52811bos42323-cp18.pdf

18 ANALYSIS OF FINANCIAL STATEMENTS LEARNING OUTCOMES After studying this chapter, you would be able to:  Examine the key features of the financial statements and its relevancy for

better reporting.

 Examine the key factors to be kept in mind in the preparation of financial

statements.  Follow the best practices in the preparation of financial statements.  Analyse the common mistakes incurred by the preparers of the financial

statements in the presentation of financial statements with respect to Schedule III and Accounting Standards.

 Rectify the mistakes found in the financial statements by addressing the

issues and prescribing the correct presentation and disclosures.

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18.2

FINANCIAL REPORTING

CHAPTER OVERVIEW Analysis of Financial Statements (FS) Characteristics of good financial statements

Best Practices

Common Defects in FS

Compliance

True and fair view Relevance Understand ability Consistency Regulatory Compliance Universality

Complete Simple and specific Transparency Materiality Integration of Notes Disclosure of significant accounting policies Disclosures of key estimates and judgements Integrated approach

Illustrations

Schedule III Disclosure Disclosure of Balance Sheet Items Disclosure of Statement of Profit and Loss Items

Disclosure of Other Items of Financial Statements Other Constituents of Financial Statements Consolidated Financial Statements

Based on AS

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Based on Ind AS

ANALYSIS OF FINANCIAL STATEMENTS

1.

18.3

INTRODUCTION

Business is important organ of society that helps in its overall development. A typical business has a variety of stakeholder that include its employees, owners, banks, trade associations, government, general public and so on. These stakeholders, particularly investors are keenly interested in knowing about the financial well-being of business organisations. Financial reporting is an important means of communication for entities to disseminate information of its operations to various stakeholders. With the increased focus on governance the significance of financial reporting has exponentially increased. The importance of robust financial reporting cannot be emphasized enough. As India and Indian enterprises move ahead in the growth p ath at much faster pace and exposure of Indian entities to global environment expands, ever increasing complexities of transactions throws up newer challenges in financial reporting and related guidance. Presentation and disclosures, in this context, are assuming greater significance as enterprises aim to achieve excellence in financial reporting. Today, there are a number of requirements mandated by the regulators. It has now become imperative for entities to keep pace with the fast evolving requirements in the area of financial reporting. The financial statements are a source of critical communication between an entity and the investors and other stakeholders. They act as the barometer to assess the performance, both past and future, for any enterprise. Decades back when enterprises were mostly proprietary owned, the financial statements were simpler in content and were presented annually just to provide the historical data. However, with globalization and increased dependence on technology, where companies are expanding both horizontally and vertically, many even spanning across geographies; the number of stakeholders – be it be investors, suppliers, employees, or even tax authorities, have increased manifold. The financial statements are supplemented with the disclosures which are the key source of information and help the users in interpreting the financial statements in a better manner in taking appropriate decisions. Therefore, one can say that disclosures are added for good reasons. Disclosures are not the only requirement which will make a financial statement to be a good financial statement. The presentation and the compliance of formats are also the important factors which are taken into consideration while evaluation a financial statement. This chapter enumerates some of the practices currently being followed in financial reporting and sets out suggested ‘best practice’ to enhance the quality of financial reporting to enable preparers of financial statements in benchmarking their financial statements. It intends to bring to the notice of the preparers and reviewers of the financial statements some common errors or omissions which they shall avoid while preparing the financial statements .

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18.4

2.

FINANCIAL REPORTING

FINANCIAL STATEMENTS OF CORPORATE ENTITIES

The format and content of the financial statements for companies is required to be in accordance with Schedule III to the Companies Act, 2013. Further, there are several additional disclosure requirements both with respect to the balance sheet and statement of profit and loss. Certain industries have formats specified by their industry regulators, which need to be followed by them. This fact has also been recognised in the Companies Act, 2013 in the proviso to Section 129(1) which implies that the format set out in Schedule III will not be applicable to insurance companies and banking companies. The formats for these companies are prescribed by specific regulators. In terms of format, Schedule III only prescribes the vertical format of balance sheet and does not provide the alternative of using the horizontal format. Further, Schedule III sets out the minimum requirements for disclosure on the face of the balance sheet and the statement of profit and loss. It allows line items, sub-line items and sub-totals to be presented as an addition or substitution on the face of the financial statements when such presentation is relevant to an understanding of the company’s financial position or performance or to cater to industry/sector -specific disclosure requirements or when required for compliance with the amendments to the Companies Act or under the Accounting Standards. Schedule III now requires all disclosures to be made as a part of the notes. Apart from granting an overriding status to the Accounting Standa rds, cognizance has also been given to the requirements of Accounting Standards in the format of the balance sheet and accordingly elements such as deferred tax assets and intangible assets have been included in the balance sheet. Also, it has been clearly stated that the disclosure requirements specified in Part I and Part II of the Schedule III are in addition to and not in substitution of the disclosure requirements specified in the notified Accounting Standards. The terms used in Schedule III are to be considered as per the notified Accounting Standards. One of the pertinent aspect which needs to be considered in the preparation of financial statements with regard to Schedule III is that it does not prescribe the accounting treatment to be adopted by the entity; it only prescribes the format and content. Consequently, the fact that a particular item has been included in the format of the balance sheet in Schedule III does not imply that the particular item can be recognized in the balance sheet. Sched ule III prescribes only presentation and not treatment which is a subject matter of Accounting Standards, which has also been specifically acknowledged in Schedule III.

3.

CHARACTERISTICS STATEMENTS

OF

GOOD

FINANCIAL

In the Indian scenario, the ICAI has been the recognized accounting body issuing generally accepted accounting policies, and has made the standards mandatory for enterprises operating

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ANALYSIS OF FINANCIAL STATEMENTS

18.5

within India. Recently, ICAI has issued the converged set of Ind AS that is adopted by MCA, and many large entities are already in the transition phase for adoption. The key features to any set of financial statements are: 1. True and fair view of the affairs of the enterprise: This is the most important feature of any set of financial statements. The user of the financial statements depends fully on the same and hence the reliability factor is supreme. 2. Relevance: The financial statements should provide the relevant information for the period it is presented. There is no point in presenting historical data of past several years that is may be redundant as of date. The key here is that the user of the financial statements should be in a position to take independent decision after reading the financial statements. This decision can be different for different users – for an investor the decision whether to hold the shares of the enterprise will stem from the set of statements, for a senior employee of the company it can be the future growth prospects of the company etc. But what is important is that the users should be empowered to make decisions through the financial statements 3. Understandability: For the user to make sense, the financial statements should be readable and content lucid to digest. Even a layman should be able to read the same, and understand the basic information, if not the accounting policies and procedures. 4. Consistency: The users of the financial statements will be benefitted only if the statements are released in periodic intervals and in standard formats. Else, the entire purpose of furnishing financials will be defeated. That’s the reason that laws are prescribed for presentation formats and periodicity. 5. Regulatory Compliance: Needless to say, the tax authorities, market regulators etc rely hugely on financial statements to understand and gauge the compliances met by the enterprise. 6. Universality: Last but not the least; the financial statements should be comparable both within the industry and outside. So financial statements by two different companies should look in similar lines if both are engaged in, say, manufacturing steel. Likewise, the financials of a company manufacturing steel in India should be comparable to the set of financial statements of a company based out of US engaged in the similar line of business. The need to have the above key characteristics have brought the accounting bodies world over to come together to have a set of common standards for better integration and harmonization of accounting principles and practices.

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FINANCIAL REPORTING True and fair view of the affairs of the enterprise Universality

Relevance Good Financial Statements Understand ability

Regulatory Compliance Consistency

4.

BEST PRACTICES - APPLICABLE TO ALL COMPANIES

Following are some of the practices, if followed by the preparers of the financial statements, it would lead to better presentation and disclosure and will also serve the meaningful purpose for various stakeholders in understanding the functioning, financial position and financial performance of the entity and in appropriate decision making: 1.

Compliance Financial reporting is a regulated activity and compliance with the requirements is a must. Comply with the standards and regulations but also ensure your financial statements are an effective part of your wider communication with your stakeholders. It should be simple and understandable without any change in the interpretation. Example : It would not be appropriate to term ‘other than temporary diminution’ as ‘permanent diminution’ in case of investments in line with the requirements of Accounting Standard (AS) 13, Accounting for Investments, Example : Usage of the term ‘remaining maturity’ instead of ‘original maturity’ while describing cash and cash equivalents.

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ANALYSIS OF FINANCIAL STATEMENTS 2.

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Complete The information disclosed in the financial statements should be complete and should not lead to any further cross questioning in the mind of the users. Ensure consistency of disclosures across the financial statements. Example : Where the accounting policy states that “Balances of debtors, creditors and loans and advances are subject to reconciliations and confirmations”. This indicates that these balances may or may not be appropriately stated as well as raising questions regarding the appropriateness of the audit process. Example : In one case, it was observed that there were loans given to a subsidiary company which was disclosed as a part of disclosures made in compliance with Clause 32 of the equity listing agreement. However, there was no disclosure of the same loans under related party disclosures.

3.

Simple and specific •

Draft your notes, accounting policies, commentary on more complex areas in simple and plain English. Ensuring that there are no vague or ambiguous notes. Example : The definition of a derivative and a hedged item and how the company uses such items: “A derivative is a type of financial instrument the company uses to manage risk. It is something that derives its value based on an underlying asset. It's generally in the form of a contract between two parties entered into for a fixed period. Underlying variables, such as exchange rates, will cause its value to change over time. A hedge is where the company uses a derivative to manage its underlying exposure. The company's main exposure is to fluctuation in foreign exchange risk. We manage this risk by hedging forex movements, in effecting the boundaries of exchange rate changes to manageable, affordable amounts.”

•

Make your policies clear and specific.

•

Ensure that there should not be any vague or ambiguous notes, with no further information or explanation which may lead to misinterpretation of information.

•

Reduce generic disclosures and focus on company specific disclosures that explain how the company applies the policies.

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FINANCIAL REPORTING Example : A note stated “Land not registered in the name of the company has been given for the use of group companies”. However, there are no disclosures regarding such lease elsewhere in the financial statements. This leads to ambiguity regarding whether the land has been capitalized in the books of account or not. A better disclosure would be to include this note in the note relating to fixed assets with an asterix against land and a note which states “Land includes area measuring XX acres, towards which the registration process is still in progress. This land has been given on lease to group companies.”

4.

Transparency In preparation of financial statements many a times certain assumptions, or other bases are taken. Disclose those assumptions and bases transparently, so that they users are not misled. Rather such transparency shall provide useful additional information and substantiate your decision/judgement.

5.

Materiality •

The lack of clarity in how to apply the concept of materiality is perceived to be one of the main drivers for overloaded financial statements. Make effective use of materiality to enhance the clarity and conciseness of your financial statements.

•

Information should only be disclosed if it is material. It is material if it could influence users’ decisions which are based on the financial statements.

•

Your materiality assessment is the ‘filter’ in deciding what information to disclose and what to omit.

•

Once you have determined which specific line items require disclosure, you should assess what to disclose about these items, including how much detail to provide and how best to organise the information. Example: Capital Commitments A company has committed to purchase several items of property, plant and equipment. Individually each purchase is immaterial. However, the total amounts to a material commitment for the company and therefore some disclosure should be made regarding this commitment. Example : New Revenue Stream A company in the software sector has communicated to its stakeholders a strategic intention to focus its new development efforts in cloud-based solutions. In a particular financial year cloud-based revenues are less than 5% of the total but have grown rapidly. The company therefore decides to provide separate disclosure about this revenue

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ANALYSIS OF FINANCIAL STATEMENTS

18.9

stream in accordance with Ind AS 108 ‘Operating Segments’ even though other revenue streams of similar size are typically combined into ‘other revenue.’ 6.

Integration of Notes •

Notes cover the largest portion of the financial statements. They are an effective tool of communication and have the greatest impact on the effectiveness of your financial statements.

•

Group notes into categories, place the most critical information more prominently or a combination of both.

•

Integrate your main note of a line item with its accounting policy and any relevant key estimates and judgements. Example: Inventories 1.

Accounting Policy

Inventories are stated at the lower of cost and net realisable value. Cost includes all expenses directly attributable to the manufacturing process as well as suitable portions of related production overheads, based on normal operating capacity. Costs of ordinarily interchangeable items are assigned using the first in, first out cost formula. Net realisable value is the estimated selling price in the ordinary course of business less any applicable selling expenses. 2.

Significant Estimation of Uncertainty

Management estimates the net realisable values of inventories, taking into account the most reliable evidence available at each reporting date. The future realisation of these inventories may be affected by future technology or other market-driven changes that may reduce future selling prices. 3.

Inventories consist of the following:

(` in crores)

31 March 20X2 Raw materials and consumables Merchandise

•

31 March 20X1

7,000

6,000

11,000

9,000

18,000

15,000

Ensuring that the accounting policies are disclosed in one place and not scattered across various notes. For example, in one case it was observed that the policy of recognizing 100% depreciation on assets costing less than ` 5,000 was specified in the note on fixed assets, rather than in the accounting policy for fixed assets.

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18.10 7.

FINANCIAL REPORTING

Disclosure of Significant Accounting Policies •

The financial statements should disclose your significant accounting policies. Disclose only your significant accounting policies – remove your non-significant disclosures that do not add any value.

•

Your disclosures should be relevant, specific to your company and explain how you apply your policies.

•

The aim of accounting policy disclosures is to help your investors and other stakehold ers to properly understand your financial statements.

•

Use judgement to determine whether your accounting policies are significant, considering not only the materiality of the balances or transactions affected by the policy but also other factors including the nature of the company’s operations.

Example: Taxable temporary differences arise on certain brands and licenses that were acquired in past business combinations. Management considers that these assets have an indefinite life and are expected to be consumed by use in the business. For these assets de ferred tax is recognised using the capital gains tax applicable on sale. 8.

9.

Disclosures of Key Estimates and Judgements •

Effective disclosures about the most important estimates and judgements enable investors to understand your financial statements.

•

Focus on the most difficult, subjective and complex estimates.

•

Include details of how the estimate was derived, key assumptions involved, the process for reviewing and an analysis of its sensitiveness.

•

Provide sufficient background information on the judgement, explain how the judgement was made and the conclusion reached.

Integrated Approach •

Financial statements are just one part of your communication with the stakeholders. An annual report typically includes financial statements, a management commentary and information about governance, strategy and business developments , CSR Reporting, Business Responsibility Reporting etc. There is also a growing trend towards integrated reporting.

•

To ensure overall effective communication consider the annual report as a whole and deliver a consistent and coherent message throughout.

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ANALYSIS OF FINANCIAL STATEMENTS

18.11

•

Ind AS 1 also acknowledges that one may present, outside the financial statements, a financial review that describes and explains the main features of the company’s financial performance and financial position, and the principal uncertainties it faces.

•

Many companies also present, outside the financial statements, reports and statements such as environmental reports and value added statements, particularly in industries in which environmental factors are significant and when employees are regarded as an important user group.

•

Even though the reports and statements presented outside financial statements are outside the scope of AS / Ind AS, they are not out of the scope of regulation. Example : CSR disclosures, as required by the Companies Act, 2013. in section 134 and Schedule VII.

5.

COMMON DEFECTS IN FINANCIAL STATEMENTS OF CORPORATE ENTITIES

5.1 General Observations on Schedule III Disclosure S. No.

Title

Observation on the basis of the review of some published financial statements

Points to remember

1.

Cross references

Many a times cross references to the notes to accounts are not given which makes it difficult to understand whether the related disclosure are made. Schedule III permits giving the additional information, if any, in notes to the accounts with proper linking.

Against each item, give the appropriate cross reference to the respective note in the financial statements, if any

2.

Corresponding amounts for immediately preceding reporting period

At times, the amounts for the previous reporting period are not presented, particularly in footnotes / notes to accounts, which is not in compliance with the requirements of Schedule III

Instruction 5 in the ‘general instructions for preparation of balance sheet and Statement of Profit and Loss of a company’ in Schedule III, states ‘Except in the case of the first Financial Statements laid before the company (after its incorporation) the corresponding amounts (comparatives) for the immediately preceding reporting

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18.12

FINANCIAL REPORTING period for all items shown in the Financial Statements including notes shall also be given.’ For all the numbers disclosed in the financial statements including those in the notes, disclose the corresponding previous period numbers as well.

3.

Rounding off

• In some cases, it was

The specific rule for rounding off as per Schedule III based on ‘turnover’ is: • Less than ` 100 crore: to the nearest hundreds, thousands, lakhs or millions, or decimals thereof • ` 100 crore or more: to the nearest lakhs, millions or crores, or decimals thereof. Mention the rounding off convention adopted – at the beginning or on each page of the balance sheet, statement of profit and loss, cash flow statement and other notes (For example, ` in hundreds, `’000s, etc.). It could be placed at the top right hand corner of the page. Ensure consistency across the financial statements Where the numbers to be disclosed are smaller than the rounding off adopted by the company, the best practice may be to lower the level of rounding off to that of material items.

•

•

observed that the financial statements did not include any reference regarding ‘rounding off’ adopted by the company (For example, ` in ‘00s, ‘000s, etc.) • Further, in some cases, it was observed that different rounding off was adopted in different places (For example, the figures were rounded off to millions in balance sheet and statement of profit and loss, but there was no rounding off at all in the notes)

4.

Disclosure of accounting policies

•

At some places it has been observed that the accounting policies have been given but the relevant/related item is missing. The accounting policy should be drafted

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Avoid retention of accounting policies while the transactions to which they relate are no longer entered into by the company for a considerable number of years.

ANALYSIS OF FINANCIAL STATEMENTS considering the relevance of the terminology used in the accounting standard.

•

18.13

Compliance of the standards and other statutes shall be made without any misinterpretation.

5.2 Observations on Disclosure of Balance Sheet Items S. No.

Title

Observation on the basis of the review of some published financial statements

Points to remember

1.

Shareholders’ Fund

a

Share application money received pending allotment / calls received in advance

It was observed that share application money received pending allotment was included in paid up capital disclosed on the face of the balance sheet. The note on share capital disclosed the share application money separately as being added to the share capital

Schedule III now has a specific requirement for disclosure of share application money pending allotment on the face of the balance sheet. It also additionally provides that application money received for allotment of securities and due for refund should be disclosed under ‘other current liabilities’.

b

Options outstanding

In a few cases, where the company had outstanding employee stock options, no disclosure was made regarding outstanding in the note on share capital.

The requirement of the Schedule III is to disclose: ‘shares reserved for issue under options and contracts / commitments for sale of shares / disinvestment, including the terms and amounts’ Where a company has options such as employee stock options or options under a shareholders’ agreement, disclose such options in the note relating to share capital.

2.

Reserves and Surplus

a

Movement reserves

in

It was observed, in some cases, that the balances for current and previous year were different for certain reserves, however movement of the reserves was not given

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The requirement of Schedule III is: ‘Additions and deductions since last balance sheet to be shown under each of the specified heads’ Adjustments in securities premium / other reserves

18.14

FINANCIAL REPORTING When there has been a change in the balance of any reserve as compared to the last year, disclose the movement in reserve

b

Adjustment in Securities premium or other reserves

3.

Long-term Borrowings Debentures: Terms redemption conversion

Where certain amounts were adjusted directly in securities premium or other reserves, it was observed that there was no reference to the treatment of tax impact on account of the same

In an announcement, titled ‘Tax effect of expenses/income adjusted directly against the reserves and/or Securities Premium Account’, the ICAI has recommended that ‘any expense charged directly to reserves and/or -Securities Premium Account should be net of tax benefits expected to arise from the admissibility of such expenses for tax purposes’. Similarly, any income credited directly to a reserve account or a similar account should be net of its tax effect.

It has been observed in a few cases that the disclosures are incomplete – either terms of redemption/ conversion or the dates of redemption / conversion were not disclosed in descending order

The requirement of Schedule III is ‘Bonds/Debentures (along with the rate of interest and particulars of redemption or conversion, as the case may be) shall be stated in descending order of maturity or conversion, starting from farthest redemption or conversion date, as the case may be’

Nature of security

In some cases, it was noted that the nature of security was not disclosed for all loans, particularly where there were a large number of loans from various sources or were disclosed as an aggregated disclosure

Schedule III requires specific disclosure of the nature of security separately in each case

Interest accrued and due

It was observed in some cases, that no distinction was made between interest accrued and due and interest accrued but not due, which is

With respect to interest, Schedule III requires to disclose two sub heads under ‘other current liabilities’ viz: i. Interest accrued and due on borrowings and

of /

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ANALYSIS OF FINANCIAL STATEMENTS necessary in order to ensure appropriate disclosure under current liabilities 4.

18.15

ii. Interest accrued but not due on borrowings. Also the nature of security should be disclosed in case of each loan from every source

Tax related Assets / Liabilities: Presentation Presenting advance for tax and provision for tax

In many cases, it was observed that advance taxes were presented under the head ‘loans and advances’ and provision for tax under the head ‘provisions’ without offsetting the two amounts

AS 22 has a specific requirement with respect to offsetting. As per para 27, an enterprise should offset assets and liabilities representing current tax if the enterprise: (a) has a legally enforceable right to set off the recognised amounts; and (b) intends to settle the asset and the liability on a net basis. • Where the enterprise can infact fulfill the criteria set out in paragraph 27 of AS 22, disclose the advance tax / provision for tax on a net basis. • Do remember to mention the adjusted amount as well. For example (without the corresponding previous period figures): Where advance tax is greater than provision for tax: Loans and Advances Advance tax (net of provision for tax: ` XX) OR Where provision for tax is greater than for advance tax: Provisions Provision for taxes (net of advance tax: ` XX)

Presentation of deferred tax liability / asset in the balance sheet

•

In some cases, it was observed that deferred tax liability and deferred tax asset were shown

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(in `) XXX

(in `) XXX

AS 22 has a specific requirement with respect to offsetting. As per paragraph 29 of AS 22, an enterprise should offset deferred tax assets and deferred tax liabilities if:

18.16

FINANCIAL REPORTING

•

5.

separately in the standalone financial statements of a company located in India with no branches outside India. In certain other cases, it was observed that deferred tax liability and deferred tax asset were presented on a net basis, despite the company being subject to taxes under various jurisdictions.

(a) the enterprise has a legally enforceable right to set off assets against liabilities representing current tax; and (b) the deferred tax assets and the deferred tax liabilities relate to taxes on income levied by the same governing taxation laws. Where the conditions of paragraph 29 of AS 22 are fulfilled, deferred tax asset and deferred tax liability should be offset and disclosed net in the financial statements to the extent they are in the same jurisdiction.

Tax related Assets / Liabilities: Other Disclosures Break-up components

Convincing evidence

of

It was noticed in some cases that although the total deferred tax asset / liability was disclosed, the break-up into the various components was not disclosed and the amount involved was material.

Paragraph 31 of AS 22 states ‘The break-up of deferred tax assets and deferred tax liabilities into major components of the respective balances should be disclosed in the notes to accounts.’ Ensure that the components of deferred tax asset / liability are disclosed separately

In certain cases, it was observed that the notes to accounts included a note that deferred tax assets have been recognized on unabsorbed depreciation / carried forward business losses using the principle of virtual certainty. However, no disclosures were made as to what is the convincing evidence supporting the virtual certainty test as required by AS 22

Paragraph 32 of AS 22 has a specific disclosure requirement relating to convincing evidence which reads as follows: ‘The nature of the evidence supporting the recognition of deferred tax assets should be disclosed, if an enterprise has unabsorbed depreciation or carry forward of losses under tax laws’

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ANALYSIS OF FINANCIAL STATEMENTS 6.

7.

18.17

Property, Plant and Equipment Tangible and intangible assets

In certain cases, it was observed that there was no distinction made between tangible and intangible assets in the note. Further, there was no bifurcation of intangible assets into acquired intangible assets and internally generated intangible assets.

The requirement of Schedule III is to disclose tangible assets and intangible asset separately. The financial statements should disclose the following for each class of intangible assets, distinguishing between internally generated intangible assets and other intangible assets: (a) the useful lives or the amortisation rates used; (b) the amortization methods used…….

Impairment

In certain instances, it was noticed, that the column of depreciation was presented as ‘depreciation / impairment’ implying that the figures disclosed in that column are an aggregation of both depreciation and impairment loss.

AS 28 requires disclosures of information as required under paragraph 117 to be made for each ‘class of assets’. Impairment loss should be presented separately in Fixed Assets Schedule as per requirement of AS 28.

Property, Plant and Equipment: Accounting Policies Leasehold assets

In certain cases, it was observed that there was no amortization recognized with respect to leasehold assets

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An asset acquired on lease indicates a finite useful life of the asset. Accordingly, there should be an amortization charge pertaining to such leased asset over the period of the lease. The amortization policy used for leasehold assets should be disclosed.

18.18

8.

FINANCIAL REPORTING

Intangible assets – Useful life beyond ten years

In certain cases, it was observed, that there was no explanation regarding the rationale behind amortising a specific intangible asset beyond the rebuttable assumption of ten years as required by AS 26.

If an intangible asset is amortised over more than ten years, the reasons why it is presumed that the useful life of an intangible asset will exceed ten years from the date when the asset is available for use shall be disclosed. In giving these reasons, the enterprise should describe the factor(s) that played a significant role in determining the useful life of the asset.

Intangible assets – Assets with indefinite life

In certain cases, it was noticed, that the entities disclosed certain intangible assets – particularly, right of use, as perpetual assets with no amortisation being provided on the same.

AS 26 provides that amortisation is to be provided based on ‘best estimate of useful life’. The Standard also prescribes a rebuttable presumption that useful life of an intangible asset will not exceed ten years.

Borrowing costs

In certain cases, it was observed that the accounting policy with respect to borrowing costs, specified that borrowing costs attributable to qualifying assets were capitalized up to the date of ‘commissioning’ of the assets.

The requirement of AS 16 is to ensure that borrowing costs are capitalized only till the time substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. Consequently, the reference to ‘commissioning’ of assets may not be an appropriate.

Property, Plant and Equipment: Disclosures Discount rate used in computing value in use

In a few cases, where the company had recognized impairment loss and had computed value in use, the disclosure made with regard to discount rate was “….based on an appropriate discounting factor” rather than specifically stating the discount rate used.

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AS 28 requires the disclosure of discount rate used for computing value in use.

ANALYSIS OF FINANCIAL STATEMENTS 9.

Capital Work in Progress Components of In some cases, the entity Capital Work in had not disclosed the components of capital Progress work in progress. Presentation of Capital Advances

10.

11.

18.19

As a best practice, the components of capital work in progress should be disclosed especially in case of significant capitalisation projects.

In few cases, capital Schedule III requires capital advances were disclosed advances to be disclosed under as part of capital work-in- ‘Long-term loans and advances’ progress.

Investments: Presentation Categorization of In certain cases, it was observed that in the note investments on investments: • In case of few noncorporate entities, the investments were not classified as current or long term. • Also segregation between quoted and unquoted investments was not made. Diminution in the In some cases, it was value of observed that the provision for diminution in investment the value of investments was disclosed under the sub-head ‘provisions’ rather than reducing the same from the carrying value of investments. Current Assets - Inventories Valuation of It has been observed, in some inventories cases, that the accounting policy relating to valuation of inventories specified that certain categories of inventories, usually raw materials stores and spares or work in progress, were valued only at cost with no reference to net realizable value.

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As per AS 13, an enterprise should disclose current investments and long-term investments distinctly in its financial statements AS 13 requires to disclose, ‘the aggregate amount of quoted and unquoted investments, giving the aggregate market value of quoted investments’. Also, Schedule III requires classification of investments as ‘trade’ and ‘other investments’. As per AS 13, when there is a decline, other than temporary, in the value of a long term investment, the carrying amount is reduced to recognise the decline.

With regard to measurement, AS 2 requires that Inventories should be valued at the lower of cost and net realisable value.

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FINANCIAL REPORTING

Cost formula

12.

AS 2 specifically requires disclosure of the accounting policies adopted in measuring inventories, including the cost formula used. The cost formula used should be included in the accounting policy of inventories (For example, FIFO, weighted average method, specific identification, etc.)

Cash and Bank Balances Overdrafts

13.

It was observed that most companies did not disclose the cost formula as required by AS 2

It was observed in some cases that the bank overdrafts were disclosed as a reduction from fixed deposits or from balances with banks rather than disclosing them separately under current liabilities.

An overdraft is not ordinarily offset with the bank balance, unless there is a legal right with the company to do so.

Loans and Advances Distinction between considered good and considered doubtful

In some cases, it was noticed that short term loans and advances were not bifurcated based on whether they are considered good or considered doubtful

Schedule III requires the following disclosures relating to short term loans and advances as: • Secured, considered good • Unsecured, considered good • Doubtful Allowance for bad and doubtful loans and advances shall be disclosed under the relevant heads separately.

5.3 Observations on Disclosure of Statement of Profit and Loss Items S. No.

Title

1.

Revenue Recognition: Presentation Income disclosed net of expenses

Observation on the basis of the review of some published financial statements It was noticed in some cases that the revenue from sale of goods was disclosed net of the related expenses. For

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Points to remember

The definition of ‘revenue’ as per AS 9 as stated above refers to ‘gross inflows’ Revenue should be disclosed

ANALYSIS OF FINANCIAL STATEMENTS

Gain/loss from foreign currency transactions

2.

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example, in one case, sale of goods was disclosed after reducing expenses relating to ocean freight.

as the gross inflows rather than reducing related expenses such as ocean freight, etc. from such gross inflows

It was noticed in some cases that the revenue included gain/loss from foreign currency transactions.

Schedule III specifically requires net gain or loss on foreign currency transaction and translation to be disclosed as additional information (other than that disclosed as finance cost) and not under revenue.

Revenue Recognition: Accounting Policies Extent of risks and rewards transfer

It has been observed that the terminology used in the accounting policy for revenue recognition with respect to transfer of risks and rewards is not in line with that of AS 9. For example - the accounting policies state that the revenue is recognized on transfer of ‘sufficient’ or ‘substantial’ risks and rewards.

Paragraph 11 of AS 9 inter alia states all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of the goods transferred to a degree usually associated with ownership.

Extent of crystallizing the timing of revenue recognition and transfer of risks and rewards

It has been observed that the accounting policy with respect to timing of revenue recognition is inadequate as it does not mention either the manner in which the transfer of significant risks and rewards occurs or it mentions a particular event but does not mention whether the occurrence of that event indicates a transfer of the significant risks and rewards. A few examples include:

As required by AS 9, the requirement is to make an assessment of whether ‘significant’ risks and rewards have been transferred. The accounting policy of the company needs to elaborate on this assessment and specify that the occurrence of the specific event indicates that significant risks and rewards have been transferred and hence revenue is recognized on occurrence of such event. Few examples could be:

•

Revenue is recognized on transfer of goods to customers

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•

Revenue is recognised at

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FINANCIAL REPORTING

Service revenue – Method of accounting

3.

•

Revenue is recognized on dispatch of goods

•

Revenue from resale of software is recognized on delivery of products

•

Sale is recognized on completion of sale of goods

the time of transfer of significant risks and rewards which occurs at the time of dispatch of goods in the instant case.

•

Revenue from resale of software is recognised at the time of transfer of significant risks and rewards which in the instant case occurs at the time of delivery of products.

The accounting policy in case of service revenue, in some cases, did not specify the method used for recognizing revenue – either proportionate completion method or completed service contract method

AS 9 provides for accounting for Service revenue either by the proportionate completion method or by the completed service contract method. In order to get an understanding of how revenue has been recognized, it would be appropriate to specify the method of revenue recognition used by the company. Example: Revenue from fixed price contracts is recognized as per the proportionate completion method with contract cost determining the degree of completion.

It was observed in a few cases, that subsidy received from Government of India was disclosed as ‘revenue’ instead of ‘other income’

Reference is made to the definition of revenue in AS 9, which inter alia states “Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from the use by others of enterprise resources yielding interest, royalties and

Government Grants Presentation subsidy

of

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ANALYSIS OF FINANCIAL STATEMENTS

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dividends. Since grants received from the government are not consideration towards sale of goods, rendering of services or use of the resources of the company, it would not be appropriate to classify the same as revenue. Rather such grants should be classified as ‘other income’.

4.

Nature of Government Grant

In certain cases, it was noticed that the accounting policy for government grants was generic without specifying the nature of the grants leading to ambiguity in terms of appropriateness of the accounting treatment. For example, a policy read as under: “Government grants are recognized in the profit and loss account in accordance with the related scheme and in the period in which these are accrued.”

The requirement of AS 12 is to account for grants based on their nature, viz., grants related to assets, grants related to revenue or grants in the nature of promoter’s contribution. Accordingly, both the nature of grant as well as the consequent accounting treatment will need to be provided in the accounting policy in order to give a complete understanding.

Specific assets

Where grants were received for specific assets, it was observed, that no disclosures were made regarding the amount of grant received, the manner of adjustments, etc.

Paragraph 23(ii) of AS 12 requires the disclosure of “the nature and extent of government grants recognized in the financial statements, including grants of non-monetary assets given at a concessional rate or free of cost”.

gains

In many cases, it was observed that there was no accounting policy disclosed regarding treatment of actuarial gains and losses.

Paragraph 120 (a) of AS 15 requires disclosure of accounting policy for recognizing actuarial gains and losses.

benefit –

In some cases, employee benefit in the nature of gratuity

Appropriate recognition and measurement of employee

Employee Benefits Actuarial and losses

Defined plans

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5.

FINANCIAL REPORTING

inappropriate classification

(which is in the nature of defined benefit plan) was classified as a ‘short term employee benefits’ with no explanation as to the reason for such classification.

benefits is dependent on the accurate classification of the employee benefit in accordance with the guidance in AS 15. Inappropriate classification of employee benefits could potentially lead to inappropriate recognition of expenses, related provision as well as incorrect disclosures. Reference should be made to the definitions of the various categories of employee benefits and each employee benefit needs to be carefully analyzed to identify appropriate classification.

Details of provisions for employee benefits

In a few cases, it was observed that the details of provisions recognized towards employee benefits such as liability towards earned leave, medical leave, post-retirement benefit plans, etc., were disclosed as a part of disclosures made for compliance with the requirements of AS 29.

Reference is made to paragraph 5 of AS 29, which inter alia states: “Where another Accounting Standard deals with a specific type of provision, contingent liability or contingent asset, an enterprise applies that Standard instead of this Standard.

Foreign Currency Transactions Monetary assets and liabilities

It was observed that the accounting policy in relation to foreign currency transactions stated that “current assets and current liabilities” denominated in foreign currencies as at the balance sheet date are translated at the rate of exchange prevailing at the year-end” rather than referring to “monetary assets and monetary liabilities”.

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The requirement of translation by AS 11 is with regard to monetary assets and liabilities and not with respect to current assets and current liabilities.

ANALYSIS OF FINANCIAL STATEMENTS 6.

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Prior Period Expenses and Change in Accounting Policy Prior expenses

period

In certain cases, where the profit and loss account included a prior period expense, it was observed that, there was no disclosure regarding the nature of expense either in the profit and loss account or in the notes to accounts.

In case of prior period expenses, as per para 15 of AS 5, "the nature and amount of prior period items should be separately disclosed in the statement of profit and loss in a manner that their impact on the current profit or loss can be perceived."

Change in accounting policy

In certain cases, it was observed that notes to the financial statements mentioned that a change in accounting policy e.g. change in valuation of plan assets from book value to fair value was made. However, there were no further disclosures regarding the impact of change.

In case of change in accounting policy, as per para 32 of AS 5, "Any change in an accounting policy which has a material effect should be disclosed. The impact of, and the adjustments resulting from, such change, if material, should be shown in the financial statements of the period in which such change is made, to reflect the effect of such change. Where the effect of such change is not ascertainable, wholly or in part, the fact should be indicated. If a change is made in the accounting policies which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted."

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FINANCIAL REPORTING

5.4 Observations on Other Components of Financial Statements S. No.

Title

Observation on the basis of the review of some published financial statements

1.

Cash Flow Statement

Points to remember

Components of cash and cash equivalents

Cash and cash equivalents, in a few cases, included deposits with maturity over twelve months. In other cases, it additionally included earmarked balances.

In explaining the definition of cash equivalents, paragraph 6 of AS 3 states: “Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent, it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value. Therefore, an investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition.” Consequently, where deposits with maturity over 12 months are included in cash equivalents, it would be appropriate to explain why these were considered as cash equivalents.

Non-cash adjustments

In certain cases, it was noted that export incentives accrued were disclosed as a non-cash adjustment in arriving at the operating profit before working capital changes. In another case, it was observed that foreign currency translation reserve, which is clearly a non-cash transaction, was disclosed under investing activities.

The requirement of AS 3 with regard to non-cash adjustments is prescribed in para 20, which states: “Under the indirect method, the net cash flow from operating activities is determined by adjusting net profit or loss for the effects of: (a) changes during the period in inventories and operating receivables and payables; (b) non-cash items such as depreciation, provisions, deferred taxes, and unrealised foreign

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exchange gains and losses; and (c) all other items for which the cash effects are investing or financing cash flows”. Export incentives are cash transactions, as cash will be received in future and accordingly, it would have to be disclosed as a change in operating receivable rather than as a non-cash transaction. Also non cash transactions should not be disclosed under investing and financing activities in Cash Flow Statement. Dividend distribution tax

In certain cases, it was observed that, there was no specific mention of dividend distribution tax although the cash flows from financing activities included dividend paid.

Dividends paid are to be disclosed as cash flows from financing activities. It follows that tax on dividend should also be disclosed along with the dividends paid.

Reporting cash flows on a net basis

It was observed that in several cases, proceeds and repayment of term loans, etc. were disclosed on a net basis in the cash flow statement. Similarly, in certain cases, purchase / sale of investments in subsidiaries were disclosed on a net basis.

AS 3 has specific conditions to be fulfilled in order to report cash flows on a net basis which have been specified in paragraph 22 as: “Cash flows arising from the following operating, investing or financing activities may be reported on a net basis: (a) cash receipts and payments on behalf of customers when the cash flows reflect the activities of the customer rather than those of the enterprise; and (b) cash receipts and payments for items in which the turnover is quick, the amounts are large, and the maturities are short”. Unless the above conditions are fulfilled, ensure that disclosures are made on a gross basis rather than net basis.

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FINANCIAL REPORTING

Segment Reporting Segment disclosures made in consolidated financial statements

Where companies opted to present segment disclosures only in the consolidated financial statements, it was observed that no reference to this fact was made in the standalone financial statements.

While para 4 of AS 17, allows enterprises to present segment disclosures only in consolidated financial statements, it would be appropriate to disclose the fact in the standalone financial statements that the disclosures are being made, in the consolidated financial statements where both, stand alone and consolidated financial statements are part of a single financial report.

5.5 Observations on Disclosure of Other Items of Financial Statements S. No.

Title

Observation on the basis of the review of some published financial statements

1.

Related Party Disclosures

Points to remember

Disclosures relating to key managerial personnel

It was observed in a few cases, that the volume of transaction (either as amount or as a proportion) was not made. This was particularly in case of key managerial personnel, where the disclosure of remuneration / dividend paid to them was either not made in entirety or where made, it was done as a single aggregate amount of remuneration / dividend.

Reference is drawn to the requirement of para 23 of AS 18 (iii) and (iv) which requires disclosure of the following: “(iii) a description of the nature of transactions; (iv) volume of the transactions either as an amount or as an appropriate proportion” Further, where disclosure is made on the basis of aggregation of similar transactions, cognizance needs to be given to the requirements of para 27 including the explanation thereto.

Disclosure of non-executive directors as key managerial personnel

It was observed in a few cases, that non-executive directors were being considered as key managerial personnel and disclosed accordingly.

Owing to the explanation to para 14 of AS 18, non- executive directors are not generally considered as key managerial personnel. “A non-executive director of a company is not considered as a key management person under this Standard by virtue of merely his being a director unless he has

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ANALYSIS OF FINANCIAL STATEMENTS

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the authority and responsibility for planning, directing and controlling the activities of the reporting enterprise. The requirements of this Standard are not applied in respect of a non-executive director even enterprise, unless he falls in any of the categories in para 3 of this Standard.” Accordingly, in cases where nonexecutive directors are considered as key management personnel and disclosed as such, the fact that they have the authority and responsibility for planning, directing and controlling the activities of the reporting enterprise should be disclosed. 2.

Leases Amortization of operating leases

In a few cases, it was observed that the accounting policy with respect to operating leases stated that the operating lease obligations were ‘amortised as per the terms of the lease’.

The accounting treatment specified in case of operating leases in the books of the lessee in para 23 of AS 19 is as follows: “Lease payments under an operating lease should be recognised as an expense in the statement of profit and loss on a straight line basis over the lease term unless another systematic basis is more representative of the time pattern of the user’s benefit.” Consequently, the accounting policy needs to refer to ‘straight line basis’, else if some other basis is being used by the company, such basis and the reason for using such basis needs to be elaborated in the accounting policy.

Operating leases: Disclosures

In a few cases, it was observed that the company had operating leases, as disclosed in the accounting policies and statement of profit and loss. However, there were no disclosures made in accordance with AS 19 with respect to the future minimum lease

Compliance with the following disclosure requirements of AS 19 needs to be ensured in case of operating leases: “25. The lessee should make the following disclosures for operating leases: (a) the total of future minimum lease payments under non- cancellable operating leases for each of the following periods:

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FINANCIAL REPORTING

Cancelable operating leases in the books of the lessee

3.

payments.

(i) not later than one year; (ii) later than one year and not later than five years; (iii) later than five years;…….”

In some cases, where the company had specifically mentioned that the operating leases were cancelable leases, it was observed that, there were no further disclosures as required by AS 19.

While certain disclosure requirements under para 25 of AS 19 are specifically mandated for non-cancelable leases, certain disclosures are mandated without any distinction between cancelable or non-cancelable leases, which include: ‘……(c) lease payments recognised in the statement of profit and loss for the period, with separate amounts for minimum lease payments and contingent rents; (d) sub-lease payments received (or receivable) recognised in the statement of profit and loss for the period; (e) a general description of the lessee’s significant leasing arrangements including, but not limited to, the following: ……’ Accordingly, for cancelable operating leases also, disclosure of the amounts recognized in the profit and loss account and a general description of the leasing arrangements is required as per AS 19.

Earnings per Share Nominal Value shares

of

•

In several instances, it was observed that the nominal value of the shares was not disclosed along with the basic and diluted earnings per share on the face of the statement of profit and loss, although the same was mentioned in the relevant note on earnings per share in the notes to the financial statements. • In certain cases, it was observed that, the

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The requirement of para 48 of AS 20 is to disclose the nominal value of shares along with the earnings per share figures. As per para 8 of AS 20, an enterprise should present basic and diluted earnings per share on the face of the statement of profit and loss for each class of equity shares that has a different right to share in the net profit for the period. In order to appreciate the earnings per share figure, it is also essential to know what the nominal value of the shares are, and hence it is necessary to disclose the nominal value of the share along with the

ANALYSIS OF FINANCIAL STATEMENTS

Weighted average number shares

of

Dividend on cumulative preference shares

18.31

nominal value of shares was not disclosed either on the face of the statement of profit and loss or in the relevant note.

basic and diluted earnings per share disclosures on the face of the profit and loss account.

In certain cases, it was observed that the disclosure of reconciliation of number of weighted average number of equity shares used as denominator in calculating the basic and diluted earnings per share was not made.

The specific requirement of para 48(ii)(b) of AS 20 is to state that the weighted average number of equity shares used as the denominator in calculating basic and diluted earnings per share, and a reconciliation of these denominators to each other.

In certain cases, it was observed that the dividend on cumulative preference shares was not adjusted while determining earnings for the period.

Para 13 of AS 20 specifically requires that the full amount of the required preference dividends for cumulative preference shares should be deducted from the net profit for the period, whether or not the dividends have been provided for. Where the company has cumulative preference shares, adjustment of dividend on such preference shares should be ensured while determining earnings for the period.

5.6 Observations on Consolidated Financial Statements S. No.

1.

Title

Observation on the basis of the review of some published financial statements

Points to remember

General Disclosures made in standalone financial statements, but no corresponding disclosures in consolidated financial statements

In some cases, it was observed that for certain items there were no disclosures made in the consolidated financial statements while the disclosures were made in the standalone financial statements.

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Compliance with the requirements of Accounting Standards (including disclosure requirements) should be ensured for all items in the consolidated financial statements.

18.32

FINANCIAL REPORTING For example, while the disclosures relating to employee benefits were made as per AS 15 in the standalone financial statements, there were no corresponding disclosures in the consolidated financial statements. Similarly, in some cases, there were no accounting policies specified in the consolidated financial statements, with only a reference to the accounting policies included in the standalone financial statements.

Presentation goodwill

of

In certain cases, it was observed that goodwill and capital reserve arising on separate acquisitions were disclosed net.

Companies should not net off the goodwill and capital reserve arising on separate acquisitions but disclose goodwill and capital reserve arising on all acquisitions separately as a note in the financial statements.

Presentation of deferred tax liability / asset in the balance sheet

In some cases, it was observed that deferred tax liability/deferred tax asset were presented net in the consolidated financial statements of a company.

AS 22 has a specific requirement with respect to offsetting. As per para 29 of AS 22, ‘An enterprise should offset deferred tax assets and deferred tax liabilities if: (a) the enterprise has a legally enforceable right to set off assets against liabilities representing current tax; and (b) the deferred tax assets and the deferred tax liabilities relate to taxes on income levied by the same governing taxation laws.’ Consequently, in case of consolidated financial statements, it would be appropriate to offset the deferred

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ANALYSIS OF FINANCIAL STATEMENTS

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tax assets and deferred tax liabilities of the parent and the subsidiaries, only in cases where the abovementioned conditions are satisfied. Different accounting policies

In certain cases, it was observed that the actuarial gains/ losses in respect of employee benefits relating to the subsidiary/(ies) of the parent, were recognised directly in the reserves and were not recognised in the statement of profit and loss in line with the requirements of AS 15.

Reference is drawn to para 3 of AS 21, which states: “In the preparation of consolidated financial statements, other Accounting Standards also apply in the same manner as they apply to the separate statements.” Consequently, the accounting policy pertaining to recognition of actuarial gain/loss should be aligned across the group and recognised in the statement of profit and loss as mandated under AS 15.

Intragroup transactions

In certain infrastructure entities, it was observed that Build-OperateTransfer (BOT) contracts were entered into by one of the group companies (holding company or fellow subsidiary) and the contract was further subcontracted to other entities within the group. The profits / losses on such subcontracted work within the group were considered as ‘realised’ and were not eliminated in accordance with AS 21.

Reference is drawn to para 16 of AS 21 which states: “Intragroup balances and intragroup transactions and resulting unrealized profits should be eliminated in full. Unrealised losses resulting from intragroup transactions should also be eliminated unless cost cannot be recovered.” Consequently, it needs to be ensured that the accounting policies and disclosures made by companies are in accordance with the consolidation procedures specified in AS 21.

Consolidation disclosure

In some cases, where subsidiaries had not been consolidated, the reason for the same was stated as “on account of impairment of the investment”.

Para 9 of AS 21 requires a parent which presents consolidated financial statements should consolidate all subsidiaries, domestic as well as foreign, other than those referred to in para 11. Further para 11 provides that a subsidiary should be excluded

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FINANCIAL REPORTING from consolidation when (a) control is intended to be temporary because the subsidiary is acquired and held exclusively with a view to its subsequent disposal in the near future; or (b) it operates under severe long- term restrictions which significantly impair its ability to transfer funds to the parent. Accordingly, ensure that all the subsidiaries are consolidated in accordance with the above requirements of AS 21.

Goodwill / Capital reserve

2.

While the accounting policy had disclosed that the goodwill /capital reserve arising on acquisition of an associate is adjusted in the carrying amount of the investment, there was no separate disclosure of the amount of goodwill / capital reserve

Para 12 of AS 23 states, that “Goodwill / capital reserve arising on the acquisition of an associate by an investor should be included in the carrying amount of investment in the associate but should be disclosed separately” Non-disclosure of goodwill / capital reserve separately does not convey the status of the investment appropriately

In most cases, it was observed that while detailed disclosures were given in the consolidated financial statements with regard to jointly controlled entities, such disclosure were not made in the standalone financial statements

It needs to be noted that as per para 49 of AS 27, a venture should disclose the information required by paras 50, 51 and 52 in both the standalone and consolidated financial statements

In disclosing the information as per para 52 of AS 27, in a number of cases, it was observed that, the country of incorporation or residence was not disclosed

Para 52 states “A venture should disclose a list of all joint ventures and description of interests in significant joint ventures. In respect of jointly controlled entities, the venture should also disclose the proportion of

Joint Ventures Jointly Controlled Entities: Disclosures in separate financial statements

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ANALYSIS OF FINANCIAL STATEMENTS

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ownership interest, name and country of incorporation or residence”. Jointly Controlled Entities: Proportionate Consolidation in consolidated financial statements

Separate financial statements included disclosure of investments in joint venture entities. However, in the consolidated financial statements, there was no reference either in the accounting policy relating to consolidation procedures or disclosures as share of joint ventures in the respective account heads in the balance sheet and statement of profit and loss. In a few instances, it was noted that while the fact that a jointly controlled entity existed was disclosed, there was no separate disclosure regarding the share of assets, liabilities, expenses and income of the joint venture as required to be done by AS 27

Para 28 of AS 27 requires a venturer to report its interest in jointly controlled entity using proportionate consolidation with only two specific exemptions. Consequently, where the investment in the jointly controlled entity does not satisfy the two conditions, it should be accounted for on proportionate consolidation basis

Para 32 of AS 27, specifically requires the share in joint venture to be disclosed separately with each line item: ‘Under proportionate consolidation, the venturer includes separate line items for its share of the assets, liabilities, income and expenses of the jointly controlled entity in its consolidated financial statements. For example, it shows its share of the inventory of the jointly controlled entity separately as part of the inventory of the consolidated group; it shows its share of the fixed assets of the jointly controlled entity separately as part of the same items of the consolidated group.’ From the above illustrative common defects, one can infer that many of the defects in the financial statements are either on account of non-compliance of Schedule III or Standards. In preparation of a good financial statements it is very important that it should reflect true and fair view of the company’s business, which is possible only when the preparer complies with the relevant applicable provisions given in the Statute or in the Standard in true sense. Correctness of the

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FINANCIAL REPORTING

financial statements is utmost important. Let us examine some of the concepts of the standards which affect the presentation of financial statements.

6.

ILLUSTRATIONS BASED ON ACCOUNTING STANDARDS

Illustration 1 C Ltd. is a group engaged in manufacture and sale of industrial and FMCG products. One of their division also deals in Leasing of properties - Mobile Towers. The accountant showed the rent arising from the leasing of such properties as other income in th e Statement of Profit and Loss. Comment whether the classification of the rent income made by the accountant is correct or not in the light of Schedule III to the Companies Act, 2013. Solution As per the “General Instructions for preparation of Statement of Profit and Loss” given in Schedule III to the Companies Act, 2013, “Other Income” does not include operating income. The term “Revenue from operations” has not been defined under Schedule III to the Companies Act, 2013. However, as per the Guidance Note on Schedule III to the Companies Act, 2013 this would include revenue arising from a company’s operating activities, i.e., either its principal or ancillary revenue generating activities. Whether a particular income constitutes “Revenue from operations” or “Other income” is to be decided based on the facts of each case and detailed understanding of the company’s activities. The classification of income would also depend on the purpose for whi ch the particular asset is acquired or held. As per the information given in the question, C Ltd. is a group engaged in manufacture and sale of industrial and FMCG products and its one of the division deals in leasing of properties - Mobile Towers. Since its one division is continuously engaged in leasing of properties, it shall be considered as its principal or ancillary revenue-generating activities. Therefore, the rent arising from such leasing shall be shown under the head “Revenue from operations” a nd not as “other income”. Hence, the presentation of rent arising from the leasing of such properties as “other income” in the Statement of Profit and Loss is not correct. It should be shown under the head “Revenue from operations”. ***** Illustration 2 A private limited company manufacturing fancy terry towels had valued its closing inventory of inventories of finished goods at the realisable value, inclusive of profit and the export cash incentives. Firm contracts had been received and goods were packed for export, but the ownership in these goods had not been transferred to the foreign buyers. Comment on the valuation of the inventories by the company.

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ANALYSIS OF FINANCIAL STATEMENTS

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Solution Accounting Standard 2 “Valuation of Inventories” states that inventories should be valued at lower of historical cost and net realizable value. AS 9 on “Revenue Recognition” states, “at certain stages in specific industries, such as when agricultural crops have been harvested or mineral ores have been extracted, performance may be substantially complete prior to the execution of the transaction generating revenue. In such cases, when sale is assured under forward contract or a government guarantee or when market exists and there is a negligible risk of failure to sell, the goods invoiced are often valued at net realisable value.” Terry Towels do not fall in the category of agricultural crops or mineral ores. Accordingly, taking into account the facts stated, the closing inventory of finished goods (Fancy terry towel) should have been valued at lower of cost and net realisable value and not at net realisable value. Further, export incentives are recorded only in the year the export sale takes place. Therefore, the policy adopted by the company for valuing its closing inventory o r inventories of finished goods is not correct. ***** Illustration 3 Night Ltd. sells beer to customers. Some of the customers consume the beer in the bars run by Night Limited. While leaving the bars, the consumers leave the empty bottles in the bars and the company takes possession of these empty bottles. The company has laid down a detailed internal record procedure for accounting for these empty bottles which are sold by the company by calling for tenders. The accountant of the company is of the view that these empty bottles are not an asset to the company and are scrap for the company. Analyse the contention of the accountant of the company. Solution (i)

Tangible objects or intangible rights carrying probable future benefits, owned by an enterprise are called assets. Night Ltd. sells these empty bottles by calling tenders. It means further benefits are accrued on its sale. Therefore, empty bottles are assets for the company.

(ii) As per AS 2 “Valuation of Inventories”, inventories are assets held for sale in the ordinary course of business. Inventory of empty bottles existing on the Balance Sheet date is the inventory and Night Ltd. has detailed controlled recording and accounting procedure which duly signify its materiality. Hence inventory of empty bottles cannot be considered as scrap and should be valued as inventory in accordance with AS 2. ***** Illustration 4 Omega Ltd. has to pay delayed cotton clearing charges over and above the negotiated price for taking delayed delivery of cotton from the Suppliers' godown. Up to 20X1-20X2, the company has regularly included such charges in the valuation of closing inventory. This being in the nature of

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FINANCIAL REPORTING

interest the company has decided to exclude it from closing inventory valuation for the year 20 X220X3. This would result into decrease in profit by ` 7.60 lakhs. Treatment to be done in the annual accounts of a company for the year ended 31st March, 20 X3 and appropriate disclosures to be made in this regards. Solution Para 29 of AS 5 (Revised) ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies” states that a change in an accounting policy should be made only if a. b. c.

It is required by statute, or for compliance with an accounting standard, or if it is considered that the change would result in a more appropriate presentation of the financial statements of an enterprise.

Therefore, the change in the method of inventory valuation is justified in view of the fact that the change is in line with the recommendations of AS 2 (Revised) ‘Valuation of Inventories’ and would result in more appropriate preparation of the financial statements. Disclosure: As per AS 2, this accounting policy adopted for valuation of inventories including the cost formulae used should be disclosed in the financial statements in Notes to Accounts. Also, appropriate disclosure of the change and the amount by which any item in the financial statements is affected by such change is necessary as per AS 1, AS 2 and AS 5. Therefore, the under mentioned note should be given in the annual accounts. "In compliance with the Accounting Standards, delayed cotton clearing charges which are in the nature of interest have been excluded from the valuation of closing inventory unlike preceding years. Had the company continued the accounting practice followed earlier, the value of closing inventory as well as profit before tax for the year would have been higher by ` 7.60 lakhs." ***** Illustration 5 During the course of the last three years, a company owning and operating He licopters lost four Helicopters. The company Accountant felt that after the crash, the maintenance provision created in respect of the respective helicopters was no longer required, and proposed to write back to the Profit and Loss account as a prior period item. Analyse the company’s proposed accounting treatment. Solution The balance amount of maintenance provision written back to profit and loss account, no longer required due to crash of the helicopters, is not a prior period item because there was no error in the preparation of previous periods’ financial statements. The term ‘prior period items’, as defined in AS 5 (revised) “Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting

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ANALYSIS OF FINANCIAL STATEMENTS

18.39

Policies”, refer only to income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods. As per paragraph 8 of AS 5, extraordinary items should be disclosed in the statement of profit and loss as a part of net profit or loss for the period. The nature and the amount of each extraordinary item should be separately disclosed in the statement of profit and loss in a manner that its impact on current profit or loss can be perceived. The amount so written-back (If material) should be disclosed as an extraordinary item as per AS 5. ***** Illustration 6 Sagar Limited belongs to the engineering industry. The Chief Accountant has prepared the draft accounts for the year ended 31.03.20X1. The company undertook a contract for building a crane for ` 10 lakhs. As on 31.03.20X1 it incurred a cost of ` 1.5 lakhs and expects that there will be ` 9 lakhs more for completing the crane. It has received so far ` 1 lakh as progress payment. Advise the company on the above from the viewpoint of finalization of accounts, taking note of the mandatory accounting standards. Solution Para 21 of AS 7 (Revised) ‘Construction Contracts’ provides that when the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract should be recognized as revenue and expenses respectively with reference to the stage of completion of the contract activity at the reporting date. Para 35 of AS 7 states that when it is probable that total contract cost will exceed total contract revenue, the expected losses should be recognized as an expense irrespective of: a.

Whether or not work has commenced

b.

Stage of completion of contract

c.

The amount of profit on other contracts which are not treated as a single contract

Thus, when Estimated Contract Costs > Total Contract Revenue Expected Loss = Work Certified + Work uncertified + Estimated cost to complete the project - Total value of contract Thus, in the given case, the foreseeable loss of ` 50,000 (expected cost ` 10.5 lakhs less contract revenue ` 10 lakhs) should be recognized as an expense in the year ended 31 st March, 20X1. The following disclosures should also be given in the financial statements: (a) the amount of contract revenue recognized as revenue in the period; (b) the aggregate amount of costs incurred and loss recognized upto the reporting date; (c) amount of advances received;

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FINANCIAL REPORTING

(d) amount of retentions; and (e) gross amount due from/due to customers’ amount  ***** Illustration 7 Mr. ‘X’ as a contractor has just entered into a contract with a local municipal body for building a flyover. As per the contract terms, ‘X’ will receive an additional ` 2 crore if the construction of the flyover were to be finished within a period of two years of the commencement of the contract. Mr. X wants to recognize this revenue since in the past he has been able to meet similar targ ets very easily. Discuss the correctness of the above proposal of Mr. X. Solution According to para 14 of AS 7 (Revised) ‘Construction Contracts’, incentive payments are additional amounts payable to the contractor if specified performance standards are met or exceeded. For example, a contract may allow for an incentive payment to the contractor for early completion of the contract. Incentive payments are included in contract revenue when: (i)

the contract is sufficiently advanced that it is probable that the specified performance standards will be met or exceeded; and

(ii) the amount of the incentive payment can be measured reliably. In the given problem, the contract has not even begun and hence the contractor (Mr. X) should not recognize any revenue of this contract. ***** Illustration 8 Victory Ltd. purchased goods on credit from Lucky Ltd. for ` 250 crores for export. The export order was cancelled. Victory Ltd. decided to sell the same goods in the local market with a price discount. Lucky Ltd. was requested to offer a price discount of 15%. The Chief Accountant of Lucky Ltd. adjusted the sales figure to the extent of the discount requested by Victory Ltd. Discuss whether this treatment is justified. Solution Lucky Ltd. had sold goods to Victory Ltd on credit worth for ` 250 crores and the sale was completed in all respects. Victory Ltd.’s decision to sell the same in the domestic market at a discount does not affect the amount recorded as sales by Lucky Ltd. The price discount of 15% offered by Lucky Ltd. after request of Victory Ltd. was not in the nature of a discount given during 

Amount due from/to customers = contract costs + Recognised profits – Recognised losses – Progress billings = ` 1.5 + Nil – ` 0.5 – ` 1.0 = Nil.

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ANALYSIS OF FINANCIAL STATEMENTS

18.41

the ordinary course of trade because otherwise the same would have been given at the time of sale itself. Now, as far Lucky Ltd is concerned, there appears to be an uncertainty relating to the collectability of the debt, which has arisen subsequent to the time of sale theref ore, it would be appropriate to make a separate provision to reflect the uncertainty relating to collectability rather than to adjust the amount of revenue originally recorded. Therefore, such discount should be written off to the profit and loss account and not shown as deduction from the sales figure. ***** Illustration 9 Golden Eagle Ltd., has been successful jewellers for the past 100 years and sales are against cash only. The company diversified into apparels. A young senior executive was put in charge of Apparels business and sales increased 5 times. One of the conditions for sales is that dealers can return the unsold stocks within one month of the end of season. Sales return for the year was 25% of sales. Suggest a suitable Revenue Recognition Policy, with reference to AS 9. Solution As per AS 9 “Revenue recognition”, revenue recognition is mainly concerned with the timing of recognition of revenue in statement of profit and loss of an enterprise. The amount of revenue arising on a transaction is usually determined by the agreement between the parties involved in the transaction. When uncertainties exist regarding the determination of the amount, or its associated costs, these uncertainties may influence the timing of revenue recognition. Effect of Uncertainty- In the case of the jewellery business the company is selling for cash and returns are negligible. Hence, revenue can be recognized on sales. On the other hand, in Apparels Industry, the dealers have a right to return the unsold goods within one month of the end of the season. In this case, the company is bearing the risk of sales return and therefore, the company should not recognize the revenue to the extent of 25% of its sales. The company may disclose suitable revenue recognition policy in its financial statements separately for both Jewellery and Apparels business. ***** Illustration 10 A company had imported raw materials worth US Dollars 6,00,000 on 5 th January, 20X1, when the exchange rate was ` 43 per US Dollar. The company had recorded the transaction in the books at the above mentioned rate. The payment for the import transaction was made on 5 th April, 20X1 when the exchange rate was ` 47 per US Dollar. However, on 31 st March, 20X1, the rate of exchange was ` 48 per US Dollar. The company passed an entry on 31st March, 20X1 adjusting the cost of raw materials consumed for the difference between ` 47 and ` 43 per US Dollar. In the background of the relevant accounting standard, discuss whether the correctness of the company’s accounting treatment.

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FINANCIAL REPORTING

Solution As per AS 11 (revised 2003), ‘The Effects of Changes in Foreign Exchange Rates’, monetary items denominated in a foreign currency should be reported using the closing rate at each balance sheet date. The effect of exchange difference should be taken into profit and loss account. Trade payables is a monetary item, hence should be valued at the closing rate i.e, ` 48 at 31st March, 20X1 irrespective of the payment for the same subsequently at lower rate in the next financial year. The difference of ` 5 (` 48-` 43) per US dollar should be shown as an exchange loss in the profit and loss account for the year ended 31 st March, 20X1 and is not to be adjusted against the cost of raw- materials. In the subsequent year, the company would record an exchange gain of ` 1 per US dollar, i.e., the difference between ` 48 and ` 47 per US dollar. Hence, the accounting treatment adopted by the company is incorrect. ***** Illustration 11 A company has a scheme for payment of settlement allowance to retiring employees. Under the scheme, retiring employees are entitled to reimbursement of certain travel expenses for class they are entitled to as per company rule and to a lump-sum payment to cover expenses on food and stay during the travel. Alternatively, employees can claim a lump sum amount equal to one month pay last drawn. The company’s contentions in this matter are: (i)

Settlement allowance does not depend upon the length of service of employee. It is restricted to employee’s eligibility under the travel rule of the company or where option for lump-sum payment is exercised, equal to the last pay drawn.

(ii) Since it is not related to the length of service of the employees, it is accounted for on claim basis. State whether the contentions of the company are correct as per relevant Accounting Standard. Give reasons in support of your answer. Solution The present case falls under the category of defined benefit scheme under Para 49 of AS 15 (Revised) “Employee Benefits”. The said para encompasses cases where payment promised to be made to an employee at or near retirement presents significant difficulties in the determination of periodic charge to the statement of profit and loss. The contention of the Company that the settlement allowance will be accounted for on claim basis is not correct even if company ’s obligation under the scheme is uncertain and requires estimation. In estimating the obligation, assumptions may need to be made regarding future conditions and events , which are largely outside the company’s control. Thus,

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ANALYSIS OF FINANCIAL STATEMENTS

18.43

(1) Settlement allowance payable by the company is a defined retirement benefit, covered by AS 15 (Revised). (2) A provision should be made every year in the accounts for the accruing liability on ac count of settlement allowance. The amount of provision should be calculated according to actuarial valuation. (3) Where, however, the amount of provision so determined is not material, the company can follow some other method of accounting for settlement allowances. ***** Illustration 12 The Chief Accountant of Sports Ltd. gives the following data regarding its six segments:

` in lakhs Particulars

M

N

O

P

Q

R

Total

Segment Assets

40

80

30

20

20

10

200

Segment Results

50

(190)

10

10

(10)

30

(100)

Segment Revenue

300

620

80

60

80

60

1,200

The chief accountant is of the opinion that segments “M” and “N” alone should be reported. Is the Chief Accountant justified in his view? Discuss. Solution As per para 27 of AS 17 ‘Segment Reporting’, a business segment or geographical segment should be identified as a reportable segment if: (i)

Its revenue from sales to external customers and from other transactions with other segments is 10% or more of the total revenue- external and internal of all segments; or

(ii) Its segment result whether profit or loss is 10% or more of: (1) The combined result of all segments in profit; or (2) The combined result of all segments in loss, whichever is greater in absolute amount; or (iii) Its segment assets are 10% or more of the total assets of all segments. If the total external revenue attributable to reportable segments constitutes less than 75% of total enterprise revenue, additional segments should be identified as reportable segment s even if they do not meet the 10% thresholds until atleast 75% of total enterprise revenue is included in reportable segments.

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FINANCIAL REPORTING

(a) On the basis of turnover criteria segments M and N are reportable segments. (b) On the basis of the result criteria, segments M, N and R are reportable segments (since their results in absolute amount is 10% or more of ` 200 lakhs). (c) On the basis of asset criteria, all segments except R are reportable segments. Since all the segments are covered in atleast one of the above criteria all segments have to be reported upon in accordance with Accounting Standard (AS) 17. Hence, the opinion of chief accountant is wrong. ***** Illustration 13 A company has an inter-segment transfer pricing policy of charging at cost less 10%. The market prices are generally 25% above cost. Examine the correctness of the policy adopted by the company. Solution AS 17 ‘Segment Reporting’ requires that inter-segment transfers should be measured on the basis that the enterprise actually used to price these transfers. The basis of pricing inter-segment transfers and any change therein should be disclosed in the financial statements. Hence, the enterprise can have its own policy for pricing inter-segment transfers and hence, inter-segment transfers may be based on cost, below cost or market price. However, whichever policy is followed, the same should be disclosed and applied consistently. Therefore, in the given case inter -segment transfer pricing policy adopted by the company is correct if, followed consistently. ***** Illustration 14 XYZ Ltd. has three segments namely X, Y, Z. The total Assets of the Company are ` 10.00 crores. Segment X has ` 2.00 crores, segment Y has ` 3.00 crores and segment Z has ` 5.00 crores. Deferred tax assets included in the assets of each segments are X` 0.50 crores, Y— ` 0.40 crores and Z— ` 0.30 crores. The accountant contends that all the three segments are reportable segments. Evaluate the contention of the Accountant. Solution According to AS 17 “Segment Reporting”, segment assets do not include income tax assets. Therefore, the revised total assets are ` 8.8 crores [ ` 10 crores – (` 0.5 + ` 0.4 + ` 0.3)]. Segment X holds total assets of ` 1.5 crores (` 2 crores – ` 0.5 crores); Segment Y holds ` 2.6 crores (` 3 crores – ` 0.4 crores); and Segment Z holds ` 4.7 crores (` 5 crores –` 0.3 crores). Thus all the three segments hold more than 10% of the total assets, all segments are reportable segments. *****

© The Institute of Chartered Accountants of India

ANALYSIS OF FINANCIAL STATEMENTS

18.45

Illustration 15 On 30.6.20X1, Asmitha Ltd. incurred ` 2,00,000, net loss from disposal of a business segment. Also, on 30.7.20X1, the company paid ` 60,000 for property taxes assessed for the calendar year 20X1. How the above transactions should be included in determination of net income of Asmitha Ltd. for the six months interim period ended on 30.9.20X1. Solution According to Para 10 of AS 25 “Interim Financial Reporting”, if an enterprise prepares and presents a complete set of financial statements in its interim financial report, the form and content of those statements should conform to the requirements as applicable to annual complete set of financial statements. As on 30.9.20X1, Asmitha Ltd., would report the entire ` 2,00,000 loss on the disposal of its business segment since the loss was incurred during interim period. A cost charged as an expense in an annual period should be allocated to Interim periods on accrual basis. Since ` 60,000 Property Tax payment relates to entire calendar year 20X1, ` 30,000 would be reported as an expense for six months ended on 30th September, 20X1 while out of the remaining ` 30,000, ` 15,000 for January, 20X1 to March, 20X1 should be shown as payment of the outstanding amount of previous year and another ` 15,000 related to quarter October, 20X1 to December, 20X1 would be reported as prepaid expenses. *****

7.

CASE STUDIES BASED ON ACCOUTING STANDARDS

Case Study 1 The following is the excerpt of Note on Fixed Assets from the Balance Sheet of a public company. (All figures are INR in millions)

Buildings Building on long lease out Intangibles Machineries Land under Development

Gross Block As of 1 st Additions Deletions Apr 20X1 5,000 100 2,000 500 500

50 100

1,000 9,000

100 350

-

As at 31 st Mar 20X2 5,100 2,000

Accumulated Depreciation Net Block As of 1 st Additions Deletions As at 31 st As at 31 st Apr 20X1 Mar 20X2 Mar 20X2 1000 3 1003 4,097 500 500 1,500

550 600

200 400

10 20

1,100 9,350

2,100

33

© The Institute of Chartered Accountants of India

-

210 420

340 180

-

2,133

1,100 7,217

18.46

FINANCIAL REPORTING

Additional information: a)

Intangibles include purchased goodwill (related to acquisition of CGU), for INR 5 Million, which has not been amortized till date. However, an entity feels it should be amortised.

b)

Intangibles also include internally generated software of INR 2 Million. Th e management believes that the useful life of the software shall atleast be for ten years.

Draw the corrected Note after substantiating your views. Solution The Excerpt of the Note given in the question has been examined with respect to A.

Presentation as per Schedule III; and

B.

Compliance as per Accounting Standards

A.

As per Schedule III to the Companies Act, 2013

B.

1.

‘Land under development’ should be disclosed under the heading ‘Capital Work in progress’.

2.

Fixed Asset should further be classified into tangible asset, intangible assets and other categories as per the requirement.

Compliance as per Accounting Standards 1.

Para 3.4 of AS 13 “Accounting from Investments” defines Investment property as an investment in land or buildings that are not intended to be occupied substantially for use by, or in the operations of, the investing enterprise. Since no depreciation is charged on such building, it may be inferred that it is not a tangible asset used in t he operations of the business. Infact, opening balance of depreciation appears to be the diminution in the value of the building other than temporary. Accordingly, the ‘buildings on long lease out’ should be shown as an ‘Investment Property’ as a line item of Fixed Asset.

2.

Para 78 of AS 28 “Impairment of Assets” states that in testing a cash-generating unit (CGU) for impairment, an enterprise should identify whether goodwill that relates to this CGU is recognized in the financial statements. Where the goodwill cannot be allocated to the CGU, the bottom-up and top-down approaches to impairment testing should be applied. Hence the goodwill of INR 5 Million should be tested for impairment as per above.

Note on Fixed Assets FIXED ASSETS

Tangibles: Buildings Machineries TOTAL

(All figures are INR in millions) Gross Block

Net Block As at As at Deletions 31st Mar 31st Mar 20X2 20X2

Accumulated Depreciation

As of 1 st Apr 20X1

Additions

Deletions

As at 31st Mar 20X2

As of 1 st Apr 20X1

Additions

5,000 500 5,500

100 100 200

-

5,100 600 5,700

1,000 400 1,400

3 20 35

© The Institute of Chartered Accountants of India

-

1,003 420 1,423

4,097 180 4,277

ANALYSIS OF FINANCIAL STATEMENTS Intangible TOTAL

500 6,000

50 250

550 6,250

200 1,600

10 33

18.47 210 1,633

340 4,617

Note: Intangibles pertaining to goodwill should be shown as a separate line item in above excerpt. However due to lack of information on accumulated depreciation; they have been presented at consolidated level. Excerpts of Balance Sheet (Asset side) Fixed Assets Tangible Assets Intangible Assets

4,277 340

Capital WIP

1,100

Non-current Investment Investment Property (after decline other than temporary)

1,500

Note: Note for Investment property to be made separately. Case Study 2 H Industries is a cash rich company and has got substantial investments. The following is the extract of its Note on Investment from its draft financial statements for year ending 31st March 20X1 Investment in: Mutual Funds - Liquid Funds Mutual Funds - ETFs X Ltd. a wholly owned subsidiary

INR in Lakhs 500 20 100

H Foundation – 100%

20

Time Deposit

20

Total

660

Additional information: 1.

Mutual funds are valued at MTM basis as of yearend. These were initially invested for 300 Lacs for liquid funds and 25 Lacs for ETFs respectively.

2.

The Foundation has a clause in its deed that in the event of liquidation, the net assets of the trust shall be transferred to another trust with similar objects.

Prepare the correct Note to Accounts on Investment.

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18.48

FINANCIAL REPORTING

Solution Notes to Accounts on Investment Note Ref

In Lakhs

Non-current Investment (at cost) X Ltd., a wholly owned subsidiary H Foundation Total Non-current Investment Current Investment

1

100 20

2

120 325

Total Current Investment

325

Total

445

In accordance with Para 35 (d) of AS 13, a note should be given that there exists a significant restriction on the realisability of investments or the remittance of income and proceeds of disposal. Accordingly, the note is prepared as follows: Note 1: The Company has a 100% stake holding in H Foundation. There exists a significant restriction on the realisability of investments due to the clause in the constitution deed of the Foundation that in the event of liquidation, the net assets of the trust shall be transferred to another trust with similar objects. (Refer Para 35 (d) of AS 13). Note 2: Para 31 of AS 13 states – ‘Investment classified as current investment should be carried in the financial statements at the lower of cost and fair value determined either on an individual investment basis or by category of investment, but not on an overall (or global) basis’. Assuming that the MTM values provided represent the fair value, accordingly investments in mutual funds are treated as follows: Investment in Mutual Funds

INR in Lakhs

Mutual Funds - Liquid Funds

300

Mutual Funds - ETFs

25 325

Total

Note 3: Time deposit will be a part of cash and cash equivalents. Case Study 3 XMCC Ltd has provided its segmental report for its secondary geographical segment s as follows: All figures are INR in crores Geography US UK

Segment Assets

Segment Revenue

1,962 1,691

2522 1241

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ANALYSIS OF FINANCIAL STATEMENTS

18.49

India

2,030

1255

Others Total

1,082 6,765

1022 6040

Segment Assets in ‘Others’ category comprises of INR 744 crores held for a new project yet to commence operations in Bulgaria. Additionally, it has provided its primary segment reporting as follows: Segment Revenue Segment Results

Segment 1

Segment 2

Segment 3

Total

2,655 504

2,121 1,111

1,264 114

6,040 1,729

Unallocable Costs Interest Income

403

Finance Costs Others

(120) (50)

Net Profit Tax

Before

1,962

Note: Tax expenses are not considered in above reporting as the management is of the opinion that taxes are not a part of operating cost. Identify and report the errors and misstatements in the above extract, if any. Solution 1.

Geographical segment reporting: The ‘others’ category represents 16% of the total segment assets. In this context, Para 48 of AS 17 states to disclose, inter alia ‘the total carrying amount of segment assets by geographic allocation of assets, for each geographical segment whose segment assets are 10 per cent or more of the total assets of all geographical segments’. Hence to comply with AS 17 disclosures, the management has to breakdown the ‘others’ category further and identify reportable geographies. In this case, the reportable geographical segment will be Bulgaria. The revised Note on secondary segmental reporting will be as follows: All figures are INR in crores Geography

Segment Assets

Segment Revenue

US

1,962

2,522

UK

1,691

1,241

India

2,030

1,255

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18.50

FINANCIAL REPORTING

Bulgaria

744

0

Others

338

1,022

TOTAL

6,765

6,040

Besides, the same Para mandates to disclose ‘the total cost incurred during the period to acquire segment assets that are expected to be used during more than one period (tangible and intangible fixed assets) by geographical location of assets, for each geographical segment whose segment assets are 10 per cent or more of the total assets of all segments’. Hence, the management has to show the addition to segment assets in a separate table; and if there are no additions during the year, the same has to be stated as nil for the year. 2.

Primary Business segment reporting: The management’s interpretation of presenting ‘Net profit before taxes’ is incorrect. It is clear that the standard requires allocating expenses to each segment to the possible extent, and unallocated costs to be shown separate ly as such. In this case, tax expense will be added as an unallocable cost.

Case Study 4 The following disclosures are noticed under the section ‘Contingencies and Provisions’ in the notes to accounts of Umble Co. Ltd as of 31 st March 20X5. Note 1: The Company has achieved a major breakthrough in its consultancy services in Middle East following which it has entered into a contract of rendering services with Offlae Inc for INR 6 billion during the year. The termination clause of the contract is equi valent to INR 7 Million and is payable in case transition time schedule is missed from 15 th December 20X5. The management however is of the view that the liability cannot be treated as onerous. Note 2: The Company is not able to assess the final liability for a particular tax assessment pertaining to assessment year 20X1-20X2 wherein it has received a demand notice of INR 6 Million. However, the company is contesting the same with CIT (Appeals) as on the reporting date. Review the disclosures and state 1. Whether you agree with the current treatment; 2. If you don’t agree, prepare the revised notes to accounts. In both cases, you are required to substantiate with suitable explanations. Solution 1.

It is common to have a termination clause in service contracts and having a termination clause per se will not create a liability on the company. Para 14 to AS 29 states ‘a provision will be recognized when: (a) An enterprise has a present obligation as a result of a past event;

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ANALYSIS OF FINANCIAL STATEMENTS

18.51

(b) It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and (c) A reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision should be recognized. In the above case, there is nothing to show that there is a present obligation, and hence there is no provision to be made. As per para 27 of AS 29, a contingent liability is recognized only where the possibility of an outflow of resources embodying economic benefits is not remote. In the present note, the management is of the view that there is no onerous liability as of date. Hence, the possibility of an outflow being remote, no contingent liability arises. In fact, the management has wrongly worded ‘onerous liability’ in its notes to accounts. Onerous liability arises only if the unavoidable costs of meeting the obligation under the contract should exceed the economic benefits expected to be received under it, which doesn’t seem to be the case as far as Umble Co. Ltd is concerned. Hence, this note shall be eliminated. 2.

The demand notice from the tax department that is under litigation is a clear instance of a ‘contingent liability’. Accordingly, the note should be revised as – ‘Contingent Liability- Demand notice from income tax department pertaining to INR 6 Million, under contest with CIT (Appeals) as on the reporting date.

Case Study 5 Following are the financial statements of SL Parvati Industries Ltd: Balance Sheet Particulars

Note

As at March 31, 20X1 (INR in million)

EQUITY AND LIABILITIES Shareholders’ funds Share capital (shares of Rs. 10 each) Reserves and surplus

1,000 1

2,000

Long-term borrowings

2

5,555

Deferred tax liabilities

3

200

Non-current liabilities

Current liabilities Trade payables

300

Short-term provisions

250

Other current liabilities

4

© The Institute of Chartered Accountants of India

150

18.52

FINANCIAL REPORTING

TOTAL

9,455

ASSETS Non - current assets Fixed Assets

5,655

Deferred Tax Assets

3

500

Current assets Inventories

1,000

Trade receivables

5

1,100

Cash and bank balances

1,200

TOTAL

9,455 Statement of Profit & Loss

Particulars

Note

Year ended March 31, 20X1

Revenue from operations

5,500

Expenses Employee Benefit Expense

1,200

Operating Costs

2,200

Depreciation

999

Total Expenses

4,399

Profit before tax

1,101

Tax Expense

(150)

Profit after tax

951

Notes to Accounts: Note 1: Reserves and surplus

(INR in millions)

Capital Reserve

500

Surplus from P & L Opening Balance

49

Additions

951

Reserve for foreseeable loss Total

1,000 500 2,000

Note 2: Long Term Borrowings Term Loan from Bank Total

© The Institute of Chartered Accountants of India

5,555 5,555

ANALYSIS OF FINANCIAL STATEMENTS

18.53

Note 3: Deferred Tax Deferred Tax Asset Deferred Tax Liability

500 (200)

Total

300

Note 4: Other Current Liabilities Unclaimed dividends

3

Billing in Advance

147

Total Note 5: Trade Receivables Considered good (outstanding within 6 months)

150 1,065

Considered doubtful (due from past 1 year)

40

Provision for doubtful debts

(5)

Total Additional Information:

1,100

a. Share capital comprises of 100 million shares of INR 10 each b. Term Loan from bank for INR 5555 million also includes interest accrued and due of INR 555 million as on the reporting date. c. Reserve for forseeable loss is created against a service contract due within 6 months. Required: 1. Identify and report the errors and misstatements in the above extract, if any: and, 2. Prepare the corrected Balance Sheet & Statement of Profit and Loss Solution Analysis: 1.

Reserve for foreseeable loss for INR 500 million, due within 6 months, should be a part of provisions. Hence it needs to be regrouped, and if it was a part of previous year’s comparatives, a Note should be added in the notes to account on the regrouping done this year.

2.

Interest accrued and due of INR 555 million on term loan will be a part of current liabilities. Hence, it should be shown under the heading “Other Current Liabilities”

3.

It can be inferred from the Note a, that the deferred tax liabilities and assets relate to taxes on income levied by the same governing taxation laws, hence these shall be set off, in accordance with AS 22. The net DTA of INR 300 million will be shown in the balance sheet.

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18.54 4.

FINANCIAL REPORTING

The notes to trade receivables is incorrectly presented. The recommended notes would be as below: Trade receivables (Unsecured) consist of the following: a) Over six months from the date they were due for payment i.

Considered good

0

ii.

Considered doubtful

40

Less: Provision for doubtful receivables

(5) (A)

35

b) Others i.

Considered good

1,065

ii.

Considered doubtful

0

Less: Provision for doubtful receivables

0 (B)

5.

1,065

Total 1,100 The statement to Profit and Loss needs to represent earnings per share, to be compliant with AS 20. Revised extracts of the financial statements: Balance Sheet

(INR in Million)

Note No.

As at March 31, 20X1

EQUITY AND LIABILITIES Shareholders’ funds Share capital Reserves and surplus

1,000 1

1,500

2

5,000

3

300

Non-current liabilities Long-term borrowings Current liabilities Trade payables Short-term provisions Other current liabilities TOTAL

750 4

705 9,255

ASSETS Non - current assets Fixed Assets

© The Institute of Chartered Accountants of India

5,655

ANALYSIS OF FINANCIAL STATEMENTS Deferred Tax Assets

18.55

a

300

Current assets Inventories

1,000

Trade receivables

5

1,100

Cash and Cash Equivalents

6

1,200

TOTAL

9,255 Statement of Profit and Loss

(INR in Million) Notes No.

Revenue from operations

Year ended March 31, 20X1 5,500

Expenses Employee Benefit Expense

1,200

Operating Costs

2,200

Depreciation

999

Total Expenses

4,399

Profit Before Tax

1,101

Tax Expense

150

Profit for the period

951

Earnings Per Equity Share Basic

9.51

Diluted

9.51

Number of equity shares (face value of ` 10 each)

100 million

Revised Notes (wherever applicable): Note on Reserves and Surplus

(INR in Million) 500

Capital Reserve Surplus from P & L Opening Bal Additions Total

© The Institute of Chartered Accountants of India

49 951

1,000 1,500

18.56

FINANCIAL REPORTING

Note on Long Term Borrowings Term Loan from Bank

5,000

Total

5,000

Note on Other Current Liabilities Unclaimed dividends

3

Interest on Term Loan

555

Billing in Advance

147

Total

705

8.

CASE STUDIES BASED ON IND AS

Case Study 1 On April 1, 20X1, Pluto Ltd. has advance a loan for ` 10 lakhs to one of its employees for an interest rate at 4% per annum (market rate 10%) which is repayable in 5 equal annual installments along with interest at each year end. Employee is not required to give any specific performance against this benefit. The accountant of the company has recognised the staff loan in the balance sheet equivalent to the amount disbursed i.e. ` 10 lakhs. The interest income for the period is recognised at the contracted rate in the Statement of Profit and Loss by the company i.e. ` 40,000 (` 10 lakhs x 4%). Analyse whether the above accounting treatment made by the accountant is in compliance with the Ind AS. If not, advise the correct treatment alongwith working for the same. Solution The above treatment needs to be examined in the light of the provisions given in Ind AS 32 and Ind AS 109 on Financial Instruments’ and Ind AS 19 ‘Employee Benefits’. Para 11 (c) (i) of Ind AS 32 ‘Financial Instruments : Presentation’ states that: “A financial asset is any asset that is: (c) a contractual right: (i)

to receive cash or…..”

Further, paragraph 5.1.1 of Ind AS 109 states that: “at initial recognition, an entity shall measure a financial asset or financial lia bility at its fair value”. Further, paragraph 5.1.1 of Appendix B to Ind AS 109 states that: “The fair value of a financial instrument at initial recognition is normally the transaction price (i.e. the fair value of the consideration given or received. However, if part of the consideration given

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or received is for something other than the financial instrument, an entity shall measure the fair value of the financial instrument. For example, the fair value of a long term loan or receivable that carries no interest can be measured as the present value of all future cash receipts discounted using the prevailing market(s) of interest rate of similar instrument with a similar credit rating. Any additional amount lent is an expense or reduction of income unless it qualifies for recognition as some other type of asset”. Further, paragraph 5.2.1 of Ind AS 109 states that: “After initial recognition, an entity shall measure a financial asset at: (a) amortised cost; (b) fair value through other comprehensive income; or (c) fair value through profit or loss. Further, paragraph 5.4.1 of Ind AS 109 states that: “Interest revenue shall be calculated by using the effective interest method. This shall be calculated by applying the effective interest rate to the gross carrying amount of a financial asset” Paragraph 8 of Ind AS 19 states that: “Employee Benefits are all forms of consideration given by an entity in exchange for service rendered by employees or for the termination of employment”. The Accountant of Pluto Ltd. has recognised the staff loan in the balance sheet at ` 10 lakhs being the amount disbursed and ` 40,000 as interest income for the period is recognised at the contracted rate in the statement of profit and loss which is not correct and not in accordance with Ind AS 19, Ind AS 32 and Ind AS 109. Accordingly, the staff advance being a financial asset shall be initially measured at the fair value and subsequently at the amortised cost. The interest income is calculated by using the effective interest method. The difference between the amount lent and fair value is charged as Employee benefit expense in statement of profit and loss. a)

Calculation of Fair Value of the Loan Year

Cash Inflow

Discounting Factor (10%)

Present Value

1

2,40,000

0.909

2,18,160

2

2,32,000

0.826

1,91,632

3

2,24,000

0.751

1,68,224

4

2,16,000

0.683

1,47,528

5

2,08,000

0.621

1,29,168

Total

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8,54,712

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Staff loan should be initially recorded at ` 8,54,712. b) Employee Benefit Expense Loan Amount – Fair Value of the loan = ` 10,00,000 – ` 8,54,712 = ` 1,45,288 ` 1,45,288 shall be charged as Employee Benefit expense in Statement of Profit and Loss for the year ended 31.03.20X2. Amortisation table: Year

Opening balance of Staff Advance

Interest (10%)

Repayment

(a)

(b)= (a x 10%)

(c)

Closing balance of Staff Advance (d) = a + b -c

1

8,54,712

85,471

2,40,000

7,00,183

2

7,00,183

70,018

2,32,000

5,38,201

3

5,38,201

53,820

2,24,000

3,68,021

4

3,68,021

36,802

2,16,000

1,88,823

5

1,88,823

19,177 (b.f.)

2,08,000

Nil

Balance Sheet extracts showing the presentation of staff loan as at 31 st March 20X2 Ind AS compliant Division II of Sch III needs to be referred for presentation requirement in Balance Sheet on Ind AS. Assets Non-Current Assets Financial Assets (i) Loan

5,38,201

Current Assets Financial Assets (i) Loans (7,00,183 - 5,38,201)

1,61,982

Case Study 2 Pluto Ltd. has purchased a manufacturing plant for ` 6 lakhs on 1 April 20X1. The useful life of the plant is 10 years. On 30th September 20X3, Pluto temporarily stops using the manufacturing plant because demand has declined. However, the plant is maintained in a workable condition and it will be used in future when demand picks up. The accountant of Pluto ltd. decided to treat the plant as held for sale until the demands picks up and accordingly measures the plant at lower of carrying amount and fair value less cost to sell.

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ANALYSIS OF FINANCIAL STATEMENTS

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Also, the accountant has also stopped charging the depreciation for the rest of period considering the plant as held for sale. The fair value less cost to sell on 30 th September 20X3 and 31 March 20X4 was ` 4 lakhs and ` 3.5 lakhs respectively. The accountant has performed the following working:

INR

Carrying amount on initial classification as held for sale Purchase Price of Plant Less: Accumulated dep (6,00,000/ 10 Years)* 2.5 years

6,00,000 (1,50,000)

4,50,000

Fair Value less cost to sell as on 30th September, 20X3

4,00,000

The value will be lower of the above two

4,00,000

Balance Sheet extracts as on 31 March 20X4 Assets Current Assets Other Current Assets Assets classified as held for sale 3,50,000 Analyse whether the above accounting treatment made by the accountant is in compliance with the Ind AS. If not, advise the correct treatment alongwith the necessary workings. Solution The above treatment needs to be examined in the light of the provisions given in Ind AS 16 ‘Property, Plant and Equipment’ and Ind AS 105 ‘Non-current Assets Held for Sale and Discontinued Operations’. Para 6 of Ind AS 105 ‘Non-current Assets Held for Sale and Discontinued Operations’ states that: “An entity shall classify a non-current asset (or disposal group) as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use”. Paragraph 7 of Ind AS 105 states that: “For this to be the case, the asset (or disposal group) must be available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets (or disposal groups) and its sale must be highly probable. Thus, an asset (or disposal group) cannot be classified as a non-current asset (or disposal group) held for sale, if the entity intends to sell it in a distant future”.

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Further, paragraph 8 of Ind AS 105 states that: “For the sale to be highly probable, the appropriate level of management must be committed to a plan to sell the asset (or disposal group), and an active programme to locate a buyer and complete the plan must have been initiated. Further, the asset (or disposal group) must be actively marketed for sale at a price that is reasonable in relation to its current fair value. In addition, the sale should be expected to qualify for recognition as a completed sale within one year from the date of classification and actions required to complete the plan should indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.” Paragraph 13 of Ind AS 105 states that: “An entity shall not classify as held for sale a non-current asset (or disposal group) that is to be abandoned. This is because its carrying amount will be recovered principally through continuing use.” Paragraph 14 of Ind AS 105 states that: “An entity shall not account for a non-current asset that has been temporarily taken out of use as if it had been abandoned.” Paragraph 55 of Ind AS 16 states that: “Depreciation does not cease when the asset becomes idle or is reti red from active use unless the asset is fully depreciated.” Going by the guidance given above, The Accountant of Pluto Ltd. has treated the plant as held for sale and measured it at the fair value less cost to sell. Also, the depreciation has not been charged thereon since the date of classification as held for sale which is not correct and not in accordance with Ind AS 105 and Ind AS 16. Accordingly, the manufacturing plant should neither be treated as abandoned asset nor as held for sale because its carrying amount will be principally recovered through continuous use. Pluto Ltd. shall not stop charging depreciation or treat the plant as held for sale because its carrying amount will be recovered principally through continuing use to the end of their economic life. The working of the same for presenting in the balance sheet is given as below: Calculation of carrying amount as on 31 March 20X4 Purchase Price of Plant Less: Accumulated depreciation (6,00,000/ 10 Years)* 3 Years

6,00,000 (1,80,000) 4,20,000

Less: Impairment loss

(70,000) 3,50,000

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Balance Sheet extracts as on 31 March 20X4 Assets Non-Current Assets Property, Plant and Equipment

3,50,000

Working Note: Fair value less cost to sell of the Plant

= Rs. 3,50,000

Value in Use (not given) or = Nil (since plant has temporarily not been used for manufacturing due to decline in demand) Recoverable amount = higher of above i.e. Rs. 3,50,000 Impairment loss = Carrying amount – Recoverable amount Impairment loss = Rs. 4,20,000 - Rs.3,50,000 = Rs. 70,000. Case Study 3 On 5th April, 20X2, fire damaged a consignment of inventory at one of the Jupiter’s Ltd.’s warehouse. This inventory had been manufactured prior to 31 st March 20X2 costing ` 8 lakhs. The net realisable value of the inventory prior to the damage was estimated at ` 9.60 lakhs. Because of the damage caused to the consignment of inventory, the company was required to spend an additional amount of ` 2 lakhs on repairing and re-packaging of the inventory. The inventory was sold on 15 th May, 20X2 for proceeds of ` 9 lakhs. The accountant of Jupiter Ltd treats this event as an adjusting event and adjusted this event of causing the damage to the inventory in its financial statement and accordingly re -measures the inventories as follows: INR lakhs Cost

8.00

Net realisable value (9.6 -2)

7.60

Inventories (lower of cost and net realisable value)

7.60

Analyse whether the above accounting treatment made by the accountant in regard to financial year ending on 31.0.20X2 is in compliance of the Ind AS. If not, advise the correct treatment alongwith working for the same. Solution The above treatment needs to be examined in the light of the provisions given in Ind AS 10 ‘Events after the Reporting Period’ and Ind AS 2 ‘Inventories’. Para 3 of Ind AS 10 ‘Events after the Reporting Period’ defines “Events after the reporting period are those events, favourable and unfavourable, that occur between the end of the reporting period and the date when the financial statements are approved by the Board of Directors in case of a

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company, and, by the corresponding approving authority in case of any other entity for issue. Two types of events can be identified: (a) those that provide evidence of conditions that existed at the end of the reporting period (adjusting events after the reporting period); and (b) those that are indicative of conditions that arose after the reporting period (non-adjusting events after the reporting period). Further, paragraph 10 of Ind AS 10 states that: “An entity shall not adjust the amounts recognised in its financial statements to re flect nonadjusting events after the reporting period”. Further, paragraph 6 of Ind AS 2 defines: “Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale”. Further, paragraph 9 of Ind AS 2 states that: “Inventories shall be measured at the lower of cost and net realisable value”. Accountant of Jupiter Ltd. has re-measured the inventories after adjusting the event in its financial statement which is not correct and nor in accordance with provision of Ind AS 2 and Ind AS 10. Accordingly, the event causing the damage to the inventory occurred after the reporting date and as per the principles laid down under Ind AS 10 ‘Events After the Reporting Date’ is a nonadjusting event as it does not affect conditions at the reporting date. Non -adjusting events are not recognised in the financial statements, but are disclosed where their effect is material. Therefore, as per the provisions of Ind AS 2 and Ind AS 10, the consignment of inventories shall be recorded in the Balance Sheet at a value of ` 8 Lakhs calculated below: INR’ lakhs Cost

8.00

Net realisable value

9.60

Inventories (lower of cost and net realisable value)

8.00

Case Study 4 On April 1, 20X1, Sun Ltd. has acquired 100% shares of Earth Ltd. for ` 30 lakhs. Sun Ltd. has 3 cash-generating units A, B and C with fair value of Rs 12 lakhs, 8 lakhs and 4 lakhs respectively. The company recognizes goodwill of Rs 6 lakhs that relates to CGU ‘C’ only. During the financial year 20X2-20X3, the CFO of the company has a view that there is no requirement of any impairment testing for any CGU since their recoverable amount is comparatively higher than the carrying amount and believes there is no indicator of impairment.

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Analyse whether the view adopted by the CFO of Sun Ltd is in compliance of the Ind AS. If not, advise the correct treatment in accordance with relevant Ind AS Solution The above treatment needs to be examined in the light of the provisions given in Ind AS 36: Impairment of Assets. Para 9 of Ind AS 36 ‘Impairment of Assets’ states that “An entity shall assess at the end of each reporting period whether there is any indication that an asset may be impaired. If any such indication exists, the entity shall estimate the recoverable amount of the asset. ” Further, paragraph 10(b) of Ind AS 36 states that: “Irrespective of whether there is any indication of impairment, an entity shall also test goodwill acquired in a business combination for impairment annually.” Sun Ltd has not tested any CGU on account of not having any indication of impairment is partially correct i.e. in respect of CGU A and B but not for CGU C. Hence the treatment made by the Company is not in accordance with Ind AS 36. Accordingly, impairment testing in respect of CGU A and B are not required since there are no indications of impairment. However, Sun Ltd shall test CGU C irrespective of any indication of impairment annually as the goodwill acquired on business combination is fully allocated to CGU ‘C’.

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TEST YOUR KNOWLEDGE Questions based on AS 1.

The company had spent ` 45 lakhs for publicity and research expenses on one of its new consumer product, which was marketed in the accounting year 20X1-20X2, but proved to be a failure. Required: Analyse, how you will deal with this amount in the accounts of the company for the year ended 31stMarch, 20X2 with reference to Accounting Standards:

2.

A company with a turnover of ` 250 crores and an annual advertising budget of ` 2 crores had taken up the marketing of a new product. It was estimated that the company would have a turnover of ` 25 crores from the new product. The company had debited to its Profit and Loss account the total expenditure of ` 2 crore incurred on extensive special initial advertisement campaign for the new product. Required: Evaluate the correctness of the procedure adopted by the company?

3.

Good Drugs and Pharmaceuticals Ltd. acquired a sachet filling machine on 1 st April, 20X1 for ` 60 lakhs. The machine was expected to have a productive life of 6 years. At the end of financial year 20X1-20X2 the carrying amount was ` 41 lakhs. A short circuit occurred in this financial year but luckily the machine did not get badly damaged and was still in working order at the close of the financial year. The machine was expected to fetch ` 36 lakhs, if sold in the market. The machine by itself is not capable of generating cash flows. However, the smallest group of assets comprising of this machine also, is capable of generating cash flows of ` 54 crore per annum and has a carrying amount of ` 3.46 crore. All such machines put together could fetch a sum of ` 4.44 crore if disposed. Required: Discuss the applicability of Impairment loss.

4.

Mini Ltd. took a factory premises on lease on 1.4.20X1 for ` 2,00,000 per month. The lease is operating lease. During March, 20X3, Mini Ltd. relocates its operation to a new factory building. The lease on the old factory premises continues to be live upto 31.12.20X5. The lease cannot be cancelled and cannot be sub-let to another user. The auditor insists that lease rent of balance 33 months upto 31.12.20X5 should be provided in the accounts for the year ending 31.3.20X3. Required: Advise Mini Ltd. in the above situation.

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An oil company has been contaminating land for several years. It does not clean up because there is no legislation requiring cleaning up. At 31 st March 20X1, it is virtually certain that a law requiring a clean-up of land already contaminated will be enacted shortly after the year end. Is provisioning presently necessary?

Questions based on Ind AS 1.

Venus Ltd. is a multinational entity that owns three properties. All three properties were purchased on April 1, 20X1. The details of purchase price and market values of the properties are given as follows: Particulars

Property 1

Property 2

Property 3

Factory

Factory

Let-Out

15,000

10,000

12,000

16,000

11,000

13,500

Life

10 Years

10 Years

10 Years

Subsequent Measurement

Cost Model

Revaluation Model

Revaluation Model

Purchase price Market 31.03.20X2

value

Property 1 and 2 are used by Venus Ltd. as factory building whilst property 3 is let -out to a nonrelated party at a market rent. The management presents all three properties in balance sheet as ‘property, plant and equipment’. The Company does not depreciate any of the properties on the basis that the fair values are exceeding their carrying amount and recognise the difference between purchase price and fair value in Statement of Profit and Loss. Required: Analyse whether the accounting policies adopted by the Venus Ltd. in relation to these properties is in accordance of Indian Accounting Standards (Ind AS). If not, advise the correct treatment alongwith working for the same. 2.

On 1st January 20X2, Sun Ltd. was notified that a customer was taking legal action against the company in respect of a financial losses incurred by the customer. Customer alleged that the financial losses were caused due to supply of faulty products on 30 th September 20X1 by the Company. Sun Ltd. defended the case but considered, based on the progress of the case up to 31st March 20X2, that there was a 75% probability they would have to pay damages of ` 10 lakhs to the customer. However, the accountant of Sun Ltd. has not recorded this transaction in its financial statement as the case is not yet finally settled. The case was ultimately settled against the company

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resulting in to payment of damages of ` 12 lakhs to the customer on 15th May 20X2. The financials have been authorized by the Board of Directors in its meeting held on 18 th May 20X2. Required: Analyse whether the above accounting treatment made by the accountant is in compliance of the Ind AS. If not, advise the correct treatment along with working for the same. 3.

Mercury Ltd. is an entity engaged in plantation and farming on a large scale diversified across India. On 1 st April 20X1, the company has received a government grant for ` 10 lakhs subject to a condition that it will continue to engage in plantation of eucalyptus tree for a coming period of five years. The management has a reasonable assurance that the entity will comply with condition of engaging in the plantation of eucalyptus tree for specified period of five years and accordingly it recognises proportionate grant for ` 2 lakhs in Statement of Profit and Loss as income following the principles laid down under Ind AS 20 Accounting for Government Grants and Disclosure of Government Assistance. Required: Analyse whether the above accounting treatment made by the management is in compliance of the Ind AS. If not, advise the correct treatment alongwith working for the same.

4.

Mercury Ltd. has sold goods to Mars Ltd. at a consideration of ` 10 lakhs, the receipt of which receivable in three equal installments of ` 3,33,333 over a two year period (receipts on 1 st April 20X1, 31st March 20X2 and 31st March 20X3). The company is offering a discount of 5 % (i.e. ` 50,000) if payment is made in full at the time of sale. The sale agreement reflects an implicit interest rate of 5.36% p.a. The total consideration to be received from such sale is at ` 10 Lakhs and hence, the management has recognised the revenue from sale of goods for ` 10 lakhs. Further, the management is of the view that there is no difference in this aspect between Indian GAAP and Ind AS. Required: Analyse whether the above accounting treatment made by the accountant is in compliance of the Ind AS. If not, advise the correct treatment along with working for the same.

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ANSWERS TO TEST YOUR KNOWLEDGE Answers to AS based Questions 1.

In the given case, the company spent ` 45 lakhs for publicity and research of a new product which was marketed but proved to be a failure. It is clear that in future there will be no related further revenue/benefit because of the failure of the product. Thus according to paras 41 to 43 of AS 26 ‘Intangible Assets’, the company should charge the total amount of ` 45 lakhs as an expense in the profit and loss account.

2.

According to paras 55 and 56 of AS 26 ‘Intangible Assets’, expenditure on an intangible item should be recognised as an expense when it is incurred unless it forms part of the cost of an intangible asset. In the given case, advertisement expenditure of ` 2 crores had been taken up for the marketing of a new product which may provide future economic benefits to an enterprise by having a turnover of ` 25 crores. Here, no intangible asset or other asset is acquired or created that can be recognised. Therefore, the accounting treatment by the company of debiting the entire advertising expenditure of ` 2 crores to the Profit and Loss account of the year is correct.

3.

As per provisions of Para 91(b) of AS 28 “Impairment of Assets”, impairment loss is not to be recognized for a given asset if its cash generating unit (CGU) is not impaired. In the given question, the related cash generating unit which is group of asset to which the damaged machine belongs is not impaired; and the recoverable amount is more than the carrying amount of group of assets. Hence there is no need to provide for impairment loss on the damaged sachet filling machine.

4.

In accordance with explanation to para 1(b) of AS 29 ‘Provisions, Contingent Liabilities and Contingent Assets’, if an enterprise has a contract that is onerous, the present obligation under the contract should be recognized and measured as a provision. In the given case, the operating lease contract has become onerous as the economic benefit of lease contract for next 33 months up to 31.12.20X5 will be nil. However, the lessee, Mini Ltd., has to pay lease rent of ` 66,00,000 (i.e.2,00,000 p.m. for next 33 months). Therefore, provision on account of ` 66,00,000 is to be provided in the accounts for the year ending 31.03.X3. Hence auditor is right.

5.

As per para 29 of AS 29 ‘Provisions, Contingent Liabilities and Contingent Assets’, a past event will lead to present obligation when the enterprise has no realistic alternative to settle the obligation created by the past event.



For a contract to qualify as an onerous contract, the unavoidable costs of meeting the obligation under the contract should exceed the economic benefits expected to be received under it.

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However, when environmental damage is caused there may be no obligation to remedy the consequences. The causing of the damage will become an obligating event when a new law requires the existing damage to be rectified. Where details of a proposed new law have yet to be finalised, an obligation arises only when the legislation is virtually certain to be enacted. In the given case it is virtually certain that law will be enacted requiring clean -up of a land already contaminated. Therefore, an oil company has to provide for such clean -up cost in the year in which the law is virtually certain to be enacted.

Answers to Ind AS based Questions 1.

The above issue needs to be examined in the umbrella of the provisions given in Ind AS 1 ‘Presentation of Financial Statements’, Ind AS 16 ‘Property, Plant and Equipment’ in relation to property ‘1’ and ‘2’ and Ind AS 40 ‘Investment Property’ in relation to property ‘3’. Property ‘1’ and ‘2’ Para 6 of Ind AS 16 ‘Property, Plant and Equipment’ defines: “Property, plant and equipment are tangible items that: (a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and (b) are expected to be used during more than one period.” Paragraph 29 of Ind AS 16 states that: “An entity shall choose either the cost model or the revaluation model as its accounting policy and shall apply that policy to an entire class of property, plant and equipment ”. Further, paragraph 36 of Ind AS 16 states that: “If an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs shall be revalued”. Further, paragraph 39 of Ind AS 16 states that: “If an asset’s carrying amount is increased as a result of a revaluation, the increase shall be recognised in other comprehensive income and accumulated in equity under the heading of revaluation surplus. However, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss”. Further, paragraph 52 of Ind AS 16 states that: “Depreciation is recognised even if the fair value of the asset exceeds its carrying amount, as long as the asset’s residual value does not exceed its carrying amount”.

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Property ‘3’ Para 6 of Ind AS 40 ‘Investment property’ defines: “Investment property is property (land or a building—or part of a building—or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both, rather than for: (a) use in the production or supply of goods or services or for administrative purposes; or (b) sale in the ordinary course of business”. Further, paragraph 30 of Ind AS 40 states that: “An entity shall adopt as its accounting policy the cost model to all of its investment property”. Further, paragraph 79 (e) of Ind AS 40 requires that: “An entity shall disclose the fair value of investment property”. Further, paragraph 54 (2) of Ind AS 1 ‘Presentation of Financial Statements’ requires that: “As a minimum, the balance sheet shall include line items that present the following amounts: (a) property, plant and equipment; (b) investment property; As per the facts given in the question, Venus Ltd. has (a) presented all three properties in balance sheet as ‘property, plant and equipment’; (b) applied different accounting policies to Property ‘1’ and ‘2’; (c) revaluation is charged in statement of profit and loss as profit; and (d) applied revaluation model to Property ‘3’ being classified as Investment Property. These accounting treatment is neither correct nor in accordance with provision of Ind AS 1, Ind AS 16 and Ind AS 40. Accordingly, Venus Ltd. shall apply the same accounting policy (i.e. either revaluation or cost model) to entire class of property being property ‘1’ and ‘2”. It also required to depreciate these properties irrespective of that, their fair value exceeds the carrying amount. The revaluation gain shall be recognised in other comprehensive income and accumulated in equity under the heading of revaluation surplus. There is no alternative of revaluation model in respect to property ‘3’ being classified as Investment Property and only cost model is permitted for subsequent measurement. However, Venus ltd. is required to disclose the fair value of the property in the Notes to Accounts. Also the property ‘3’ shall be presented as separate line item as Investment Property. Therefore, as per the provisions of Ind AS 1, Ind AS 16 and Ind AS 40, the presentation of these three properties in the balance sheet is as follows:

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Case 1: Venus Ltd. has applied the Cost Model to an entire class of property, plant and equipment. Balance Sheet extracts as at 31 st March 20X2

INR

Assets Non-Current Assets Property, Plant and Equipment Property ‘1’

13,500

Property ‘2’

9,000

22,500

Investment Properties Property ‘3’

10,800

Case 2: Venus Ltd. has applied the Revaluation Model to an entire class of property, plant and equipment. Balance Sheet extracts as at 31 st March 20X2

INR

Assets Non-Current Assets Property, Plant and Equipment Property ‘1’

16,000

Property ‘2’

11,000

27,000

Investment Properties Property ‘3’

10,800

Equity and Liabilities Other Equity Revaluation Reserve Property ‘1’

2,500

Property ‘2’

2,000

4,500

The revaluation reserve should be routed through Other Comprehensive Income (subsequently not reclassified to Profit and Loss) in Statement of Profit and Loss and Shown as a separate column in Statement of Changes in Equity. 2.

The above treatment needs to be examined in the light of the provisions given in Ind AS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’ and Ind AS 10 ‘Events After the Reporting Period’.

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Para 10 of Ind AS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’ defines: “Provision is a liability of uncertain timing or amount. Liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits”. Further, paragraph 14 of Ind AS 37, states: “A provision shall be recognised when: (a) an entity has a present obligation (legal or constructive) as a result of a past event; (b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation”. Further, paragraph 36 of Ind AS 37, states: “The amount recognised as a provision shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period”. Further, paragraph 3 of Ind AS 10 ‘Events after the Reporting Period’ defines: “Events after the reporting period are those events, favourable and unfavourable, that occur between the end of the reporting period and the date when the financial statements are approved by the Board of Directors in case of a company, and, by the corresponding approving authority in case of any other entity for issue. Two types of events can be identified: (a) those that provide evidence of conditions that existed at the end of the reporting period (adjusting events after the reporting period); and (b) those that are indicative of conditions that arose after the reporting period (nonadjusting events after the reporting period). Further, paragraph 8 of Ind AS 10 states that: “An entity shall adjust the amounts recognised in its financial statements to re flect adjusting events after the reporting period.” The Accountant of Sun Ltd. has not recognised the provision and accordingly not adjusted the amounts recognised in its financial statements to reflect adjusting events after the reporting period is not correct and nor in accordance with provision of Ind AS 37 and Ind AS 10. As per given facts, the potential payment of damages to the customer is an obligation arising out of a past event which can be reliably estimated. Therefore, following the provision of Ind AS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’ – a provision is required.

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18.72

FINANCIAL REPORTING

The provision should be for the best estimate of the expenditure required to settle the obligation at 31 March 20X2 which comes to ` 7.5 lakhs (` 10 lakhs * 75%). Further, following the principles of Ind AS 10 ‘Events After the Reporting Period’ evidence of the settlement amount is an adjusting event. Therefore, the amount of provision created shall be increased to ` 12 lakhs and accordingly be recognised as a current liability. 3.

As per given facts, the company is engaged in plantation and farming. Hence Ind AS 41 Agriculture shall be applicable to this company. The above facts need to be examined in the light of the provisions given in Ind AS 20 ‘Accounting for Government Grants and Disclosure of Government Assistance ’ and Ind AS 41 ‘Agriculture’. Para 2(d) of Ind AS 20 ‘Accounting for Government Grants and Disclosure of Government Assistance’ states: “This Standard does not deal with government grants covered by Ind AS 41, Agriculture”. Further, paragraph 1 (c) of Ind AS 41 ‘Agriculture’, states: “This Standard shall be applied to account for the government grants covered by paragraphs 34 and 35 when they relate to agricultural activity”. Further, paragraph 1 (c) of Ind AS 41 ‘Agriculture’, states: “If a government grant related to a biological asset measured at its fair value less costs to sell is conditional, including when a government grant requires an entity not to engage in specified agricultural activity, an entity shall recognise the government grant in profit or loss when, and only when, the conditions attaching to the government grant are met ”. Understanding of the given facts, The Company has recognised the proportionate grant for ` 2 lakhs in Statement of Profit and Loss before the conditions attaching to government grant are met which is not correct and nor in accordance with provision of Ind AS 41 ‘Agriculture’. Accordingly, the accounting treatment of government grant received by the Mercury Ltd. is governed by the provision of Ind AS 41 ‘Agriculture’ rather Ind AS 20 ‘Accounting for Government Grants and Disclosure of Government Assistance’. Government grant for ` 10 lakhs shall be recognised in profit or loss when, and only when, the conditions attaching to the government grant are met i.e. after the expiry of specified period of five years of continuing engagement in the plantation of eucalyptus tree.

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ANALYSIS OF FINANCIAL STATEMENTS

18.73

Balance Sheet extracts showing the presentation of Government Grant as on 31 st March 20X2

INR

Liabilities Non-Current liabilities Other Non-Current Liabilities Government Grants 4.

10,00,000

The revenue from sale of goods shall be recognised at the fair value of the consideration received or receivable. The fair value of the consideration is determined by discounting all future receipts using an imputed rate of interest where the receipt is deferred beyond normal credit terms. The difference between the fair value and the nominal amount of the consideration is recognised as interest revenue. The fair value of consideration (cash price equivalent) of the sale of goods is calculated as follows: INR Year

Consideration Present value Present value of (Installment) factor consideration Time of sale 3,33,333 3,33,333 End of 1 st year 3,33,333 0.949 3,16,333 nd End of 2 year 3,33,334 0.901 3,00,334 10,00,000 9,50,000 The Company that agrees for deferring the cash inflow from sale of goods will recognise the revenue from sale of goods and finance income as follows: Initial recognition of sale of goods

INR

Cash

Dr.

3,33,333

Trade Receivable

Dr.

6,16,667

To Sale

9,50,000

Recognition of interest expense and receipt of second installment Cash

Dr.

3,33,333

To Interest Income

33,053

To Trade Receivable

3,00,280

Recognition of interest expense and payment of final installment Cash

Dr. To Interest Income (Balancing figure) To Trade Receivable

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3,33,334 16,947 3,16,387

18.74

FINANCIAL REPORTING Balance Sheet (extracts) as at 31 st March 20X2 and 31 st March 20X3 INR As at Mar 31, 20X2

As at Mar 31, 20X3

9,50,000

-

Other Income (Finance income) 33,0532,999 Statement of Profit and Loss (extracts)

16,947

Income Sale of Goods

for the year ended 31 st March 20X2 and 31 st March 20X3 INR As at Mar 31, 20X2

As at Mar 31, 20X3

3,16,387

XXX

Assets Current Assets Financial Assets Trade Receivables

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