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 CHAPTER – 1

FINANCIAL REPORTING STANDARDS

MEANING:

Accounting standards are the written statements issued by the statutory

accounting bodies on specific accounting policies for the preparation and
presentation of uniform and consistent financial statements.

OBJECTIVES OF ACCOUNTING STANDARDS:

The objective of accounting standards is to standardize the diverse

accounting policies and practices. The other objectives are outlines as
below:

1. To provide information:
It sets the standards on which accounts have to be prepared.

2. To harmonies different accounting processes:

Accounting standards are evolved to bridge the gap between various
accounting procedures to harmonies different accounting processes.

3. To enhance the contents:

It enhances the credibility and comparability of the financial statements.

4. To communicate uniform results:

Another objective of accounting standard is to communicate uniform
results to external users as well as internal users for decision making.

5. To facilitate comparison:
Accounting standards aim at facilitating inter – firm comparison and intra
firm comparison.
 6. To improve the quality of financial statements:
Another objective of accounting standards is to make the financial
statements more reliable, comparable, relevant and understandable.

ADVANTAGES OF ACCOUNTING STANDARDS:

1. Credibility and reliability of the financial statements:

The accounting standards create a sense of confidence amongst the users of
the accounting information by providing a definite structure of uniform
guidelines. This provides credibility and reliability to the financial
information.

2. Uniformity:
The accounting information disclosed in financial statements cannot be
interpreted in any manner other than the purpose it is intended for.

3. Elimination of ambiguity:
As the general principle of disclosure and valuation have been developed on
uniform basis, there would be no ambiguity in interpretation.

4. Comparison:
As the same methodology is being followed in all cases comparison between
the results of different organizations has become easier.

5. Determination of managerial accountability:

Accounting standards are useful in measuring the efficiency of the
management regarding the profitability, liquidity, solvency and general
progress of the enterprise.

6. Useful to shareholders, investors, researchers etc:

Accounting standards help the investors to take decisions regarding
investments. The government officials can make effective use of accounting
data for planning etc. the researcher through better analysis of accounting
data can arrive at meaningful conclusions.

7. Raises the standards of auditing:

Accounting standards raise the standards of auditing itself in its task of
reporting on the financial statements.

ACCOUNTING STANDARDS BOARD OF INDIA (ASB):

ASB was set up in India on 21st April 1977 with a view to harmonies the
diverse accounting policies and practices in India. It was set up by the
council of ICAI. ICAI is one of the members of IASC. Hence, while
formulating the accounting standards, ASB gives much weight to the
standards issued by the IASC. ICAI tries to incorporate those international
standards in India, in the light of the conditions and practices prevailing in
India.

OBJECTIVES OF ACCOUNTING STANDARDS BOARD OF INDIA:

To determine the areas in which accounting standards need to be

developed.
To formulate accounting standards with a view to assisting the
council of the ICAI in evolving and establishing accounting standards
in India.
To examine how far the relevant international accounting
standard/international financial reporting standard can be adapted
while formulating the accounting standard and to adapt the same.
To review the accounting standards at periodical intervals.
To provide, from time to time, interpretation and guidance on
accounting standards.
To give clarification on issues arising therefrom.
To carry out such other functions relating to accounting standards.

FUNCTIONS OF ACCOUNTING STANDARDS BOARD OF INDIA

(ASB)
The main function of the ASB is to formulate accounting standards so that
such standards may be established by the ICAI in India. The other
functions are outlined as below:

1. To consider the applicable tax laws, customs, usages, and business

environment prevailing in India, while formulating accounting
standards.
2. To actively promote the pronouncements of International Accounting
Standard Board, in the country with a view to facilitate global
harmonization of accounting standards.
3. To persuade the concerned parties to adopt accounting standards in
the preparation and presentation of financial statements.
4. To provide interpretations and guidance on issues arising from
accounting standards.
5. To review the accounting standards periodically and to revise them, if
necessary.

NEED AND IMPORTANCE OF GLOBAL ACCOUNTING

STANDARDS:

1. Development of multinational corporations:

Multinational and transnational companies have their head offices

established in one country, while they operate in different corners of the
world. The results in recording of transactions following the standards of
the respective country of operation, but they have to be complied following
the accounting principles of their parent nation. This has been a
complicated task and a major challenge for such multinational
corporations.

2. Growth of international capital markets:

In the present era, organizations do not depend only on their domestic

country for the purpose of raising their capital. They can even raise capital
from the foreign markets. This requires the entities to redraft their financial
statements applying the accounting standards of the foreign
country/economy.
 3. Legislative equipment:

It was realized that having a multiplicity of accounting standards around

the world is against public interest. Thus, a strong need was felt by the
legislation to bring about uniformity, harmonization, rationalization,
comparability, transparency and adaptability in financial statements.

BENEFITS OF GLOBAL ACCOUNTING STANDARDS:

1. Saving time and costs:

The acceptance of global standards would eliminate the requirement of

translation and restatement of financial statements following the standards
of its country of origin to that of a foreign country. This expensive and time
- consuming exercise can be avoided with the introduction of global
accounting standards.

2. Better analysis of financial data:

In today’s world, investors, analysts and researchers from all across the
globe are interested in studying, comparing and analyzing the financial
statements of various organizations existing in different parts of the world.
Such study becomes feasible, meaningful, and effective when these
organization follow the global accounting standards.

3. Increasing investor confidence:

Following such global standards by the different organizations would allow

investors to better understand the financial statements and have more faith
on the reported facts and figures. This would lead to higher level of investor
confidence.

4. Ease in listing of securities:

The stock markets across the world follow different criteria in allowing
companies to list their shares for the purpose of trading. One such criterion
includes the submission of translated and restated financial statements.
This exercise can be avoided when global standards are followed.
INTERNATIONAL FINANCIAL REPORTING STANDARDS
(IIFRS):

IFRS are a set of international accounting standards, stating how particular

types of transactions and events should be reported in the financial
statements. They are the guidelines and rules set by IASB which the
companies and organizations can follow while preparing their financial
statements.

FEATURES OF IFRS:

 These are global accounting standards.

 These are ‘principle based’ and not ‘rule based’.
 IFRS are developed and maintained by IASB.
 There are issued with the intention of applying these standards across
the globe on a consistent basis.
 They ensure high quality transparent reporting that would ensure
comparability among the entities across the globe.
 Every standard has a specific structure to ensure uniformity and
facilities reading, interpretation, and application.

NEED FOR IFRS CONVERGENCE

1. Financial globalization:

Diversity in international accounting practices adversely affects capital

flows. Therefore, a need for a single set of high - quality international
accounting standards. Such standards will promote confidence in the
capital markets. Besides, uniformity of accounting standards will increase
the comparability of the financial statements.

2. Multinational corporations:

MNC’s will probably be the greatest beneficiaries of IFRS convergence. The

preparation of consolidated financial statements would be greatly
simplified if stand alone financial statements from all over the world were
prepared on a uniform basis.
 3. Accounting profession:

Convergence of accounting practices would promote the

internationalization of the accounting profession. Convergence of
accounting practices will improve the quality of services provided by
countries such as China and India. This reduces the risk on account of
accounting scandals that occurred in the recent past.

4. Government and revenue authorities:

If the financial reporting and disclosure requirements are converged, the

government would find it easier to understand and control them.

BENEFITS OF ADOPTING IFRS (BENEFITS OF CONVERGING

IFRS):

1. Benefits to economy:

Convergence with IFRS helps an economy by increasing the growth of its

global business. Financial statements made under IFRS is accepted by stock
exchanges all over the world. This facilitates international business. It helps
to develop industrial and capital markets in the country.

2. Benefits to investors:

Convergence with IFRS makes accounting information more reliable,

relevant, timely and comparable. Convergence with IFRS also develops
better understanding of financial statements globally. It also develops
increased confidence among the investors.

3. Benefits to industry:
 Industry would be able to raise capital from markets at a lower
cost.
 The cost of preparing the financial statements is reduced.
 The task of maintaining different sets of financial statements is
eliminated by adoption of IFRS.
 The adoption of IFRS may reduce the risk premium,
consequently, the cost of capital will decrease.
  It improves comparability of financial statements of a
company with that of another company not only in the same
country but also in other countries.
4. Benefits to accounting professionals:

Convergence of accounting practices would foster the globalization of

accounting profession. Therefore, accounting professional can provide their
services throughout the world.

5. Benefits to tax authorities and researchers:

Convergence with IFRS helps in uniformity in reporting to interested

groups, i.e., tax authorities, researchers etc.

GENERAL DIFFERENCE BETWEEN IFRS AND IND – AS

1. IFRS is based on fair value concept. But Indian accounting standards

are based on historical cost.
2. Financial elements under IFRS and Indian accounting standards
differ in form and substance.
3. Under IFRS, past errors are incorporated in the accounts of the years
it pertains to, even if audited and adopted by shareholders. But, these
are treated as adjustments in the current year under Indian
accounting standards.
4. Depreciation on revalued assets needs to be routed through income
statements under IFRS. But Indian accounting standards disallow
such a treatment.
5. Certain Indian accounting standards offer accounting policy choices.
These are not available under IFRS, e.g., use of pooling of interest
method in accounting for amalgamation.
6. Indian accounting standards define assets by classes which can be
depreciated at given rates, whereas IFRS promotes the concept of
components of fixed assets based on their usefulness.
7. Under IFRS, prior period items will be given retrospective effect in
opening equity under Ind AS, it is not so.
 8. Proposed dividend is not required to be reflected in financial
statements under IFRS. But this is required to be reflected in
financial statements under Ind AS.
9. Under IFRS, provision made for dismantling of asset or for site
closure can be capitalized. But under Ind AS, this cannot be
capitalized.
10. Under IFRS, EPS has to be disclosed separately for continuing
and discontinuing operations. This is not required under Ind AS.

CONCEPTUAL FRAMEWORK:

Conceptual framework comprises of the theoretical principles which

provides the basis for the development of accounting standards.

FINANCIAL ELEMENTS:

Financial elements are the elements from which financial statements and
other forms of financial reports are to be constructed.

The important financial elements prescribed by the IASB are assets,

liabilities, equity, income and expenses. Of the five elements, the first three
are related to the balance sheer and the last two are related to the income
statement.

Recognition of assets:

 The flow of economic benefits to entity is probable.

 The cost/value can be measured reliably

Recognition of liabilities:

 The outflow of resources embodying economic benefits from the

entity is probable.
 The cost/value of the obligation can be measured reliably

Revenue recognition:

 Economic benefit increases and thereby equity increases.

 Asset increases or liability decreases, resulting in increase in equity
 Revenue does not include contribution made by equity participants.

Expense recognition criteria:

 Economic benefits decrease as a result of decrease in an asset.

 Economic benefits decrease as a result of increase of a liability.

BASES OF MEASUREMENT OF FINANCIAL ELEMENTS:

1. Historical cost:

Assets are recorded at the amount paid or fair value of consideration given
to acquire them at the time of their acquisition. Liabilities are recorded at
the amount of proceeds received in exchange for the obligation.

2. Current cost:

Assets are carried at the amount of cash and cash equivalents that would
have to be paid if the same or equivalent asset were acquired currently.
Liabilities are carried at the undiscounted amount of cash or cash
equivalents that would be required to settle the obligation currently.

3. Realizable:

Assets are carried at the amount of cash and cash equivalents that would be
obtained by selling the assets in an orderly disposal. Liabilities are carried
at their settlement values, that is, the undiscounted amount of cash or cash
equivalents expected to be paid to satisfy the liabilities in the normal course
of business.

4. Present value:

Assets are carried at the present discounted value of the future net cash
inflows that the item is expected to generate in the normal course of
business. Liabilities are carried at the present discounted value of the future
net cash outflows that are expected to be required to settle the liabilities in
the normal course of business.
FAIR VALUE:

Fair value simply means current market value. It is the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.

PRINCIPLES OF PRESENTATION:

While presenting the information in the financial statements, the following

principles should be observed:

1. Fair presentation and compliance with IFRS:

The financial statements must “present fairly” the financial position,

financial performance and cash flows of an entity. Fair presentation
requires the faithful representation of the effects of transactions, other
events, and conditions in accordance with the definitions and recognition
criteria for assets, liabilities, income and expenses set out in the framework.

2. Consistency of presentation:

The presentation and classification of items in the financial statements

shall be retained from one period to the next unless a change is justified
either by a change in circumstances or a requirement of a new IFRS.

3. Materiality and aggregation:

Each material class of similar items must be presented separately in the

financial statements. Dissimilar items may be aggregated only if they are
individually Immaterial. However, information should not be obscured by
aggregating or by providing immaterial information. Materiality
consideration apply to all parts of the financial statements.

4. Offsetting:

Assets and liabilities, and income and expenses, may not be offset unless
required or permitted by an IFRS.

5. Comparative information:
IFRS requires that comparative information should be presented and
disclosed in respect of the previous period for all amounts reported in the
financial statements, both on the face of the financial statements and in the
notes, unless another standard requires otherwise.

6. Structure of statement of financial position (balance sheet):

Assets and liabilities should be classified as current and non - current

assets.

7. Line items:

When an entity presents subtotals, those subtotals shall be comprised of

line items made up of amounts recognized and measured in accordance
with IFRS should be presented and labelled in a clear and understandable
manner. They should be consistent from period to period and not displayed
with more prominence than the required subtotals and totals.

8. Format of statement of financial position (or balance

sheet):

IAS does not describe the format of the statement of financial position.
Assets can be presented as current, then non – current, or vice versa, and
liabilities and equity can be presented as current, then non – current, then
equity, or vice versa. A net asset presentation is allowed.

9. Statement of profit and loss and other comprehensive

income:

Profit or loss is defined as the total of income less expenses, excluding the
components of other comprehensive income. Other comprehensive income
is defined as comprising items of income and expenses that are not
recognized in profit or loss as required or permitted by other IFRS”. Total
comprehensive income is defined as “the change in equity during a period
resulting from transactions and other events, other than those changes
resulting from transactions with owners in their capacity as owners”.
 10. Choice in presentation and basic requirements:

An entity has a choice of presenting a single statement of profit or loss and

other comprehensive income , or two statements: a separate statement of
profit or loss and a statement of other comprehensive income, immediately
following the statement of profit or loss and beginning with profit or loss.

11. Profit or loss section or statement:

Expenses recognized in profit or loss should be analyzed either by nature or

by function. If an entity categorizes by function, then additional
information on the nature of expenses – at a minimum depreciation,
amortization and employee benefits expense – must be disclosed.

12. Other comprehensive income section:

The other comprehensive income section is required to present line items

which are classified by their nature, and grouped between those items that
will or will not be reclassified to profit and loss in subsequent periods

13. Statement of changes in equity:

The statement must show: total comprehensive income for the period,
showing separately amounts attributable to owners of the parent and to
non – controlling interests, the effects of any retrospective application of
accounting policies or restatements made in accordance with IAS 8,
separately for each component of other comprehensive income
reconciliations between the carrying amounts at the beginning and the end
of the period for each component of equity, separately disclosing: profit or
loss, other comprehensive income, transactions with owners, showing
separately contributions by and distributions to owners, and changes in
ownership interests in subsidiaries that do not result in a loss of control. An
analysis of other comprehensive income by item is required to be presented
either in the statement or in the notes.

14. Notes to the financial statements:

The notes must present information about the basis of preparation of the
financial statements and the specific accounting policies used to disclose
any information required by IFRS that is not presented elsewhere in the
financial statements, and provide additional information that is not
presented elsewhere In the financial statements but is relevant to an
understanding of any of them. Notes are presented in a systematic manner
and cross referenced from the face of the financial statements to the
relevant note.

PRINCIPLES OF DISCLOSURES IN FINANCIAL STATEMENTS:

While disclosing financial information in financial statements, certain

principles have to be observed:

1. Materiality:

According to this convention, only the material or important facts about the
business are to be disclosed through the financial statements. All other
unimportant or less important information should either be totally ignored
or recorded as foot notes, or merged with important items. If this is not
done, accounting treatment will be unnecessarily overburdened.

2. Summary of accounting policies:

Judgements and key assumptions should be disclosed. An entity must

disclose, in the summary of significant accounting policies or other notes,
the judgements, apart from those involving estimations, that management
has made in the process of applying the entity’s accounting policies that
have the most significant effect on the amounts recognized in the financial
statements.

3. Share capital and reserves:

Regarding issued share capital and reserves, the following disclosures are
required: number of shares authorized, issued and fully paid, and issued
but not fully paid par value, a reconciliation of the number of shares
outstanding at the beginning and the end of the period, description of
rights, preferences, and restrictions treasury shares, including shares held
by subsidiaries and associates, shares reserved for issuance under options
and contracts, a description of the nature and purpose of each reserve
within equity
Additional disclosures are required in respect of entities without share
capital and where an entity has reclassified puttable financial instruments.

4. Dividends:

In addition to the distributions information in the statement of changes in

equity, the following must be disclosed in the notes: the amount of
dividends proposed or declared before the financial statements were
authorized for issue but which were not recognized as a distribution to
owners during the period, and the related amount per share, the amount of
any cumulative preference dividends not recognized.

5. Capital disclosure:

An entity discloses information about its objectives, policies and processes

for managing capital. To comply with this, the disclosure include:
qualitative information about the entity’s objectives, policies and processes
for managing capital, including description of capital it manages, nature of
external capital requirements, if any how it is meeting its objectives,
quantitative data about what the entity regards as capital changes from one
period to another, whether the entity has complied with any external capital
requirements, and if it has not complied, the consequences of such non –
compliance

6. Other information:

The following other note disclosures are required by IFRS, if not disclosed
elsewhere in information published with the financial statements: domicile
and legal form of the entity’s country of incorporation, address of registered
office or principal place of business, description of the entity’s operations
and principal activities, if it is part of a group the name of its parent and the
ultimate parent of the group, if it is a limited life entity, information
regarding the length of the life.
 CHAPTER – 2

IFRS CONVERGED INDIAN ACCOUNTING STANDARDS

CONCEPT IND AS

Ind ASs are the new set of Indian accounting standards which incorporate
the requirements of IFRS. These are the accounting standards adopted by
companies in India and issued under the supervision of ASB.

ACCOUNTING FOR INVENTORIES (IND AS 2):

Accounting for inventories is based on the matching concept. As per this

concept, inventories should be accounted for as an expense in the year in
which it is sold. Till that time, it is accounted for as an asset, i.e., closing
stock. It is also credited in the statement of profit and loss. Ind AS 2
prescribes accounting treatment for inventories.

Objective:

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

inventories. This standard deals with determination of cost and its
subsequent recognition as an expense, including any write – down to net
realizable value.

Scope:

This standard applies to all inventories except the following:

1. Work in progress under a construction contract (dealt by Ind AS 11,

construction contracts).
2. Financial instruments, e.g., shares, debentures, bonds (governed by
Ind AS 32, financial instruments).
3. Biological assets related to agricultural activity and agricultural
produce at the point of harvest (dealt by Ind AS 41 agriculture).
Measurement Of Inventories (Accounting Treatment)

Inventories must be measured at cost or net realizable value, whichever is

less. Thus, the two components are cost and net realizable value.

1. Cost of inventories:

It includes the following:

a) Cost of purchase: the costs of purchase of inventories includes

the following:
 Purchase price
 Import duties and other taxes (excluding those recoverable
from the taxing authorities, e.g., GST credit). Only non –
recoverable duties and taxes should be included.
 Transport costs
 Handling costs
 Other costs directly attributable to the acquisition of
finished goods, materials and services.
b) Cost of conversion:

Cost of conversion of inventories include direct costs such as direct labour,

and systematic allocation of production overhead incurred in converting
materials into finished goods. Production overhead consists of fixed
production overheads and variable production overheads. Fixed production
overheads should be allocated on the basis of normal capacity.

Unallocated overheads are recognized as an expense in the statement of

profit and loss in the period in which they are incurred.

c) Other costs:

Other costs to be included in the cost of inventory are those which are
incurred in bringing the inventories to their present location and condition.
These costs include inward transport and storage prior to completion of
production and specific design work required for a special client.

2. Net realizable value:

Estimation of net realizable value is necessary in the valuation of
inventories. Net realizable value is the estimated selling price in he ordinary
course of business, less the estimated cost of completion and the estimated
costs necessary to make the sale.

Techniques for measurement of cost:

1. Standard cost method:

It takes into account normal levels of materials and supplies, labour

efficiency and capacity situation. They are regularly reviewed and, if
necessary revised in the light of current conditions.

2. Retail method:

Under this method, the cost of inventory is determined by deducting an

appropriate percentage of gross margin from sale value. In short,
percentage of gross margin is deducted from the sale value to get the cost of
inventory.

Cost formulas:

For inventories with a different nature or use, different cost formulas may
be justified. Following are the important cost formula for the valuation of
inventories:

1. Specific identification method:

This method is used when inventories are not ordinarily interchangeable

and are specifically segregated for a specific project. Under this method,
specific costs are attributed to the specific individual items of inventory.

Specific identification method is not suitable when there are a large number
of items of inventory that are interchangeable. In such cases the cost of
inventory is valued by the following 2 methods:

FIFO method

Weighted average cost method:

FIFO method:

This method assumes that the first items bought are the first items sold.
Therefore, at the end of the period, any items in inventory are the items
purchased for produced most recently.

Weighted average cost method:

It is calculated from the inventory at the beginning of the period plus any
items purchased during the period.

Write down of inventories:

The general rule is that inventories should not be carried in excess of

amounts expected to be realized from their sale or use (i.e., NRV).

In some situations NRV is likely to be less than cost. Following are the
situations:

 An increase in cost
 Fall in selling price
 Physical deterioration in the condition of inventory (i.e., damage)
 Obsolescence
 Errors in production of purchasing.

Recognition as an expense:

The following treatment is required when inventories are sold:

1. The carrying amount of the inventory (i.e., cost of goods sold) is

recognized as an expense in the period in which the related revenue (on
sale) is recognized.
2. The amount of any write down of inventories to its net realizable value
(i.e., loss of inventory) and all losses of inventories are recognized as an
expense in the period the write down or loss occurs.
3. If an inventory item which was written down previously, remains
unsold and its NRV has subsequently increased, then in such cases, the
previous write down should be reversed and the inventory should be
carried at cost.
 4. Some inventories may be allocated or transferred to other asset
accounts. An example is inventory used as a component of self
constructed property, plant or equipment. Such inventories are
recognized as an expense during the useful life of that assets.

Presentation and disclosure:

Financial statements should disclose the following in respect of inventories:

1. Accounting policies adopted for measuring inventories and cost

formula used.
2. Total carrying amount of inventories and amount per category.
3. Amount of inventory recognized as an expense during the period.
4. Amount of inventory carried at fair value less costs to sell.
5. Circumstances led to the reversal of a written down.
6. Inventory pledged as security for liabilities.
7. The amount of any write down of inventories recognized as an
expense in the period.
8. The amount of any reversal of any write – down that is recognized in
the period.

INCOME TAX (Ind AS 12):

Income tax consists of two parts – current tax and deferred tax. As per the
accrual concept, income tax must be accrued in the accounting period in
which income is earned. Similarly, tax benefits must be recorded in the
accounting period in which expenses are incurred. However, tax payable is
calculated in accordance with the applicable tax laws, i.e., Income Tax Act,
1961. The applicable tax laws may calculate the taxable profits differently
from that calculated as per Ind AS. The tax calculated as per the tax laws of
the country is known as current tax. To conform the accrual concept, the
standard requires entities to create deferred tax.

Objective: the objective of this standard is to prescribe the accounting

treatment for income tax.
Scope: the standard must be applied top accounting for all income taxes,
including domestic, foreign and withholding taxes, as well as the income
tax consequences of dividend payments.

Ind AS 12 does not apply to:

 Accounting for government grants;

 Investment tax credits

However, Ind AS 12 does not apply to accounting for temporary differences

that may arise from such grants or investments tax credits.

Definitions:

1. Accounting profit:

Accounting profit is the net profit or loss for a period before deducting tax
expense.

2. Taxable profit:

Taxable profit is the profit for a period, determined in accordance with the
rules established by the taxation authorities, based on which income taxes
are payable.

3. Tax expense:

Tax expense for a period is the total of current tax and deferred tax.

4. Current tax:

Current tax is the amount of income taxes payable on the taxable profit for
a period.

Recognition of current tax liabilities and assets:

According to (Ind AS 12 any unpaid tax in respect of the current or prior

periods should be recognized as a liability. If the tax paid in respect of
current and prior periods exceeds the amount due for those periods, the
excess shall be recognized as an asset. Thus, the excess of the tax paid in
respect of the current and prior periods over the tax payable for the current
and prior periods is known as current tax asset.

Similarly, if the tax paid in respect of the current year and prior periods is
less than the amount due for those periods, the shortfall is known as
current tax liability.

Recognition of current tax:

Current tax should be recognized when taxable profits are earned in the
period to which it relates in the following manner:

A current tax expense or income item should be recognized in the

income statement.
A current tax liability should be recognized to the extent that amounts
owing are unpaid to tax authorities.
A current tax asset should be recognized to the extent that the amount
already paid exceed the amount due.

Tax base:

The tax base of an asset is the amount that will be deductible for tax
purposes against any taxable economic benefits that will flow to an entity
when the carrying amount of the asset is equal to its carrying amount.

Difference in accounting profit and taxable profit:

Accounting profits form the basis for computing taxable profits, on which
the tax liability for the year is calculated. However, accounting profits and
taxable profits are different. There are two reasons for the differences –
permanent differences and temporary differences:

1. Permanent difference:

Permanent differences occur when certain items of revenue or expenses are

excluded from the computation of taxable profits. Permanent differences do
not reverse subsequently. They remain permanent. Hence they are ignored.

2. Temporary differences:
Temporary differences are differences between the carrying amount of an
asset or liability in the balance sheet and its tax base. Temporary difference
is a difference which is going to be settled in subsequent years. Since it is
settled in subsequent years, the difference is temporary.

Types of temporary differences:

T3emporary differences may be either taxable temporary differences or

deductible temporary differences.

1. Taxable temporary differences:

These are temporary differences that will result in taxable amounts in

determining taxable profit of future periods when the carrying amount of
the asset or liability is recovered or settled. The following are the
circumstances that give rise to taxable temporary differences.

a) Transactions affecting profit or loss:

 Interest revenue received it arrears and included in accounting
profit on the basis of time apportionment. It is included in
taxable profit, however, on a cash basis.
 Sale of goods revenue is included in accounting profits when
the goods are delivered, but included in taxable profit only
when cash is received.
 Depreciation of an asset is accelerated for tax purpose.
 Development costs which have been capitalized will be
amortized in profit or loss, but they were deducted in full form
taxable profit in the period in which they were incurred.
 Prepaid expenses have already been deducted on a cash basis
in determining the taxable profit of the current or previous
periods.
b) Transactions affecting balance sheet:
 No deduction for depreciation will be available for tax
purposes when the asset is sold or scraped.
 A borrower reports a loan at proceeds received (amount due at
maturity) less transaction costs. The carrying amount of the
 loan is subsequently increased by amortization of the
transaction cost against accounting profit. The transaction
costs were, however, deducted for tax purposes in the period
when the loan was first recognized.

2. Deductible temporary difference:

These are temporary differences that will result in amounts that are
deductible in determining taxable profit (or tax loss) of future periods when
the carrying amount of the asset or liability is recovered or settled. All
deductible temporary differences give rise to a deferred tax asset. The
following are the circumstances that give rise to deductible temporary
differences:

 Retirement benefit costs are deducted from accounting profit as

service is provided by the employee. They are not deducted in
determining taxable profit until the entity pays the retirement
benefits.
 Accumulated depreciation in the financial statements is greater than
the accumulated depreciation allowed for tax purposes.
 The cost of inventories sold before the end of the balance sheet date is
deducted from accounting profit when goods/services delivered, but
is deducted from taxable profit when the cash is received.
 The carrying amount of inventory, or the recoverable amount of an
item of property, plant and equipment fails and the carrying value is
therefore reduced, but that reduction is ignored for tax purposes.
 Research costs are recognized as an expense for accounting purposes
but are not deductible against taxable profits until a later period.

Deferred tax:

It is the difference in tax liability calculated for temporary difference

between the taxable profit and accounting profit. The temporary difference
either be a tax liability to met in future or a tax asset.

Deferred tax liability:

When the accounting profit is more than the taxable profit, it means that
we pay less tax now. But we have to pay more tax in future. This is deferred
tax liability. Thus, when the accounting income is more than the taxable
income, deferred tax liability is created.

Recognition of deferred tax:

A deferred tax liability shall be recognized for all taxable temporary

differences, except to the extent that it arises from:

1. The initial recognition of goodwill

2. The initial recognition of an asset or liability in a transaction which is
not a business combination and at the the time of the transaction,
affects neither accounting profit nor taxable profit.

Deferred tax asset:

Deferred tax asset is an accounting term that refers to a situation where a

business has overpaid taxes or taxes paid in advance on its balance sheet
date. These taxes are eventually returned to the business in the form of tax
relief, and the over payment is, therefore, an asset for the company.

Recognition of a deferred tax asset:

The carrying amount of deferred tax assets should be reviewed at the end of
each reporting period. An entity shall reduce the carrying amount of a
deferred tax asset to the extent that it is no longer probable that sufficient
taxable profit will be available to allow the benefit of deferred tax asset to be
utilized. Any such reduction should be subsequently reversed to the extent
that it becomes probable that sufficient taxable profit will be available.

A deferred tax asset should be recognized for an unused tax loss carry
forward or unused tax credit if, and only if, it is considered probable that
there will be sufficient future taxable profit against which the loss or credit
carry forwards can be utilized.

Unused tax losses and unused tax credits:

An enterprise may have unused tax losses or credits at the end of a period.
These will be carried forward to be offset against taxable profits. IAS ( Ind
AS) 12 states that under such circumstances, deferred tax assets may be
recognized to the extent that future taxable profits will be available against
which the unused tax losses and unused tax credits can be utilized.

Revalued asset:

Under Ind AS 16, assets may be revaluated to be shown at their fair values.
The revaluation of an asset does not affect taxable profit in the period of the
revaluation. As a result, the tax base of the asset is not adjusted. Then the
temporary difference of the revalued asset will be the difference between
carrying amount of the revalued asset and its tax base. This gives rise to a
deferred tax liability or asset.

PROPERTY, PLANT AND EQUIPMENT (Ind AS 16):

Property, plant and equipment are tangible assets. These were

conventionally called ‘fixed assets’ under Indian GAAP, property plant and
equipment include land, building, plant and machinery, vehicles,
computers, equipments, furniture etc. these are not meant for sale. These
are expected to be used for more than one period. In other words, they
provide economic benefits for more than one accounting period. Ind AS 16
describes accounting treatment for property, plant and equipment.

Objective:

The objective of Ind AS 16 is to prescribe the accounting treatment for

property, plant and equipment (PPE). The principal issues are recognition
of assets, the determination of their carrying amounts, and the depreciation
charges and impairment losses to be recognized in relation to them.

Scope:

This standard shall be applied in accounting for property, plant and

equipment, except when another standard requires, or permits a different
accounting treatment. But this standard does not apply to:
 Property, plant and equipment which are classified as held for sale.
Biological assets related to agricultural activities.
Exploration and evaluation assets.
Mineral rights and mineral reserves, such as oil, natural gas and
similar non - regenerative resources.
However, this standard applies to property, plant and equipment
used to develop or maintain the above mentioned assets.
Accounting for bearer plants related to agricultural activity has now
been included in the scope of IAS 16 instead of IAS 41, i.e., now on
bearer plants would be accounted for as PPE.

Definitions:

Property plant and equipment:

These are tangible assets held for use in the production or supply of goods
or services, or for rental to others, or for administrative purpose and
expected to use for more than one accounting period.

Fair value:

It is the amount for which an asset could be exchanged between

knowledgeable, willing parties.

Carrying amount:

It is the amount at which an asset is recognized or recorded in the balance

sheet after deducting any accumulated depreciation and impairment losses.

Accounting treatment:

Initial recognition

a) Recognition as an asset:

An item of property, plant and equipment should be recognized as an asset

if and only if:

a) It is probable that future economic benefits asscociated with the

item will flow to the entity.
 b) Cost of the item can be reliably measured.

These recognition criteria apply to costs incurred initially as well as

subsequent expenditure.

b) Spare parts, stand – by equipments and servicing

equipment:

These are smaller items such as tools, dies and moulds. These are usually
classified as inventory. Hence, these are treated as expenses and taken in
the statement of profit and loss. However, major spare parts, stand – by
equipment and servicing equipment should be recognized as assets when
they meet the definitions of PPE. Major spare oarts are also known as
capital spare parts.

c) Safety and environmental equipment:

Items acquired for safety or environmental reasons are included in PPE.

That is, they are recognized as assets. This is because they may be necessary
for obtaining future economic benefits from other assets.

d) Frequent replacements:

Parts of some property, plant and equipment may require replacement

frequently. The cost of such replacement is included in the carrying amount
of the asset, if the criteria of recognition are fulfilled. The carrying amount
of those parts that are replaced is derecognized in accordance with the de
recognized in accordance with the de - recognition provisions of Ind AS 16.

Initial measurement:

When an item of PPE qualifies for recognition as an asset, it shall be

initially measured at its cost. This cost is called initial cost. It is the cost
incurred initially to acquire or construct an item of PPE. To measure an
item of PPE, the following shall be considered:

a) Elements to be included in the cost.

b) Measurements of those elements.
c) Cost incurred after recognition.
Elements of cost:

The cost of an item of property, plant and equipment includes the

following:

1. Its purchase price after deducting trade discounts and rebates;

2. Import duties;
3. Non refundable purchase taxes;
4. Any costs directly attributable to bring the asset to the working
conditions
5. The costs of dismantling and removing the asset and restoring the site
on which it is located. The present value of dismantling cost should be
included in the cost of the asset.
6. Borrowing costs to the extent permitted by Ind AS 23, borrowing
costs.

All the above costs can be capitalized and included in the cost of PPE.

Measurements of elements of cost:

1. Cost:

Cost is the amount of cash or cash equivalents paid to acquire an asset at

the time of its acquisition or construction.

2. When the payment is deferred:

If payment is deferred beyond credit terms, the difference between the cash
price equivalent and the total payment is recognized as interest over the
period of credit unless such interest is capitalized in accordance with Ind
AS 23, borrowing costs.

Costs incurred after recognition (subsequent expenditure):

Subsequent costs include costs of servicing, repairs and maintenance,

inspections, replacement of parts, etc. subsequent expenditure on PPE
should be capitalized only if:

1. It enhances the economic benefits provided by the asset.

2. It relates to an overhaul of the asset
 3. It is replacing a component of a complex asset.

All other subsequent expenditure should be recognized as expenses in the

statement of profit or loss. This is because it merely maintains the
economic benefits originally expected.

Self - constructed asset:

the cost of a self – constructed asset is determined using the same

principles as applicable to a purchased asset. If an entity makes similar
assets for sale in the normal course of business, the cost of the asset is
usually the same as the cost of constructing an asset for sale. Any internal
profits are eliminated in arriving such costs. Similarly, the cost of abnormal
amounts of wasted material, labour or other resources incurred in self –
constructing an asset is not included in the cost of an asset.

Measurement after recognition (subsequent measurement):

There are mainly two valuation models for subsequent measurement – cost
model and revaluation model. An entity can choose either the cost model or
the revaluation model as its accounting policy. Once the choice is made,
that policy should be applied to an entire class of PPE. Thus, an entity can
use a different model for different class of assets but only one model within
a particular class.

1. Cost model:

Under this method, an item of property, plant and equipment is carried at

its cost less any accumulated depreciation and any impairment loss. Most
companies use the cost model for subsequent measurement of items of
PPE. Entities in India usually use the cost model but revalue items of PPE
from time to time.

2. Revaluation model:

According to Ind AS 16, after recognition as an asset, an item of PPE may be

carried at a revalued amount. This revalued amount will be the fair value at
the date of revaluation less any subsequent accumulated depreciation and
subsequent accumulated impairment losses. Revaluation model can be
used only for those items of PPE whose fair value can be measured reliably.

With respect to revaluation model, the following points should be noted:

 Under the revaluation model, revaluations should be carried out

regularly so that the carrying amount of an asset soes not differ
materially from its fair value at the balance sheet date.
 If an item is revalued, the entire class of assets to which that asset
belongs should be revalued.
 Revalued assets are depreciated in the same way as under the cost
model.

Accounting method for revaluation under revaluation model:

1. Revaluation increase (upward revaluation):

A. If an asset’s carrying amount is increased as a result of
revaluation, the increased amount is recognized in “other
comprehensive income” and accumulated under equity under
the head “revaluation surplus”, unless there is a previous
revaluation decrease in respect of the same asset.
B. If there is previous revaluation decrease in respect of the same
asset, the increase in revaluation (gain) shall first be recorded in
the statement of profit and loss to the extent of the previous
revaluation decrease. The balance, if any, shall be recognized in
“other comprehensive term” under the head “revaluation
surplus”. Thus the revaluation gain is first used to reverse the
previous the previous revaluation loss that was previously
recognized in statement of profit or loss. Only the balance of
gain shall be recognized in ‘other comprehensive income’ as
revaluation surplus.
2. Revaluation decrease (downward revaluation):
A. If an asset’s carrying amount is decreased as a result of
revaluation, then the decrease shall be recognized in statement of
profit and loss, unless there is a previous revaluation increase in
respect of the same asset.
 B. If there is a previous revaluation increase in respect of the same
asset, the decrease in revaluation shall be first adjusted against
the “revaluation surplus” to the extent of previous revaluation
increase in respect of the same asset. The balance, if any, shall be
recognized in the statement of profit and loss. The decrease in
revaluation reduces the amount accumulated in equity under the
head “revaluation surplus”.

Disposal of a revalued asset:

When a revalued asset is disposed of, any revaluation surplus may be

transferred directly to retained earnings. This means that the transfer to
retained earnings should not be made through the statement of profit and
loss.

Depreciation:

Depreciation is the systematic allocation of the depreciable amount of an

asset over its useful life. The depreciable amount of an asset is the cost of an
asset less its residual value.

Important points in connection with depreciation:

1. The residual value and the useful life of an asset should be reviewed at
least at the end of each accounting period. If expectations differ from
previous estimates, the change shall be accounted for as a change in
accounting estimate in accordance with Ind AS 8.
2. The useful life of an asset is defined as the period over which an asset is
expected to be available for use by entity or the number of production
or similar units expected to be obtained from the asset by an entity.
3. Depreciation begins when the asset is available for use and continues
until the asset is derecognized, even if it is idle.
4. There are three important methods of charging depreciation. They are
straight line method, diminishing balance method, and units of
production method.
5. Depreciation should be charged to the statement of profit and loss,
unless it is included in the carrying amount of another asset.
Depreciation of revalued assets:

When a revalued asset is depreciated, there is a further complication.

Normally a revaluation surplus is realized only when the asset is sold. But
when it is depreciated, part of that surplus is realized as the asset used. The
amount of surplus realized is the difference between depreciation charged
on the revalued amount and the depreciation which would have been
charged on the asset’s original cost. This amount is transferred to retained
earnings nut not through statement of profit or loss.

Derecognition (retirement and disposals):

An asset should be removed from the balance sheet on disposal or when it

is withdrawn from use and no future economic benefits are expected from
it. The disposal of PPE shall take place in the following two methods: (a) by
sale, and (b) by entering into a finance lease. The difference between the
sale proceeds and the carrying amount represents the gain or loss on
disposal. This should be recognized in the statement of profit and loss
statement. However, the gain on derecognition shall not be classified as
revenue. It is a non – operating gain. Hence it is not taken in the statement
of profit and loss.

Nature of revaluation surplus:

Revaluation surplus represents accumulated unrealized gain arising from

revaluation of items of PPE. It is not available for distribution to
shareholders either as dividend or as bonus shares. Revaluation surplus is
also known as revaluation reserve. it is a component of retained earnings.

BORROWING COST (Ind AS 23):

Enterprise may borrow funds to acquire, build and install plant, machinery
and other assets. These assets may take time to make them usable or
saleable. Thus, enterprises incur interest to acquire and build these assets.
The interest is the borrowing costs on funds needed to acquire and build
assets. The Ind AS 23 deals with such costs of borrowing.
Objective:

The objective of the standard is to prescribe the treatment of borrowing

costs in accounting. It tells whether the cost of borrowing should be
included in the cost of asset or not.

Scope:

1. This standard applies to borrowing costs incurred by an entity in

connection with borrowing of funds.
2. This standard does not apply to borrowing costs directly attributable to
the acquisition, construction or production of:
a) A qualifying asset measured at fair value
b) Inventories that are produced in large quantities on a repetitive
basis over a short period of time.
c) Assets that are already for their intended use or sale when
purchased.
3. The standard does not deal with the actual or imputed cost of equity,
including preferred capital not classified as a liability.

Definition of borrowing cost:

Borrowing costs mean interest and other costs that an entity occurs in
connection with the borrowing of funds. It includes the following:

 Interest on bank overdrafts and short term and long term borrowings.
 Amortization of discounts or premiums relating to borrowings.
 Amortization of ancillary costs incurred in connection with the
arrangements of borrowings.
 Finance charges in respect of finance leases recognized in accordance
with Ind AS 17.

Other definitions:

1. Qualifying assets:

Qualifying assets are those assets that take a substantial time to get ready fr
their intended use or sale. For example:
  Power generation facilities which will take long period for
completion.
 Intangible assets which are development phase or acquired but
not ready for use or sale.
 Investment properties

Examples for not qualifying asset:

 Financial assets
 Inventories that are manufactured over a short period of time
 Assets that are ready for their intended use or sale when
purchased.
2. Substantial period of time:

Standard does not provide a specific providence on how long a ‘substantial

period of time’. Generally, a period of 12 months is considered as
substantial period of time.

Accounting treatment:

Recognition

1. Borrowing costs to be capitalized:

Borrowing costs that are directly attributable to the acquisition,

construction or production of a qualifying asset should be capitalized when
it is probable that they will bring future economic benefits to the entity and
the costs can be measured reliably.

2. Borrowing costs to be charged as an expense:

Other borrowing costs are recognized as expenses and written off in the
statement of profit and loss in the period in which they are incurred.

Commencement of capitalization:

An entity should begin capitalizing borrowing costs on the date when all of
the following conditions are met:

 Expenditure on qualifying asset has begun

  Borrowing costs are being incurred.
 Activities to prepare the asset for its intended use or sale are in
progress.

Suspension of capitalization:

Capitalization of borrowing cost is suspended during extended periods in

which active developments is interrupted. This means that borrowing cost
should not be capitalized during the extended period. It is also suspended
when acquisition or construction activities are suspended intentionally.

However, capitalization is not suspended in the following cases:

 Temporary delays caused by external forces

 When substantial technical and administrative work is being carried
out.
 When a temporary delay is necessary part of the process of getting an
asset ready for its intended use or sale.

Cessation of capitalization:

An entity should cease (or stop) capitalizing borrowing costs when:

1. Substantially all the activities necessary to prepare the qualifying asset

for the intended use or sale are complete.
2. The construction is completed in part and the completed part can be
independently used.

Capitalization should not cease when there is a short interruption in

activities or when it is delayed and that delays are inherent in the asset
acquisition process.

Measurement:

Measurement of borrowing cost depends upon whether it is a specific

borrowing or general borrowing.

1. Specific borrowing:
When an entity borrows fund specifically for the purpose of obtaining a
qualifying asset, the actual borrowing costs incurred is capitalized. Howeer,
any investment income on the temporary investment of those borrowings
should be deducted from the borrowing cost.

In short, the borrowing cost on the specific borrowings should be

capitalized in that asset, i.e., it should be added to the cost of that asset.

Income from temporary investment of borrowed funds: when

there is a delay in spending the amount drawn down on the qualifying
asset, such an idle fund may be temporarily invested. This temporary
investment yields income (interest). This investment should be deducted
from the borrowing costs. Only the balance amount can be capitalized.

Excess of the carrying amount:

The amount capitalized during a period should not exceed the amount of
borrowing costs incurred during that period. If the carrying value of an
asset exceeds the net realizable value, the asset should be written down to
the NRV.

PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT

ASSETS (Ind AS 37)

The accounting standards discussed so far are based on revenue. The Ind
AS 37 is based on liabilities and provisions. The Ind AS 37 deals with
provisions, contingent liabilities, and contingent assets.

Objective:

The objective of this standard is to ensure that appropriate recognition

criteria and measurement bases are applied to provisions, contingent
liabilities and contingent assets and that sufficient information is disclosed
in the notes to enable users to understand their nature, timing and amount.

Scope:

Ind AS 37 shall be applied by all entities in accounting for provisions,

contingent liabilities and contingent assets, except those resulting from:
1. Financial instruments carried at fair value
2. Executory contracts
3. Insurance contracts with policyholders
4. Events or transactions covered by any other Ind AS

Definition of provision:

A provision is a liability of uncertain timing or amount. Examples of

provisions are: income tax liability, product warranty, environment
restoration, post employment employee benefits etc. in all these examples,
the time is uncertain, or the amount is uncertain , or both time and amount
are uncertain.

A liability is defined as a present obligation arising from past events, the

settlement of which is expected to result in an outflow of resources.

Recognition of provisions:

A provision should be recognized only when all of the following conditions

are met:

1. There is a present obligation as a result of a past event

2. It is a probable that an outflow of resources embodying economic
benefits will be required to settle the obligation
3. The amount of obligation can be reliably estimated.

Conditions to be met for recognition:

1. Present obligation:

To become a provision, it must be a liability first. To become a liability,

there must be a present obligation and not future obligation.

2. Past event (obligating event):

An obligating event simply refers to obligation arising from past events. It is

an event that creates a legal or constructive obligation. A legal obligation is
an obligation that derives from a contract or legislation. A constructive
obstructive obligation arises if past practice creates a valid expectation on
the part of a third party.
3. Probable outflow of resources embodying economic benefits:

In order a provision to be recognized, there must be a probable outflow of

resources in order to settle the obligation. Where it is not probable that a
person obligation exists, an entity discloses it as contingent liability.

4. Reliable estimate of the obligation:

Where a liability exists but no reliable estimate can be made, it cannot be

recorded. That liability is disclosed as a contingent liability.

Measurement of provision:

A provision is measured at the best estimate of the expenditure required to

settle the present obligation at the balance sheet date. Best estimate is the
amount that an entity would be paid to settle the obligation at the balance
sheet date or to transfer it to a third party.

The estimation of outcome and financial effect are determined by the

judgement of the management of the entity, supplemented by experience of
similar transactions and reports from independent experts.

When the measurement of provision involves large population of events,

then obligation is estimated on the basis of expected value. The expected
value is determined by weighing all possible outcomes by their associated
probabilities.

Important consideration in measuring provisions:

1. Present value:

Where the time value of money is important, the provision should be

discounted. In other words, the amount of provision should be present
value of the expenditures expected to be required to settle the obligation.
The discount rates should be the pre – tax rate that reflects current market
assessment.
 2. Reimbursements:

Some or all of the expenditure required to settle an obligation is expected to

be reimbursed from a third party. If so, the reimbursement should be
recognized only when it is virtually certain that the reimbursement will be
received if the entity settles the obligation. This implies that the amount of
reimbursement should not be shown as a reduction of the required
provision. Reimbursement of the expenditure required to settle a provision
may arise from insurance contracts, indemnity clauses, or suppliers’
warranties. The amount recognized should not exceed the amount of
provision itself.

In the statement of profit and loss, the expense relating to a provision may
be net of the amount recognized for a reimbursement.

3. Changes in provisions:

Provision should be reviewed at the end of the reporting period and

adjusted to reflect the current best estimate. If it is no longer probable that
an outflow of resources will be required to settle the obligation, the
provision shall be reversed.

Where discounting is used, the carrying amount of a provision increases in

each period to reflect the passage of time. This increase is recognized as
borrowing cost.

4. Use of provision:

A provision should be used only for expenditures for which the provision
was originally recognized and not for another purpose. Setting expenditures
against a provision that was originally recognized for another purpose
would conceal the impact of 2 different events.

5. Future operating losses:

Provision should not be recognized for future operating losses. This is

because they do not meet the definition of a liability and the general
recognition criteria.
 6. Onerous contracts:

It is a contract in which the unavoidable costs of fulfilling the obligations

under the contract exceed the economic benefits from it. Vacant leasehold
property is an example. The entity is under an obligation to maintain the
property but is not receiving income from it. The present obligation under
the onerous contract should be recognized and measures as a provision.

7. Restructuring (provision for restructuring):

It is defined as a programme that is planned and controlled by management

that materially changes either the scope of business or the manner in which
that business is conducted. Examples of events falling under restructuring
are:

 Sale or termination of a line of business.

 Closure of business locations.
 Changes in management structure.
 Fundamental reorganization of company.

Recognition of restructuring costs:

A provision for restructuring costs is recognised only when the general

recognition criteria for recognising a provision are met. Besides, the
following criteria should also be met:

o An entity must have a detailed formal plan for the restructuring.

o It must have raised a valid expectation that it will carry out the
restructuring, by starting to implement that plan or announcing its
main features.
A restructuring provision should include only the direct expenditures
arising from the restructuring that are both:

o Necessitated by the restructuring

o Not associated with the ongoing activities of the enterprise.
Following costs should not be included in the restructuring provision:

o Cost of retraining or relocating continuing staff

 o Cost of marketing
o Cost of investment in new systems and distribution network.
Examples of possible provision:

1. Warranties:
These are argued to the genuine provisions. This is because these are
probable on past experience. Besides, there is clear legal obligation. Hence,
provision should be made for warranties. It must be estimated on the basis
of the class as a whole and not on individual claims.

2. Major repairs:
This is a capital expenditure rather than expenditure. The reason is that
that there is no obligation to carry out repairs. The only solution is to treat
major assets such as aircraft, ship, furnaces etc. as a series of small assets
where each part is depreciated over shorter lives.

3. Environmental contamination:
If the company has an environmental policy such that other parties would
expect the company to clean up any contamination or if the company has
broken current environmental legislation, then a provision for
environmental damages must be made.

Contingent liabilities:

A contingent liability is possible obligation that arises from past event and
the existence of which will be confirmed only by the occurrence or non –
occurance of one or more uncertain future events not wholly within the
control of the enterprise, or a present obligation that arises from past
events but is not recognised because, it is not probable that an outflow of
resources embodying economic benefits will be required to settle the
obligation, or a reliable estimate of the amount of the obligation cannot be
made. Thus, contingent liabilities are not payable at present. It may be
repayable on happening of a contingency or future uncertain event.
Contingent liabilities are assessed continually to determine whether
settlement has become probable. If it becomes probable that payment will
be required for an item previously dealt with as a contingent liability, a
provision is recorded in the financial statements of the period in which the
change in probability occurs.

Examples of contingent liabilities:

 Guarantees on behalf associates and others

 Claims against firm
 Liabilities of case pending in the court
 Income tax demand under appeal
 Uncalled liability on partly paid up shares
Recognition of contingent liabilities:

An entity should not recognise contingent liabilities in the financial

statements. Instead, an entity should disclose them by way of notes below
the balance sheet. If the possibility of an outflow of resources is remote,
even the disclosure is not required.

Contingent assets:

Contingent assets are only possible assets. They are not real assets. To be
called a contingent asset, the following conditions must be fulfilled:

 Possible asset as a result of past events.

 Existence of contingent assets is to be confirmed by occurrence and
non – occurrence of one or more future events.
 Future event not wholly within the control of the enterprise.

Recognition of contingent asset:

Contingent assets are not recognised in financial statements because this

may result in the recognition of income that may be realised. However,
when the realization of income is virtually certain, then the related asset is
recognised. A contingent asset is disclosed, where an inflow of economic
benefits is probable.
Contingent assets are assessed continually and if it has become virtually
certain that the inflow of economic benefits will arise, the asset and the
related income are recognised in the financial statements of the period in
which the change occurs.

INTANGIBLE ASSETS (Ind AS 38):

Intangible assets are assets not having any physical substance. Therefore,
they cannot be seen and touched. But they have economic value. Their
value comes from the economic benefits that flow to the entity.

Objective:

The objective of this standard is to prescribe the accounting treatment and

recognition, measurement and disclosure requirements of an intangible
asset.

Scope:

The standard applies to all intangible assets, except the following:

Intangible assets covered by another standard

Financial assets
Exploration and evaluation asset as per Ind AS 106
Mineral, oil, natural gas and similar non – regenerative resource
expenditure.
Other definitions:

Development:

Development is the application of research finding or other knowledge to a

plan or design for the production of new products or services before the
start of commercial production or use.

Research:

Research is original and planned investigation for gaining new technical

knowledge and understanding.

Accounting treatment:
Initial recognition as an asset:

An intangible asset must be identifiable in order to distinguish it from

goodwill. An intangible asset is identifiable when it is separable or aroses
from contractual or other legal rights.

In order to capitalise an intangible asset – it must be identifiable, it must be

controlled by the entity, future economic benefits are probable and it must
be capable of reliable measurement.

If these criteria are met, the intangible asset can be initially recognised at
cost.

Purchased intangibles:

If an intangible asset is purchased separately. It should be recognised as

intangible asset initially at cost.

Recognition as an expense:

Costs may be incurred to provide future benefits to an enterprise. If no

asset is created or acquired, then the cost is recorded as an expense.

Initial measurement:

After intangible assets have been first recognised, they are to be measured.
They should be initially measured at cost. But subsequently, they can be
carried at cost or at a revalued amount. The cost of an intangible asset
comprises the following: purchase price, import duties, non – refundable
purchases taxes etc.

Measurement of intangible assets acquired as a part of business

combinations:

In this case the intangible asset is measured at fair value at the date of
acquisition.

Measurement of internal project:

In case of an internal project, expenditure of creating an intangible asset is

treated differently. The research phase and development phase should be
distinguished from one another. Research expenditures are treated as an
expense. Development expenditure qualifying for recognition is measured
at cost and is capitalised.

Measurement of intangible asset acquired in exchange for equity

instruments:

If an intangible asset is acquired in exchange for equity instruments, the

cost of the asset is the fair value of those equity instruments.

Measurements in case of exchange of assets:

An intangible asset may be acquired in exchange for a similar asset with a

similar fair value. No gain or loss is recorded on the transaction. Instead,
the cost of the new asset is the carrying amount of the asset given up.

Subsequent measurement (measurement after recognition):

Under this standard, there are two methods of valuation of intangible

assets after they have been first recognised. They are:

1. Cost model:
Under this method, an intangible asset should be carried at its cost, less any
accumulated amortisation and impairment loss. Generally companies select
cost model for all classes of intangible assets.

2. Revaluation model:
Under the revaluation method, an intangible asset is carried at a revalued
amount. This is fair value of the intangible asset at the date of revaluation,
less subsequent accumulated amortisation and accumulated impairment
loss. The revaluation method is applied after an asset has been initially
recorded at cost. While applying the revaluation method, the following
points may be considered:

 The fair value must be determined by reference to an active market.

 If an asset is revalued, all the new assets in its class should also be
revalued.
 If an intangible asset in a class of revalued intangible assets cannot be
revalued because there is no active market for this asset, then that
 asset should be carried at its cost less any accumulated amortisation
and impairment loss.
 Revaluation should be made regularly so that the carrying amount
does not differ significantly from the fair value.
Revaluation increase (upward revaluation):

Where an intangible asset is revalued upwards to a fair value, the

revaluation increase is credited directly to equity under the head
‘revaluation surplus’, unless the asset was previously revalued downwards.
If the asset was previously revalued downwards, the revaluation increase
should be first used to set off the previous revaluation decrease. Balance of
revaluation increase will be credited to revaluation surplus.

Revaluation decrease (downward revaluation):

When the carrying amount of an intangible asset is revalued downwards,

the amount of the downward revaluation should be charged as an expense
in the income statement, unless the asset was previously revalued upwards.
If the asset was previously revalued upwards, the revaluation decrease
should be first charged against previous revaluation surplus in respect of
that asset. Balance of revaluation decrease will be debited in the income
statement as expense.

Elimination of intangible asset:

An intangible asset should be eliminated from the balance sheet when it is

disposed or when there is no further expected economic benefit from its
future use. On disposal, the gain or loss should be taken to the statement of
profit and loss as a gain or loss on disposal, it should be treated as income
or expense.

When the asset is written out of the balance sheet, the revaluation surplus
included in the equity may be transferred directly to the retained earnings.

Useful life:

An enterprise should assess the useful life of an intangible asset. The useful
life may be finite or inde3finite. Many factors are considered in determining
the useful life of an intangible asset. Important factors are: expected usage,
typical product life cycles of the asset, technical or technological or other
types of obsolescence, etc.

Intangible life with finite life:

The cost less residual value of an intangible asset with a finite useful life
should be amortized on a systematic basis over that life after taking into
consideration the following points:

 Amortization method should reflect the pattern of benefits.

 If the pattern cannot be determined reliably, amortize by the straight
line method.
 The amortization charge is recognized in profit or loss unless another
Ind AS requires that it to be included in the cost of another asset.
 The amortization period should be reviewed at least annually.

The asset should be assessed for impairment in accordance with Ind AS 36.

Amortization:

Amortization is a systematic allocation of the cost of revalued amount less

any residual value, over the asset’s useful life. Thus, amortization has the
effect of recognizing proportionate expenditure as an expense.

For amortization, straight line method or diminishing balance method or

the unit of production method may be used. The method selected is based
on the likely consumption of benefits, and is consistently applied from
period to period. Generally, straight line method is used to amortize the
depreciable amount of the intangible asset.

Intangible asset with indefinite useful lives:

An intangible asset with indefinite useful life should not be amortized. An

intangible asset with indefinite useful life should be reviewed each year to
determine whether it is still appropriate to assess its useful life as
indefinite. Reassessing the useful life of an intangible asset as finite rather
than indefinite is an indicator that the asset may be impaired. Then it is
necessary to test the asset for impairment by comparing its recoverable
amount with its carrying amount. Then any excess of the carrying amount
over the recoverable amount should be recorded as an impairment loss.

Residual value:

The depreciable amount of asset is determined after deducting its residual

value. Any residual value implies that an enterprise expects to dispose of
the intangible asset before the end f its economic life.

The residual value of an intangible asset is assumed to be zero unless :

(1)there is a commitment by a third party to purchase the asset at the end of
its useful life, (2) there is an active market for the asset, (3) residual value
can be determined with reference to that market, and (4) it is probable that
such a market will exist at the end of the asset’s useful life. Hence residual
value of an intangible asset is usually assumed to be zero.

Internally generated goodwill:

Costs may be incurred to generate future benefits. But these do not result in
an asset that meets the recognition criteria. Such expenditure may be
described as ‘internally generated goodwill’. This should not be recorded as
an asset. This is because it requires that, for the initial recognition, the cost
of the asset should be capable of being measured reliably and that it should
be identifiable and controlled. An internally generated goodwill is
subjective. Hence, it cannot be measured reliably. Goodwill appears in the
balance sheet of an entity only when it recognizes goodwill in a business
combination.

Internally generated intangible assets:

It may be difficult to know whether an internally generated asset qualifies

for recognition. This is because it is often difficult to : (1) identify whether,
and when, there is an identifiable asset that will generate future benefits,
and (2) determine the cost of the asset. To assess whether an internally
generated assets meet the criteria for recognition, an enterprise splits the
generation of assets into : (1) a research phase, and (2) a development
phase. If it is not possible to distinguish the research phase from the
development phase, the expenditure on that project may be treated as
incurred in the research phase only.

Research phase: in the research phase of a project, expenditure is always

recorded as an expense when it is incurred. This is because no intangible
asset is created in this phase. Examples of research activities are as follows:

 Activities to obtain new knowledge

 Search for application f research findings, or other knowledge
 Search for product or process alternatives
 Formulation and design of possible new or improved product or process
alternatives.

Thus, research activities do not meet the criteria for recognition under Ind
AS 38. This is because, at the research stage of a project, it is not certain
that future economic benefits will probably flow to the entity from the
project. Hence, research cost should be written off as an expense when they
are incurred

Development phase: expenditure incurred during the development

phase is known as development cost. Development cost is recognized as an
intangible asset only if the enterprise can satisfy all of the following
conditions or criteria:

 Technical feasibility of completing the asset, so that it will be available

for use or sale.
 Intention to complete the asset and use or sell it.
 Ability to use or sell the asset.
 Probable future economic benefits from the asset, whether through sale
or internal cost saving.
 Resources available to complete the development and to use or sell the
asset.
 Expenses attributable to the intangible asset during the development
can be measured.

Among other things, the enterprise should demonstrate the existence of a

market for the output of the intangible asset or the intangible asset itself or,
if it is used internally, the use4fulness of the tangible asset.
Cost of an internally generated intangible assets:

The cost of an internally generated asset is the total costs incurred from the
date when the asset first meets the recognition criteria and that can be
directly attributed or allocated to it on a reasonable and consistent basis.
The cost comprises of all expenditures for creating , producing and
preparing the assets for its intended use. Such costs include the following:

1. Expenditure on materials and services used in generating the asset.

2. The employment costs of personnel directly engaged in producing the
assets
3. Any expenditure that is directly attributable to the asset, such as fees
to register a legal right and the amortization of parents and licenses.
4. Overheads that are necessary to generate the asset.
5. Interest

The following expenditure on an internally generated intangible asset

should not be included in its costs:

1. Selling, administrative and other general overhead expenditure

provided that these expenditure cannot be directly attributed to
prepare the asset for use.
2. Clearly identified inefficiencies and initial operating loss, incurred
before n asset achieves planned performance.
3. Expenditure on training staff to operate the asset.

Acquisition of intangible assets on deferred payment basis:

When an intangibility asset is acquired on deferred payment basis, the cost

of acquisition is calculated on the basis of present value of cash flows.
 CHAPTER – 3

REDEMPTION OF PREFERENCE SHARES

MEANING OF REDEMPTION OF PREFERENCE SHARES:

Redemption means repayment of capital. Thus, redemption of preference

share means repayment of preference share capital to the preference
shareholders.

PROVISIONS (CONDITIONS) OF PREFERENCE SHARES:

According to Section 55 of the Companies Act, 2013, a company limited by

shares, if authorized by its articles, can redeem the preference shares,
subject to the following conditions:

1. The shares to be redeemed must be fully paid up.

2. The shares should be redeemed either out of profits of the company
available for distribution as dividend or out of the proceeds of fresh
issue of shares made for the purpose of redemption.
3. Any premium payable on redemption must be provided out of the
profits of the company or out of the company’s securities out of
securities premium reserve. If there is existing securities premium
reserve or premium on fresh issue. It may also be noted that the
redemption premium can be provided out of any other capital profits
in addition to securities premium reserve.
4. Where any such shares are redeemed out of profits available for
dividend, an amount equal to the nominal value of shares to be
redeemed must be transferred out of the divisible profits to capital
redemption reserve account.
5. The capital redemption reserve account can be utilized pnly for the
issue of fully paid up bonus shares. This means that partly paid uyp
shares cannot be made fully paid up out of capital redemption reserve
a/c.
6. Notice of the redemption must be sent to the registrar of companies
within 30 days from the date of redemption.
 7. The redemption of preference shares is not to be considered as
reduction of share capital. Hence the company may issue shares upto
the nominal amount of shares redeemed.
SOURCES OF REDEMPTION OF PREFERENCE SHARES:

1. Redemption out of fresh issue of shares:

Under this method the company redeems the preference shares out of the
proceeds of fresh issue of shares made for the purpose. In other words, a
company issues new shares and the proceeds from such issue are used for
redemption of preference shares. The company may issue fresh shares
either at par or at premium. Only face or nominal value of shares so issued
can be utilized of shares so issued can be utilized for redemption. However,
the share premium from the fresh issue can be used to provide for premium
payable on redemption.

2. Redemption out of profits:

Redeemable preference shares can be redeemed out of divisible profits.
Divisible profit means the profits available for dividend. Divisible profits
such as general reserve, reserve fund etc are available for distribution of
dividends and Capital profits such as capital reserves, securities premium
reserve, etc. are not available for dividends. Hence, these are not used to
redeem preference shares. In other words, the capital profits or reserves
cannot be utilized for redemption of preference shares.

In the case of redemption out of profits, an amount equal to face value or

nominal value of shares so redeemed should be transferred from divisible
profits to capital redemption reserve account. [CRR]

3. Redemption partly out of fresh issue and partly out of

profits
This is the most practical method of redemption. Under this method the
company can redeem the preference shares partly from the fresh issue of
shares and partly out of revenue profits.
REASONS FOR CREATING CRR:
1. Capital maintenance: by creating CRR, it is possible to protect capital
structure and components of capital as it is. If much variation is taking
place in components and volume of capital, business activities would be
reduced. This causes dissatisfaction among shareholders. In short, CRR
safeguards interest of shareholders.
2. Safeguard of creditors:
if CRR is not created, the directors may distribute the entire amount of
profits by way of dividend. This will adversely affect the interest of
shareholders,
ACCOUNTING PROCEDURE FOR REDEMPTION OF
PREFERENCE SHARES: [IMP]

1. First see whether the redeemable preference shares are fully paid up. If
they are partly paid p, pass the following journal entries to make them
fully paid.
a) Preference shares final call A/c Dr
To preference share capital A/c

b) Bank A/c
To preference share final call A/c Dr

(For making the preference share final call A/c)

2. Make journal entry for fresh issue of shares when company issues new
share:

a) At par Dr
Bank A/c
To share capital
(Issue of shares at par)
b) At premium Dr
Bank A\c
To share capital A/c
To securities premium reserve A/c
 (Issue of shares at premium)

3. Write journal entry for redemption of preference shares:

a) When redemption is at par
Redeemable preference share capital A/c Dr
To preference shareholders A/c
(Transfer of capital to preference shareholders)
Preference shareholders A/c Dr
To bank A/c
(Payment to preference shareholders)
b) When redemption is at premium
Securities premium reserve/statement of profit & loss Dr
To premium on redemption of preference shares A/c
(Premium on redemption provided out of securities premium or
profit & loss)
Redeemable preference share capital A/c Dr
Premium on redemption of preference share A/c Dr
To preference shareholders A/c
(Transfer of capital and premium to preference shareholders)
Preference shareholders A/c Dr
To bank A/c
(for paying the amount due to preference shareholders)

DIVISIBLE PROFIT: [IMP]

Divisible profit means the profits available for dividend. The examples of
divisible or undistributed profits include general reserve, reserve fund,
insurance fund, reserve for contingencies etc.

ARRANGEMENT OF CASH:
Cash is required for redemption of preference shares. If fresh shares are not
issued for the purpose of redemption, the problem of availability of cash
may arise. If sufficient cash is not available, the company will have to
arrange it. For arranging cash, the company may dispose off investments or
assets. Sometimes, it arranges from banks in the form of loans.
UNTRACEABLE PREFERENCE SHAREHOLDERS:
Sometimes it is not possible to trace a preference shareholder due to
change of address or some other reason. Therefore, it is not possible to
make payment to them at the time of redemption. In such cases, amounts
due to untraceable preference shareholders should be treated as current
liability. This appears in the balance sheet under the subhead “other
current liabilities” under the head “current liabilities”. A separate entry is
not required for this.
 CHAPTER – 4

REDEMPTION OF DEBENTURES

MEANING OF REDEMPTION OF DEBENTURES:

Redemption of debentures simply means repayment of debentures. It is the

discharging of the liability on account of debentures. They may be
redeemed at par or at premium.

SOURCES OF REDEMPTION OF DEBENTURES:

 Out of fresh issue of shares/debentures.

 By utilization of a part of capital.
 By utilization of profits (accumulated profits)
 By conversion into shares/debentures.
 Out of proceeds from sales of fixed assets.
 By purchase of own debentures.
METHODS OF REDEEMING DEBENTURES:

1. Redemption by lump – sum payment:

Under this method the entire amount of debentures is redeemed at the end
of the specified period (expiry) as per the terms of the issue. Funds are
required for redeeming debentures. The board of directors should decide
the sources from which debentures are to be redeemed. Debentures may be
redeemed out of capital or out of profit.

a) Redemption out of capital:

When debentures are redeemed out of current assets or sources of the
company. It is known as redemption of out of capital. In this method, the
debenture redemption reserve account(DRR) is not created.

b) Redemption out of profit:

When sufficient profits are transferred from statement of profits and loss to
the debenture redemption deserve at the time of redemption of debentures,
such redemption is said to be out of profits. This is called redemption out of
profit because it reduces the amount of profit available for dividend.

2. Redemption of debentures by annual drawings or

installments:
When redemption of debentures is made by annual installments (drawings)
then it is called as redemption of debentures by annual installments
(drawings). This method is also called “lottery method” of redeeming
debentures ( i.e., drawing by lots).

There are two methods of redemption of debentures by annual installments

(drawings). They are:

a) Redemption of debentures out of capital:

When the debentures are redeemed out of current sources of the company.
It is known as redemption of debentures out of capital. It adversely affects
the working capital of the company.

b) Redemption of debentures out of profits:

When the amount of payable is charged out of surplus from profit and loss
statement before the redemption of debentures, then it is called redemption
of debentures out of profits.

3. Redemption by sinking method:

Under this method of redemption, every year a part of the profit (fixed
installment) is set aside and sinking fund is created. The sinking fund is
invested in outside securities like shares, bonds etc. the interest received on
such investments along with annual amount set aside from profit will again
be invested as usual. This process continues till the date of redemption. The
investment will be sold and the cash thus received will be used to repay the
debentures.

4. Redemption by insurance policy method:

Under insurance policy method, an insurance policy is purchased by annual
premium. Such policy will mature on the date when the debentures become
redeemable. The total premium paid will amount to less than the policy
amount, but the policy amount will be equal to the amount required for
redemption.

5. Redemption by purchase of own debentures in open

market:
The debentures may be purchase either for immediate cancellation or for
investment:

Purchase of own debentures for immediate cancellation:

When the debentures are cancelled immediately, generally there may be

profit to the company. This is because the debentures are purchased from
open market at lower price than the face value of the debentures. Besides, if
debentures are redeemable at premium, the company need not pay this
redemption premium ( i.e., the redemption premium is saved). This is a
gain to the company. Both gains should be transferred to ‘profit on
purchase ( or redemption) of debentures A/C.’ no interest is to be paid on
the debentures purchased and cancelled after the date of cancellation.

6. Redemption by conversion into new shares or debentures:

Redemption by conversion means redeeming the debentures by converting
them into new debentures and/or shares within a stipulated period at the
option of the debenture holders. Under this method, a company gives an
option to debenture holders at the time of issue of debentures that after a
certain period they can convert their debentures into shares or new
debentures. The redemption by conversion of debentures can be made
either at par or at premium but not at discount.

EX – INTEREST AND CUM - INTEREST QUOTATIONS: [NOTE :

IMP]

If the purchase price excludes the interest for the expired period, it is called
ex – interest price. This means that the purchase price of debentures does
not include the interest for the expired period.

If the purchase price includes the interest for the period from previous date
of interest to the date of purchase, it is called cum interest price. It means
the price paid by the company for the debentures includes the interest for
the EXPIRED PERIOD ALSO.

MERITS OF SINKING FUND METHOD:

As the funds required for redemption accumulates outside the

business. Liquid cash is available at the time of redemption. Hence
debentures can be repaid without disturbing the financial position of
the company.
In the interim period, the security may be pledged or sold out to get
liquid cash in case of any emergency.
DEMERITS OF SINKING FUND METHOD:

There may be losses in realizing the investments.

The rate of returns on investments may be less than the earning rate
of the business.
As a part of the profit is set aside for creating a sinking fund,
shareholders get a comparatively low rate of dividend during the
currency of debentures.