company reviews the carrying amounts of its fixed assets to determine whether there is any indication that those assets suffered an impairment loss. if any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of impairment loss, Reversal of impairment loss is recognised immediately as income in the profit and loss account. d)_Income and expenses in foreign currencies are converted at exchange rates prevailing on the date of the transaction. Foreign currency monetary assets and liabilies are translated at the exchange rate prevailing on the balance sheet date. Forward exchange contracts outstanding at the balance sheet date are stated at fair values and any gains or losses are recognised in the profit and loss account CA Inter_40e_Accounting Standards_Supplementary Material98851 25025/26 www.mastermindsin e) Inventories are valued as under: Poultry for livestock breeding At cost Raw materials and packing materials [At cost or net realisable value, whichever is lower Work-in-process [At cost or net realisable value, whichever is lower Finished goods [At cost or net realisable value, whichever is lower Stores and spares At cost By products [At estimated selling price Cost of finished goods and work in process include cost of conversion and other costs incurred in bringing the inventories to their present location and conditions. Pera Ua ils) 1. A private limited company manufacturing fancy terry towels had valued its closing inventory of inventories of finished goods at the realizable value, inclusive of profit and the export cash incentives. Firm contracts had been received and goods were packed for export, but the ownership in these ‘goods had not been transferred to the foreign buyers. You are required to advise the company on the valuation of the inventories in line with the provisions of AS 2, (RTP MtB (NEO) Solution: EQ Sat inventories should be valued at lower of Reisiates, “at certain stages in specific industries, Nested or mineral ores have been extracted Accounting Standard 2 “Valuation of Inventories” s| historical cost and net realizable value. The stang such as when agricultural crops have been} perirmance may be subsiantaly compleketeo! fo he execution of the transaction generating fevenuo In such cases, en sale is aee@Nndor forward contract or a goverment gurantee of when market exists and there is a neg sAGGEN® risk of failure to sel, the goods are often valued at net realizable value at certain stages BN lon Terry Towels do not fall in the categ&sy of agricultural crops or mineral ores. Accordingly, taking into account the facts stated, the closing inventory of finished goods (Fancy terry towel) should have been valued at lower of cost and net realizable value and not at net realizable value. Further, export incentives are recorded only in the year the export sale takes place. Therefore, the policy adopted by the company for valuing its closing inventory of inventories of finished goods is not correct. PROBLEMS FOR SELF PRACTICE 4, On 31% March 2017, a business firm finds that cost of a partly finished unit on that date is Rs. 530. The unit can be finished in 2017-18 by an additional expenditure of Rs. 310. The finished unit can be sold for Rs. 750 subject to payment of 4% brokerage on selling price. The firm seeks your advice regarding the amount at which the unfinished unit should be valued as at 31% March, 2017 for preparation of final accounts. Assume that the partly finished unit cannot be sold in semi-finished form and its NRV is zero without processing it further. (NEW SM) Solution: Valuation of unfinished unit Net selling price 750 Less: Estimated cost of completion (G10) 440 Less: Brokerage (4% of 750) (80) Net Realisable Value 410 Cost of inventory 530 Value of inventory (Lower of cost and net realisable value) 410 CA Inter_40e_Accounting Standards_Supplementary Material 10No.1 for CA/CWA & MECICEC MASTER MINDS 2. A trader purchased certain articles for Rs. 85,000. He sold some of articles for Rs. 1,05,000. The average percentage of gross margin is 25% on cost. Opening stock of inventory at cost was Rs. 15,000. (NEW SM) Solutior Cost of closing inventory is shown below Particulars Amount (Rs.) Sale value of opening stock and purchase (Rs. 85,000 + Rs. 15,000) x 1.25 4,25,000 Sales (7,05,000) Sale value of unsold stock 20,000 Less: Gross Margin (Rs. 20,000 / 1.25) x 0.25 (4,000) Cost of inventory 16,000 3. You are required to value the inventory per kg of finished goods consisting of: Particulars Rs. perkg. Material cost 200 Direct labour 40 Direct variable overhead 20 Fixed production charges for the year on normal working capacity of 2 lakh kgs is Rs. 20 lakhs. 4,000 kgs of finished goods are in stock at the year end. ew smn Sol In accordance with AS 2 (Revised), the cost of conversig@g@lude a systematic allocation of fixed and variable overheads that are incurred in converting m Into finished goods. The allocation of fixed overheads for the purpose of their inclusion in th conversion is based on normal capacity of the production facilities. ~ Cost of eS e008 (Per kg.) Particulars <@) Amount (Rs.)_| Amount (Rs.) Material Cost 200 Direct Labour 40 Direct Variable Production Overhead 20 ( Rs. 20,00,000 10 Fixed Production Overhead: | S= 2000000 {200,000 Units To| 270 Hence the value of 4,000 kgs. of finished goods = 4,000 kgs x Rs. 270 = Rs. 10,80,000 4, Hello Ltd. purchased goods at the cost of Rs 20 lakhs in October. Till the end of the financial year, 75% of the stocks were sold. The Company wants to disclose closing stock at Rs 5 lakhs. The expected sale value is Rs 5.5 lakhs and a commission at 10% on sale is payable to the agent. What is the correct value of closing stock? (RTP NA7) Solution: As per para 5 of AS 2 “Valuation of Inventories’, the inventories are to be valued at lower of cost or net realizable value. In this case, the cost of inventory is Rs 5 lakhs. The net realizable value is Rs 4.95 lakhs (Rs 5.5 lakhs less cost to make the sale @ 10% of Rs 5.5 lakhs). So, the closing stock should be valued at Rs 4.95 lakhs, 5. Suraj Stores is a departmental store, which sell goods on retail basis. It makes a gross profit of 20% on net sales. The following figures for the year-end are available: Opening Inventory Rs 50,000; Purchases Rs 3,60,000; Purchase Retums Rs 10,000; Freight Inwards Rs 10,000; Gross Sales Rs 4,50,000; Sales Retums Rs 11,250; Carriage Outwards Rs 5,000 Compute the estimated cost of the inventory on the closing date. (re m7) CA Inter_40e_Accounting Standards_Supplementary Material 148851 25025/26 www.mastermindsindia.com Solution: Calculation of cost of closing inventory Particulars Amount (Rs.) (Opening Inventory 50,000 Purchases less retums (Rs.3,60,000 - Rs. 10,000) 3,50,000 Freight inwards 10,000 4,10,000 Less: Net Sales (Rs. 4,50,000 - Rs. 11,250) (4.38,750) (28,750) ‘Add: Gross Profit (Rs. 4,38,750 x 20%) 87,750 Closing Inventory 59,000 6. Capital Cables Ltd., has a normal wastage of 4% in the production process. During the year 2013-14 the Company used 12,000 MT of raw material costing Rs 150 per MT. At the end of the year 630 MT of wastage was in stock. The accountant wants to know how this wastage is to be treated in the books. Explain in the context of AS 2 the treatment of normal loss and abnormal loss and also find out the amount of abnormal loss if any (MTP2 N18 (NBO), MTP2 H18 (NSO)) Solution: ‘As per para 13 of AS 2 (Revised) ,Valuation of Inventories'’ , abnormal amounts of wasted materials, Labour and other production costs are excluded from cost of inventories and such costs are recognized as expenses in the period in which they are incurred, The normal loss will be included in determining the cost of inventories (finished goods) at Amount of Normal Loss and Abnormal Loss Material used (12,000 MT @ Rs. 150) Rs.18,00,000 Normal Loss (4% of 12,000 MT) 480 MT Net quantity of material S&S 44,520 MT ‘Abnormal Loss in quantity ¥ 150 MT (630 MT - 480 MT) ‘Abnormal Loss [150 units @ Rs 186.25 (Rs 18,00,000/11,520)] Rs 23,437.50 Amount Rs 23,437.50 will be charged to the Profit and Loss statement. 7. On the basis of information given below, find the value of inventory (by periodic inventory method) as per AS 2, to be considered while preparing the Balance Sheet as on 31" March, 2017 on weighted Average Basis, (MTP1 M18 (N&O) Details of Purchases: Date of purchase Unit (Nos.) Purchase cost per unit (Rs.) (01-08-2017 20 108 (08-03-2017 15 107 17-03-2017 30 109 25-03-2017 15 I 107 Details of issue of Inventory: Date of Issue Unit (Nos.) 03-03-2017 10 12-03-2017 20 18-03-2017 10 24-03-2017 20 Net realizable value of inventory as on 31st March, 2017 is Rs 107.75 per unit You are required to compute the value of Inventory as per AS 2? CA Inter_40e_Accounting Standards_Supplementary Mate: 12No.1 for CA/CWA & MECICEC MASTER MINDS Sol Net Realisable Value of Inventory as on 31st March, 2017 = Rs 107.75 x 20 units = Rs 2,155 Value of inventory as per Weighted Average ba Total units purchased and total cost: 01.03.2017 Rs. 108 x 20 units = Rs. 2,160 08.3.2017 Rs. 107 x 15 units = Rs. 1,605 17.03.2017 Rs. 109 x 30 units = Rs. 3.270 25.03.2017 Rs, 107 x 15 units = Rs. 1,605, Total 80 units = Rs. 8,640 Weighted Average Cost = Rs. 8,640/80 units = Rs. 108 Total cost = Rs. 108 x 20 units = Rs. 2,160 Value of inventory to be considered while preparing Balance Sheet as on 31% March, 2017 is, Cost or Net Realisable value whichever is lower i.e. Rs. 2,155, 8. Induga Ltd. manufacture computers, during the year ended 31st March, 2010 the company manufactured 550 computers, it has the policy of valuing finished stock of goods at a standard cost of Rs. 1.8 lakhs per computer. The details of the cost are as under: (Rs. in Lakhs) Raw material consumed 400 Direct Labour 250 Variable production overheads 150 Fixed production overheads (Including interest of Rs hs) 290 ‘Compute the value of cost per computer for the put f closing stock. inventories, finished stock of goods should be bie" absorbing fixed production overheads the normal Inished stock has been valued at a standard rate of Rs. Solution: As per AS-2 (Revised), On valug, valued on the basis of absorption costing. <4 production capacity is considered, In thi 118 lakhs per computer which incidegQQySynchronizes with the value computed on the basis of absorption costing as under: Ly (Rs. in lakhs) Materials, 400 Direct Labour 250 Variable production overheads 150 Fixed production overheads 290 Less: Interest 100 190 Total Cost 990 Number of computers produced (Assumed to be normal production) Cost per computer (990 lakhs /550) 50 Rs. 1.80 lakhs Policy of the company to value closing stock is not as per AS-2. As per AS-2, the techniques of standard cost method may be used for convenience if the result approximates to the actual cost and standard cost is regularly reviewed if necessary. In the instant case, the cost of inventory can be conveniently calculated as per absorption costing. Therefore, there is no reason that standard costing method should be adopted. 9, Raw material was purchased at Rs. 100 per kg. Price of raw material is on the decline. The finished ‘goods in which the raw material is incorporated are expected to be sold at below cost. 10,000 kgs. of raw material is in stock at the year-end Replacement cost is Rs. 80 perkg. How will you value the inventory? Sol ‘As per AS-2, on valuation of inventories, material and other supplies held for use in the production of inventories are not written down below cost if the finished products in which they will be CA Inter_40e_Accounting Standards_Supplementary Material 1398851 25025/26 www.mastermindsin om incorporated are expected to be sold at or above cost. However, when there has been a decline in the price of materials and it is estimated that the cost of the finished products will exceed net realisable value, the materials are written down to net realisable value. In such circumstances, the replacement cost of the material may be the best available measure of their net realisable value. Hence in this case, the stock of 10,000 kgs. of raw material will be valued at Rs.80 per kg, The finished goods, if on stock, should be valued at cost or net realisable value, whichever is lower. 10. The Company sells IMFL and beer to the customers, some of the customers consumed the beer in the bars run by it. While leaving the bar, the consumers left the empty bottles in the bars and the company takes the possession of these empty bottles. These empty bottles are disposed of by the company. The company has laid down detailed procedures for the maintenance of the records, tenders to be called for the disposal of empty bottles etc. Keep in view the above a) Whether the stock of empty bottles is an asset of the company. b) If so, whether the stock of empty bottles existing as on the date of the balance sheet is to be considered as inventories of the company. ¢) If the answer to (b) above is positive, whether the stock of empty bottles existing as on the date of the balance sheet is to he valued at net realisable value and considered as income to be shown in the profit and loss account or is to be considered as a stock suspense account on the liabilities side of the balance sheet if the cost of empty bottles is NIL. Solution: a) The stock of empty bottles is an asset of the company being a resource controlled by the company b) The stock of empty bottles existing at the bal ee een REA Teena at same is not considered as income. In caskP\apcost of empty bottles i nil, the total stock of botles should be reflected at the nominal valu@R®. 1 in balance sheet. AS - 4: CONTINGENCIES AND EVENTS OCCURRING AFTER THE BALANCE SHEET DATE PROBLEMS FOR CLASSROOM DISCUSSION 1. Accompany deals in petroleum products. The sale price of petrol is fixed by the government. After the Balance Sheet date, but before the finalisation of the company’s accounts, the govemment unexpectedly increased the price retrospectively. Can the company account for additional revenue at the close of the year? Discuss in line with provisions of AS 4. (RTP NIT) Solution: ‘According to para 8 of AS 4, the unexpected increase in sale price of petrol by the government after the balance sheet date cannot be regarded as an event occurring after the Balance Sheet date, which requires an adjustment at the Balance Sheet date, since it does not represent a condition present at the balance sheet date. The revenue should be recognized only in the subsequent year with proper disclosures. 2. Board of Directors of M/s. New Graphics Ltd. in its Board Meeting held on 18th April, 2017, considered and approved the Audited Financial results along with Auditors Report for the Financial Year ended 31st March, 2017 and recommended a dividend of Rs 2 per equity share (on 2 crore fully paid up equity shares of Rs 10 each) for the year ended 31st March, 2017 and if approved by the members at the forthcoming Annual General Meeting of the company on 18th June, 2017, the same will be paid to all the eligible shareholders. (MTP NIB{N), MPI MI8(N)) Solution: As per the amendment in AS 4 “Contingencies and Events Occurring after the Balance Sheet Date” vide ‘Companies (Accounting Standards) Amendments Rules, 2016 dated 30" March, 2016, the events which take place after the balance sheet date, are sometimes reflected in the financial statements because of statutory requirements or because of their special nature. However, dividends declared after the balance CA Inter_40e_Accounting Standards_Supplementary Material 14No.1 for CA/CWA & MECICEC MASTER MINDS sheet date but before approval of financial statements are not recognized as a liability at the balance sheet date because no statutory obligation exists at that time. Hence such dividends are disclosed in the notes to financial statements. So, provision for proposed dividends is not required to be made. Such proposed dividends are to be disclosed in the notes to financial statements. Accordingly, the dividend of Rs 4 crores recommended by New Graphics Ltd. in its Board meeting on 18th April, 2017 shall not be accounted for in the books for the year 2016-17 irrespective of the fact that it pertains to the year 2016- 17 and will be paid after approval in the Annual General Meeting of the members / shareholders. PROBLEMS FOR SELF PRACTICE An earthquake destroyed a major warehouse of ACO Ltd. on 20.05.2017. The accounting year of the ‘company ended on 31.03.2017. The accounts were approved on 30.6.2017. The loss from earthquake is estimated at Rs. 30 lakhs. State with reasons, whether the loss due to earthquake is an adjusting or non-adjusting event and how the fact of loss is to be disclosed by the company. (NEW SM) Solution: AS 4 (Revised) “Contingencies and Events Occurring after the Balance Sheet Date’, states that adjustments to assets and liabilities are not appropriate for events occurring after the balance sheet date, if such events do not relate to conditions existing at the balance sheet date. The destruction of warehouse due to earthquake did not exist on the balance sheet date i.e. 31.03.2017. Therefore, loss ‘occurred due to earthquake is not to be recognised in the financial year 2016-2017. However, according to the standard, unusual changes affecting the existence or substratum of the enterprise after the balance sheet date may indicate a need to consider the use of fundamental accounting assumption of going concem in the preparation of the financial statements. As per the information given in the question, the earthquake has caused major destruction; therefore fundamental accounting assumption of going concem is called upon. Considering that the going concem assumption is stil valid, the fact of earthquake together wis an estimated loss of Rs. 30 lakhs should be disclosed in the financial statements for the financial, 2. A company has filed a legal suit against the det im whom Rs. 15 lakh is recoverable as on 31.03.2017. The chances of recovery by way o} uit are not good as per legal opinion given by the counsel in April, 2017. Can the compan ene for full amount of Rs. 15 lakhs as provision for doubtful debts? Discuss, (wewsm) Solution: Ss As per AS 4 (Revised) "Contingencif NE Events Occurring After the Balance Sheet Date", assets and liabilities should be adjusted for 8vents 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. In the given case, company should make the provision for doubtful debts, as legal suit has been filed on 31st March, 2017 and the chances of recovery from the suit are not good. Though, the actual result of legal suit will be known in future yet situation of non-recovery from the debtors exists before finalisation of financial statements. Therefore, provision for doubtful debts should be made for the year ended on 31st March, 2017. 3. You are an accountant preparing accounts of A Ltd. as on 31.03.2017. After year end the following events have taken place in Apri, 2017: i) fire broke out in the premises damaging, uninsured stock worth Rs.10 lakhs (Salvage value Rs 2 lakhs). ii) A suit against the company's advertisement was filed by a party claiming damage of Rs. 20 lakhs. Describe, how above will be dealt within the accounts of the company for the year ended on 31.03.2017 (NEW su) Solutio In accordance with AS 4 (Revised), events occurring after the balance sheet date are those significant events, both favourable and unfavourable, that occur between the balance sheet date and the date on which the financial statements are approved by the Board of Directors in the case of a company. ‘Two types of events can be identified a) Adjusting events: Those which provide further evidence of conditions that existed at the balance sheet date. CA Inter_40e_Accounting Standards_Supplementary Material 1598851 25025/26 www.mastermindsin om b) Non-adjusting events: balance sheet date. Those which are indicative of conditions that arose subsequent to the Both the cases discussed in the question are non-adjusting events since they are indicative of conditions that arose subsequent to the balance sheet date In such a case, no adjustment to assets and liabilities is required at the balance sheet date, however, in accordance with AS 4 (Revised), disclosure should be made in the report of the approving authority of those events occurring after the balance sheet date that represent material changes and ‘commitments affecting the financial position of the enterprise. The key point here is whether the impact of the loss is material or not. As the loss has arisen from non-insurance the event becomes very material not merely on account of the current loss but the future vulnerability. Hence, fire accident and loss thereof must be disclosed in the director's report as also the fact that the stocks of the company are uninsured with a value of the future risk (if possible). Suit filed against the company being a contingent liability must also be disclosed, 4. In preparing the financial statements of R Ltd, for the year ended 31st March, 2017, you come across the following information. State with reasons, how you would deal with this in the financial statements: ‘The company invested 100 lakhs in April, 2017 before approval of Financial Statements by the Board of directors in the acquisition of another company doing similar business, the negotiations for which had started during the year. (NEW SM) Solution: AS 4 (Revised) defines “Events Occurring after the Balance Sheet Date" as those significant events, both favourable and unfavorable, that occur between the balance sheet date and the date on which the financial statements are approved by the Approving Aujh@@ity in the case of a company. Accordingly, the acquisition of another company is an event occurrin balance sheet date. However, no adjustment to assets and liabil required as the event does not affect the determination and the condition of the amount in the financial statements for the year ended 31st March, 2017. Applying AS 4 (Revised) whi ly states that disclosure should be made in the report of the approving authority of those event ing after the balance sheet date that represent material changes and commitments affecting tt cial position of the enterprise, the investment of Rs. 100 lakhs in April, 2017 in the acquisi "another company should be disclosed in the report of the Approving Authority to enable users ONpMancial statements to make proper evaluations and decisions, 5. A Limited Company closed its accounting year on 30.06.2017 and the accounts for that period were considered and approved by the board of directors on 20th August, 2017.The company was engaged in laying pipe line for an oil company deep beneath the earth. While doing the boring work on 01.09.2017 it had met a rocky surface for which it was estimated that there would be an extra cost to the tune of Rs 80 lakhs. You are required to state with reasons, how the event would be dealt with in the financial statements for the year ended 30.06.2017, (NEW SM) Sol AS 4 (Revised) on Contingencies and Events Occurring after the Balance Sheet Date defines ‘events ‘occurring after the balance sheet date’ as ‘significant events, both favourable and unfavorable, that occur between the balance sheet date and the date on which financial statements are approved by the Board of Directors in the case of a company’. The given case is discussed in the light of the above mentioned definition and requirements given in AS 4 (Revised) In this case the incidence, which was expected to push up cost, became evident after the date of approval of the accounts. So it is not an ‘event occurring after the balance sheet date. However, this may be mentioned in the Report of Approving Authority. 6. With reference to AS 4 "Contingencies and events occurring after the balance sheet date”, Identify whether the following events will be treated as contingencies, adjusting events or non-adjusting events occurring after balance sheet date in case of a company which follows April to March as its financial year. i) A:major fire has damaged the assets in a factory on Sth April, 5 days after the year end. However, the assets are fully insured and the books have not been approved by the Directors. ii) A suit against the company’s advertisement was filed by a party on 10th April, 10 days after the year end claiming damages of Rs 20 lakhs. (RTP MI8(N)) CA Inter_40e_Accounting Standards_Supplementary Material 16No.1 for CA/CWA & MECICEC MASTER MINDS Solution: According to AS 4 on ‘Contingencies and Events Occurring after the Balance Sheet Date’ adjustments to assets and liabilities are required for events occurring after the balance sheet date that provide additional information materially affecting the determination of the amounts relating to conditions existing at the balance sheet date. However, adjustments to assets and liabilities are not appropriate for events occurring after the balance sheet date, if such events do not relate to conditions existing at the balance sheet date. “Contingencies” used in the Standard is restricted to conditions or situations at the balance sheet date, the financial effect of which is to be determined by future events Which may or may not occur. i) Fire has occurred after the balance sheet date and also the loss is totally insured, Therefore, the event becomes immaterial and the event is non-adjusting in nature. ii) The contingency is restricted to conditions existing at the balance sheet date. However, in the given case, suit was filed against the company's advertisement by a party on 10th April for amount of Rs 20 lakhs. Therefore, it does not fit into the definition of a contingency and hence is a non- adjusting event 7. Acompany entered into an agreement to sell its immovable property included in the Balance Sheet at Rs. 5 lakhs to another company for Rs. 20 lakhs. The agreement to sell was concluded on 31-01-2010 and the sale deed was registered on 30-04-2010. How this will be treated in Balance Sheet as on 31-03-2010. Solution: As per AS-4, 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. In this case sale of immovable property was concluded before approval by the Board. This is clearly an event occurring after the balance sheet date. Agreement to sell was entered into before the balance sheet date. Registration of the sale deed simply provides additional information relating to the conditions existing balance sheet date. So adjustments to assets are necessary and Asset will be derecognized i lance Sheet as on 31-03-2010. ended 31st March, 2010, ‘On 15th April, 2010, due to destruction of, of the company’s debtors, declared hims ivent. He owed Rs, 1,17,000 to B Co Lt. As per AS-4, Adjustment of: ‘and liabilities is to be made if event relates to the condition existing on the balance sheet date and pYovides additional evidence to assist the estimation of amounts relating to conditions existing at the balance sheet date. In this case the fire took place on 27th March, 2010 before the date of balance sheet and debtors are declared insolvent on 18th Apri, 2010, the event of 15th April, 2010 only provides the additional evidence to estimate the amount of loss. Accordingly, adequate provision for bad debts should be created to cover the loss arising Out of insolvency for the year ended 31st March, 2010. 8. Advise to B Co, Ltd. about the treatment of the follSQQQNIn the final statement of accounts for the year {ory by fire (fire took place on 27" March, 2010) one See STU ato 1. Bela Ltd, has a vacant land measuring 20,000 sq,mts, which it had no intention to use in the future. The Company decided to sell the land to tide over its liquidity problems and made a profit of Rs10 Lakhs by selling the said land. Moreover, there was a fire in the factory and a part of the unused factory shed valued at Rs. 8 Lakhs was destroyed. The loss from fire was set off against the profit from sale of land and profit of Rs. 2 lakhs was disclosed as net profit from sale of assets. You are required to examine the treatment and disclosure done by the company and advise the company in line with AS 5. (RTP M18 (N), RTP N16) Solution: As per AS 5 "Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies” Extraordinary items should be disclosed in the statement of profit and loss as a part of net profit or loss for the period. The nature and the amount of each extraordinary item should be separately disclosed in the statement of profit and loss in a manner that its impact on current profit or loss can be perceived. CA Inter_40e_Accounting Standards_Supplementary Material 1798851 25025/26 www.mastermindsin om In the given case the selling of land to tide over liquidation problems as well as fire in the Factory does not constitute ordinary activities of the Company. These items are distinct from the ordinary activities of the business, Both the events are material in nature and expected not to recur frequently or regularly. Thus, these are Extraordinary Items. Therefore, in the given case, disclosing net profits by setting off fire losses against profit from sale of land is not correct. The profit on sale of land, and loss due to fire should be disclosed separately in the statement of profit and loss. 2. The company has to pay delayed cotton clearing charges over and above the negotiated price for taking delayed delivery of cotton from the Supplier's Godown. Upto 2008-09, the company has regularly included such charges in the valuation of closing stock. This being in the nature of interest. the company has decided to exclude it from closing stock valuation for the year 2009-10. This would result into decrease in profit by Rs. 7.60 lakhs. Comment. Solution: AS-5 states that a change in an accounting policy should be made only if the adoption of a different accounting policy is required by statute or for compliance with an accounting standard or if it is considered that the change would result in a more appropriate preparation or presentation of the financial statements of an enterprise. Therefore, the change in the method of stock valuation is justified in view of the fact that the change is in line with the recommendations of AS-2 and would result in more appropriate preparation of the financial statements. As per AS-2, this accounting policy adopted for valuation of inventories including the cost formulae used should be disclosed in the financial statements, ‘Also, appropriate disclosure of the change and the amount by which any item in the financial statements is affected by such change is necessary as per AS-1, AS-2 and AS-5. Therefore, the under mentioned note should be given in the Annual Accounts. “In compliance with the Accounting Standard issue which are in the nature of interest have been e preceding years. Had the company continued closing stock as well as profit before tax for t 1@ ICAI, delayed cotton clearing charges from the valuation of closing stock unlike Counting practice followed earlier, the value of uld have been higher by Rs, 7.60 lakhs" ‘SELF PRACTICE ity Board at provisional rates. Final bill for fuel surcharge of Rs 5.0 lakhs for the period OSNRYF, 2008 to September, 2015 has been received and paid in February, 2016. However, the same Was accounted in the year 2016-17. Comment on the accounting treatment done in the said case. (NEW SM) Solution: The final bill having been paid in February, 2016 should have been accounted for in the annual accounts of the company for the year ended 31st March, 2016. However, it seems that as a result of error or ‘omission in the preparation of the financial statements of prior period ie., for the year ended 31st March 2016, this material charge has arisen in the current period ie., year ended 31st March, 2017. Therefore it should be treated as ‘Prior period item’ as per AS 5. As per AS 5, prior period items are normally included in the determination of net profit or loss for the current period. An altemative approach is to show such items in the statement of profit and loss after determination of current net profit or loss. In either case, the objective is to indicate the effect of such items on the current profit or loss. It may be mentioned that it is an expense arising from the ordinary course of business. Although abnormal in amount or infrequent in occurrence, such an expense does not qualify an extraordinary item as per AS 5. For better understanding, the fact that power bill is accounted for at provisional rates billed by the state electricity board and final adjustment thereof is made as and when final bill is received may be mentioned as an accounting policy. Fuel surcharge is billed by the Stat 2. The Accountant of Mobile Limited has sought your opinion with relevant reasons, whether the following transactions will be treated as change in Accounting Policy or not for the year ended 31st March, 2017. Please advise him in the following situations in accordance with the provisions of AS 5: i) Provision for doubtful debts was created @ 2% till 31st March, 2016. From the Financial year 2016-2017, the rate of provision has been changed to 3%. During the year ended 31st March, 2017, the management has introduced a formal gratuity ‘scheme in place of ad-hoc ex-gratia payments to employees on retirement. CA Inter_40e_Accounting Standards_Supplementary Material 18No.1 for CA/CWA & MECICEC MASTER MINDS i) Till the previous year the furniture was depreciated on straight line basis over a period of 5 years. From current year, the useful life of furniture has been changed to 3 years. iv) Management decided to pay pension to those employees who have retired after completing 5 years of service in the organization. Such employees will get pension of Rs. 20,000 per month Earlier there was no such scheme of pension in the organization. v) During the year ended 31st March, 2017, there was change in cost formula in measuring the cost of inventories, (RTP NAB (NBO) Solution: i) In the given case, Mobile limited created 2% provision for doubtful debts til 31st March, 2016. ‘Subsequently in 2016-17, the company revised the estimates based on the changed circumstances and wants to create 3% provision. Thus change in rate of provision of doubtful debt is change in estimate and is not change in accounting policy. This change will affect only current year. ii) As per AS 5, the adoption of an accounting policy for events or transactions that differ in substance from previously occurring events or transactions, will not be considered as a change in accounting policy. Introduction of a formal retirement gratuity scheme by an employer in place of ad hoc ex-gratia payments to employees on retirement is a transaction which is substantially different from the previous policy, will not be treated as change in an accounting policy. Change in useful life of furniture from 5 years to 3 years is a change in estimate and is not a change in accounting policy. iv) Adoption of a new accounting policy for events or transactions which did not occur previously should not be treated as a change in an accounting policy. Hence the introduction of new pension ‘scheme is not a change in accounting policy. v)_ Change in cost formula used in measurement of cost. lories is a change in accounting policy. 3. At December 31, 2010, Matson Inc. was holdin company appropriately recognized a loss in 201 statement for the year ended December 31, 2 assets, which it intended to sell. The id to these assets. On Matson Inc.'s income joss should be reported as an a) Extraordinary item b) Component of income from contin ations before income-taxes. ¢) Separate component of selling or g8XS¥al and administrative expenses, disclosed net of tax benefit d) Component of the gain (loss) from sale of discontinued operations, disclosed net of income-taxes. Solution: As per AS-5, Losses associated with long-lived assets, which are to be disposed of, are to be reported as a component of income from continuing operations before income-taxes for entities preparing income statements. Therefore, answer (b) is correct, Answer (a) is incorrect because losses on long-lived assets to be disposed of are neither unusual nor infrequent occurrences. Answer (c) is incorrect because these losses are not part of selling or general and administrative expenses and they are not disclosed net of tax, answer (d) is incorrect, because discontinued operations result from disposal of a business, not the disposal of long-lived assets held for resale. CSSA Ga Tab PROBLEMS FOR SELF PRACTICE 1. A contractor entered into a contract for building roads for Rs. 2 crores. After completing 60% of the contract he came to know that the cost of completing the contract would be Rs. 2.40 crores. The accountant transferred Rs. 0.24 crores i.e., 60% of total loss of Rs. 0.40 crores to Profit and Loss account in the current year, You are required to give your opinion in line with AS 7. (MTP NIT) Solution: As per AS 7, when it is probable that total contract costs will exceed total contract revenue, the expected loss should be recognized as an expense immediately irrespective of the stage of completion. In the given case the revenue that can be recognized for the contract i.e. Rs. 2 crore and the expected expense on the contract is Rs. 2.4 cores. 60% of the contract has been completed. CA Inter_40e_Accounting Standards_Supplementary Material 1998851 25025/26 www.mastermindsin om Therefore as per AS 7 whole amount of expected loss i.e. Rs. 0.40 crores should be recognized as an expense immediately irrespective of the stage of completion of the contract. Therefore the action of accountant of transferring only Rs. 0.24 crores to the profit & loss alc is wrong. He must transfer whole Rs. 0.40 crore to profit & loss a/c as an expense. 2. Ms Highway Constructions undertook the construction of a highway on 01.04.2013. The contract was to be completed in 2 years. The contract price was estimated at Rs 150 crores. Up to 31.03.2014 the ‘company incurred Rs 120 crores on the construction. The engineers involved in the project estimated that a further Rs 45 crores would be incurred for completing the work What amount should be charged to revenue for the year 2013-14 as per the provisions of Accounting Standard 7 "Construction Contracts"? Show the extract of the Profit & Loss A/c in the books of Mis. Highway Constructions. (MTP2 N18 (N&O) ‘Solutic Statement showing the amount to be charged to Revenue as per AS 7 Particulars Rs in crores ‘Cost of construction incurred up to 31.03.2014 120 ‘Add: Estimated future cost 45 Total estimated cost of construction 165 Degree of completion (120/165 x 100) T2T3% Revenue recognized (72.73% of 150) 709 (approx) Total foreseeable loss (165 - 150) 45 Less: Loss for the current year (120 - 109) 1 Loss to be provided for 4 Profit and Loss Agg@Oi (Extract) Particulars Rs in crores Particulars Rs in crores To Construction Costs 12, ntract Price 109 To Provision for loss ANS Contract Price 15 124 3. Gammon India Ltd. has anderen 8 osrcion contract as per detail given below, bridge will be constructed in 3 years a) Initial contract revenue Rs. 900 crores b) Initial contract cost Rs. 800 crores Years ist lind Wire Estimated contract cost 805) Increase in contract revenue -| 20 Estimated additional increase cost : 15 ‘Contract cost incurred up to 161 584 820 ‘At the end of the 2 year cost incurred includes Rs, 10 crores, for material stored at the sites to be used in 3" year to complete the project. Solution: (Rs. in crores) Particulars Yeart Year il Year ill ‘a)_Initial revenue agreed 900 900) 900 b) Variation =| 20) 20 ‘¢) Total Contract Value ‘300 920) 920 ‘d) Contract cost incurred up to the date of 161] 584 (includes 10 820 reporting crores of Material) ) Estimated cost to complete 644 236 | f) Total estimated contract 805, 820) 820 [g) Estimated Profit 95) 100) 100 h) Stage of Completion (dif x 100) 20% 70% 100% (1617805 x 100) | (684 -107 820 x 100)| (820/820 x 100) CA Inter_40e_Accounting Standards_Supplementary Material 20No.1 for CA/CWA & MECICEC MASTER MINDS ‘Amount of revenue, expenses and profit recognized in statement of Profit and Loss Account in three years a Up to reporting | Recognized in prior | Recognized in current fear | date year year Revenue (900 x 20%) 780) 180 Expenses. 161 161 Profit 19 3 Year Il Revenue (920x70/100) 644 180 a Expenses (820x70/100) 574 161 413, Profit 70) 19 El Year Il Revenue 920 644 276 Expenses 820 574 246 Profit 100) 70! 30 4, Induga Ltd. undertook construction contract to construct sub-way for Rs 100 crores on 1-1-2009. It estimated construction cost initially at Rs. 70 crores. Contract was estimated to be completed in three years. However, when starting the work it was found that there were rocks underground at construction site and cost shall increase by Rs. 36 crores and the contract shall be completed in 3 years. The company wants to provide for expected loss of Rs. 2 crores per year. a) Is the treatment is correct? b) If work has not yet started but by technical survey it was known on 25-12-2009 that there was rock undemeath at construction site. Company did not want to provide for any losses of Rs. 6 crores for the year ended 31-3-2010; considering that when project Ra start, the losses shall be provided for. Solution: SY a) No, the stand of company is not correct. As ps exceed total contract revenue. The expe Therefore total expected loss of Rs. 6 cr b) No, the stand of company is not irrespective of - whether or not for the year ended 31-3-2010 ‘when itis probable that total contract cost will fhould be recognized as an expense immediately. 'e provided for the year ended 31-03-2010. “As per AS-7, the amount of such loss is determined ‘commenced on the contract, while loss is to be provided 5. NDA Ltd. began operation of its construction division on April 1, 2008 and entered into contracts for two separate projects X and Y. The X project contract price was Rs. 6,00,000 and provided for penalties of Rs. 10,000 per week for late completion. Although during 2008-09 the X project had been ‘on schedule for timely completion, it was completed four weeks late in February 2010. The Y project's original contract price was Rs. 8,00,000. Due to change in orders during January 2010 the contract price has been increased by Rs. 40,000. The following data pertains to the separate long-term construction projects in progress. (Amt. in Rs.) Particulars x ¥ As of March 31, 2009: Cost incurred to date 360,000 4,10,000 Estimated costs to complete 40,000 4,10,000 Billings 3,15,000 4,40,000 Cash Collections 2,75,000 3,65,000 As of March 31, 2010: Cost incurred to date 4,50,000 7,20,000 Estimated Costs to Complete | 7,80,000 Billings 560,000 710,000 Cash Collections 560,000 6,25,000 Required: Prepare a schedule showing NDA Ltd. Gross Profit/Loss recognised for the years ended March 31, 2009 and 2010 as per AS-7. CA Inter_40e_Accounting Standards_Supplementary Mate: 248851 25025/26 www.mastermindsindia.com Solution: Step 1: Recognition of Profit for the year ended March 31, 2009 (Amt. in Rs.) Particulars x Y ‘a)_Estimated gross profitlloss: i) Contract price 600,000 8,00,000 ))_Less: Total costs (including estimated cost of completion) 4,00,000. 8,20,000 iii) Estimated gross profitioss 2,00,000 (20,000) b) Percentage complete: Cost incurred to date 360,000 410,000 )) Total costs 4,00,000 8,20,000 i) Percentage completed 90% 50% ‘¢)_Gross Profit/loss to be recognised 7,80,000) (20,000) ‘Step 2: Recognition of Profit for the year ended March 31, 2010 (Amt. in Rs.) a) Estimated gross profitlloss: i) Contract price 560,000 840,000 (€,00,000 - 40,000)| (8,00,000 + 40,000) ji) Less: Total costs (induding estimated cost of completion) 4,50,000 9,00,000 Estimated gross profitioss 7,10,000 (60,000) b) Percentage complete: i) Cost incurred to date 4,50,000 7,20,000 )) Total costs 4,50,000 9,00,000 Percentage completed 100% 80% ¢)_ Gross profitiloss to be recognised 7,10,000 (60,000) 'd)_Less: Gross profitioss recognised in previous yegt Transaction from B 7,00,000 50,000| 7,50,000 ‘Transaction from C 5) 10,000] 50,000! 60,000 Transaction from A, 25,000] 1,00,000| _1,25,000 Total segment revenue as per AS 17 660,000 4,15,000| 2,70,000| _13,45,000 Operating expenses '3,00,000| 1,50,000|_75,000| _5,25,000 Enterprise expenses (allocated in 5 4 :2 basis) 35,000| 28,000] 14,000! 77,000 Expenses on transactions with other segments Transaction from B [75,000] 30,000| _1,05,000 Transaction from C 6,000/ 40,000 46,000 Transaction from A, I [18,000] 82,000] 7,00,000 Total segment expenses as per AS 17 (B) 416,000) 236,000] "2,01,000| 8,53,000 Segment result (A-B) 2,44,000| 1,79,000| _ 69,000[ _4,92,000 2. As per AS- 17 “Enterprise revenue is revenue from sales to external customers as reported in the statement of profit or loss” and Segment revenue is the aggregate of the portion of enterprise revenue that is directly attributable to a segment, the relevant portion of enterprise revenue that can be allocated on a reasonable basis to a segment, and revenue from transactions& with other segments of the enterprise. Segment revenue does not include: a) Extraordinary items as defined in AS-5, Net Profit or Loss for the Period, Prior Period Items and ‘Changes in Accounting Policies; b) Interest or dividend income, including interest eared on advances or loans to other segments unless the operations of the segment are primarily of a financial nature; and ¢) Gains on sales of investments or on extinguishment of debt unless the operations of the segment are primarily of a financial nature. Comment whether other income like export incentives, lease rent interest from customers etc. should be included as segment revenue as per the above definition CA Inter_40e_Accounting Standards_Supplementary Mate: 4998851 25025/26 www.mastermindsin om Solution: Other income should be included as part of the segment revenue if they do not fall under the exclusion definition and if it is essentially operating in nature. Other income will have to be analyzed into what is operating and non-operating, i.e. what belongs to be segment and what does not. Segment result is the net of the operating position and therefore includes income incidental to external turnover or the main activity of the segment. Export incentives are price subsidies for achieving exports in a fiercely competitive export market. Therefore they are indirectly a component of export turnover and should in. included in segment revenue. Non-operating interest should be excluded from segment revenue. However, interest received from customers due to delay in making payment is an operating income. Segment assets are those operating assets that are employed by a segment in its operating activities and that either are directly attributable to the segment or can be allocated to the segment on a reasonable basis. Since receivables are part of the segment asset. The related income should be included in segment revenue. This is because AS- 17 requires that ‘if the segment assets include the related income generating assets’. If however the enterprise is financing its customer then in addition to an operating ‘segment it would also have a finance segment. For example, if an automobile company sells car on lease then besides automobile segment it would also have a leasing segment. Rentals would be included in segment revenue if eamed out of segment operating assets; ie. those assets that are employed by a segment in its operating activities. Sometimes segment facilities are idle, and these maybe used to eam rentals. Such income would be operating income and consequently form part of segment revenue. However, lease rent eared out of HO assets or assets that are not required for the operation of the segment, would not constitute segment revenue but would be included in the HO or ‘unallocated column’ Internal MIS though not conclusive would be helpful in the allocation of revenues, expenses, assets and liabilities to various segments, 3. Following details are given for NDA Ltd, for the year, 1st March, 2010: (Amt. in Sales: LS’ Food Products Loo Plastic and Packaging & 625 345 Health and Scientific Others 162 6,782 (Amt. in lakhs) Expenses: Food Products 3,335 Plastic and Packaging 425 Health and Scientific 222 Others 200 4.182 Other Items: General Corporate Expenses 562 Income from investments 132 Interest expenses 65 Identifiable assets: Food products 7,320 Plastic and Packaging 1,320 Health and Scientific 1,050 Others 665 10,355 General Corporate Assets 722 CA Inter_40e_Accounting Standards_Supplementary Material 50No.1 for CA/CWA & MECICEC MASTER MINDS Other information: a) Inter-segment sales are as below: Food products Plastic and Packaging Health and Scientific Others (Amt. in lakhs) 55 72 24 7 b) Operating profit includes Rs. 33 lakhs on inter-segment sales. ¢) Information about inter-segment expenses are not available. You are required to prepare a statement showing financial information about NDA Ltd.’s operations in different industry segments. Solution: Information about NDA Ltd.'s operations in different Industry segments is furnished in the following table: Inter- prrcod, | ase] Heath® | owner | segment [consotcatd External Sales 5,595 553, 324 155 =| 6,627 Inter-segment 55 72 24 7 755) = Total 5,850 625 345) 162 155) 6,627 Segment Expenses 3,335 425 222, 200 122 4,060 Operating Profit 2,315 200 @ (38) 33) 2,567 General Corporate| SS | (662) Expenses Income from invest. 132 Interest (65) Income from continuing] 2,072 operations Identifiable assets 7,320 & 7,050 665 10,355 Corporate assets =| = =| - 722 Total assets 11,077 4. Identify the reportable segment by profitability test is demonstrated as follows for XYZ Ltd. Segment Profit (Loss) A 450 B 50 c (350) D (40) E (210) Solution: First, the operating segments are grouped according to whether they incurred a profit or loss, as follows ‘Segments incurring Profits Segments incurring Losses ‘Segment Profit (Rs.) ‘Segment Profit (Rs.) A 450 c (350) B 50. D (40) = E (210) 500 600 From this point on in the profitability test, only absolute amounts are used. The combined total of those segments incurring a loss is larger than the combined total of those segments incurring a profit, Therefore any segment for which the absolute amount of its operating profit or loss equals or exceeds Rs. 60 (i¢.10% of Rs. 600) meets the profitability test and is therefore a reportable segment. ‘Segments A, C and E meet the profitability test, summarized as follows: CA Inter_40e_Accounting Standards_Supplementary Mate: Sa98851 25025/26 www.mastermindsin ‘Absolute amt. of Seoment Profitor loss aoe A 450 Yes (Feportable segment) B 50 No | c 350 Yes | (reportable segment) D 40 No E 210 Yes (eportable segment) If the total extemal revenue (.e., sales to unaffiliated customers) of the reportable segments is less than 75% of total consolidated revenue, additional operating segments must be identified as reportable segments (even if they do not otherwise qualify as a reportable segment) until at least 75% of total consolidated revenue is included in reportable segments. Information about all operating segments that did not qualify as reportable segments must be combined and disclosed in an ‘all other" category. If an operating segment was identified in the immediately preceding prior period as a reportable segment and management deems that segment to be of continuing significance, information about that segment should continue to be reported separately in the current period even if that segment does not otherwise qualify as a reportable segment in the current period If an operating segment qualifies in the current period as a reportable segment but did not qualify as a reportable segment in the prior period(s), prior-period segment data presented for comparative purposes should be restated as if the segment qualified as a reportable segment in the prior period(s). PSB MAS Identity the related parties in the followingloeeee (NEW sm) A Lid. holds 51% of B Ltd B Ltd holds 51% of O Ltd Z Ltd holds 49% of O Ltd, Sol ‘* BLtd, (subsidiary) is a related party © OLtd (subsidiary) is a related party Reporting entity. B Ltd. ‘+ ALtd. (holding company) is a related party * OLtd, (subsidiary) is a related party Reporting entity- © Ltd, ‘* ALtd. (holding company) is a related party ‘* Bd, (holding company) is a related party + Z Ltd, (investor! investing party) is a related party Reporting entity- Z Ltd © OLtd, (associate) is a related party 2. ALLimited has two associates, B Limited and C Limited, and owns 25% of voting power of B Limited and 30% of voting power of C Limited. Would B Limited is considered a related party in the financial statements of C Limited? CA Inter_40e_Accounting Standards_Supplementary Material 52No.1 for CA/CWA & MECICEC MASTER MINDS Soli Both B Limited and C Limited are associates of A Limited. Co-associates cannot be regarded as related parties only by virtue of this relationship. Para 3(b) of AS-I 8 states that “associates and joint ventures of the reporting enterprise and the investing party or venture in respect of which the reporting enterprise is an associate or a joint venture’. As B Limited is not an associate of C Limited nor is it being controlled, directly or indirectly, by C Limited or is not so controlling C Limited, it is not a related party of C Limited 3. X Limited is a wholly owned subsidiary of Z Limited and a 50% co-venturer in joint venture X Y. ‘Whether transactions between joint venture X Y and Z would require disclosures? Solution: Under Para 3(a) related party relationship for AS-18 proposes to include enterprise that directly or indirectly through one or more intermediaries, control or is controlled by, or are under common control with the reporting enterprise. Control is defined as to include substantial interest in voting power and the power to direct by statute or agreement the financial and/or operating policies of the enterprise. Z Limited controls X Limited, due to holding subsidiary relationship. X Limited is a 50% venturer and accordingly Z Limited has the joint control over the joint venture X Y through X Limited. Hence transactions between Z Limited and the joint venture may be considered as related party transactions under AS-18. However, some may argue that joint control does not give the power to direct financial and/or operating policies to any one venturer as all critical decisions are taken jointly Therefore, Para 3 (a) cannot be said to be applicable. 4. If a majority of directors of one company constitutes the majority of the board of another company in their individual capacity as professional (and not by virtue etheir being directors in the first company), can it be considered that the companies are related? Se Solution: VS The companies are not related merely becai ony of the directors of one became the majority of directors of the second in their ind pacity as professionals. AAs per the definition of ‘control’ as containg&SSaragraph 10 of the Statement, the abil to control is gained by: N ‘Ownership, directly or indirectly, of morSQR&n one half of the voting power of an enterprise, or Control of the composition of the board of directors in the case of a company or of the composition of the corresponding govemiing body in case of any other enterprise, or A substantial interest in voting power and the power to direct, by statute or agreement, the financial and/or operating policies of the enterprise.” Further, as per paragraph 11 of the Statement, an enterprise is considered to control the composition of the board of directors 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. In the given example, the first company cannot be said to control the composition of the board of directors of the second company as the directors have been appointed in their individual capacity and not by virtue of their being directors in the first company. Further, an evaluation is required to ascertain whether any of the directors has a relationship with both companies [as specified in paragraph 3(c) and (d) which would create a related party relationship between the two companies]. Such relationship would include these directors being key management personnel in both companies, being a key management person in one company and owning an interest in another, which enables him to exercise significant influence etc. 5. Is remuneration paid to Key Management Personnel or Non-Executive Directors or Board of Directors, a related party transaction? Solution: Key Management Personnel are related parties under AS- 18, Hence, remuneration paid to Key Management Personnel will be a related party transaction requiring disclosure under AS-18 Non-Executive Directors or the board of directors are not related parties as per Accounting Standard Interpretation (ASI) 21. So, remuneration paid to them will not be considered a related party transaction, CA Inter_40e_Accounting Standards_Supplementary Material 5398851 25025/26 www.mastermindsin PROBLEMS FOR SELF PRACTICE 1. WIN Ltd. has entered into a three year lease arrangement with Tanya sports club in respect of Fitness Equipment’ costing Rs.16,99,999.50, The annual lease payments to be made at the end of each year are structured in such a way that the sum of the Present Values of the lease payments and that of the residual value together equal the cost of the equipment’s leased out, The unguaranteed residual value of the equipment at the expiry of the lease is estimated to be Rs.1,33,500. The assets would revert to the lessor at the end of the lease. Given that the implicit rate of interest is 10%, You are required to compute the amount of the annual lease payment and the uneamed finance income. Discounting Factor at 10% for years 1, 2 and 3 are 0.909, 0.826 and 0.751 respectively. (RTP MB (NBO), Solution: i) Computation of annual lease payment to the lessor Particulars ‘Amount (Rs.) Cost of equipment 16,99,999.50 Unguaranteed residual value 1,33,500,00 Present value of residual value after third year @ 10% (Rs, 1,33,500 x 0.751) 1,00,258.50 Fair value to be recovered from lease payments (Rs. 16,99,999.5 - Rs.| 15,99,741.00 1,00,258.5) Present value of annully for three years is 2.486 ‘Annual lease payment = Rs. 15,99,741/ 2.486 y 643,500.00 ii) Computation of Uneamed Finance Income Partigaga SS ‘Amount (Rs.) Total lease payments (Rs. 6,43,500 x4£09 19,30,500 ‘Add: Unguaranteed residual value @NS 1,33,500 Gross investment in the lease 20/64,000.00 Less: Present value of investQM (lease payments and residual value) (Rs.| (16,99,999.50) 1,00,258.5+ Rs. 15,99,741) Unearned finance income 364,000.50 2. Sun Limited wishes to obtain a machine costing Rs.30 lakhs by way of lease. The effective life of the machine is 14 years, but the company requires it only for the first 5 years. It enters into an agreement with Star Ltd, for a lease rental forRs.3 lakhs p.a. payable in arrears and the implicit rate of interest is, 15%. The chief accountant of Sun Limited is not sure about the treatment of these lease rentals and seeks your advice. (Use annuity factor at @ 15% for 3 years as 3.36). (RTPM17, MTPt NI8 (NSO) -5M) Solutio As per AS 19 ‘Leases’, a lease will be classified as finance lease if at the inception of the lease, the present value of minimum lease payment amounts to at least substantially all of the fair value of leased asset. In the given case, the implicit rate of interest is given at 15%. The present value of minimum lease payments at 15% using PV- Annuity Factor can be computed as. ‘Annuity Factor (Year 1 to Year 5) 3.36 (approx.) Present Value of minimum lease payments (Rs.3 lakhs each year) Rs.10.08 lakhs (approx.) Thus present value of minimum lease payments is Rs.10.08 lakhs and the fair value of the machine is. Rs. 30 lakhs. In a finance lease, lease term should be for the major part of the economic life of the asset even if title is not transferred. However, in the given case, the effective useful life of the machine is 14 years while the lease is only for five years. Therefore, lease agreement is an operating lease. 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. CA Inter_40e_Accounting Standards_Supplementary Material 54No.1 for CA/CWA & MECICEC MASTER MINDS 3. R Ltd. (the lessee) acquired machinery on lease from S Ltd. (the Lessor) on January 1, 2000. The lease term covers the entire economic life of the machinery ie. 3 years. The fair value of the machinery on January 12,000 is Rs. 3,50,000. The lease agreement requires the lessee to pay an amount of Rs. 1,50,000 per year beginning December 31, 2000. The lessee has guaranteed a residual value of Rs. 11,400 on December 31, 2002 to the lessor. The lessor however estimates that the machinery will have a salvage value of only Rs. 10,000 on December 31, 2002. The implicit rate of interest is 15% p.a. Compute the value of machinery to he recognized by the lessee and also the finance charges every year on the basis of AS 19. PV Factor of 15% in three years is 2.283. Solution: As per AS 19, Inception of a finance lease, the lessee should recognize 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 lease. However, if the fair value of leased asset exceeds the present value of minimum lease payments from the standpoint of the lessee, the amount recorded, as an asset and liability should be the present value of minimum lease payments from the standpoint of the lessee is also Rs. 3,50,000 and the net present value of minimum lease payment from the standpoint of lessee is also Rs. 3,50,000 (approx.). As the net present value of minimum lease payment is not less than the fair value, then the machinery will be recognized by the lessee at Rs. 3,50,000. Present value of minimum lease payment Annual lease rental x P.V. Factor + Present value of Guaranteed residual value = 1,50,000 x (0.8695 + 0.7561 + 0.6575) + 11,400 x 0.6575 = 3,42,465 + 7,496 = Payment Rs, 3,49,961. Rounded off to 3,50,000 — Finance Payment Reduction in Outstanding Charges Ougstanding Liabi Liability Year 1 (January 1) |- . WL 3,50,000 Year 1 (Dec. 31) 52,500 1,50,0 97,500 2,52,500 Year 2 (Dec. 31) 37,875 1,59,008) 1,12,125 4,40,375 Year3 (Dec. 31) 21,056 1,28,044 11,434 4, On January 1, 2006, Milestones Ltd. 5; pment to Induga Ltd. for Rs. 12,28,920. The carrying amount of the equipment on that dat s, 2,00,000. The sale was a part of the package under which Induga Ltd. leased the asset to NNBStones Ltd. for a ten-year term. The economic life of the asset is estimated at 10 years. The minimum lease rents payable by the lessor has been fixed at Rs. 2,00,000 payable annually beginning December 31, 2006. The incremental borrowing interest rate of Milestones. Ltd. is estimated at 10% per annum. Calculate the net effect on the profit and loss account? Solu The PV of minimum lease payments at 10% discount rate = Rs.2,00,000 x 6.1446 = Rs.12,28,920 Milestones Ltd. should recognize the asset and the liability at Rs. 12,28,920. The excess of sale over carrying amount (Rs.12,28,920 - 2,00,000) = Rs, 10,28,920 ‘Assume that Milestones Ltd. has decided to charge depreciation on straight line basis, AS-19 requires Milestones Ltd. to nm: a) Recognize depreciation at Rs.1,22,892 per annum for 10 years b) Allocated excess of Rs.10,28,920 over the lease term at the rate of Rs, 1,02,892 per annum, The net effect is a debit of (Rs.1,22,892 - 1,02,892) or Rs. 20,000 per annum to the profit arid loss account for 10 year, as covered under the lease term. Had there been no sale and lease back transaction, the profit and loss account for each year covered in the lease term would have been charged by (Rs. 2,00,000/10) or Rs. 20,000, towards depreciation Thus, the sale and lease back transaction has no impact on profit or loss to be reported by the lessee (vendor in the sale transaction) over the lease period, The deferred income (excess) should be presented as a deduction from the canying amount of the asset. Thus, the asset should be presented by Milestones Ltd. in its balance sheet dated December 31, 2006 as follows: CA Inter_40e_Accounting Standards_Supplementary Material 5598851 25025/26 www.mastermindsindia.com ‘Amount (Rs.) ‘Gross Block 12,28,920 Less: Accumulated depreciation 1,22,892, Net Block 17,06,028 Less: Deferred Income 9,26,028 Net Block 1,80,000 In effect, the carrying amount of the equipment does not change with the sale and lease back transaction, In substance, the sale and lease back transaction is a borrowing transaction resulting in recognition of a liability in the balance sheet and recognition of interest expense in the profit and loss account. 5. An Equipment is leased for 3 years and its useful life is 5 years. Both the cost and the fair market value of the equipment is Rs. 3,00,000. The amount will be paid in 3 instalments and at the termination of lease lessor will get back the equipment. The unguaranteed residual value at the end of 3 years is Rs. 40,000. The (internal rate of retum) IRR of the investment is 10%. The present value of annuity factor of Re.1 due at the end of 3rd year at 10% IRR is 2.4868. The present value of Re. 1 due at the end of 3 year at 10% rate of interest is 0.7513. i) State with reason whether the lease constitute finance lease ii) Calculate uneamed finance income. Solution: ‘As per the question, IRR of the investment is 10% Investment in lease is Rs. 3, 00,000 If IRR is 10% that means P.V. of minimum lease payment (MLP) from lessor point of view plus unguaranteed residual value is equal to Rs. 3,00,000. P.V of unguaranteed residual value (40,000 x 0.754 P.V. of M.L-P. should be (3,00,000 - 30,052) = As at the beginning of lease period the P; 2,69,948/3,00,000= 90% approx. ILP cover substantially the initial fair value i.e. Moreover lease period covers major lease of the asset Hence, itis a finance lease. Calculation of annual lease payme lessor: 2,69,948 /2.4868 = Rs. 1,08,552 PartiSulars. ‘Amount (in Rs). ‘Gross investment in lease (1,08,552 x 3) 3,25,657 Unguaranteed residual value 40,000, Total 3,65,657 Less: P.V. of Gross investment in lease 3,00,000 Uneamed finance income 65,657 6. On 1 October 2011 Omega sold a property it owned for Rs. 900 lacs and leased it back on a 10 year operating lease for rentals of Rs. 80 lacs per annum, payable on 30 September in arrears. The carrying value of the property in the financial statement of Omega at 1 October was Rs. 550 lacs and its market value on that date was Rs. 700 lacs, Compute the amount that will be shown in the statement of profit & loss for the year ended 30 September 2012 and in the statement of financial position at 30 September 2012 in respect of the sale and leaseback. Solution: Since the lease is an operating lease the property will be removed from the financial statements. A profit on sale of Rs. 150 lacs (Rs. 700 lacs -550 lacs) will be shown as other income in the statement of profit & loss. The rental expense of Rs. 80 lacs will be shown as an operating cost in the statement of profit & loss. The difference of Rs, 200 lacs between the disposal proceeds (RS. 900 lacs) and the market value of the asset (Rs. 700 lacs) will be shown as deferred income and released to the statement of profit & loss over the lease term of 10 year Therefore Rs, 20 lacs (Rs. 200 lacs X 1/10) will be credited to the statement of profit & loss in the year ended 30 September 2012, probably as a reduction in operating costs. The remaining deferred income balance of Rs. 180 lacs (Rs. 200 lacs -20 lacs) will be included as a liability in the statement of financial position. Rs. 20 lacs of this will be a current liability and Rs. 160 lacs (Rs. 180 lacs 20 lacs) will be non-current. CA Inter_40e_Accounting Standards_Supplementary Material 56No.1 for CAICWA & MECICEC MASTER MINDS Prue Ry Ig PROBLEMS FOR SELF PRACTICE 1. In 2010, Alpha Ltd, reported net income of Rs. 200,000 and had 20,000 equity shares during the entire year. Alpha Ltd. also had outstanding during all of 2010 the following convertible securities: a) 6% Convertible preference shares, Rs. 100 par, 1,000 shares, each share convertible into 15 equity shares b) Convertible debentures, 15% Rs. 100,000 face amount, each Rs. 1,000, convertible into 10 equity shares. Assume a tax rate of 40% Calculate Basic EPS and diluted EPS Solution: Basic EPS is: Net Income _Rs.200,000 _ WAES, ‘20000 Rs, 10.00 The per share effect of each of the convertible securities is as follows: Convertible preference shares: Dividends Rs.6,000° Incremental Shares 15,000 Shares' a) Dividends = Rs, 100,000 x 0.06 = Rs. 6,000 b) Incremental shares = 1,000 preference shares X, = 15,000 equity shares Convertible Debentures: Per - Share Effect (PSE) =Rs.40 Per-Share Effect (PSE) = nterest (Neto a) Interest Rs. 100,000 X 0.15(1-0.40 tax rate) = Rs. 9,000 Rs. 100,000 total face value of debenture Rs. 1,000 face value per debenture 1°? b) Incremental share: = 100 x 10 equity shares 1,000 equity shares Since the convertible preference shares has the lowest per share effect (Re. 0.40), it is the most dilutive and therefore should be assumed to be converted before the convertible debentures which have a higher per share effect (Rs. 9.00). If only the preference shares is assumed to be converted the diluted EPS is Net income + Preferred =Rs. 200,000+Rs. 6,000 Dituted Eps -Netincome + Preferred i WAES + WAPES Note that even though the Rs. 9.00 per share effect of the convertible debentures is less than basic EPS of Rs. 10, the convertible debentures are anti-dilutive because their per share effect of Rs. 9 is greater than the Rs. 5.89 diluted EPS computed with only the convertible preference shares assumed to be converted. Thus by computing the per share effect of each potential equity shares and assuming their exercise or conversion in ascending order (smallest to largest per share effects) and continuing until the next lowest per-share effect is greater than diluted EPS without including that next PSE (or until all PSE have been included in the computation of diluted EPS if all prove to be diluted), one is assured that the final diluted EPS calculated is the lowest diluted BPS (and therefore, the most diluted BPS) for the period CA Inter_40e_Accounting Standards_Supplementary Material 5798851 25025/26 www.mastermindsin Perret Tag 1. To comply with listing requirements and other statutory obligations Quaker Ltd. prepares interim financial reports at the end of each quarter. The company has brought forward losses of Rs. 700 lakhs under Income Tax Law, of which 90% is eligible for set off as per the recent verdict of the court, that has attained finality. No Deferred Tax Asset has been recognized on such losses in view of the uncertainty over its eligibility for set off. The company has reported quarterly earnings of Rs. 700 lakhs and Rs. 300 lakhs respectively for the first two quarters of Financial year 2013-14 and anticipates a net eamings of Rs. 800 lakhs in the coming half year ended March 2014 of which Rs, 100 lakhs will be the loss in the quarter ended Dec.2013. The tax rate for the company is 30% with a 10% surcharge. You are required to calculate the amount of Tax Expense to be reported for each quarter of financial year 2013-14. Solution: The estimated payment of annual tax is: {700 + 300 + 800 - 630] = 1,170 x 30% = 351 + 10%=Rs.386.10 lakhs Average annual effective tax rate (386.10/1800) x 100 = 21.45% Tax expense to be reported each quarter as under: ist Quarter 700.00 150.15 2nd Quarter 300.00 65.35 ‘3rd Quarter (100.00) (21.45) 4th Quarter 900.00 193.05 4. X Ltd. has ‘company has become outdated and company will eam any taxable profits, rather it expec given any effect under AS-22 whether this, ‘What should the company do to fully a ‘xpect with reasonable certainty that in future it ere will be loss in future. The company has not nt is correct fh the requirement of AS-22 assuming tax rate is 30%? Solution: As the company has in foss of Rs. 5 lakhs which is also the loss as per Income-tax Act, the company should have créR@Y the deferred tax assets for Rs. 1,50,000 (30% of 5 lakhs) however as per para 17 of AS-22 deferred tax should be recognized and carried forward only to the extent that there is a virtual certainty that sufficient future taxable income will be available against which such deferred tax assets can be realized. In this case the company do not expect sufficient future taxable income, therefore the company is correct in not creating deferred tax assets as per AS- 22, However the company to comply with AS-22 should disclose this fact by way of accounting notes. 2. The issue is how AS-22 should be applied in the situations of tax holiday under sections 10A and 10B of the Act Sol The deferred tax in respect of timing differences, which originate during the tax holiday period and reverse during the tax holiday period, should not be recognized 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 108 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 recognized 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 paragraphs 15 to 18 of AS-22. For the above purposes, the timing differences, which originate first, should be considered to reverse first. [Answer is as per Accounting Standard Interpretation (AS 15 of ICAI] 3. The issue is how AS-22 is applied in a situation where a company pays tax u/s 115JB (commonly referred to as Minimum Alternative Tax) of the Income-tax Act, 1961 (hereinafter referred to as the Act) Another issue is how deferred tax is measured on the timing differences originated during the current year if the enterprise expects that these differences would reverse in a period in which it may pay tax Us 115JB of the Act. CA Inter_40e_Accounting Standards_Supplementary Material 58No.1 for CA/CWA & MECICEC MASTER MINDS Solution: The payment of tax u/s 115JB of the Act is a current tax for the period. In a period in which a company pays tax u/s 115JB of the Act, the deferred tax assets and liabilities in respect of timing differences arising during the period, tax effect of which current period, tax effect of Which is required to be recognized under AS-22, should be measured using the regular tax rates and not the tax rate u/s 115JB of the Act In case an enterprise expects that the timing differences arising in the current period would reverse in period in which It may pay tax u/s 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 and not the tax rate u/s 115JB of the Act [Answer is as per Accounting Standard Interpretation (ASI)-6 of ICAT]. 4, JCB Ltd. has previously recorded temporary differences of Rs. 10,000. The enacted rate in the year the temporary differences originated was 20%. The deferred tax liability has a beginning balance of Rs. 2,000 (Rs. 10,000 x 20%). For the current year, taxable income is Rs. 1,00,000 and financial statement income is Rs. 1,20,000, The Rs. 20,000 difference is a temporary difference caused by depreciation. The newly enacted rate for the future periods is 30%. The previously recorded temporary differences have not yet reversed. Calculate the tax expense for the current year and deferred lax as on current year end. Sol Tax Expenses Taxable Income Rs. 1,00,000 Rate of Tax (Current Year) 30% Tax Expenses Rs, 1,00,000 x 30% = Rs. 30,000 Deferred Tax at the end of the current year Beginning temporary Difference Current year temporary difference SS Tax Rate at which measurement to be done & Deferred Tax (Liability) both are liability Rs. 30,000 x 30% = Rs, 9,000 Deferred Tax Liability to be recognize rent year : Rs. 9,000- Rs, 2,000 = Rs, 7,000 Entry to be passed in Current Year: Income Tax Expense (current) Dr. Rs, 30,000 Income Tax Expense (deferred) Dr. Rs. 7,000 To Deferred Tax Liability Rs. 7,000 To Income Tax Payable Rs. 30,000 PROBLEMS FOR SELF PRACTICE 1. During 2016-17, an enterprise incurred costs to develop and produce a routine, low risk computer software product as follows: (TPH N18(0}) ‘Amount (Rs.) ‘Completion of detailed programme and design 25,000 ‘Coding and Testing 20,000 (Other coding costs 42,000 Testing costs 42,000 Product masters for training materials 13,000 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? CA Inter_40e_Accounting Standards_Supplementary Material 5998851 25025/26 www.mastermindsin Answer: 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 feasibilitylasset recognition criteria have been established upon completion of detailed programme design or working model. In this case, Rs 45,000 would be recorded as an expense (Rs 25,000 for completion of detailed program design and Rs 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 (Rs. 42,000 + Rs. 12,000 + Rs. 13,000) Rs. 67,000. 2. Classify each of the following assets as either tangible or intangible i) The operating system of a personal computer ‘An off-the-shelf integrated publishing software package ili) Specialized software embedded in computer controlled machine tools iv) A firewall’ controlling access to restricted section of an internet website. Solut nm: i) Tangible: The operating system (e.g. DOS or Windows) of a personal computer is an integral part of the related hardware and should be accounted for under AS-10 ‘Fixed Assets’ Intangible: Such computer software (¢.9. QuarkXPress) is not an integral part of the hardware on which itis used. i) Tangible: Specialized software integrated into p in line "robots" is similar in nature to (i. iv) Intangible: Companies developing “firewall Ware to protect their own website may also sell the technology to other companies 3. On January 2, 2010 NDA Corp. bought an independent consultant, who e: ark from Induga Corp. for Rs. 500,000, NDA retained the trademark’s remaining life to be 20 years. Its unamortized cost on Induga ac records was Rs.3,80,000. NDA decided to amortize the trademark over the maximum pend§sallowed. In NDA’s December 31, 2010 balance sheet, what amount should be reported as accumulated amortization? a) Rs. 7,600 b) Rs. 9,500 ¢) Rs. 25,000 a) Rs. 50,000. Solution: As per AS-26,intangible assets should be measured initially at cost therefore, NDA Company should amortize the trademark at its cost of Rs. 500,000. The unamortized cost on the seller's books (Rs. 3,80,000) is irrelevant to the buyer. Although the trademark has a remaining useful life of 20 years, intangible assets is generally amortized over a maximum period of 10 years per AS-26. Therefore, the 2010 amortization expense and accumulated amortization is 50,000 (RS. 5,00,000/10 years) 4, On January 2, 2010, NDA Co. purchased Induga Co. at a cost that resulted in recognition of goodwill of Rs. 2,00,000 having an expected benefit period of 10 years. During the first quarter of 2010, NDA spent an additional sum of Rs. 80,000 on expenditures designed to maintain goodwill. At December 31, 2010, NDA estimated that the benefit period of goodwill was 20 years. In its December 31, 2010 balance sheet, what amount should NDA report as goodwill? (AS-14 not applicable) a) Rs. 1,80,000 b) Rs. 1,90,000 ¢) Rs. 2,62,000 a) Rs. 2,73,000. CA Inter_40e_Accounting Standards_Supplementary Material 60No.1 for CA/CWA & MECICEC MASTER MINDS Soli As per AS- 26, the company should record as an asset the cost of intangible assets such as goodwill acquired from other entities. AS-26 also states that subsequent expenditure on a recognized intangible asset is recognized as an expense if this expenditure is required to maintain the asset at its originally assessed standard of performance. In addition, itis difficult to attribute Rs. 80,000 expenditure directly to good will rather than the business as a whole. Cost of developing intangible assets such as goodwill “which are not specifically identifiable, have indeterminate lives, or are inherent in a continuing business and related to an enterprise as a whole” should be expensed when incurred. Therefore, only Rs. 2,00,000 (and not the additional Rs. 80,000) should be capitalized as goodwill. Amortization at 31- 12-2010 is recorded using the best estimate of useful life at that time (20 years). Therefore, the net amount reported for goodwill at 31-12-2010 is Rs. 1,90,000 [Rs.2,00,000 - Rs. 2,00,000 X 1 /20] Goodwill has been amortized presuming that NDA Corp. has sufficient evidence that benefit of ‘goodwill is 20 years instead of 10 year. 5. NDA Inc, has two patents that have allegedly been infringed by competitors. After investigation, legal ‘counsel informed NDA that it had a weak case on patent A34 and a strong case in regard to patent B19. NDA incurred additional legal fees to stop infringement on B19. Both patents have a remaining legal life of 8 years. How should NDA account for these legal costs incurred relating to the two patents? a) Expense costs for A34 and capitalize costs for B19. b) Expense costs for both A34 and B19. ¢) Capitalize costs for both A34 and B19. d) Capitalize costs for A34 and expense costs for B19. Sol As per AS-26, subsequent expenditure on an intangity should be recognized as an expense when itis incurrae® SS a. Itis probable that the expenditure will enable@@pset to generate future economic benefits in oxgartdimance; and excess of its originally assessed standard gS b. The expenditure can be measured and_ {fed to the asset reliably. ¢. If these conditions are met, the su@ge@ent expenditures should be added to the cost of the intangible asset et after its purchase or its completion Because NDA Inc. has a weak case on patent A34; the legal fees incurred in its defence should be expensed, rather than capitalized as an asset. This is in accordance with the doctrine of conservatism. AS a result of this occurrence, NDA Inc. should also consider whether the patent would provide benefit to future periods. NDA Inc. has a strong case in regard to patent B19, however, and can expect to receive benefits in the future as a result of its successful defence. Consequently, the legal fees to stop infringement on B19 should be capitalized as an asset and answers (b), (c) and (d) are incorrect. 6. On January 1, 2010, NDA Corp. incurred organization costs/preliminary expenses of Rs.24,000. What portion of the organization costs will NDA Corp. defer to years subsequent to 2010? a) Rs. 23,400 b) Rs. 19,200 ©) Rs. 4,800 d)Re.0. Solution: ‘As per AS-26,organization costs/preliminary expenses are those incurred in the formation of a corporation. Since uncertainty exists conceming the future benefit of these costs in future years, they are properly recorded as an expense in 2010. 7. Costs generally incurred by a newly established entity include a) Pre-operating costs of a business facility b) Recipes, secret formulas, models and designs, prototype ¢) Training customer loyalty and market share d) An in-house generated accounting software e) The design of a pilot plan CA Inter_40e_Accounting Standards_Supplementary Material 6198851 25025/26 www.mastermindsin f) Licensing, royalty, and stand-still agreements 9) Operating and broadcast rights h) Goodwill purchased in a business combination i) Acompany-developed patented drug approved for medical use i) Alicense to manufacture a steroid by means of a government grant k)_ Cost of courses taken by management in quality engineering management 1) television advertisement that will stimulate the sales in the technology industry. Which of the above-mentioned costs are eligible for capitalization according to IAS 38, and which of them should be expensed when they are incurred? Solution: Costs that are eligible for capitalization include items (b), (e), (, (@), and (h); for item (), after initial recognition at cost, both the asset and the grant can be recognized at fair value. These costs are eligible for capitalization under IAS 38 because They meet the criteria of “identifiability” (ie., they are separable or they arise from contractual rights) Itis probable that future economic benefits will low to the entity, These costs can be measured reliably. Costs that should be expensed because they do not meet the criteria under IAS 38 include items (a), (©), and (d). Item (i) is a case of an internally generated intangible asset that can be capitalized only provided it meets the development criterion. The maip. @sye with item (k) is that the entity does not have "control" over its workforce. Despite the o nefit of item (I) to the business, such 8. PBC Lid. registered as NBFC is primaril jed in the business of lending for purchase of equipments. The company has received gh@f@spplication money of R's. 55,62,55,000. To be able to allot further equity shares, the shareho@aXo¥F the company, have approved increase in authorized share capital to Rs. 75,00,00,000. (WRsSmpany has incurred an expenditure of Rs. 47,60,000 (Rs. 34,00,000 towards stamp duty and&¥%3,60,000 towards registration fees paid to the Registrar of Companies) for the said increase in authorized share capital. The Company is of the view that these expenditures can be capitalize and treated as an intangible asset in the Balance Sheet which can be amortised over the period. Comment, whether the view of the company is correct? Solution: AS-26, Intangible Assets, provides that in some cases, expenditure is incurred to provide future economic benefits to an enterprise, but no intangible asset or other asset is acquired or created that can be recognised. In these cases, the expenditure is recognised as an expense when itis incurred. From the above provision of AS 26, it is clear that if expenditure does not result into acquisition of an asset, it should be recognised as an expense as and when incurred. The amount spent towards increase in authorized share capital does not give rise to any resource controlled by the enterprise. In fact, such expenses are only permitting the company to enhance the limit for the paid-up capital of the ‘company which does not ensure any flow of funds to the company. Accordingly, it does not meet the definition of an asset, as provided in AS-26, Thus, the amount aggregating to Rs.47,60,000 incurred towards stamp duty and fees paid to the Registrar of companies should be recognised as expense in the statement of profit and loss as per the requirements AS-26. PSEA SU eta by Classification of Contingent Assets and Liabilities (by using Example) Contingent Assets Contingent Liabilities Land/ Buildings under dispute, Claims against third parties which are acknowledged as debts, Bills sent for collection etc. Guarantees given to third parties, Legal fees payable on a building under dispute ete. CA Inter_40e_Accounting Standards_Supplementary Material 62No.1 for CAICWA & MECICEC MASTER MINDS PROBLEMS FOR SELF PRACTICE 1. EXOX Ltd. is in the process of finalizing its accounts for the year ended 31st March, 2017. The ‘company seeks your advice on the following i) The Company's sales tax assessment for assessment year 2014-15 has been completed on 14th February, 2017 with a demand of Rs. 2.76 crore. The company paid the entire due under protest without prejudice to its right of appeal. The Company files its appeal before the appellate authority wherein the grounds of appeal cover tax on additions made in the assessment order for a sum of 2.10 crore, ii) The Company has entered into a wage agreement in May, 2017 whereby the labour union has accepted a revision in wage from June, 2016. The agreement provided that the hike fill May, 2017 will not be paid to the employees but will be settled to them at the time of retirement. The company agrees to deposit the arrears in Government Bonds by September, 2017. (NEWS) Solution: i) Since the company is not appealing against the addition of Rs. 0.66 crore the same should be provided for in its accounts for the year ended on 31st March, 2017. The amount paid under protest can be kept under the heading ‘Loans & Advances’ and disclosed along with the contingent liability of Rs. 2.10 crore ii) The arrears for the period from June, 2013 to March, 2017 are required to be provided for in the accounts of the company for the year ended on 31st March, 2017. 2. Sun Ltd. has entered into a sale contract of Rs. 5 crores with X Ltd. during financial year 2015-16. The profit on this transaction is Rs. 1 crore. The delivery of goods to take place during the first month of financial year 2016-2017. In case of failure of Sun Ltd. to deliver within the schedule, a compensation of Rs 1.5 crores is to be paid to X Ltd. Sun Ltd. plannegsig manufacture the goods during the last month of 2018-16 financial years. As on balance sj te (31.03.2016), the goods were not manufactured and it was unlikely that Sun Ltd. will b sition to meet the contractual obligation < (TPS M18(0), MTPI MI8(N) i) Should Sun Ltd, provide for contingency a 297 Should provision be measured as the ex@&¢} compensation to be paid over the profit? Solution: Ss AS 29 “Provisions, Contingent Liabilt ong Assets” provides that when an enterprise has a present obligation, as a result of past eves, that probably requires an outflow of resources and a reliable estimate can be made of the amount of obligation, a provision should be recognised. Sun Ltd. has the obligation to deliver the goods within the scheduled time as per the contract. Itis probable that Sun Ltd. will fail to deliver the goods within the schedule and itis also possible to estimate the amount of compensation Therefore, Sun Ltd, should provide for the contingency amounting Rs. 1.5 crores as per AS 29. 3. A company incorporated under section 25 of the Companies Act, 1956 (now section 8 of the Companies Act 2013), having main objectives to promote the trade by organizing trade fairs/exhibitions. When company was organizing the trade fair and exhibitions it decided to charge 5% contingency charges for the participants/,outside agencies on the income received from them by the ‘company, while in the case of fairs organized by outside agencies, 5% contingency charges are levied separately in the invoice, the contingency charges in respect of fairs organized by the company itself are inbuilt in the space rent charged from the participants. Both are credited to Income and Expenditure Account of the company. The intention of levying these charges is to meet any unforeseen liability, which may arise in future. The instances of such unforeseen liabilities could be on account of injuryiloss of life to visitors/exhibitors, etc., due to fire, terrorist attack, stampede, natural calamities and other public and third party liability. The chances of occurrence of these events are high because of large crowds visit the fair. The decision to levy 5% contingency charges was based on assessment only as actual liability on this account cannot be estimated. The following accounting treatment and disclosure was made by the company in its financial statements: 1. 5% contingency charges are treated as income and matching provision for the same is also being made in accounts. 2. Asuitable disclosure to this effect is also made in the notes forming part of accounts. CA Inter_40e_Accounting Standards_Supplementary Material 6398851 25025/26 www.mastermindsin Required: i) Whether creation of provision for contingencies under the facts and circumstances of the case is in conformity with AS-29, ii) If the answer of (\) is "No" what should be the treatment of the provision which is already created in the balance sheet. Solution: i) As per AS-29: “Provisions, Contingent Liabilities and Contingent Assets” is reproduced below: 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 ¢) Areliable estimate can be made of the amount of the obligation, Ifthese conditions are not met, no provision should be recognised.” From the above, it is clear that the contingencies considered by the company neither a present obligation exists as a result of past event, nor a reliable estimate can be made of the amount of the obligation. Accordingly, a provision cannot be recognised for contingencies under the facts and circumstances of the case ii) “Provision is any amount retained by way of providing for any known liability since the contingencies stipulated by the company are not known at the balance sheet date, the provision in < & teen CA Inter_40e_Accounting Standards_Supplementary Material 64