Intermediate Course

Study Material
(Modules 1 to 3)

Paper 1

Advanced
Accounting
(Relevant for May, 2025 and
onward Examinations)

Module – 2

BOARD OF STUDIES
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

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This Study Material has been prepared by the faculty of the Board of Studies. The
objective of the Study Material is to provide teaching material to the students to
enable them to obtain knowledge in the subject. In case students need any
clarification or have any suggestion for further improvement of the material
contained herein, they may write to the Joint Director, Board of Studies.
All care has been taken to provide interpretations and discussions in a manner
useful for the students. However, the Study Material has not been specifically
discussed by the Council of the Institute or any of its committees and the views
expressed herein may not be taken to necessarily represent the views of the
Council or any of its Committees.
Permission of the Institute is essential for reproduction of any portion of this
material.

© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

All rights reserved. No part of this book may be reproduced, stored in a retrieval
system, or transmitted, in any form, or by any means, electronic, mechanical,
photocopying, recording, or otherwise, without prior permission, in writing, from the
publisher.

Basic draft of this publication was prepared by CA. (Dr.) Rashmi Goel

Edition : July, 2024

Committee/Department : Board of Studies

E-mail : [email protected]

Website : www.icai.org

Price : ` /- (For All Modules)

ISBN No. : 978-81-19472-30-7

Published by : The Publication & CDS Directorate on behalf of

The Institute of Chartered Accountants of India,
ICAI Bhawan, Post Box No. 7100,
Indraprastha Marg, New Delhi 110 002 (India)
Printed by :

© The Institute of Chartered Accountants of India

 CONTENTS

MODULE I

CHAPTER 1: Introduction to Accounting Standards

CHAPTER 2: Framework for Preparation and Presentation of Financial

Statements

CHAPTER 3: Applicability of Accounting Standards

CHAPTER 4: Presentation & Disclosures Based Accounting Standards

MODULE II

CHAPTER 5: Assets Based Accounting Standards

CHAPTER 6: Liabilities based Accounting Standards

CHAPTER 7: Accounting Standards based on items impacting Financial

Statements

CHAPTER 8: Revenue based Accounting Standards

CHAPTER 9: Other Accounting Standards

CHAPTER 10: Accounting Standards for Consolidated Financial
Statements

MODULE III

CHAPTER 11: Financial Statements of Companies

CHAPTER 12: Buy back of Securities

CHAPTER 13: Amalgamation of companies

CHAPTER 14: Accounting for Reconstruction of companies

CHAPTER 15: Accounting for Branches including foreign branches.

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DETAILED CONTENTS: MODULE – 2

CHAPTER 5: ASSETS BASED ACCOUNTING STANDARDS .................. 5.1 – 5.252

UNIT 1: ACCOUNTING STANDARD 2 VALUATION OF INVENTORY ...... 5.1-5.20

Learning Outcomes ................................................................................................................ 5.1
1.1 Introduction ................................................................................................................. 5.2
1.2 Inventories.................................................................................................................... 5.2
1.3 Measurement of Inventories ................................................................................... 5.4
1.4 Costs of inventory ...................................................................................................... 5.6
1.5 Costs of purchase ....................................................................................................... 5.6
1.6 Costs of Conversion................................................................................................... 5.6
1.7 Joint or By-Products .................................................................................................. 5.7
1.8 Other Costs .................................................................................................................. 5.8
1.9 Exclusions from the cost of inventories ............................................................... 5.9
1.10 Cost Formula ............................................................................................................... 5.9
1.11 Other techniques of cost measurement .............................................................. 5.9
1.12 Estimates of Net Realisable Value ....................................................................... 5.10
1.13 Comparison of Cost and Net Realisable Value ................................................ 5.11
1.14 NRV of materials held for use or disposal ........................................................ 5.11
1.15 Disclosures ................................................................................................................. 5.12
Test Your Knowledge .......................................................................................................... 5.15

UNIT 2: ACCOUNTING STANDARD 10 Property, Plant and

Equipment ............................................................................... 5.21-5.77
Learning Outcomes .............................................................................................................. 5.21
2.1 Introduction ............................................................................................................... 5.22
2.2 Scope of the Standard ............................................................................................ 5.22
2.3 Definition of Property, Plant and Equipment (PPE) ........................................ 5.23

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2.4 Other Definitions ..................................................................................................... 5.24

2.5 Recognition Criteria for PPE .................................................................................. 5.26
2.6 Measurement of PPE .............................................................................................. 5.27

2.7 Initial Recognition .................................................................................................. 5.28

2.8 Cost of a self-constructed Asset .......................................................................... 5.33
2.9 PPE acquired in Exchange for a Non-monetary Asset or
Assets or A combination of Monetary and Non-monetary Assets ............. 5.34
2.10 Treatment of Subsequent Costs ......................................................................... 5.38
Test Your Knowledge ........................................................................................................... 5.61

UNIT 3: ACCOUNTING STANDARD 13 ACCOUNTING FOR

INVESTMENTS ....................................................................... 5.78-5.112
Learning Outcomes .............................................................................................................. 5.78
3.1 Introduction ............................................................................................................... 5.78

3.2 Definition of the terms used in the Standard................................................... 5.79

3.3 Forms of Investments .............................................................................................. 5.79
3.4 Classification of Investments ................................................................................ 5.80
3.5 Cost of Investments ................................................................................................. 5.80
3.6 Carrying Amount of Investments ......................................................................... 5.82
3.7 Investment Properties ............................................................................................. 5.86
3.8 Disposal of Investments ......................................................................................... 5.86
3.9 Reclassification of Investments ............................................................................ 5.86
3.10 Disclosure ................................................................................................................... 5.88

Test Your Knowledge .......................................................................................................... 5.98

UNIT 4: ACCOUNTING STANDARD 16 BORROWING COSTS .......... 5.113-5.136

Learning Outcomes ........................................................................................................... 5.113
4.1 Introduction ............................................................................................................ 5.113

4.2 Definitions ............................................................................................................... 5.114

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4.3 Exchange Differences on Foreign Currency Borrowings ............................ 5.115

4.4 Borrowing Costs Eligible for Capitalisation.................................................... 5.117
4.5 Recognition criteria .............................................................................................. 5.118

4.6 Specific borrowings .............................................................................................. 5.119

4.7 General borrowings .............................................................................................. 5.120
4.8 Excess of the Carrying Amount of the Qualifying Asset over
Recoverable Amount ............................................................................................ 5.120
4.9 Commencement of Capitalisation .................................................................... 5.122
4.10 Suspension of Capitalisation .............................................................................. 5.123
4.11 Cessation of Capitalisation ................................................................................. 5.124
4.12 Disclosure ................................................................................................................ 5.125
Test Your Knowledge ....................................................................................................... 5.128

UNIT 5: ACCOUNTING STANDARD 19 LEASES ................................. 5.137-5.182

Learning Outcomes ........................................................................................................... 5.137
5.1 Introduction ............................................................................................................ 5.138
5.2 Applicability of AS 19 [Scope] ........................................................................... 5.138
5.3 Definitions ............................................................................................................... 5.139
5.4 Types of leases ....................................................................................................... 5.144
5.5 Indicators of Finance Lease ................................................................................ 5.145
5.6 Deterministic Conditions ..................................................................................... 5.146
5.7 Suggestive Conditions ......................................................................................... 5.147
5.8 Accounting for Finance Leases (Books of lessee) ......................................... 5.147

5.9 Accounting for Operating Leases ..................................................................... 5.163

5.10 Sale and Leaseback ............................................................................................... 5.168
Test Your Knowledge ....................................................................................................... 5.172

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UNIT 6: ACCOUNTING STANDARD 26 INTANGIBLE ASSETS ........... 5.183-5.215

Learning Outcomes ........................................................................................................... 5.183
6.1 Introduction ............................................................................................................ 5.183
6.2 Scope ........................................................................................................................ 5.184

6.3 Definitions ............................................................................................................... 5.185

6.4 Identifiability ........................................................................................................... 5.187
6.5 Control ..................................................................................................................... 5.188

6.6 Future Economic Benefits ................................................................................... 5.189

6.7 Recognition and Initial Measurement of an Intangible Asset .................. 5.189
6.8 Separate Acquisition ............................................................................................ 5.189

6.9 Acquisition as part of an Amalgamation ........................................................ 5.190

6.10 Acquisition by way of a Government Grant ................................................... 5.191
6.11 Exchange of assets ................................................................................................ 5.192
6.12 Internally generated goodwill ........................................................................... 5.192
6.13 Internally generated intangible assets ............................................................ 5.193
6.14 Research Phase ...................................................................................................... 5.193
6.15 Development Phase .............................................................................................. 5.194
6.16 Cost of an Internally Generated Intangible Asset ........................................ 5.195
6.17 Recognition of an Expense ................................................................................. 5.197
6.18 Subsequent Expenditure ..................................................................................... 5.198
6.19 Measurement subsequent to initial recognition .......................................... 5.199
6.20 Amortisation Period ............................................................................................. 5.199
6.21 Amortisation Method ........................................................................................... 5.201
6.22 Residual Value ........................................................................................................ 5.202
6.23 Review of amortisation period and amortisation method......................... 5.202

6.24 Recoverability of the Carrying Amount-Impairment Losses ..................... 5.203

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6.25 Retirements and Disposals ................................................................................. 5.203

6.26 Disclosure ................................................................................................................ 5.204
6.27 Other Disclosures .................................................................................................. 5.205

Test Your Knowledge ........................................................................................................ 5.208

UNIT 7: ACCOUNTING STANDARD 28 IMPAIRMENT OF ASSETS ... 5.216-5.252

Learning Outcomes ........................................................................................................... 5.216
7.1 Introduction ............................................................................................................ 5.217
7.2 Scope ........................................................................................................................ 5.218
7.3 Assessment ............................................................................................................ 5.218
7.4 Measurement of Recoverable Amount ........................................................... 5.219
7.5 Basis for Estimates of Future Cash Flows ....................................................... 5.221
7.6 Composition of Estimates of Future Cash Flows .......................................... 5.222
7.7 Recognition and Measurement of an Impairment Loss ............................. 5.224
7.8 Identification of the Cash-Generating Unit to which an Asset
Belongs .................................................................................................................... 5.225
7.9 Recoverable Amount and Carrying Amount of a Cash-Generating
Unit ............................................................................................................................ 5.226
7.10 Goodwill ................................................................................................................... 5.228
7.11 Corporate Assets ................................................................................................... 5.231
7.12 Impairment Loss for a Cash-Generating Unit ................................................ 5.231
7.13 Reversal of an Impairment Loss ........................................................................ 5.233
7.14 Reversal of an Impairment Loss for an Individual Asset ............................ 5.234
7.15 Reversal of an Impairment Loss for a Cash-Generating Unit .................... 5.234
7.16 Reversal of an Impairment Loss for Goodwill ............................................... 5.235
7.17 Impairment in case of Discontinuing Operations ........................................ 5.235

7.18 Disclosure ................................................................................................................ 5.236

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7.19 Illustrations ............................................................................................................. 5.238

Test Your Knowledge ........................................................................................................ 5.243

CHAPTER-6: LIABILITIES BASED ACCOUNTING STANDARDS ............. 6.1 – 6.50

UNIT 1: ACCOUNTING STANDARD 15 EMPLOYEE BENEFITS ................ 6.1-6.27

Learning Outcomes ................................................................................................................. 6.1

1.1 Introduction ................................................................................................................. 6.2
1.2 Applicability ................................................................................................................. 6.5
1.3 Meaning of the term “Employee Benefits” .......................................................... 6.5
1.4 Short-term Employee Benefits ............................................................................... 6.6

1.5 Post Employment Benefits: Defined Contribution vs Defined Benefits..... 6.12

1.6 Is the Gratuity Scheme a Defined Contribution or Defined Benefit
Scheme? ...................................................................................................................... 6.13
1.7 Accounting Treatment ............................................................................................ 6.13
1.8 Disclosures ................................................................................................................. 6.14
1.9 Actuarial Assumptions ............................................................................................ 6.15

1.10 Actuarial Gains and Losses .................................................................................... 6.16

1.11 Other Long Term Employee Benefits .................................................................. 6.21
1.12 Termination Benefits ............................................................................................... 6.21

Test Your Knowledge ............................................................................................................ 6.22

UNIT 2: AS 29 (REVISED) PROVISIONS, CONTINGENT LIABILITIES
AND CONTINGENT ASSETS ..................................................... 6.28-6.50

Learning Outcomes ............................................................................................................... 6.28

2.1 Introduction ............................................................................................................... 6.28
2.2 Scope ........................................................................................................................... 6.30
2.3 Definitions .................................................................................................................. 6.31
2.4 Recognition of provision ........................................................................................ 6.32

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2.5 Present Obligation ................................................................................................... 6.32

2.6 Past Event ................................................................................................................... 6.33
2.7 Probable Outflow of Resources Embodying Economic Benefits ................. 6.34

2.8 Reliable Estimate of the Obligation .................................................................... 6.35

2.9 Contingent Liabilities .............................................................................................. 6.35
2.10 Contingent Assets .................................................................................................... 6.37

2.11 Measurement: Best Estimate ................................................................................. 6.38

2.12 Risks and uncertainties ........................................................................................... 6.38
2.13 Future Events ............................................................................................................. 6.39
2.14 Expected Disposal of Assets .................................................................................. 6.39
2.15 Reimbursements ....................................................................................................... 6.40
2.16 Table- Reimbursements ......................................................................................... 6.40
2.17 Changes in Provisions ............................................................................................. 6.41
2.18 Use of Provisions ...................................................................................................... 6.41
2.19 Application of the Recognition and Measurement Rules ............................. 6.42
2.20 Disclosure ................................................................................................................... 6.43
Test Your Knowledge ............................................................................................................ 6.47

CHAPTER-7: ACCOUNTING STANDARDS BASED ON ITEMS IMPACTING

FINANCIAL STATEMENT ................................................... 7.1 – 7.69
UNIT 1: ACCOUNTING STANDARD 4 CONTINGENCIES AND EVENTS
OCCURRING AFTER THE BALANCE SHEET DATE ...................... 7.1-7.13

Learning Outcomes ................................................................................................................. 7.1

1.1 Introduction ................................................................................................................. 7.1
1.2 Contingencies .............................................................................................................. 7.2
1.3 Events Occurring after the Balance Sheet Date ................................................. 7.3
1.4 Adjusting Events ......................................................................................................... 7.4

1.5 Non-Adjusting Events ............................................................................................... 7.4

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1.6 Disclosure ..................................................................................................................... 7.6

Test your knowledge............................................................................................................. 7.11
UNIT 2: ACCOUNTING STANDARD 5 NET PROFIT OR LOSS FOR
THE PERIOD, PRIOR PERIOD ITEMS AND CHANGES IN
ACCOUNTING POLICIES .......................................................... 7.13-7.27

Learning Outcomes ............................................................................................................... 7.13

2.1 Introduction ............................................................................................................... 7.13
2.2 Net Profit or Loss for the Period .......................................................................... 7.14
2.3 Prior Period Items .................................................................................................... 7.16

2.4 Changes in Accounting Estimates ....................................................................... 7.17

2.5 Changes in Accounting Policies ........................................................................... 7.19
Test Your Knowledge ............................................................................................................ 7.24
UNIT 3: ACCOUNTING STANDARD 11 THE EFFECTS OF CHANGES IN
FOREIGN EXCHANGE RATES ................................................... 7.28-7.53

Learning Outcomes ............................................................................................................... 7.28

3.1 Introduction ............................................................................................................... 7.28
3.2 Definitions of the terms used in the Standard ................................................. 7.30
3.3 Initial Recognition .................................................................................................... 7.31
3.4 Reporting at each balance sheet date................................................................ 7.32
3.5 Recognition of Exchange Differences ................................................................. 7.32
3.6 Classification of Foreign Operations as Integral or Non-integral............... 7.34
3.7 Translation of Foreign Integral Operations ..................................................... 7.35
3.8 Translation of Non-Integral Foreign Operations ............................................. 7.36
3.9 Change in the Classification of a Foreign Operation ..................................... 7.40
3.10 Tax Effects of Exchange Differences ................................................................... 7.41
3.11 Forward Exchange Contract .................................................................................. 7.41
3.12 Disclosure ................................................................................................................... 7.45

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3.13 Presentation of Foreign Currency Monetary Item Translation

Difference Account (FCMITDA)............................................................................. 7.46
Test Your Knowledge ............................................................................................................ 7.50
UNIT 4: ACCOUNTING STANDARD 22 ACCOUNTING FOR TAXES
ON INCOME ............................................................................. 7.54-7.69

Learning Outcomes ............................................................................................................... 7.54

4.1 Introduction ............................................................................................................... 7.54
4.2 Objective..................................................................................................................... 7.54
4.3 Definitions .................................................................................................................. 7.55
4.4 Recognition ................................................................................................................ 7.56
4.5 Measurement ............................................................................................................ 7.57
4.6 Re-assessment of Unrecognised Deferred Tax Assets ................................... 7.57
4.7 Review of previously recognised Deferred Tax Assets .................................. 7.57
4.8 Virtual certainty supported by convincing evidence..................................... 7.58
4.9 Disclosure ................................................................................................................... 7.58
4.10 Relevant Explanations to AS 22 ............................................................................ 7.59
Test Your Knowledge ............................................................................................................ 7.64

CHAPTER-8: REVENUE BASED ACCOUNTING STANDARDS................. 8.1 – 8.55

UNIT 1 : ACCOUNTING STANDARD 7 CONSTRUCTION
CONTRACTS ............................................................................. 8.1-8.33

Learning Outcomes ................................................................................................................. 8.1

1.1 Significance of the Standard ................................................................................... 8.2
1.2 Introduction ................................................................................................................. 8.3

1.3 Combining and Segmenting Construction Contracts ...................................... 8.4

1.4 Types of construction contracts ............................................................................. 8.6

1.5 Contract Revenue and Costs ................................................................................... 8.7

1.6 Percentage Completion Method.......................................................................... 8.12

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1.7 Treatment of Costs Relating to Future Activity................................................ 8.17

1.8 Uncollectable Contract Revenue .......................................................................... 8.17

1.9 Stage of Completion ............................................................................................... 8.18

1.10 Changes in Estimates .............................................................................................. 8.20

1.11 Disclosure ................................................................................................................... 8.20

Test Your Knowledge ............................................................................................................ 8.26

UNIT 2: ACCOUNTING STANDARD 9 REVENUE RECOGNITION .......... 8.34-8.55

Learning Outcomes ............................................................................................................... 8.34

2.1 Introduction ............................................................................................................... 8.34

2.2 Definition of Revenue ............................................................................................. 8.36

2.3 Agency Relationship ................................................................................................ 8.37

2.4 Sale of Goods ............................................................................................................ 8.39

2.5 Timing of Recognition of Revenue from Sale of Goods ................................ 8.39

2.6 Rendering of Services ............................................................................................. 8.41

2.7 Income from other sources - Interest, Royalties and Dividends ................. 8.42

2.8 Conditions for Sale of Goods ................................................................................ 8.44

2.9 Effect of Uncertainties on Revenue Recognition ............................................. 8.47

2.10 Disclosure ................................................................................................................... 8.48

Test Your Knowledge ............................................................................................................ 8.50

CHAPTER 9: OTHER ACCOUNTING STANDARDS ................................. 9.1 – 9.41

UNIT 1: ACCOUNTING STANDARD 12 ACCOUNTING FOR GOVERNMENT
GRANTS ..................................................................................... 9.1-9.22

Learning Outcomes ................................................................................................................. 9.1

1.1. Introduction ................................................................................................................. 9.2
1.2 Government Grants ................................................................................................... 9.2
1.3 Accounting Treatment of Government Grants................................................... 9.3

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1.4 Recognition of Government Grants ...................................................................... 9.3

1.5 Non-monetary Government Grants ...................................................................... 9.4
1.6 Presentation of Grants Related to Specific Fixed Assets ................................. 9.4

1.7 Presentation of Grants Related to Revenue ........................................................ 9.8

1.8 Presentation of Grants of the Nature of Promoters’ Contribution............... 9.9
1.9 Refund of Government Grants ............................................................................. 9.11

1.10 Disclosure ................................................................................................................... 9.12

Test Your Knowledge ............................................................................................................ 9.19
UNIT 2: ACCOUNTING STANDARD 14 ACCOUNTING FOR
AMALGAMATIONS .................................................................. 9.23-9.42

Learning Outcomes ............................................................................................................... 9.23

2.1 Introduction ............................................................................................................... 9.23

2.2 Definition of the Terms used in the Standard .................................................. 9.24
2.3 Types of Amalgamations ........................................................................................ 9.24
2.4 Amalgamation in the Nature of Merger ............................................................ 9.25
2.5 Amalgamation in the Nature of Purchase ......................................................... 9.26
2.6 Methods of Accounting for Amalgamations .................................................... 9.26

2.7 Consideration ............................................................................................................ 9.27

2.8 Treatment of Reserves of the Transferor Company on
Amalgamation ........................................................................................................... 9.28
2.9 Adjustments to reserves - Amalgamation in the Nature of Merger .......... 9.28
2.10 Adjustments to reserves - Amalgamation in the Nature of
Purchase...................................................................................................................... 9.29

2.11 Treatment of Goodwill Arising on Amalgamation .......................................... 9.30

2.12 Balance of Profit and Loss Account..................................................................... 9.31
2.13 Disclosures ................................................................................................................. 9.31

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2.14 Amalgamation after the Balance Sheet Date ................................................... 9.32

Test Your Knowledge ............................................................................................................ 9.38

CHAPTER 10: ACCOUNTING STANDARDS FOR CONSOLIDATED

FINANCIAL STATEMENT .......................................... 10.1 – 10.166
UNIT 1: ACCOUNTING STATNDARD 21 CONSOLIDATED FINANCIAL
STATEMENTS ....................................................................... 10.1-10.109

Learning Outcomes ............................................................................................................... 10.1

Unit Overview.......................................................................................................................... 10.2
1.1 Concept of Group, Holding Company and Subsidiary Company ............... 10.2
1.2 Objectives of AS 21.................................................................................................. 10.5
1.3 Wholly Owned and Partly Owned Subsidiaries ................................................ 10.7
1.4 Purpose of Preparing the Consolidated Financial Statements .................... 10.7
1.5 Scope of AS 21 ....................................................................................................... 10.10
1.6 Control ..................................................................................................................... 10.11
1.7 Exclusion from Preparation of Consolidated Financial Statements ........ 10.12
1.8 Advantages of Consolidated Financial Statements ..................................... 10.15
1.9 Components of Consolidated Financial Statements ................................... 10.16
1.10 Consolidation Procedures ................................................................................... 10.18
1.11. Calculation of Goodwill/Capital Reserve (Cost of Control) ....................... 10.20
1.12 Minority Interests .................................................................................................. 10.24
1.13. Profit or Loss of Subsidiary Company ............................................................. 10.26

1.14 Consolidation Adjustments ................................................................................ 10.27

1.15 Preparation of Consolidated Statement of Profit and Loss ....................... 10.73

1.16 Preparation of Consolidated Cash Flow Statement ..................................... 10.76
1.17 Uniform Accounting Policies .............................................................................. 10.78

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1.18 Treatment of Subsidiary Company having Preference Share

Capital ...................................................................................................................... 10.83

Summary ............................................................................................................................... 10.83

Test your knowledge.......................................................................................................... 10.94
UNIT 2: ACCOUNTING STANDARD 23 ACCOUNTING FOR
INVESTMENTS IN ASSOCIATES IN CONSOLIDATED
FINANCIAL STATEMENTS ................................................ 10.110-10.133
Learning Outcomes .......................................................................................................... 10.110
2.1 Introduction .......................................................................................................... 10.110
2.2 Objective................................................................................................................ 10.110
2.3 Definitions of the terms used in the Accounting Standard ..................... 10.111
2.4 Associates Accounted for using the Equity method ................................. 10.114
2.5 Circumstances under which Equity Method is followed .......................... 10.115
2.6 Application of the Equity Method .................................................................. 10.116
2.7 Contingencies ....................................................................................................... 10.124
2.8 Why is Equity Method of Accounting Adopted for Investment in
Associates? ............................................................................................................ 10.124
2.9 Disclosure .............................................................................................................. 10.125
2.10 Relevant Explanations to AS 23 ....................................................................... 10.126
Test your knowledge........................................................................................................ 10.126

UNIT 3:ACCOUNTING STANDARD 27 FINANCIAL REPORTING OF

INTERESTS IN JOINT VENTURES ...................................... 10.134-10.168
Learning Outcomes .......................................................................................................... 10.134
3.1 Introduction .......................................................................................................... 10.135
3.2 Scope ...................................................................................................................... 10.135
3.3 Definitions ............................................................................................................. 10.135
3.4 Contractual Arrangement ................................................................................. 10.136

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3.5 Forms of Joint Ventures10.136 ........................................................................ 10.138

3.6 Jointly Controlled Operations (JCO) .............................................................. 10.138
3.7 Jointly Controlled Assets (JCA) ........................................................................ 10.143

3.8 Jointly Controlled Entities (JCE) ....................................................................... 10.149

3.9 Consolidated Financial Statements of a Venturer ...................................... 10.154
3.10 Transactions between a Venturer and Joint Venture ................................ 10.161

3.11 Reporting Interests in Joint Ventures in the Financial Statements

of an Investor ....................................................................................................... 10.162
3.12 Operators of Joint Ventures ............................................................................. 10.162
3.13 Disclosure .............................................................................................................. 10.162
Test your knowledge........................................................................................................ 10.163

CASE SCENARIOS .............................................................................. CS.1 – CS.15

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ASSETS BASED ACCOUNTING

STANDARDS

UNIT 1: ACCOUNTING STANDARD 2

VALUATION OF INVENTORY

LEARNING OUTCOMES
After studying this unit, you will be able to comprehend the

 Definition of Inventory;

 Measurement of Inventories;

 What is included in Cost of Inventories;

 Exclusions from the Cost of Inventories;

 Cost Formulas;

 Techniques for the Measurement of Cost.

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1.1v INTRODUCTION
The accounting treatment for inventories is prescribed in AS 2 (Revised)
‘Valuation of Inventories’, which provides guidance for determining the value at
which inventories, are carried in the financial statements until related revenues
are recognised. It also provides guidance on the cost formulas that are used to
assign costs to inventories and any write-down thereof to net realisable value.

1.2 INVENTORIES
AS 2 (Revised) defines inventories as assets held
• for sale in the ordinary course of business, or
• in the process of production for such sale, or
• for consumption in the production of goods or services for sale, including
maintenance supplies and consumables other than machinery spares, servicing
equipment and standby equipment meeting the definition of Property, plant
and equipment.
Inventories encompass goods purchased and held for resale, for example
merchandise (goods) purchased by a retailer and held for resale, or land and other
property held for resale. Inventories also include finished goods produced, or work in
progress being produced, by the enterprise and include materials, maintenance
supplies, consumables and loose tools awaiting use in the production process.
Inventories do not include spare parts, servicing equipment and standby equipment
which meet the definition of property, plant and equipment as per AS 10 (Revised),
Property, Plant and Equipment. Such items are accounted for in accordance with
Accounting Standard (AS) (Revised) 10, Property, Plant and Equipment.

Following are excluded from the scope of AS 2 (Revised).

(a) Work in progress arising under construction contracts, i.e. cost of part
construction, including directly related service contracts, being covered under
AS 7, Accounting for Construction Contracts; Inventory held for use in
construction, e.g. cement lying at the site should however be covered by AS 2
(Revised).

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5.3
ASSETS BASED ACCOUNTING STANDARDS
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(b) v
Work in progress arising in the ordinary course of business of service providers
i.e. cost of providing a part of service. For example, for a shipping company,v
fuel and stores not consumed at the end of accounting period is inventory but
not costs for voyage-in-progress. Work-in-progress may arise for different
other services e.g. software development, consultancy, medical services,
merchant banking and so on.
(c) Shares, debentures and other financial instruments held as stock-in-trade. It
should be noted that these are excluded from the scope of AS 13 (Revised) as
well. The current Indian practice is however to value them at lower of cost and
fair value.
(d) Producers’ inventories of livestock, agricultural and forest products, and
mineral oils, ores and gases to the extent that they are measured at net
realisable value in accordance with well established practices in those
industries, e.g. where sale is assured under a forward contract or a government
guarantee or where a homogenous market exists and there is negligible risk of
failure to sell.
The types of inventories are related to the nature of business. The inventories of a
trading concern consist primarily of products purchased for resale in their existing
form. It may also have an inventory of supplies such as wrapping paper, cartons,
and stationery. The inventories of manufacturing concern consist of several types
of inventories: raw material (which will become part of the goods to be
produced), parts and factory supplies, work-in-process (partially completed
products in the factory) and, of course, finished products.

At the year end every business entity needs to ascertain the closing balance of
Inventory which comprise of Inventory of raw material, work-in-progress, finished
goods and miscellaneous items. The cost of closing inventory, e.g. cost of closing
stock of raw materials, closing work-in-progress and closing finished stock, is a
part of costs incurred in the current accounting period that is carried over to next
accounting period. Likewise, the cost of opening inventory is a part of costs
incurred in the previous accounting period that is brought forward to current
accounting period.
Since inventories are assets, and assets are resources expected to generate future
economic benefits to the enterprise, the costs to be included in inventory costs,

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are costs that are expected to generate future economic benefits to the
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enterprise. Such costs must be costs of acquisition and costs incurred in bringing
the assets to their present (i) location of the inventory, e.g. freight incurred to
carry the materials to factory and (ii) conditions of the inventory, e.g. costs
incurred to convert the materials into finished stock. The costs incurred to
maintain the inventory, e.g. storage costs, do not generate any extra economic
benefits for the enterprise and therefore should not be included in inventory
costs unless those costs are necessary in production process prior to a further
production stage.
The valuation of inventory is crucial because of its direct impact in measuring
profit/loss for an accounting period. Higher the value of closing inventory lower is
the cost of goods sold and hence higher is the profit. The principle of prudence
demands that no profit should be anticipated while all foreseeable losses should
be recognised. Thus, if net realisable value of inventory is less than inventory cost,
inventory is valued at net realisable value to reduce the reported profit in
anticipation of loss. On the other hand, if net realisable value of inventory is more
than inventory cost, the anticipated profit is ignored and the inventory is valued
at cost. In short, inventory is valued at lower of cost and net realisable value. The
standard specifies (i) what the cost of inventory should consist of and (ii) how the
net realisable value is determined.
Abnormal gains or losses are not expected to recur regularly. For a meaningful
analysis of an enterprise’s performance, the users of financial statements need to
know the amount of such gains/losses included in current profit/loss. For this
reason, instead of taking abnormal gains and losses in inventory costs, these are
shown in the Profit and Loss statement in such way that their impact on current
profit/loss can be perceived.

Part I of Schedule III to the Companies Act, 2013 prescribes that valuation method
should be disclosed for inventory held by companies.

1.3 MEASUREMENT OF INVENTORIES

Inventories should be valued at lower of cost and net realisable value. 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

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the sale. The valuation of inventory at lower of cost and net realisable value vis
v
based on the view that no asset should be carried at a value which is in excess of
the value realisable by its sale or use.

Inventories

Raw Materials Finished Goods and

Work in progress
At cost (if
finished goods Lower of the following
are sold at or
above cost),
otherwise at Net Realisable
Cost
replacement Value
cost
Realisable Value
Cost of Cost of Other
Less Selling
Purchase Conversion Costs
Expenses less
estimated cost of
completion

Example 1
Cost of a partly finished unit at the end of 20X1-X2 is ` 150. The unit can be
finished next year by a further expenditure of ` 100. The finished unit can be sold at
` 250, subject to payment of 4% brokerage on selling price. Assume that the partly
finished unit cannot be sold in semi-finished form and its NRV is zero without
processing it further. The value of inventory will be determined as below:

`
Net selling price 250
Less: Estimated cost of completion (100)
150
Less: Brokerage (4% of 250) (10)
Net Realisable Value 140
Cost of inventory 150
Value of inventory (Lower of cost and net realisable value) 140

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1.4v COSTS OF INVENTORY
Costs of inventories comprise all costs of purchase, costs of conversion and other
costs incurred in bringing the inventories to their present location and condition.

1.5 COSTS OF PURCHASE

The costs of purchase consist of the purchase price including duties and taxes
(other than those subsequently recoverable by the enterprise from the taxing
authorities, and other expenditure directly attributable to the acquisition. Trade
discounts, rebates, duty drawbacks and other similar items are deducted in
determining the costs of purchase.

1.6 COSTS OF CONVERSION

The costs of conversion include costs directly related to production, e.g. direct
labour. They also include overheads, both fixed and variable that are incurred in
converting raw material to finished goods.

The fixed production overheads should be absorbed systematically to units of

production over normal capacity. Normal capacity is the production the
enterprise expects to achieve on an average over a number of periods or seasons
under normal circumstances, taking into account the loss of capacity resulting
from planned maintenance. The actual level of production may be used if it
approximates the normal capacity. The amount of fixed production overheads
allocated to each unit of production should not be increased as a consequence of
low production or idle plant. Unallocated overheads (i.e. under recovery) are
recognised as an expense in the period in which they are incurred. In periods of
abnormally high production, the amount of fixed production overheads allocated
to each unit of production is decreased so that inventories are not measured
above cost. Variable production overheads are assigned to each unit of
production on the basis of the actual use of the production facilities.

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Example 2 v
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ABC Ltd. has a plant with the capacity to produce 1 lac unit of a product per annum
and the expected fixed overhead is ` 18 lacs. Fixed overhead on the basis of normal
capacity is ` 18 (18 lacs/1 lac).
Case 1: Actual production is 1 lac units. Fixed overhead on the basis of normal
capacity and actual overhead will lead to same figure of ` 18 lacs. Therefore, it is
advisable to include this on normal capacity.
Case 2: Actual production is 90,000 units. Fixed overhead is not going to change
with the change in output and will remain constant at ` 18 lacs, therefore,
overheads on actual basis is ` 20 per unit (18 lacs/ 90 thousands). Hence by valuing
inventory at ` 20 each for fixed overhead purpose, it will be overvalued and the
losses of ` 1.8 lacs will also be included in closing inventory leading to a higher
gross profit then actually earned. Therefore, it is advisable to include fixed overhead
per unit on normal capacity to actual production (90,000 x 18) ` 16.2 lacs and rest `
1.8 lacs should be transferred to Profit & Loss Account.
Case 3: Actual production is 1.2 lacs units. Fixed overhead is not going to change
with the change in output and will remain constant at ` 18 lacs, therefore,
overheads on actual basis is ` 15 (18 lacs/ 1.2 lacs). Hence by valuing inventory at `
18 each for fixed overhead purpose, we will be adding the element of cost to
inventory which actually has not been incurred. At ` 18 per unit, total fixed
overhead comes to ` 21.6 lacs whereas, actual fixed overhead expense is only ` 18
lacs. Therefore, it is advisable to include fixed overhead on actual basis (1.2 lacs x
15) ` 18 lacs.

1.7 JOINT OR BY-PRODUCTS

In case of joint or by products, the costs incurred up to the stage of split off
should be allocated on a rational and consistent basis. The basis of allocation may
be sale value at split off point, for example, value of by products, scraps and
wastes are usually not material. These are therefore valued at net realisable value.
The cost of main product is then valued as joint cost minus net realisable value of
by-products, scraps or wastes.

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1.8 v OTHER COSTS
(a) These may be included in cost of inventory provided they are incurred to bring
the inventory to their present location and condition. Cost of design, for
example, for a custom made unit may be taken as part of inventory cost.
(b) Interest and other borrowing costs are usually considered as not relating to
bringing the inventories to their present location and condition. These costs
are therefore not usually included in cost of inventory. Interests and other
borrowing costs however are taken as part of inventory costs, where the
inventory necessarily takes substantial period of time for getting ready for
intended sale. Example of such inventory is wine.
(c) The standard is silent on treatment of amortisation of intangibles for
ascertaining inventory costs. It nevertheless appears that amortisation of
intangibles related to production, e.g. patents right of production or
copyright for a publisher should be taken as part of inventory costs.

(d) Exchange differences are not taken in inventory costs.

Conversion Cost

Factory Overheads Direct labour Joint Cost

Fixed Variable Main/Joint*** By Products

Sale Value Measured at NRV.

at Sale Value This NRV is
At Normal At actual At actual
Separation at deducted from
Capacity* Production** Production
completion cost of main /
joint products

*When actual production is almost equal or lower than normal capacity.

** When actual production is higher than normal capacity.
*** Allocation at reasonable and consistent basis.

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1.9 EXCLUSIONS FROM THE COST OF
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INVENTORIES
In determining the cost of inventories, it is appropriate to exclude certain costs
and recognise them as expenses in the period in which they are incurred.
Examples of such costs are:
(a) Abnormal amounts of wasted materials, labour, or other production costs;

(b) Storage costs, unless the production process requires such storage;
(c) Administrative overheads that do not contribute to bringing the inventories to
their present location and condition;
(d) Selling and distribution costs.

1.10 COST FORMULA

Mostly inventories are purchased / made in different lots and unit cost of each lot
frequently differs. In all such circumstances, determination of closing inventory
cost requires identification of units in stock to have come from a particular lot.
This specific identification is best wherever possible. In all other cases, the cost of
inventory should be determined by the First-In First-Out (FIFO), or Weighted
Average cost formula. The formula used should reflect the fairest possible
approximation to the cost incurred in bringing the items of inventory to their
present location and condition.

1.11 OTHER TECHNIQUES OF COST

MEASUREMENT
(a) Instead of actual, the standard costs may be taken as cost of inventory
provided standards fairly approximate the actual. Such standards (for finished
or partly finished units) should be set in the light of normal levels of material
consumption, labour efficiency and capacity utilisation. The standards so set
should be regularly reviewed and if necessary, be revised to reflect current
conditions.

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(b) v
In retail business, where a large number of rapidly changing items are traded,
v
the actual costs of items may be difficult to determine. The units dealt by a
retailer however, are usually sold for similar gross margins and a retail method
to determine cost in such retail trades makes use of the fact. By this method,
cost of inventory is determined by reducing sale value of unsold stock by
appropriate average percentage of gross margin.
Example 3
A trader purchased certain articles for ` 85,000. He sold some of articles for
` 1,05,000. The average percentage of gross markup is 25% on cost. Opening stock
of inventory at cost was ` 15,000.
Cost of closing inventory is shown below:

Sale value of opening stock and purchase 1,25,000

(` 85,000 + ` 15,000) x 1.25

Sales (1,05,000)

Sale value of unsold stock 20,000

Less: Gross Markup (` 20,000 / 1.25) x 0.25 (4,000)

Cost of inventory 16,000

Note: Margin is on sales and mark-up is on cost.

1.12 ESTIMATES OF NET REALISABLE VALUE

Estimates of net realisable value are based on the most reliable evidence available
at the time the estimates are made as to the amount the inventories are expected
to realise. These estimates take into consideration fluctuations of price or cost
directly relating to events occurring after the balance sheet date to the extent
that such events confirm the conditions existing at the balance sheet date.

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1.13 COMPARISON OF COST AND NET
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REALISABLE VALUE
The comparison between cost and net realisable value should be made on item-
by-item basis. In some cases nevertheless, it may be appropriate to group similar
or related items.
Example 4
The cost, net realisable value and inventory value of two items that a company has
in its inventory are given below:

Cost Net Realisable Value Inventory Value

` ` `
Item 1 50,000 45,000 45,000
Item 2 20,000 24,000 20,000
Total 70,000 69,000 65,000
Estimates of NRV should be based on evidence available at the time of estimation.
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. AS 2 (Revised) also provides that estimates of net realisable value are to be
based on the most reliable evidence available at the time the estimates are made as
to the amount the inventories are expected to realise. These estimates take into
consideration fluctuations of price or cost directly relating to events occurring after
the balance sheet date to the extent that such events confirm the conditions
existing at the balance sheet date.

1.14 NRV OF MATERIALS HELD FOR USE OR

DISPOSAL
Materials and other supplies held for use in the production of inventories are not
written down below cost if the selling price of finished product containing the
material exceeds the cost of the finished product. The reason is, as long as these
conditions hold the material realises more than its cost as shown below.

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Review of net realisable value at each balance sheet date
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An assessment is made of net realisable value as at each balance sheet date.

1.15 DISCLOSURES
The financial statements should disclose:
(a) The accounting policies adopted in measuring inventories, including the cost
formula used; and
(b) The total carrying amount of inventories together with a classification
appropriate to the enterprise.
Information about the carrying amounts held in different classifications of
inventories and the extent of the changes in these assets is useful to financial
statement users. Common classifications of inventories are
(1) raw materials and components,
(2) work in progress,
(3) finished goods,
(4) Stock-in-trade (in respect of goods acquired for trading),
(5) stores and spares,
(6) loose tools, and
(7) Others (specify nature).
Illustration 1
The company deals in three products, A, B and C, which are neither similar nor
interchangeable. At the time of closing of its account for the year 20X1-X2, the
Historical Cost and Net Realisable Value of the items of closing stock are
determined as follows:

Items Historical Cost (` in lakhs) Net Realisable Value ( ` in lakhs)

A 40 28
B 32 32
C 16 24

What will be the value of closing stock?

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Solution v
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As per AS 2 (Revised) on ‘Valuation of Inventories’, inventories should be valued
at the lower of cost and net realisable value. Inventories should be written down
to net realisable value on an item-by-item basis in the given case.

Items Historical Cost Net Realisable Value Valuation of closing

(` in lakhs) stock (` in lakhs)
(` in lakhs)

A 40 28 28

B 32 32 32
C 16 24 16

88 84 76

Hence, closing stock will be valued at ` 76 lakhs.

Illustration 2
X Co. Limited purchased goods at the cost of ` 40 lakhs in October, 20X1. Till
March, 20X2, 75% of the stocks were sold. The company wants to disclose closing
stock at 10 lakhs. The expected sale value is ` 11 lakhs and a commission at 10%
on sale is payable to the agent. Advise, what is the correct closing stock to be
disclosed as at 31.3.20X2.
Solution
As per AS 2 (Revised) “Valuation of Inventories”, the inventories are to be valued
at lower of cost or net realisable value.
In this case, the cost of inventory is ` 10 lakhs. The net realisable value is
11,00,000  90% = ` 9,90,000. So, the stock should be valued at ` 9,90,000.
Illustration 3
In a production process, normal waste is 5% of input. 5,000 MT of input were put in
process resulting in wastage of 300 MT. Cost per MT of input is ` 1,000. The entire
quantity of waste is on stock at the year end. State with reference to Accounting
Standard, how will you value the inventories in this case?

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Solutionv
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As per AS 2 (Revised), abnormal amounts of wasted materials, labour and other
production costs are excluded from cost of inventories and such costs are
recognised as expenses in the period in which they are incurred.

In this case, normal waste is 250 MT and abnormal waste is 50 MT. The cost of
250 MT will be included in determining the cost of inventories (finished goods) at
the year end. The cost of abnormal waste (50 MT x 1,052.6315 = ` 52,632) will be
charged to the profit and loss statement.

Cost per MT (Normal Quantity of 4,750 MT) = 50,00,000 / 4,750 = ` 1,052.6315

Total value of inventory = 4,700 MT x ` 1,052.6315 = ` 49,47,368.

Illustration 4
You are required to value the inventory per kg of finished goods consisting of:

` per kg.

Material cost 200

Direct labour 40

Direct variable overhead 20

Fixed production charges for the year on normal working capacity of 2 lakh kgs is
` 20 lakhs. 4,000 kgs of finished goods are in stock at the year end.
Solution
In accordance with AS 2 (Revised), the cost of conversion include a systematic
allocation of fixed and variable overheads that are incurred in converting
materials into finished goods. The allocation of fixed overheads for the purpose
of their inclusion in the cost of conversion is based on normal capacity of the
production facilities.

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Cost per kg. of finished goods: v
v
`

Material Cost 200

Direct Labour 40

Direct Variable Production Overhead 20

 20,00,000 
  10 70
Fixed Production Overhead  2,00,000 

270

Hence the value of 4,000 kgs. of finished goods = 4,000 kgs x ` 270 = ` 10,80,000

TEST YOUR KNOWLEDGE

Multiple Choice Questions
1. Which item of inventory is under the scope of AS 2 (Revised)?
(a) WIP arising under construction contracts
(b) Raw materials
(c) Shares
(d) Debentures held as stock in trade.
2. Materials and other supplies held for use in the production of inventories are
not written down below cost if the finished products in which they will be
incorporated are expected to be
(a) sold at or above cost.

(b) sold above cost.

(c) sold less than cost.
(d) sold at market value(where market value is more than cost).

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3. v
All of the following costs are excluded while computing value of inventories
v
except?

(a) Selling and Distribution costs

(b) Allocated fixed production overheads based on normal capacity.
(c) Abnormal wastage
(d) Storage costs (which is not necessary part of the production process)

4. Identify the statement(s) which is/are incorrect.

(a) Storage costs which is a necessary part of the production process is
included in inventory valuation.
(b) Administration overheads are never included in inventory valuation.
(c) Full amount of variable production overheads incurred are included in
inventory valuation.
(d) Administration overheads are always included in inventory valuation.

Theoretical Questions
5. “In determining the cost of inventories, it is appropriate to exclude certain costs
and recognise them as expenses in the period in which they are incurred”.
Provide examples of such costs as per AS 2 (Revised) ‘Valuation of Inventories’.

Scenario base Questions

6. Capital Cables Ltd., has a normal wastage of 4% in the production process.
During the year 20X1-20X2 the Company used 12,000 MT of raw material
costing ` 150 per MT. At the end of the year 630 MT of wastage was in stock.
The accountant wants to know how this wastage is to be treated in the books.
Explain in the context of AS 2 (Revised) the treatment of normal loss and
abnormal loss and also find out the amount of abnormal loss, if any.
7. Mr. Mehul gives the following information relating to items forming part of
inventory as on 31-3-20X1. His factory produces Product X using Raw
material A.

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(i) v
600 units of Raw material A (purchased @ ` 120). Replacement cost of
raw material A as on 31-3-20X1 is ` 90 per unit. v

(ii) 500 units of partly finished goods in the process of producing X and cost
incurred till date ` 260 per unit. These units can be finished next year by
incurring additional cost of ` 60 per unit.

(iii) 1500 units of finished Product X and total cost incurred ` 320 per unit.
Expected selling price of Product X is ` 300 per unit.
Determine how each item of inventory will be valued as on 31-3-20X1. Also
calculate the value of total inventory as on 31-3-20X1.
8. On 31st March 20X1, a business firm finds that cost of a partly finished unit
on that date is ` 530. The unit can be finished in 20X1-X2 by an additional
expenditure of ` 310. The finished unit can be sold for ` 750 subject to
payment of 4% brokerage on selling price. The firm seeks your advice
regarding the amount at which the unfinished unit should be valued as at
31st March, 20X1 for preparation of final accounts. Assume that the partly
finished unit cannot be sold in semi-finished form and its NRV is zero without
processing it further.

9. Alpha Ltd. sells flavored milk to customers; some of the customers consume
the milk in the shop run by Alpha Limited. While leaving the shop, the
consumers leave the empty bottles in the shop 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.
Keeping this in view:
Decide whether the inventory of empty bottles is an asset of the company;
If so, whether the inventory of empty bottles existing as on the date of
Balance Sheet is to be considered as inventories of the company and valued
as per AS 2 or to be treated as scrap and shown at realizable value with
corresponding credit to ‘Other Income’?

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ANSWERS/SOLUTION
Answer to the Multiple Choice Questions
1. (b) 2. (a) 3. (b) 4. (b)

Answer to the Theoretical Questions

5. As per AS 2 (Revised) ‘Valuation of Inventories’, certain costs are excluded from
the cost of the inventories and are recognised as expenses in the period in
which incurred. Examples of such costs are:
(a) abnormal amount of wasted materials, labour, or other production costs;
(b) storage costs, unless those costs are necessary in the production
process prior to a further production stage;
(c) administrative overheads that do not contribute to bringing the
inventories to their present location and condition; and
(d) selling and distribution costs.

Answer to the Scenario base Questions

6. As per AS 2 (Revised) ‘Valuation of Inventories’, abnormal amounts of
wasted materials, labour and other production costs are excluded from cost
of inventories and such costs are recognised as expenses in the period in
which they are incurred. The normal loss will be included in determining the
cost of inventories (finished goods) at the year end.
Amount of Abnormal Loss:
Material used 12,000 MT @ `150 = `18,00,000
Normal Loss (4% of 12,000 MT) 480 MT
Net quantity of material 11,520 MT
Abnormal Loss in quantity 150 MT

Abnormal Loss ` 23,437.50

[150 units @ ` 156.25 (` 18,00,000/11,520)]
Amount ` 23,437.50 will be charged to the Statement of Profit and Loss.

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7. As per AS 2 (Revised) “Valuation of Inventories”, materials and other v
supplies held for use in the production of inventories are not written down v
below cost if the finished products in which they will be incorporated are
expected to be sold at cost or above cost. However, when there has been a
decline in the price of materials and it is estimated that the cost of the
finished products will exceed net realisable value, the materials are written
down to net realisable value. In such circumstances, the replacement cost of
the materials may be the best available measure of their net realisable
value. In the given case, selling price of product X is ` 300 and total cost per
unit for production is ` 320.
Hence the valuation will be done as under:

(i) 600 units of raw material will be written down to replacement cost as
market value of finished product is less than its cost, hence valued at
` 90 per unit.

(ii) 500 units of partly finished goods will be valued at 240 per unit i.e.
lower of cost (` 260) or Net realisable value ` 240 (Estimated selling
price ` 300 per unit less additional cost of ` 60).

(iii) 1,500 units of finished product X will be valued at NRV of ` 300 per
unit since it is lower than cost ` 320 of product X.
Valuation of Total Inventory as on 31.03.20X1:

Units Cost NRV / Value = units x

(`) Replacement cost or NRV
cost whichever is less
(`)

Raw material A 600 120 90 54,000

Partly finished goods 500 260 240 1,20,000

Finished goods X 1,500 320 300 4,50,000
Value of Inventory 6,24,000

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8. v Valuation of unfinished unit

`
Net selling price 750
Less: Estimated cost of completion (310)

440
Less: Brokerage (4% of 750) (30)

Net Realisable Value 410

Cost of inventory 530

Value of inventory (Lower of cost and net realisable value) 410

9. As per the ‘Framework on Presentation and Preparation of Financial

Statements’:
Tangible objects or intangible rights carrying probable future benefits,
owned by an enterprise are called assets.
Alpha 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.
As per AS 2, 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 Alpha Ltd. has detailed controlled recording and accounting
procedure which duly signify its materiality.
Thus, inventory of empty bottles cannot be considered as scrap and should
be valued as inventory in accordance with AS 2.

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UNIT 2: ACCOUNTING STANDARD 10
PROPERTY, PLANT AND EQUIPMENT

LEARNING OUTCOMES
After studying this unit, you will be able to comprehend the
 Definition of PPE
 What is the Recognition Criteria for PPE
• Initial Costs
• Subsequent Costs
 Measurement at Recognition
• What is included in elements of Cost
• Measurement of Cost
 Measurement after Recognition
• Cost Model
• Revaluation Model
 Depreciation
• Depreciable Amount and Useful life
• Depreciation Method
 Retirement in case of PPE
 Derecognition aspects
 Disclosure requirements.

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2.1 v INTRODUCTION
The objective of this Standard is to prescribe accounting treatment for Property,
Plant and Equipment (PPE).

Help the Information about

Prescribe Users of Investment in PPE
Objectives of "Accounting Financial
AS 10 (Revised) Treatment Statements
for PPE" to Changes in such
understand Investment

The principal issues in Accounting for PPE are:

Determination
Depreciation
of their carrying
charge
amounts

Impairment
Recognition of losses to be
PPE Principle recognised in
Issues in relation to
Accounting them
of PPE

2.2 SCOPE OF THE STANDARD

As a general principle, AS 10 (Revised) should be applied in accounting for PPE.
Exception:
When another Accounting Standard requires or permits a different accounting
treatment.
Example:
AS 19 on Leases, requires an enterprise to evaluate its recognition of an item of
leased PPE on the basis of the transfer of risks and rewards. However, it may be
noted that in such cases other aspects of the accounting treatment for these assets,
including depreciation, are prescribed by this Standard.

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ASSETS BASED ACCOUNTING STANDARDS
v
v v
v
AS 10 (Revised)
v
Not Applicable to

Biological Assets (other than Wasting Assets including Mineral

Bearer Plants) related to rights, Expenditure on the exploration
agricultural activity for and extraction of minerals, oil,
natural gas and similar non-
regenerative resources

Note: AS 10 (Revised) applies to Bearer Plants but it does not apply to the produce
on Bearer Plants.

Clarifications:
1. AS 10 (Revised) applies to PPE used to develop or maintain the assets
described above.
2. Investment property (defined in AS 13 (Revised)), should be accounted for
only in accordance with the Cost model prescribed in this standard.

2.3 DEFINITION OF PROPERTY, PLANT AND

EQUIPMENT (PPE)
There are 2 conditions to be satisfied for a TANGIBLE item to be called PPE. PPE are
tangible items that:

Use in Production or Supply

of Goods or Services, or
Condition 1:
Held for For Rental to others, or
PPE
For Administrative purposes
(Tangible Items)
Condition 2: Used for more than 12
Expected to be months

Note: Intangible items are covered under AS 26.

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 5.24 ADVANCED ACCOUNTING
v
v
v
“Administrative purposes”: The term ‘Administrative purposes’ has been used in
v
wider sense to include all business purposes. Thus, PPE would include assets used
for:
• Selling and distribution
• Finance and accounting

• Personnel and other functions of an Enterprise.

Items of PPE may also be acquired for safety or environmental reasons.
The acquisition of such PPE, although not directly increasing the future economic
benefits of any particular existing item of PPE, may be necessary for an enterprise
to obtain the future economic benefits from its other assets.
Such items of PPE qualify for recognition as assets because they enable an
enterprise to derive future economic benefits from related assets in excess of what
could be derived had those items not been acquired.
Example:

A chemical manufacturer may install new chemical handling processes to comply

with environmental requirements for the production and storage of dangerous
chemicals; related plant enhancements are recognised as an asset because without
them the enterprise is unable to manufacture and sell chemicals.
The resulting carrying amount of such an asset and related assets is reviewed for
impairment in accordance with AS 28 ‘Impairment of Assets’.

2.4 OTHER DEFINITIONS

1. Biological Asset: An Accounting Standard on “Agriculture” is under
formulation, which will, inter alia, cover accounting for livestock. Till the time,
the Accounting Standard on “Agriculture” is issued, accounting for livestock
meeting the definition of PPE, will be covered as per AS 10 (Revised).

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ASSETS BASED ACCOUNTING STANDARDS
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v v
v
AS 10 (Revised) v
Living Animal does not apply if definition of
PPE not met
Biological Asset
AS 10 (Revised) applies to
Plant
Bearer Plants

2. Bearer Plant: Is a plant that (satisfies all 3 conditions):

Is used in the production or supply •Of Agricultural produce

•For more than a period of

Is expected to bear produce
12 months

Has a remote likelihood of being •Except for incidental scrap

sold as Agricultural produce sales

Note: When bearer plants are no longer used to bear produce they might be cut
down and sold as scrap. For example - use as firewood. Such incidental scrap sales
would not prevent the plant from satisfying the definition of a Bearer Plant.

What are not

"Bearer Plants"

Plants cultivated to be Plants cultivated to Produce when Annual Crops

harvested as Agricultural there is more than a remote
produce likelihood that the entity will also
harvest and sell the plant as
agricultural produce, other than as Maize and wheat
Trees grown for use as incidental scrap sales
lumber

Trees which are cultivated both for

their fruit and their lumber

Agricultural Produce is the harvested product of Biological Assets of the

enterprise.

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 5.26 ADVANCED ACCOUNTING
v
v
3. v
Agricultural Activity: Is the management by an Enterprise of:
v
o Biological transformation; and

o Harvest of Biological Assets

• For sale, Or
• For conversion into Agricultural Produce, Or
• Into additional Biological Assets

For Sale
Biological
Agricultural transformation For Conversion into
Management Agriculture Produce
Activity and harvest of
Biological Assets
Into Additional
Biological Assets

2.5 RECOGNITION CRITERIA FOR PPE

The cost of an item of PPE should be recognised as an asset if, and only if:

o It is probable that future economic benefits associated with the item will flow
to the enterprise, and
o The cost of the item can be measured reliably.
Notes:
1. It may be appropriate to aggregate individually insignificant items, such as
moulds, tools and dies and to apply the criteria to the aggregate value.
2. An enterprise may decide to expense an item which could otherwise have
been included as PPE, because the amount of the expenditure is not material.
Illustration 1 (Capitalising the cost of “Remodelling” a Supermarket)
Entity A, a supermarket chain, is renovating one of its major stores. The store will
have more available space for in store promotion outlets after the renovation and
will include a restaurant. Management is preparing the budgets for the year after the
store reopens, which include the cost of remodelling and the expectation of a 15%
increase in sales resulting from the store renovations, which will attract new
customers. State whether the remodelling cost will be capitalised or not.

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ASSETS BASED ACCOUNTING STANDARDS
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v v
Solution v
v
The expenditure in remodelling the store will create future economic benefits (in
the form of 15% of increase in sales) and the cost of remodelling can be measured
reliably, therefore, it should be capitalised.
Treatment of Spare Parts, Stand by Equipment and Servicing
Equipment
Case I If they meet the definition of PPE as per AS 10 (Revised):
• Recognised as PPE as per AS 10 (Revised)
Case II If they do not meet the definition of PPE as per AS 10 (Revised):
• Such items are classified as Inventory as per AS 2 (Revised)
When do we apply the above criteria for Recognition?
An enterprise evaluates under this recognition principle all its costs on PPE at the
time they are incurred.
These costs include costs incurred:

Situation I To acquire or construct an

Initially item of PPE
Cost Incurred
Situation II To add to, replace part of,
Subsequently or service it

2.6 MEASUREMENT OF PPE

Cost Model
At Recognition
Measurement Cost Model
After Recognition
Revaluation Model

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v
v
2.7v INITIAL RECOGNITION
An item of PPE that qualifies for recognition as an asset should be measured at its
cost.
What are the elements of Cost?
Cost of an item of PPE comprises:

Cost of an Item of
PPE

Includes Excludes

Any Directly Decommissioning, 1. Costs of opening a new

Purchase
Attributable Restoration and facility or business (Such as,
Price
Costs similar Liabilities Inauguration costs)
2. Costs of introducing a new
product or service (including
costs of advertising and
promotional activities)
3. Costs of conducting
business in a new location or
with a new class of customer
(including costs of staff
training)
4. Administration and other
general overhead costs

Let us understand the above in detail.

A. Purchase Price:
• It includes import duties and non –refundable purchase taxes.

• It requires deduction of Trade discounts and rebates

B. Directly Attributable Costs:
Any costs directly attributable to bringing the asset to the ‘location and condition’
necessary for it to be capable of operating in the manner intended by management.
Recognition of costs in the carrying amount of an item of PPE ceases when the item

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ASSETS BASED ACCOUNTING STANDARDS
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v v
v
is in the location and condition necessary for it to be capable of operating in the
manner intended by management. v

The following costs are not included in the carrying amount of an item of PPE:
1. Costs incurred while an item capable of operating in the manner intended by
management has yet to be brought into use or is operated at less than full
capacity.
2. Initial operating losses, such as those incurred while demand for the output
of an item builds up. And

3. Costs of relocating or reorganising part or all of the operations of an

enterprise.
Examples of directly attributable costs are:

1. Costs of employee benefits (as defined in AS 15) arising directly from the
construction or acquisition of the item of PPE
2. Costs of site preparation

3. Initial delivery and handling costs

4. Installation and assembly costs
5. Costs of testing whether the asset is functioning properly, after deducting the
net proceeds from selling any items produced while bringing the asset to that
location and condition (such as samples produced when testing equipment)
6. Professional fees

Examples of costs that are not costs of an item of property, plant and
equipment are:
(a) costs of opening a new facility or business, such as, inauguration costs

(b) costs of introducing a new product or service (including costs of advertising

and promotional activities)
(c) costs of conducting business in a new location or with a new class of customer
(including costs of staff training)
(d) administration and other general overhead costs

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v
v
v
Note: Some operations occur in connection with the construction or development
v
of an item of PPE but are not necessary to bring the item to the location and
condition necessary for it to be capable of operating in the manner intended by
management. These incidental operations may occur before or during the
construction or development activities.

Example:
Income may be earned through using a building site as a car park until construction
starts because incidental operations are not necessary to bring an item to the location
and condition necessary for it to be capable of operating in the manner intended by
management, the income and related expenses of incidental operations are
recognised in the Statement of Profit and Loss and included in their respective
classifications of income and expense.

Income earned during

development of PPE

Directly Attributable
Incomes (e.g. sale of Not directly attriubtable
debris/ scrap material to the asset (e.g. car
on demolition in case parking rental income)
of redevelopment

Recognize as income in
Adjust from the cost of the Statement of Profit
PPE and Loss

Illustration 2
Entity A has an existing freehold factory property, which it intends to knock down and
redevelop. During the redevelopment period the company will move its production
facilities to another (temporary) site. The following incremental costs will be incurred:
1. Setup costs of ` 5,00,000 to install machinery in the new location.
2. Rent of ` 15,00,000

© The Institute of Chartered Accountants of India

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ASSETS BASED ACCOUNTING STANDARDS
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v v
3. v
Removal costs of ` 3,00,000 to transport the machinery from the old location
to the temporary location. v

Can these costs be capitalised into the cost of the new building?
Solution
Constructing or acquiring a new asset may result in incremental costs that would have
been avoided if the asset had not been constructed or acquired. These costs are not
to be included in the cost of the asset if they are not directly attributable to bringing
the asset to the location and condition necessary for it to be capable of operating in
the manner intended by management. The costs to be incurred by the company are in
the nature of costs of relocating or reorganising operations of the company and do
not meet the requirement of AS 10 (Revised) and therefore, cannot be capitalised.
Illustration 3
Omega Ltd. contracted with a supplier to purchase machinery which is to be installed
in its one department in three months' time. Special foundations were required for
the machinery which were to be prepared within this supply lead time. The cost of
the site preparation and laying foundations were ` 1,40,000. These activities were
supervised by a technician during the entire period, who is employed for this purpose
of ` 45,000 per month. The machine was purchased at ` 1,58,00,000 and ` 50,000
transportation charges were incurred to bring the machine to the factory site. An
Architect was appointed at a fee of ` 30,000 to supervise machinery installation at
the factory site. You are required to ascertain the amount at which the Machinery
should be capitalized.
Solution
Particulars `
Purchase Price Given 1,58,00,000
Add: Site Preparation Cost Given 1,40,000
Technician’s Salary Specific/Attributable overheads 1,35,000
for 3 months (45,000 x 3)
Initial Delivery Cost Transportation 50,000
Professional Fees for Architect’s Fees 30,000
Installation
Total Cost of Machinery 1,61,55,000

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 5.32 ADVANCED ACCOUNTING
v
v
v 4 (Capitalisation of directly attributable costs)
Illustration
v
Entity A, which operates a major chain of supermarkets, has acquired a new store
location. The new location requires significant renovation expenditure. Management
expects that the renovations will last for 3 months during which the supermarket will
be closed.

Management has prepared the budget for this period including expenditure related
to construction and remodelling costs, salaries of staff who will be preparing the store
before its opening and related utilities costs. What will be the treatment of such
expenditures?
Solution
Management should capitalise the costs of construction and remodelling the
supermarket, because they are necessary to bring the store to the condition
necessary for it to be capable of operating in the manner intended by management.
The supermarket cannot be opened without incurring the remodelling expenditure,
and thus the expenditure should be considered part of the asset.
However, if the cost of salaries, utilities and storage of goods are in the nature of
operating expenditure that would be incurred if the supermarket was open, then
these costs are not necessary to bring the store to the condition necessary for it to
be capable of operating in the manner intended by management and should be
expensed.
Illustration 5 (Operating costs incurred in the start-up period)
An amusement park has a 'soft' opening to the public, to trial run its attractions.
Tickets are sold at a 50% discount during this period and the operating capacity is
80%. The official opening day of the amusement park is three months later.
Management claim that the soft opening is a trial run necessary for the amusement
park to be in the condition capable of operating in the intended manner. Accordingly,
the net operating costs incurred should be capitalised. Comment.
Solution
The net operating costs should not be capitalised but should be recognised in the
Statement of Profit and Loss.

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v v
v
Even though it is running at less than full operating capacity (in this case 80% of
v
operating capacity), there is sufficient evidence that the amusement park is capable
of operating in the manner intended by management. Therefore, these costs are
specific to the start-up and, therefore, should be expensed as incurred.
C. Decommissioning, Restoration and similar Liabilities:
Initial estimate of the costs of dismantling, removing the item and restoring the
site on which it is located, referred to as ‘Decommissioning, Restoration and similar
Liabilities’, the obligation for which an enterprise incurs either when the item is
acquired or as a consequence of having used the item during a particular period
for purposes other than to produce inventories during that period.
Exception: An enterprise applies AS 2 (Revised) “Valuation of Inventories”, to the
costs of obligations for dismantling, removing and restoring the site on which an
item is located that are incurred during a particular period as a consequence of
having used the item to produce inventories during that period.
Note: The obligations for costs accounted for in accordance with AS 2 (Revised) or
AS 10 (Revised) are recognised and measured in accordance with AS 29 (Revised)
“Provisions, Contingent Liabilities and Contingent Assets”.

2.8 COST OF A SELF-CONSTRUCTED ASSET

Cost of a self-constructed asset is determined using the same principles as for an
acquired asset.

1. If an enterprise makes similar assets for sale in the normal course of business,
the cost of the asset is usually the same as the cost of constructing an asset
for sale (Refer AS 2). Therefore, any internal profits are eliminated in arriving
at such costs.
2. Cost of abnormal amounts of wasted material, labour, or other resources
incurred in self constructing an asset is not included in the cost of the asset.
3. AS 16 on Borrowing Costs, establishes criteria for the recognition of interest
as a component of the carrying amount of a self-constructed item of PPE.
4. Bearer plants are accounted for in the same way as self-constructed items of
PPE before they are in the location and condition necessary to be capable of
operating in the manner intended by management.

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v
v
v
v Summary: Initial Recognition
(COST)

Purchase Self-constructed

Purchase Price xxx

Material xxx
+ non-creditable taxes xxx
+ Labour xxx
- Trade discount xxx
+ Fixed/Variable Prod. Overheads xxx
+ Directly attributable Expense/Income xxx
+ Directly attributabel Exp/Income xxx
+ Initial Estimate of Restoration etc. xxx
+ Initial Estimate of Restoration etc. xxx
COST OF ASSET xxx
+ Borrowing Cost (if qualifying asset) xxx
COST OF ASSET xxx

2.9 PPE ACQUIRED IN EXCHANGE FOR A NON-

MONETARY ASSET OR ASSETS OR A
COMBINATION OF MONETARY AND NON-
MONETARY ASSETS:
Cost of such an item of PPE is measured at fair value unless:

(a) Exchange transaction lacks commercial substance; or

(b) Fair value of neither the asset(s) received nor the asset(s) given up is reliably
measurable.

Note:
1. The acquired item(s) is/are measured in this manner even if an enterprise
cannot immediately derecognise the asset given up.

2. The fair value of an asset is reliably measurable if (a) the variability in the range
of reasonable fair value measurements is not significant for that asset or (b) the

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ASSETS BASED ACCOUNTING STANDARDS
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v v
probabilities of the various estimates within the range can be reasonably v
v
assessed and used when measuring fair value. If an enterprise is able to measure
reliably the fair value of either the asset received or the asset given up, then the
fair value of the asset given up is used to measure the cost of the asset received
unless the fair value of the asset received is more clearly evident.

3. If the acquired item(s) is/are not measured at fair value, its/their cost is measured
at the carrying amount of the asset(s) given up.

4. An enterprise determines whether an exchange transaction has commercial

substance by considering the extent to which its future cash flows are expected
to change as a result of the transaction. An exchange transaction has commercial
substance if:

(a) the configuration (risk, timing and amount) of the cash flows of the
asset received differs from the configuration of the cash flows of the
asset transferred; or

(b) the enterprise-specific value of the portion of the operations of the

enterprise affected by the transaction changes as a result of the
exchange;

(c) and the difference in (a) or (b) is significant relative to the fair value of
the assets exchanged.

For the purpose of determining whether an exchange transaction has

commercial substance, the enterprise-specific value of the portion of
operations of the enterprise affected by the transaction should reflect post-
tax cash flows. In certain cases, the result of these analyses may be clear
without an enterprise having to perform detailed calculations.

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v
v
v
Acquisition of Assets for non-
v cash/partly cash partly non-cash
consideration

Transaction has Transaction has no

Commercial Substance Commercial Substance

Cost of such PPE is measured at Fair A transaction lacks commercial substance if

Value (FV) of the assets given up the position of the company (in terms of
unless the FV of the asset received is cash flows or enterprise-specific values)
more reliable. before and after the exchange transaction
reamin the same.
If information about reliability is not
available, the following order of
preference for recording PPE can be
followed:
In such cases, the assets
1. Measure at FV of asset given up.
acquired will be measured at
2. Measure at FV of assets received (if the WDV of the assets given up.
FV of asset given up is not available).
3. WDV of assets given up (ONLY if
Points 1 and 2 are not available, which
is a very remote possibility).

Illustration 6 (Consideration received comprising a combination of non-

monetary and monetary assets)
Entity A exchanges land with a book value of ` 10,00,000 for cash of ` 20,00,000 and
plant and machinery valued at ` 25,00,000. What will be the measurement cost of
the assets received. (Consider that the transaction has commercial substance)?
Solution
In the given case, Plant & Machinery is valued at ` 25,00,000, which is assumed to
be fair value in absence of information. Further, since fair value of land (asset given
up) is not given, the transaction will be recorded at fair value of assets acquired of
` 45,00,000 (` Cash 20,00,000 + ` Plant & Machinery 25,00,000). Since land of book
value ` 10,00,000 is transferred in exchange of assets worth ` 45,00,000, a gain of
` 35,00,000 will be recognised in the books of Entity A.

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v v
The following journal entry will be passed in the books of Entity A: v
v
Cash/ Bank A/c Dr. 20,00,000
Plant & Machinery A/c Dr. 25,00,000
To Land 10,00,000
To Profit on Sale of Land (balancing figure) 35,00,000
Illustration 7 (Exchange of assets that lack commercial substance)
Entity A exchanges car X with a book value of ` 13,00,000 and a fair value of
` 13,25,000 for cash of ` 15,000 and car Y which has a fair value of ` 13,10,000. The
transaction lacks commercial substance as the company’s cash flows are not expected
to change as a result of the exchange. It is in the same position as it was before the
transaction. What will be the measurement cost of the assets received?
Solution
Since the transaction lacks commercial substance, the entity recognises the assets
received at the book value of car X. Therefore, it recognises cash of ` 15,000 and
car Y as PPE with a carrying value of ` 12,85,000.
The following journal entry will be passed in the books of Entity A:
Cash/ Bank A/c Dr. 15,000
Car Y A/c (balancing figure) Dr. 12,85,000
To Car X A/c 13,00,000
Determination of Cost in special cases:
Cost of an item of PPE is the cash price equivalent at the recognition date.
A. If payment is deferred beyond normal credit terms:
Total payment minus Cash price equivalent
• is recognised as an interest expense over the period of credit
• unless such interest is capitalised in accordance with AS 16
B. PPE purchased for a Consolidated Price:
Where several items of PPE are purchased for a consolidated price, the
consideration is apportioned to the various items on the basis of their
respective fair values at the date of acquisition.

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v
v
v
Note: In case the fair values of the items acquired cannot be measured
v
reliably, these values are estimated on a fair basis as determined by
competent valuers.
C. PPE held by a lessee under a Finance Lease:
The cost of an item of PPE held by a lessee under a finance lease is determined
in accordance with AS 19 (Leases).
D. Government Grant related to PPE:
The carrying amount of an item of PPE may be reduced by government grants
in accordance with AS 12 (Accounting for Government Grants).

2.10 TREATMENT OF SUBSEQUENT COSTS

Cost of day-to-day servicing
Meaning

Costs of day-to-day servicing are primarily the costs of labour and consumables
and may include the cost of small parts. The purpose of such expenditures is often
described as for the ‘Repairs and Maintenance’ of the item of PPE.

Accounting Treatment:

An enterprise does not recognise in the carrying amount of an item of PPE the costs
of the day-to-day servicing of the item. Rather, these costs are recognised in the
Statement of Profit and Loss as incurred.

Replacement of Parts of PPE

Parts of some items of PPE may require replacement at regular intervals.

Examples
1. A furnace may require relining after a specified number of hours of use.

2. Aircraft interiors such as seats and galleys may require replacement several
times during the life of the airframe.

3. Major parts of conveyor system, such as, conveyor belts, wire ropes, etc., may
require replacement several times during the life of the conveyor system.

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v v
4. v
Replacing the interior walls of a building, or to make a non-recurring
replacement. v

Accounting Treatment

An enterprise recognises in the carrying amount of an item of PPE the cost of replacing
part of such an item when that cost is incurred if the recognition criteria are met.

Note: The carrying amount of those parts that are replaced is derecognised in
accordance with the de-recognition provisions of this Standard.

Regular Major Inspections - Accounting Treatment

In certain cases, a condition of continuing to operate an item of property, plant and
equipment (for example, an aircraft) may be performing regular major inspections for
faults regardless of whether parts of the item are replaced. When each such major
inspection is performed, its cost is recognised in the carrying amount of the item of
PPE as a replacement, if the recognition criteria are satisfied.

Any remaining carrying amount of the cost of the previous inspection (as distinct
from physical parts) is derecognised.

Subsequent
Expenditure

Expenses which
increase life or Major replacements / major
Regular / day-to-day
efficiency of the asset inspection / major overhaul
Repairs & Maintenance
beyond the originally
assessed life or
efficiency

Capitalized as under:
Expensed to P/L WDV of Asset xxx
Capitalized + Cost of New Part xxx
- WDV of Old Part xxx
Revised WDV xxx

The WDV of the old part / inspection (in case of major replacements / inspection)
can be determined through the following sources (in order of preference):

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v
v
(i) v
Breakup from suppliers’ invoice
v
(ii) Fair value of the part / inspection at the time of purchase

If it is not practicable for an enterprise to determine the carrying amount of the

replaced part/ inspection, it may use the cost of the replacement or the estimated
cost of a future similar inspection as an indication of what the cost of the replaced
part/ existing inspection component was when the item was acquired or
constructed.
The WDV of the old part / inspection is computed after deducting the applicable
depreciation.

Illustration 8

What happens if the cost of the previous part/inspection was/ was not identified in
the transaction in which the item was acquired or constructed?

Solution

De-recognition of the carrying amount occurs regardless of whether the cost of the
previous part/inspection was identified in the transaction in which the item was
acquired or constructed.

Illustration 9
What will be your answer in the above question, if it is not practicable for an
enterprise to determine the carrying amount of the replaced part/inspection?
Solution
It may use the cost of the replacement or the estimated cost of a future similar
inspection as an indication of what the cost of the replaced part/existing inspection
component was when the item was acquired or constructed.
MEASUREMENT AFTER RECOGNITION
An enterprise should choose

• Either Cost model,

• Or Revaluation model
as its accounting policy and should apply that policy to an entire class of PPE.

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ASSETS BASED ACCOUNTING STANDARDS
v
v v
Class of PPE: A class of PPE is a grouping of assets of a similar nature and use vin
operations of an enterprise. v

Examples of separate classes:

(a) Land (b) Land and Buildings
(c) Machinery (d) Ships
(e) Aircraft (f) Motor Vehicles
(g) Furniture and Fixtures (h) Office Equipment
(j) Bearer plants

Cost Model
After recognition as an asset, an item of PPE should be carried at:
Cost- Any Accumulated Depreciation- Any Accumulated Impairment losses
Revaluation Model
After recognition as an asset, an item of PPE whose fair value can be measured
reliably should be carried at a revalued amount.
Fair value at the date of the revaluation —
Less: Any subsequent accumulated depreciation (—)
Less: Any subsequent accumulated impairment losses (—)
Carrying value —
Revaluation for entire class of PPE
If an item of PPE is revalued, the entire class of PPE to which that asset belongs
should be revalued.
Reason
The items within a class of PPE are revalued simultaneously to avoid selective
revaluation of assets and the reporting of amounts in the Financial Statements that
are a mixture of costs and values as at different dates. It will ensure true and fair
view of financial statements.

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 5.42 ADVANCED ACCOUNTING
v
v
v 10 (Revaluation on a class by class basis)
Illustration
v
Entity A is a large manufacturing group. It owns a number of industrial buildings, such
as factories and warehouses and office buildings in several capital cities. The industrial
buildings are located in industrial zones, whereas the office buildings are in central
business districts of the cities. Entity A's management want to apply the revaluation
model as per AS 10 (Revised) to the subsequent measurement of the office buildings but
continue to apply the historical cost model to the industrial buildings.
State whether this is acceptable under AS 10 (Revised) or not with reasons?
Solution
Entity A's management can apply the revaluation model only to the office buildings.
The office buildings can be clearly distinguished from the industrial buildings in
terms of their function, their nature and their general location.AS 10 (Revised)
permits assets to be revalued on a class by class basis.
The different characteristics of the buildings enable them to be classified as
different PPE classes. The different measurement models can, therefore, be applied
to these classes for subsequent measurement.
However, all properties within the class of office buildings must be carried at
revalued amount.
Frequency of Revaluations
Revaluations should be made with sufficient regularity to ensure that the carrying
amount does not differ materially from that which would be determined using Fair
value at the Balance Sheet date.
The frequency of revaluations depends upon the changes in fair values of the items
of PPE being revalued.

© The Institute of Chartered Accountants of India

 5.43
ASSETS BASED ACCOUNTING STANDARDS
v
v v
Frequency of Revaluations v
(Sufficient Regularity) v

Items of PPE experience significant Items of PPE with only insignificant

and volatile changes in Fair value changes in Fair value

Revalue the item only every 3 or 5

Annual revaluation
years

Determination of Fair Value

Fair value of items of PPE is usually determined from market-based evidence by
appraisal that is normally undertaken by professionally qualified valuers.
If there is no market-based evidence of fair value because of the specialised nature
of the item of PPE and the item is rarely sold, except as part of a continuing
business, an enterprise may need to estimate fair value using an income approach
Based on (Discounted cash flow projections) Ora depreciated replacement cost
approach which aims at making a realistic estimate of the current cost of
acquiring or constructing an item that has the same service potential as the existing
item.
Accounting Treatment of Revaluations
When an item of PPE is revalued, the carrying amount of that asset is adjusted to
the revalued amount.
At the date of the revaluation, the asset is treated in one of the following ways:

A. Technique 1: Gross carrying amount is adjusted in a manner that is consistent

with the revaluation of the carrying amount of the asset.
Gross carrying amount

• May be restated by reference to observable market data, or

• May be restated proportionately to the change in the carrying amount.

Accumulated depreciation at the date of the revaluation is

• Adjusted to equal the difference between the gross carrying amount

and the carrying amount of the asset after taking into account
accumulated impairment losses

© The Institute of Chartered Accountants of India

 5.44 ADVANCED ACCOUNTING
v
v
v
Case Study on Technique I
v
PPE is revalued to ` 1,500 consisting of ` 2,500 Gross cost and ` 1,000
Depreciation based on observable market data.

Details of the PPE before and after revaluation are as follows:

Particulars Cost/ Accumulated Net book

Revalued depreciation value
Cost

PPE before revaluation (assumed) 1,000 400 600

Fair Value 1,500
Revaluation Gain 900

Gain allocated proportionately to 1,500 600 900

cost and depreciation (900 x 1,000/600) (900 x 400/600)

PPE after revaluation 2,500 1,000 1,500

The increase on revaluation is ` 900 (i.e., ` 1,500 – ` 600).

The following journal entry will be passed:

PPE Dr. 1,500

To Accumulated Depreciation 600

To Gain on Revaluation* 900

* Accounting treatment discussed later

B. Technique 2: Accumulated depreciation Is eliminated against the Gross

Carrying amount of the asset

Case Study on Technique II

(Taking the information given in the above Example)

© The Institute of Chartered Accountants of India

 5.45
ASSETS BASED ACCOUNTING STANDARDS
v
v v
Details of the PPE before and after revaluation are as follows: v
v
Particulars Cost/Revalued Accumulated Net book value
Cost depreciation

PPE before 1,000 400 600

revaluation
(assumed)

PPE after 1,500 1,500

revaluation

Revaluation gain 500 400

The increase on revaluation is ` 900 (i.e., ` 500 + ` 400).

The following journal entries will be passed:

Accumulated Depreciation Dr. 400

To PPE 400

(Accumulated depreciation eliminate against gross carrying amount of asset)

Therefore, carrying amount of asset is reduced to = 1,000 – 400 = 600

PPE Dr. 900

To Gain on Revaluation* 900

* Gain on Revaluation 1,500 – 600 = 900 recognized entirely in PPE, accounting

treatment of this gain to be discussed later.

© The Institute of Chartered Accountants of India

 5.46 ADVANCED ACCOUNTING
v
v
v
Revaluation – Increase or Decrease
v
Revaluation

Increase Decrease

Credited directly Exception:

Exception: Charged to
to owners’
When it is the Statement When it is subsequently
interests under
subsequently of profit and Decreased (Initially
the heading of
Increased loss Increased)
Revaluation
surplus (Initially
Decreased)
Decrease should be
debited directly to
owners’ interests under
Recognised in the Statement of
the heading of
profit and loss to the extent that it
Revaluation surplus to the
reverses a revaluation decrease of
extent of any credit
the same asset previously
balance existing in the
recognised in the Statement of
Revaluation surplus in
profit and loss
respect of that asset

Treatment of Revaluation Surplus

The revaluation surplus included in owners’ interests in respect of an item of PPE
may be transferred to the Revenue Reserves when the asset is derecognised.

Case I: When whole surplus is transferred:

When the asset is:
• Retired; Or
• Disposed of
Case II: Some of the surplus may be transferred as the asset is used by an
enterprise:

In such a case, the amount of the surplus transferred would be:

Depreciation (based on Revalued Carrying amount) – Depreciation
(based on Original Cost)

Transfers from Revaluation Surplus to the Revenue Reserves are not made
through the Statement of Profit and Loss.

© The Institute of Chartered Accountants of India

 5.47
ASSETS BASED ACCOUNTING STANDARDS
v
v v
Depreciation v
v
Component Method of Depreciation:

Each part of an item of PPE with a cost that is significant in relation to the total cost
of the item should be depreciated separately. An enterprise allocates the amount
initially recognised in respect of an item of PPE to its significant parts and
depreciates each such part separately.
Example:
It may be appropriate to depreciate separately the airframe and engines of an
aircraft, whether owned or subject to a finance lease.
Is Grouping of Components possible?
Yes. A significant part of an item of PPE may have a useful life and a depreciation
method that are the same as the useful life and the depreciation method of another
significant part of that same item. Such parts may be grouped in determining the
depreciation charge.

Accounting Treatment
Depreciation charge for each period should be recognised in the Statement of
Profit and Loss unless it is included in the carrying amount of another asset.
Examples on Exception
AS 2 (Revised): Depreciation of manufacturing plant and equipment is included in
the costs of conversion of inventories as per AS 2 (Revised).

AS 26: Depreciation of PPE used for development activities may be included in the cost
of an intangible asset recognised in accordance with AS 26 on Intangible Assets.
Depreciable Amount and Depreciation Period

Depreciable amount is:

Cost of an asset (or other amount substituted for cost i.e. revalued amount) less
Residual value.

The depreciable amount of an asset should be allocated on a systematic basis over

its useful life.

© The Institute of Chartered Accountants of India

 5.48 ADVANCED ACCOUNTING
v
v
v is:
Useful life
v
(a) the period over which an asset is expected to be available for use by an
enterprise; or

(b) the number of production or similar units expected to be obtained from the
asset by an enterprise.

The residual value of an asset is the estimated amount that an enterprise would
currently obtain from disposal of the asset, after deducting the estimated costs of
disposal, if the asset were already of the age and in the condition expected at the
end of its useful life.

All the following factors are considered in determining the useful life of an asset:

(a) expected usage of the asset. Usage is assessed by reference to the expected
capacity or physical output of the asset.

(b) expected physical wear and tear, which depends on operational factors
such as the number of shifts for which the asset is to be used and the repair
and maintenance programme, and the care and maintenance of the asset
while idle.

(c) technical or commercial obsolescence arising from changes or

improvements in production, or from a change in the market demand for the
product or service output of the asset. Expected future reductions in the
selling price of an item that was produced using an asset could indicate the
expectation of technical or commercial obsolescence of the asset, which, in
turn, might reflect a reduction of the future economic benefits embodied in
the asset.

(d) legal or similar limits on the use of the asset, such as the expiry dates of
related leases.

Illustration 11
Entity A has a policy of not providing for depreciation on PPE capitalised in the year
until the following year, but provides for a full year's depreciation in the year of
disposal of an asset. Is this acceptable?

© The Institute of Chartered Accountants of India

 5.49
ASSETS BASED ACCOUNTING STANDARDS
v
v v
Solution v
v
The depreciable amount of a tangible fixed asset should be allocated on a
systematic basis over its useful life. The depreciation method should reflect the
pattern in which the asset's future economic benefits are expected to be consumed
by the entity.
Useful life means the period over which the asset is expected to be available for
use by the entity. Depreciation should commence as soon as the asset is acquired
and is available for use. Thus, the policy of Entity A is not acceptable.
Review of Residual Value and Useful Life of an Asset
Residual value and the useful life of an asset should be reviewed at least at each
financial year-end and, if expectations differ from previous estimates, the change(s)
should be accounted for as a change in an accounting estimate in accordance with
AS 5 ‘Net Profit or Loss for the Period, Prior Period Items and Changes in
Accounting Policies’.
Example:
As per accounting policy of NS Limited, engaged in shipping business, residual value
of Steel containers is 5%. Based on the external factors, steel prices have increased in
recent past and based on the recent data, company has observed that realized scrap
value is approximately 10% of the cost of the container. The company does not
anticipate any material movement in the steel price in the foreseeable future.
In the above case, based on the yearly review of residual value of Steel containers,
company should revise the residual value to 10%. The above change shall be treated
as change in accounting estimate as per AS 5 and should be applied prospectively.
Illustration 12 (Change in estimate of useful life)
Entity A purchased an asset on 1 st January 20X1 for ` 1,00,000 and the asset had an
estimated useful life of 10 years and a residual value of nil.
On 1st January 20X5, the directors review the estimated life and decide that the asset
will probably be useful for a further 4 years.
Calculate the amount of depreciation for each year, if company charges depreciation
on Straight Line basis.

© The Institute of Chartered Accountants of India

 5.50 ADVANCED ACCOUNTING
v
v
Solutionv
v
The entity has charged depreciation using the straight-line method at ` 10,000 per
annum i.e (1,00,000/10 years).

On 1st January 20X5, the asset's net book value is [1,00,000 – (10,000 x 4)] ` 60,000.

The remaining useful life is 4 years.

The company should amend the annual provision for depreciation to charge the
unamortised cost over the revised remaining life of four years.

Consequently, it should charge depreciation for the next 4 years at ` 15,000 per
annum i.e. (60,000 / 4 years).

Note: Depreciation is recognised even if the Fair value of the Asset exceeds its
Carrying Amount. Repair and maintenance of an asset do not negate the need to
depreciate it.

Commencement of period for charging Depreciation

Depreciation of an asset begins when it is available for use, i.e., when it is in the
location and condition necessary for it to be capable of operating in the manner
intended by the management.

Illustration 13

Entity B constructs a machine for its own use. Construction is completed on 1 st

November 20X1 but the company does not begin using the machine until 1 st March
20X2. Comment.

Solution
The entity should begin charging depreciation from the date the machine is ready
for use – that is, 1st November 20X1. The fact that the machine was not used for a
period after it was ready to be used is not relevant in considering when to begin
charging depreciation.

© The Institute of Chartered Accountants of India

 5.51
ASSETS BASED ACCOUNTING STANDARDS
v
v v
Cessation of Depreciation v
v
I. Depreciation ceases to be charged when asset’s residual value exceeds
its carrying amount.
The residual value of an asset may increase to an amount equal to or greater than
its carrying amount. If it does, depreciation charge of the asset is zero unless and
until its residual value subsequently decreases to an amount below its carrying
amount.
Illustration 14 (Depreciation where residual value is the same as or close to
Original cost)
A property costing ` 10,00,000 is bought in 20X1. Its estimated total physical life is
50 years. However, the company considers it likely that it will sell the property after
20 years.
The estimated residual value in 20 years' time, based on 20X1 prices, is:
Case (a) ` 10,00,000
Case (b) ` 9,00,000.
Calculate the amount of depreciation.
Solution
Case (a)
The company considers that the residual value, based on prices prevailing at the
balance sheet date, will equal the cost.
There is, therefore, no depreciable amount and depreciation is correctly zero.
Case (b)
The company considers that the residual value, based on prices prevailing at the
balance sheet date, will be ` 9,00,000 and the depreciable amount is, therefore,
` 1,00,000.
Annual depreciation (on a straight-line basis) will be ` 5,000 [{10,00,000 – 9,00,000}
÷ 20].
II. Depreciation of an asset ceases at the earlier of:
• The date that the asset is retired from active use and is held for disposal, and
• The date that the asset is derecognised.

© The Institute of Chartered Accountants of India

 5.52 ADVANCED ACCOUNTING
v
v
v
Therefore, depreciation does not cease when the asset becomes idle or is retired
v
from active use (but not held for disposal) unless the asset is fully depreciated.

However, under usage methods of depreciation, the depreciation charge can be

zero while there is no production.
Land and Buildings

Land and buildings are separable assets and are accounted for separately, even
when they are acquired together.
A. Land: Land has an unlimited useful life and therefore is not depreciated.

Exceptions: Quarries and sites used for landfill.

Depreciation on Land:
I. If land itself has a limited useful life:

It is depreciated in a manner that reflects the benefits to be derived from it.

II. If the cost of land includes the costs of site dismantlement, removal and
restoration:

That portion of the land asset is depreciated over the period of benefits
obtained by incurring those costs.
B. Buildings:
Buildings have a limited useful life and therefore are depreciable assets.
An increase in the value of the land on which a building stands does not affect
the determination of the depreciable amount of the building.
Depreciation Method
The enterprise selects the method that most closely reflects the expected pattern
of consumption of the future economic benefits embodied in the asset. The
depreciation method used should reflect the pattern in which the future economic
benefits of the asset are expected to be consumed by the enterprise.
The method selected is applied consistently from period to period unless:
• There is a change in the expected pattern of consumption of those future
economic benefits; Or

© The Institute of Chartered Accountants of India

 5.53
ASSETS BASED ACCOUNTING STANDARDS
v
v v
• v
That the method is changed in accordance with the statute to best reflect the
way the asset is consumed. v

Methods of Depreciation

Straight-line Diminishing Units of Production

Method Balance Method Method

Results in a constant Results in a Results in a

charge over the useful decreasing charge charge based on
life if the residual value over the useful the expected use
of the asset does not life or output
change

Review of Depreciation Method

The depreciation method applied to an asset should be reviewed at least at each
financial year-end and, if there has been a significant change in the expected
pattern of consumption of the future economic benefits embodied in the asset, the
method should be changed to reflect the changed pattern.
Such a change should be accounted for as a change in an accounting estimate
in accordance with AS 5.
Depreciation Method based on Revenue
A depreciation method that is based on revenue that is generated by an activity
that includes the use of an asset is not appropriate. Because the price component
of revenue may be affected by inflation, which has no bearing upon the way in
which an asset is consumed.
Illustration 15 (Determination of appropriate Depreciation Method)
Entity B manufactures industrial chemicals and uses blending machines in the
production process. The output of the blending machines is consistent from year to
year and they can be used for different products.
However, maintenance costs increase from year to year and a new generation of
machines with significant improvements over existing machines is available every 5
years. Suggest the depreciation method to the management.

© The Institute of Chartered Accountants of India

 5.54 ADVANCED ACCOUNTING
v
v
Solutionv
v
The straight-line depreciation method should be adopted, because the production
output is consistent from year to year.

Factors such as maintenance costs or technical obsolescence should be considered

in determining the blending machines’ useful life.

Changes in Existing Decommissioning, Restoration and other Liabilities

The cost of PPE may undergo changes subsequent to its acquisition or construction
on account of:

• Changes in Liabilities

• Price Adjustments

• Changes in Duties

• Changes in initial estimates of amounts provided for Dismantling, Removing,

Restoration, and

• Similar factors

The above are included in the cost of the asset.

Accounting for the above changes:

Related Asset is measured using Cost

Accounting Model

(Depends upon) Related Asset is measured using

Revaluation Model

A. If the related asset is measured using the Cost model

Changes in the Liability should be added to, or deducted from, the cost of the
related asset in the current period

Note: Amount deducted from the cost of the asset should not exceed its
carrying amount. If a decrease in the liability exceeds the carrying amount of
the asset, the excess should be recognised immediately in the Statement of
Profit and Loss.

© The Institute of Chartered Accountants of India

 5.55
ASSETS BASED ACCOUNTING STANDARDS
v
v v
If the adjustment results in an addition to the cost of an asset v
v
• Enterprise should consider whether this is an indication that the new
carrying amount of the asset may not be fully recoverable.

Note: If it is such an indication, the enterprise should test the asset for
impairment by estimating its recoverable amount, and should account for any
impairment loss, in accordance with applicable Accounting standards.

B. If the related asset is measured using the Revaluation model:

Changes in the liability alter the revaluation surplus or deficit previously
recognised on that asset, so that:
(i) Decrease in the liability credited directly to revaluation surplus in the
owners’ interest

Exception
*It should be recognised in the Statement of Profit and Loss to the
extent that it reverses a revaluation deficit on the asset that was
previously recognised in the Statement of Profit and Loss.

Note: In the event that a decrease in the liability exceeds the carrying
amount that would have been recognised had the asset been carried
under the cost model, the excess should be recognised immediately in
the Statement of Profit and Loss.

(ii) Increase in the liability should be recognised in the Statement of Profit

and Loss
Exception
*It should be debited directly to Revaluation surplus in the owners’
interest to the extent of any credit balance existing in the Revaluation
surplus in respect of that asset
Caution

A change in the liability is an indication that the asset may have to be

revalued in order to ensure that the carrying amount does not differ
materially from that which would be determined using fair value at the
balance sheet date.

© The Institute of Chartered Accountants of India

 5.56 ADVANCED ACCOUNTING
v
v
v The adjusted depreciable amount of the asset is depreciated over its
v
useful life.

What happens if the related asset has reached the end of its useful life?
All subsequent changes in the liability should be recognised in the
Statement of Profit and Loss as they occur.

Note: This applies under both the cost model and the revaluation
model.

Accounting for Compensation for Impairment:

Situations and Its

Accounting

De-recognition Compensation from Cost of items of PPE

Impairments of of items of PPE third parties for items restored, purchased
items of PPE retired or of PPE that were or constructed as
disposed of impaired, lost or given replacements
up

Recognised in Determined in Is included in

accordance with accordance with determining profit or Is determined in
AS 28* AS 10 (Revised) loss when it becomes accordance with AS
receivable 10 (Revised)

Illustration 16 (Gain on replacement of Insured Assets)

Entity A carried plant and machinery in its books at ` 2,00,000. These were destroyed
in a fire. The assets were insured 'New for old' and were replaced by the insurance
company with new machines that cost ` 20,00,000. The machines were acquired by the
insurance company and the company did not receive ` 20,00,000 as cash
compensation. State, how Entity A should account for the same?
Solution
Entity A should account for a loss in the Statement of Profit and Loss on de-
recognition of the carrying value of plant and machinery in accordance with AS 10
(Revised).

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 5.57
ASSETS BASED ACCOUNTING STANDARDS
v
v v
Entity A should separately recognise a receivable and a gain in the income v
statement resulting from the insurance proceeds under AS 29 (Revised)* once v
receipt is virtually certain. The receivable should be measured at the fair value of
assets that will be provided by the insurer.
Retirements
Items of PPE retired from active use and held for disposal should be stated at the
lower of:
• Carrying Amount, and

• Net Realisable Value

Note: Any write-down in this regard should be recognised immediately in the

Statement of Profit and Loss.

De-recognition
The carrying amount of an item of PPE should be derecognised:
• On disposal

o By sale
o By entering into a finance lease, or
o By donation, Or
• When no future economic benefits are expected from its use or disposal
Accounting Treatment
Gain or loss arising from de-recognition of an item of PPE should be included in
the Statement of Profit and Loss when the item is derecognised unless AS 19 on
Leases, requires otherwise on a sale and leaseback (AS 19 on Leases, applies to
disposal by a sale and leaseback.)

Where,
Gain or loss arising from de-recognition of an item of PPE
= Net disposal proceeds (if any) - Carrying Amount of the item

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 5.58 ADVANCED ACCOUNTING
v
v
v
Note: Gains should not be classified as revenue, as defined in AS 9 ‘Revenue
v
Recognition’. The consideration receivable on disposal of an item of property, plant
and equipment is recognised in accordance with the principles enunciated in AS 9.

Exception
An enterprise that in the course of its ordinary activities, routinely sells items of PPE
that it had held for rental to others should transfer such assets to inventories at
their carrying amount when they cease to be rented and become held for sale.
The proceeds from the sale of such assets should be recognised in revenue in
accordance with AS 9 on Revenue Recognition.
Determining the date of disposal of an item
An enterprise applies the criteria given in AS 9 for recognising revenue from the
sale of goods.
Disclosure

Disclosures

General Additional Disclosures related to Voluntary

Revalued Assets disclosures

General Disclosures
The financial statements should disclose, for each class of PPE:
(a) The measurement bases (i.e., cost model or revaluation model) used for
determining the gross carrying amount;
(b) The depreciation methods used;
(c) The useful lives or the depreciation rates used.
In case the useful lives or the depreciation rates used are different from those
specified in the statute governing the enterprise, it should make a specific
mention of that fact;
(d) The gross carrying amount and the accumulated depreciation (aggregated
with accumulated impairment losses) at the beginning and end of the period;
and

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 5.59
ASSETS BASED ACCOUNTING STANDARDS
v
v v
(e) v
A reconciliation of the carrying amount at the beginning and end of the
period showing: v

(i) additions
(ii) assets retired from active use and held for disposal
(iii) acquisitions through business combinations
(iv) increases or decreases resulting from revaluations and from impairment
losses recognised or reversed directly in revaluation surplus in
accordance with AS 28
(v) impairment losses recognised in the statement of profit and loss in
accordance with AS 28
(vi) impairment losses reversed in the statement of profit and loss in
accordance with AS 28
(vii) depreciation
(viii) net exchange differences arising on the translation of the financial
statements of a non-integral foreign operation in accordance with
AS 11
(ix) other changes
Additional Disclosures
The financial statements should also disclose:
(a) The existence and amounts of restrictions on title, and property, plant and
equipment pledged as security for liabilities;
(b) The amount of expenditure recognised in the carrying amount of an item of
property, plant and equipment in the course of its construction;
(c) The amount of contractual commitments for the acquisition of property, plant
and equipment;
(d) If it is not disclosed separately on the face of the statement of profit and loss,
the amount of compensation from third parties for items of property, plant
and equipment that were impaired, lost or given up that is included in the
statement of profit and loss; and
(e) The amount of assets retired from active use and held for disposal.

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 5.60 ADVANCED ACCOUNTING
v
v
v related to Revalued Assets
Disclosures
v
If items of property, plant and equipment are stated at revalued amounts, the
following should be disclosed:
(a) The effective date of the revaluation;
(b) Whether an independent valuer was involved;
(c) The methods and significant assumptions applied in estimating fair values of
the items;
(d) The extent to which fair values of the items were determined directly by
reference to observable prices in an active market or recent market
transactions on arm’s length terms or were estimated using other valuation
techniques; and

(e) The revaluation surplus, indicating the change for the period and any
restrictions on the distribution of the balance to shareholders.
(f) Disclosure of the methods adopted and the estimated useful lives or
depreciation rates.
(g) Disclosures as per AS 5, applicable if any.
(h) Information on impaired PPE.
Voluntary disclosures:
An enterprise is encouraged to disclose the following:
(a) the carrying amount of temporarily idle property, plant and equipment;

(b) the gross carrying amount of any fully depreciated property, plant and
equipment that is still in use;
(c) for each revalued class of property, plant and equipment, the carrying amount
that would have been recognised had the assets been carried under the cost
model;
(d) the carrying amount of property, plant and equipment retired from active use
and not held for disposal.

Reference: The students are advised to refer the full text of AS 10 (Revised)
“Property, Plant and Equipment” (2016).

© The Institute of Chartered Accountants of India

 5.61
ASSETS BASED ACCOUNTING STANDARDS
v
v v
v
TEST YOUR KNOWLEDGE v

Multiple Choice Questions

1. As per AS 10 (Revised) ‘Property, plant and equipment’, which of the following
costs is not included in the carrying amount of an item of PPE
(a) Costs of site preparation
(b) Costs of relocating

(c) Installation and assembly costs.

(d) initial delivery and handling costs
2. As per AS 10 (Revised) ‘Property, Plant and Equipment’, an enterprise holding
investment properties should value Investment property
(a) as per fair value
(b) under discounted cash flow model.
(c) under cost model
(d) under cash flow model
3. A plot of land with carrying amount of ` 1,00,000 was revalued to ` 1,50,000
at the end of Year 2. Subsequently, due to drop in market values, the land was
determined to have a fair value of ` 1,30,000 at the end of Year 4. Assuming
that the entity adopts Revaluation Model, what would be the accounting
treatment of Revaluation?
(a) Initial upward valuation of ` 50,000 credited to Revaluation Reserve.
Subsequent downward revaluation of ` 20,000 debited to P/L.
(b) Initial upward valuation of ` 50,000 credited to P/L. Subsequent
downward revaluation of ` 20,000 debited to P/L.
(c) Initial upward valuation of ` 50,000 credited to Revaluation Reserve.
Subsequent downward revaluation of ` 20,000 debited to Revaluation
Reserve.
(d) Initial upward valuation of ` 50,000 debited to P/L. Subsequent
downward revaluation of ` 20,000 credited to P/L.

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 5.62 ADVANCED ACCOUNTING
v
v
4. v
A plot of land with carrying amount of ` 1,00,000 was revalued to ` 90,000 at
v
the end of Year 2. Subsequently, due to increase in market values, the land was
determined to have a fair value of ` 1,05,000 at the end of Year 4. Assuming
that the entity adopts Revaluation Model, what would be the accounting
treatment of Revaluation?

(a) Initial downward valuation of ` 10,000 debited to Revaluation Reserve.

Subsequent upward revaluation of ` 15,000 credited to P/L.
(b) Initial downward valuation of ` 10,000 debited to P/L. Subsequent
upward revaluation of ` 15,000 credited to P/L.
(c) Initial downward valuation of ` 10,000 debited to P/L. Subsequent
upward revaluation of ` 10,000 credited to P/L and ` 5,000 credited to
Revaluation Reserve.
(c) Initial downward valuation of ` 10,000 credited to P/L. Subsequent
upward revaluation of ` 10,000 debited to P/L and ` 5,000 debited to
Revaluation Reserve.
5. On sale of an asset which was revalued upwards, what would be the treatment
of Revaluation Reserve?

(a) The Revaluation Reserve is credited to P/L since the profit on sale of such
asset is now realized.
(b) The Revaluation Reserve is credited to Retained Earnings as a movement
in reserves without impacting the P/L.
(c) No change in Revaluation Reserve since profit on sale of such asset is
already impacting the P/L.

(d) The Revaluation Reserve is reduced from the asset value to compute profit
or loss.
6. A machinery was purchased having an invoice price ` 1,18,000 (including GST
` 18,000) on 1 April 20X1. The GST amount is available as input tax credit. The
rate of depreciation is 10% on SLM basis. The depreciation for 20X2 -X3 would
be
(a) ` 10,000.
(b) ` 11,800.

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(c) ` 9,000. v
v
(d) ` 10,500.

Theoretical Questions
7. A company changed its method of depreciation from SLM to WDV. How should
the change be recognised?
8. A company has debited the Building Account with the Cost of the Land on which
the building stands and has provided depreciation on such total cost. Comment
on the accounting treatment.
9. An entity is setting up a manufacturing plant. Construction of the plant is
completed in August and the plant is ready for commercial production in
November. However, the entity commences production in March. When should
be company start charging depreciation.
10. Which factors should be considered by a company while determining useful
life?
11. An entity gave the following Note in its Financial Statements:
‘The company chooses not to charge depreciation on Property, Plant and
Equipment on account of:
(a) Annual Maintenance Contracts being expensed thereby ensuring timely
repairs of Plant and Machinery.
(b) Depreciation being a non-cash expense has no impact on cash flows.
Accordingly, it is not necessary to depreciate an asset when repairs and
maintenance charges are expensed in the Statement of Profit and Loss.
(c) The values of certain assets like Property increase with passage of time,
and hence charging depreciation does not make sense.
(d) At the end of the useful life, the asset is ultimately sold, and since the
asset is at cost due to no depreciation, exact profit or loss on sale of the
asset is stated.’
You are required to state the appropriateness of the above accounting policy in
line with the relevant Accounting Standards.

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v
v
Scenario based Questions
v
12. With reference to AS-10 Revised, classify the items under the following heads:
HEADS

(i) Purchase Price of Property, plant and Equipment (PPE)

(ii) Directly attributable cost of PPE or
(iii) Cost not included in determining the carrying amount of an item of PPE.

ITEMS
(1) Import duties and non-refundable purchase taxes.
(2) Initial delivery and handling costs.
(3) Initial operating losses, such as those incurred while demand for
the output of an item builds up.
(4) Costs incurred while an item capable of operating in the manner
intended by management has yet to be brought into use or is
operated at less than full capacity.
(5) Trade discounts and rebates.
(6) Costs of relocating or reorganizing part or all of the operations of
an enterprise.
(7) Installation and assembly costs.
(8) Administration and other general overhead costs.
13. ABC Ltd. is installing a new plant at its production facility. It has incurred these
costs:

1. Cost of the plant (cost per supplier’s invoice plus taxes) ` 25,00,000
2. Initial delivery and handling costs ` 2,00,000
3. Cost of site preparation ` 6,00,000
4. Consultants used for advice on the acquisition of the ` 7,00,000
plant
5. Interest charges paid to supplier of plant for deferred ` 2,00,000
credit

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v v
v
6. Estimated dismantling costs to be incurred after 7 ` 3,00,000
v
years
7. Operating losses before commercial production ` 4,00,000
Please advise ABC Ltd. on the costs that can be capitalised in accordance with
AS 10 (Revised).
14. Arka Ltd. purchased machinery for ` 3,000 lakhs. Depreciation was charged at 10%
on SLM basis for a useful life of 10 years. At the end of Year 4, the machinery was
revalued to ` 2,700 lakhs and the same was adopted. What will be the carrying
amount of the asset at the end of Year 5 and Year 6? Assume no change in the
useful life.
15. Skanda Ltd. acquired a machinery for ` 2,50,00,000 five years ago. Depreciation
was charged at 10% p.a. on SLM basis, useful life being 10 years. At the
beginning of Year 3, the machinery was revalued to ` 3,00,00,000 with the
surplus on revaluation being credited to Revaluation Reserve. Depreciation was
provided on the revalued amount over the balance useful life of 8 years. The
machinery was sold in the current year for ` 1,12,50,000. Give the accounting
treatment for the above in the Company’s accounts. What will be the treatment
if the machinery fetched only ` 42,50,000 now?
16. Akshar Ltd. installed a new Plant (not a qualifying asset), at its production
facility, and incurred the following costs:
▪ Cost of the Plant (as per supplier’s invoice): ` 30,00,000
▪ Initial delivery and handling costs: ` 1,00,000
▪ Cost of site preparation: ` 2,00,000

▪ Consultant fee for advice on acquisition of Plant: ` 50,000

▪ Interest charges paid to supplier against deferred credit: ` 1,00,000
▪ Estimate of Dismantling and Site Restoration costs: ` 50,000 after 10
years (Present Value is ` 30,000)
▪ Operating losses before commercial production: ` 40,000
The company identified motors installed in the Plant as a separate component
and a cost of ` 5,00,000 (Purchase Price) and other costs were allocated to them
proportionately. The company estimates the useful life of the Plant and those

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v
v
of the Motors as 10 years and 6 years respectively and SLM method of
v
Depreciation is used.
At the end of Year 4, the company replaces the Motors installed in the Plant at
a cost of ` 6,00,000 and estimated the useful life of new motors to be 5 years.
Also, the company revalued its entire class of Fixed Assets at the end of Year 4.
The revalued amount of Plant as a whole is ` 25,00,000. At the end of Year 8,
the company decides to retire the Plant from active use and also disposed the
Plant as a whole for ` 6,00,000.
There is no change in the Dismantling and Site Restoration liability during the
period of use. You are required to explain how the above transaction would be
accounted in accordance with AS 10.
17. Bharat Infrastructure Ltd. acquired a heavy machinery at a cost of ` 1,000 lakhs,
the breakdown of its components is not provided. The estimated useful life of
the machinery is 10 years. At the end of Year 6, the turbine, which is a major
component of the machinery, needed replacement, as further usage and
maintenance was uneconomical. The remainder of the machine is in good
condition and is expected to last for the remaining 4 years. The cost of the new
turbine is ` 450 lakhs. Give the accounting treatment for the new turbine,
assuming SLM Depreciation and a discount rate of 8%.
18. Preet Ltd. intends to set up a steel plant, for which it has acquired a dilapidated
factor having an area of 5,000 acres at a cost of ₹ 60,000 per acre. Preet Ltd.
has incurred ` 1.10 crores on demolishing the old Factory Building thereon. A
sum of ` 63,00,000 (including 5% GST thereon) was realized from the sale of
material salvaged from the site. Preet Ltd. incurred Stamp Duty and
Registration Charges of 7% of land value, paid legal and consultancy charges
` 8,00,000 for land acquisition and incurred ` 1,25,000 on title guarantee
insurance. Compute the value of the land acquired.
19 Star Limited purchased machinery for ` 6,80,000 (inclusive of GST of
` 40,000). Input credit is available for entire amount of GST paid. The company
incurred the following other expense for installation.
`
Cost of preparation of site for installation 21,200
Total Labour charges 56,000

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v v
(200 out of the total of 500 men hours worked, v
were spent on installation of the machinery) v

Spare parts and tools consumed in installation 5,000

Total salary of supervisor 26,000
(Time spent for installation was 25% of the total time worked)
Total technical expense 34,000
(1/10 relates to the plant installation)
Test run and experimental production expenses 18,000
Consultancy charges to architect for plant set up 11,000
Depreciation on assets used for installation 12,000
The machine was ready for use on 15.01.20X1 but was used from 01.02.20X1.
Due to this delay further expenses of ` 8,900 were incurred. Calculate the value
at which the plant should be capitalized in the books of Star Limited.

ANSWERS/SOLUTIONS
Answer to the Multiple Choice Questions
1. (b) 2. (c) 3. (c) 4. (c) 5. (b) 6. (a)

Answer to the Theoretical Questions

7. As per AS 10, Property, Plant and Equipment, the depreciation method
applied to an asset should be reviewed at least at each financial year-end and,
if there has been a significant change in the expected pattern of consumption
of the future economic benefits embodied in the asset, the method should
be changed to reflect the changed pattern. Such a change should be
accounted for as a change in an accounting estimate in accordance with
AS 5.

Accordingly, the change in method of depreciation should be accounting for

as a change in accounting estimate, prospectively.
8. As per AS 10, Property, Plant and Equipment, each part of an item of property,
plant and equipment with a cost that is significant in relation to the total cost

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v
v
v
of the item should be depreciated separately. Further, Land and buildings are
v
separable assets and are accounted for separately, even when they are
acquired together. With some exceptions, such as quarries and sites used for
landfill, land has an unlimited useful life and therefore is not depreciated.
Buildings have a limited useful life and therefore are depreciable assets.

In the given case, land should not be depreciated unless it has a limited useful
life. Accordingly, it is incorrect to debit the cost of land to the Building
Account and provide depreciation on the aggregate cost.

9. As per AS 10, Property, Plant and Equipment, depreciation of an asset begins

when it is available for use, i.e., when it is in the location and condition
necessary for it to be capable of operating in the manner intended by
management.
In the given case, since the plant is ready for commercial production in
November, depreciation shall commence from November. The date of
commencement of commercial production is irrelevant for charging
depreciation.
10. All the following factors are considered in determining the useful life of an
asset:
(a) expected usage of the asset. Usage is assessed by reference to the
expected capacity or physical output of the asset.
(b) expected physical wear and tear, which depends on operational factors
such as the number of shifts for which the asset is to be used and the
repair and maintenance programme, and the care and maintenance of
the asset while idle.
(c) technical or commercial obsolescence arising from changes or
improvements in production, or from a change in the market demand
for the product or service output of the asset. Expected future
reductions in the selling price of an item that was produced using an
asset could indicate the expectation of technical or commercial
obsolescence of the asset, which, in turn, might reflect a reduction of
the future economic benefits embodied in the asset.

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(d) v
legal or similar limits on the use of the asset, such as the expiry dates
of related leases. v

11. Depreciation refers to writing off the value of the asset over its useful life.
Such write-off is necessitated on account of normal wear-and-tear, usage, or
obsolescence. Since items of Property, Plant and Equipment are generally
used in generating revenue, the pro-rated write-off in value of such item
should be recorded in the books against the income earned by such an asset.
Providing depreciation is mandatory, in spite of the fact that repairs are
expensed in the Statement of Profit and Loss, or the value of the Property is
appreciating. Depreciation is a systematic allocation of cost of the asset
against the income generated from the continued use of the asset. Further,
the Companies Act, 2013 mandates depreciation to be charged in order to
determine the correct profits. Thus, not charging depreciation would result in
non-compliance with the Companies Act provisions as well.

The argument laid down by the company and the reasons for the same being
invalid are discussed below.
(a) Annual Maintenance Contracts being expensed thereby ensuring timely
repairs of Plant and Machinery:
The fact that the company enters into Annual Maintenance Contracts
for timely repairs can be regarded as a running cost. Such expense is
incurred in order to ensure that the machine continues to run as
intended. Thus, it implies that because the machine is being utilized, it
will need regular repairs. In other words, continuous use is resulting in
normal wear-and-tear which is the reason why depreciation should be
charged by the company. By stating that the company incurs Annual
Maintenance Expenses, the company is recording only the ’maintenance
expenses’, but not the wear-and-tear requiring the maintenance in the
first place. Hence, this argument put forth by the company is not valid.
(b) Depreciation being a non-cash expense has no impact on cash flows.
Accordingly, it is not necessary to depreciate an asset when repairs and
maintenance charges are expensed in the Statement of Profit and Loss.
When viewed from the prism of depreciation alone, it appears that the
fact that depreciation is a non-cash item is correct. However, it must be

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v
v
v noted that at the time of procurement of the asset, the company would
v
have paid cash. Depreciation is after all writing off this amount over the
life of the asset. Hence the argument that depreciation is a non-cash
item is not valid. Depreciation is writing off the cost of the asset (which
was already paid for) over the useful life of the asset, and hence is
mandatory.
(c) The values of certain assets like Property increase with passage of time,
and hence charging depreciation does not make sense.

Certain assets like immovable property do increase in value with the

passage of time. However, such assets are ‘used for the purposes of
business’ and are not ‘held for sale’ or held as investment property.
Accordingly, since the asset is being used for carrying on business,
providing depreciation will give a true and fair view of the results of the
company, and hence the argument that the value of the property
appreciates is not valid.
If the company wants to show the fair market value of the PPE, then it
has the option to apply Revaluation model. However, depreciation is
mandatory to be charged in Revaluation model also.
(d) At the end of the useful life, the asset is ultimately sold, and since the
asset is at cost due to no depreciation, exact profit or loss on sale of the
asset is stated.’
The value of any asset, after usage, will reduce. Accordingly, the
argument that the ‘exact profit or loss on sale of the asset’ will be
obtained is incorrect. Due to usage of the asset, the value of the asset
would be lower than the cost. Charging depreciation would seek to
bring the book value approximating to such reduced value. Thereafter,
on sale of the asset, the true profit or loss would be available.
Accordingly, this argument is also invalid.
It may be pertinent to note that Accounting Standard 1, Disclosure of
Accounting Policies states that Disclosure of accounting policies or of
changes therein cannot remedy a wrong or inappropriate treatment of the
item in the accounts. In other words, the company cannot be absolved of the

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fact that it has not complied with the relevant accounting standards merely v
by giving a disclosure of incorrect policies or practices being followed. v

Thus, the company’s stand of disclosing the incorrect policy as a remedy is

not correct. The company is suggested to charge depreciation on a systematic
basis over the useful life of the asset thereby complying with the Accounting
Standards.

Answer to the Scenario based Questions

12. Heads
(i) Purchase price of PPE
(iii) Directly attributable cost of PPE
(iii) Cost not included in determining the carrying amount of an item of PPE

Items Classified
under Head
1 Import duties and non-refundable purchase taxes (i)
2 Initial delivery and handling costs (ii)
3 Initial operating losses, such as those incurred while (iii)
demand for the output of an item builds up
4 Costs incurred while an item capable of operating in (iii)
the manner intended by management has yet to be
brought into use or is operated at less than full
capacity.
5 Trade discounts and rebates (deducted for computing (i)
purchase price)
6 Costs of relocating or reorganizing part or all of the (iii)
operations of an enterprise.
7 Installation and assembly costs (ii)
8 Administration and other general overhead costs (iii)

13. According to AS 10 (Revised), these costs can be capitalised:

1. Cost of the plant ` 25,00,000

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v
v
2. Initial delivery and handling costs ` 2,00,000
v
3. Cost of site preparation ` 6,00,000
4. Consultants’ fees ` 7,00,000
5. Estimated dismantling costs to be incurred after 7 years ` 3,00,000
` 43,00,000

Note: Interest charges paid on “Deferred credit terms” to the supplier of the
plant (not a qualifying asset) of ` 2,00,000 and operating losses before
commercial production amounting to ` 4,00,000 are not regarded as directly
attributable costs and thus cannot be capitalised. They should be written off
to the Statement of Profit and Loss in the period they are incurred.

14.

Particulars ` in lakhs
Original Cost of the Asset 3,000.00
Less: Depreciation for 4 years (` 3,000 lakhs x 10% x 4 years) (1,200.00)
Book Value at the end of Year 4 1,800.00
Add: Revaluation Surplus (balancing figure) 900.00
Revalued Amount as given (= revised depreciable value) 2,700.00
Less: Depreciation for Year 5 (` 2,700 lakhs ÷ 6 years) 450.00
Carrying Amount at the end of Year 5 2,250.00
Less: Depreciation for Year 6 (` 2,700 lakhs ÷ 6 years) 450.00
Carrying Amount at the end of Year 6 1,800.00

15.

Particulars `
Original Cost of the Asset 2,50,00,000
Less: Depreciation for 2 years (` 2,50,00,000 x 10% x 2 years) 50,00,000
Book Value at the beginning of Year 3 2,00,00,000
Add: Revaluation Surplus (balancing figure) 1,00,00,000
Revalued Amount as given (= revised depreciable value) 3,00,00,000

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v
v v
Less: Depreciation for Years 3-5 (` 3,00,00,000 ÷ 8 yrs x 3 v
1,12,50,000
yrs) v

Carrying Amount at the end of Year 5 1,87,50,000

The treatment of Gain / Loss on Disposal / Revaluation is as below:

Particulars Disposal Proceeds = Disposal Proceeds =

` 1,12,50,000 ` 42,50,000

Book Value Less

` 1,87,50,000 – ` 1,87,50,000 –
Disposal Proceeds
` 1,12,50,000 = ` 42,50,000 =
= Loss recognized
` 75,00,000 (Loss) ` 1,45,00,000 (Loss)
in Profit or Loss

Revaluation
Surplus directly
` 1,00,00,000 ` 1,00,00,000
transferred to
Retained Earnings

16. 1. Cost at Initial Recognition:

Particulars `

Cost of the Plant (as per Invoice) 30,00,000

Initial Delivery and Handling Costs 1,00,000
Cost of Site Preparation 2,00,000
Consultants’ Fees 50,000
Estimated Dismantling and Site Restoration Costs 30,000
Total Cost of Plant including Motors 33,80,000
Less: Cost of Motors identified as a separate component 5,63,333
(1/6)*
Cost of the Plant (excluding Motors – balance 5/6) 28,16,667

* Purchase price of Motors = ` 5,00,000 out of ` 30,00,000 i.e., 1/6 of

value of Plant

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v
v
v
Note: Since the asset is not a qualifying asset, payment of interest to
v
the supplier is not capitalized. Further, operating losses of ` 40,000
incurred before commercial production is not a directly attributable
cost, and hence excluded from cost of asset. These costs are expensed
to the P/L as and when they are incurred.

2 Recognition of Motors Replacement

Particulars `

Cost of Motors determined above 5,63,333

Less: Depreciation for 4 years (as per SLM) 3,75,555

5,63,333 ÷ 6 years x 4 years

Carrying Amount of Motors at the end of Year 4 1,87,778

Accounting: The company should derecognize the existing Carrying

Amount of Motors replaced of ` 1,87,778. Further, the acquisition cost
of new motors of ` 6,00,000 would be capitalized as a separate
component. This amount will be depreciated over the next 5 years at
` 6,00,000 ÷ 5 years = ` 1,20,000 p.a.
3. Revaluation

Particulars `
Cost of the Plant at initial recognition [from (1) above] 28,16,667
Less: SLM Depreciation for 4 years: ` 28,16,667 ÷ 10 years 11,26,667
x 4 years
Carrying Amount of Plant at the end of Year 4 16,90,000
Revalued Amount of Plant (Excluding Motors, since the 19,00,000
same is treated as a separate component: ` 25,00,000 –
` 6,00,000)
Therefore, Gain on Revaluation credited to 2,10,000
Revaluation Reserve
Revised Depreciation Charge p.a.: 19,00,000 ÷ 6 years 3,16,667

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v v
4. Derecognition v
v
Particulars Motors Plant
(excluding
Motors)
Cost / Revalued Amount at end of 6,00,000 19,00,000
Year 4
Less: Depreciation for Years 5-8 1,20,000 x 4 3,16,667 x 4
= 4,80,000 =12,66,668
Carrying Amount before Disposal / 1,20,000 6,33,332
De-recognition
Less: Disposal Proceeds ` 6,00,000 95,575 5,04,425
allocated in ratio of carrying amount
Loss to be written off to P/L 24,425 1,28,907

Notes:
(a) The Revaluation Surplus of ` 2,10,000 would be transferred
directly to Retained Earnings.
(b) The allocation of disposal proceeds of ` 6,00,000 for the plant as
whole is apportioned based on carrying amount of motors and
plant (excluding motors)
Alternatively, it may be apportioned as 1/6 towards motors and 5/6
plant (excluding motors) based on the reasoning that the initially,
motors amounted to 1/6 of the entire plant. This approach may not be
preferable because there has been a revaluation of the plant (excluding
motors) and a disposal and subsequent acquisition of the Motor, which
is not in the initial proportion of 5/6 and 1/6 respectively.

17. As per AS 10, Property, Plant and Equipment, the derecognition of the
carrying amount of components of an item of Property, Plant and Equipment
occurs regardless of whether the cost of the previous part / inspection was
identified in the transaction in which the item was acquired or constructed. If
it is not practicable for an enterprise to determine the carrying amount of the
replaced part/ inspection, it may use the cost of the replacement or the

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v
v
estimated cost of a future similar inspection as an indication of what the cost
v
of the replaced part/ existing inspection component was when the item was
acquired or constructed.
In the given case, the new turbine will produce economic benefits to Bharat
Infrastructure Ltd. and the cost is measurable. Since the recognition criteria
is fulfilled, the same should be recognised as a separate item of Property,
Plant and Equipment. However, since the initial breakup of the components
is not available, the cost of the replacement of ` 450 lakhs can be used as an
indication based on the guidance given above, discounted at 8% for the 6-
year period lapsed.
Thus, estimate of cost 6 years back = ` 450 lakhs ÷ 1.08 6 = ` 283.58 lakhs
Current carrying amount of turbine (to be de-recognised) = Estimated cost `
283.58 lakhs (–) SLM depreciation at 10% (useful life 10 years) for 6 years
` 170.15 lakhs= ` 113.43 lakhs.
Hence revised carrying amount of the machinery will be as under:

Particulars ` in lakhs
Historical Cost [` 1,000 lakhs (–) SLM Depreciation at 10% 400.00
(10 year life) for 6 years]
Add: Cost of new turbine 450.00
Less: Derecognition of current carrying amount of old turbine (113.43)
New Carrying Amount of Machinery 736.57

18.
Particulars `
Purchase Price: 5,000 acres x ` 60,000 per acre 3,000.00
Stamp Duty and Registration Charges at 7% 210.00
Legal and Consultancy Fees 8.00
Title Guarantee Insurance 1.25
Demolition Expenses (Net of Salvage Income) 50.00
[` 110 lakhs (–)` 60 lakhs (` 63 lakhs x 100/105)]
Cost of Land 3,269.25

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19. Calculation of Cost of Plant v
v
Particulars `
Purchase Price Given 6,80,000
Add: Site Preparation Cost Given 21,200
Labour charges (56,000×200/500) 22,400
Given
Spare parts 5,000
Supervisor’s Salary 25% of ` 26,000 6,500
Technical costs 1/10 of ` 34,000 3,400
Test run and experimental Given 18,000
production charges
Architect Fees for set up Given 11,000
Depreciation on assets used for Given 12,000
installation
Total Cost of Asset 7,79,500
Less: GST credit receivable (40,000)
Value to be capitalized 7,39,500

Note: Further Expenses of ` 8,900 from 15.1.20X1 to 1.2.20X1 to be charged

to profit and loss A/c as plant was ready for production on 15.1.20X1.

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v
v
v
v
UNIT 3: ACCOUNTING STANDARD 13
ACCOUNTING FOR INVESTMENTS

LEARNING OUTCOMES
After studying this unit, you will be able to comprehend–
 What are the various Forms of Investments

 Classification of Investments
 How to compute the Cost of Investments

• Current Investments
• Long-term Investments

• Investment Properties
 Disposal of Investments

 Reclassification of Investments
 Disclosure Requirements as per the standard.

3.1 INTRODUCTION
The standard deals with accounting for investments in the financial statements of
enterprises and related disclosure requirements.
Shares, debentures and other securities held as stock-in-trade (i.e., for sale in the
ordinary course of business) are not ‘investments’ as defined in this Standard.
However, the manner in which they are accounted for and disclosed in the financial
statements is quite similar to that applicable in respect of current investments.
Accordingly, the provisions of this Standard, to the extent that they relate to current
investments, are also applicable to shares, debentures and other securities held as
stock-in-trade, with suitable modifications as specified in this Standard.

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v
v
This Standard does not deal with: v
v
a. The basis for recognition of interest, dividends and rentals earned on
investments which are covered by AS 9
b. Operating or finance leases
c. Investments on retirement benefit plans and life insurance enterprises
d. Mutual funds, venture capital funds and/ or the related asset management
companies, banks and public financial institutions formed under a Central or
State Government Act or so declared under the Companies Act, 2013.

3.2 DEFINITION OF THE TERMS USED IN THE

STANDARD
Investments are assets held by an enterprise for earning income by way of
dividends, interest, and rentals, for capital appreciation, or for other benefits to the
investing enterprise. Assets held as stock-in-trade (inventory) are not ‘investments’
Fair value is the amount for which an asset could be exchanged between a
knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s length
transaction. Under appropriate circumstances, market value or net realisable value
provides an evidence of fair value.
Market value is the amount obtainable from the sale of an investment in an open
market, net of expenses necessarily to be incurred on or before disposal.

3.3 FORMS OF INVESTMENTS

Enterprises hold investments for diverse reasons. For some enterprises, investment
activity is a significant element of operations, and assessment of the performance
of the enterprise may largely, or solely, depend on the reported results of this
activity.
Some investments have no physical existence and are represented merely by
certificates or similar documents (e.g., shares) while others exist in a physical form
(e.g., buildings). For some investments, an active market exists from which a market
value (fair value) can be established. For other investments, an active market does
not exist and other means are used to determine fair value.

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3.4v CLASSIFICATION OF INVESTMENTS

Classification of Investments

Current Investments Long Term Investments

A current investment is an investment that is by its nature readily realisable and

is intended to be held for not more than one year from the date on which such
investment is made. The intention to hold for not more than one year is to be
judged at the time of purchase of investment.
A long term investment is an investment other than a current investment.
Further classification of current and long-term investments should be as specified
in the statute governing the enterprise. In the absence of a statutory requirement,
such further classification should disclose, where applicable, investments in:
(a) Government or Trust securities
(b) Shares, debentures or bonds
(c) Investment properties
(d) Others—specifying nature

3.5 COST OF INVESTMENTS

The cost of an investment includes acquisition charges such as brokerage, fees and
duties etc.
Example

X Ltd invests in long-term deposit worth ` 200 lakhs on 1st April 2022. It incurs
brokerage cost of ` 1 lakh to be able to make the investment. The value of the
investment on 1st April 2022 is ` 201 lakhs.

If an investment is acquired, or partly acquired, by the issue of shares or other

securities, the acquisition cost is the fair value of the securities issued. The fair value
may not necessarily be equal to the nominal or par value of the securities issued.

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v
If an investment is acquired in exchange, or part exchange, for another asset, the
v
acquisition cost of the investment is determined by reference to the fair value of
the asset given up or the fair value of the investment acquired, whichever is more
clearly evident.
Interest, dividends and rentals receivables in connection with an investment are
generally regarded as income, being the return on the investment. However, in
some circumstances, such inflows represent a recovery of cost and do not form part
of income.

For example, when unpaid interest has accrued before the acquisition of an
interest-bearing investment and is therefore included in the price paid for the
investment, the subsequent receipt of interest is allocated between pre-acquisition
and post-acquisition periods; the pre-acquisition portion is deducted from cost.
When dividends on equity are declared from pre-acquisition profits, a similar
treatment may apply. If it is difficult to make such an allocation except on an
arbitrary basis, the cost of investment is normally reduced by dividends receivable
only if they clearly represent a recovery of a part of the cost.
When right shares offered are subscribed for, the cost of the right shares is added
to the carrying amount of the original holding. If rights are not subscribed for but
are sold in the market, the sale proceeds are taken to the profit and loss statement.
However, where the investments are acquired on cum-right basis and the market
value of investments immediately after their becoming ex-right is lower than the
cost for which they were acquired, it may be appropriate to apply the sale proceeds
of rights to reduce the carrying amount of such investments to the market value.

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v
v Acquisition Charges

Fair value of the securities

issued

Added fair value of the asset given up

or the fair value of the
investment acquired, whichever
is more clearly evident.

Cost of Right shares

subscribed
Cost of
Investment Interest received for pre-
acquisition period

Dividend received for

pre-acquisition period
only if they clearly
represent a recovery of
cost.
Reduced
If investments acquired on cum-
right basis and the market value of
investments immediately after their
becoming ex-right is lower than the
cost for which they were acquired,
then sale proceeds till carrying
amount becomes equal to market
value.

3.6 CARRYING AMOUNT OF INVESTMENTS

The carrying amount for current investments is the lower of cost and fair value.

Valuation of current investments on overall (or global) basis is not considered

appropriate. Sometimes, the concern of an enterprise may be with the value of a
category of related current investments and not with each individual investment,
and accordingly the investments may be carried at the lower of cost and fair value
computed category-wise (i.e. equity shares, preference shares, convertible
debentures, etc.). However, the more prudent and appropriate method is to carry
investments individually at the lower of cost and fair value.

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v
v
Any reduction to fair value is debited to profit and loss account, however, if fair
value of investment is increased subsequently, the increase in value of current v
investment up to the cost of investment is credited to the profit and loss account
(and excess portion, if any, is ignored).
Long term investments are usually carried at cost. The carrying amount of long-
term investments is therefore determined on an individual investment basis. Where
there is a decline, other than temporary, in the carrying amounts of long term
valued investments, the resultant reduction in the carrying amount is charged to
the profit and loss statement. The reduction in carrying amount is reversed when
there is a rise in the value of the investment, or if the reasons for the reduction no
longer exist. Example of Decline other than temporary:

(A) Company in which investment is made is making cash operating losses which
has resulted in reduction of its net worth,
(B) New regulation which has negative impact in the working of the investee,

(C) Significant reduction of quoted price of the investment, etc.

Carrying Amount

Current Long term

investments investments

Lower of cost Carried Valuation

Valuation
and fair value.

Any reduction to fair on overall (or global) at cost. Determined on

value is debited to basis is not an individual
profit and loss considered investment
account, however, if appropriate; prudent basis.
fair value of method is to carry Where there is a decline, other
investment is investment than temporary,in the carrying
increased individually. amounts of long term valued
subsequently, the investments, the resultant
increase in value of reduction in the carrying amount is
current investment charged to the profit and loss
up to the cost of statement. The reduction in
investment is carrying amount is reversed when
credited to the profit there is a rise in the value of the
and loss account investment, or if the reasons for
(and excess portion, the reduction no longer exist.
if any, is ignored).

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v 1
Illustration
v
An unquoted long term investment is carried in the books at a cost of ` 2 lakhs. The
published accounts of the unlisted company received in May, 20X1 showed that the
company was incurring cash losses with declining market share and the long term
investment may not fetch more than ` 20,000. How will you deal with this in
preparing the financial statements of R Ltd. for the year ended 31 st March, 20X1?
Solution
As stated in the question that financial statements for the year ended 31st March,
20X1 are still under preparation – The answer has been given on the assumption
that the financial statements are yet to be completed and approved by the Board
of Directors.

Also, the fall in value of investments has been considered on account of conditions
existing on the balance sheet date.
Investments classified as long term investments should be carried in the financial
statements at cost. However, provision for diminution should be made to recognise
a decline, other than temporary, in the value of the investments, such reduction
being determined and made for each investment individually. AS 13 (Revised)
‘Accounting for Investments’ states that indicators of the value of an investment
are obtained by reference to its market value, the investee's assets and results and
the expected cash flows from the investment. On the above basis, the facts of the
given case clearly suggest that the provision for diminution should be made to
reduce the carrying amount of long term investment to ` 20,000 in the financial
statements for the year ended 31 st March, 20X1.
Illustration 2
X Ltd. on 1-1-20X1 had made an investment of ` 600 lakhs in the equity shares of Y
Ltd. of which 50% is made in the long term category and the rest as temporary
investment. The realisable value of all such investment on 31-3-20X1 became ` 200
lakhs as Y Ltd. lost a case of copyright. From the given market conditions, it is
apparent that the reduction in the value is not temporary in nature. How will you
recognise the reduction in financial statements for the year ended on 31 -3-20X1?

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Solution v
v
X Ltd. invested ` 600 lakhs in the equity shares of Y Ltd. Out of the same, the
company intends to hold 50% shares for long term period i.e. ` 300 lakhs and
remaining as temporary (current) investment i.e. ` 300 lakhs. Irrespective of the fact
that investment has been held by X Ltd. only for 3 months (from 1.1.20 X1 to
31.3.20X1), AS 13 (Revised) lays emphasis on intention of the investor to classify
the investment as current or long term even though the long term investment may
be readily marketable.

In the given situation, the realisable value of all such investments on 31.3.20X1
became ` 200 lakhs i.e. ` 100 lakhs in respect of current investment and ` 100 lakhs
in respect of long term investment.

As per AS 13 (Revised), ‘Accounting for Investment’, the carrying amount for current
investments is the lower of cost and fair value. In respect of current investments for
which an active market exists, market value generally provides the best evidence of
fair value.

Accordingly, the carrying value of investment held as temporary investment should

be shown at realisable value i.e. at ` 100 lakhs. The reduction of ` 200 lakhs in the
carrying value of current investment will be charged to the profit and loss account.

The Standard further states that long-term investments are usually carried at cost.
However, when there is a decline, other than temporary, in the value of long term
investment, the carrying amount is reduced to recognise the decline.

Here, Y Ltd. lost a case of copyright which drastically reduced the realisable value of its
shares to one third which is quiet a substantial figure. Losing the case of copyright may
affect the business and the performance of the company in the long run. Accordingly,
it will be appropriate to reduce the carrying amount of long term investment by ` 200
lakhs and show the investments at ` 100 lakhs, since the downfall in the value of shares
is other than temporary. The reduction of ` 200 lakhs in the carrying value of long term
investment will also be charged to the Statement of profit and loss.

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3.7v INVESTMENT PROPERTIES
An investment property is 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.

An investment property is accounted for in accordance with cost model as

prescribed in AS 10 (Revised), ‘Property, Plant and Equipment’. The cost of any
shares in a co-operative society or a company, the holding of which is directly
related to the right to hold the investment property, is added to the carrying
amount of the investment property.

3.8 DISPOSAL OF INVESTMENTS

On disposal of an investment, the difference between the carrying amount and the
disposal proceeds, net of expenses, is recognised in the profit and loss statement.
When disposing of a part of the holding of an individual investment, the carrying
amount to be allocated to that part is to be determined on the basis of the average
carrying amount of the total holding of the investment 1.

3.9 RECLASSIFICATION OF INVESTMENTS

Where long-term investments are reclassified as current investments, transfers are
made at the lower of cost and carrying amount at the date of transfer.

Where investments are reclassified from current to long-term, transfers are made
at the lower of cost and fair value at the date of transfer.
Illustration 3
ABC Ltd. wants to re-classify its investments in accordance with AS 13 (Revised).
Decide and state on the amount of transfer, based on the following information:

1
In respect of shares, debentures and other securities held as stock -in-trade, the cost of
stocks disposed of is determined by applying an appropriate cost formula (e.g. first -in, first-
out, average cost, etc.). These cost formulae are the same as those sp ecified in AS 2
(Revised), in respect of Valuation of Inventories.

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(1) v
A portion of current investments purchased for ` 20 lakhs, to be reclassified as
long term investment, as the company has decided to retain them. The market v
value as on the date of Balance Sheet was ` 25 lakhs.
(2) Another portion of current investments purchased for ` 15 lakhs, to be
reclassified as long term investments. The market value of these investments as
on the date of balance sheet was ` 6.5 lakhs.
(3) Certain long term investments no longer considered for holding purposes, to be
reclassified as current investments. The original cost of these was ` 18 lakhs
but had been written down to ` 12 lakhs to recognise other than temporary
decline as per AS 13 (Revised).

Reclassfication of investment

Long term to Current Current to Long term

lower of cost and carrying lower of cost and fair value

amount at the date of at the date of transfer
transfer
Solution
As per AS 13 (Revised), where investments are reclassified from current to long-
term, transfers are made at the lower of cost and fair value at the date of transfer.
(1) In the first case, the market value of the investment is ` 25 lakhs, which is higher
than its cost i.e. ` 20 lakhs. Therefore, the transfer to long term investments
should be carried at cost i.e. ` 20 lakhs.

(2) In the second case, the market value of the investment is ` 6.5 lakhs, which is
lower than its cost i.e. ` 15 lakhs. Therefore, the transfer to long term investments
should be carried in the books at the market value i.e. ` 6.5 lakhs. The loss of `
8.5 lakhs should be charged to profit and loss account.

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v
As per AS 13 (Revised), where long-term investments are re-classified as
v
current investments, transfers are made at the lower of cost and carrying
amount at the date of transfer.
(3) In the third case, the book value of the investment is ` 12 lakhs, which is lower
than its cost i.e. ` 18 lakhs. Here, the transfer should be at carrying amount and
hence this re-classified current investment should be carried at ` 12 lakhs.

3.10 DISCLOSURE
The following disclosures in financial statements in relation to investments are
appropriate: -
a. The accounting policies followed for the determination of carrying amount of
investments.

b. The amounts included in profit and loss statement for:

i. Interest, dividends (showing separately dividends from subsidiary
companies), and rentals on investments showing separately such
income from long term and current investments. Gross income should
be stated, the amount of income tax deducted at source being included
under Advance Taxes Paid.
ii. Profits and losses on disposal of current investments and changes in
carrying amount of such investments.
iii. Profits and losses on disposal of long term investments and changes in
the carrying amount of such investments.
c. Significant restrictions on the right of ownership, realisability of investments
or the remittance of income and proceeds of disposal.

d. The aggregate amount of quoted and unquoted investments, giving the

aggregate market value of quoted investments.
e. Other disclosures as specifically required by the relevant statute governing
the enterprise.
f. Classification of investments.

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Illustration 4 v
v
M/s Innovative Garments Manufacturing Company Limited invested in the shares of
another company on 1st October, 20X3 at a cost of ` 2,50,000. It also earlier
purchased Gold of ` 4,00,000 and Silver of ` 2,00,000 on 1 st March, 20X1. Market
value as on 31 st March, 20X4 of above investments are as follows:

`
Shares 2,25,000
Gold 6,00,000

Silver 3,50,000
How above investments will be shown in the books of accounts of M/s Innovative
Garments Manufacturing Company Limited for the year ending 31st March, 20 X4 as
per the provisions of Accounting Standard 13 "Accounting for Investments"?
Solution
As per AS 13 (Revised) ‘Accounting for Investments’, for investment in shares if the
investment is purchased with an intention to hold for short-term period (less than
one year), then it will be classified as current investment and to be carried at lower
of cost and fair value, i.e., in case of shares, at lower of cost (` 2,50,000) and market
value (` 2,25,000) as on 31 March 20X4, i.e., ` 2,25,000.
If equity shares are acquired with an intention to hold for long term period (more than
one year), then should be considered as long-term investment to be shown at cost in
the Balance Sheet of the company. However, provision for diminution should be made
to recognise a decline, if other than temporary, in the value of the investments.
Gold and silver are generally purchased with an intention to hold it for long term
period (more than one year) until and unless given otherwise. Hence, the
investment in Gold and Silver (purchased on 1 st March, 20X1) should continue to
be shown at cost (since there is no ‘other than temporary’ diminution) as on 31 st
March, 20X4, i.e., ` 4,00,000 and ` 2,00,000 respectively, though their market values
have been increased.

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Illustration
v
In 20X1, M/s. Wye Ltd. issued 12% fully paid debentures of ` 100 each, interest being
payable half yearly on 30th September and 31 st March of every accounting year.
On 1st December, 20X2, M/s. Bull & Bear purchased 10,000 of these debentures at
` 101 ex-interest price, also paying brokerage @ 1% of ex-interest amount of the
purchase. On 1st March, 20X3 the firm sold all these debentures at ` 103 ex-interest
price, again paying brokerage @ 1 % of ex-interest amount. Prepare Investment
Account in the books of M/s. Bull & Bear for the period 1 st December, 20X2 to 1 st
March, 20X3.
Solution
In the books of M/s Bull & Bear
Investment Account
for the period from 1 December 20X2 to 1 st March, 20X3
st

(Scrip: 12% Debentures of M/s. Wye Ltd.)

Date Particulars Nominal Interest Cost Date Particulars Nominal Interest Cost
Value (` ) Value (`)
(` ) (` )

1.12.20X2 To Bank A/c 10,00,000 20,000 10,20,100 1.03.20X3 By Bank A/c 10,00,000 50,000 10,19,700
(W.N.1) (W.N.2)

1.3.20X3 To Profit & 1.3.20X3 By Profit &

loss A/c* loss A/c
(b.f.) - 30,000 (b.f.) 400

10,00,000 50,000 10,20,100 10,00,000 50,000 10,20,100

* This represents income for M/s. Bull & Bear for the period 1 st December, 20X2 to
1st March, 20X3, i.e., interest for three months- 1st December, 20X2 to 28 February, 20X3).

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Working Notes: v
v
1. Cost of 12% debentures purchased on 1.12.20X2 `
Cost Value (10,000  ` 101) = 10,10,000
Add: Brokerage (1% of ` 10,10,000) = 10,100
Total = 10,20,100
2. Sale proceeds of 12% debentures sold `
Sales Price (10,000  ` 103) = 10,30,000
Less: Brokerage (1% of ` 10,30,000) = (10,300)

Total = 10,19,700
Illustration 6
On 1.4.20X1, Mr. Krishna Murty purchased 1,000 equity shares of ` 100 each in TELCO
Ltd. @ ` 120 each from a Broker, who charged 2% brokerage. He incurred 50 paise per
` 100 as cost of shares transfer stamps. On 31.1.20X2, Bonus was declared in the ratio
of 1: 2. Before and after the record date of bonus shares, the shares were quoted at
` 175 per share and ` 90 per share respectively. On 31.3.20X2, Mr. Krishna Murty sold
bonus shares to a Broker, who charged 2% brokerage.
Show the Investment Account in the books of Mr. Krishna Murty, who held the shares as
Current assets and closing value of investments shall be made at Cost or Market value
whichever is lower.
Solution
In the books of Mr. Krishna Murty
Investment Account for the year ended 31st March, 20X2
(Scrip: Equity Shares of TELCO Ltd.)

Date Particulars Nominal Cost Date Particulars Nominal Cost

Value (`) (`) Value (`) (`)

1.4.20X1 To Bank A/c 1,00,000 1,23,000 31.3.20X2 By Bank A/c 50,000 44,100
(W.N.1) (W.N.2)

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31.1.20X2 To Bonus shares 50,000 − 31.3.20X2 By Balance c/d
v
(W.N.5) (W.N.4) 1,00,000 82,000

31.3.20X2 To Profit & loss

A/c (W.N.3) − 3,100

1,50,000 1,26,100 1,50,000 1,26,100

Working Notes:
1. Cost of equity shares purchased on 1.4.20X1 = (1,000 ` 120) + (2% of
` 1,20,000) + (½% of ` 1,20,000) = ` 1,23,000
2. Sale proceeds of equity shares (bonus) sold on 31st March, 20X2= (500 ` 90) –
(2% of ` 45,000) = ` 44,100.
3. Profit on sale of bonus shares on 31st March, 20X2
= Sale proceeds – Average cost
Sale proceeds = ` 44,100
Average cost = ` (1,23,000 /1,50,000) x 50,000 = ` 41,000
Profit = ` 44,100 – ` 41,000 = ` 3,100.
4. Valuation of equity shares on 31st March, 20X2
Cost = (` 1,23,000/1,50,000) x 1,00,000 = ` 82,000
Market Value = 1,000 shares × ` 90 = ` 90,000
Closing balance has been valued at ` 82,000 being lower than the market value.
5. Bonus shares do not have any cost.
Illustration 7
Mr. X purchased 500 equity shares of ` 100 each in Omega Co. Ltd. for ` 62,500 inclusive
of brokerage and stamp duty. Some years later the company resolved to capitalise its
profits and to issue to the holders of equity shares, one equity bonus share for every share
held by them. Prior to capitalisation, the shares of Omega Co. Ltd. were quoted at ` 175
per share. After the capitalisation, the shares were quoted at ` 92.50 per share. Mr. X.
sold the bonus shares and received at ` 90 per share.

Prepare the Investment Account in X’s books on average cost basis.

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Solution v
v
In the books of X
Investment Account
[Scrip: Equity shares in Omega Co. Ltd.]

Particulars Nominal Cost Particulars Nominal Cost

Value Value

` ` ` `

To Cash 50,000 62,500 By Cash - Sale (500 x 90) 50,000 45,000

To Bonus shares (W.N.1) 50,000 - By Balance c/d (W.N. 3) 50,000 31,250

To P & L A/c (W.N. 2) - 13,750

1,00,000 76,250 1,00,000 76,250

To Balance b/d 50,000 31,250

Working Notes:

1. Bonus shares do not have any cost.

2. Profit on sale of bonus shares = Sales proceeds – Average cost
Sales proceeds = ` 45,000

Average cost = 500  62,500 = ` 31,250

1,000

Profit = ` 45,000 – `31,250 = ` 13,750.

3. Valuation of Closing Balance of Shares at the end of year

The total cost of 1,000 share including bonus is `62,500

Therefore, cost of 500 shares (carried forward) is 500  62,500 = ` 31,250

1,000

Market price of 500 shares = 92.50 x 500 = ` 46,250

Cost being lower than the market price, therefore shares are carried forward at cost.

© The Institute of Chartered Accountants of India

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Illustration
v
On 1st April, 20X1, Rajat has 50,000 equity shares of P Ltd. at a book value of ` 15 per
share (nominal value ` 10 each). He provides you the further information:
(1) On 20th June, 20X1 he purchased another 10,000 shares of P Ltd. at ` 16 per share.
(2) On 1st August, 20X1, P Ltd. issued one equity bonus share for every six shares held
by the shareholders.
(3) On 31st October, 20X1, the directors of P Ltd. announced a right issue which entitles
the holders to subscribe three shares for every seven shares at ` 15 per share.
Shareholders can transfer their rights in full or in part.
Rajat sold 1/3rd of entitlement to Umang for a consideration of ` 2 per share and
subscribed the rest on 5th November, 20X1.

You are required to prepare Investment A/c in the books of Rajat for the year ending
31st March, 20X2.
Solution
In the books of Rajat
Investment Account
(Equity shares in P Ltd.)

Date Particulars No. of Amount Date Particulars No. of Amount

shares (`) shares (`)

1.4.X1 To Balance b/d 50,000 7,50,000 31.3.X2 By Balance c/d 90,000 12,10,000

20.6.X1 To Bank A/c 10,000 1,60,000 (Bal. fig.)

1.8.X1 To Bonus issue

(W.N.1) 10,000 -

5.11.X1 To Bank A/c

(right shares)
(W.N.4) 20,000 3,00,000

90,000 12,10,000 90,000 12,10,000

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Working Notes: v
v
50,000 + 10,000
(1) Bonus shares = = 10,000 shares
6
50,000 + 10,000 + 10,000
(2) Right shares =  3 = 30,000 shares
7
1
(3) Sale of rights = 30,000 shares× × ` 2= ` 20,000 to be credited to
3
statement of profit and loss
2
(4) Rights subscribed = 30,000 shares × × ` 15 = ` 3,00,000
3

Illustration 9
On 1.4.20X1, Sundar had 25,000 equity shares of ‘X’ Ltd. at a book value of ` 15 per
share (Nominal value ` 10). On 20.6.20X1, he purchased another 5,000 shares of the
company at `16 per share. The directors of ‘X’ Ltd. announced a bonus and rights issue.
No dividend was payable on these issues. The terms of the issue are as follows:
Bonus basis 1:6 (Date 16.8.20X1).
Rights basis 3:7 (Date 31.8.20X1) Price ` 15 per share.
Due date for payment 30.9.20X1.
Shareholders were entitled to transfer their rights in full or in part. Accordingly,
Sundar sold 33.33% of his entitlement to Sekhar for a consideration of ` 2 per share.
Dividends: Dividends for the year ended 31.3.20X1 at the rate of 20% were declared
by X Ltd. and received by Sundar on 31.10.20X1. Dividends for shares acquired by
him on 20.6.20X1 are to be adjusted against the cost of purchase.
On 15.11.20X1, Sundar sold 25,000 equity shares at a premium of ` 5 per share.
You are required to prepare in the books of Sundar.
(1) Investment Account
(2) Profit & Loss Account.
For your exercise, assume that the books are closed on 31.12.20X1and shares are valued
at average cost.

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Solutionv
v
Books of Sundar
Investment Account
(Scrip: Equity Shares in X Ltd.)

No. Amount No. Amount

` `
1.4.20X1 To Bal b/d 25,000 3,75,000 31.10.20X1 By Bank — 10,000
20.6.20X1 To Bank 5,000 80,000 (dividend
16.8.20X1 To Bonus 5,000 — on shares
(W.N.1) acquired on
30.9.20X1 To Bank 10,000 1,50,000 20/6/20X1)
(Rights (W.N.4)
Shares)
(W.N.3)
15.11.20X1 To Profit 44,444 15.11.20X1 By Bank 25,000 3,75,000
(on sale of (Sale of
shares) shares)
31.12.20X1 By Bal. c/d 20,000 2,64,444
(W.N.6)

45,000 6,49,444 45,000 6,49,444

Profit and Loss Account (An extract)

To Balance c/d 1,04,444 By Profit transferred 44,444

By Sale of rights (W.N.3) 10,000
By Dividend (W.N.4) 50,000
1,04,444 1,04,444

Working Notes:
( 25,000+5,000 )
(1) Bonus Shares = = 5,000 shares
6

(2) Right Shares =

(25,000+5,000+5,000 ) ×3 = 15,000 shares
7

© The Institute of Chartered Accountants of India

 ASSETS BASED ACCOUNTING STANDARDS 5.97
5.97
v
v
(3) Right shares renounced = 15,000×1/3 = 5,000 shares v
v
Sale of right shares = 5,000 x 2 = ` 10,000

Right shares subscribed = 15,000 – 5,000 = 10,000 shares

Amount paid for subscription of right shares = 10,000 x 15 = ` 1,50,000
(4) Dividend received = 25,000 (shares as on 1st April 20X1) × 10 × 20% = ` 50,000
Dividend on shares purchased on 20.6.20X1 = 5,000×10×20% = ` 10,000 is
adjusted to Investment A/c
(5) Profit on sale of 25,000 shares

= Sales proceeds – Average cost

Sales proceeds = ` 3,75,000

Average cost =
(3,75,000+80,000+1,50,000 -10,000 ) ×25,000 = ` 3,30,556
45,000

Profit = ` 3,75,000– ` 3,30,556= `44,444.

(6) Cost of shares on 31.12.20X1

(3,75,000+80,000+1,50,000 -10,000 ) ×20,000 = ` 2,64,444

45,000

Reference: The students are also advised to refer the full bare text of AS 13
(Revised) “Accounting for Investments”.

© The Institute of Chartered Accountants of India

 5.98 ADVANCED ACCOUNTING
v
v
v
v
TEST YOUR KNOWLEDGE
Multiple Choice Questions
1. The cost of Right shares is
(a) added to the cost of investments.
(b) subtracted from the cost of investments.
(c) no treatment is required.

(d) added to cost of investments at market value.

2. Long term investments are carried at
(a) fair value.
(b) cost less ‘other than temporary’ decline.
(c) Cost and market value whichever is less.
(d) Cost and market value whichever is higher.
3 Current investments are carried at
(a) Fair value.
(b) cost.

(c) Cost and fair value, whichever is less.

(d) Cost and fair value, whichever is higher.
4. A Ltd. acquired 2,000 equity shares of Omega Ltd. on cum-right basis at ` 75
per share. Subsequently, omega Ltd. made a right issue of 1:1 at ` 60 per share,
which was subscribed for by A. Total cost of investments at the year-end will
be `

(a) 2,70,000.
(b) 1,50,000.
(c) 1,20,000.
(d) 1,70,000.

© The Institute of Chartered Accountants of India

 ASSETS BASED ACCOUNTING STANDARDS 5.99
5.99
v
v
5. Cost of investment includes v
v
(a) Purchase costs.

(b) Brokerage and Stamp duty paid.

(c) Both (a) and (b).
(d) none of the above.

Theoretical Questions
6. Briefly explain disclosure requirements for Investments as per AS-13.
7. How will you classify the investments as per AS 13? Explain in Brief.
8. Whether the accounting treatment 'at cost' under the head ‘Long Term
Investments’ without providing for any diminution in value is correct and in
accordance with the provisions of AS 13. If not, what should have been the
accounting treatment in such a situation? Explain in brief.

Scenario based Questions

9 Mr. X acquires 200 shares of a company on cum-right basis for ` 70,000. He
subsequently receives an offer of right to acquire fresh shares in the company
in the proportion of 1:1 at ` 107 each. He does not subscribe but sells all the
rights for ` 12,000. The market value of the shares after their becoming ex-
rights has also gone down to ` 60,000. What should be the accounting
treatment in this case?
10. On 1st April, 20X1, XY Ltd. has 15,000 equity shares of ABC Ltd. at a book value
of ` 15 per share (nominal value ` 10 per share). On 1 st June, 20X1, XY Ltd.
acquired 5,000 equity shares of ABC Ltd. for ` 1,00,000. ABC Ltd. announced a
bonus and right issue.
(1) Bonus was declared, at the rate of one equity share for every five shares
held, on 1 st July 20X1.
(2) Right shares are to be issued to the existing shareholders on 1 st September
20X1. The company will issue one right share for every 6 shares at 20%
premium. No dividend was payable on these shares.

© The Institute of Chartered Accountants of India

 5.100 ADVANCED ACCOUNTING
v
v
v
(3) Dividend for the year ended 31.3.20X1 were declared by ABC Ltd. @ 20%,
v
which was received by XY Ltd. on 31 st October 20X1.
XY Ltd.
(i) Took up half the right issue.
(ii) Sold the remaining rights for ` 8 per share.
(iii) Sold half of its shareholdings on 1st January 20X2 at ` 16.50 per share.
Brokerage being 1%.
You are required to prepare Investment account of XY Ltd. for the year ended
31st March 20X2 assuming the shares are being valued at average cost.
11. The following information is presented by Mr. Z (a stock broker), relating to his
holding in 9% Central Government Bonds.
Opening balance (nominal value) ` 1,20,000, Cost ` 1,18,000 (Nominal value of
each unit is ` 100).
1.3.20X1 Purchased 200 units, ex-interest at ` 98.
1.7.20X1 Sold 500 units, ex-interest out of original holding at ` 100.
1.10.20X1 Purchased 150 units at ` 98, cum interest.
1.11.20X1 Sold 300 units, ex-interest at ` 99 out of original holdings.

Interest dates are 30th September and 31st March. Mr. Z closes his books every
31st December. Show the investment account as it would appear in his books. Mr.
Z follows FIFO method.
12. Mr. Purohit furnishes the following details relating to his holding in 8% Debentures
(` 100 each) of P Ltd., held as Current assets:
1.4.20X1 Opening balance – Nominal value ` 1,20,000, Cost ` 1,18,000

1.7.20X1 100 Debentures purchased ex-interest at ` 98

1.10.20X1 Sold 200 Debentures ex-interest at ` 100
1.1.20X2 Purchased 50 Debentures at ` 98 ex-interest
1.2.20X2 Sold 200 Debentures ex-interest at `99

Due dates of interest are 30th September and 31st March.

© The Institute of Chartered Accountants of India

 ASSETS BASED ACCOUNTING STANDARDS 5.101
5.101
v
v
Mr. Purohit closes his books on 31.3.20X2. Brokerage at 1% is to be paid for each v
v
transaction (at ex-interest price). Show Investment account as it would appear in his
books. Assume FIFO method. Market value of 8% Debentures of P Limited on 31.3.20X2
is ` 99.
13. On 1st April, 20X1, Mr. Vijay had 30,000 Equity shares in X Ltd. at a book value
of ` 4,50,000 (Face Value ` 10 per share). On 22 nd June, 20X1, he purchased
another 5000 shares of the same company for ` 80,000.
The Directors of X Ltd. announced a bonus of equity shares in the ratio of one
share for seven shares held on 10th August, 20X1.
On 31st August, 20X1 the Company made a right issue in the ratio of three
shares for every eight shares held, on payment of ` 15 per share. Due date for
the payment was 30th September, 20X1, Mr. Vijay subscribed to 2/3rd of the
right shares and sold the remaining of his entitlement to Viru for a
consideration of ` 2 per share.

On 31st October, 20X1, Vijay received dividends from X Ltd. @ 20% for the year
ended 31st March, 20X1. Dividend for the shares acquired by him on 22nd June,
20X1 to be adjusted against the cost of purchase.

On 15th November, 20X1 Vijay sold 20,000 Equity shares at a premium of ` 5 per
share.
You are required to prepare Investment Account in the books of Mr. Vijay for
the year ended 31st March, 20X2 assuming the shares are being valued at
average cost.
14. Blue-chip Equity Investments Ltd., wants to re-classify its investments in
accordance with AS 13 (Revised). State the values, at which the investments
have to be reclassified in the following cases:
(i) Long term investments in Company A, costing ` 8.5 lakhs are to be re-
classified as current. The company had reduced the value of these
investments to ` 6.5 lakhs to recognise ‘other than temporary’ decline in
value. The fair value on date of transfer is ` 6.8 lakhs.
(ii) Long term investments in Company B, costing ` 7 lakhs are to be re-
classified as current. The fair value on date of transfer is ` 8 lakhs and
book value is ` 7 lakhs.

© The Institute of Chartered Accountants of India

 5.102 ADVANCED ACCOUNTING
v
v
v
(iii) Current investment in Company C, costing ` 10 lakhs are to be re-
v
classified as long term as the company wants to retain them. The market
value on date of transfer is ` 12 lakhs.
15. Gowtham Limited invested in shares of another company (with the intention
to hold the shares for short-term period) on 30th November, 2021 at a cost of
` 4,25,000. It also earlier purchased Gold of ` 8,00,000 and Silver of ` 3,50,000
on 31st March, 20X1.
Market values as on 31st March, 20X4, of the above investments are as
follows:
Shares ` 3,50,000
Gold ` 10,25,000
Silver ` 5,10,000
You are required to explain how will the above investments be shown
(individually and in total) in the books of account of Gowtham Limited for the
year ending 31st March, 20X4 as per the provisions of AS 13.

ANSWERS/SOLUTIONS
Answer to the Multiple Choice Questions
1. (a) 2. (b) 3. (c) 4. (a) 5. (c)

Answer to the Theoretical Questions

6. The disclosure requirements as per AS 13 (Revised) are as follows:
(i) Accounting policies followed for the determination of carrying amount
of investments.
(ii) Classification of investment into current and long term.
(iii) The amount included in profit and loss statements for

(a) Interest, dividends and rentals for long term and current
investments, disclosing therein gross income and tax deducted at
source thereon;

© The Institute of Chartered Accountants of India

 ASSETS BASED ACCOUNTING STANDARDS 5.103
5.103
v
v
(b) v
Profits and losses on disposal of current investment and changes
in carrying amount of such investments; v

(c) Profits and losses and disposal of long term investments and
changes in carrying amount of investments.
(iv) Aggregate amount of quoted and unquoted investments, giving the
aggregate market value of quoted investments;
(v) Any significant restrictions on investments like minimum holding period
for sale/disposal, utilisation of sale proceeds or non-remittance of sale
proceeds of investment held outside India.
(vi) Other disclosures required by the relevant statute governing the
enterprises

7. The investments are classified into two categories as per AS 13, viz., Current
Investments and Long-term Investments.
A current Investment is an investment that is by its nature readily realisable and
is intended to be held for not more than one year from the date on which such
investment is made. The carrying amount for current investments is the lower of
cost and fair value. Any reduction to fair value and any reversals of such
reductions are included in the statement of profit and loss.
A long-term investment is an investment other than a current investment. Long
term investments are usually carried at cost. However, 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. The reduction in carrying amount
is charged to the statement of profit and loss.

8. The accounting treatment 'at cost' under the head 'Long Term Investment’ in
the financial statements of the company without providing for any diminution
in value is correct and is in accordance with the provisions of AS 13 provided
that there is no decline, other than temporary, in the value of investment. If
the decline in the value of investment is, other than temporary, compared to
the time when the shares were purchased, provision is required to be made.

© The Institute of Chartered Accountants of India

 5.104 ADVANCED ACCOUNTING
v
v
Answerv to the Scenario based Questions
v
9. As per AS 13, where the investments are acquired on cum-right basis and the
market value of investments immediately after their becoming ex-right is lower
than the cost for which they were acquired, it may be appropriate to apply the
sale proceeds of rights to reduce the carrying amount of such investments to
the market value. In this case, the amount of the ex-right market value of 200
shares bought by X immediately after the declaration of rights falls to ` 60,000.
In this case, out of sale proceeds of ` 12,000, ` 10,000 may be applied to reduce
the carrying amount to bring it to the market value and ` 2,000 would be
credited to the profit and loss account.
10.

In the books of XY Ltd.

Investment in equity shares of ABC Ltd.
for the year ended 31st March, 20X2

Date Particulars No. Dividend Amount Date Particulars No. Dividend Amount

` ` ` `

20X1 April To Balance b/d 15,000 - 2,25,000 20X1 By Bank A/c - 30,000 10,000
1 Oct. 31 (W.N. 5)

June 1 To Bank A/c 5,000 -- 1,00,000 20X2 By Bank A/c 13,000 - 2,12,355
Jan. 1 (W.N.4)

July 1 To Bonus Issue 4,000 - - March By Balance c/d 13,000 - 1,69,500

(W.N. 1) 31 (W.N. 6)

Sept.1 To Bank A/c 2,000 - 24,000

(W.N. 2)

20X2 To P & L A/c - - 42,855

Jan 1 (W.N. 4)

“20X2 To P & L A/c - 30,000 -

March 31

26,000 30,000 3,91,855 26,000 30,000 3,91,855

© The Institute of Chartered Accountants of India

 ASSETS BASED ACCOUNTING STANDARDS 5.105
5.105
v
v
Working Notes: v
v
1. Calculation of no. of bonus shares issued
15,000 shares+5,000 shares
Bonus Shares = x 1= 4,000 shares
5
2. Calculation of right shares subscribed
15,000 shares+5,000 shares+4,000 shares
Right Shares = = 4,000 shares
6
4,000
Shares subscribed by XY Ltd. = = 2,000 shares
2
Value of right shares subscribed = 2,000 shares @ ` 12 per share
= ` 24,000
3. Calculation of sale of right entitlement
2,000 shares x ` 8 per share = ` 16,000
Amount received from sale of rights will be credited to statement of profit
and loss.
4. Calculation of profit on sale of shares
Total holding = 15,000 shares original
5,000 shares purchased
4,000 shares bonus
2,000 shares right shares
26,000 shares
50% of the holdings were sold
i.e. 13,000 shares (26,000 x1/2) were sold.
Cost of total holdings of 26,000 shares (on average basis)
= ` 2,25,000 + ` 1,00,000 + ` 24,000– ` 10,000 = ` 3,39,000
Average cost of 13,000 shares would be
3,39,000
= ×13,000 = ` 1,69,500
26,000

© The Institute of Chartered Accountants of India

 5.106 ADVANCED ACCOUNTING
v
v
v `
v Sale proceeds of 13,000 shares (13,000 x `16.50) 2,14,500
Less: 1% Brokerage (2,145)
2,12,355
Less: Cost of 13,000 shares (1,69,500)
Profit on sale 42,855
5. Dividend received on investment held as on 1st April, 20X1
= 15,000 shares x ` 10 x 20%
= ` 30,000 will be transferred to Profit and Loss A/c
Dividend received on shares purchased on 1st June, 20X1
= 5,000 shares x ` 10 x 20% = `10,000 will be adjusted to Investment A/c
Note: It is presumed that no dividend is received on bonus shares as
bonus shares are declared on 1st July, 20X1 and dividend pertains
to the year ended 31.3.20X1.
6. Calculation of closing value of shares (on average basis) as on
31st March, 20X2
3,39,000
13,000× = ` 1,69,500
26,000

11.
In the Books of Mr. Z
9% Central Government Bonds (Investment) Account
Particulars Nominal Interest Principal Particulars Nominal Interest Principal
Value Value
20X1 ` ` ` 20X1 ` ` `
Jan.1 To Balance Mar. By Bank A/c
b/d 1,20,000 2,700 1,18,000 31 (W.N.3) - 6,300 -
(W.N.1)
Marc To Bank A/c July 1 By Bank A/c
h1 (W.N.2) 20,000 750 19,600 (W.N.4) 50,000 1,125 50,000
July 1 To P&L A/c - - 833 Sept. By Bank A/c
(W.N.5) 30 (W.N.6) - 4,050 -
Oct. To Bank A/c Nov. By Bank A/c
1 (150 x 98) 15,000 - 14,700 1 (W.N.7) 30,000 225 29,700

© The Institute of Chartered Accountants of India

 ASSETS BASED ACCOUNTING STANDARDS 5.107
5.107
v
v
Nov. To P&L A/c - - 200 Dec. By Balance v
1 (W.N.8) 31 c/d (W.N. 9 75,000 1,688 v
73,633
& W.N.10)
Dec. To P&L A/c
31 (b.f.) 9,938
(Transfer)
1,55,000 13,388 1,53,333 1,55,000 13,388 1,53,333

Working Note:
1. Interest element in opening balance of bonds = 1,20,000 x 9% x 3/12 =
` 2,700
2. Purchase of bonds on 1. 3.20X1
Interest element in purchase of bonds = 200 x 100 x 9% x 5/12 = ` 750
Investment element in purchase of bonds = 200 x 98 = ` 19,600
3. Interest for half-year ended 31 March = 1,400 x 100 x 9% x 6/12 = ` 6,300
4. Sale of bonds on 1.7.20X1
Interest element = 500 x 100 x 9% x 3/12 = ` 1,125
Investment element = 500 x 100 = ` 50,000
5. Profit on sale of bonds on 1.7.20X1
Cost of bonds = (1,18,000/ 1,200) x 500 = ` 49,167
Sale proceeds = ` 50,000
Profit element = ` 833
6. Interest for half-year ended 30 September
= 900 x 100 x 9% x 6/12 = ` 4,050
7. Sale of bonds on 1.11.20X1
Interest element = 300 x 100 x 9% x 1/12 = ` 225
Investment element = 300 x 99 = ` 29,700
8. Profit on sale of bonds on 1.11.20X1
Cost of bonds = (1,18,000/ 1,200) x 300 = ` 29,500
Sale proceeds = ` 29,700
Profit element = ` 200

© The Institute of Chartered Accountants of India

 5.108 ADVANCED ACCOUNTING
v
v
9. v Closing value of investment
v
Calculation of closing Nominal `
balance: value

Bonds in hand remained in

hand at 31st December 20X1
From original holding 1,18,000 39,333
 40,000
1,20,000
(1,20,000 – 50,000 – 30,000) = 40,000
Purchased on 1st March 20,000 19,600
Purchased on 1st October 15,000 14,700

75,000 73,633

10. Interest element in closing balance of bonds = 750 x 100 x 9% x 3/12

= ` 1,688
12.
Investment A/c of Mr. Purohit
for the year ending on 31-3-20X2
(Scrip: 8% Debentures of P Limited)
(Interest Payable on 30th September and 31st March)

Date Particulars Nominal Interest Cost Date Particulars Nominal Interest Cost
Value Value

` ` ` `

1.4.20X1 To Balance b/d 1,20,000 - 1,18,000 30.9.20X1 By Bank (1,300 x - 5,200 -

100 x 8% x 6/12)

1.7.20X1 To Bank (ex- 10,000 200 9,898 1.10.20X1 By Bank (W.N.4) 20,000 - 19,800
Interest)

(W.N.1)

1.10.20X1 To Profit & Loss 133 1.2.20X2 By Bank (ex- 20,000 533 19,602
A/c (W.N.4) Interest) (W.N.5)

© The Institute of Chartered Accountants of India

 ASSETS BASED ACCOUNTING STANDARDS 5.109
5.109
v
v
1.1.20X2 To Bank (ex- 5,000 100 4,949 1.2.20X2 By Profit & Loss
v
64
v
Interest) A/c (W.N.5)
(W.N.2)

31.3.20X2 To Profit & Loss - 9,233 31.3.20X2 By Bank (950 x - 3,800 -

A/c (Bal. fig.) 100 x 8% x 6/12)

31.3.20X2 By Balance c/d 95,000 - 93,514

(W.N.3)

1,35,000 9,533 1,32,980 1,35,000 9,533 1,32,980

Working Notes:
1. Purchase of debentures on 1.7.20X1
Interest element = 100 x 100 x 8% x 3/12 = ` 200
Investment element = (100 x 98) + [1% (100 x 98)] = ` 9,898
2. Purchase of debentures on 1.1.20X2
Interest element = 50 x 100 x 8% x 3/12 = ` 100

Investment element = {(50 x 98) + [1%(50 x 98)]} = ` 4,949

3. Valuation of closing balance as on 31.3.20X2:
Market value of 950 Debentures at ` 99 = ` 94,050
Cost of
 1,18,000 
800 Debentures cost = x80,000  = 78,667
 1,20,000 

100 Debentures cost = 9,898

50 Debentures cost = 4,949

93,514
Value at the end = ` 93,514, i.e., whichever is less
4. Profit on sale of debentures as on 1.10.20X1

Sales price of debentures (200 x ` 100) 20,000

© The Institute of Chartered Accountants of India

 5.110 ADVANCED ACCOUNTING
v
v
v
Less: Brokerage @ 1% (200)
v
19,800

Less: Cost of Debentures  1,18,000 x20,000  = (19,667)

 1,20,000 

Profit on sale 133

5. Loss on sale of debentures as on 1.2.20X2

Sales price of debentures (200 x ` 99) 19,800

Less: Brokerage @ 1% (198)

19,602
 1,18,000  (19,666
Less: Cost of Debentures  x20,000  =
 1,20,000  )

Loss on sale 64

Interest element in sale of investment = 200 x 100 x 8% x 4/12 ` 533

13.
Investment Account in Books of Vijay
(Scrip: Equity Shares in X Ltd.)

No. Amount No. Amount

` `
1.4.20X1 To Bal b/d 30,000 4,50,000 31.10.20X1 By Bank — 10,000
(dividend
22.6.20X1 To Bank 5,000 80,000 on shares
acquired on
22.6.20X1)

10.8.20X1 To Bonus 5,000 _

30.9.20X1 To Bank 10,000 1,50,000

(Rights
Shares)

© The Institute of Chartered Accountants of India

 ASSETS BASED ACCOUNTING STANDARDS 5.111
5.111
v
v
v
15.11.20X1 To P&L A/c 32,000 15.11.20X1 By Bank 20,000 3,00,000
v
(Profit

on sale of (Sale of
shares) shares)

31.3.20X2 By Bal. c/d 30,000 4,02,000

50,000 7,12,000 50,000 7,12,000

Working Notes:

(1) Bonus Shares = (30,000 + 5,000) / 7 = 5,000 shares

(2) Right Shares =

( 30, 000 + 5, 000 + 5, 000 )  3 = 15,000 shares
8
(3) Rights shares sold = 15,000×1/3 = 5,000 shares

(4) Dividend received = 30,000×10×20% = ` 60,000 will be taken to P&L

statement
(5) Dividend on shares purchased on 22.6.20X1
= 5,000×10×20%
= ` 10,000 is adjusted to Investment A/c
(6) Profit on sale of 20,000 shares
= Sales proceeds – Average cost
Sales proceeds = ` 3,00,000

Average cost =
( 4, 50, 000 + 80, 000 + 1, 50, 000 - 10, 000) × 20, 000 = ` 2,68,000
50, 000

Profit = ` 3,00,000– ` 2,68,000= ` 32,000.

(7) Cost of shares on 31.3.20X2
( 4, 50, 000 + 80, 000 + 1, 50, 000 - 10, 000) × 30, 000 = ` 4,02,000
50, 000

(8) Sale of rights amounting ` 10,000 (` 2 x 5,000 shares) will not be shown
in investment A/c but will directly be taken to P & L statement.
14. As per AS 13 (Revised) ‘Accounting for Investments’, where long-term
investments are reclassified as current investments, transfers are made at the

© The Institute of Chartered Accountants of India

 5.112 ADVANCED ACCOUNTING
v
v
v
lower of cost and carrying amount at the date of transfer. And where
v
investments are reclassified from current to long term, transfers are made at
lower of cost and fair value on the date of transfer.
Accordingly, the re-classification will be done on the following basis:
(i) In this case, carrying amount of investment on the date of transfer is
less than the cost; hence this re-classified current investment should be
carried at ` 6.5 lakhs in the books.
(ii) The carrying / book value of the long term investment is same as cost
i.e. ` 7 lakhs. Hence this long term investment will be reclassified as
current investment at book value of ` 7 lakhs only.
(iii) In this case, reclassification of current investment into long-term
investments will be made at ` 10 lakhs as cost is less than its market
value of ` 12 lakhs.
15. As per AS 13 (Revised) ‘Accounting for Investments’, for investment in shares
- if the investment is purchased with an intention to hold for short-term
period (less than one year), then it will be classified as current investment and
to be carried at lower of cost and fair value, i.e., in case of shares, at lower of
cost (` 4,25,000) and market value (` 3,50,000) as on 31 March 20X4, i.e.,
` 3,50,000.
Gold and silver are generally purchased with an intention to hold it for long
term period (more than one year) until and unless given otherwise. Hence,
the investment in Gold and Silver (purchased on 31 stMarch, 20X1) should
continue to be shown at cost (since there is no ‘other than temporary’
diminution) as on 31 st March, 20X4, i.e., ` 8,00,000 and `3,50,000 respectively,
though their market values have been increased.
Thus the shares, gold and silver will be shown at ` 3,50,000, ` 8,00,000 and
` 3,50,000 respectively and hence, total investment will be valued at
` 15,00,000 for the year ending on 31st March, 20X4 as per AS 13.

© The Institute of Chartered Accountants of India

 ASSETS BASED ACCOUNTING STANDARDS 5.113

UNIT 4: ACCOUNTING STANDARD 16

BORROWING COSTS

LEARNING OUTCOMES
After studying this unit, you will be able to recognize–
♦ Meaning of Borrowing costs;
♦ Definition of Qualifying Asset;
♦ Accounting treatment for borrowings – Specific and general
borrowings;
♦ Time when does Commencement of Capitalisation takes place;
♦ Time when does Suspension and cessation of Capitalisation takes
place;
♦ Disclosure requirements for this standard.

4.1 INTRODUCTION
The objective of AS 16 is to prescribe the accounting treatment for borrowing
costs. It does not deal with the actual or imputed cost of owners’ equity, including
preference share capital not classified as a liability.
Clarification Chart:

Particulars Remarks – Is the fund

covered by AS 16?

Equity share capital No

Retained earnings No

Preference Share Capital classified as a liability Yes

Preference Share Capital classified as equity No

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 5.114 ADVANCED ACCOUNTING

4.2 DEFINITIONS
Borrowing costs are interest and other costs incurred by an enterprise in
connection with the borrowing of funds.

Borrowing Cost

Finance
Amortisation
Interest & Amortisation charges for
of ancillary
Commitment of Discount/ assets Exchange
costs
charges on Premium on acquired on Differences*
relating to
Borrowings Borrowings Finance
Borrowings
Lease

*To the extent they are regarded as an adjustment to interest cost

A qualifying asset is an asset (Tangible or intangible) that necessarily takes a

substantial period of time to get ready for its intended use or sale.
Examples of qualifying assets are manufacturing plants, power generation
facilities, inventories that require a substantial period of time to bring them to a
saleable condition, and investment properties. Other investments and those
inventories that are routinely manufactured or otherwise produced in large
quantities on a repetitive basis over a short period of time, are not qualifying
assets. Assets that are ready for their intended use or sale when acquired also are
not qualifying assets.
Clarification Chart:

Particulars Is it a qualifying asset?

PPE (Property, plant and equipment) Yes

Intangible assets Yes
Investment Properties Yes
(Building meant for capital appreciation
and earning rental income)

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Inventory Yes – If they require a substantial

period of time to bring them to a
saleable condition.
Investments (Financial assets) No
Accounting standard further clarifies the meaning of the expression ‘substantial
period of time’. According to it, substantial period of time primarily depends on
the facts and circumstances of each case. It further states that, ordinarily, a period
of twelve months is considered as substantial period of time unless a shorter or
longer period can be justified on the basis of the facts and circumstances of the
case. Therefore, a rebuttable presumption of a period of twelve months is
considered “substantial” period of time. In estimating the period, time which an
asset takes technologically and commercially to get it ready for its intended use
or sale should be considered.

4.3 EXCHANGE DIFFERENCES ON FOREIGN

CURRENCY BORROWINGS
Exchange differences arising from foreign currency borrowing and considered as
borrowing costs are those exchange differences which arise on the amount of
principal of the foreign currency borrowings to the extent of the difference
between interest on local currency borrowings and interest on foreign currency
borrowings. Thus, the amount of exchange difference not exceeding the
difference between interest on local currency borrowings and interest on foreign
currency borrowings is considered as borrowings cost to be accounted for under
this Standard and the remaining exchange difference, if any, is accounted for
under AS 11, ‘The Effect of Changes in Foreign Exchange Rates’. For this
purpose, the interest rate for the local currency borrowings is considered as that
rate at which the enterprise would have raised the borrowings locally had the
enterprise not decided to raise the foreign currency borrowings.
Clarification Chart:

Particulars Accounting Treatment

Exchange Credited to P&L

Gain

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Exchange Lower of the following is treated as a part of borrowing costs:

Loss 1. Actual exchange loss;
2. Difference between interest on local currency borrowings
and interest on foreign currency borrowings.
Note: The excess exchange difference if any will be charged to
P&L A/c.
If the difference between the interest on local currency borrowings and the interest
on foreign currency borrowings is equal to or more than the exchange difference on
the amount of principal of the foreign currency borrowings, the entire amount of
exchange difference is covered under paragraph 4 (e) of AS 16.
If there is exchange gain in the next year, then it will reduce the borrowing cost in
that year to the extent exchange loss was earlier treated as borrowing cost for that
borrowing.
Example
XYZ Ltd. has taken a loan of USD 10,000 on April 1, 20X1, for a specific project at
an interest rate of 5% p.a., payable annually. On April 1, 20X1, the exchange rate
between the currencies was ` 45 per USD. The exchange rate, as at March 31, 20X2,
is ` 48 per USD. The corresponding amount could have been borrowed by XYZ Ltd.
in local currency at an interest rate of 11 per cent per annum as on April 1, 20X1.
The following computation would be made to determine the amount of borrowing
costs for the purposes of paragraph 4(e) of AS 16:
(i) Interest for the period = USD 10,000 x 5% x ` 48/USD = ` 24,000
(ii) Increase in the liability towards the principal amount = USD 10,000 x (48-45)
= ` 30,000
(iii) Interest that would have resulted if the loan was taken in Indian currency
= USD 10,000 x 45 x 11% = ` 49,500
(iv) Difference between interest on local currency borrowing and foreign currency
borrowing = ` 49,500 – ` 24,000 = ` 25,500
Therefore, out of ` 30,000 increase in the liability towards principal amount, only
` 25,500 will be considered as the borrowing cost. Thus, total borrowing cost would
be ` 49,500 being the aggregate of interest of ` 24,000 on foreign currency
borrowings (covered by paragraph 4(a) of AS 16) plus the exchange difference to

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the extent of difference between interest on local currency borrowing and interest
on foreign currency borrowing of ` 25,500.
Thus, ` 49,500 would be considered as the borrowing cost to be accounted for as
per AS 16 and the remaining ` 4,500 would be considered as the exchange
difference to be accounted for as per Accounting Standard (AS) 11, The Effects of
Changes in Foreign Exchange Rates.
In the above example, if the interest rate on local currency borrowings is assumed
to be 13% instead of 11%, the entire exchange difference of ` 30,000 would be
considered as borrowing costs, since in that case the difference between the interest
on local currency borrowings and foreign currency borrowings [i.e., ` 34,500
(` 58,500 – ` 24,000)] is more than the exchange difference of ` 30,000. Therefore,
in such a case, the total borrowing cost would be ` 54,000 (` 24,000 + ` 30,000)
which would be accounted for under AS 16 and there would be no exchange
difference to be accounted for under AS 11 ‘The Effects of Changes in Foreign
Exchange Rates’.

4.4 BORROWING COSTS ELIGIBLE FOR

CAPITALISATION
Treatment of Borrowing Costs

Borrowing Costs

Directly related* for

* acquisition
* construction
* production of

Qualifying Assets Assets other than Qualifying assets

Capitalized Revenue Expenditure

*or that could have been avoided if the expenditure on qualifying assets had not been made.

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The borrowing costs (including exchange loss treated as borrowing cost as per
para 4(e)) that are directly attributable to the acquisition, construction or
production of a qualifying asset are those borrowing costs that would have been
avoided if the expenditure on the qualifying asset had not been made. Other
borrowing costs are recognised as an expense in the period in which they are
incurred.

4.5 RECOGNITION CRITERIA

Borrowing costs are capitalised as part of the cost of a qualifying asset when:
(a) it is probable that they will result in future economic benefits to the
enterprise; and
(b) the costs can be measured reliably.

Borrowing costs

Specific borrowings General borrowings

Illustration 1
PRM Ltd. obtained a loan from a bank for ` 120 lakhs on 30-04-20X1. It was
utilised as follows:

Particulars Amount (` in lakhs)

Construction of a shed 50
Purchase of a machinery 40
Working Capital 20
Advance for purchase of truck 10

Construction of shed was completed in March 20X2. The machinery was installed on
the date of acquisition. Delivery of truck was not received. Total interest charged by
the bank for the year ending 31-03-20X2 was ` 18 lakhs. Show the treatment of
interest.

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 ASSETS BASED ACCOUNTING STANDARDS 5.119

Solution
Qualifying Asset as per AS 16 = ` 50 lakhs (construction of a shed)

Borrowing cost to be capitalised = 18 x 50/120 = ` 7.5 lakhs

Interest to be debited to Profit or Loss account = ` (18 – 7.5) lakhs = ` 10.5 lakhs

4.6 SPECIFIC BORROWINGS

When an enterprise borrows funds specifically for the purpose of obtaining a
particular qualifying asset, the borrowing costs that directly relate to that
qualifying asset can be readily identified.
To the extent that funds are borrowed specifically for the purpose of obtaining a
qualifying asset, the amount of borrowing costs eligible for capitalisation on that
asset should be determined as the actual borrowing costs incurred on that
borrowing during the period less any income on the temporary investment of
those borrowings.

Amount eligible for capitalisation:

= Actual borrowing costs incurred (-) Any income on the temporary investment of
those borrowings

The financing arrangements for a qualifying asset may result in an enterprise

obtaining borrowed funds and incurring associated borrowing costs before some
or all of the funds are used for expenditure on the qualifying asset. In such
circumstances, the funds are often temporarily invested pending their expenditure
on the qualifying asset. In determining the amount of borrowing costs eligible for
capitalisation during a period, any income earned on the temporary investment of
those borrowings is deducted from the borrowing costs incurred.

4.7 GENERAL BORROWINGS

It may be difficult to identify a direct relationship between particular borrowings and
a qualifying asset and to determine the borrowings that could otherwise have been
avoided. To the extent that funds are borrowed generally and used for the purpose
of obtaining a qualifying asset, the amount of borrowing costs eligible for

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capitalisation should be determined by applying a capitalisation rate to the

expenditure on that asset. The capitalisation rate should be the weighted average of
the borrowing costs applicable to the borrowings of the enterprise that are
outstanding during the period, other than borrowings made specifically for the
purpose of obtaining a qualifying asset. The amount of borrowing costs capitalised
during a period should not exceed the amount of borrowing costs incurred during
that period.

Step 1 - Compute the capitalisation rate:

Where,
Borrowing cost on general borrowings
Capitalization Rate = ×100
Weighted average of general borrowings
outstanding during the period

Step 2 - Amount eligible for capitalisation:

= Expenditure incurred on Qualifying asset x Capitalisation rate
Step 3 – Cross check:
The amount of borrowing costs capitalised during a period should not exceed the
amount of borrowing costs incurred during that period.

4.8 EXCESS OF THE CARRYING AMOUNT OF THE

QUALIFYING ASSET OVER RECOVERABLE
AMOUNT
When the carrying amount or the expected ultimate cost of the qualifying asset
exceeds its recoverable amount or net realisable value, the carrying amount is
written down or written off in accordance with the requirements of other
Accounting Standards. In certain circumstances, the amount of the write-down or
write-off is written back in accordance with those other Accounting Standards.
Illustration 2
X Ltd. began construction of a new building on 1 st January, 20X1. It obtained ` 1
lakh special loan to finance the construction of the building on 1 st January, 20X1 at
an interest rate of 10%. The company’s other outstanding two non-specific loans
were:

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 ASSETS BASED ACCOUNTING STANDARDS 5.121

Amount Rate of Interest

` 5,00,000 11%
` 9,00,000 13%

The expenditures that were made on the building project were as follows:

`
January 20X1 2,00,000
April 20X1 2,50,000
July 20X1 4,50,000
December 20X1 1,20,000

Building was completed by 31st December 20X1. Following the principles prescribed
in AS 16 ‘Borrowing Cost,’ calculate the amount of interest to be capitalised and
pass one Journal Entry for capitalising the cost and borrowing cost in respect of the
building.
Solution
(i) Computation of weighted average accumulated expenses

`
` 2,00,000 x 12 / 12 = 2,00,000
` 2,50,000 x 9 / 12 = 1,87,500
` 4,50,000 x 6 / 12 = 2,25,000
` 1,20,000 x 1 / 12 = 10,000
6,22,500

(ii) Calculation of weighted average interest rate other than for specific
borrowings

Amount of loan (`) Rate of Amount of interest

interest (`)
5,00,000 11% = 55,000
9,00,000 13% = 1,17,000
14,00,000 1,72,000
Weighted average rate of interest = 12.285% (approx.)
 1,72,000 
 14,00,000 × 100 
 

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(iii) Interest on weighted average accumulated expenses

`
Specific borrowings (` 1,00,000 x 10%) = 10,000
Non-specific borrowings (` 5,22,500 ∗ x 12.285%) = 64,189

Amount of interest to be capitalised = 74,189

(iv) Total expenses to be capitalized for building

`
Cost of building ` (2,00,000 + 2,50,000 + 4,50,000 + 10,20,000
1,20,000)
Add: Amount of interest to be capitalised 74,189

10,94,189

(v) Journal Entry

Date Particulars Dr. (`) Cr. (`)

31.12. Building account Dr. 10,94,189

20X1

To Bank account 10,94,189

(Being amount of cost of building
and borrowing cost thereon
capitalised)

4.9 COMMENCEMENT OF CAPITALISATION

The capitalisation of borrowing costs as part of the cost of a qualifying asset
should commence when all the following conditions are satisfied:
a. Expenditure for the acquisition, construction or production of a
qualifying asset is being incurred: Expenditure on a qualifying asset
includes only such expenditure that has resulted in payments of cash,

∗
(` 6,22,500 – ` 1,00,000)

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 ASSETS BASED ACCOUNTING STANDARDS 5.123

transfers of other assets or the assumption of interest-bearing liabilities.

Expenditure is reduced by any progress payments received and grants
received in connection with the asset. The average carrying amount of the
asset during a period, including borrowing costs previously capitalised, is
normally a reasonable approximation of the expenditure to which the
capitalisation rate is applied in that period.

b. Borrowing costs are being incurred.

c. Activities that are necessary to prepare the asset for its intended use or
sale are in progress: The activities necessary to prepare the asset for its
intended use or sale encompass more than the physical construction of the
asset. They include technical and administrative work prior to the
commencement of physical construction. However, such activities exclude
the holding of an asset when no production or development that changes
the asset’s condition is taking place. For example, borrowing costs incurred
while land is under development are capitalised during the period in which
activities related to the development are being undertaken. However,
borrowing costs incurred while land acquired for building purposes is held
without any associated development activity do not qualify for
capitalisation.

4.10 SUSPENSION OF CAPITALISATION

Capitalisation of borrowing costs should be suspended during extended periods
in which active development is interrupted.

Borrowing costs may be incurred during an extended period in which the

activities necessary to prepare an asset for its intended use or sale are
interrupted. Such costs are costs of holding partially completed assets and do not
qualify for capitalisation. However, capitalisation of borrowing costs is not
normally suspended during a period when substantial technical and
administrative work is being carried out.

Capitalisation of borrowing costs is also not suspended when a temporary delay is

a necessary part of the process of getting an asset ready for its intended use or

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sale. For example: capitalisation continues during the extended period needed for
inventories to mature or the extended period during which high water levels
delay construction of a bridge, if such high water levels are common during the
construction period in the geographic region involved.

4.11 CESSATION OF CAPITALISATION

Capitalisation of borrowing costs should cease when substantially all the activities
necessary to prepare the qualifying asset for its intended use or sale are
complete.

An asset is normally ready for its intended use or sale when its physical
construction or production is complete even though routine administrative work
might still continue. If minor modifications, such as the decoration of a property
to the user’s specification, are all that are outstanding, this indicates that
substantially all the activities are complete.

When the construction of a qualifying asset is completed in parts and a

completed part is capable of being used while construction continues for the
other parts, capitalisation of borrowing costs in relation to a part should cease
when substantially all the activities necessary to prepare that part for its intended
use or sale are complete. A business park comprising several buildings, each of
which can be used individually, is an example of a qualifying asset for which each
part is capable of being used while construction continues for the other parts. An
example of a qualifying asset that needs to be complete before any part can be
used is an industrial plant involving several processes which are carried out in
sequence at different parts of the plant within the same site, such as a steel mill.

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Capitalization of
Borrowing Cost

Commencement Suspension Cessation

Expenditure during when

Borrowing Activities to
for extended substantia
costs are prepare the
qualifying periods in lly all the
being qualifying
asset is which active activities
incurred asset is in
being development are
progress.
incurred. is interrupted. complete.

4.12 DISCLOSURE
The financial statements should disclose:
a. The accounting policy adopted for borrowing costs; and

b. The amount of borrowing costs capitalised during the period.

Illustration 3
The company has obtained Institutional Term Loan of ` 580 lakhs for
modernisation and renovation of its Plant & Machinery. Plant & Machinery
acquired under the modernisation scheme and installation completed on 31st
March, 20X2 amounted to ` 406 lakhs, ` 58 lakhs has been advanced to suppliers
for additional assets and the balance loan of ` 116 lakhs has been utilised for
working capital purpose. The Accountant is on a dilemma as to how to account for
the total interest of ` 52.20 lakhs incurred during 20X1-20X2 on the entire
Institutional Term Loan of ` 580 lakhs.

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Solution
As per para 6 of AS 16 ‘Borrowing Costs’, borrowing costs that are directly
attributable to the acquisition, construction or production of a qualifying asset
should be capitalised as part of the cost of that asset. Other borrowing costs
should be recognised as an expense in the period in which they are incurred.
A qualifying asset is an asset that necessary takes a substantial period of time* to
get ready for its intended use or sale.
The treatment for total interest amount of ` 52.20 lakhs can be given as:

Purpose Nature Interest to be Interest to be

capitalised charged to profit
and loss account
` in lakhs ` in lakhs
Modernisation Qualifying asset
406
and renovation * *52.20 × = 36.54
580
of plant and
machinery
58
* *52.20 × = 5.22
580
Advance to Qualifying asset
supplies for 116
52.20 × = 10.44
additional assets 580
Working Capital Not a qualifying
asset
41.76 10.44
* A substantial period of time primarily depends on the facts and circumstances of
each case. However, ordinarily, a period of twelve months is considered as
substantial period of time unless a shorter or longer period can be justified on the
basis of the facts and circumstances of the case.
** It is assumed in the above solution that the modernisation and renovation of
plant and machinery will take substantial period of time (i.e. more than twelve
months). Regarding purchase of additional assets, the nature of additional assets
has also been considered as qualifying assets. Alternatively, the plant and

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machinery and additional assets may be assumed to be non-qualifying assets on

the basis that the renovation and installation of additional assets will not take
substantial period of time. In that case, the entire amount of interest, ` 52.20 lakhs
will be recognised as expense in the profit and loss account for year ended 31st
March, 20X2.
Illustration 4
Take Ltd. has borrowed ` 30 lakhs from State Bank of India during the financial
year 20X1-20X2. The borrowings are used to invest in shares of Give Ltd., a
subsidiary company of Take Ltd., which is implementing a new project, estimated to
cost ` 50 lakhs. As on 31st March, 20X2, since the said project was not complete, the
directors of Take Ltd. resolved to capitalise the interest accruing on borrowings
amounting to ` 4 lakhs and add it to the cost of investments. Comment.
Solution
As per AS 13 (Revised) "Accounting for Investments", the cost of investment
includes acquisition charges such as brokerage, fees and duties. In the present
case, Take Ltd. has used borrowed funds for purchasing shares of its subsidiary
company Give Ltd. ` 4 lakhs interest payable by Take Ltd. to State Bank of India
cannot be called as acquisition charges, therefore, cannot be constituted as cost
of investment.
Further, as per para 3 of AS 16 "Borrowing Costs", a qualifying asset is an asset
that necessarily takes a substantial period of time to get ready for its intended
use or sale. Since, shares are ready for its intended use at the time of sale, it
cannot be considered as qualifying asset that can enable a company to add the
borrowing cost to investments. Therefore, the directors of Take Ltd. cannot
capitalise the borrowing cost as part of cost of investment. Rather, it has to be
charged to the Statement of Profit and Loss for the year ended 31st March, 20X2.

Reference: The students are advised to refer the full text of AS 16 “Borrowing
Costs” (issued 2000).

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TEST YOUR KNOWLEDGE

Multiple Choice Questions
1. As per AS 16, all the following are qualifying assets except

(a) Manufacturing plants and Power generation facilities

(b) Inventories that require substantial period of time

(c) Assets those are ready for sale.

(d) None of the above

2. Which of the following statement is correct:

(a) Entire exchange gain is reduced from the cost of the Qualifying asset.

(b) Entire exchange loss is added to the cost of a Qualifying asset.

(c) No adjustment is done for the exchange loss while computing cost of
Qualifying asset.

(d) None of the above

3. Capitalisation rate considers:

(a) Borrowing costs on general borrowings only.

(b) Borrowing costs on general and specific borrowings both.

(c) Borrowing costs on specific borrowings only

(d) None of the above

4. If the amount eligible for capitalisation in case of inventory as per AS 16 is `

12,000 and cost of inventory is ` 40,000 and its net realizable value is `
45,000; What amount can be capitalised as a part of inventory cost.

(a) ` 12,000.
(b) ` 5,000.
(c) ` 7,000.
(c) ` 10,000.

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5. X Ltd is commencing a new construction project, which is to be financed by

borrowing. The key dates are as follows:

(i) 15th May, 20X1: Loan interest relating to the project starts to be
incurred

(ii) 2nd June, 20X1: Technical site planning commences

(iii) 19th June, 20X1: Expenditure on the project started to be incurred

(iv) 18th July, 20X1: Construction work commences

Identify the commencement date for capitalisation under AS 16.

(a) 15th May, 20X1.

(b) 19th June, 20X1.

(c) 18th July, 20X1.

(d) 2nd June, 20X1

Theoretical Questions
6. When capitalization of borrowing cost should cease as per Accounting Standard
16? Explain the provision.

7. H Ltd. incurs borrowing costs for the purpose of construction of a qualifying asset
for its own use. The construction gets completed on May 31, 20X1. However,
decoration work is under process which is expected to be completed by
November 20X1 after which H Ltd. will be able to start using the said asset for its
own use. H Ltd. wants to capitalize the eligible borrowing costs incurred up to
November 20X1.

8. ABC Ltd. is in the process of getting an entertainment park constructed. For this
purpose, it has taken loan from a bank. The said park consists of several rides
and facilities, each of which can be used individually. Three fourth part of the
park has been constructed and can be opened up for public, while construction
on the remaining part is continuing. Whether the capitalization of borrowing cost
should continue for the whole park until construction continues?

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Scenario based Questions

9. On 1st April, 20X1, Amazing Construction Ltd. obtained a loan of ` 32 crores
to be utilised as under:

(i) Construction of sealink across two cities:

(work was held up totally for a month during the : ` 25 crores

year due to high water levels)

(ii) Purchase of equipments and machineries : ` 3 crores

(iii) Working capital : ` 2 crores

(iv) Purchase of vehicles : ` 50,00,000

(v) Advance for tools/cranes etc. : ` 50,00,000

(vi) Purchase of technical know-how : ` 1 crores

(vii) Total interest charged by the bank for the year : ` 80,00,000
ending 31st March, 20X2

Show the treatment of interest by Amazing Construction Ltd.

10. Rainbow Limited borrowed an amount of ` 150 crores on 1.4.20X1 for
construction of boiler plant @ 11% p.a. The plant is expected to be completed
in 4 years. Since the weighted average cost of capital is 13% p.a., the
accountant of Rainbow Ltd. capitalized ` 19.50 crores for the accounting
period ending on 31.3.20X2. Due to surplus fund out of ` 150 crores, income
of ` 3.50 crores were earned and credited to profit and loss account.
Comment on the above treatment of accountant with reference to relevant
accounting standard.
11. Harish Construction Company is constructing a huge building project consisting
of four phases. It is expected that the full building will be constructed over several
years but Phase I and Phase II of the building will be started as soon as they are
completed.
Following is the detail of the work done on different phases of the building
during the current year:

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(` in lakhs)

Phase I Phase II Phase III Phase IV

` ` ` `
Cash expenditure 10 30 25 30

Building purchased 24 34 30 38
Total expenditure 34 64 55 68

Total expenditure of all phases 221

Loan taken @ 15% at the 200

beginning of the year
During mid of the current year, Phase I and Phase II have become operational.
Find out the total amount to be capitalized and to be expensed during the year.
12. Expert Limited issued 12% secured debentures of ` 100 lakhs on 01.06.20X1.
Money raised from debentures to be utilized as under:

Intended Purpose Amount ` in

lakhs
Construction of factory building 40
Working Capital 30
Purchase of Machinery 15
Purchase of Furniture 2
Purchase of truck 13

Additional Information:
(i) Interest on debentures for the Financial Year 20X1-20X2 was paid by
the Company.
(ii) During the year, the company invested idle fund of ` 5 lakhs (out of
the money raised from debentures) in Bank's fixed deposit and earned
interest of ` 50,000.
(iii) In March, 20X2 construction of factory building was not completed (it
is expected that it will take another 6 months).

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(iv) In March 20X2, Machinery was installed and ready for its intended use.
(v) Furniture was put to use at the end of March 20X2.
(vi) Truck is going to be received in April, 20X2.
You are required to show the treatment of interest as per AS 16 in respect
of borrowing cost for the year ended 31st March, 20X2 in the Books of
Expert Limited.

ANSWERS/SOLUTIONS
Answer to the Multiple Choice Questions
1. (c) 2. (c) 3. (a) 4. (b) 5. (b)

Answer to the Theoretical Questions

6. Capitalization of borrowing costs should cease when substantially all the
activities necessary to prepare the qualifying asset for its intended use or sale
are complete. An asset is normally ready for its intended use or sale when its
physical construction or production is complete even though routine
administrative work might still continue. If minor modifications such as the
decoration of a property to the user’s specification, are all that are outstanding,
this indicates that substantially all the activities are complete. When the
construction of a qualifying asset is completed in parts and a completed part is
capable of being used while construction continues for the other parts,
capitalisation of borrowing costs in relation to a part should cease when
substantially all the activities necessary to prepare that part for its intended use
or sale are complete.

7. The capitalization of borrowing costs shall cease when substantially all the
activities necessary to prepare the qualifying assets for its intended use or sale
is completed.

In the given case, H Ltd. should capitalize borrowing costs only up to May 31,
20X1. The borrowing cost incurred thereafter cannot be capitalized as the asset
was ready for its intended use on May 31, 20X1. The fact that decoration work

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 ASSETS BASED ACCOUNTING STANDARDS 5.133

was being carried out should not be considered as the asset was ready for its
intended use on May 31, 20X1.

8. ABC Ltd. is in process of constructing an entertainment park which consists of

several rides and facilities that can operate independently for their intended
use. Even though the park as whole is not complete, the individual facilities are
ready for their intended use.

The cessation of capitalization depends upon the nature of the qualifying

assets, particularly where the qualifying assets consists of various parts. There
are qualifying assets where each part is capable of being used while the
construction continues on other parts. There are qualifying assets where all
parts have to be completed before any earlier completed part can be put to
use.

Since in the given scenario, the individual facilities are capable of operating
independently and are ready for their intended use, therefore the borrowing
costs shall cease to be capitalized for the three-fourth part of the project.

Answer to the Scenario based Questions

9. According to AS 16 ‘Borrowing costs’, qualifying asset is an asset that
necessarily takes substantial period of time to get ready for its intended use.

Borrowing costs that are directly attributable to the acquisition, construction

or production of a qualifying asset should be capitalised as part of the cost
of that asset. Other borrowing costs should be recognised as an expense in
the period in which they are incurred.
The treatment of interest by Amazing Construction Ltd. can be shown as:

Qualifying Interest to Interest to

Asset be be charged
capitalised to Profit &
` Loss A/c `
Construction Yes 62,50,000 [80,00,000x(25/32)]
of sea-link
Purchase of No 7,50,000 [80,00,000x(3/32)]

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 5.134 ADVANCED ACCOUNTING

equipment and
machineries
Working No 5,00,000 [80,00,000x(2/32)]
capital
Purchase of No 1,25,000 [80,00,000x(0.5/32)]
vehicles
Advance for No 1,25,000 [80,00,000x(0.5/32)]
tools, cranes
etc.
Purchase of No 2,50,000 [80,00,000x(1/32)]
technical
know-how
Total 62,50,000 17,50,000
*It is assumed that work held up for a month due to high water level is normal
during the construction of sealink and capitalization of borrowing cost should
not be suspended for necessary temporary delay.
10. Para 10 of AS 16 'Borrowing Costs' states "To the extent that funds are
borrowed specifically for the purpose of obtaining a qualifying asset, the
amount of borrowing costs eligible for capitalization on that asset should be
determined as the actual borrowing costs incurred on that borrowing during
the period less any income on the temporary investment of those borrowings."
The capitalization rate should be the weighted average of the borrowing costs
applicable to the borrowings of the enterprise that are outstanding during the
period, other than borrowings made specifically for the purpose of obtaining a
qualifying asset.
Thus, the treatment of accountant of Rainbow Ltd. is incorrect.
Amount of borrowing costs capitalized should be calculated as follows:

Particulars ` in crores
Actual interest for 20X1-20X2 (11% of ` 150 crores) 16.50
Less: Income on temporary investment from specific (3.50)
borrowings
Borrowing costs to be capitalized during year 20X1-20X2 13.00

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11. Computation of amount to be capitalized

No. Particulars `
1. Interest expense on loan ` 2,00,00,000 at 15% 30,00,000
2. Total cost of Phases I and II (` 34,00,000 +64,00,000) 98,00,000
3. Total cost of Phases III and IV (` 55,00,000 + 1,23,00,000
` 68,00,000)
4. Total cost of all 4 phases 2,21,00,000
5. Total loan 2,00,00,000
6. Interest on loan used for Phases I & II, based on 13,30,317
proportionate (approx.)
30,00,000
Loan amount = × 98,00,000
2,21,00,000
7. Interest on loan used for Phases III & IV, based on 16,69,683
30,00,000 (approx.)
proportionate Loan amount = ×1,23,00,000
2,21,00,000

Accounting treatment
For Phase I and Phase II
Since Phase I and Phase II have become operational at the mid of the year, half
of the interest amount of ` 6,65,158.50 (i.e. ` 13,30,317/2) relating to Phase I
and Phase II should be capitalized (in the ratio of asset costs 34:64) and added
to respective assets in Phase I and Phase II and remaining half of the interest
amount of ` 6,65,158.50 (i.e. ` 13,30,317/2) relating to Phase I and Phase II
should be expensed during the year.
For Phase III and Phase IV
Interest of ` 16,69,683 relating to Phase III and Phase IV should be held in
Capital Work-in-Progress till assets construction work is completed, and
thereafter capitalized in the ratio of cost of assets. No part of this interest
amount should be charged/expensed off during the year since the work on
these phases has not been completed yet.
12. According to AS 16 “Borrowing Costs”, a qualifying asset is an asset that
necessarily takes a substantial period of time to get ready for its intended

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 5.136 ADVANCED ACCOUNTING

use. As per the Standard, borrowing costs that are directly attributable to
the acquisition, construction or production of a qualifying asset should be
capitalized as part of the cost of that asset. The amount of borrowing costs
eligible for capitalization should be determined in accordance with this
Standard. Other borrowing costs should be recognized as an expense in the
period in which they are incurred. It also states that to the extent that funds
are borrowed specifically for the purpose of obtaining a qualifying asset, the
amount of borrowing costs eligible for capitalization on that asset should
be determined as the actual borrowing costs incurred on that borrowing
during the period less any income on the temporary investment of those
borrowings.

Thus, eligible borrowing cost = ` 10,00,000 (100 lakhs x 12% x 10/12) –

` 50,000 = ` 9,50,000

Particulars Nature of assets Interest to be Interest to be

capitalized charged to Profit
(`) & Loss Account
(`)
Construction of Qualifying Asset 9,50,000x40/1 NIL
factory building 00
= ` 3,80,000
Purchase of Not a Qualifying NIL 9,50,000x15/100
Machinery Asset = 1,42,500
Purchase of and Not a Qualifying NIL 9,50,000x2/100
furniture Asset =19,000
Purchase of truck Not a Qualifying NIL 9,50,000x13/100
Asset = 1,23,500
Working Capital Not a Qualifying NIL 9,50,000x30/100
Asset = ` 2,85,000
Total ` 3,80,000 ` 5,70,000

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UNIT 5: ACCOUNTING STANDARD 19 LEASES v

LEARNING OUTCOMES

After studying this unit, you will be able to comprehend–

 What is a lease
 What are the parameters for Classification of Leases
 Accounting for leases in the Financial Statements of Lessees
• Finance Leases
• Operating Leases
 Accounting for Leases in the Financial Statements of Lessors
• Finance Leases
• Operating Leases
 Sale And Leaseback Transactions
 Disclosures required as per the standard.

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5.1 v INTRODUCTION
Before, we start with the standard, let us lay down the coverage of AS 19 from the
examination point of view as under:
Areas covered by AS 19:

What is a lease and how do we classify a lease (Finance or Operating)?

Lessee's point of view Lessor's point of view

Accounting of a Lease (Finance and Opearting)

Books of Lessee Books of Lessor

Special Issue - Related to Lease Accounting

Sale and Lease back Transaction

The objective of AS 19 is to prescribe, for lessees and lessors, the appropriate

accounting policies and disclosures in relation to finance leases and operating
leases.
What is a Lease?
A Lease is an agreement whereby the Lessor (legal owner of an asset) conveys to
the Lessee (another party) in return for a payment or series of periodic payments
(Lease rents), the right to use an asset for an agreed period of time.

5.2 APPLICABILITY OF AS 19 [SCOPE]

The standard applies to all leases other than:
(a) lease agreements to explore for or use of natural resources, such as oil, gas,
timber metals and other mineral rights; and
(b) licensing agreements for items such as motion picture films, video
recordings, plays, manuscripts, patents and copyrights; and
(c) lease agreements to use lands

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5.3 DEFINITIONS v

A non-cancellable lease is a lease that is cancellable only:

(a) upon the occurrence of some remote contingency; or

(b) with the permission of the lessor; or
(c) if the lessee enters into a new lease for the same or an equivalent asset with
the same lessor; or
(d) upon payment by the lessee of an additional amount such that, at inception,
continuation of the lease is reasonably certain.

The lease term is the non-cancellable period for which the lessee has agreed to
take on lease the asset together with any further periods for which the lessee has
the option to continue the lease of the asset, with or without further payment,
which option at the inception of the lease it is reasonably certain that the lessee
will exercise.
The inception of the lease is the earlier of the date of the lease agreement and
the date of a commitment by the parties to the principal provisions of the leas e.
Minimum lease payments are the payments over the lease term that the lessee
is, or can be required, to make excluding contingent rent, costs for services and
taxes to be paid by and reimbursed to the lessor, together with:
(a) in the case of the lessee, any residual value guaranteed by or on behalf of
the lessee; or

(b) in the case of the lessor, any residual value guaranteed to the lessor:
(i) by or on behalf of the lessee; or
(ii) by an independent third party financially capable of meeting this
guarantee.
However, if the lessee has an option to purchase the asset at a price which is
expected to be sufficiently lower than the fair value at the date the option
becomes exercisable that, at the inception of the lease, is reasonably certain to be
exercised, the minimum lease payments comprise minimum payments payable
over the lease term and the payment required to exercise this purchase option.

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v
The above definition can be summarized as under:
v
Note: The definition can be seen separately from the point of view of Lessee and
Lessor.

From the point of view of Lessee

Case I – Lessee will return the asset Case II – Lessee will retain the asset
at the end of the lease term at the end of the lease term (as he
has option to buy the asset and it is
reasonably certain that he will exercise
the option)
Payments over the lease term that Payments over the lease term that the
the lessee is, or can be required, to lessee is, or can be required, to make
make excluding: excluding:
(a) contingent rent. (a) contingent rent.
(b) costs for services and (b) costs for services and taxes
taxes to be paid by and to be paid by and
reimbursed to the lessor. reimbursed to the lessor.
+ +
Any residual value guaranteed by or Payment required to exercise the
on behalf of the lessee. purchase option.

From the point of view of Lessor

Case I – Lessee will return the asset Case II – Lessee will retain the asset
at the end of the lease term at the end of the lease term (as he
Payments over the lease term that has option to buy the asset and it is
the lessee is, or can be required, to reasonably certain that he will exercise
make excluding: the option)
(a) contingent rent. Same as Lessee given above

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(b) costs for services and taxes to v
v
be paid by and reimbursed to
the lessor.
+
Any residual value guaranteed:
(a) by or on behalf of the lessee; or
(b) by an independent third party
financially capable of meeting
this guarantee.

Fair value is the amount for which an asset could be exchanged or a liability
settled between knowledgeable, willing parties in an arm’s length transaction.
Economic life is either:
(a) the period over which an asset is expected to be economically usable by
one or more users; or
(b) the number of production or similar units expected to be obtained from the
asset by one or more users.
Useful life of a leased asset is either:
(a) the period over which the leased asset is expected to be used by the lessee;
or
(b) the number of production or similar units expected to be obtained from the
use of the asset by the lessee.

Note: The economic life is always greater than the useful life of the asset. Useful
life represents the depreciable life of an asset whereas, economic life represents
the total life during which an asset is capable of generating economic benefits.

Residual value of a leased asset is the estimated fair value of the asset at the end
of the lease term.
Guaranteed residual value is:

(a) in the case of the lessee, that part of the residual value which is guaranteed
by the lessee or by a party on behalf of the lessee (the amount of the
guarantee being the maximum amount that could, in any event, become
payable); and

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v
(b) v
in the case of the lessor, that part of the residual value which is guaranteed
v
by or on behalf of the lessee, or by an independent third party who is
financially capable of discharging the obligations under the guarantee.
Unguaranteed residual value of a leased asset is the amount by which the
residual value of the asset exceeds its guaranteed residual value.

Note: Residual value = Guaranteed Residual value (GRV) + Unguaranteed

Residual value (UGRV)

Gross investment in the lease is the aggregate of the minimum lease payments
under a finance lease from the standpoint of the lessor and any unguaranteed
residual value accruing to the lessor.
In simple words,

Gross Undiscounted total cash inflows from the point of view of the
Investment lessor
(GI) Undiscounted total of:
(a) Minimum Lease Payments (MLP); and
(b) Unguaranteed Residual Value (UGRV).
Undiscounted total of:
(a) Lease Payments;
(b) Guaranteed residual value (GRV); and
(c) Unguaranteed Residual value (UGRV).
Undiscounted total of:
(a) Lease Payments; and
(b) Residual value (GRV and UGRV);
Unearned finance income is the difference between:
(a) the gross investment in the lease; and

(b) the present value of

(i) the minimum lease payments under a finance lease from the
standpoint of the lessor; and
(ii) any unguaranteed residual value accruing to the lessor,
at the interest rate implicit in the lease.

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Unearned Gross Investment (GI) – Net Investment (NI)
v
Finance
Gross Investment (GI) – Present value of Gross Investment
Income
Gross Investment – Fair Value
(UFI)
Simply speaking = Total Interest
Net investment in the lease is the gross investment in the lease less unearned
finance income.
In simple words,

Net Discounted total cash inflows from the point of view of the
Investment lessor
(NI) Discounted total of:
(a) Minimum Lease Payments (MLP); and
(b) Unguaranteed Residual Value (UGRV).
Discounted total of:
(a) Lease Payments;
(b) Guaranteed residual value (GRV); and
(c) Unguaranteed Residual value (UGRV).
Discounted total of:
(a) Lease Payments; and
(b) Residual value (GRV and UGRV);
Discounted Gross Investment (GI) i.e. Present value of GI
Simply speaking = Fair value
The interest rate implicit in the lease is the discount rate that, at the inception
of the lease, causes the aggregate present value of

(a) the minimum lease payments under a finance lease from the standpoint of
the lessor; and
(b) any unguaranteed residual value accruing to the lessor, to be equal to the
fair value of the leased asset.

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Interest Discount rate at which:
v
rate Cash Outflows = Present value of Cash Inflows
implicit in Where,
the lease
Cash Outflow = Fair value of the asset;
Cash Inflow = Lease Payments + Residual Value (GRV and
UGRV)
Simply speaking = Lessor’s IRR

The lessee’s incremental borrowing rate of interest is the rate of interest the
lessee would have to pay on a similar lease or, if that is not determinable, the rate
that, at the inception of the lease, the lessee would incur to borrow over a similar
term, and with a similar security, the funds necessary to purchase the asset.
Contingent rent is that portion of the lease payments that is not fixed in amount
but is based on a factor other than just the passage of time (e.g., percentage of
sales, amount of usage, price indices, market rates of interest).
The definition of a lease includes agreements for the hire of an asset which
contain a provision giving the hirer an option to acquire title to the asset upon
the fulfillment of agreed conditions. These agreements are commonly known as
hire purchase agreements. Hire purchase agreements include agreements under
which the property in the asset is to pass to the hirer on the payment of the last
instalment and the hirer has a right to terminate the agreement at any time
before the property so passes.

5.4 TYPES OF LEASES

For accounting purposes, leases are classified as:
(i) Finance leases; and
(ii) Operating leases.
Finance lease - A lease classified as Finance Lease if it transfers substantially all
the risks and rewards incident to ownership of an asset. Title may or may not be
eventually transferred.
Operating Lease -A lease is classified as an Operating Lease if it does not transfer
substantially all the risk and rewards incident to ownership.

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v
Whether a lease is a finance lease or an operating lease depends on the
substance of the transaction rather than its form. v

Risks include the possibilities of losses from idle capacity or technological

obsolescence and of variations in return due to changing economic conditions.
Rewards may be represented by the expectation of profitable operation over the
economic life of the asset and of gain from appreciation in value or realisation of
residual value.
We can summarize the types of lease conceptually as under:

Transfers the risk and reward

Finance
Typically, a loan arrangement
Type of Lease
Does not transfer the risk and reward
Operating
Typically, a rental arrangement

5.5 INDICATORS OF FINANCE LEASE

AS 19 has given a total of 8 parameters to decide whether it is a finance
lease or not. (These parameters have been discussed in para 5.6 and 5.7.
These 8 conditions can be divided into following categories:

5 Parameters -
Any 1 condition is met – It will
Deterministic in
be classified as finance lease.
nature
8 Parameters
3 Parameters - Even if all the conditions are met
Suggestive in – It does not necessarily imply
nature that it is a finance lease.

Let us take up these conditions one by one;

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5.6v DETERMINISTIC CONDITIONS
Situations, which would normally lead to a lease being classified as a finance lease
are:
(a) The lease transfers ownership of the asset to the lessee by the end of the
lease term;
(b) The lessee has the option to purchase the asset at a price which is expected
to be sufficiently lower than the fair value at the date the option becomes
exercisable such that, at the inception of the lease, it is reasonably certain
that the option will be exercised;
Example
Mr. A has taken a car on lease for 5 years from XYZ. After 5 years of lease
term Mr. A has the option to purchase this car for ` 20,000, whereas it is
assumed the car market value at the end of 5 th year would be ` 2,00,000.
Considering the option to buy it at bargain price, it is reasonably certain
that Mr. A would exercise that option.
(c) The lease term is for the major part of the economic life of the asset even if
title is not transferred;
Example
XYZ has taken a property on lease for 32 years from ABC, expected economic
life of the property is 40 years. Since XYZ is going to use the asset over major
part of its economic life (80% in this case), it will meet the condition to be
treated as finance lease.
(d) At the inception of the lease, present value of the minimum lease payments
amounts to at least substantially all of the fair value of the leased asset; and
(e) The leased asset is of a specialized nature such that only the lessee can use
it without major modifications being made.
Example
PQR, a hospital ordered 10 ambulances, specially designed as per the
requirement of PQR. These ambulances are taken on lease and it cannot be
used by anyone else without major modifications. This would meet the
condition of finance lease.

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5.7 SUGGESTIVE CONDITIONS v

Additional Indicators of situations which individually or in combination could also

lead to a lease being classified as a finance lease are:
(a) If the lessee can cancel the lease and the lessor’s losses associated with the
cancellation are borne by the lessee;
(b) If gains or losses from the fluctuations in the residual value accrue to the
lessee (for example if the lessor agrees to allow rent rebate equaling most
of the disposal value of leased asset at the end of the lease); and

(c) If the lessee can continue the lease for a secondary period at a rent, which is
substantially lower than market rent.
Lease classification is made at the inception of the lease. If at any time the
lessee and the lessor agree to change the provisions of the lease, other than by
renewing the lease, in a manner that would have resulted in a different
classification of the lease had the changed terms been in effect at the inception of
the lease, the revised agreement is considered as a new agreement over its
revised term.
Changes in estimates (for example, changes in estimates of the economic life or
of the residual value of the leased asset) or changes in circumstances (for
example, default by the lessee), however, do not give rise to a new classification
of a lease for accounting purposes.

5.8 ACCOUNTING FOR FINANCE LEASES

(BOOKS OF LESSEE)
Following is the accounting treatment of Finance Leases in the books of Lessee:
(i) On the date of inception of Lease, Lessee should show it as an asset and
corresponding liability at lower of:

• Fair value of leased asset at the inception of the lease

• Present value of minimum lease payments from the standpoint of the
lessee

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v (Present value to be calculated with discount rate equal to interest
v
rate implicit in the lease, if this is practicable to determine; if not, the
lessee’s incremental borrowing rate should be used).
Thus, the journal entry at inception will be as under:

Particulars Debit Credit

Asset Refer Note

To Lessor (Lease Liability) Refer Note

It is not appropriate to present the liability for a leased asset as a deduction

from the leased asset in the financial statements. The liability for a leased
asset should be presented separately in the balance sheet as a current
liability or a long-term liability as the case may be.
Note:
The amount will be lower of the two:
(a) Fair value.
(b) Present value of MLP (Minimum Lease payments) from the point of
view of lessee.

(ii) Lease payments to be apportioned between the finance charge and the
reduction of the outstanding liability.
(iii) Finance charges to be allocated to periods during the lease term so as to
produce a constant rate of interest on the remaining balance of liability for
each period.
(iv) A finance lease gives rise to a depreciation expense for the asset as well as a
finance expense for each accounting period. The depreciation policy for a
leased asset should be consistent with that for depreciable assets which are
owned, and the depreciation recognised should be calculated on the basis
set out in AS 10 (Revised), Property, Plant and Equipment.
(v) If there is no reasonable certainty that the lessee will obtain ownership by
the end of the lease term, the asset should be fully depreciated over the
lease term or its useful life, whichever is shorter.

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Note: v
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Cases Useful life for Depreciation

Case I – Asset will be retained by the Useful life

lessee

Case II – Asset will be returned to the Useful life or lease term

lessor whichever is shorter

(vi) Initial direct costs are often incurred in connection with specific leasing
activities, as in negotiating and securing leasing arrangements. The costs
identified as directly attributable to activities performed by the lessee for a
finance lease are included as part of the amount recognised as an asset
under the lease.

5.8.1 Computation of interest rate implicit on lease

The interest rate implicit in the lease is the discount rate that, at the inception of
the lease, causes the aggregate present value of:
(a) the minimum lease payments under a finance lease from the standpoint of
the lessor; and
(b) any unguaranteed residual value accruing to the lessor, to be equal to the
fair value of the leased asset.

Discounting rate = R% p.a;

Lease Rents = L 1, L2 ……… Ln (Payable annually, at the end of each year)

Lease period = n years;

Guaranteed residual value = GR;

Unguaranteed residual value = UGR

Fair Value at the inception (beginning) of lease = FV

L1 L2 Ln GR
PV of MLP = + + +
(1+ R ) 1
(1+ R )2
(1+ R) n
(1+ R)n

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v UGR
Presentvvalue of unguaranteed residual value =
(1+ R )n
If interest rate implicit on lease is used as discounting rate:

Fair Value = PV of Minimum Lease Payments + PV of unguaranteed residual

value ….. (1)

The interest rate implicit on lease can be computed by trial and error, provided
the information required, e.g. the unguaranteed residual value can be reasonably
ascertained.
Example 1
Annual lease rents = ` 50,000 at the end of each year.
Lease period = 5 years;
Guaranteed residual value = ` 25,000
Unguaranteed residual value (UGR) = ` 15,000
Fair Value at the inception (beginning) of lease = ` 2,00,000
Interest rate implicit on lease is computed below:
Interest rate implicit on lease is a discounting rate at which present value of
minimum lease payments and unguaranteed residual value is ` 2 lakhs.
PV of minimum lease payments and unguaranteed residual value at guessed rate 10%

Year MLP + UGR DF (10%) PV

` `
1 50,000 0.909 45,450
2 50,000 0.826 41,300
3 50,000 0.751 37,550
4 50,000 0.683 34,150
5 50,000 0.621 31,050
5 25,000 0.621 15,525
5 15,000 0.621 9,315
2,14,340

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PV of minimum lease payments and unguaranteed residual value at guessed rate
v
14%
Year MLP + UGR DF (14%) PV
` `
1 50,000 0.877 43,850
2 50,000 0.769 38,450
3 50,000 0.675 33,750
4 50,000 0.592 29,600
5 50,000 0.519 25,950
5 25,000 0.519 12,975
5 15,000 0.519 7,785
1,92,360

Interest rate implicit on lease is computed below by interpolation:

14% − 10%
Interest rate implicit on lease =10% +  (2,14,340 − 2,00,000 ) = 12.6%
2,14,340 − 1,92,360

Example 2
Annual lease rents = ` 50,000 at the end of each year.

Lease period = 5 years;

Guaranteed residual value = ` 25,000
Unguaranteed residual value (UGR) = ` 15,000
Fair Value at the inception (beginning) of lease = ` 2,00,000
Interest rate implicit on lease is =12.6%
Present value of minimum lease payment is computed below:

Year MLP PV
DF (12.6%)
` `
1 50,000 0.890 44,500
2 50,000 0.790 39,500
3 50,000 0.700 35,000

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4 50,000 0.622 31,100
v
5 50,000 0.552 27,600
5 25,000 0.552 13,800
1,91,500

Present value of minimum lease payment = ` 1,91,500

Fair value of leased asset = ` 2,00,000

The accounting entry at the inception of lease to record the asset taken on finance
lease in books of lessee is suggested below:
` `
Asset A/c Dr. 1,91,500
To Lessor (Lease Liability) A/c 1,91,500
(Being recognition of finance lease as asset
and liability)

Example 3
Using data for example 2 and assuming zero residual value, allocation of finance
charge over lease period is shown below:

Year Minimum Lease Finance Charge Principal Principal due

Payments (12.6%)
` ` ` `
0 -- -- -- 1,91,500
1 50,000 24,129 25,871 1,65,629
2 50,000 20,869 29,131 1,36,498
3 50,000 17,199 32,801 1,03,697
4 50,000 13,066 36,934 66,763
5 75,000 8,237  66,763
2,75,000 83,500 1,91,500


The difference between this figure and finance charge [66,763×12.6%=8412] is due to
approximation in computation.

© The Institute of Chartered Accountants of India

 ASSETS BASED ACCOUNTING STANDARDS 5.153
5.153
v
v
v
Accounting entries in year 1 to recognise the finance charge in books of lessee are
v
suggested below:

` `
Finance Charge A/c Dr. 24,129

To Lessor 24,129
(Being finance charge due for the year)

Lessor Dr. 50,000

To Bank A/c 50,000
(Being payment of lease rent for the year)

P & L A/c Dr. 24,129

To Finance Charge A/c 24,129
(Being recognition of finance charge as expense for the
year)

Example 4
In example 2, suppose unguaranteed residual value is not determinable and lessee’s
incremental borrowing rate is 10%.
Since interest rate implicit on lease is discounting rate at which present value of
minimum lease payment and present value of unguaranteed residual value equals
the fair value, interest rate implicit on lease cannot be determined unless
unguaranteed residual value is known. If interest rate implicit on lease is not
determinable, the present value of minimum lease payments should be determined
using lessee’s incremental borrowing rate.
Present value of minimum lease payment using lessee’s incremental borrowing rate
10% is computed below:

Year MLP DF (10%) PV

` `
1 50,000 0.909 45,450

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 5.154 ADVANCED ACCOUNTING
v
v
v
2 50,000 0.826 41,300
v
3 50,000 0.751 37,550

4 50,000 0.683 34,150

5 50,000 0.621 31,050
5 25,000 0.621 15,525

2,05,025

Present value of minimum lease payment = ` 2,05,025

Fair value of leased asset = ` 2,00,000

The accounting entry at the inception of lease to record the asset taken on finance
lease in books of lessee is suggested below:

` `
Asset A/c Dr. 2,00,000

To Lessor (Lease Liability) 2,00,000

(Being recognition of finance lease as asset and liability)

Since the liability is recognised at fair value ` 2 lakh (total principal), we need to
ascertain a discounting rate at which present value minimum lease payments
equals ` 2 lakh. The discounting rate can then be used for allocation of finance
charge over lease period.

PV of minimum lease payments at guessed rate 12%.

Minimum Lease Payments DF (12%) PV

Year
` `
1 50,000 0.893 44,650
2 50,000 0.797 39,850
3 50,000 0.712 35,600
4 50,000 0.636 31,800
5 50,000 0.567 28,350

© The Institute of Chartered Accountants of India

 ASSETS BASED ACCOUNTING STANDARDS 5.155
5.155
v
v
v
5 25,000 0.567 14,175
v
1,94,425

12% − 10%
Required discounting rate = 10%+  (2,05,025 − 2,00,000 ) = 10.95%
2,05,025 − 1,94,425

Allocation of finance charge over lease period is shown below:

Year Minimum Lease Finance Charge Principal Principal due

Payments (10.95%)
` ` ` `
0 -- -- -- 2,00,000
1 50,000 21,900 28,100 1,71,900
2 50,000 18,823 31,177 1,40,723
3 50,000 15,409 34,591 1,06,132
4 50,000 11,621 38,379 67,753
5 75,000 7,247  67,753
2,75,000 75,000 2,00,000

Accounting entries in year 1 to recognise the finance charge in books of lessee are
suggested below:

` `
Finance Charge A/c Dr. 21,900
To Lessor 21,900
(Being finance charge due for the year)
Lessor Dr. 50,000
To Bank A/c 50,000
(Being payment of lease rent for the year)


The difference between this figure & finance charge [67,753×10.95% = 7418] is due to
approximation in computation

© The Institute of Chartered Accountants of India

 5.156 ADVANCED ACCOUNTING
v
v
v
P & L A/c Dr. 21,900
v
To Finance Charge 21,900
(Being recognition of finance charge as expense for the year)

Illustration 1
S. Square Private Limited has taken machinery on finance lease from S.K. Ltd. The
information is as under:

Lease term = 4 years

Fair value at inception of lease = ` 20,00,000

Lease rent = ` 6,25,000 p.a. at the end of year

Guaranteed residual value = ` 1,25,000

Expected residual value = ` 3,75,000

Implicit interest rate = 15%

Discounted rates for 1 st year, 2nd year, 3 rd year and 4 th year are 0.8696, 0.7561,
0.6575 and 0.5718 respectively.

Calculate the value of the lease liability as per AS-19 and disclose impact of this on
Balance sheet and Profit & loss account at the end of year 1

Solution
According to para 11 of AS 19 “Leases”, the lessee should recognise the lease as
an asset and a liability at an amount equal to the lower of the fair value of the
leased asset at the inception of the finance lease and the present value of the
minimum lease payments from the standpoint of the lessee.

In calculating the present value of the minimum lease payments the discount rate
is the interest rate implicit in the lease. Present value of minimum lease payments
will be calculated as follows:

© The Institute of Chartered Accountants of India

 ASSETS BASED ACCOUNTING STANDARDS 5.157
5.157
v
v
v
Year Minimum Lease Implicit interest rate Present value `
v
Payment ` (Discount rate @15%)
1 6,25,000 0.8696 5,43,500
2 6,25,000 0.7561 4,72,563
3 6,25,000 0.6575 4,10,937
4 7,50,000 0.5718 4,28,850
Total 26,25,000 18,55,850

Present value of minimum lease payments ` 18,55,850 is less than fair value at
the inception of lease i.e. ` 20,00,000, therefore, the asset and corresponding
lease liability should be recognised at ` 18,55,850 as per AS 19.

5.8.2 Disclosures made by the Lessee

The lessee should, in addition to the requirements of AS 10 (Revised), Property,
Plant and Equipment, and the governing statute, make the following disclosures
for finance leases:
(a) assets acquired under finance lease as segregated from the assets owned;

(b) for each class of assets, the net carrying amount at the balance sheet date;
(c) a reconciliation between the total of minimum lease payments at the balance
sheet date and their present value. In addition, an enterprise should disclose the
total of minimum lease payments at the balance sheet date, and their present
value, for each of the following periods:
(i) not later than one year;
(ii) later than one year and not later than five years;
(iii) later than five years;
(d) contingent rents recognised as expense in the statement of profit and loss
for the period;


Minimum Lease Payment of 4 th year includes guaranteed residual value amounting
` 1,25,000.

© The Institute of Chartered Accountants of India

 5.158 ADVANCED ACCOUNTING
v
v
(e) v
the total of future minimum sublease payments expected to be received
v
under non-cancelable subleases at the balance sheet date; and

(f) a general description of the lessee's significant leasing arrangements

including, but not limited to, the following:
(i) the basis on which contingent rent payments are determined;

(ii) the existence and terms of renewal or purchase options and escalation
clauses; and
(iii) restrictions imposed by lease arrangements, such as those concerning
dividends, additional debt, and further leasing.

5.8.3 Accounting for finance leases (Books of lessor)

The lessor should recognise assets given under a finance lease in its balance sheet
as a receivable at an amount equal to the net investment in the lease.
In a finance lease, the lessor recognises the net investment in lease (which is
usually equal to fair value, i.e. usual market price of the asset, as shown below) as
receivable by debiting the Lessee A/c.
Journal entries at inception:

Particulars Debit Credit

Asset Fair value
To Bank Fair value
(Being purchase of asset by lessor at FV)
Lease Receivable Fair value = NI
To Asset Fair value = NI
(Being asset by lessor given at lease)

Where,
Gross investment in Lease (GI)

= Minimum Lease Payments (MLP) + Unguaranteed Residual value (UGRV)

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 ASSETS BASED ACCOUNTING STANDARDS 5.159
5.159
v
v
Net investment in Lease (NI) v
v
= Gross investment in Lease (GI) – Unearned Finance Income (UFI).

Unearned finance income (UFI) = GI – (PV of MLP + PV of UGRV)

The discounting rate for the above purpose is the rate of interest implicit in the
lease.
From the definition of interest rate implicit on lease:
(PV of MLP + PV of UGRV) = Fair Value.
The above definitions imply that:

(a) Unearned Finance Income (UFI) = GI – Fair Value

(b) Net Investment in Lease = GI – UFI = GI – (GI – Fair Value) = Fair Value
Since the sale and receivables are recognised at net investment in lease, which is
equal to fair value: Profit recognised at the inception of lease = Fair Value – Cost
Total earning of lessor = GI – Cost
= (GI – Fair Value) + (Fair Value – Cost)

= Unearned Finance Income + (Fair Value – Cost)

The above analysis does not hold where the discounting rate is not equal to interest
rate implicit on lease. Such is the case, where the interest rate implicit on lease is
artificially low. The discounting rate in such situations should be the commercial rate
of interest (refer discussion on ‘manufacturer or dealer lessor’ below).

5.8.4 Recognition of Finance Income

The unearned finance income is recognised over the lease term on a systematic
and rational basis. This income allocation is based on a pattern reflecting a
constant periodic return on the net investment in lease outstanding.

The constant periodic return is the rate used for discounting, i.e. either the
interest rate implicit on lease or the commercial rate of interest.

© The Institute of Chartered Accountants of India

 5.160 ADVANCED ACCOUNTING
v
v
v
5.8.5 Initial Direct Costs
v
Initial direct costs, such as commissions and legal fees, are often incurred by lessors in
negotiating and arranging a lease. For finance leases, these initial direct costs are
incurred to produce finance income and are either recognised immediately in the
statement of profit and loss or allocated against the finance income over the lease
term.

5.8.6 Review of unguaranteed residual value by lessor

AS 19 requires a lessor to review unguaranteed residual value used in computing
the gross investment in lease regularly.
In case any reduction in the estimated unguaranteed residual value is identified,
the income allocation over the remaining lease term is to be revised. Also, any
reduction in respect of income already accrued is to be recognised immediately.
An upward adjustment of the estimated residual value is not made.
Illustration 2
Prakash Limited leased a machine to Badal Limited on the following terms:

(` In lakhs)

(i) Fair value of the machine 28.3

(ii) Lease term 5 years

(iii) Lease rental per annum 8.00

(iv) Guaranteed residual value 1.60

(v) Expected residual value 3.00

(vi) Internal rate of return 15%

Discounted rates for 1 st year to 5th year are 0.8696, 0.7561, 0.6575, 0.5718, and
0.4972 respectively.
Ascertain Unearned Finance Income.

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 ASSETS BASED ACCOUNTING STANDARDS 5.161
5.161
v
v
Solution v
v
As per AS 19 on Leases, unearned finance income is the difference between (a)
the gross investment in the lease and (b) the present value of minimum lease
payments under a finance lease from the standpoint of the lessor; and any
unguaranteed residual value accruing to the lessor, at the interest rate implicit in
the lease.
Where:
(a) Gross investment in the lease is the aggregate of (i) minimum lease
payments from the stand point of the lessor and (ii) any unguaranteed
residual value accruing to the lessor.
Gross investment = Minimum lease payments + Unguaranteed residual
value
= [Total lease rent + Guaranteed residual value (GRV)] +
Unguaranteed residual value (URV)
= [(` 8,00,000  5 years) + ` 1,60,000] + ` 1,40,000
= ` 43,00,000 (a)

(b) Table showing present value of (i) Minimum lease payments (MLP) and
(ii) Unguaranteed residual value (URV).

Year MLP inclusive of Internal rate of return Present Value

URV (`) (Discount factor @ 15%) (`)

1 8,00,000 0.8696 6,95,680

2 8,00,000 0.7561 6,04,880
3 8,00,000 0.6575 5,26,000
4 8,00,000 0.5718 4,57,440
5 8,00,000 0.4972 3,97,760
1,60,000 (GRV) 0.4972 79,552
41,60,000 27,61,312 (i)
1,40,000 (URV) 0.4972 69,608 (ii)
43,00,000 (i)+ (ii) 28,30,920 (b)
Unearned Finance Income (a) - (b) = ` 43,00,000 – ` 28,30,920= ` 14,69,080.

© The Institute of Chartered Accountants of India

 5.162 ADVANCED ACCOUNTING
v
v
v
Manufacturer or dealer lessor
v
The manufacturer or dealer lessor should recognise the transaction of sale in the
statement of profit and loss for the period, in accordance with the policy followed
by the enterprise for outright sales. If artificially low rates of interest are quoted,
profit on sale should be restricted to that which would apply if a commercial rate
of interest were charged. Initial direct costs should be recognised as an expense
in the statement of profit and loss at the inception of the lease.

Disclosures
The lessor should make the following disclosures for finance leases:

(a) a reconciliation between the total gross investment in the lease at the
balance sheet date, and the present value of minimum lease payments
receivable at the balance sheet date. In addition, an enterprise should
disclose the total gross investment in the lease and the present value of
minimum lease payments receivable at the balance sheet date, for each of
the following periods:

(i) not later than one year;

(ii) later than one year and not later than five years;

(iii) later than five years;

(b) unearned finance income;

(c) the unguaranteed residual values accruing to the benefit of the lessor;

(d) the accumulated provision for uncollectible minimum lease payments

receivable;

(e) contingent rents recognised in the statement of profit and loss for the
period;

(f) a general description of the significant leasing arrangements of the lessor;

and

(g) accounting policy adopted in respect of initial direct costs.

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 ASSETS BASED ACCOUNTING STANDARDS 5.163
5.163
v
v
v
As an indicator of growth, it is often useful to also disclose the gross investment
v
less unearned income in new business added during the accounting period, after
deducting the relevant amounts for cancelled leases.

5.9 ACCOUNTING FOR OPERATING LEASES

5.9.1 Accounting treatment in the Books of lessee
Lease payments under an operating lease should be recognised as an expense in the
statement of profit and loss of a lessee 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.

Lease payments may be tailor made to suit the payment capacity of the lessee.
For example, a lease term may provide for low initial rents and high terminal rent.
Such payment patterns do not reflect the pattern of benefit derived by the lessee
from the use of leased asset. To have better matching between revenue and costs,
AS 19 requires lessees to recognise operating lease payments as 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.
Example

Suppose outputs from a machine taken on a 3 year operating lease are estimated
as 10,000 units in year 1; 20,000 units in year 2 and 50,000 units in year 3. The
agreed annual lease payments are ` 25,000, ` 45,000 and ` 50,000 respectively.

The total lease payment ` 1,20,000 in this example should be recognised in

proportion of output as ` 15,000 in year 1, ` 30,000 in year 2 and ` 75,000 in year
3. The difference between lease rent due and lease rent recognised can be debited /
credited to Lease Equalisation A/c.
The accounting entries for year 1 in books of lessee are suggested below:

` `
Lease Rent A/c Dr. 15,000

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 5.164 ADVANCED ACCOUNTING
v
v
v
Lease Equalization A/c Dr. 10,000
v
To Lessor 25,000
(Being lease rent for the year due)
Lessor Dr. 25,000
To Bank A/c 25,000
(Being payment of lease rent for the year)
P & L A/c Dr. 15,000
To Lease Rent A/c 15,000
(Being recognition of lease rent as expense for the year)

Since total lease rent due and recognised must be same, the Lease Equalisation A/c
will close in the terminal year. Till then, the balance of Lease Equalisation A/c can
be shown in the balance sheet under "Current Assets" or Current Liabilities"
depending on the nature of balance.

5.9.2 Disclosures by lessees

The paragraph 25 requires lessees to make following disclosures for operating
leases:
(a) the total of future minimum lease payments under non-cancelable
operating leases for each of the following periods:
(i) not later than one year;
(ii) later than one year and not later than five years;
(iii) later than five years;

(b) the total of future minimum sublease payments expected to be received

under non-cancelable subleases at the balance sheet date;
(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;

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 ASSETS BASED ACCOUNTING STANDARDS 5.165
5.165
v
v
(e) v
a general description of the lessee's significant leasing arrangements
including, but not limited to, the following: v

(i) the basis on which contingent rent payments are determined;

(ii) the existence and terms of renewal or purchase options and escalation
clauses; and

(iii) restrictions imposed by lease arrangements, such as those concerning

dividends, additional debt, and further leasing.

5.9.3 Accounting treatment in the books of lessor

(i) The lessor should present an asset given under operating lease as PPE in its
balance sheets.
(ii) Lease income from operating leases should be recognised in the statement
of profit and loss on a straight line basis over the lease term, unless another
systematic basis is more representative of the time pattern in which benefit
derived from the use of the leased asset is diminished.
(iii) Depreciation should be recognised in the books of lessor. The depreciation
of leased assets should be on a basis consistent with the normal
depreciation policy of the lessor for similar assets, and the depreciation
charge should be calculated on the basis set out in AS 10.
(iv) The impairment losses on assets given on operating leases are determined
and treated as per AS 28

We can summarize the accounting treatment for the lessor and lessee for an
operating lease as under:

Particulars Books of lessor Books of Lessee

Asset Continues to appear in Asset does not appear in his

his books books

Depreciation Yes - charged Not applicable

Impairment Yes - applicable Not applicable
Lease rent Income recognized on Expense recognized on SLM
SLM

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 5.166 ADVANCED ACCOUNTING
v
v
v
Initial direct costs incurred specifically to earn revenues from an operating lease
v
are either deferred and allocated to income over the lease term in proportion to
the recognition of rent income, or are recognised as an expense in the statement
of profit and loss in the period in which they are incurred.

A manufacturer or dealer lessor should recognise the asset given on operating

lease as PPE in their books by debiting concerned PPE A/c and crediting Cost of
Production / Purchase at cost. No selling profit should be recognised on entering
into operating lease, because such leases are not equivalents of sales.

Suppose outputs from a machine of economic life of 6 years are estimated as

10,000 units in year 1, 20,000 units in year 2 and 30,000 units in year 3, 40,000
units in year 4, 20,000 units in year 5 and 5,000 units in year 6. The machine was
given on 3-year operating lease by a dealer of the machine for equal annual lease
rentals to yield 20% profit margin on cost ` 5,00,000. Straight-line depreciation in
proportion of output is considered appropriate.

Total lease rent = 120% of ` 5 lakhs  Output during lease period

Total output
60,000 units
= ` 6 lakhs  = ` 2.88 lakhs
1,25,000 units

Annual lease rent = ` 2,88,000 / 3 = ` 96,000

Total lease rent should be recognised as income in proportion of output during

lease period, i.e. in the proportion of 10 : 20 : 30. Hence income recognised in years
1, 2 and 3 are ` 48,000, ` 96,000 and ` 1,44,000 respectively.

Since depreciation in proportion of output is considered appropriate, the

depreciable amount ` 5 lakh should be allocated over useful life 6 years in
proportion of output, i.e. in proportion of 10 : 20 : 30 : 40 : 20 : 5. Depreciation for
year 1 is ` 40,000.

The accounting entries for year 1 in books of lessor are suggested below:

` `
Machine given on Operating Lease Dr. 5,00,000
To Purchase 5,00,000

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 ASSETS BASED ACCOUNTING STANDARDS 5.167
5.167
v
v
v
(Being machine given on operating lease brought into
v
books)
Lessee Dr. 96,000
To Lease Equalization A/c 48,000
To Lease Rent 48,000
(Being lease rent for the year due)
Bank Dr. 96,000
To Lessee 96,000
(Being receipt of lease rent for the year)
Lease Rent Dr. 48,000
To P & L A/c 48,000
(Being recognition of lease rent as income for the year)
Depreciation Dr. 40,000
To Machine given on Operating Lease 40,000
(Being depreciation for the year)
P & L A/c Dr. 40,000
To Depreciation 40,000
(Being depreciation for the year transferred to P & L A/c)

Since total lease rent due and recognised must be same, the Lease Equalisation A/c
will close in the terminal year. Till then, the balance of Lease Equalisation A/c can
be shown in the balance sheet under "Current Assets" or Current Liabilities"
depending on the nature of balance.

5.9.4 Disclosures by lessors

As per AS 19, the lessor should, in addition to the requirements of AS 10 (Revised)
and the governing statute, make the following disclosures for operating leases:
(a) for each class of assets, the gross carrying amount, the accumulated
depreciation and accumulated impairment losses at the balance sheet date;
and

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 5.168 ADVANCED ACCOUNTING
v
v
(i) v the depreciation recognized in the statement of profit and loss for the
v
period;

(ii) impairment losses recognized in the statement of profit and loss for
the period;

(iii) impairment losses reversed in the statement of profit and loss for the
period;

(b) the future minimum lease payments under non-cancellable operating leases
in the aggregate and for each of the following periods:

(i) not later than one year;

(ii) later than one year and not later than five years;

(iii) later than five years;

(c) total contingent ren recognized as income in the statement of profit and
loss for the period;

(d) a general description of the lessor ’s significant leasing arrangements; and

(e) accounting policy adopted in respect of initial direct costs.

5.10 SALE AND LEASEBACK

The basis of a sale and leaseback agreement is simply that one sells an asset for
cash and then leases it back from the buyer. The asset subject to such sale and
leaseback agreement is generally property. Under such an agreement the
property owner agrees to sell the property at an agreed valuation and lease it
back from the buyer. The lessee or seller receives cash immediately and makes
periodic payment in form of lease rents for right to use the property. The lease
payments and the sale price are generally interdependent as they are negotiated
as a package. The accounting treatment of a sale and lease back depends upon
the type of lease involved. Accounting treatment of profits / losses on sale of
asset, as required by the standard in respect of sale and lease-back transactions,
are summarised below.

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 ASSETS BASED ACCOUNTING STANDARDS 5.169
5.169
v
v
v
The accounting treatment depends upon the classification of the lease in the
v
books of the seller-lessee.

Situation I

• Where sale and leaseback results in finance lease

The excess or deficiency of sales proceeds over the carrying amount should be
deferred and amortised over the lease term in proportion to the depreciation of
the leased asset.

Situation II

• Where sale and leaseback results in operating lease

Case 1: Sale price = Fair Value

Profit or loss should be recognised immediately.

Case 2: Sale Price < Fair Value

Profit and loss should be recognised immediately. However if the loss is

compensated by future lease payments at below market price, it should be
deferred and amortised in proportion to the lease payments over the period for
which the asset is expected to be used.

Case 3: Sale Price > Fair Value

The excess over fair value should be deferred and amortised over the period for
which the asset is expected to be used.

For operating leases, if the fair value at the time of a sale and leaseback
transaction is less than the carrying amount of the asset, a loss equal to the
amount of the difference between the carrying amount and fair value should be
recognised immediately.

For finance leases, no such adjustment is necessary unless there has been an
impairment in value, in which case the carrying amount is reduced to recoverable
amount in accordance with AS 28.

© The Institute of Chartered Accountants of India

 5.170 ADVANCED ACCOUNTING
v
v
v
Thus it can be summarised as:
v
Sale price at Carrying Carrying amount less Carrying amount
fair value amount than fair value above fair value
equal to fair
value

Profit No Profit Recognise profit Not Applicable

immediately

Loss No Loss Not Applicable Recognise loss

immediately

Sale price below fair Carrying Carrying Carrying amount

value amount amount less above fair value
equal to fair than fair value
value

Profit No Profit Recognise profit No Profit.

immediately (Carrying amount
of an asset to be
written down to
fair value)

Loss not compensated Recognise loss Recognise loss Carrying amount

by future lease immediately immediately of an asset to be
payments at below written down to
market price fair value

Loss compensated by Defer and Defer and Carrying amount

future lease payments amortise loss. amortise loss. of an asset to be
at below market price written down to
fair value

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 ASSETS BASED ACCOUNTING STANDARDS 5.171
5.171
v
v
v
Sale Carrying Carrying amount less Carrying amount
v
price amount than fair value above fair value
Above equal to fair
fair value
value
Profit Defer and 1. Difference between Defer and amortise profit.
amortise carrying amount and (The profit would be the
profit. fair value to be difference between fair
immediately value and sale price as the
recognised. carrying amount would
2. Excess over fair have been written down to
value to be Deferred fair value)
and amortised.
Loss No Loss No Loss 1. Carrying amount of an
asset to be written
down to fair value.

2. Defer and amortise the

difference of sale price
and fair value.

Illustration 3
A Ltd. sold machinery having WDV of ` 40 lakhs to B Ltd. for ` 50 lakhs and the same
machinery was leased back by B Ltd. to A Ltd. The lease back is operating lease.
Comment if –

(a) Sale price of ` 50 lakhs is equal to fair value.

(b) Fair value is ` 60 lakhs.

(c) Fair value is ` 45 lakhs and sale price is ` 38 lakhs.

(d) Fair value is ` 40 lakhs and sale price is ` 50 lakhs.

(e) Fair value is ` 46 lakhs and sale price is ` 50 lakhs

(f) Fair value is ` 35 lakhs and sale price is ` 39 lakhs.

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Solutionv
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Following will be the treatment in the given cases:

(a) When sales price of ` 50 lakhs is equal to fair value, A Ltd. should
immediately recognise the profit of ` 10 lakhs (i.e. 50 – 40) in its books.
(b) When fair value is ` 60 lakhs then also profit of ` 10 lakhs should be
immediately recognised by A Ltd.
(c) When fair value of leased machinery is ` 45 lakhs & sales price is ` 38 lakhs,
then loss of ` 2 lakhs (40 – 38) to be immediately recognised by A Ltd. in its
books provided loss is not compensated by future lease payment, otherwise
defer and amortise the loss.
(d) When fair value is ` 40 lakhs & sales price is ` 50 lakhs then, profit of ` 10
lakhs is to be deferred and amortised over the lease period.
(e) When fair value is ` 46 lakhs & sales price is ` 50 lakhs, profit of ` 6 lakhs
(46 - 40) to be immediately recognised in its books and balance profit of ` 4
lakhs (50-46) is to be amortised/deferred over lease period.
(f) When fair value is ` 35 lakhs & sales price is ` 39 lakhs, then the loss of ` 5
lakhs (40-35) to be immediately recognised by A Ltd. in its books and profit
of ` 4 lakhs (39-35) should be amortised/deferred over lease period.

TEST YOUR KNOWLEDGE

Multiple Choice Questions
1. A Ltd. sold machinery having WDV of ` 40 lakhs to B Ltd. for ` 50 lakhs (Fair
value ` 50 lakhs) and same machinery was leased back by B Ltd. to A Ltd. The
lease back is in nature of operating lease. The treatment will be
(a) A Ltd. should amortise the profit of ` 10 lakhs over lease term.

(b) A Ltd. should recognise the profit of ` 10 lakhs immediately.

(c) A Ltd. should defer the profit of ` 10 lakhs.
(d) B Ltd. should recognise the profit of ` 10 lakhs immediately.

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2. In case of an operating lease – identify which statement is correct: v
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(a) The lessor continues to show the leased asset in its books of accounts.

(b) The lessor de-recognises the asset from its Balance Sheet.
(c) The lessor discontinues to claim depreciation in its books.
(d) The lessee recognises the asset in its Balance Sheet.
3. In case of finance lease, if the asset is returned back to the lessor at the end of
the lease term - the lessee always claims depreciation based on which of the
following:

(a) Useful life.

(b) Lease term.
(c) Useful life or lease term whichever is less.

(d) Useful life or lease term whichever is higher.

4. AS 19 lays down 5 deterministic conditions to classify the lease as a finance
lease. To classify the lease as an operating lease – which statement is correct?

(a) Any 1 condition fails.

(b) Majority of the 5 conditions fail.
(c) All 5 conditions fail.
(d) Any 2 conditions fails.
5. The basis of classification of a lease is:
(a) Control Test.

(b) Risk and reward Test.

(c) Both control test and risk and reward test.
(d) Only reward Test

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Theoretical Questions
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6. Explain the types of lease as per AS 19.
7. Explain the accounting treatment for a sale and leaseback transaction under
Operating lease.
8. What do you understand by the term “Interest rate implicit on lease”?
9. What are the disclosures requirements for operating leases by the lessee as
per AS-19?

Scenario based Questions

10. Classify the following into either operating or finance lease:
(i) Lessee has option to purchase the asset at lower than fair value, at the
end of lease term;
(ii) Economic life of the asset is 7 years, lease term is 6 years, but asset is
not acquired at the end of the lease term;
(iii) Economic life of the asset is 6 years, lease term is 2 years, but the asset
is of special nature and has been procured only for use of the lessee;
(iv) Present value (PV) of Minimum lease payment (MLP) = “X”. Fair value of
the asset is “Y”.
11. A machine was given on 3 years operating lease by a dealer of the machine
for equal annual lease rentals to yield 30% profit margin on cost ` 1,50,000.
Economic life of the machine is 5 years and output from the machine are
estimated as 40,000 units, 50,000 units, 60,000 units, 80,000 units and 70,000
units consecutively for 5 years. Straight line depreciation in proportion of
output is considered appropriate. Compute the following:
(i) Annual Lease Rent
(ii) Lease Rent income to be recognized in each operating year and
(iii) Depreciation for 3 years of lease.

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12. v
Lessee Ltd. took a machine on lease from Lessor Ltd., the fair value being
` 7,00,000. v

The economic life of machine as well as the lease term is 3 years. At the end
of each year Lessee Ltd. pays ` 3,00,000. The Lessee has guaranteed a residual
value of ` 22,000 on expiry of the lease to the Lessor. However, Lessor Ltd.,
estimates that the residual value of the machinery will be only ` 15,000. The
implicit rate of return is 15% p.a. and present value factors at 15% are 0.869,
0.756 and 0.657 at the end of first, second and third years respectively.

Calculate the value of machinery to be considered by Lessee Ltd. and the

finance charges in each year.
13. B&P Ltd. availed a lease from N&L Ltd. The conditions of the lease terms are
as under:
(i) Lease period is 3 years, in the beginning of the year 2009, for
equipment costing ` 10,00,000 and has an expected useful life of 5
years.
(ii) The Fair market value is also ` 10,00,000
(iii) The property reverts back to the lessor on termination of the lease.
(iv) The unguaranteed residual value is estimated at ` 1,00,000 at the end
of the year 2011.
(v) 3 equal annual payments are made at the end of each year.
(vi) Consider IRR = 10%.
The present value off ` 1 due at the end of 3rd year at 10% rate of interest is
` 0.7513. The present value of annuity of ` 1 due at the end of 3rd year at
10% IRR is ` 2.4868.
State whether the lease constitute finance lease and also calculate unearned
finance income.

14. X Ltd. sold machinery having WDV of ` 300 lakhs to Y Ltd. for ` 400 lakhs and
the same machinery was leased back by Y Ltd. to X Ltd. The lease back
arrangement is operating lease.

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Give your comments in the following situations:
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(i) Sale price of ` 400 lakhs is equal to fair value.

(ii) Fair value is ` 450 lakhs.

(iii) Fair value is ` 350 lakhs and the sale price is ` 250 lakhs.
(iv) Fair value is ` 300 lakhs and sale price is ` 400 lakhs.
(v) Fair value is ` 250 lakhs and sale price is ` 290 lakhs.

ANSWERS/solutions
Answer to the Multiple Choice Questions
1. (b) 2. (a) 3. (c) 4. (c) 5. (b)

Answer to the Theoretical Questions

6. For the purpose of accounting AS 19, classifies leases into two categories as
follows:
1. Finance Lease
2. Operating Lease
Finance Lease:
It is a lease, which transfers substantially all the risks and rewards incidental
to ownership of an asset to the lessee by the lessor but not the legal
ownership.
As per para 8 of the standard, in following situations, the lease transactions
are called Finance lease:

1. The lessee will get the ownership of leased asset at the end of the
lease term.
2. The lessee has an option to buy the leased asset at the end of the
lease term at price, which is lower than its expected fair value at the
date on which option will be exercised.

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3. The lease term covers the major part of the life of asset even if title vis
not transferred. v

4. At the beginning of lease term, present value of minimum lease rental

covers the initial fair value.
5. The asset given on lease to lessee is of specialized nature and can only
be used by the lessee without major modification.
Operating Lease:
It is lease, which does not transfer all the risks and rewards incidental to
ownership.
7. As per AS 19, where sale and leaseback results in operating lease, then the
accounting treatment in different situations is as follows:

Situation 1: Sale price = Fair Value

Profit or loss should be recognized immediately.
Situation 2: Sale Price < Fair Value

Profit should be recognized immediately. The loss should also be

recognized immediately except that, if the loss is compensated by future
lease payments at below market price, it should be deferred and amortized
in proportion to the lease payments over the period for which the asset is
expected to be used.
Situation 3: Sale Price > Fair Value

The excess over fair value should be deferred and amortized over the period
for which the asset is expected to be used.
8. As per para 3 of AS 19 'Leases' the interest rate implicit in the lease is the
discount rate that, at the inception of the lease, causes the aggregate
present value of:
(a) the minimum lease payments under a finance lease from the
standpoint of the lessor; and
(b) any unguaranteed residual value accruing to the lessor,
to be equal to the fair value of the leased asset.

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9. v
As per AS 19, lessees are required to make following disclosures for
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operating leases:

(a) the total of future minimum lease payments under non-cancelable

operating leases for each of the following periods:
(i) not later than one year;

(ii) later than one year and not later than five years;
(iii) later than five years;
(b) the total of future minimum sublease payments expected to be
received under non- cancelable subleases at the balance sheet date;
(c) lease payments recognized 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) recognized 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:
(i) the basis on which contingent rent payments are determined;
(ii) the existence and terms of renewal or purchase options and
escalation clauses; and
(iii) restrictions imposed by lease arrangements, such as those
concerning dividends, additional debt, and further leasing.

Answer to the Scenario based Questions

10. (i) If it becomes certain at the inception of lease itself that the option will
be exercised by the lessee, it is a Finance Lease.
(ii) The lease will be classified as a finance lease, since a substantial
portion of the life of the asset is covered by the lease term.
(iii) Since the asset is procured only for the use of lessee, it is a finance
lease.
(iv) The lease is a finance lease if X = Y, or where X substantially equals Y.

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11. (i) Annual lease rent v
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Total lease rent
Output during lease period
= 130% of ` 1,50,000 
Total output

= 130% of ` 1,50,000 x (40,000 +50,000+ 60,000)/(40,000 + 50,000 +

60,000 + 80,000 + 70,000)
= 1,95,000 x 1,50,000 units/3,00,000 units = ` 97,500
Annual lease rent = ` 97,500 / 3 = ` 32,500
(ii) Lease rent Income to be recognized in each operating year
Total lease rent should be recognised as income in proportion of
output during lease period, i.e. in the proportion of 40 : 50 : 60.
Hence income recognised in years 1, 2 and 3 will be as:
Year 1 ` 26,000,
Year 2 ` 32,500 and
Year 3 ` 39,000.

(iii) Depreciation for three years of lease

Since depreciation in proportion of output is considered appropriate,
the depreciable amount ` 1,50,000 should be allocated over useful life
5 years in proportion of output, i.e. in proportion of 40 : 50 : 60 : 80 :
70 .
Depreciation for year 1 is ` 20,000, year 2 = 25,000 and year 3 =
30,000.
12. As per para 11 of AS 19 "Leases", the lessee should recognize the lease as
an asset and a liability at the inception of a finance lease. Such recognition
should be at an amount equal to the fair value of the leased asset at the
inception of lease. However, if the fair value of the leased asset exceeds the
present value of minimum lease payment from the standpoint of the lessee,
the amount recorded as an asset and liability should be the present value of
minimum lease payments from the standpoint of the lessee.

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Computation of Value of machinery:
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Present value of minimum lease payment = ` 6,99,054

(See working note below)

Fair value of leased asset = ` 7,00,000
Therefore, the recognition will be at the lower of the two i.e. 6,99,054
Working Note - Present value of minimum lease payments:
Annual lease rental × PVIF+ Present value of guaranteed residual value
= ` 3,00,000 × (0.869 + 0.756 + 0.657) + ` 22,000 × 0.657

= ` 6,84,600 + ` 14,454 = 6,99,054

Computation of finance charges:

Year Finance Payment Reduction in Outstanding

charge outstanding liability
liability
1st Year – – – 6,99,054
beginning
End of 1st year 1,04,858 3,00,000 1,95,142 5,03,912
End of 2nd year 75,587 3,00,000 2,24,413 2,79,499
rd
End of 3 year 41,925 3,00,000 2,58,075 21,424

13. Computation of annual lease payment:

Particulars `
Cost of equipment 10,00,000
Unguaranteed residual value 1,00,000
Present value of unguaranteed residual value
(` 1,00,000 x 0.7513) 75,130
Present value of lease payments
(` 10,00,000 - ` 75,130) 9,24,870
Present value of annuity for three years is 2.4868
Annual lease payment [9,24,870/2.4868] 3,71,911.70

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Classification of lease: v
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Parameter 1:

The present value of lease payment i.e., ` 9,24,870 which equals 92.48% of
the fair market value i.e., ` 10,00,000.
The present value of minimum lease payments substantially covers the fair
value of the leased asset
Parameter 2:
The lease term (i.e. 3 years) covers the major part of the life of asset (i.e. 5
years).
Therefore, it constitutes a finance lease.
Computation of Unearned Finance Income:

Particulars `

Total lease payments (` 3,71,911.70 x 3) 11,15,735

Add: Unguaranteed residual value 1,00,000

Gross investment in the lease 1,215,735

Less: Present value of lease payments and residual value

i.e.
(10,00,000)
Net Investment (` 75,130 + ` 9,24,870)

Unearned finance income 2,15,735

14. Accounting Treatment:

S. No. Particulars Accounting Treatment

(i) When sale price of X Ltd. should immediately recognize

` 400 lakhs is equal to the profit of ` 100 lakhs (i.e. 400 –
fair value 300) in its books.
(ii) When fair value is Profit of ` 100 lakhs should be
` 450 lakhs immediately recognized by X Ltd.

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(iii) When fair value of Then loss of ` 50 lakhs (300 – 250) to
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leased machinery is be immediately recognized by X Ltd.
` 350 lakhs & sales in its books provided loss is not
price is ` 250 lakhs compensated by future lease
payment.
(iv) When fair value is Then, profit of ` 100 lakhs is to be
` 300 lakhs & sales deferred and amortized over the
price is ` 400 lakhs lease period.

(v) When fair value is Then the loss of ` 50 lakhs (300-250)

` 250 lakhs & sales to be immediately recognized by X
price is ` 290 lakhs Ltd. in its books and profit of ` 40
lakhs (290-250) should be amortized/
deferred over lease period.

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UNIT 6: ACCOUNTING STANDARD 26
INTANGIBLE ASSETS

LEARNING OUTCOMES
After studying this unit, you will be able to comprehend–
 Definition of Intangible Assets
 Parameters for Recognition and Initial Measurement of an Intangible
Asset
• Separate Acquisition
• Acquisition as part of an Amalgamation
• Acquisition by way of a Government Grant
• Exchanges of Assets
• Internally Generated Goodwill and other Intangible Assets
 Measurement Subsequent to Initial Recognition
 Principles for
• Amortisation Period
• Amortisation Method
• Residual Value
• Review of Amortisation Period and Amortisation Method
 Retirements and Disposals
 Disclosures as per the standard.

6.1 INTRODUCTION
The objective of AS 26 is to prescribe the accounting treatment for intangible
assets that are not dealt with specifically in another Accounting Standard. AS 26
requires an enterprise to recognise an intangible asset if, and only if, certain

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criteria are met. AS 26 also specifies how to measure the carrying amount of
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intangible assets and requires certain disclosures about intangible assets.

6.2 SCOPE
AS 26 should be applied by all enterprises in accounting for intangible assets,
except:
a. Intangible assets that are covered by another Accounting Standard, such as:
(a) intangible assets held by an enterprise for sale in the ordinary course
of business (AS 2, Valuation of Inventories and AS 7, Construction
Contracts)
(b) deferred tax assets (AS 22, Accounting for Taxes on Income)
(c) leases that fall within the scope of AS 19, Leases; and
(d) goodwill arising on an amalgamation (AS 14 (Revised), Accounting for
Amalgamations) and goodwill arising on consolidation (AS 21
(Revised), Consolidated Financial Statements)
b. Financial assets.
c. Mineral rights and expenditure on the exploration for, or development and
extraction of, minerals, oil, natural gas and similar non-regenerative
resources and
d. Intangible assets arising in insurance enterprises from contracts with
policyholders.
e. expenditure in respect of termination benefits.
However, AS 26 applies to other intangible assets used (such as computer
software), and other expenditure (such as start-up costs), in extractive industries
or by insurance enterprises.
AS 26 also applies to:
(i) expenditure on advertising, training, start - up cost
(ii) Research and development activities
(iii) Right under licensing agreements for items such as motion picture films,
video recordings, plays, manuscripts, patents and copyrights. These items
are excluded from the scope of AS 19.

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(iv) the underlying intangible asset in finance lease after its initial recognition. v
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6.3 DEFINITIONS
An asset is a resource:
a. Controlled by an enterprise as a result of past events and
b. From which future economic benefits are expected to flow to the enterprise.

Monetary assets are money held and assets to be received in fixed or

determinable amounts of money.
Non-monetary assets are assets other than monetary assets.

Amortisation is the systematic allocation of the depreciable amount of an

intangible asset over its useful life.
Depreciable amount is the cost of an asset less its residual value.

Useful life is either:

(a) the period of time over which an asset is expected to be used by the
enterprise; or

(b) the number of production or similar units expected to be obtained from the
asset by the enterprise.
Fair value of an asset is the amount for which that asset could be exchanged
between knowledgeable, willing parties in an arm's length transaction.
An active market is a market where all the following conditions exist:
a. The items traded within the market are homogeneous.

b. Willing buyers and sellers can normally be found at any time and
c. Prices are available to the public.
An impairment loss is the amount by which the carrying amount of an asset
exceeds its recoverable amount.
Carrying amount is the amount at which an asset is recognised in the balance
sheet, net of any accumulated amortisation and accumulated impairment losses
thereon.

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A financial asset is any asset that is:
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a. Cash;

b. A contractual right to receive cash or another financial asset from another

enterprise;
c. A contractual right to exchange financial instruments with another
enterprise under conditions that are potentially favourable; or
d. An ownership interest in another enterprise.
Termination benefits are employee benefits payable as a result of either:

a. an enterprise’s decision to terminate an employee’s employment before the

normal retirement date; or
b. an employee’s decision to accept voluntary redundancy in exchange for
those benefits (voluntary retirement).
Intangible Asset is
• an identifiable

• non-monetary asset
• without physical substance
• held for use in the production or supply of goods or services, for rental to
others, or for administrative purposes.
Enterprises frequently expend resources, or incur liabilities, on the acquisition,
development, maintenance or enhancement of intangible resources such as
scientific or technical knowledge, design and implementation of new processes or
systems, licences, intellectual property, market knowledge and trademarks
(including brand names and publishing titles). Common examples are computer
software, patents, copyrights, motion picture films, customer lists, mortgage
servicing rights, fishing licences, import quotas, franchises, customer or supplier
relationships, customer loyalty, market share and marketing rights. Goodwill is
another example of an item of intangible nature which either arises on acquisition
or is internally generated.
Not all the items described above will meet the definition of an intangible asset,
that is, identifiability, control over a resource and expectation of future economic

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benefits flowing to the enterprise. If an item covered by AS 26 does not meet the v
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definition of an intangible asset, expenditure to acquire it or generate it internally
is recognised as an expense when it is incurred.
Some intangible assets may be contained in or on a physical substance such as a
compact disk (in the case of computer software), legal documentation (in the case
of a licence or patent) or film (in the case of motion pictures). The cost of the
physical substance containing the intangible assets is usually not significant.
Accordingly, the physical substance containing an intangible asset, though tangible
in nature, is commonly treated as a part of the intangible asset contained in or on
it.
In some cases, an asset may incorporate both intangible and tangible elements
that are, in practice, inseparable. Judgement is required to assess as to which
element is predominant. For example, computer software for a computer-
controlled machine tool that cannot operate without that specific software is an
integral part of the related hardware and it is treated as a fixed asset. The same
applies to the operating system of a computer. Where the software is not an
integral part of the related hardware, computer software is treated as an
intangible asset.

6.4 IDENTIFIABILITY
• The definition of an intangible asset requires that an intangible asset be
identifiable. To be identifiable, it is necessary that the intangible asset is
clearly distinguished from goodwill.

• An intangible asset can be clearly distinguished from goodwill if the asset is

separable which means that enterprise could rent, sell, exchange or
distribute the specific future economic benefits attributable to the asset
without also disposing of future economic benefits that flow from other
assets used in the same revenue earning activity.
• Separability is not a necessary condition for identifiability since an
enterprise may be able to identify an asset in some other way. For example,
if an intangible asset is acquired with a group of assets, the transaction may
involve the transfer of legal rights that enable an enterprise to identify the
intangible asset. Also, even If an asset generates future economic benefits

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only in combination with other assets, the asset is identifiable if the
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enterprise can identify the future economic benefits that will flow from the
asset.

6.5 CONTROL
An enterprise controls an asset if the enterprise has the power to obtain the
future economic benefits flowing from the underlying resource and also can
restrict the access of others to those benefits. The capacity of an enterprise to
control the future economic benefits from an intangible asset would normally
stem from legal rights that are enforceable in a court of law. However, legal
enforceability of a right is not a necessary condition for control since an
enterprise may be able to control the future economic benefits in some other
way.
Market and technical knowledge may give rise to future economic benefits. An
enterprise controls those benefits if, for example, the knowledge is protected by
legal rights such as copyrights, a restraint of trade agreement or by a legal duty
on employees to maintain confidentiality.
Future economic benefit is also flown from the skill of labour and customer
loyalty but usually this flow of benefits cannot be controlled by the enterprise as
employees may leave the enterprise anytime or even loyal customers may decide
to purchase goods and services from other suppliers. Hence, these items don’t
even qualify as intangible asset as per the definition given in AS 26.
Example 1:
Moon Limited has provided training to its staff on various new topics like GST, AS,
Ind AS etc. to ensure the compliance as per the required law. Can the company
recognise such cost of staff training as intangible asset?
In this case, it is clear that the company will obtain the economic benefits from the
work performed by the staff as it increases their efficiency. But it does not have
control over them because staff could choose to resign the company at any time.
Hence the company lacks the ability to restrict the access of others to those
benefits. Therefore, the staff training cost does not meet the definition of an
intangible asset.

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6.6 FUTURE ECONOMIC BENEFITS v

The future economic benefits flowing from an intangible asset may include
revenue from the sale of products or services, cost savings, or other benefits
resulting from the use of the asset by the enterprise. For example, the use of
intellectual property in a production process may reduce future production costs
rather than increase future revenues.

6.7 RECOGNITION AND INITIAL MEASUREMENT

OF AN INTANGIBLE ASSET
The recognition of an item as an intangible asset requires an enterprise to
demonstrate that the item meets the definition of an intangible asset and
recognition criteria set out as below:
An intangible asset should be recognised if, and only if:
a. It is probable that the future economic benefits that are attributable to the
asset will flow to the enterprise; and
b. The cost of the asset can be measured reliably.
An enterprise should assess the probability of future economic benefits using
reasonable and supportable assumptions that represent best estimate of the set
of economic conditions that will exist over the useful life of the asset.
An intangible asset should be measured initially at cost.

6.8 SEPARATE ACQUISITION

If an intangible asset is acquired separately, the cost of the intangible asset can
usually be measured reliably. This is particularly so when the purchase
consideration is in the form of cash or other monetary assets.
The cost of an intangible asset comprises:
• its purchase price,

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• any v import duties and other taxes (other than those subsequently
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recoverable by the enterprise from the taxing authorities), and

• any directly attributable expenditure on making the asset ready for its
intended use. Directly attributable expenditure includes, for example,
professional fees for legal services.

• Any trade discounts and rebates are deducted in arriving at the cost.
If an intangible asset is acquired in exchange for shares or other securities of the
reporting enterprise, the asset is recorded at its fair value, or the fair value of the
securities issued, whichever is more clearly evident.

6.9 ACQUISITION AS PART OF AN

AMALGAMATION
An intangible asset acquired in an amalgamation in the nature of purchase is
accounted for in accordance with AS 14 (Revised). In accordance with AS 26:
a. A transferee recognises an intangible asset that meets the recognition
criteria, even if that intangible asset had not been recognised in the
financial statements of the transferor and
b. If the cost (i.e. fair value) of an intangible asset acquired as part of an
amalgamation in the nature of purchase cannot be measured reliably, that
asset is not recognised as a separate intangible asset but is included in
goodwill.
Where in preparing the financial statements of the transferee company, the
consideration is allocated to individual identifiable assets and liabilities on the
basis of their fair values at the date of amalgamation.

Hence, judgement is required to determine whether the cost (i.e. fair value) of an
intangible asset acquired in an amalgamation can be measured with sufficient
reliability for the purpose of separate recognition. Quoted market prices in an
active market provide the most reliable measurement of fair value. The
appropriate market price is usually the current bid price. If current bid prices are
unavailable, the price of the most recent similar transaction may provide a basis
from which to estimate fair value, provided that there has not been a significant

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v v
v
change in economic circumstances between the transaction date and the date at
which the asset's fair value is estimated. v

If no active market exists for an asset, its cost reflects the amount that the
enterprise would have paid, at the date of the acquisition, for the asset in an
arm's length transaction between knowledgeable and willing parties, based on
the best information available. The cost initially recognised for the intangible
asset in this case is restricted to an amount that does not create or increase any
capital reserve arising at the date of the amalgamation.

Quoted market price

Determination of Fair value

Current bid price

If active market exists

Price of the most

recently similar
transaction

Amount that the

If active market does
enterprise would
not exist
have paid

6.10 ACQUISITION BY WAY OF A GOVERNMENT

GRANT
In some cases, an intangible asset may be acquired free of charge, or for nominal
consideration, by way of a government grant. This may occur when a government
transfers or allocates to an enterprise intangible assets such as airport landing
rights, licences to operate radio or television stations, import licences or quotas
or rights to access other restricted resources.
AS 12, requires that government grants in the form of non-monetary assets, given
at a concessional rate should be accounted for on the basis of their acquisition
cost.

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v
v
Accordingly, intangible asset acquired free of charge, or for nominal
v
consideration, by way of government grant is recognised at a nominal value or at
the acquisition cost, as appropriate; any expenditure that is directly attributable
to making the asset ready for its intended use is also included in the cost of the
asset.

6.11 EXCHANGE OF ASSETS

An intangible asset may be acquired in exchange or part exchange for another
asset. In such a case, the cost of the asset acquired is determined in accordance
with the principles laid down in this regard in AS 10.

The cost of such an item is measured at fair value unless:

(a) the exchange transaction lacks commercial substance or

(b) the fair value of neither the asset(s) received nor the asset(s) given up is
reliably measurable.

The acquired item is measured in this manner even if an enterprise cannot

immediately derecognize the asset given up. If the acquired item is not measured at
fair value, its/their cost is measured at the carrying amount of the asset(s) given up.

6.12 INTERNALLY GENERATED GOODWILL

Internally generated goodwill is not recognised as an asset because it is not an
identifiable resource controlled by the enterprise that can be measured reliably at
cost.

Differences between the market value of an enterprise and the carrying amount
of its identifiable net assets at any point in time may be due to a range of factors
that affect the value of the enterprise. However, such differences cannot be
considered to represent the cost of intangible assets controlled by the enterprise.

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6.13 INTERNALLY GENERATED INTANGIBLE
v
ASSETS
It is sometimes difficult to assess whether an internally generated intangible asset
qualifies for recognition. It is often difficult to:
(a) identify whether, and the point of time when, there is an identifiable asset
that will generate probable future economic benefits; and

(b) determine the cost of the asset reliably. In some cases, the cost of
generating an intangible asset internally cannot be distinguished from the
cost of maintaining or enhancing the enterprise’s internally generated
goodwill or of running day-to- day operations.
To assess whether an internally generated intangible asset meets the criteria for
recognition, an enterprise classifies the generation of the asset into
➢ Research Phase &
➢ Development Phase
If an enterprise cannot distinguish the research phase from the development
phase of an internal project to create an intangible asset, the enterprise treats the
expenditure on that project as if it were incurred in the research phase only.

6.14 RESEARCH PHASE

Research is original and planned investigation undertaken with the prospect of
gaining new scientific or technical knowledge and understanding.
No intangible asset arising from research or from the research phase should be
recognised. Expenditure on research or on the research phase should be
recognised as an expense when it is incurred.
Examples of research activities are:
a. Activities aimed at obtaining new knowledge.
b. The search for, evaluation and final selection of, applications of research
findings or other knowledge.

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c. v
The search for alternatives for materials, devices, products, processes, systems
v
or services;

d. The formulation, design, evaluation and final selection of possible alternatives

for new or improved materials, devices, products, processes, systems or
services.

6.15 DEVELOPMENT PHASE

Development is the application of research findings or other knowledge to a plan
or design for the production of new or substantially improved materials, devices,
products, processes, systems or services prior to the commencement of
commercial production or use.

An intangible asset arising from development (or from the development phase of
an internal project) should be recognised if, and only if, an enterprise can
demonstrate all of the following:

a. The technical feasibility of completing the intangible asset so that it will be

available for use or sale.
b. Its intention to complete the intangible asset and use or sell it.
c. Its ability to use or sell the intangible asset.
d. How the intangible asset will generate probable future economic benefits.
Among other things, the enterprise should demonstrate the existence of a
market for the output of the intangible asset or the intangible asset itself or,
if it is to be used internally, the usefulness of the intangible asset.
e. The availability of adequate technical, financial and other resources to
complete the development and to use or sell the intangible asset and
f. Its ability to measure the expenditure attributable to the intangible asset
during its development reliably.

Examples of development activities are:

a. The design, construction and testing of pre-production or pre-use
prototypes and models.

b. The design of tools, jigs, moulds and dies involving new technology.

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c. v
The design, construction and operation of a pilot plant that is not of a scale
economically feasible for commercial production and v

d. The design, construction and testing of a chosen alternative for new or

improved materials, devices, products, processes, systems or services.
AS 26 takes the view that expenditure on internally generated brands, mastheads,
publishing titles, customer lists and items similar in substance cannot be
distinguished from the cost of developing the business as a whole. Therefore,
such items are not recognised as intangible assets.

To demonstrate how an intangible asset will generate probable future economic

benefits, an enterprise assesses the future economic benefits to be received from
the asset using the principles in Accounting Standard on Impairment of Assets. If
the asset will generate economic benefits only in combination with other assets,
the enterprise applies the concept of cash generating units as set out in
Accounting Standard on Impairment of Assets.

6.16 COST OF AN INTERNALLY GENERATED

INTANGIBLE ASSET
The cost of an internally generated intangible asset is the sum of expenditure
incurred from the time when the intangible asset first meets the recognition
criteria. Reinstatement of expenditure recognised as an expense in previous
annual financial statements or interim financial reports is prohibited.
The cost of an internally generated intangible asset comprises all expenditure that
can be directly attributed, or allocated on a reasonable and consistent basis, to
creating, producing and making the asset ready for its intended use from the time
when the intangible asset first meets the recognition criteria. The cost includes, if
applicable:
a Expenditure on materials and services used or consumed in generating the
intangible asset.
b. The salaries, wages and other employment related costs of personnel
directly engaged in generating the asset.

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c. v
Any expenditure that is directly attributable to generating the asset, such as
v
fees to register a legal right and the amortisation of patents and licenses
that are used to generate the asset (E.g., borrowing cost as per para 4(e) of
AS 16, etc.) and
d. Overheads that are necessary to generate the asset and that can be
allocated on a reasonable and consistent basis to the asset. Allocations of
overheads are made on bases similar to those discussed in AS 2 & AS 16.
The following are not components of the cost of an internally generated
intangible asset, these should be expensed off in profit and loss account:
a. Selling, administrative and other general overhead expenditure unless this
expenditure can be directly attributed to making the asset ready for use.

b. Clearly identified inefficiencies and initial operating losses incurred before

an asset achieves planned performance and
c. Expenditure on training the staff to operate the asset.
Example
An enterprise is developing a new production process. During the year 20X1,
expenditure incurred was ` 10 lacs, of which ` 9 lacs was incurred before 1
December 20X1 and 1 lac was incurred between 1 December 20X1 and 31
December 20X1. The enterprise is able to demonstrate that, at 1 December 20X1,
the production process met the criteria for recognition as an intangible asset. The
recoverable amount of the know-how embodied in the process (including future
cash outflows to complete the process before it is available for use) is estimated to
be ` 5 lacs.

At the end of 20X1, the production process is recognised as an intangible asset at a

cost of ` 1 lac (expenditure incurred since the date when the recognition criteria
were met, that is, 1 December 20X1). The ` 9 lacs expenditure incurred before 1
December 20X1 is recognised as an expense because the recognition criteria were
not met until 1 December 20X1. This expenditure will never form part of the cost of
the production process recognised in the balance sheet.
During the year 20X2, expenditure incurred is ` 20 lacs. At the end of 20X2, the
recoverable amount of the know-how embodied in the process (including future

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v
cash outflows to complete the process before it is available for use) is estimated to
be ` 19 lacs. v

At the end of the year 20X2, the cost of the production process is ` 21 lacs ( ` 1 lac
expenditure recognised at the end of 20X1 plus ` 20 lacs expenditure recognised in
20X2). The enterprise recognises an impairment loss of ` 2 lacs to adjust the
carrying amount of the process before impairment loss ( ` 21 lacs) to its recoverable
amount (` 19 lacs). This impairment loss will be reversed in a subsequent period if
the requirements for the reversal of an impairment loss in AS 28, are met.

6.17 RECOGNITION OF AN EXPENSE

Expenditure on an intangible item should be recognised as an expense when it is
incurred unless:
a. It forms part of the cost of an intangible asset that meets the recognition
criteria or

b. The item is acquired in an amalgamation in the nature of purchase and

cannot be recognised as an intangible asset. It forms part of the amount
attributed to goodwill (capital reserve) at the date of acquisition.
In some cases, expenditure is incurred to provide future economic benefits to an
enterprise, but no intangible asset or other asset is acquired or created that can
be recognised. In these cases, the expenditure is recognised as an expense when
it is incurred. For example, expenditure on research is always recognised as an
expense when it is incurred.
Examples of other expenditure that is recognised as an expense when it is
incurred include:
(a) expenditure on start-up activities (start-up costs), unless this expenditure is
included in the cost of an item of fixed asset under AS 10. Start-up costs
may consist of preliminary expenses incurred in establishing a legal entity
such as legal and secretarial costs, expenditure to open a new facility or
business (pre-opening costs) or expenditures for commencing new
operations or launching new products or processes (pre-operating costs);
(b) expenditure on training activities;

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(c) v
expenditure on advertising and promotional activities; and
v
(d) expenditure on relocating or re-organising part or all of an enterprise.

The above guidance does not apply to payments for the delivery of goods or
services made in advance of the delivery of goods or the rendering of services.
Such prepayments are recognised as assets.

Past Expenses not to be recognised as an Asset

Expenditure on an intangible item that was initially recognised as an expense in
previous annual financial statements or interim financial reports should not be
recognised as part of the cost of an intangible asset at a later date.

6.18 SUBSEQUENT EXPENDITURE

Subsequent expenditure on an intangible asset after its purchase or its
completion should be recognised as an expense when it is incurred unless:
a. It is probable that the expenditure will enable the asset to generate future
economic benefits in excess of its originally assessed standard of
performance and
b. The expenditure can be measured and attributed to the asset reliably.
If these conditions are met, the subsequent expenditure should be added to the
cost of the intangible asset.
Subsequent expenditure on brands, mastheads, publishing titles, customer lists
and items similar in substance is always recognised as an expense to avoid the
recognition of internally generated goodwill.
The nature of intangible assets is such that, in many cases, it is not possible to
determine whether subsequent expenditure is likely to enhance or maintain the
economic benefits that will flow to the enterprise from those assets. Therefore,
only rarely will expenditure incurred after the initial recognition of a purchased
intangible asset or after completion of an internally generated intangible asset
result in additions to the cost of the intangible asset.

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6.19 MEASUREMENT SUBSEQUENT TO INITIAL
v
RECOGNITION
After initial recognition, an intangible asset should be carried at its cost less any
accumulated amortisation and any accumulated impairment losses.

6.20 AMORTISATION PERIOD

The depreciable amount of an intangible asset should be allocated on a
systematic basis over the best estimate of its useful life. Amortisation should
commence when the asset is available for use.
Estimates of the useful life of an intangible asset generally become less reliable as
the length of the useful life increases. AS 26 adopts a rebuttable presumption that
the useful life of an intangible asset will not exceed ten years from the date when
the asset is available for use. Amortisation is recognised whether or not there has
been an increase in, for example, the asset's fair value or recoverable amount.

Many factors need to be considered in determining the useful life of an intangible

asset including:
(a) the expected usage of the asset by the enterprise and whether the asset
could be efficiently managed by another management team;
(b) typical product life cycles for the asset and public information on estimates
of useful lives of similar types of assets that are used in a similar way;

(c) technical, technological or other types of obsolescence;

(d) the stability of the industry in which the asset operates and changes in the
market demand for the products or services output from the asset;

(e) expected actions by competitors or potential competitors;

(f) the level of maintenance expenditure required to obtain the expected future
economic benefits from the asset and the company's ability and intent to
reach such a level;
(g) the period of control over the asset and legal or similar limits on the use of
the asset, such as the expiry dates of related leases; and

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(h) v
whether the useful life of the asset is dependent on the useful life of other
v
assets of the enterprise.

Given the history of rapid changes in technology, computer software and many
other intangible assets are susceptible to technological obsolescence. Therefore,
it is likely that their useful life will be short.

In some cases, there may be persuasive evidence that the useful life of an
intangible asset will be a specific period longer than ten years. In these cases, the
presumption that the useful life generally does not exceed ten years is rebutted
and the enterprise:
a. Amortises the intangible asset over the best estimate of its useful life.
b. Estimates the recoverable amount of the intangible asset at least annually in
order to identify any impairment loss and
c. Discloses the reasons why the presumption is rebutted and the factors that
played a significant role in determining the useful life of the asset.
Example:
A. An enterprise has purchased an exclusive right to generate hydroelectric power
for 60 years. The costs of generating hydro-electric power are much lower than the
costs of obtaining power from alternative sources. It is expected that the
geographical area surrounding the power station will demand a significant amount
of power from the power station for at least 60 years.
The enterprise amortises the right to generate power over 60 years, unless there is
evidence that its useful life is shorter.
B. An enterprise has purchased an exclusive right to operate a toll motorway for 30
years. There is no plan to construct alternative routes in the area served by the
motorway. It is expected that this motorway will be in use for at least 30 years.
The enterprise amortises the right to operate the motorway over 30 years, unless
there is evidence that its useful life is shorter.
If control over the future economic benefits from an intangible asset is achieved
through legal rights that have been granted for a finite period, the useful life of the
intangible asset should not exceed the period of the legal rights unless the legal
rights are renewable and renewal is virtually certain.

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The useful life of an intangible asset may be very long but it is always finite.
v
There may be both economic and legal factors influencing the useful life of an
intangible asset: economic factors determine the period over which future
economic benefits will be generated; legal factors may restrict the period over
which the enterprise controls access to these benefits. The useful life is the
shorter of the periods determined by these factors.

Example:
Company X has purchased a copyright to produce a safety equipment for sale in the
market. The rights have been obtained for 10 years. Hence, company is amortizing
the intangible asset in 10 years. After 7 years, due to change in the environmental
law, safety equipments produced out of new technology are only considered valid.

In above scenario, the company need to write off the balance amount in the year of
implementation of the law.

6.21 AMORTISATION METHOD

The amortisation method used should reflect the pattern in which the asset's
economic benefits are consumed by the enterprise. If that pattern cannot be
determined reliably, the straight-line method should be used. A variety of
amortisation methods can be used to allocate the depreciable amount of an asset
on a systematic basis over its useful life. These methods include

• the straight-line method,

• the diminishing balance method and

• the unit of production method.

The method used for an asset is selected based on the expected pattern of
consumption of economic benefits and is consistently applied from period to
period, unless there is a change in the expected pattern of consumption of
economic benefits to be derived from that asset.

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v
The amortisation charge for each period should be recognised as an expense
v
unless another Accounting Standard permits or requires it to be included in the
carrying amount of another asset. For example, the amortisation of intangible
assets used in a production process is included in the carrying amount of
inventories.

6.22 RESIDUAL VALUE

Residual value is the amount, which an enterprise expects to obtain for an asset at
the end of its useful life after deducting the expected costs of disposal.
The residual value of an intangible asset should be assumed to be zero unless:

a. There is a commitment by a third party to purchase the asset at the end of

its useful life or
b. There is an active market for the asset and:

i. Residual value can be determined by reference to that market and

ii. It is probable that such a market will exist at the end of the asset's
useful life.

A residual value other than zero implies that an enterprise expects to dispose of
the intangible asset before the end of its economic life.

6.23 REVIEW OF AMORTISATION PERIOD AND

AMORTISATION METHOD
The amortisation period and the amortisation method should be reviewed at least
at each financial year end. If the expected useful life of the asset is significantly
different from previous estimates, the amortisation period should be changed
accordingly. If there has been a significant change in the expected pattern of
economic benefits from the asset, the amortisation method should be changed to
reflect the changed pattern. Such changes should be accounted for in accordance
with AS 5.

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6.24 RECOVERABILITY OF THE CARRYING
v
AMOUNT-IMPAIRMENT LOSSES
Impairment losses of intangible assets are calculated on the basis of AS 28 . AS 28
“Impairment of Assets” is covered in next unit of this chapter.
In addition to the requirements of Accounting Standard on Impairment of Assets,
an enterprise should estimate the recoverable amount of the following intangible
assets at least at each financial year end even if there is no indication that the
asset is impaired:
(a) an intangible asset that is not yet available for use; and
(b) an intangible asset that is amortised over a period exceeding ten years from
the date when the asset is available for use.
AS 26 requires an enterprise to test for impairment, at least annually, the carrying
amount of an intangible asset that is not yet available for use.
Example:
X limited is developing a customized software for ` 10 Cr. It will take 3 years to
complete development. Present value of future economic benefit is considered to be
` 15 Cr. After 2 years, 70% work is completed. However, due to change in market
conditions, present value of future economic benefits are estimated to be ` 6 Cr
only.
Company should recognize ` 1 Cr as impairment loss on "Intangible asset under
development” as per AS 28. Only ` 6 Cr can be shown as "Intangible asset under
development”. Company cannot capitalize any further amount till the time
recoverable amount increases even if work of ` 10 Cr is completed.

6.25 RETIREMENTS AND DISPOSALS

An intangible asset should be derecognised (eliminated from the balance sheet) if

➢ disposed or
➢ when no future economic benefits are expected from its use and
subsequent disposal.

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Gains or losses arising from the retirement or disposal of an intangible asset
v
should be determined as the difference between the net disposal proceeds and
the carrying amount of the asset and should be recognised as income or expense
in the statement of profit and loss.
An intangible asset that is retired from active use and held for disposal is carried
at its carrying amount at the date when the asset is retired from active use.

6.26 DISCLOSURE
The financial statements should disclose the following for each class of intangible
assets, distinguishing between internally generated intangible assets and other
intangible assets:

1. The useful lives or the amortisation rates used.

2. The amortisation methods used.
3. The gross carrying amount and the accumulated amortisation (aggregated
with accumulated impairment losses) at the beginning and end of the
period.
4. A reconciliation of the carrying amount at the beginning and end of the
period showing:
I. Additions, indicating separately those from internal development and
through amalgamation.
II. Retirements and disposals.
III. Impairment losses recognised in the statement of profit and loss
during the period.
IV Impairment losses reversed in the statement of profit and loss during
the period.
V Amortisation recognised during the period and
VI Other changes in the carrying amount during the period.
A class of intangible assets is a grouping of assets of a similar nature and
use in an enterprise's operations. Examples of separate classes may include:

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(a) brand names; v
v
(b) mastheads and publishing titles;
(c) computer software;
(d) licences and franchises;
(e) copyrights, and patents and other industrial property rights, service
and operating rights;
(f) recipes, formulae, models, designs and prototypes; and
(g) intangible assets under development.

6.27 OTHER DISCLOSURES

The financial statements should also disclose:

a. If an intangible asset is amortised over more than ten years, the reasons
why it is presumed that the useful life of an intangible asset will exceed ten
years from the date when the asset is available for use. In giving these
reasons, the enterprise should describe the factor(s) that played a significant
role in determining the useful life of the asset.
b. A description, the carrying amount and remaining amortisation period of
any individual intangible asset that is material to the financial statements of
the enterprise as a whole.
c. The existence and carrying amounts of intangible assets whose title is
restricted and the carrying amounts of intangible assets pledged as security
for liabilities and
d. The amount of commitments for the acquisition of intangible assets.

The financial statements should disclose the aggregate amount of research and
development expenditure recognised as an expense during the period.
An enterprise is encouraged, but not required, to give a description of any fully
amortised intangible asset that is still in use.

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Illustration
v
ABC Ltd. developed know-how by incurring expenditure of ` 20 lakhs, The know-how
was used by the company from 1.4.20X1. The useful life of the asset is 10 years from
the year of commencement of its use. The company has not amortised the asset till
31.3.20X8. Pass Journal entry to give effect to the value of know-how as per
Accounting Standard-26 for the year ended 31.3.20X8.

Solution
Journal Entry

` `
Profit and Loss A/c (Prior period item) Dr. 12,00,000
Amortization A/c Dr. 2,00,000
To Know-how A/c 
14,00,000
[Being amortization of 7 years (out of which
amortization of 6 years charged as prior period
item)]

Illustration 2
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. State, how you will deal with the following matters in the
accounts of U Ltd. for the year ended 31st March, 20X2.
Solution
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 AS 26 ‘Intangible Assets’, the company should
charge the total amount of ` 45 lakhs as an expense in the profit and loss
account.


As per para 63 of AS 26 “Intangible Assets”, there is a rebuttable presumption that the useful life of an
intangible asset will not exceed ten years from the date when the asset is available for use. Amortisation
should commence when the asset is available for use.

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Illustration 3 v
v
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.
Is the procedure adopted by the company correct?
Solution
According to 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”.

AS 26 mentions that expenditure on advertising and promotional activities should

be recognised as an expense when incurred.
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.

Reference: The students are advised to refer the full text of AS 28

“Intangible Assets” (issued 2002).

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TEST YOUR KNOWLEDGE
Multiple Choice Questions
1. Which of the following is not covered within the scope of AS 26?
(a) Intangible assets held-for-sale in the ordinary course of business
(b) Assets arising from employee benefits
(c) (a) & (b) both

(d) Research and development activities

2. Intangible asset is recognised if it:

(a) meets the definition of an intangible asset
(b) is probable that future economic benefits will flow
(c) the cost can be measured reliably
(d) meets all of the above parameters
3. Sun Limited has purchased a computer with various additional software.
These are integral part of the computer. Which of the following are true in the
context of AS 26:

(a) Recognise Computer and software as tangible asset

(b) Recognise tangible and intangible separately
(c) Recognise computer and software as intangible asset
(d) Does not recognize the software as an asset.
4. Hexa Ltd developed a technology to enhance the battery life of mobile
devices. Hexa has capitalised development expenditure of ` 5,00,000. Hexa
estimates the life of the technology developed to be 3 years but the company
has forecasted that 50% of sales will be in year 1, 35% in year 2 and 15% in
year 3. What should be the amortisation charge in the second year of the
product’s life?
(a) ` 2,50,000
(b) ` 1,75,000

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(c) ` 1,66,667 v
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(d) ` 1,85,000

Theoretical Questions
5. What is meant by Intangible Assets and what are the important factors to
consider the recognition of item as an Intangible asset? What is the
recognition criteria in accordance with the provisions of AS 26?
6. What is the measurement criteria at the time of initial recognition of Intangible
assets acquired through separate acquisition?

7. What is the criteria for recognition and measurement of Internally generated

intangible assets. Describe which kind of cost is considered for capitalisation with
respect to provisions of AS 26. Whether the same applies for internally generated
goodwill also?

8. Advise the complete accounting treatment for Research and development phase
as per AS 26.

9. What is meant by Amortisation of an Intangible asset. What are the different

methods for amortisation as per AS 26?

Scenario based Questions

10. Swift Ltd. acquired a patent at a cost of ` 80,00,000 for a period of 5 years
and the product life-cycle is also 5 years. The company capitalized the cost
and started amortizing the asset at ` 10,00,000 per annum. The company
had amortized the patent at 10,00,000 per annum in first two years on the
basis of economic benefits derived from the product manufactured under the
patent. After two years it was found that the product life-cycle may continue
for another 5 years from then. The patent was renewable and Swift Ltd. got it
renewed after expiry of five years. The net cash flows from the product during
these 5 years were expected to be ` 36,00,000, ` 46,00,000, ` 44,00,000,
` 40,00,000 and ` 34,00,000. Find out the amortization cost of the patent for
each of the years.

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11. v
AB Ltd. launched a project for producing product X in October, 20X1. The
v
Company incurred ` 20 lakhs towards Research. Due to prevailing market
conditions, the Management came to conclusion that the product cannot be
manufactured and sold in the market for the next 10 years. The Management
hence wants to defer the expenditure write off to future years.

Advise the Company as per the applicable Accounting Standard.

12. During 20X1-X2, an enterprise incurred costs to develop and produce a
routine low risk computer software product, as follows:

Particular `

Completion of detailed program and design (Phase 1) 50,000

Coding and Testing (Phase 2) 40,000

Other coding costs (Phase 3 & 4) 63,000

Testing costs (Phase 3 & 4) 18,000

Product masters for training materials (Phase 5) 19,500

Packing the products (1,500 units) (Phase 6) 16,500

After completion of phase 2, it was established that the product is technically

feasible for the market. You are required to state how the above referred cost
to be recognized in the books of accounts.
13. As per provisions of AS-26, how would you deal to the following situations:
(1) ` 23,00,000 paid by a manufacturing company to the legal advisor for
defending the patent of a product is treated as a capital expenditure.
(2) During the year 20X1-X2, a company spent ` 7,00,000 for publicity and
research expenses on one of its new consumer product which was
marketed in the same accounting year but proved to be a failure.
(3) A company spent ` 25,00,000 in the past three years to develop a
product, these expenses were charged to profit and loss account since
they did not meet AS-26 criteria for capitalization. In the current year

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approval of the concerned authority has been received. The company v
wishes to capitalize ` 25,00,000 by disclosing it as a prior period item.v
(4) A company with a turnover of ` 200 crores and an annual advertising
budget of ` 50,00,000 had taken up for the marketing of a new
product by a company. It was estimated that the company would
have a turnover of ` 20 crore from the new product. The company had
debited to its Profit & Loss Account the total expenditure of `
50,00,000 incurred on extensive special initial advertisement campaign
for the new product.

ANSWERS/SOLUTIONS
Answer to the Multiple Choice Questions

1. (c) 2. (d) 3. (a) 4. (b)

Answer to the Theoretical Questions

5. An intangible asset is an identifiable non-monetary asset, without physical
substance, held for use in the production or supply of goods or services, for
rental to others, or for administrative purposes. Below are the 3 key
ingredients to be satisfied to cover an item as an intangible asset under this
standard:
• identifiability,
• control over a resource and
• expectation (i.e. probable – 50% plus) of future economic benefits
flowing to the enterprise.
The recognition of an item as an intangible asset requires an enterprise to
demonstrate that the item meets the definition of an intangible asset and
recognition criteria set out as below:
a. It is probable that the future economic benefits that are attributable
to the asset will flow to the enterprise; and
b. The cost of the asset can be measured reliably.

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6. If anv intangible asset is acquired separately, the cost of the intangible asset
can vusually be measured reliably. This is particularly so when the purchase
consideration is in the form of cash or other monetary assets.
The cost of an intangible asset comprises:
• its purchase price,
• any import duties and other taxes (other than those subsequently
recoverable by the enterprise from the taxing authorities), and
• any directly attributable expenditure on making the asset ready for its
intended use. Directly attributable expenditure includes, for example,
professional fees for legal services.
• Any trade discounts and rebates are deducted in arriving at the cost.
7. To assess whether an internally generated intangible asset meets the criteria
for recognition, an enterprise classifies the generation of the asset into 2
phases:
➢ Research Phase &
➢ Development Phase
Research Phase - The expenses related to Research phase is expensed off in
statement of Profit and loss.
Development Phase - Development is the application of research findings or
other knowledge to a plan or design for the production of new or
substantially improved materials, devices, products, processes, systems or
services prior to the commencement of commercial production or use.
An intangible asset arising from development (or from the development
phase of an internal project) should be recognised if, and only if, an
enterprise can demonstrate all of the conditions given in para 6.15.
Cost of an Internally Generated Intangible Asset
The cost of an internally generated intangible asset is the sum of
expenditure incurred from the time when the intangible asset first meets the
recognition criteria. Reinstatement of expenditure recognised as an expense
in previous annual financial statements or interim financial reports is
prohibited.
The cost of an internally generated intangible asset comprises all

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expenditure that can be directly attributed, or allocated on a reasonable and
consistent basis, to creating, producing and making the asset ready for its v
intended use from the time when the intangible asset first meets the
recognition criteria. For details, refer para 6.16.
Internally generated goodwill is not recognised as an asset because it is not
an identifiable resource controlled by the enterprise that can be measured
reliably at cost.
8. Research phase means acquisition of knowledge and Development phase
means application of knowledge.
The expenditure related to Research phase is expensed off in statement of
Profit and loss. However, the expenditure incurred in Development phase is
capitalised as a cost of the internally generated intangible asset.
If an enterprise cannot distinguish the research phase from the
development phase of an internal project to create an intangible asset, the
enterprise treats the expenditure on that project as if it were incurred in the
research phase only.
9. Amortisation is the systematic allocation of the depreciable amount of an
intangible asset over its useful life.
The amortisation method used should reflect the pattern in which the
asset's economic benefits are consumed by the enterprise. If that pattern
cannot be determined reliably, the straight-line method should be used. A
variety of amortisation methods can be used to allocate the depreciable
amount of an asset on a systematic basis over its useful life. These methods
include
• the straight-line method,
• the diminishing balance method and
• the unit of production method.

The method used for an asset is selected based on the expected pattern of
consumption of economic benefits and is consistently applied from period
to period, unless there is a change in the expected pattern of consumption
of economic benefits to be derived from that asset.

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Answerv to the Scenario based Questions
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10. Swift Limited amortised ` 10,00,000 per annum for the first two years i.e.
` 20,00,000. The remaining carrying cost can be amortised during next
5 years on the basis of net cash flows arising from the sale of the product.
The amortisation may be found as follows:

S Net cash flows ` Amortisation Ratio Amortisation Amount `

I - 0.125 10,00,000

II - 0.125 10,00,000
III 36,00,000 0.180 10,80,000
IV 46,00,000 0.230 13,80,000
V 44,00,000 0.220 13,20,000
VI 40,00,000 0.200 12,00,000
VII 34,00,000 0.170 10,20,000
Total 2,00,00,000 1.000 80,00,000

It may be seen from above that from third year onwards, the balance of
carrying amount i.e., ` 60,00,000 has been amortised in the ratio of net cash
flows arising from the product of Swift Ltd.
11. As per para 41 of AS 26 “Intangible Assets”, expenditure on research should
be recognised as an expense when it is incurred. Hence, the expenses
amounting ` 20 lakhs incurred on the research has to be charged to the
statement of profit and loss in the current year ending 31 st March, 20X2.

12. As per AS 26, costs incurred in creating a computer software product should
be charged to research and development expense when incurred until
technological feasibility/asset recognition criteria has been established for
the product. Technological feasibility/asset recognition criteria have been
established upon completion of detailed program design, coding and
testing. In this case, ` 90,000 would be recorded as an expense (` 50,000 for
completion of detailed program design and ` 40,000 for coding and testing
to establish technological feasibility/asset recognition criteria). Cost
incurred from the point of technological feasibility/asset recognition criteria

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until the time when products costs are incurred are capitalized as software
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cost (63,000+ 18,000+ 19,500) = ` 1,00,500. Packing cost ` 16,500 should be
recognized as expenses and charged to P & L A/c.
13. As per AS 26 “Intangible Assets”, subsequent expenditure on an intangible
asset after its purchase or its completion should be recognized as an
expense when it is incurred unless (a) it is probable that the expenditure will
enable the asset to generate future economic benefits in excess of its
originally assessed standard of performance; and (b) expenditure can be
measured and attributed to the asset reliably. If these conditions are met,
the subsequent expenditure should be added to the cost of the intangible
asset.
(i) In the given case, the legal expenses to defend the patent of a
product amounting ` 23,00,000 should not be capitalized and be
charged to Profit and Loss Statement.
(ii) The company is required to expense the entire amount of ` 7,00,000
in the Profit and Loss account for the year ended 31 st March, 20X2
because no benefit will arise in the future.
(iii) As per AS 26, expenditure on an intangible item that was initially
recognized as an expense by a reporting enterprise in previous annual
financial statements should not be recognized as part of the cost of an
intangible asset at a later date. Thus the company cannot capitalize
the amount of ` 25,00,000 and it should be recognized as expense
(iv) Expenditure of ` 50,00,000 on advertising and promotional activities
should always be charged to Profit and Loss Statement. Hence, the
company has done the correct treatment by debiting the sum of 50
lakhs to Profit and Loss Account.

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UNIT 7: ACCOUNTING STANDARD 28
IMPAIRMENT OF ASSETS

LEARNING OUTCOMES
After studying this unit, you will be able to:
 Define the terms ‘recoverable amount’, ‘value in use’, ‘net selling
price’, ‘cost of disposal’, ‘impairment loss’ and other related terms.
 Identify an asset that may be Impaired.
 Measure the recoverable amount after computing net selling price
and value in use
 Recognise and measure the impairment loss
 Identify the cash generating units
 Compute the recoverable amount and carrying amount of a cash-
generating unit
 Identify goodwill that whether it relates to the cash-generating unit
 Impair the cash generating unit
 Set out the requirements for reversing an impairment loss
 Apply impairment provisions in case of discontinuing operations

7.1 INTRODUCTION
AS 28 came into effect in respect of accounting period commenced on or after
1-4-2004 and is mandatory in nature from that date for the following:
(i) Enterprises whose equity or debt securities are listed on a recognised stock
exchange in India, and enterprises that are in the process of issuing equity
or debt securities that will be listed on a recognised stock exchange in India
as evidenced by the board of directors’ resolution in this regard.
(ii) All other commercial, industrial and business reporting enterprises, whose
turnover for the accounting period exceeds ` 50 crores.

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In respect of all other enterprises, the Accounting Standard came into effect
in respect of accounting periods commenced on or after 1-4-2005 and vis
mandatory in nature from that date.
This standard prescribes the procedures to be applied to ensure that the assets of
an enterprise are carried at an amount not exceeding their recoverable amount
(amount to be recovered through use or sale of the asset). The standard also lays
down principles for reversal of impairment losses and prescribes certain
disclosures in respect of impaired assets. An enterprise is required to assess at
each balance sheet date whether there is an indication that an enterprise’s assets
may be impaired. If such an indication exists, the enterprise is required to
estimate the recoverable amount and the impairment loss, if any, should be
recognised in the profit and loss account.

7.2 SCOPE
The standard should be applied in accounting for impairment of all assets except
1. inventories (AS 2),
2. assets arising under construction contracts (AS 7),
3. financial assets including investments covered under AS 13, and
4. deferred tax assets (AS 22).
There are chances that the provision on account of impairment losses may
increase sickness of companies and potentially sick companies may actually
become sick.

7.3 ASSESSMENT
An enterprise should assess at each balance sheet date whether there is any
indication that an asset may be impaired. If any such indication exists, the
enterprise should estimate the recoverable amount of the asset. An asset is
impaired when the carrying amount of the asset exceeds its recoverable amount.
The requirements use the term ‘an asset’ but apply equally to an individual asset
or a cash-generating unit. In assessing whether there is any indication that an
asset may be impaired, an enterprise should consider, as a minimum, the

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following vindications:
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External sources
Indicators of Impairment

[List is NOT exhaustive]

Internal sources

External sources of information

a. During the period, an asset’s market value has declined significantly more
than would be expected as a result of the passage of time or normal use.
b. Significant changes with an adverse effect on the enterprise have taken
place during the period, or will take place in the near future, in the
technological, market, economic or legal environment in which the
enterprise operates or in the market to which an asset is dedicated.
c. Market interest rates or other market rates of return on investments have
increased during the period, and those increases are likely to affect the
discount rate used in calculating an asset’s value in use and decrease the
asset’s recoverable amount materially.
d. The carrying amount of the net assets of the reporting enterprise is more
than its market capitalization.
Internal sources of information
a. Evidence is available of obsolescence or physical damage of an asset.
b. Significant changes with an adverse effect on the enterprise have taken
place during the period, or are expected to take place in the near future, in
the extent to which, or manner in which, an asset is used or is expected to
be used. These changes include plans to discontinue or restructure the
operation to which an asset belongs or to dispose of an asset before the
previously expected date and

c. Evidence is available from internal reporting that indicates that the

economic performance of an asset is, or will be, worse than expected.
An enterprise may identify other indications that an asset may be impaired and

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these would also require the enterprise to determine the asset’s recoverable
amount. v

Example that indicates that an asset may be impaired because of the following:
a) cash flows for acquiring the asset, or subsequent cash needs for operating or
maintaining it, that are significantly higher than those originally budgeted;

b) actual net cash flows or operating profit or loss flowing from the asset that
are significantly worse than those budgeted;
c) a significant decline in budgeted net cash flows or operating profit, or a
significant increase in budgeted loss, flowing from the asset; or
d) operating losses or net cash outflows for the asset, when current period
figures are aggregated with budgeted figures for the future.

The concept of materiality applies in identifying whether the recoverable amount

of an asset needs to be estimated.

Note: If there is an indication that an asset may be impaired, this may indicate
that the remaining useful life, the depreciation method or the residual value
for the asset need to be reviewed and adjusted under the Accounting Standard
10, even if no impairment loss is recognised for the asset.

7.4 MEASUREMENT OF RECOVERABLE AMOUNT

An impairment loss is the amount by which the carrying amount of an asset
exceeds its recoverable amount.
Recoverable amount is the higher of an asset’s net selling price and it’s value in
use.
Net selling price is the amount obtainable from the sale of an asset in an arm’s
length transaction between knowledgeable, willing parties, less the costs of
disposal.
Costs of disposal are incremental costs directly attributable to the disposal of an
asset, excluding finance costs and income tax expense.The best evidence for net
selling price is a price in the bidding sales agreement for the disposal of the
assets or similar assets. In the absence of this, net selling price is estimated from

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the transactions for the assets in active market, if the asset has the active market.
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If there is no binding sale agreement or active market for an asset, net selling
price is based on the best information available to reflect the amount that an
enterprise could obtain, at the balance sheet date, for the disposal of the asset in
an arm’s length transaction between knowledgeable, willing parties, after
deducting the costs of disposal.
Value in Use is the present value of estimated future cash flows expected to arise
from the continuing use of an asset and from its disposal at the end of its useful
life.
Estimating the value in use of an asset involves the following steps:
a. Estimating the future cash inflows and outflows arising from continuing use
of the asset and from its ultimate disposal; and
b. Applying the appropriate discount rate to these future cash flows.
Carrying amount is the amount at which an asset is recognised in the balance
sheet after deducting any accumulated depreciation (amortisation) and
accumulated impairment losses thereon.
Depreciation (Amortisation) is a systematic allocation of the depreciable
amount of an asset over its useful life.
Depreciable amount is the cost of an asset, or other amount substituted for cost
in the financial statements, less its residual value.
Useful life is either:
• The period of time over which an asset is expected to be used by the
enterprise; or

• The number of production or similar units expected to be obtained from the

asset by the enterprise.

Note 1: If there is no reason to believe that an asset’s value in use materially

exceeds its net selling price, the asset’s recoverable amount may be taken to be
its net selling price. This will often be the case for an asset that is held for
disposal. Otherwise, if it is not possible to determine the selling price we take
value in use of assets as it’s recoverable amount.

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It is not always necessary to determine both an asset’s net selling price and itsv
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value in use. For example, if either of these amounts exceeds the asset’s carrying
amount, the asset is not impaired, and it is not necessary to estimate the other
amount.
It may be possible to determine net selling price, even if an asset is not traded in
an active market. However, sometimes it will not be possible to determine net
selling price because there is no basis for making a reliable estimate of the
amount obtainable from the sale of the asset in an arm’s length transaction
between knowledgeable and willing parties. In this case, the recoverable amount
of the asset may be taken to be its value in use.
Note 2: Recoverable amount is determined for an individual asset, unless the
asset does not generate cash inflows from continuing use that are largely
independent of those from other assets or groups of assets. If this is the case,
recoverable amount is determined for the cash-generating unit to which the
asset belongs, unless either:
a. The asset’s net selling price is higher than its carrying amount; or
b. The asset’s value in use can be estimated to be close to its net selling price
and net selling price can be determined.

7.5 BASIS FOR ESTIMATES OF FUTURE CASH

FLOWS
Cash flow projections should be based on the most recent approved
budgets/forecasts for a maximum of five years. Financial budgets/forecasts over a
period longer than five years may be used if management is confident that these
projections are reliable and it can demonstrate its ability, based on past
experience, to forecast cash flows accurately over that longer period.

Cash flow projections until the end of an asset’s useful life are estimated by
extrapolating the cash flow projections based on the financial budgets/forecasts
using a growth rate for subsequent years. This rate is steady or declining. This
growth rate should not exceed the long-term average growth rate for the
products, industries, or country or countries in which the enterprise operates, or
for the market in which the asset is used, unless a higher rate can be justified.

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Cash flow projections should be based on reasonable and supportable
v
assumptions that represent management’s best estimate of the set of economic
conditions that will exist over the remaining useful life of the asset. Greater
weight should be given to external evidence.

7.6 COMPOSITION OF ESTIMATES OF FUTURE

CASH FLOWS
Estimates of future cash flows should include

(i) Projections of net cash inflows from the continuing use of the asset

(ii) projections of cash outflows that are necessarily incurred to generate

the cash inflows from continuing use of the asset and that can be
directly attributed, or allocated on a reasonable and consistent basis,
to the asset; and

(iii) Net cash flows, if any, to be received (or paid) for the disposal of the
asset at the end of its useful life.

Care should be taken for the following points:

a. When the carrying amount of an asset does not yet include all the cash
outflows to be incurred before it is ready for use or sale, estimate of any
further cash outflow that is expected to be incurred before the asset is
ready for use or sale should be included.

b. Cash inflows from assets that generate cash inflows from continuing use
that are largely independent of the cash inflows from the asset under review
should not be included.

c. Cash outflows that relate to obligations that have already been recognised
as liabilities to be excluded.
d. Future cash outflows or inflows expected to arise because of restructuring
of the organization should be not considered.
e. Any future capital expenditure enhancing the capacity of the assets and its
related savings/outflow should be excluded.

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Any increase in expected cash inflow from the above expenditure should
also be excluded. v

g. Estimates of future cash flows should not include cash inflows or outflows
from financing activities and also income tax receipts or payments.
h. The estimate of net cashflow upon disposal of the asset should be the
amount that an enterprise expects to obtain from the disposal of the asset
in an arm’s length transaction between knowledgeable, willing parties
prevailing at the date of the estimates, after deducting the estimated costs
of disposal.
When an enterprise becomes committed to a restructuring, some assets are likely
to be affected by this restructuring. Once the enterprise is committee to the
restructuring, in determining value in use, estimates of future cash inflows and
cash outflows reflect the cost savings and other benefits from the restructuring
(based on the most recent financial budgets/forecasts that have been approved
by management).
Foreign Currency Future Cash Flows are estimated in the currency in which it
will be generated and then they are discounted for the time value of money using
a discount rate appropriate for that currency. we convert cashflow in the
reporting currency on the basis of AS 11.
Discount Rate
The discount rate(s) should be a pre-tax rate(s) that reflect(s) current market
assessments of the time value of money and the risks specific to the asset. The
discount rate(s) should not reflect risks for which future cash flow estimates have
been adjusted.
A rate that reflects current market assessments of the time value of money and
the risks specific to the asset is the return that investors would require if they
were to choose an investment that would generate cash flows of amounts, timing
and risk profile equivalent to those that the enterprise expects to derive from the
asset.
When an asset-specific rate is not directly available from the market, an enterprise
uses other bases to estimate the discount rate such as incremental borrowing
rate, rate using capital asset pricing model, etc.

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These rates
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(a) to reflect the way that the market would assess the specific risks associated
with the projected cash flows; (Consideration is given to risks such as country risk,
currency risk, price risk and cash flow risk) and
(b) to exclude risks that are not relevant to the projected cash flows.
An enterprise normally uses a single discount rate for the estimate of an asset’s
value in use. However, an enterprise uses separate discount rates for different
future periods where value in use is sensitive to a difference in risks for different
periods or to the term structure of interest rates.

7.7 RECOGNITION AND MEASUREMENT OF AN

IMPAIRMENT LOSS
Case I:
If recoverable amount of assets more than carrying amount, we ignore the
difference and asset is carried on at the same book value.

Note: As mentioned above, if there is an indication that an asset may be impaired,

this may indicate that the remaining useful life, the depreciation method or the
residual value for the asset need to be reviewed and adjusted under the
Accounting Standard 10, even if no impairment loss is recognised for the asset.

Case II:
When this recoverable amount is less than the carrying amount, this difference
termed as Impairment Loss.

Accounting implications:

Particulars Remarks

Treatment of Impairment It should be written off immediately as expenses to

loss Profit & Loss Account.
If assets are carried out at revalued figures then the
impairment loss equivalent to revalued surplus is
adjusted with it and the balance (if any) is charged
to Profit & Loss Account.

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Depreciation Depreciation for the coming years on the assets are
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recalculated on the basis of the new carrying
amount, residual value and remaining useful life of
the asset, according to AS 10.

Case III:
When the amount estimated for an impairment loss is greater than the carrying
amount of the asset to which it relates, an enterprise should recognise a liability
if, and only if, that is required by another Accounting Standard.

7.8 IDENTIFICATION OF THE CASH-

GENERATING UNIT TO WHICH AN ASSET
BELONGS
A cash generating unit is the smallest identifiable group of assets that generates
cash inflows from continuing use that are largely independent of the cash inflows
from other assets or groups of assets.
If there is any indication that an asset may be impaired, the recoverable amount
should be estimated for the individual asset, if it is not possible to estimate the
recoverable amount of the individual asset because the value in use of the asset
cannot be determined and it is probably different from scrap value. Therefore, the
enterprise estimates the recoverable amount of the cash-generating unit to which
the asset belongs.
If recoverable amount cannot be determined for an individual asset, an enterprise
identifies the lowest aggregation of assets that generate largely independent cash
inflows from continuing use. Even if part or all of the output produced by an asset
or a group of assets is used by other units of the reporting enterprise, this asset
or group of assets forms a separate cash-generating unit if the enterprise could
sell this output in an active market. This is because this asset or group of assets
could generate cash inflows from continuing use that would be largely
independent of the cash inflows from other assets or groups of assets. In using
information based on financial budgets/forecasts that relates to such a cash-
generating unit, an enterprise adjusts this information if internal transfer prices
do not reflect management’s best estimate of future market prices for the cash-
generating unit’s output.

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Cash-generating units should be identified consistently from period to period for
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the same asset or types of assets, unless a change is justified.

Example 1
A mining enterprise owns a private railway to support its mining activities. The
private railway could be sold only for scrap value and the private railway does not
generate cash inflows from continuing use that are largely independent of the cash
inflows from the other assets of the mine.
It is not possible to estimate the recoverable amount of the private railway because
the value in use of the private railway cannot be determined and it is probably
different from scrap value. Therefore, the enterprise estimates the recoverable
amount of the cash-generating unit to which the private railway belongs, that is,
the mine as a whole.
Example 2
A bus company provides services under contract with a municipality that requires
minimum service on each of five separate routes. Assets devoted to each route and
the cash flows from each route can be identified separately. One of the routes
operates at a significant loss.

Since the enterprise does not have the option to curtail any one bus route, the
lowest level of identifiable cash inflows from continuing use that are largely
independent of the cash inflows from other assets or groups of assets is the cash
inflows generated by the five routes together. The cash-generating unit for each
route is the bus company as a whole.
If an active market exists for the output produced by an asset or a group of
assets, this asset or group of assets should be identified as a separate cash-
generating unit, even if some or all of the output is used internally.

7.9 RECOVERABLE AMOUNT AND CARRYING

AMOUNT OF A CASH-GENERATING UNIT
The carrying amount of a cash-generating unit should be determined consistently
with the way the recoverable amount of the cash-generating unit is determined
i.e., carrying amount is the summation of the carrying amount of all the assets

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v
v v
grouped under one cash-generating unit. This also includes the liability only vif
that liability is necessary to be considered to determine the recovery amount. This v
may occur if the disposal of a cash-generating unit would require the buyer to
take over a liability. In this case, the net selling price of the cash-generating unit is
the estimated selling price for the assets of the cash-generating unit and the
liability together, less the costs of disposal. In order to perform a meaningful
comparison between the carrying amount of the cash-generating unit and its
recoverable amount, the carrying amount of the liability is deducted in
determining both the cash-generating unit’s value in use and its carrying amount.
For practical reasons, the recoverable amount of a cash-generating unit is
sometimes determined after consideration of assets that are not part of the cash-
generating unit or liabilities that have already been recognised in the financial
statements. In such cases, the carrying amount of the cash-generating unit is
increased by the carrying amount of those assets and decreased by the carrying
amount of those liabilities.
Example 3
A company operates a mine in a country where legislation requires that the owner
must restore the site on completion of its mining operations. The cost of restoration
includes the replacement of the overburden, which must be removed before mining
operations commence. A provision for the costs to replace the overburden was
recognised as soon as the overburden was removed. The amount provided was
recognised as part of the cost of the mine and is being depreciated over the mine’s
useful life. The carrying amount of the provision for restoration costs is ` 50,00,000,
which is equal to the present value of the restoration costs.
The enterprise is testing the mine for impairment. The cash-generating unit for the
mine is the mine as a whole. The enterprise has received various offers to buy the
mine at a price of around ` 80,00,000; this price encompasses the fact that the
buyer will take over the obligation to restore the overburden. Disposal costs for the
mine are negligible. The value in use of the mine is approximately
` 1,20,00,000 excluding restoration costs. The carrying amount of the mine is
` 1,00,00,000.
The net selling price for the cash-generating unit is ` 80,00,000. This amount
considers restoration costs that have already been provided for. As a consequence,

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v
v
v
the value in use for the cash-generating unit is determined after consideration of
v
the restoration costs and is estimated to be ` 70,00,000 ( ` 1,20,00,000 less `
50,00,000). The carrying amount of the cash-generating unit is ` 50,00,000, which
is the carrying amount of the mine ( ` 1,00,00,000) less the carrying amount of the
provision for restoration costs ( ` 50,00,000).

7.10 GOODWILL
Goodwill does not generate cash flows independently from other assets or groups
of assets and, therefore, the recoverable amount of goodwill as an individual
asset cannot be determined. As a consequence, if there is an indication that
goodwill may be impaired, recoverable amount is determined for the cash-
generating unit to which goodwill belongs. This amount is then compared to the
carrying amount of this cash-generating unit and any impairment loss is
recognized.
If goodwill can be allocated on a reasonable and consistent basis, an enterprise
applies the ‘bottom-up’ test only. If it is not possible to allocate goodwill on a
reasonable and consistent basis, an enterprise applies both the ‘bottom-up’ test
and ‘top-down’ test.

Can be allocated on a
Perform Bottom up
reasonable and
Test ONLY
consistent basis
Goodwill
Cannot be allocated Perform Bottom up
on a reasonable and and Top Down Test
consistent basis BOTH

Example:
At the end of 20X0, enterprise M acquired 100% of enterprise Z for ` 3,000 lakhs. Z
has 3 cash-generating units A, B and C with net fair values of ` 1,200 lakhs, ` 800
lakhs and` 400 lakhs respectively. M recognises goodwill of ` 600 lakhs (` 3,000
lakhs less ` 2,400 lakhs) that relates to Z.
At the end of 20X4, A makes significant losses. Its recoverable amount is estimated
to be ` 1,350 lakhs. Carrying amounts are detailed below ( ` In Lakh).

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v v
v
End of 20X4 A B C Goodwill Total
v
Net carrying 1300 1200 800 120 3420
amount

Scenario A - Goodwill Can be Allocated on a Reasonable and

Consistent Basis
On the date of acquisition of Z, the net fair values of A, B and C are considered a
reasonable basis for a pro-rata allocation of the goodwill to A, B and C.

Allocation of goodwill at the end of 20X4:

A B C Goodwill
End of 20X0
Net fair values 1200 800 400 2400
Pro-Rata 50% 33% 17% 100%
End of 20X4
Net carrying amount 1300 1200 800 3300
Allocation of goodwill 60 40 20 120
(Using pro rate above)
Net carrying amount (After goodwill) 1360 1240 820 3420

In accordance with the ‘bottom-up’ test in paragraph 78(a) of AS 28, M compares

A’s recoverable amount to its carrying amount after the allocation of the carrying
amount of goodwill:

End of 20X4 A (Rs. In Lakh)

Carrying amount after allocation of goodwill 1360

Recoverable amount 1350

Impairment loss 10
M recognises an impairment loss of ` 10 lakhs for A. The impairment loss is fully
allocated to the goodwill in accordance with paragraph 87 of AS 28.

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v
v
Scenariov B - Goodwill Cannot be Allocated on a Reasonable and
v Basis
Consistent
There is no reasonable way to allocate the goodwill that arose on the acquisition
of Z to A, B and C. At the end of 20X4, Z’s recoverable amount is estimated to be
` 3,400 lakhs.

At the end of 20X4, M first applies the ‘bottom-up’ test in accordance with
paragraph 78(a) of this Statement. It compares A’s recoverable amount to its
carrying amount excluding the goodwill.

End of 20X4 A (Rs. In Lakh)

Carrying amount 1300
Recoverable amount 1350
Impairment loss 0

Therefore, no impairment loss is recognised for A as a result of the ‘bottom-up’

test.
Since the goodwill could not be allocated on a reasonable and consistent basis to
A, M also performs a ‘top-down’ test in accordance with paragraph 78(b) of AS
28. It compares the carrying amount of Z as a whole to its recoverable amount (Z
as a whole is the smallest cash-generating unit that includes A and to which
goodwill can be allocated on a reasonable and consistent basis).
Application of the ‘top-down’ test (Amount in ` lakhs)

End of 20X4 A B C Goodwill Total

Carrying amount 1300 1200 800 120 3420
Impairment loss arising from the 0 - - - 0
‘bottom-up’ test
Carrying amount after the ‘bottom-up’ 1300 1200 800 120 3420
test
Recoverable amount - - - - 3400
Impairment loss arising from ‘top- - - - - 20
down’ test

Therefore, M recognises an impairment loss of ` 20 lakhs that it allocates fully to

goodwill in accordance with paragraph 87 of AS 28.

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v v
v
7.11 CORPORATE ASSETS v

Key characteristics of corporate assets are that they do not generate cash inflows
independently from other assets or groups of assets and their carrying amount
cannot be fully attributed to the cash-generating unit under review.

Examples
Building of a headquarter or a division of the enterprise, EDP equipment or a
research Centre.

In testing a cash-generating unit for impairment, an enterprise should identify all

the corporate assets that relate to the cash-generating unit under review. For
each identified corporate asset:

a. If the carrying amount of the corporate asset can be allocated on a

reasonable and consistent basis to the cash-generating unit under review,
an enterprise should apply the ‘bottom-up’ test only; and

b. If the carrying amount of the corporate asset cannot be allocated on a

reasonable and consistent basis to the cash-generating unit under review,
an enterprise should apply both the ‘bottom-up’ and ‘top-down’ tests.

Can be allocated on a
Perform Bottom up
reasonable and
Test ONLY
consistent basis
Corporate Assets
Cannot be allocated Perform Bottom up
on a reasonable and and Top Down Test
consistent basis BOTH

7.12 IMPAIRMENT LOSS FOR A CASH-

GENERATING UNIT
The impairment loss should be allocated to reduce the carrying amount of the
assets of the unit in the following order:

a. First, to goodwill allocated to the cash-generating unit (if any); and

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v
b. v
Then, to the other assets of the unit on a pro-rata basis based on the
v
carrying amount of each asset in the unit.

These reductions in carrying amounts should be treated as impairment losses on

individual assets

The carrying amount of an asset should not be reduced below the highest of:

a. Its net selling price (if determinable);

b. Its value in use (if determinable); and

c. Zero.

The amount of the impairment loss that would otherwise have been allocated to
the asset should be allocated to the other assets of the unit on a pro-rata basis.

After the requirements of impairment loss have been applied, a liability should be
recognised for any remaining amount of an impairment loss for a cash-generating
unit if that is required by another Accounting Standard.
Example 4
A machine has suffered physical damage but is still working, although not as well
as it used to. The net selling price of the machine is less than its carrying amount.
The machine does not generate independent cash inflows from continuing use.
The smallest identifiable group of assets that includes the machine and generates
cash inflows from continuing use that are largely independent of the cash inflows
from other assets is the production line to which the machine belongs. There
coverable amount of the production line shows that the production line taken as
a whole is not impaired.

Assumption 1: Budgets/forecasts approved by management reflect no

commitment of management to replace the machine.
The recoverable amount of the machine alone cannot be estimated since the
machine’s value in use:
(a) may differ from its net selling price; and
(b) can be determined only for the cash-generating unit to which the machine
belongs (the production line).

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v v
The production line is not impaired, therefore, no impairment loss is recognisedv
for the machine. Nevertheless, the enterprise may need to reassess the v
depreciation period or the depreciation method for the machine. Perhaps, a
shorter depreciation period or a faster depreciation method is required to reflect
the expected remaining useful life of the machine or the pattern in which
economic benefits are consumed by the enterprise.
Assumption 2: Budgets/forecasts approved by management reflect a
commitment of management to replace the machine and sell it in the near future.
Cash flows from continuing use of the machine until its disposal are estimated to
be negligible.
The machine’s value in use can be estimated to be close to its net selling price.
Therefore, the recoverable amount of the machine can be determined and no
consideration is given to the cash-generating unit to which the machine belongs
(the production line). Since the machine’s net selling price is less than its carrying
amount, an impairment loss is recognised for the machine.

7.13 REVERSAL OF AN IMPAIRMENT LOSS

An enterprise should assess at each balance sheet date whether there is any
indication that an impairment loss recognised for an asset in prior accounting
periods may no longer exist or may have decreased. If any such indication exists,
the enterprise should estimate the recoverable amount of that asset. An
impairment loss recognised for an asset in prior accounting periods should be
reversed if there has been a change in the estimates of cash inflows, cash
outflows or discount rates used to determine the asset’s recoverable amount
since the last impairment loss was recognised. If this is the case, the carrying
amount of the asset should be increased to its recoverable amount. That increase
is a reversal of an impairment loss. Indications of a potential decrease in an
impairment loss are mainly mirror the indications of a potential impairment loss
discussed above as external and internal indicators. The concept of materiality
applies in identifying whether an impairment loss recognised for an asset in prior
accounting periods may need to be reversed and the recoverable amount of the
asset determined.

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v
v
7.14
v REVERSAL OF AN IMPAIRMENT LOSS FOR

AN INDIVIDUAL ASSET
Case I:
If impairment loss was written off to profit and loss account, then the reversal of
impairment loss should be recognized as income in the financial statement
immediately.
Case II:
If impairment loss was adjusted with the Revaluation Reserve; then reversal of
impairment loss will be written back to the reserve account to the extent it was
adjusted, any surplus will be recognised as revenue. But in any case the increased
carrying amount of an asset due to a reversal of an impairment loss should not
exceed the carrying amount that would have been determined (net of
amortisation or depreciation) had no impairment loss been recognised for the
asset in prior accounting periods. This is mainly because any further increase in
value of asset is revaluation, which is governed by AS 10.
Depreciation impact post reversal of impairment loss:
After a reversal of an impairment loss is recognised, the depreciation
(amortisation) charge for the asset should be adjusted in future periods to
allocate the asset’s revised carrying amount, less its residual value (if any), on a
systematic basis over its remaining useful life.

7.15 REVERSAL OF AN IMPAIRMENT LOSS FOR A

CASH-GENERATING UNIT
A reversal of an impairment loss for a cash-generating unit should be allocated to
increase the carrying amount of the assets of the unit in the following order:
a. First, assets other than goodwill on a pro-rata basis based on the carrying
amount of each asset in the unit; and
b. Then, to goodwill allocated to the cash-generating unit (if any),
In allocating a reversal of an impairment loss for a cash generating unit under
paragraph 106, the carrying amount of an asset should not be increased above

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v v
the lower of: v
v
(a) its recoverable amount (if determinable); and
(b) the carrying amount that would have been determined (net of amortisation or
depreciation) had no impairment loss been recognised for the asset in prior
accounting periods.
The amount of the reversal of the impairment loss that would otherwise have
been allocated to the asset should be allocated to the other assets of the unit on
a pro-rata basis.

7.16 REVERSAL OF AN IMPAIRMENT LOSS FOR

GOODWILL
This Statement does not permit an impairment loss to be reversed for goodwill
because of a change in estimates (for example, a change in the discount rate or in
the amount and timing of future cash flows of the cash generating unit to which
goodwill relates), an impairment loss recognised for goodwill should not be
reversed in a subsequent period unless:
a. The impairment loss was caused by a specific external event of an
exceptional nature that is not expected to recur; and
b. Subsequent external events have occurred that reverse the effect of that
event.

7.17 IMPAIRMENT IN CASE OF DISCONTINUING

OPERATIONS
The approval and announcement of a plan for discontinuance is an indication that
the assets attributable to the discontinuing operation may be impaired or that an
impairment loss previously recognised for those assets should be increased or
reversed.
In applying this Statement to a discontinuing operation, an enterprise determines
whether the recoverable amount of an asset of a discontinuing operation is
assessed for the individual asset or for the asset’s cash-generating unit. For

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v
example: v
v
a. If the enterprise sells the discontinuing operation substantially in its
entirety, none of the assets of the discontinuing operation generate cash
inflows independently from other assets within the discontinuing operation.
Therefore, recoverable amount is determined for the discontinuing
operation as a whole and an impairment loss, if any, is allocated among the
assets of the discontinuing operation in accordance with this Statement;
b. If the enterprise disposes of the discontinuing operation in other ways such
as piecemeal sales, the recoverable amount is determined for individual
assets, unless the assets are sold in groups; and
c. If the enterprise abandons the discontinuing operation, the recoverable
amount is determined for individual assets as set out in this Statement.
After announcement of a plan, negotiations with potential purchasers of the
discontinuing operation or actual binding sale agreements may indicate that the
assets of the discontinuing operation may be further impaired or that impairment
losses recognised for these assets in prior periods may have decreased.

7.18 DISCLOSURE
For each class of assets, the financial statements should disclose:
a. The amount of impairment losses recognised in the statement of profit and
loss during the period and the line item(s) of the statement of profit and
loss in which those impairment losses are included;

b. The amount of reversals of impairment losses recognised in the statement

of profit and loss during the period and the line item(s) of the statement of
profit and loss in which those impairment losses are reversed;

c. The amount of impairment losses recognised directly against revaluation

surplus during the period; and
d. The amount of reversals of impairment losses recognised directly in
revaluation surplus during the period.
This information may be included in a reconciliation of the carrying amount of
fixed assets, at the beginning and end of the period, as required under AS 10.

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v v
An enterprise that applies AS 17, Segment Reporting, should disclose the v
v
following for each reportable segment based on an enterprise’s primary format
(as defined in AS 17):
a. The amount of impairment losses recognised in the statement of profit and
loss and directly against revaluation surplus during the period; and

b. The amount of reversals of impairment losses recognised in the statement

of profit and loss and directly in revaluation surplus during the period.
If an impairment loss for an individual asset or a cash-generating unit is
recognised or reversed during the period and is material to the financial
statements of the reporting enterprise as a whole, an enterprise should disclose:
a. The events and circumstances that led to the recognition or reversal of the
impairment loss;
b. The amount of the impairment loss recognised or reversed;
c. For an individual asset:

(i) The nature of the asset; and

(ii) The reportable segment to which the asset belongs, based on the
enterprise’s primary format (as defined in AS 17, Segment Reporting);
d. For a cash-generating unit:
(i) A description of the cash-generating unit (such as whether it is a product
line, a plant, a business operation, a geographical area, a reportable
segment as defined in AS 17 or other);
(ii) The amount of the impairment loss recognised or reversed by class of
assets and by reportable segment based on the enterprise’s primary
format (as defined in AS 17); and
(iii) If the aggregation of assets for identifying the cash-generating unit has
changed since the previous estimate of the cash-generating unit’s
recoverable amount (if any), the enterprise should describe the current
and former way of aggregating assets and the reasons for changing the
way the cash-generating unit is identified;

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v
e. v
Whether the recoverable amount of the asset (cash-generating unit) is its
v
net selling price or its value in use;

f. If recoverable amount is net selling price, the basis used to determine net
selling price (such as whether selling price was determined by reference to
an active market or in some other way); and

g. If recoverable amount is value in use, the discount rate(s) used in the

current estimate and previous estimate (if any) of value in use.
If impairment losses recognised (reversed) during the period are material in
aggregate to the financial statements of the reporting enterprise as a whole, an
enterprise should disclose a brief description of the following:
a. The main classes of assets affected by impairment losses (reversals of
impairment losses);
b. The main events and circumstances that led to the recognition (reversal) of
these impairment losses.

An enterprise is encouraged to disclose key assumptions used to determine the

recoverable amount of assets (cash-generating units) during the period.

7.19 ILLUSTRATIONS
Illustration 1
Ergo Industries Ltd. gives the following estimates of cash flows relating to Property,
Plant and Equipment on 31-12-20X1. The discount rate is 15%.
Year Cash Flow (` in lakhs)
20X2 4000
20X3 6000
20X4 6000
20X5 8000
20X6 4000
Residual value at the end of 20X6 = ` 1000 lakhs
Property, Plant and Equipment purchased on 1-1-20XX = ` 40,000 lakhs

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v v
Useful life = 8 years v
v
Net selling price on 31-12-20X1 = ` 20,000 lakhs
Calculate on 31-12-20X1:
(a) Carrying amount at the end of 20X1
(b) Value in use on 31-12-20X1
(c) Recoverable amount on 31-12-20X1
(d) Impairment loss to be recognized for the year ended 31-12-20X1
(e) Revised carrying amount
(f) Depreciation charge for 20X2.
Note: The year 20XX is the immediate preceding year before the year 20X0.
Solution
Calculation of value in use

Year Cash Flow Discount as per 15% Discounted cash flow

20X2 4,000 0.870 3,480
20X3 6,000 0.756 4,536
20X4 6,000 0.658 3,948
20X5 8,000 0.572 4,576
20X6 4,000 0.497 1,988
20X6 (residual) 1,000 0.497 497
19,025

(a) Calculation of carrying amount:

Original cost = ` 40,000 lakhs

Depreciation for 3 years = [(40,000-1000)3/8] = ` 14,625 lakhs

Carrying amount on 31-12-20X1 = [40,000-14,625] = ` 25,375 lakhs
(b) Value in use = ` 19,025 lakhs
(c) Recoverable amount = higher of value in use and net selling price i.e.
` 20,000 lakhs.

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v
v
Recoverable amount = ` 20,000 lakhs
v
(d) Impairment Loss = ` (25,375-20,000) = ` 5,375 lakhs

(e) Revised carrying amount = ` (25,375-5,375) = ` 20,000 lakhs

(f) Depreciation charge for 20X2 = (20,000-1000)/5 = ` 3,800 lakhs
Illustration 2
X Ltd. is having a plant (asset) carrying amount of which is ` 100 lakhs on
31.3.20X1. Its balance useful life is 5 years and residual value at the end of 5 years
is ` 5 lakhs. Estimated future cash flow from using the plant in next 5 years are:

For the year ended on Estimated cash flow (` in lakhs)

31.3.20X2 50
31.3.20X3 30
31.3.20X4 30
31.3.20X5 20
31.3.20X6 20
Calculate “value in use” for plant if the discount rate is 10% and also calculate the
recoverable amount if net selling price of plant on 31.3.20X1 is ` 60 lakhs.
Solution
Present value of future cash flow

Year Future Discount @ 10% Rate Discounted cash

ended Cash Flow flow
31.3.20X2 50 0.909 45.45
31.3.20X3 30 0.826 24.78
31.3.20X4 30 0.751 22.53
31.3.20X5 20 0.683 13.66
31.3.20X6 20 0.620 12.40
118.82
Present value of residual price on 31.3.20X6 = 5  0.620 3.10
Present value of estimated cash flow by use of an asset and
residual value, which is called “value in use”. 121.92

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v v
v
If net selling price of plant on 31.3.20X1 is ` 60 lakhs, the recoverable amount will
v
be higher of ` 121.92 lakhs (value in use) and ` 60 lakhs (net selling price), hence
recoverable amount is ` 121.92 lakhs.
Illustration 3
G Ltd., acquired a machine on 1 st April, 20X0 for ` 7 crore that had an estimated
useful life of 7 years. The machine is depreciated on straight line basis and does
not carry any residual value. On 1 st April, 20X4, the carrying value of the machine
was reassessed at ` 5.10 crore and the surplus arising out of the revaluation being
credited to revaluation reserve. For the year ended March, 20X6, conditions
indicating an impairment of the machine existed and the amount recoverable
ascertained to be only ` 79 lakhs. You are required to calculate the loss on
impairment of the machine and show how this loss is to be treated in the books of
G Ltd. G Ltd., had followed the policy of writing down the revaluation surplus by
the increased charge of depreciation resulting from the revaluation.
Solution
Statement Showing Impairment Loss

(` in crores)

Carrying amount of the machine as on 1 st April, 20X0 7.00

Depreciation for 4 years i.e. 20X0-20X1 to 20X3-20X4
 7 crores  (4.00)
 7 years × 4 years 
 

Carrying amount as on 31.03.20X4 3.00

Add: Upward Revaluation (credited to Revaluation Reserve 2.10
account)

Carrying amount of the machine as on 1 st April, 20X4 (revalued) 5.10

Less: Depreciation for 2 years i.e. 20X4-20X5& 20X5-20X6
 5.10 crores  (3.40)
 3 years ×2 years 
 

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v
v
Carrying amount as on 31.03.20X6 1.70
v
Less: Recoverable amount (0.79)
Impairment loss 0.91
Less: Balance in revaluation reserve as on 31.03.20X6:
Balance in revaluation reserve as on 31.03.20X4 2.10
Less: Enhanced depreciation met from revaluation reserve
20X4-20X5 & 20X5-20X6=[(1.70 – 1.00) x 2 years] (1.40)
Impairment loss set off against revaluation reserve balance as
per para 58 of AS 28 “Impairment of Assets” (0.70)
Impairment Loss to be debited to profit and loss account 0.21

Illustration 4
X Ltd. purchased a Property, Plant and Equipment four years ago for ` 150 lakhs
and depreciates it at 10% p.a. on straight line method. At the end of the fourth
year, it has revalued the asset at ` 75 lakhs and has written off the loss on
revaluation to the profit and loss account. However, on the date of revaluation, the
market price is ` 67.50 lakhs and expected disposal costs are ` 3 lakhs. What will
be the treatment in respect of impairment loss on the basis that fair value for
revaluation purpose is determined by market value and the value in use is
estimated at ` 60 lakhs?
Solution
Treatment of Impairment Loss
As per para 57 of AS 28 “Impairment of assets”, if the recoverable amount (higher
of net selling price and its value in use) of an asset is less than its carrying
amount, the carrying amount of the asset should be reduced to its recoverable
amount. In the given case, net selling price is ` 64.50 lakhs (` 67.50 lakhs – ` 3
lakhs) and value in use is ` 60 lakhs. Therefore, recoverable amount will be ` 64.50
lakhs. Impairment loss will be calculated as ` 10.50 lakhs [` 75 lakhs (Carrying
Amount after revaluation - Refer Working Note) less ` 64.50 lakhs (Recoverable
Amount)].

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v v
v
Thus impairment loss of ` 10.50 lakhs should be recognised as an expense in the
Statement of Profit and Loss immediately since there was downward revaluation v
of asset which was already charged to Statement of Profit and Loss.
Working Note:
Calculation of carrying amount of the Property, Plant and Equipment at the
end of the fourth year on revaluation

(` in lakhs)
Purchase price of a Property, Plant and Equipment 150.00
Less: Depreciation for four years [(150 lakhs / 10 years) x 4 (60.00)
years]
Carrying value at the end of fourth year 90.00
Less: Downward revaluation charged to profit and loss account (15.00)
Revalued carrying amount 75.00

Reference: The students are advised to refer the full text of AS 28

“Impairment of Assets” (issued 2002).

TEST YOUR KNOWLEDGE

Multiple Choice Questions

1. If there is indication that an asset may be impaired but the recoverable
amount of the asset is more than the carrying amount of the asset, the
following are true:
(a) No further action is required and the company can continue the asset in
the books at the book value itself.
(b) The entity should review the remaining useful life, scrap value and
method of depreciation and amortization for the purposes of AS 10.
(c) The entity can follow either (a) or (b).
(d) The entity should review the scrap value and method of depreciation
and amortization for the purposes of AS 10.

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v
2. v Goodwill appears in the Balance Sheet of an entity, the following is
In case
true:v
(a) Apply Bottom up test if goodwill cannot be allocated to CGU (cash
generating unit) under review.
(b) Apply Top down test if goodwill cannot be allocated to CGU (cash
generating unit) under review.
(c) Apply both Bottom up test and Top down test if goodwill cannot be
allocated to CGU (cash generating unit) under review.
(d) Apply either Bottom up test or Top down test if goodwill cannot be
allocated to CGU (cash generating unit) under review.
3. In case of Corporate assets in the Balance Sheet of an entity, the following is
true:
(a) Apply Bottom up test if corporate assets cannot be allocated to CGU
(cash generating unit) under review.
(b) Apply Top down test if corporate assets cannot be allocated to CGU
(cash generating unit) under review.
(c) Apply both Bottom up test and Top down test if corporate assets cannot
be allocated to CGU (cash generating unit) under review.
(d) Apply either Bottom up test or Top down test if corporate assets cannot
be allocated to CGU (cash generating unit) under review.
4. In case of reversal of impairment loss, which statement is true:
(a) Goodwill written off can never be reversed.
(b) Goodwill written off can be reversed without any conditions to be met.
(c) Goodwill written off can be reversed only if certain conditions are met.
(d) Goodwill written off can be reversed.

Theoretical Questions
5. Write short note on impairment of asset and its application to inventory.

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v
Scenario based Questions
v
6. A publisher owns 150 magazine titles of which 70 were purchased and 80
were self-created. The price paid for a purchased magazine title is recognized
as an intangible asset. The costs of creating magazine titles and maintaining
the existing titles are recognized as an expense when incurred. Cash inflows
from direct sales and advertising are identifiable for each magazine title.
Titles are managed by customer segments. The level of advertising income for
a magazine title depends on the range of titles in the customer segment to
which the magazine title relates. Management has a policy to abandon old
titles before the end of their economic lives and replace them immediately
with new titles for the same customer segment. What is the cash-generating
unit for an individual magazine title?
7. An asset does not meet the requirements of environment laws which have
been recently enacted. The asset has to be destroyed as per the law. The asset
is carried in the Balance Sheet at the year end at ` 6,00,000. The estimated
cost of destroying the asset is ` 70,000. How is the asset to be accounted for?
8. Venus Ltd. has a fixed asset, which is carried in the Balance Sheet on
31.3.20X1 at ` 500 lakhs. As at that date the value in use is ` 400 lakhs and
the net selling price is ` 375 lakhs.
From the above data:

(i) Calculate impairment loss.

(ii) Prepare journal entries for adjustment of impairment loss.
(iii) Show, how impairment loss will be shown in the Balance Sheet.

9. Good Drugs and Pharmaceuticals Ltd. acquired a sachet filling machine on

1st 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

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carrying amount of ` 3.46 crore. All such machines put together could fetch a
v
sum of ` 4.44 crore if disposed. Discuss the applicability of Impairment loss.

10. From the following details of an asset

(i) Find out impairment loss
(ii) Treatment of impairment loss
(iii) Current year depreciation
Particulars of asset:

Cost of asset ` 56 lakhs

Useful life period 10 years
Salvage value Nil
Current carrying value ` 27.30 lakhs
Useful life remaining 3 years
Recoverable amount ` 12 lakhs
Upward revaluation done in last year ` 14 lakhs

11. A plant was acquired 15 years ago at a cost of ` 5 crores. Its accumulated
depreciation as at 31 st March, 20X1 was ` 4.15 crores. Depreciation estimated
for the financial year 20X1-20X2 is ` 25 lakhs. Estimated Net Selling Price as
on 31st March, 20X1 was ` 30 lakhs, which is expected to decline by 20 per
cent by the end of the next financial year.

Its value in use has been computed at ` 35 lakhs as on 1 st April, 20X1, which
is expected to decrease by 30 per cent by the end of the financial year.
(i) Assuming that other conditions for applicability of the impairment
Accounting Standard are satisfied, what should be the carrying amount
of this plant as at 31 st March, 20X2?
(ii) How much will be the amount of write off for the financial year ended
31st March, 20X2?

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(iii) If the plant had been revalued ten years ago and the current v
v
revaluation reserves against this plant were to be ` 12 lakhs, how would
you answer to questions (i) and (ii) above?
(iv) If the value in use was zero and the enterprise were required to incur a
cost of ` 2 lakhs to dispose of the plant, what would be your response to
questions (i) and (ii) above?

ANSWERS/SOLUTIONS
Answer to the Multiple Choice Questions

1. (b) 2. (c) 3. (c) 4. (c)

Answer to the Theoretical Questions

5. The objective of AS 28 ‘Impairment of Assets’ is to prescribe the procedures
that an enterprise applies to ensure that its assets are carried at no more
than their recoverable amount. An asset is carried at more than its
recoverable amount if its carrying amount exceeds the amount to be
recovered through use or sale of the asset. If this is the case, the asset is
described as impaired and this Standard requires the enterprise to
recognize an impairment loss.
 If carrying amount < = Recoverable amount : Asset is not impaired

 If carrying amount > Recoverable amount : Asset is impaired

Impairment Loss = Carrying Amount – Recoverable Amount
Recoverable amount is the higher of net selling price and its value in use
This standard should be applied in accounting for the impairment of all
assets, other than (i) inventories (AS 2, Valuation of Inventories); (ii) assets
arising from construction contracts (AS 7, Accounting for Construction
Contracts); (iii) financial assets, including investments that are included in
the scope of AS 13, Accounting for Investments; and (iv) deferred tax assets
(AS 22, Accounting for Taxes on Income). AS 28 does not apply to
inventories, assets arising from construction contracts, deferred tax assets or

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v
v
investments because other accounting standards applicable to these assets
v
already contain specific requirements for recognizing and measuring the
impairment related to these assets.

Answer to the Scenario based Questions

6. It is likely that the recoverable amount of an individual magazine title can
be assessed. Even though the level of advertising income for a title is
influenced, to a certain extent, by the other titles in the customer segment,
cash inflows from direct sales and advertising are identifiable for each title.
In addition, although titles are managed by customer segments, decisions
to abandon titles are made on an individual title basis.
Therefore, it is likely that individual magazine titles generate cash inflows
that are largely independent of each other and that each magazine title is a
separate cash-generating unit.
7. As per AS 28 “Impairment of Assets”, impairment loss is the amount by
which the carrying amount of an asset exceeds its recoverable amount,
where recoverable amount is the higher of an asset’s net selling price  and
its value in use •. In the given case, recoverable amount will be nil [higher of
value in use (nil) and net selling price (negative ` 70,000)]. Thus impairment
loss will be calculated as ` 6,00,000 [carrying amount (` 6,00,000) –
recoverable amount (nil)]. Therefore, asset is to be fully impaired and
impairment loss of ` 6,00,000 has to be recognized as an expense
immediately in the statement of Profit and Loss as per para 58 of AS 28.
Further, as per para 60 of AS 28, When the amount estimated for an
impairment loss is greater than the carrying amount of the asset to which it
relates, an enterprise should recognise a liability if, and only if, that is
required by another Accounting Standard. Hence, the entity should
recognize liability for cost of disposal of ` 70,000 as per AS 10 & 29.


Net selling price is the amount obtainable from the sale of an asset in an arm’s length
transaction between knowledgeable, willing parties, less the costs of disposal. In the given
case, Net Selling Price = Selling price – Cost of disposal = Nil – ` 70,000 = (` 70,000)
•
Value in use is the present value of estimated future cash flows expected to arise from the
continuing use of an asset and from its disposal at the end of its useful life. In the given
case, value in use is nil.

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8. (i) v
Recoverable amount is higher of value in use ` 400 lakhs and net
selling price ` 375 lakhs. v

Recoverable amount = ` 400 lakhs

Impairment loss = Carried Amount – Recoverable amount
= ` 500 lakhs – ` 400 lakhs = ` 100 lakhs.
(ii) Journal Entries

Dr. Cr.
Particulars Amount Amount
( ` in lakhs) ( ` in lakhs)
(i) Impairment loss account Dr. 100
To Provision for Accumulated 100
Impairment Loss Account
(Being the entry for accounting
impairment loss)
(ii) Profit and loss account Dr. 100
To Impairment loss 100
(Being the entry to transfer impairment
loss to profit and loss account)

(iii) Balance Sheet of Venus Ltd. as on 31.3.20X1

( ` in lakhs)
Fixed Asset
Asset less depreciation 500
Less: Impairment loss (100)
400

9. As per provisions 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.

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10. v
According to AS 28 “Impairment of Assets”, an impairment loss on a
v
revalued asset is recognised as an expense in the statement of profit and
loss. However, an impairment loss on a revalued asset is recognised directly
against any revaluation surplus for the asset to the extent that the
impairment loss does not exceed the amount held in the revaluation surplus
for that same asset.

Impairment Loss and its treatment `

Current carrying amount (including revaluation amount of 27,30,000

` 14 lakhs)

Less: Current recoverable amount (12,00,000)

Impairment Loss 15,30,000

Impairment loss charged to revaluation reserve 14,00,000

Impairment loss charged to profit and loss account 1,30,000

After the recognition of an impairment loss, the depreciation (amortization)

charge for the asset should be adjusted in future periods to allocate the
asset’s revised carrying amount, less its residual value (if any), on a
systematic basis over its remaining useful life.
In the given case, the carrying amount of the asset will be reduced to
` 12,00,000 after impairment. This amount is required to be depreciated
over remaining useful life of 3 years (including current year). Therefore, the
depreciation for the current year will be ` 4,00,000.
11. As per AS 28 “Impairment of Assets”, if the recoverable amount  of an asset
is less than its carrying amount, the carrying amount of the asset should be
reduced to its recoverable amount and that reduction is an impairment loss.
An impairment loss on a revalued asset is recognized as an expense in the
statement of profit and loss. However, an impairment loss on a revalued
asset is recognised directly against any revaluation surplus for the asset to
the extent that the impairment loss does not exceed the amount held in the
revaluation surplus for that same asset.


Recoverable amount is the higher of an asset’s net selling price and its value in use.

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v
In the given case, recoverable amount (higher of asset’s net selling price
and value in use) will be ` 24.5 lakhs on 31.3.20X2 according to the v
provisions of AS 28 [Refer working note].

(` in lakhs)
(i) Carrying amount of plant (after impairment) as on 31 st 24.50
March, 20X2
(ii) Amount of write off (impairment loss) for the financial 35.50
year ended 31st March, 20X2 [` 60 lakhs – ` 24.5 lakhs]
(iii) If the plant had been revalued ten years ago
Debit to revaluation reserve 12.00
Amount charged to profit and loss account 23.50
(` 35.50 lakhs – ` 12 lakhs)
(iv) If Value in use is zero
Value in use (a) Nil
Net selling price (b) (-)2.00
Recoverable amount [higher of (a) and (b)] Nil
Carrying amount (closing book value) Nil
Amount of write off (impairment loss) (` 60 lakhs – Nil) 60.00
Entire book value of plant will be written off and
charged to profit and loss account.

Working Note:

Calculation of Closing Book Value, Estimated Net Selling Value and

Estimated Value in Use of Plant at 31st March, 20X2

(` in lakhs)
Opening book value as on 1.4.20X1 (` 500 lakhs – 85
` 415 lakhs)
Less: Depreciation for financial year 20X1–20X2 (25)
Closing book value as on 31.3.20X2 60

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Estimated net selling price as on 1.4.20X1 30
v
Less: Estimated decrease during the year (20% of (6)
` 30 lakhs)
Estimated net selling price as on 31.3.20X2 24
Estimated value in use as on 1.4.20X1 35.0
Less: Estimated decrease during the year (30% of (10.5)
` 35 lakhs)
Estimated value in use as on 31.3.20X2 24.5

© The Institute of Chartered Accountants of India

 CHAPTER a
6
LIABILITIES BASED
ACCOUNTING
STANDARDS
UNIT 1: ACCOUNTING STANDARD 15
EMPLOYEE BENEFITS

LEARNING OUTCOMES
After studying this unit, you will be able to
 Define ‘Employee benefits’, ‘Short-term employee benefits’, ‘Post-
employment benefits’ and other related terms used in the Standard
 Enumerate various types of employee benefits
 Recognise and measure Short-term Employee Benefits, Short-term
Compensated Absences and Profit-sharing and Bonus Plans along
with the accounting thereof
 Classify the post-employment benefits into defined contribution plans
and defined benefit plans
 Examine the various aspects inherent in these post-employment benefit
plans and recognize and measure the obligations under these plans
 Apply the actuarial valuation methods and assumptions while valuing
the obligations under Defined benefit plans
 Calculate the actuarial gains and losses on such plans
 Recognise gains or losses on the curtailment or settlement of a
defined benefit plan
 Recognise and measure other long-term benefit and termination benefits
 Understand the disclosure requirement of these employee benefits
and comply with the same.

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1.1v INTRODUCTION
The Accounting Standard 15 - ‘Employee Benefits’ (AS 15), generally deals with all
forms of employee benefits all forms of consideration given by an enterprise in
exchange for services rendered by employees The objective of this Standard is to
prescribe the accounting treatment and disclosure for employee benefits in the
books of employer except employee share-based payments. It does not deal with
accounting and reporting by employee benefit plans.

Formal
Plan/Agreement

Employee Legislative
Benefits Requirement

Informal Practices

The Standard addresses only the accounting of employee benefits by employers.

The Standard makes four things very clear at the outset:
(i) the Standard is applicable to benefits provided to all types of employees
(whether full-time, part-time, or casual staff);
(ii) employee benefits can be paid in cash or in kind;
(iii) employee benefits include benefits provided to employees and their
dependents (spouses, children and others); and
(iv) payment can be made directly to employees, their dependent or to any
other party (e.g., legal heirs, nominees, insurance companies, trust etc.).
The Standard is based on the premise that the costs associated with employees-
benefits should be matched with the timing of their service. This requires
assessment of the anticipated costs and their timing in future and aligning those
costs over the period of their service. For example, a bonus payable to an
employee for a long-term service, should ideally be spread over the period of his
service and the expectations that the employee is expected to complete that
service. Likewise, pension payable to an employee must be recognized as a cost
during the service period itself, irrespective of the fact that the pension is payable
after the service is completed.

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 LIABILITIES BASED ACCOUNTING STANDARDS 6.3
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Illustration 1 v
v
What are the kinds of employees covered in the revised AS 15 and whether a formal
employer employee relationship is necessary or not, for benefits to be covered under
the Standard?
Solution
The Standard does not define the term “employee”. Paragraph 6 of the Standard
states that ‘an employee may provide services to an enterprise on a full time, part
time, permanent, casual or temporary basis and the term would also include the
whole-time directors and other management personnel. The Standard is
applicable to all forms of employer employee relationships. There is no
requirement for a formal employer employee relationship. Several factors need to
be considered to determine the nature of relationship.

Generally, ‘outsourcing contracts’ may not meet the definition of employer -

employee relationship. However, such contracts need to be carefully examined to
distinguish between a “contract of service” and a “contract for services”. A
‘contract for services’ implies a contract for rendering services, e.g., professional
or technical services which is subject to limited direction and control whereas a
‘contract of service’ implies a relationship of an employer and employee, and the
person is obliged to obey orders in the work to be performed and as to its mode
and manner of performance.
Illustration 2
Whether an enterprise is required to provide for employee benefits arising from
informal practices?
Solution
Paragraph 3(c) of the Standard defines employee benefits to include those
informal practices that give rise to an obligation where the enterprise has no
realistic alternative but to pay employee benefits. The historical pattern of
granting such benefits, the expectation created and the impact on the
relationship with employees in the event such benefit is withdrawn should be
considered in determining whether the informal practice gives rise to a benefit
covered by the Standard. For example, where an employer has a practice of

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making a lumpsum payment on occasion of a festival or regularly grants advances
v
against informal benefits to employees it would be necessary to provide for such
benefits.

Careful judgement should be applied in assessing whether an obligation has

arisen particularly in instances where an enterprise's practice is to provide
improvements only during the collective bargaining process and not during any
informal process. If the employer has not set a pattern of benefits that can be
projected reliably to give rise to an obligation there is no requirement to provide
for the benefits.

However, if the practice established by an employer was that of a consistent

benefit granted either as part of union negotiations or otherwise that clearly
established a pattern (e.g., a cost of living adjustment or fixed rupee increase), it
could be concluded that an obligation exists and that those additional benefits
should be included in the measurement of the benefit obligation.

Employee benefits include:

(a) Short-term employee benefits (e.g., wages, salaries, paid annual leave and
sick leave, profit sharing bonuses etc. (payable within 12 months of the
year-end) and non-monetary benefits for current employees.

(b) Post-employment benefits (e.g., gratuity, pension, provident fund, post-

employment medical care etc.).

(c) long-term employee benefits (e.g., long-service leave, long-term disability

benefits, bonuses not wholly payable within 12 months of the year end etc.) ,
and

(d) termination benefits (e.g. VRS payments)

The Standard lays down recognition and measurement criteria and disclosure
requirements for the above four types of employee benefits separately.

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Short Term Post Terminal
Employee Long Term
Benefits Employment Benefits
Benefits Benefits

Salary, Wages Sabbatical Retrenchment

Gratuity
Leave

Social Security Voluntary

Contributions Long Service Pension Retirement
Awards
Annual Paid
leaves Long Term Medical Care
Disability
Medical, Benefit
Housing, Car

1.2 APPLICABILITY
The Standard applies from April 1, 2006 in its entirety for all Level 1 enterprises.
Certain exemptions are given to other than Level 1 enterprises, depending upon
whether they employ 50 or more employees. This Standard is applicable
predominantly for Level 1 enterprises and applied to other entities with certain
relaxations.

1.3 MEANING OF THE TERM “EMPLOYEE

BENEFITS”
The term employee is not defined under the standard AS 15 does not define who
is an ‘employee’, but states in that "an employee may provide services to an entity
on a full-time, part-time, permanent, casual or temporary basis. For the purpose
of this Standard, employees include directors and other management personnel".
This suggests that the intention was for the term ‘employee’ to apply more widely
than simply to persons with a contract of employment as ‘casual’ and ‘temporary’
staff may frequently not have such contracts.

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The following indicators may suggest an employee relationship may be more
v
likely to exist, and may help in making individual judgements:

• A contract of employment exists;

• Individuals are considered employees for legal/tax/social security purposes;
• There is a large amount of oversight and direction by the employer and
necessary tools, equipment and materials are provided by the employer;
• Services are performed at a location specified by the employer;
Services provided through an entity are in substance services provided by a
specific individual, indications of which could be that the entity:
• Has no other clients;
• Has served the employer for a long period;

• Faces little or no financial risk;

• Requires the explicit permissions of the employer to concurrently undertake
additional employment elsewhere.

1.4 SHORT-TERM EMPLOYEE BENEFITS

• Short-term employee benefits (other than termination benefits) are payable
within twelve months after the end of the period in which the service is
rendered.
• Accounting for these benefits is generally straightforward because no
actuarial assumptions are required to measure the obligation or cost.

• Short-term employee benefits are broadly classified into four categories:

(i) regular period benefits (e.g., wages, salaries);
(ii) short-term compensated absences (e.g., paid annual leave, maternity
leave, sick leave etc.);
(iii) profit sharing and bonuses payable within twelve months after the
end of the period in which employee render the related services and

(iv) non-monetary benefits (e.g., medical care, housing, cars etc.)

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v
All Short term
Employee v
Vesting
Benefits
Accumulating
Short term
Short Term Paid
Employee Non-vesting
Abscences
Benefits Non-
accumulating
Profit-sharing
and Bonus Plans

1.4.1 All Short-term Employee Benefits

• The Standard lays down some general recognition criteria for all short-term
employee benefits. There are further requirements in respect of short-term
compensated absences and profit sharing and bonus plans.
• The general criteria is that an enterprise should recognize as an expense
(unless another accounting standard permits a different treatment) the
undiscounted amount of all short-term employee benefits attributable to
services that been already rendered in the period.

• Any difference between the amount of expenses so recognized and cash

payments made during the period should be treated as a liability or
prepayment (asset) as appropriate.
Illustration 3
Entity XY is required to pay salary of ` 2 crore for the year 20X1-X2. It actually paid
a salary of ` 1.90 crore up to 31 st March 20X2, and balance in April 20X2.
Determine the actual costs to be recognized in the year 20X1-X2 and any amounts
to be shown through balance sheet.
Solution
Total expense for the year (20X1-X2) ` 2 crore
Amount to be shown under liability (unpaid) ` 2 crore – 1.90 `crore
= ` 10 lakhs

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1.4.2 Short-term Compensated Absences
v
Entitlement to compensated absences falls into two categories:
(a) Accumulating

 Accumulating compensated absences are those that are carried

forward and can be used in future periods if the current period’s
entitlement is not used in full.
 Accumulating compensated absences may be
(i) Vesting
It implies that employees are entitled to a cash payment for
unused entitlement on leaving the enterprise
(ii) Non-vesting
It implies that when employees are not entitled to a cash
payment for unused entitlement on leaving. An obligation arises
as employees render service that increases their entitlement to
future compensated absences.

 The expected cost of accumulating compensated absences should be

recognized when employees render the service that increase their
entitlement to future compensated absences.
 ‘An enterprise should measure the expected cost of accumulating
compensated absences as the additional amount that the enterprise
expects to pay as a result of the unused entitlement that has
accumulated at the balance sheet date’.
 No distinction should be made between vesting and non-vesting
entitlements. However, in measuring non-vesting entitlements, the
possibility of employees leaving the enterprise before receiving them
should be taken into account.
Example
An enterprise has 100 employees, who are each entitled to five working days
of leave for each year. Unused leave may be carried forward for one calendar
year. The leave is taken first out of the current year’s entitlement and then out

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of any balance brought forward from the previous year (a LIFO basis). At 31vst
December, 20X4, the average unused entitlement is two days per employee. v
The enterprise expects, based on past experience which is expected to
continue, that 92 employees will take no more than five days of leave in 20X5
and that the remaining eight employees will take an average of six and a half
days each.
The enterprise expects that it will pay an additional 12 days of pay as a result
of the unused entitlement that has accumulated at 31 st December, 20X4 (one
and a half days each, for eight employees). Therefore, the enterprise
recognises a liability, as at 31 st December, 20X4, equal to 12 days of pay.
(b) Non-accumulating

 Non-accumulating compensated absences (e.g., maternity leave) do

not carry forward and are not directly linked to the services rendered
by employees in the past. Therefore, an enterprise recognizes no
liability or expense until the time of the absence.
 In other words, the cost of non-accumulating absences should be
recognized as and when they arise.
Exception
Small and Medium-sized Company and Micro, Small and Medium-sized
Enterprises (Levels IV, III and II non-corporate entities) may not comply with short
term absences to the extent they deal with recognition and measurement of
absences which are non-vesting (i.e., short-term accumulating compensated
absences in respect of which employees are not entitled to cash payment of
unused entitlement on leaving).

1.4.3 Profit-sharing and Bonus Plans

Recognition of expenses for profit sharing and bonus plans would depend on
fulfillment of conditions mentioned the Standard. The conditions are:

(a) Enterprise has a present obligation to make such payments as a result of

past events; and
(b) Reliable estimate of the obligation can be made.

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 6.10 ADVANCED ACCOUNTING
v
v
v
The second condition can be satisfied only when the profit sharing and bonus
v
plans contained a formula for determining the amount of benefit. The enterprise
should recognize the expected cost of profit sharing and bonus payments in the
financial statements.
Example
A profit-sharing plan requires an enterprise to pay a specified proportion of its net
profit for the year to employees who serve throughout the year. If no employees
leave during the year, the total profit-sharing payments for the year will be 3% of
net profit. The enterprise estimates that staff turnover will reduce the payments to
2.5% of net profit.
The enterprise recognises a liability and an expense of 2.5% of net profit.
Illustration 4
Whether an entitlement to earned leave which can be carried forward to future
periods is a short -term employee benefit or a long-term employee benefit.
Solution
Paragraph 7.2 of the Standard defines ‘Short-term’ benefits as employee benefits
(other than termination benefits) which fall due wholly within twelve months after
the end of the period in which the employees render the related service.
Paragraph 8(b) of the Standard illustrates the term ‘Short -term benefits’ to
include “short term compensated absences (such as paid annual leave) where the
absences are expected to occur within twelve months after the end of the period
in which the employees render the related employee service”.
Paragraph 7.2 of the Standard uses “falls due” as the basis, paragraph 8(b) of the
Standard uses “expected to occur” as the basis to illustrate classification of short
term compensated absences. A reading of paragraph 8(b) together with
paragraph 7.2 would imply that the classification of short -term compensated
absences should be only when absences have “fallen due” and are also “expected
to occur”. In other words, where employees are entitled to earned leave which can
be carried forward to future periods, the benefit would be a ‘short-term benefit’
provided the employee is entitled to either encash or utilise the benefit during
the twelve months after the end of the period when the employee became
entitled to the leave and is also expected to utilise the leave.

© The Institute of Chartered Accountants of India

 LIABILITIES BASED ACCOUNTING STANDARDS 6.11
6.11
v
v
Where there are restrictions on encashment and/or availment, clearly the v
compensated absence has not fallen due and the benefit of compensated v
absences is more likely to be a long-term benefit. For example, where an
employee has 100 days of earned leave which he is entitled to an unlimited carry
forward, but the rules of the enterprise allow him to encash/utilise only 30 days
during the next twelve months, the benefit would be considered as a ‘long-term’
benefit. In some situations, where there is no restriction but the absence is not
expected to wholly occur in the next twelve months, the benefit should be
considered as ‘long-term’. For example, where an employee has 400 days carry
forward earned leave and the past pattern indicates that the employees are
unlikely to avail / encash the entire carry forward during the next twelve months,
the benefit would not be ‘short-term’.
Whilst it is necessary to consider the earned leave which “falls due”, the pattern of
actual utilisation/encashment by employees, although reflective of the
behavioural pattern of employees, does determine the status of the benefit, i.e.,
whether ‘short-term’ or ‘long-term’. The value of short-term benefits should be
determined without discounting and if the benefit is determined as long-term, it
would be recognised and measured as “Other long-term benefits” in accordance
with paragraph 129 of the Standard.
The categorisation in ‘short-term’ or ‘long-term’ employee benefits should be
done on the basis of the overall behavioural pattern of all the employees of the
enterprise and not on individual basis.
Illustration 5
In case an enterprise allows unutilised employee benefits, e.g., medical care, leave
travel, etc., to be carried forward, whether it is required to recognise a provision in
respect of carried forward benefits.
Solution
A provision should be recognised for all benefits (conditional or unconditional)
which an employee becomes entitled to as a result of rendering of the service and
should be recorded as part of the cost of service rendered during the period in
which the service was rendered which resulted the entitlement. In estimating the
cost of such benefit the probability of the employee availing such benefit should
be considered.

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 6.12 ADVANCED ACCOUNTING
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v
v
1.5v POST EMPLOYMENT BENEFITS: DEFINED
CONTRIBUTION VS DEFINED BENEFITS
Multi-
employer

State Plan

Non-
Controlled

Insured
Funded
DCP
(Mostly)

Trust/legal
Controlled Entity

The accounting treatment and disclosures required for a post-employment

benefit plan depend upon whether it is a defined contribution or a defined
benefit plan. In addition to addressing defined contribution and defined benefit
plans generally, the Standard also gives guidance as to how its requirements
should be applied to insured benefits, multi-employment benefit plans.
1. Defined contribution plans (DCP) are post-employment benefit plans
under which an enterprise pays fixed contributions into a separate fund and
will have no obligation to pay further contributions. Under defined
contribution plans, actuarial risk (that benefits will be less than expected)
and investment risk (that assets invested will be insufficient to meet
expected benefits) fall on the employee. A common example of Defined
Contribution plans is Provident Fund.
2. Defined benefit plans are post-employment benefit plans other than
defined contribution plans. In defined benefits plans, the actuarial and
investment risk fall on the employer.

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 LIABILITIES BASED ACCOUNTING STANDARDS 6.13
6.13
v
v
In defined contribution plans, the contribution is charged to income statement,v
v
whereas in defined benefit plans, detailed actuarial calculation is performed to
determine the charge.

1.6 IS THE GRATUITY SCHEME A DEFINED

CONTRIBUTION OR DEFINED BENEFIT
SCHEME?
An enterprise may pay insurance premiums to fund a post-employment benefit
plan. The enterprise should treat such a plan as a defined contribution plan unless
the enterprise will have an obligation to either:
(a) pay the employee benefits directly when they fall due; or
(b) pay further amounts if the insurer does not pay all future employee benefits
relating to employee service in the current and prior periods.
On the asset side, a question arises as to whether the funds under the scheme as
certified by LIC would be treated as plan assets or reimbursement rights. The
distinction is important (though both are measured on fair valuation basis)
because plan assets are reduced from the defined benefit obligation and the net
amount is disclosed in the balance sheet, whereas, in the case of reimbursement
rights, the defined benefit obligation and the reimbursement rights are shown
separately as liability and asset on the balance sheet. This would have the impact
of making the balance sheet heavy both on the asset side as well as the liabilities
side.

1.7 ACCOUNTING TREATMENT

In the Balance Sheet of the enterprise, ‘the amount recognized as a defined
benefit liability should be the net total of the following amounts:

(a) the present value of the defined benefit obligation at the balance sheet
date;
(b) minus any past service cost not yet recognized;

(c) minus the fair value at the balance sheet date of plan assets (if any) out of
which the obligations are to be settled directly.’

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 6.14 ADVANCED ACCOUNTING
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v
v
In case where fair value of plan assets is high, it may so happen that the net
v
amount under defined benefit liability turns negative (giving rise to net assets).
AS 15 states that the enterprise, in such a situation, should measure the resulting
asset at the lower of:
(i) the amount so determined; and

(ii) the present value of any economic benefits available in the form of refunds
from the plan or reductions in future contributions to the plan.
The recognition of expenses relating to defined benefits in the Statement of Profit
and Loss is stated in Para 61 of the Standard. The Standard identifies seven
components of defined employee benefit costs:
(a) current service cost;

(b) interest cost;

(c) the expected return on any plan assets (and on any reimbursement rights);
(d) actuarial gains and losses (to the extent they are recognized);

(e) past service cost (to the extent they are recognized);
(f) the effect of any curtailments or settlements; and
(g) the extent to which the negative net amount of defined benefit liability
exceeds the amount mentioned in Para 59(b) of the Standard.
A settlement occurs when an employer enters into a transaction that eliminates all
further legal or constructive obligations for part or whole of the benefits provided
under a defined benefit plan. For example, the commuted portion of pension. A
curtailment occurs when an employer either commits to reduce the number of
employees covered by a plan or reduces the benefits under a plan. The gains or
losses on the settlement or curtailment of a defined benefit plan should be
recognized when the settlement or curtailment occurs.

1.8 DISCLOSURES
Where there is uncertainty about the number of employees who will accept an
offer of termination benefits, a contingent liability exists.

© The Institute of Chartered Accountants of India

 LIABILITIES BASED ACCOUNTING STANDARDS 6.15
6.15
v
v
v
As required by AS 29, "Provisions, Contingent Liabilities and Contingent Assets"
v
an enterprise discloses information about the contingent liability unless the
possibility of an outflow in settlement is remote.

As required by AS 5, "Net Profit or Loss for the Period, Prior Period items and
Changes in Accounting Policies" an enterprise discloses the nature and amount of
an expense if it is of such size, nature or incidence that its disclosure is relevant to
explain the performance of the enterprise for the period.

Termination benefits may result in an expense needing disclosure in order to

comply with this requirement.

Where required by AS 18, "Related Party Disclosures", an enterprise discloses

information about termination benefits for key management personnel.

When drafting AS 15 (revised), the Standard setters felt that merely on the basis
of a detailed formal plan, it would not be appropriate to recognise a provision
since a liability cannot be considered to be crystallized at this stage. AS 15
requires more certainty for recognition of termination cost, for example, if the
employee has sign up for the termination scheme.

1.9 ACTUARIAL ASSUMPTIONS

The actuarial assumptions should be unbiased and mutually compatible. They are
an enterprise’s best estimates of the variables that will determine the ultimate
cost of providing post-employment benefits. They should be neither imprudent
nor excessively conservative, and should reflect the economic relationships
between factors such as inflation, rates of salary increase, return on plan assets
and discount rates.
AS 15 explains that actuarial assumptions comprise:
(a) demographic assumptions about the future characteristics of current and
former employees (and their dependents) who are eligible for benefits.
Demographic assumptions deal with matters such as:
(i) mortality, both during and after employment;

(ii) rates of employee turnover, disability and early retirement;

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 6.16 ADVANCED ACCOUNTING
v
v
v
(iii) the proportion of plan members with dependents who will be eligible
v
for benefits;

(iv) claim rates under medical plans; and

(b) financial assumptions, dealing with items such as:
(i) the discount rate
(ii) future salary and benefit levels
(iii) in the case of medical benefits, future medical costs, including, where
material, the cost of administering claims and benefit payments and

(iv) the expected rate of return on plan assets.

Financial assumptions: Financial assumptions should be based on market
expectation at the balance sheet date for the period over which the post-
employment benefit obligations will be settled. Discount rates and other financial
assumptions should not be inflation-adjusted unless such measures are more
reliable (e.g. where benefits are index-linked)

1.10 ACTUARIAL GAINS AND LOSSES

Actuarial gains and losses comprise:
• experience adjustments (the effects of difference between the previous
actuarial assumptions and what has actually occurred); and
• the effects of changes in actuarial assumptions.
Actuarial gains and losses should be recognized immediately in the statement of
profit and loss as income or expense.
Illustration 6
Omega Limited belongs to the engineering industry. The company received an
actuarial valuation for the first time for its pension scheme which revealed a surplus
of ` 6 lakhs. It wants to spread the same over the next 2 years by reducing the
annual contribution to ` 2 lakhs instead of ` 5 lakhs. The average remaining life of
the employees is estimated to be 6 years. You are required to advise the company
on the following items from the viewpoint of finalization of accounts, taking note of
the mandatory accounting standards.

© The Institute of Chartered Accountants of India

 LIABILITIES BASED ACCOUNTING STANDARDS 6.17
6.17
v
v
Solution v
v
According to AS 15 (Revised 2005) ‘Employee Benefits’, actuarial gains and losses
should be recognized immediately in the statement of profit and loss as income
or expense. Therefore, surplus amount of ` 6 lakhs is required to be credited to
the profit and loss statement of the current year.
Illustration 7
As on 1 st April, 20X1 the fair value of plan assets was ` 1,00,000 in respect of a
pension plan of Zeleous Ltd. On 30 th September, 20X1 the plan paid out benefits of
` 19,000 and received inward contributions of ` 49,000. On 31 st March, 20X2 the
fair value of plan assets was ` 1,50,000 and present value of the defined benefit
obligation was ` 1,47,920. Actuarial losses on the obligations for the year 20X1-
20X2 were ` 600.
On 1st April, 20X1, the company made the following estimates, based on its market
studies, understanding and prevailing prices.

Interest & dividend income, after tax payable by the fund 9.25

Realised and unrealised gains on plan assets (after tax) 2.00

Fund administrative costs (1.00)
Expected Rate of Return 10.25

You are required to find the expected and actual returns on plan assets.
Solution
Computation of Expected and Actual Returns on Plan Assets

`
Return on ` 1,00,000 held for 12 months at 10.25% 10,250

Return on ` 30,000 (49,000-19,000) held for six months at 5%

(equivalent to 10.25% annually, compounded every six
1,500
months)
Expected return on plan assets for 20X1-20X2 11,750

© The Institute of Chartered Accountants of India

 6.18 ADVANCED ACCOUNTING
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v
v
Fair value of plan assets as on 31 March, 20X2 1,50,000
v
Less: Fair value of plan assets as on 1 April,20X1 1,00,000
Contributions received 49,000 (1,49,000)
1,000
Add: Benefits paid 19,000
Actual return on plan assets 20,000

Alternatively, the above question may be solved without giving compound effect
to rate of return.
Illustration 8
Rock Star Ltd. discontinues a business segment. Under the agreement with
employee’s union, the employees of the discontinued segment will earn no further
benefit. This is a curtailment without settlement, because employees will continue
to receive benefits for services rendered before discontinuance of the business
segment. Curtailment reduces the gross obligation for various reasons including
change in actuarial assumptions made before curtailment. If the benefits are
determined based on the last pay drawn by employees, the gross obligation reduces
after the curtailment because the last pay earlier assumed is no longer valid.
Rock Star Ltd. estimates the share of unamortized service cost that relates to the
part of the obligation at ` 18 (10% of ` 180). Calculate the gain from curtailment
and liability after curtailment to be recognised in the balance sheet of Rock Star
Ltd. on the basis of given information:
(a) Immediately before the curtailment, gross obligation is estimated at ` 6,000
based on current actuarial assumption.
(b) The fair value of plan assets on the date is estimated at ` 5,100.
(c) The unamortized past service cost is ` 180.

(d) Curtailment reduces the obligation by ` 600, which is 10% of the gross
obligation.

© The Institute of Chartered Accountants of India

 LIABILITIES BASED ACCOUNTING STANDARDS 6.19
6.19
v
v
Solution v
v
Gain from curtailment is estimated as under:

`
Reduction in gross obligation 600

Less: Proportion of unamortised past service cost (18)

Gain from curtailment 582

The liability to be recognised after curtailment in the balance sheet is estimated

as under:

`
Reduced gross obligation (90% of ` 6,000) 5,400
Less: Fair value of plan assets (5,100)
300
Less: Unamortised past service cost (90% of ` 180) (162)
Liability to be recognised in the balance sheet 138

Illustration 9
An employee Roshan has joined a company XYZ Ltd. in the year 20X1. The annual
emoluments of Roshan as decided is ` 14,90,210. The company also has a policy of
giving a lump sum payment of 25% of the last drawn annual salary of the
employee for each completed year of service if the employee retires after
completing minimum 5 years of service. The salary of the Roshan is expected to
grow @ 10% per annum.
The company has inducted Roshan in the beginning of the year and it is expected
that he will complete the minimum five year term before retiring. Thus he will get
5 yearly increment.
What is the amount the company should charge in its Profit and Loss account every
year as cost for the Defined Benefit obligation? Also calculate the current service
cost and the interest cost to be charged per year assuming a discount rate of 8%.
(P.V factor for 8% - 0.735, 0.794, 0.857, 0.926, 1)

© The Institute of Chartered Accountants of India

 6.20 ADVANCED ACCOUNTING
v
v
Solutionv
v
Calculation of Defined Benefit Obligation (DBO)

Expected last drawn salary = ` 14,90,210 x 110% x 110% x 110% x 110% x 110%
= ` 24,00,000
Defined Benefit Obligation (DBO) = ` 24,00,000 x 25% x 5 = ` 30,00,000
Amount of ` 6,00,000 will be charged to Profit and Loss Account of the company
every year as cost for Defined Benefit Obligation.
Calculation of Current Service Cost

Year Equal apportioned amount of Discounting @ Current service cost

DBO [i.e. ` 30,00,000/5 years] 8% PV factor
(Present Value)

a b c d=bxc
1 6,00,000 0.735 (4 Years) 4,41,000
2 6,00,000 0.794 (3 Years) 4,76,400
3 6,00,000 0.857 (2 Years) 5,14,200
4 6,00,000 0.926 (1 Year) 5,55,600
5 6,00,000 1 (0 Year) 6,00,000

Calculation of Interest Cost to be charged per year

Year Opening Interest Current Closing balance

balance cost service
cost

a b c = b x 8% d e=b+c+d

1 0 0 4,41,000 4,41,000
2 4,41,000 35,280 4,76,400 9,52,680
3 9,52,680 76,214 5,14,200 15,43,094
4 15,43,094 1,23,447 5,55,600 22,22,141
5 22,22,141 1,77,859* 6,00,000 30,00,000
*Due to approximations used in calculation, this figure is adjusted accordingly.

© The Institute of Chartered Accountants of India

 LIABILITIES BASED ACCOUNTING STANDARDS 6.21
6.21
v
v
v
1.11 OTHER LONG TERM EMPLOYEE BENEFITS v

Other long-term employee benefits include, for example:

(a) long-term compensated absences such as long-service or sabbatical leave;
(b) jubilee or other long-service benefits;
(c) long-term disability benefits;
(d) profit-sharing and bonuses payable twelve months or more after the end of
the period in which the employees render the related services and
(e) deferred compensation paid twelve months or more after the end of the
period in which it is earned.

1.12 TERMINATION BENEFITS

Termination Benefits are employee benefits payable as a result of either an
enterprise’s decision to terminate an employee’s employment before the normal
retirement date or an employee’s decision to accept voluntary redundancy in
exchange for those benefits (e.g., payments under VRS). Termination benefits are
recognized by an enterprise as a liability and an expense only when the enterprise
has
(i) a detailed formal plan for the termination which is duly approved, and
(ii) a reliable estimate can be made of the amount of the obligation.
Where the termination benefits fall due within twelve months after the balance
sheet date, an undiscounted amount of such benefits should be recognized as
liability in the balance sheet with a corresponding charge to Profit & Loss
Account. However, when the termination benefits fall due more than twelve
months after the balance sheet date, such benefits should be discounted using an
appropriate discount rate. Where an offer has been made to encourage voluntary
redundancy, the termination benefits should be measured by reference to the
number of employees expected to accept the offer. Where there is uncertainty
with regard to the number of employees who will accept an offer of voluntary
redundancy, a contingent liability exists and should be so disclosed as per AS 29
‘Provisions, Contingent Liabilities and Contingent Assets’.
Reference: The students are advised to refer the full text of AS 15
“Employee Benefits” (Revised 2005).

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 6.22 ADVANCED ACCOUNTING
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TEST YOUR KNOWLEDGE
Multiple Choice Questions
1. Gratuity and Pension would be examples of:
(a) Short-term employee benefits
(b) Long-term employee benefits
(c) Post-employment benefits.
(d) None of the above.
2. Non-accumulating compensating absence is commonly referred to as:
(a) Earned Leave

(b) Sick Leave

(c) Casual leave
(d) All of the above

3. The plans that are established by legislation to cover all enterprises and are
operated by Governments include:
(a) Multi-Employer plans
(b) State plans
(c) Insured Benefits
(d) Employee benefit plan

4. Best estimates of the variable to determine the eventual cost of post-

employment benefits is referred to as:
(a) Employer’s contribution

(b) Actuarial assumptions

(c) Cost to Company
(d) Employee’s contribution
5. Actuarial gains / losses should be:
(a) Recognised through reserves

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 LIABILITIES BASED ACCOUNTING STANDARDS 6.23
6.23
v
v
(b) Charged over the expected life of employees v
v
(c) Charged immediately to Profit and Loss Statement

(d) Do not charged to Profit and Loss Statement

Theoretical Questions
6. What are the types of Employees benefits and what is the objective of
Introduction of this Standard i.e. AS 15?

Scenario based Questions

7. 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.

8. The following data apply to ‘X’ Ltd. defined benefit pension plan for the year
ended 31.03.20X2 calculate the actual return on plan assets:

- Benefits paid 2,00,000

- Employer contribution 2,80,000

- Fair market value of plan assets on 31.03.20X2 11,40,000
- Fair market value of plan assets as on 31.03.20X1 8,00,000

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 6.24 ADVANCED ACCOUNTING
v
v
9. v
The fair value of plan assets of Anupam Ltd. was ` 2,00,000 in respect of
v
employee benefit pension plan as on 1 st April, 20X1. On 30 th September, 20X1
the plan paid out benefits of ` 25,000 and received inward contributions of
` 55,000. On 31 st March, 20X2 the fair value of plan assets was ` 3,00,000.
On 1st April, 20X1 the company made the following estimates, based on its
market studies and prevailing prices.

Interest and dividend income (after tax) payable by fund 10.25

Realized gains on plan assets (after tax) 3.00
Fund administrative costs (3.00)

Expected rate of return 10.25

Calculate the expected and actual returns on plan assets as on 31 st March,

20X2, as per AS 15.

ANSWERS/SOLUTIONS
Answer to the Multiple Choice Questions

1. (c) 2. (c) 3. (b) 4. (b) 5. (c)

Answer to the Theoretical Questions

6. There are four types of employee benefits according to AS 15 (Revised
2005). They are:

(a) short-term employee benefits, such as wages, salaries and social

security contributions (e.g., contribution to an insurance company by
an employer to pay for medical care of its employees), paid annual
leave, profit-sharing and bonuses (if payable within twelve months of
the end of the period) and non-monetary benefits (such as medical
care, housing, cars and free or subsidised goods or services) for
current employees;

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 LIABILITIES BASED ACCOUNTING STANDARDS 6.25
6.25
v
v
(b) v
post-employment benefits such as gratuity, pension, other retirement
v
benefits, post-employment life insurance and post-employment
medical care;
(c) other long-term employee benefits, including long-service leave or
sabbatical leave, jubilee or other long-service benefits, long-term
disability benefits and, if they are not payable wholly within twelve
months after the end of the period, profit-sharing, bonuses and
deferred compensation; and

(d) termination benefits.

Because each category identified in (a) to (d) above has different
characteristics, this Statement establishes separate requirements for
each category.
The objective of AS 15 is to prescribe the accounting and disclosure for
employee benefits. The statement requires an enterprise to recognise:

(a) a liability when an employee has provided service in exchange for

employee benefits to be paid in the future; and
(b) an expense when the enterprise consumes the economic benefit
arising from service provided by an employee in exchange for
employee benefits.

Answer to the Scenario based Questions

7. 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,

© The Institute of Chartered Accountants of India

 6.26 ADVANCED ACCOUNTING
v
v
v
(1) Settlement allowance payable by the company is a defined retirement
v
benefit, covered by AS 15 (Revised).

(2) A provision should be made every year in the accounts for the
accruing liability on account 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.

8.

Fair value of plan assets on 31.3.20X1 8,00,000

Add: Employer contribution 2,80,000

Less: Benefits paid (2,00,000)

(A) 8,80,000

Fair market value of plan assets at 31.3.20X2 (B) 11,40,000

Actual return on plan assets (B-A) 2,60,000

9. Computation of Expected Returns on Plan Assets as on 31st March, 20X2, as

per AS 15

Return on opening value of plan assets of ` 2,00,000 (held 20,500

for the year) @ 10.25%

Add: Return on net gain of ` 30,000 (i.e. ` 55,000 –

` 25,000) during the year i.e. held for six months @ 5% 1,500
(equivalent to 10.25% annually, compounded every six
months)

Expected return on plan assets as on 31 st March, 20X2 22,000

© The Institute of Chartered Accountants of India

 LIABILITIES BASED ACCOUNTING STANDARDS 6.27
6.27
v
v
Computation of Actual Returns on Plan Assets as on 31st March, 20X2, v
as per AS 15 v

` `
Fair value of Plan Assets as on 31 st March, 20X2 3,00,000

Less: Fair value of Plan Assets as on (2,00,000)

1st April, 20X1
Add: Contribution received as on 55,000 (2,55,000)
th
30 September, 20X1

45,000
Add: Benefits paid as on 30 th September, 20X1 25,000

Actual returns on Plan Assets as on 70,000

31st March, 20X2

© The Institute of Chartered Accountants of India

 6.28 ADVANCED ACCOUNTING
v
v
v
v
UNIT 2: AS 29 (REVISED)

PROVISIONS, CONTINGENT LIABILITIES AND

CONTINGENT ASSETS

LEARNING OUTCOMES
After studying this unit, you will be able to comprehend the –
 Meaning of ‘Executory contracts’, ‘Provision’, ‘Liability, Obligating
event’ and other related terms used in the standard;
 Need for recognition of provision;
 Definition of Present Obligation and Past Event;
 Probable Outflow of Resources Embodying Economic Benefits;
 Application of the Recognition and Measurement Rules;
 Disclosure requirements as per the Standard.

2.1 INTRODUCTION
AS 29 (Revised) came into effect in respect of accounting periods commenced on
or after 1-4-2004. The objective of AS 29 (Revised) is to ensure that appropriate
recognition criteria and measurement bases are applied to provisions and
contingent liabilities and sufficient information is disclosed in the notes to the
financial statements to enable users to understand their nature, timing and
amount. The objective of AS 29 (Revised) is also to lay down appropriate
accounting for contingent assets.
Companies would create provisions on arbitrary basis when profits in a particular
year is more and then reverse those provisions when profits are lower in
subsequent years. This would lead to manipulation of profits. This is popularly
known as ‘profit smoothing”.

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 LIABILITIES BASED ACCOUNTING STANDARDS 6.29
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Thus, there is a need for certain parameters on the basis of which provisions are
v
measured and recognised, as they impact both Profit and Loss Statement and v
Balance Sheet (creation of an expense and creation of a liability).
AS-29 prescribes the guidance in respect of recognition, measurement and
disclosures of provisions, contingent liabilities and contingent assets.

The standard clearly defines the role of management while making an estimate
for creating provisions and the auditors to vouch for the correctness or otherwise
of the estimate made by the management. This ensures that manipulations do
not take place at the time of creation of provisions.
Earlier, the companies were not recognising the liability on the ground of
uncertainty regarding its timing or amount. With the issuance of AS 29,
transactions which qualify for creating a provision need to be accounted for in the
Balance sheet as a liability.
Example 1
During 20X1, XY Enterprise has made lower amount of profits. However, to ensure
that the Earnings Per Share do not decline significantly, XY Enterprise does not
provide for a warranty amount which should have been provided for. XY is
confident of higher amount of profits during later years, and would like to take this
provision to the later stage. This ensures consistent performance for the company
throughout the period. With AS 29, this anomaly stands removed.
Example 2
During 20X1, AB Shops has made huge profits during a particular year. This may
have resulted in payment of taxes on these profits. Further, AB Shop’s management
foresees challenges in operations in later years, and therefore, low profits. AB Shop
did not create a provision during 20X2 which should have been otherwise made.
However, to get the desired impact, AB Shop created the provision in 20X1. Since,
the intention of management is not to reflect a true and fair view; AS-29 would
ensure appropriate provisions are made in 20X2 only.
AS 29 helps to ensure transparency of information in Financial Statements.

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Higher Lower
profits profits
Create provision Do not create
while it is not provision while
required it is required

Show high
Show less profits
profits and
and avoid taxes
higher EPS

Thus, an accounting standard on provisions is essential to rule out the potential

scope for companies to manipulate profits and provisions are made on valid
grounds (based on a recognition criterion being met).

2.2 SCOPE
AS 29 should be applied in accounting for provisions and contingent liabilities
and in dealing with contingent assets, other than:
a. Those resulting from financial instruments that are carried at fair value;
b. Those resulting from executory contracts except where the contract is
onerous;
c. Those arising in insurance enterprises from contracts with policy-holders;
and
d. Those covered by another Accounting Standard.
Where another Accounting Standard such as AS 7; AS 9; AS 15; AS 19 and AS 22
deals with a specific type of provision, contingent liability or contingent asset, an
enterprise applies that Standard instead of AS 29.

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2.3 DEFINITIONS
Executory contracts are contracts under which neither party has performed any
of its obligations or both parties have partially performed their obligations to an
equal extent.
A Provision is a liability which can be measured only by using a substantial
degree of estimation.
A Liability is a present obligation of the enterprise arising from past events, the
settlement of which is expected to result in an outflow from the enterprise of
resources embodying economic benefits.
An Obligating event is an event that creates an obligation that results in an
enterprise having no realistic alternative to settling that obligation.
A Contingent liability is:
(a) A possible obligation that arises from past events and the existence of
which will be confirmed only by the occurrence or non-occurrence of one or
more uncertain future events not wholly within the control of the enterprise;
or
(b) A present obligation that arises from past events but is not recognised
because:
(i) It is not probable that an outflow of resources embodying economic
benefits will be required to settle the obligation; or
(ii) A reliable estimate of the amount of the obligation cannot be made.
A Contingent asset is a possible asset that arises from past events the existence
of which will be confirmed only by the occurrence or non-occurrence of one or
more uncertain future events not wholly within the control of the enterprise.
Present obligation - an obligation is a present obligation if, based on the
evidence available, its existence at the balance sheet date is considered probable,
i.e., more likely than not.
Possible obligation - an obligation is a possible obligation if, based on the
evidence available, its existence at the balance sheet date is considered not
probable.

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A Restructuring is a programme that is planned and controlled by management,
v
and materially changes either:

(a) The scope of a business undertaken by an enterprise; or

(b) The manner in which that business is conducted.

2.4 RECOGNITION OF PROVISION

A provision should be recognised when:
(a) An enterprise has a present obligation as a result of a past event;
(b) It is probable that an outflow of resources embodying economic benefits
will be required to settle the obligation; and
(c) A reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision should be recognised.

2.5 PRESENT OBLIGATION

An enterprise determines whether a present obligation exists at the balance sheet
date by taking account of all available evidence, e.g., the opinion of experts.
Based on such evidence:
(a) Where it is more likely than not that a present obligation exists at the
balance sheet date, the enterprise recognises a provision (if the recognition
criteria are met); and
(b) Where it is more likely that no present obligation exists at the balance sheet
date, the enterprise discloses a contingent liability, unless the possibility of
an outflow of resources embodying economic benefits is remote.
Example 3
X Ltd sells refrigerators with a warranty of 6 months. The refrigerators would be
repaired free of cost by X Ltd. if some problem arises during the next 6 months of
sale. There is a present obligation for X Ltd because if some defect arises, X Ltd
would need to incur expenses on repairs of the refrigerator. Thus, a provision is
required to be made in the books of X Ltd.

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Example 4 v
Z Ltd takes a building on lease for 10 years. The terms of the contract provide that v
Z Ltd must vacate the building in its original condition. Z Ltd expects that there is a
likely cost of ` 10 lakhs to be spent at the end of 10 years for restoration. Since
there is a present obligation on X Ltd at the time of entering into the lease contract,
a provision to the extent of present value of this amount should be created.

2.6 PAST EVENT

A past event that leads to a present obligation is called an obligating event. For
an event to be an obligating event, it is necessary that the enterprise has no
realistic alternative to settling the obligation created by the event.
Financial statements deal with the financial position of an enterprise at the end of
its reporting period and not its possible position in the future.
Therefore, no provision is recognised for costs that need to be incurred to
operate in the future. The only liabilities recognised in an enterprise's balance
sheet are those that exist at the balance sheet date.
It is only those obligations arising from past events existing independently of an
enterprise's future actions (i.e. the future conduct of its business) that are
recognised as provisions.
Examples of such obligations are penalties or clean-up costs for unlawful
environmental damage, both of which would lead to an outflow of resources
embodying economic benefits in settlement regardless of the future actions of
the enterprise.
Similarly, an enterprise recognises a provision for the decommissioning costs of
an oil installation to the extent that the enterprise is obliged to rectify damage
already caused. In contrast, because of commercial pressures or legal
requirements, an enterprise may intend or need to carry out expenditure to
operate in a particular way in the future (for example, by fitting smoke filters in a
certain type of factory). Because the enterprise can avoid the future expenditure
by its future actions, for example by changing its method of operation, it has no
present obligation for that future expenditure and no provision is recognised.

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An event that does not give rise to an obligation immediately may do so at a later
v
date, because of changes in the law. For example, when environmental damage is
caused there may be no obligation to remedy the consequences. However, 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 finalized, an obligation arises
only when the legislation is virtually certain to be enacted.

2.7 PROBABLE OUTFLOW OF RESOURCES

EMBODYING ECONOMIC BENEFITS
For a liability to qualify for recognition there must be not only a present
obligation but also the probability of an outflow of resources embodying
economic benefits to settle that obligation.
For the purpose of AS 29, an outflow of resources or other event is regarded as
probable if the probability that the event will occur is greater than the probability
that it will not. Where it is not probable that a present obligation exists, an
enterprise discloses a contingent liability, unless the possibility of an outflow of
resources embodying economic benefits is remote.
Where there are a number of similar obligations (e.g., product warranties or
similar contracts) the probability that an outflow will be required in settlement is
determined by considering the class of obligations as a whole. Although the
likelihood of outflow for any one item may be small, it may well be probable that
some outflow of resources will be needed to settle the class of obligations as a
whole. If that is the case, a provision is recognized (if the other recognition
criteria are met).
Example 5
Kell Ltd sells laptops with a replacement warranty of 1 year. If something happens
to the laptop within 1 year of purchase, the company would replace the complete
laptop. A few laptops during past years have been replaced by Kell Ltd.
In the above situation, Kell Ltd would incur some expenses to replace a laptop, if
something goes wrong. There is an outflow of resources expected to settle the
obligation that arises by virtue of sale of laptop (past event).

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Example 6 v
v
AB Ltd has received a notice from one of the customers about health issues from
using the products of AB Ltd. The customer in the notice claims damages of
` 5,00,000.
The conditions of past event (i.e. sale of goods resulting in damage) and reliable
estimate ( ` 5,00,000) have been met. However, whether an outflow of resources will
be probable or not, cannot be confirmed since the customer may or may not win
the case. This would be clear only when the decision will be taken by the court.
Hence, in the above situation, no provision for damages will be made. However, a
disclosure of the case filed is required to be made.

2.8 RELIABLE ESTIMATE OF THE OBLIGATION

The use of estimates is an inherent part of preparing financial statements and
does not undermine their reliability. Provisions require a greater degree of
estimation than most other items, but AS 29 (Revised) emphasizes that it should
not be impossible to determine a range of possible outcomes and, from this
range, to reach an appropriate conclusion that is sufficiently reliable for the
provision to be recognized. AS 29 (Revised) concludes that the circumstances in
which it will not be possible to reach a reliable estimate, will be extremely rare.
In the extremely rare case where no reliable estimate can be made, a liability
exists that cannot be recognized. That liability will, instead, be disclosed as a
contingent liability.
For example: XYZ is in mining business. It is operating in a country where XYZ is
legally bound to clean and restore the environment on expiry of license after 10
years. XYZ can reliably estimate the amount required to restore the environment
caused by the mining business. Since it if a present obligation which cannot be
avoided resulted from past event, it is probable that resources will flow out of
business to settle the same and estimate can be measured reliably. XYZ is
required to recognize a provision for the same.

2.9 CONTINGENT LIABILITIES

An enterprise should not recognize a contingent liability but should be disclosed.
A contingent liability is disclosed, unless the possibility of an outflow of resources
embodying economic benefits is remote.

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Where anventerprise is jointly and severally liable for an obligation, the part of the
obligationv that is expected to be met by other parties is treated as a contingent
liability. The enterprise recognizes a provision for the part of the obligation for
which an outflow of resources embodying economic benefits is probable, except
in the extremely rare circumstances where no reliable estimate can be made.
Contingent liabilities may develop in a way not initially expected. Therefore, they are assessed
continually to determine whether an outflow of resources embodying economic benefits has
become probable. If it becomes probable that an outflow of future economic benefits will be
required for an item previously dealt with as a contingent liability, a provision is recognized in the
financial statements of the period in which the change in probability occurs.
Example: 7
A customer of XYZ has filed a case against them for providing them wrong product
and not returning the same. XYZ has taken legal advice from their lawyer who
believes it is not probable yet that resources may be required to settle the same.
Since it is not meeting all the criteria of provision, it will be treated as contingent
liability and will just be disclosed in the notes.
Decision tree

Start

Present obligation as No No
a result of an Possible
obligating event? Obligation

Yes
Yes
No Yes
Probable outflow Remote

Yes No
No (rare)
Reliable estimate

Yes
Disclose contingent Do nothing
Provide liability

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2.10 CONTINGENT ASSETS v
Contingent assets usually arise from unplanned or other unexpected events that
give rise to the possibility of an inflow of economic benefits to the enterprise. An
example is a claim that an enterprise is pursuing through legal processes, where
the outcome is uncertain.
An enterprise should not recognize a contingent asset, since this may result in the
recognition of income that may never be realized. However, when the realization
of income is virtually certain, then the related asset is not a contingent asset and
its recognition is appropriate. A contingent asset is not disclosed in the financial
statements. It is usually disclosed in the report of the approving authority (Board
of Directors in the case of a company, and, the corresponding approving
authority in the case of any other enterprise), where an inflow of economic
benefits is probable.
Contingent assets are assessed continually and if it has become virtually certain
that an inflow of economic benefits will arise, the asset and the related income
are recognized in the financial statements of the period in which the change
occurs.

Table- Provisions and contingent liabilities

Where, as a result of past events, there may be an outflow of resources

embodying future economic benefits in settlement of: (a) a present
obligation the one whose existence at the balance sheet date is considered
probable; or (b) a possible obligation the existence of which at the balance
sheet date is considered not probable.

There is a present There is a possible There is a possible

obligation that probably obligation or a present obligation or a present
requires an outflow of obligation that may, but obligation where the
resources and a reliable probably will not, require likelihood of an outflow of
estimate can be made of an outflow of resources. resources is remote.
the amount of
obligation.

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Provisionv is recognised. No provision is No provision is
v
recognised. recognised.
Disclosures are required
for the provision. Disclosures are required No disclosure is required.
for the contingent
liability.

2.11 MEASUREMENT: BEST ESTIMATE

The amount recognised as a provision should be the best estimate of the
expenditure required to settle the present obligation at the balance sheet date.
The estimates of outcome and financial effect are determined by:
• the judgment of the management of the enterprise,

• supplemented by experience of similar transactions and,

• in some cases, reports from independent experts.
The amount of a provision should not be discounted to its present value except in
case of decommissioning, restoration and similar liabilities that are recognised as
cost of Property, Plant and Equipment.
The discount rate (or rates) should be a pre-tax rate (or rates) that reflect(s)
current market assessments of the time value of money and the risks specific to
the liability. The discount rate(s) should not reflect risks for which future cash
flow estimates have been adjusted. Periodic unwinding of discount should be
recognised in the statement of profit and loss.
The provision is measured before tax; the tax consequences of the provision, and
changes in it, are dealt with under AS 22.

2.12 RISKS AND UNCERTAINTIES

The risks and uncertainties that inevitably surround many events and
circumstances should be taken into account in reaching the best estimate of a
provision.

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2.13 FUTURE EVENTS v
It is only those obligations arising from past events that exist independently of
the enterprise’s future actions (i.e. the future conduct of its business) that are
recognized as provisions.
Future events that may affect the amount required to settle an obligation should
be reflected in the amount of a provision where there is sufficient objective
evidence that they will occur.
For example, an enterprise may believe that the cost of cleaning up a site at the
end of its life will be reduced by future changes in technology. The amount
recognized reflects a reasonable expectation of technically qualified, objective
observers, taking account of all available evidence as to the technology that will
be available at the time of the clean-up. Thus, it is appropriate to include, for
example, expected cost reductions associated with increased experience in
applying existing technology or the expected cost of applying existing technology
to a larger or more complex clean-up operation than has previously been carried
out. However, an enterprise does not anticipate the development of a completely
new technology for cleaning up unless it is supported by sufficient objective
evidence.
The effect of possible new legislation is taken into consideration in measuring an
existing obligation when sufficient objective evidence exists that the legislation is
virtually certain to be enacted. The variety of circumstances that arise in practice
usually makes it impossible to specify a single event that will provide sufficient,
objective evidence in every case. Evidence is required both of what legislation will
demand and of whether it is virtually certain to be enacted and implemented in
due course. In many cases sufficient objective evidence will not exist until the new
legislation is enacted.

2.14 EXPECTED DISPOSAL OF ASSETS

Gains on the expected disposal of assets are not taken into account in measuring
a provision, even if the expected disposal is closely linked to the event giving rise
to the provision. Instead, an enterprise recognizes gains on expected disposals of
assets at the time specified by the Accounting Standard dealing with the assets
concerned.

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2.15
v REIMBURSEMENTS

An enterprise with a present obligation may be able to seek reimbursement of

part or all of the expenditure from another party, for example via:
• An insurance contract arranged to cover a risk;
• An indemnity clause in a contract; or
• A warranty provided by a supplier.
The basis underlying the recognition of a reimbursement is that any asset arising
is separate from the related obligation. Consequently, such a reimbursement
should be recognized only when it is virtually certain that it will be received
consequent upon the settlement of the obligation.
In most cases, the enterprise will remain liable for the whole of the amount in
question so that the enterprise would have to settle the full amount if the third
party failed to pay for any reason. In this situation, a provision is recognized for
the full amount of the liability, and a separate asset for the expected
reimbursement is recognized when it is virtually certain that reimbursement will
be received if the enterprise settles the liability.
In some cases, the enterprise will not be liable for the costs in question if the third
party fails to pay. In such a case, the enterprise has no liability for those costs and
they are not included in the provision.

2.16 TABLE- REIMBURSEMENTS

Some or all of the expenditure required to settle a provision is expected to
be reimbursed by another party.

The enterprise has The obligation for the The obligation for the
no obligation for the amount expected to be amount expected to be
part of the reimbursed remains with reimbursed remains with the
expenditure to be the enterprise and it is enterprise and the
reimbursed by the virtually certain that reimbursement is not
other party. reimbursement will be virtually certain if the
received if the enterprise enterprise settles the
settles the provision. provision.

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The enterprise has The reimbursement is The expected reimbursementv
no liability for the recognized as a separate is not recognized as an asset.v
amount to be asset in the balance
reimbursed. sheet and may be offset
against the expense in
the statement of profit
and loss. The amount
recognized for the
expected reimbursement
does not exceed the
liability.

No disclosure is The reimbursement is The expected reimbursement

required. disclosed together with is disclosed.
the amount recognized
for the reimbursement.

2.17 CHANGES IN PROVISIONS

Provisions should be reviewed at each balance sheet date and adjusted to reflect
the current best estimate. If it is no longer probable that an outflow of resources
embodying economic benefits will be required to settle the obligation, the
provision should be reversed.

2.18 USE OF PROVISIONS

A provision should be used only for expenditures for which the provision was
originally recognized. Only expenditures that relate to the original provision are
adjusted against it. Adjusting expenditures against a provision that was originally
recognized for another purpose would conceal the impact of two different events.

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2.19
v APPLICATION OF THE RECOGNITION AND

MEASUREMENT RULES
2.19.1 Future Operating Losses
Future operating losses do not meet the definition of a liability and the general
recognition criteria; therefore, provisions should not be recognized for future
operating losses.

2.19.2 Restructuring
The following are examples of events that may fall under the definition of
restructuring:
(a) Sale or termination of a line of business

(b) The closure of business locations in a country or region or the relocation of

business activities from one country or region to another
(c) Changes in management structure, for example, eliminating a layer of
management
(d) Fundamental re-organizations that have a material effect on the nature and
focus of the enterprise's operations

A provision for restructuring costs is recognized only when the recognition

criteria for provisions are met. No obligation arises for the sale of an operation
until the enterprise is committed to the sale, i.e., there is a binding sale
agreement. Until there is a binding sale agreement, the enterprise will be able to
change its mind and indeed will have to take another course of action if a
purchaser cannot be found on acceptable terms.

A restructuring provision should include only the direct expenditures arising from
the restructuring, which are those that are both:
(a) Necessarily entailed by the restructuring; and

(b) Not associated with the ongoing activities of the enterprise.

A restructuring provision does not include such costs as:
(a) Retraining or relocating continuing staff;

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(b) Marketing; or v
(c) Investment in new systems and distribution networks. v

These expenditures relate to the future conduct of the business and are not
liabilities for restructuring at the balance sheet date. Such expenditures are
recognized on the same basis as if they arose independently of a restructuring.

Identifiable future operating losses up to the date of a restructuring are not

included in a provision.
Gains on the expected disposal of assets are not taken into account in measuring
a restructuring provision, even if the sale of assets is envisaged as part of the
restructuring.

2.20 DISCLOSURE
For each class of provision, an enterprise should disclose:
(a) The carrying amount at the beginning and end of the period;
(b) Additional provisions made in the period, including increases to existing
provisions;
(c) Amounts used (i.e., incurred and charged against the provision) during the
period; and
(d) Unused amounts reversed during the period.

Note: SMCs are exempt from the above disclosure requirements of AS 29

(Revised)

An enterprise should disclose the following for each class of provision:

(a) A brief description of the nature of the obligation and the expected timing
of any resulting outflows of economic benefits;

(b) An indication of the uncertainties about those outflows. Where necessary to

provide adequate information, an enterprise should disclose the major
assumptions made concerning future events, and
(c) The amount of any expected reimbursement, stating the amount of any
asset that has been recognized for that expected reimbursement.

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Note: SMCs are exempt from the above disclosure requirements of AS 29
v
(Revised)

Unless the possibility of any outflow in settlement is remote, an enterprise should

disclose for each class of contingent liability at the balance sheet date a brief
description of the nature of the contingent liability and, where practicable:

(a) An estimate of its financial effect,

(b) An indication of the uncertainties relating to any outflow; and
(c) The possibility of any reimbursement.

Where any of the information required by above paragraph is not disclosed

because it is not practicable to do so, that fact should be stated.
In extremely rare cases, disclosure of some or all of the information required by
AS 29 can be expected to prejudice seriously the position of the enterprise in a
dispute with other parties on the subject matter of the provision or contingent
liability. In such cases, an enterprise need not disclose the information, but should
disclose the general nature of the dispute, together with the fact that, and reason
why, the information has not been disclosed.
Illustration 1
At the end of the financial year ending on 31st December, 20X1, a company finds
that there are twenty law suits outstanding which have not been settled till the date
of approval of accounts by the Board of Directors. The possible outcome as
estimated by the Board is as follows:

Probability Loss (` )
In respect of five cases (Win) 100% −
Next ten cases (Win) 50% −
Lose (Low damages) 40% 1,20,000
Lose (High damages) 10% 2,00,000
Remaining five cases
Win 50% −
Lose (Low damages) 30% 1,00,000
Lose (High damages) 20% 2,10,000

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Outcome of each case is to be taken as a separate entity. Ascertain the amount of
v
contingent loss and the accounting treatment in respect thereof. v
Solution
According to AS 29 (Revised) ‘Provisions, Contingent Liabilities and Contingent
Assets’, contingent liability should be disclosed in the financial statements if
following conditions are satisfied:
(i) There is a present obligation arising out of past events but not recognized
as provision.

(ii) It is not probable that an outflow of resources embodying economic

benefits will be required to settle the obligation.
(iii) The possibility of an outflow of resources embodying economic benefits is
not remote.
(iv) The amount of the obligation cannot be measured with sufficient reliability
to be recognized as provision.

In this case, the probability of winning of first five cases is 100% and hence,
question of providing for contingent loss does not arise. The probability of
winning of next ten cases is 50% and for remaining five cases is 50%. As per AS
29 (Revised), we make a provision if the loss is probable. As the loss does not
appear to be probable and the possibility of an outflow of resources embodying
economic benefits is remote, therefore disclosure by way of note should be made.
For the purpose of the disclosure of contingent liability by way of note, amount
may be calculated as under:
Expected loss in next ten cases = 40% of ` 1,20,000 + 10% of ` 2,00,000

= ` 48,000 + ` 20,000 = ` 68,000

Expected loss in remaining five cases = 30% of ` 1,00,000 + 20% of ` 2,10,000
= ` 30,000 + ` 42,000 = ` 72,000

To disclose contingent liability on the basis of maximum loss will be highly

unrealistic. Therefore, the better approach will be to disclose the overall expected
loss of ` 10,40,000 (` 68,000  10 + ` 72,000  5) as contingent liability.

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Illustration
v
EXOX Ltd. is in the process of finalising its accounts for the year ended 31 st March,
20X2. The company seeks your advice on the following:
(i) The Company’s sales tax assessment for assessment year 20X1-X2 has been
completed on 14 th February, 20X4 with a demand of ` 2.76 crore. The
company paid the entire due under protest without prejudice to its right of
appeal. The Company files its appeal before the appellate authority wherein
the grounds of appeal cover tax on additions made in the assessment order
for a sum of 2.10 crore.
(ii) The Company has entered into a wage agreement in May, 20X2 whereby the
labour union has accepted a revision in wage from June, 20X1. The
agreement provided that the hike till May, 20X2 will not be paid to the
employees but will be settled to them at the time of retirement. The company
agrees to deposit the arrears in Government Bonds by September, 20X2.
Solution
(i) Since the company is not appealing against the addition of ` 0.66 crore the
same should be provided for in its accounts for the year ended on
31st March, 20X4. The amount paid under protest can be kept under the
heading ‘Loans & Advances’ and disclosed as a contingent liability of
` 2.10 crore.
(ii) The arrears for the period from June, 20X1 to March, 20X2 are required to
be provided for in the accounts of the company for the year ended on
31st March, 20X2.

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 LIABILITIES BASED ACCOUNTING STANDARDS 6.47
6.47
v
v
TEST YOUR KNOWLEDGE v
v
Multiple Choice Questions
1. Which of the following best describes a provision?
(a) A provision is a liability of uncertain timing or amount.
(b) A provision is a possible obligation of uncertain timing.
(c) A provision is a credit balance set up to offset a contingent asset so that
the effect on the statement of financial position is nil.
(d) A provision is a possible obligation of uncertain amount.
2. X Co is a business that sells second hand cars. If a car develops a fault within
30 days of the sale, X Co will repair it free of charge. At 1 st March 20X1, X Co
had made a provision for repairs of ` 25,000. At 31 st March 20X1, X Co
calculated that the provision should be ` 20,000. What entry should be made
for the provision in X Co's income statement for the month 31 st March 20X1?
(a) A charge of ` 5,000
(b) A credit of ` 5,000
(c) A charge of ` 20,000
(d) A credit of ` 25,000
3. Which of the following item does the statement below describe?
“A possible obligation that arises from past events and whose existence will
be confirmed only by the occurrence or non-occurrence of one or more
uncertain future events not wholly within the entity's control”
(a) A provision
(b) A current liability
(c) A contingent liability
(d) Deferred tax liability
4. Z Ltd has commenced a legal action against Y Ltd claiming substantial
damages for supply of a faulty product. The lawyers of Y Ltd have advised
that the company is likely to lose the case, although the chances of paying the
claim is not remote. The estimated potential liability estimated by the lawyers
are:

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v
v
v
Legal cost (to be incurred irrespective of the outcome of the case) ` 50,000
v
Settlement if the claim is required to be paid ` 5,00,000

What is the appropriate accounting treatment in the books of Z Ltd.?

(a) Create a Provision of ` 5,50,000
(b) Make a Disclosure of a contingent liability of ` 5,50,000
(c) Create a Provision of ` 50,000 and make a disclosure of contingent
liability of ` 5,00,000
(d) Create a Provision of ` 5,00,000

Theoretical Questions
5. When should provision be recognized as per provisions of AS 29? Explain in brief.

Scenario based Questions

6. Sun Ltd. has entered into a sale contract of ` 5 crores with X Ltd. during
20X1-20X2 financial year. The profit on this transaction is ` 1 crore. The
delivery of goods to take place during the first month of 20X2-20X3 financial
year. In case of failure of Sun Ltd. to deliver within the schedule, a
compensation of ` 1.5 crores is to be paid to X Ltd. Sun Ltd. planned to
manufacture the goods during the last month of 20X1-20X2 financial year.
As on balance sheet date (31.3.20X2), the goods were not manufactured, and
it was unlikely that Sun Ltd. will be able to meet the contractual obligation.
(i) Should Sun Ltd. provide for contingency as per AS 29?
(ii) Should provision be measured as the excess of compensation to be paid
over the profit?
7. 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?
8. A Ltd. provides after sales warranty for two years to its customers. Based on
past experience, the company has the following policy for making provision
for warranties on the invoice amount, on the remaining balance warranty
period.

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 LIABILITIES BASED ACCOUNTING STANDARDS 6.49
6.49
v
v
Less than 1 year: 2% provision v
More than 1 year: 3% provision v

The company has raised invoices as under :

Invoice Date Amount (`)
11th Feb, 20X0 60,000
25th Dec, 20X0 40,000
04th Oct, 20X1 1,35,000
Calculate the provision to be made for warranty under AS-29 as at 31st March,
20X1 and 31st March, 20X2. Also compute amount to be debited to P & L
account for the year ended 31 st March, 20X2.

ANSWERS/SOLUTIONS
Answer to the Multiple Choice Questions
1. (a) 2. (b) 3. (c) 4. (c)

Answer to the Theoretical Questions

5. A provision should be recognised only when: (a) An enterprise has a present
obligation as a result of a past event; (b) It is probable that an outflow of
resources embodying economic benefits will be required to settle the
obligation; and (c) A reliable estimate can be made of the amount of the
obligation.

Answer to the Scenario based Questions

6. (i) AS 29 “Provisions, Contingent Liabilities and Contingent Assets” provides
that when an enterprise has a present obligation, as a result of past
events, that probably requires an outflow of resources and a reliable
estimate can be made of the amount of obligation, a provision should be
recognized. Sun Ltd. has the obligation to deliver the goods within the
scheduled time as per the contract. It is probable that Sun Ltd. will fail to
deliver the goods within the schedule and it is also possible to estimate
the amount of compensation. Therefore, Sun Ltd. should provide for the
contingency amounting ` 1.5 crores as per AS 29.

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v
v
(ii) v Provision should not be measured as the excess of compensation to be
v paid over the profit. The goods were not manufactured before
31st March, 20X2 and no profit had accrued for the financial year
20X1-20X2. Therefore, provision should be made for the full amount of
compensation amounting ` 1.50 crores.
7. 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.
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.
8. Provision to be made for warranty under AS 29 ‘Provisions, Contingent
Liabilities and Contingent Assets’
As at 31 st March, 20X1 = ` 60,000 x .02 + ` 40,000 x .03
= ` 1,200 + ` 1,200 = ` 2,400
st
As at 31 March, 20X2 = ` 40,000 x .02 + ` 1,35,000 x .03
= ` 800 + ` 4,050 = ` 4,850
Amount debited to Profit and Loss Account for year ended 31 st March,
20X2

`
Balance of provision required as on 31.03.20X2 4,850
Less: Opening Balance as on 1.4.20X1 (2,400)
Amount debited to profit and loss account 2,450

Note: No provision will be made on 31 st March, 20X2 in respect of sales

amounting ` 60,000 made on 11 th February, 20X0 as the warranty period of
2 years has already expired.

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 CHAPTER a
7
CHAPTER
ACCOUNTING STANDARDS
BASED ON ITEMS
IMPACTING FINANCIAL
STATEMENTS
UNIT 1: ACCOUNTING STANDARD 4
CONTINGENCIES AND EVENTS OCCURRING
AFTER THE BALANCE SHEET DATE

LEARNING OUTCOMES
After studying this unit, you will be able to elucidate the –
 Meaning of Contingencies and accounting treatment of contingent
gains and contingent losses.
 Events Occurring after the Balance Sheet Date: Adjusting and
Non-adjusting events
 Necessary Disclosures required as per the standard.

1.1 INTRODUCTION
All paragraphs of AS 4 (Revised) that deal with contingencies are applicable only
to the extent not covered by other Accounting Standards prescribed by the
Central Government. For example, the impairment of financial assets such as
impairment of receivables (commonly known as provision for bad and doubtful
debts) is governed by this Standard. Thus, the present standard (AS 4 (Revised))

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deals with the treatment and disclosure requirements in the financial statements
of events occurring after the balance sheet.

1.2 CONTINGENCIES
Contingency is a condition or situation, the ultimate outcome of which, gain or
loss, will be known or determined only on the occurrence, or non-occurrence, of
one or more uncertain future events.

Accounting Treatment of Contingent Losses

The accounting treatment of a contingent loss is determined by the expected
outcome of the contingency. If it is likely that a contingency will result in a loss to
the enterprise, then it is prudent to provide for that loss in the financial
statements.

Example: ABC has filed case against a debtor for a recovery of ` 25 Lakhs.
According to the legal team, the chances of recovery is nil. Therefore, ABC should
make provision for doubtful debt.

The estimation of the amount of a contingent loss to be provided for in the

financial statements, may be based on judgement made, by the management. If
there is conflicting or insufficient evidence for estimating the amount of a
contingent loss, then disclosure is made of the existence and nature of the
contingency.

The estimates of the outcome and of the financial effect of contingencies are
determined by the judgment of the management of the enterprise. This judgment
is based on consideration of the information available up to the date on which
the financial statements are approved and will include a review of events
occurring after the balance sheet date, supplemented by experience of similar
transactions and, in some cases, reports from independent experts.

The existence and amount of guarantees, obligations arising from discounted bills
of exchange and similar obligations undertaken by an enterprise are generally
disclosed in financial statements by way of note, even though the possibility that
a loss to the enterprise will occur, is remote.

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Accounting Treatment of Contingent Gains

Contingent gains are not recognised in financial statements since their
recognition may result in the recognition of revenue which may never be realised.
However, when the realisation of a gain is virtually certain, then such gain is not a
contingency and accounting for the gain is appropriate.

The amount at which a contingency is stated in the financial statements is based

on the information which is available at the date on which the financial
statements are approved.

1.3 EVENTS OCCURRING AFTER THE BALANCE

SHEET DATE
Events occurring after the balance sheet date are those significant events, both
favourable and unfavourable, that occur between the balance sheet date and the
date on which the financial statements are approved by the Board of Directors in
the case of a company, and, by the corresponding approving authority in the case
of any other entity.

For example, for the year ending on 31 st March 20X1, financial statement is
finalized and approved by the Board of the directors of the company in its
meeting held on 04 th September 20X1. In this case the events taking place
between 01st April 20X1 to 04 th September 20X1 are termed as events occurring
after the balance sheet date.

Two types of events can be identified:

a. Adjusting events- those which provide further evidence of conditions that

existed at the balance sheet date. For example, a trade receivable declared
insolvent after reporting date and unable to pay full amount against whom
provision for doubtful debt was created.

b. Non-adjusting events- those which are indicative of conditions that arose

subsequent to the balance sheet date. For example, plant got damaged due
to occurrence of fire.

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1.4 ADJUSTING EVENTS

Adjustments to assets and liabilities are required for events occurring after the
balance sheet date that provide additional information materially affecting the
determination of the amounts relating to conditions existing at the balance sheet
date. For example, an adjustment may be made for a loss on a trade receivable
account which is confirmed by the insolvency of a customer which occurs after
the balance sheet date.

1.5 NON-ADJUSTING EVENTS

Adjustments to assets and liabilities are not appropriate for events occurring after
the balance sheet date, if such events do not relate to conditions existing at the
balance sheet date. An example is the decline in market value of investments
between the balance sheet date and the date on which the financial statements
are approved. Ordinary fluctuations in market values do not normally relate to the
condition of the investments at the balance sheet date but reflect circumstances
which have occurred in the following period.

Events occurring after the balance sheet date which do not affect the figures
stated in the financial statements would not normally require disclosure in the
financial statements although they may be of such significance that they may
require a disclosure in the report of the approving authority to enable users of
financial statements to make proper evaluations and decisions.

Dividend declared after balance sheet date

There are events which, although take place after the balance sheet date, are
sometimes reflected in the financial statements because of statutory requirements
or because of their special nature. For example, if dividends are declared after the
balance sheet date but before the financial statements are approved, the
dividends are not recognised as a liability at the balance sheet date because no
obligation exists at that time unless a statute requires otherwise. Such dividends
are disclosed in the notes. Thus, no liability for proposed dividends needs to be
recognised in the financial statements for financial year ended 31 st March, 2017

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and subsequent years. Such proposed dividends are to be disclosed in the notes
as per Companies (Accounting Standards) Amendment Rules, 2016 issued on 30
March 2016.

Events indicating going concern assumption inappropriate

Events occurring after the balance sheet date may indicate that the enterprise
ceases to be a going concern. A deterioration in operating results and financial
position, or unusual changes affecting the existence or substratum of the
enterprise after the balance sheet date (e.g., destruction of a major production
plant by a fire after the balance sheet date) may indicate a need to consider
whether it is proper to use the fundamental accounting assumption of going
concern in the preparation of the financial statements. In case the going concern
assumption is not valid (based on events occurring after the balance sheet date),
the financial statements are prepared on a liquidation basis.

Event occuring after the Balance

Sheet date

Evidence of such condition No evidence of such condition

been existed at the Balance been existed at the Balance
Sheet date Sheet date

Adjusting event Non-adjusting event

Adjustment to assets and Adjustment to assets and

liabilities is required liabilities is not required

Disclosure in the report of

Disclosure in the financial
the approving authority is
statements is required
required

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1.6 DISCLOSURE
Disclosure of events occurring after the balance sheet date requires the following
information be provided in the financial statements:
(a) The nature of the event;
(b) An estimate of the financial effect, or a statement that such an estimate
cannot be made.
Example
A company follows April-March as its financial year. The company recognises
cheques dated 31 st March or before, received from customers after the balance
sheet date but before approval of financial statement by debiting Cheques in hand
A/c and crediting the Debtors A/c. The Cheques in hand are shown in the balance
sheet as an item of cash and cash equivalents. All Cheques in hand are presented to
bank in the month of April and are also realised in the same month in the normal
course after deposit in the bank.
Even if the cheques bear the date 31 st March or before, the cheques received after
31st March do not represent any condition existing on 31 st March. Thus the
collection of cheques after balance sheet date is not an adjusting event. Recognition
of cheques in hand is therefore not consistent with the requirements of AS 4
(Revised). Moreover, the collection of cheques after balance sheet date does not
represent any material change or commitments affecting financial position of the
enterprise, and so no disclosure of such collections in the Directors’ Report is
necessary.
It should also be noted that, the Framework for Preparation and Presentation of
Financial Statement defines assets as resources controlled by an enterprise as a
result of past events from which economic benefits are expected to flow to the
enterprise. Since the company acquires custody of the cheques after 31 st March, it
does not have any control over the cheques on 31 st March and hence cheques in
hand do not qualify to be recognised as asset on 31 st March.
Illustration 1
In X Co. Ltd., theft of cash of ` 5 lakhs by the cashier in January, 20X1 was detected
only in May, 20X1. The accounts of the company were not yet approved by the
Board of Directors of the company.

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Decide whether the theft of cash has to be adjusted in the accounts of the company
for the year ended 31.3.20X1.
Solution
As per AS 4 (Revised) ‘Contingencies and Events occurring after the Balance Sheet
Date’, an event occurring after the balance sheet date may require adjustment to
the reported amounts of assets, liabilities, expenses or incomes.
If a fraud of the accounting period is detected after the balance sheet date but
before approval of the financial statements, it is necessary to recognise the loss
amounting ` 5,00,000 and adjust the accounts of the company for the year ended
31st March, 20X1.
Illustration 2
An earthquake destroyed a major warehouse of ACO Ltd. on 20.5.20X2. The
accounting year of the company ended on 31.3.20X2. The accounts were approved
on 30.6.20X2. The loss from earthquake is estimated at ` 30 lakhs. State with
reasons, whether the loss due to earthquake is an adjusting or non-adjusting event
and how the fact of loss is to be disclosed by the company.
Solution
AS 4 (Revised) “Contingencies and Events Occurring after the Balance Sheet Date”,
states that adjustments to assets and liabilities are not appropriate for events
occurring after the balance sheet date, if such events do not relate to conditions
existing at the balance sheet date. The destruction of warehouse due to
earthquake did not exist on the balance sheet date i.e. 31.3.20X2. Therefore, loss
occurred due to earthquake is not to be recognised in the financial year 20X1-
20X2.
However, according to the standard, unusual changes affecting the existence or
substratum of the enterprise after the balance sheet date may indicate a need to
consider the use of fundamental accounting assumption of going concern in the
preparation of the financial statements. As per the information given in the
question, the earthquake has caused major destruction; therefore, fundamental
accounting assumption of going concern would have to be evaluated.
Considering that the going concern assumption is still valid, the fact of
earthquake together with an estimated loss of ` 30 lakhs should be disclosed in

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the report of the approving authority for financial year 20X1-X2 to enable users of
financial statements to make proper evaluations and decisions.
Illustration 3
A company has filed a legal suit against the debtor from whom ` 15 lakh is
recoverable as on 31.3.20X1. The chances of recovery by way of legal suit are not
good as per legal opinion given by the counsel in April, 20X1. Can the company
provide for full amount of ` 15 lakhs as provision for doubtful debts? Discuss.

Solution
As per AS 4 (Revised) “Contingencies and Events Occurring After the Balance
Sheet Date”, assets and liabilities should be adjusted for events occurring after
the balance sheet date that provide additional evidence to assist the estimation of
amounts relating to conditions existing at the balance sheet date. In the given
case, company should make the provision for doubtful debts, as legal suit has
been filed on 31st March, 20X1 and the chances of recovery from the suit are not
good. Though, the actual result of legal suit will be known in future yet situation
of non-recovery from the debtors exists before finalisation of financial
statements. Therefore, provision for doubtful debts should be made for the year
ended on 31st March, 20X1.

Illustration 4
In preparing the financial statements of R Ltd. for the year ended 31st March, 20X1,
you come across the following information. State with reasons, how you would deal
with this in the financial statements:

The company invested 100 lakhs in April, 20X1 before approval of Financial
Statements by the Board of directors in the acquisition of another company doing
similar business, the negotiations for which had started during the year.
Solution
AS 4 (Revised) defines "Events Occurring after the Balance Sheet Date" as those
significant events, both favourable and unfavourable, that occur between the
balance sheet date and the date on which the financial statements are approved
by the Approving Authority in the case of a company. Accordingly, the acquisition
of another company is an event occurring after the balance sheet date. However,

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no adjustment to assets and liabilities is required as the event does not affect the
determination and the condition of the amounts stated in the financial statements
for the year ended 31st March, 20X1. The disclosure should be made in the
report of the approving authority of those events occurring after the balance
sheet date that represent material changes and commitments affecting the
financial position of the enterprise, the investment of ` 100 lakhs in April, 20X1
for the acquisition of another company should be disclosed in the report of the
Approving Authority to enable users of financial statements to make proper
evaluations and decisions.
Illustration 5
A Limited Company closed its accounting year on 30.6.20X1 and the accounts for
that period were considered and approved by the board of directors on 20th August,
20X1. The company was engaged in laying pipeline for an oil company deep
beneath the earth. While doing the boring work on 1.9.20X1 it had met a rocky
surface for which it was estimated that there would be an extra cost to the tune of
` 80 lakhs. You are required to state with reasons, how the event would be dealt
with in the financial statements for the year ended 30.6.20X1.
Solution
AS 4 (Revised) on Contingencies and Events Occurring after the Balance Sheet
Date defines 'events occurring after the balance sheet date' as 'significant events,
both favourable and unfavourable, that occur between the balance sheet date
and the date on which financial statements are approved by the Board of
Directors in the case of a company'. The given case is discussed in the light of the
above-mentioned definition and requirements given in AS 4 (Revised). In this case
the incidence, which was expected to push up cost, became evident after the date
of approval of the accounts. So it is not an 'event occurring after the balance
sheet date'.
Illustration 6
While preparing its final accounts for the year ended 31st March, 20X1 a company
made a provision for bad debts @ 5% of its total trade receivables. In the last week
of February, 20X1 a trade receivable for ` 2 lakhs had suffered heavy loss due to an
earthquake; the loss was not covered by any insurance policy. In April, 20X1 the
trade receivable became a bankrupt. Can the company provide for the full loss
arising out of insolvency of the trade receivable in the final accounts for the year
ended 31st March, 20X1?

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Solution
As per Accounting Standard 4, Assets and Liabilities should be adjusted for events
occurring after the balance sheet date that provide additional evidence to assist
estimation of amounts relating to conditions existing at the balance sheet date.
So full provision for bad debt amounting to ` 2 lakhs should be made to cover
the loss arising due to the insolvency in the Final Accounts for the year ended 31 st
March, 20X1. It is because earthquake took place before the balance sheet date.
Had the earthquake taken place after 31 st March, 20X1, then this would have been
treated as non-adjusting event and only disclosure required as per AS 4 (Revised),
would have been sufficient.
Illustration 7
Y Ltd. has book debts and has a doubt over recoverability of some of the book
debts. The amount that cannot be recovered is not quantifiable. Thus, Y Ltd. is of
the opinion that provision for doubtful debts should not be created. Y Ltd. creates
provision for certain other expenses on estimated basis.
Whether contention of Y Ltd. is correct?
Solution
As per AS 4, "Contingencies and Events Occurring After the Balance Sheet
Date" if it is likely that a contingency will result in a loss to an entity then it
should create provision for that contingency on the estimated basis.
Based on the above, the contention that provision for doubtful debt is not be
created merely because the amount is not quantifiable is not correct. Hence Y Ltd.
should make provision in the books on the basis of estimation.

Reference: The students are advised to refer the full text of AS 4 (Revised)
“Contingencies and Events occurring after the Balance Sheet Date”.


Pursuant to AS 29 ‘Provisions, Contingent Liabilities and Contingent Assets’, becoming mandatory in respect of
accounting periods commencing on or after 1st April, 2004, all paragraphs of AS 4 (Revised) dealing with
contingencies stand withdrawn except to the extent they deal with impairment of assets not covered by any other
AS. However, as per the Companies (Accounting Standards) Amendment Rules, 2016–30 March 2016, all
paragraphs of this Standard that deal with contingencies are applicable only to the extent
not covered by other Accounting Standards prescribed by the Central Government. For
example, the impairment of financial assets such as impairment of receivables (commonly
known as provision for bad and doubtful debts) is governed by this Standard .

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TEST YOUR KNOWLEDGE

Multiple Choice Questions
1. Cash amounting to ` 4 lakhs, stolen by the cashier in the month of March
20X1, was detected in April, 20X1. The financial statements for the year ended
31st March, 20X1 were approved by the Board of Directors on 15th May,
20X1. As per Accounting Standards, this is _____ for the financial statements
year ended on 31st March, 20X1.

(a) An Adjusting event.

(b) Non-adjusting event.

(c) Contingency.

(d) Provision

2. As per Accounting Standards, events occurring after the balance sheet date
are

(a) Only favourable events that occur between the balance sheet date and
the date when the financial statements are approved by the Board of
directors.

(b) Only unfavourable events that occur between the balance sheet date
and the date when the financial statements are approved by the Board
of directors.

(c) Those significant events, both favourable and unfavourable, that occur
between the balance sheet date and the date on which the financial
statements are approved by the Board of directors.

(d) Those significant events, both favourable and unfavourable, that occur
between the balance sheet date and the date on which the financial
statements are not approved by the Board of directors.

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3. AS 4 does not apply to

(a) Obligation under retirement benefit plans.
(b) Commitments arising from long term lease contracts.
(c) liabilities of life assurance and general insurance enterprises arising
from policies issued
(d) All of the above.
4. A Ltd. sold its building for ` 50 lakhs to B Ltd. and has also given the
possession to B Ltd. The book value of the building is ` 30 lakhs. As on 31 st
March, 20X1, the documentation and legal formalities are pending. For the
financial year ended 31 st March, 20X1
(a) The company should record the sale.
(b) The company should recognise the profit of ` 20 lakhs in its profit and
loss account.
(c) Both (a) and (b).
(d) The company should disclose the profit of ` 20 lakhs in notes to
accounts.

Scenario based Questions

5. A Ltd. has sold its building for ` 50 lakhs to B Ltd. and has also given the
possession to B Ltd. The book value of the building is ` 30 lakhs. As on 31 st
March, 20X1, the documentation and legal formalities are pending. The
company has not recorded the sale and has shown the amount received as
advance. Do you agree with this treatment?
6. During the year 20X1-20X2, Raj Ltd. was sued by a competitor for ` 15 lakhs
for infringement of a trademark. Based on the advice of the company's legal
counsel, Raj Ltd. provided for a sum of ` 10 lakhs in its financial statements
for the year ended 31st March, 20X2. On 18th May, 20X2, the Court decided
in favour of the party alleging infringement of the trademark and ordered Raj
Ltd. to pay the aggrieved party a sum of ` 14 lakhs. The financial statements
were prepared by the company's management on 30th April, 20X2, and
approved by the board on 30th May, 20X2.

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ANSWERS/SOLUTION
Answer to the Multiple Choice Questions
1. (a) 2. (c) 3. (d) 4. (c)

Answer to the Scenario based Questions

5. The economic reality and substance of the transaction is that the rights and
beneficial interest in the property has been transferred although legal title
has not been transferred. A Ltd. should record the sale and recognise the
gain of ` 20 lakhs in its profit and loss account. The building should be
derecognized in the financial statements.
6. As per AS 4 (Revised), adjustments to assets and liabilities are required for
events occurring after the balance sheet date that provide additional
information materially affecting the determination of the amounts relating
to conditions existing at the balance sheet date.
In the given case, since Raj Ltd. was sued by a competitor for infringement
of a trademark during the year 20X1-X2 for which the provision was also
made by it, the decision of the Court on 18 th May, 20X2, for payment of the
penalty will constitute as an adjusting event because it is an event occurred
before approval of the financial statements. Therefore, Raj Ltd. should adjust
the provision upward by ` 4 lakhs to reflect the award decreed by the Court
to be paid by them to its competitor.
Had the judgment of the Court been delivered on 1 st June, 20X2, it
would be considered as an event occurring after the approval of the
financial statements which is not covered by AS 4 (Revised). In that
case, no adjustment in the financial statements of 20X1-X2 would have
been required.

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 7.14 ADVANCED ACCOUNTING

UNIT 2: ACCOUNTING STANDARD 5 NET PROFIT OR

LOSS FOR THE PERIOD, PRIOR PERIOD ITEMS AND
CHANGES IN ACCOUNTING POLICIES

LEARNING OUTCOMES
After studying this unit, you will be able to comprehend the meaning
and accounting treatment for

♦ Net Profit or Loss for the Period

♦ Extraordinary Items
♦ Profit or Loss from Ordinary Activities
♦ Prior Period Items
♦ Changes in Accounting Estimates
♦ Changes in Accounting Policies.

2.1 INTRODUCTION
The objective of AS 5 is to prescribe the classification and disclosure of certain
items in the statement of profit and loss so that all enterprises prepare and
present such a statement on a uniform basis. This enhances the comparability of
the financial statements of an enterprise over time and with the financial
statements of other enterprises. Accordingly, AS 5 requires the classification and
disclosure of extraordinary and prior period items, and the disclosure of certain
items within profit or loss from ordinary activities. It also specifies the accounting
treatment for changes in accounting estimates and the disclosures to be made in
the financial statements regarding changes in accounting policies.

This Statement does not deal with the tax implications of extraordinary items,
prior period items, changes in accounting estimates, and changes in accounting
policies for which appropriate adjustments will have to be made depending on
the circumstances.

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2.2 NET PROFIT OR LOSS FOR THE PERIOD

All items of income and expense which are recognized in a period should be
included in the determination of net profit or loss for the period unless an
Accounting Standard requires or permits otherwise.
The net profit or loss for the period comprises the following components, each of
which should be disclosed on the face of the statement of profit and loss:
(a) Profit or loss from ordinary activities
Any activities which are undertaken by an enterprise as part of its business and
such related activities in which the enterprise engages in furtherance of,
incidental to, or arising from, these activities. For example, profit on sale of
merchandise, loss on sale of unsold inventory at the end of the season.
(b) Extraordinary items
Income or expenses that arise from events or transactions that are clearly distinct
from the ordinary activities of the enterprise and, therefore, are not expected to
recur frequently or regularly.
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 or in notes to accounts in a manner
that its impact on current profit or loss can be perceived. Whether an event or
transaction is clearly distinct from the ordinary activities of the enterprise is
determined by the nature of the event or transaction in relation to the business
ordinarily carried on by the enterprise rather than by the frequency with which
such events are expected to occur. Therefore, an event or transaction may be
extraordinary for one enterprise but not so for another enterprise because of the
differences between their respective ordinary activities. For example, losses
sustained as a result of an earthquake may qualify as an extraordinary item for
many enterprises. However, claims from policyholders arising from an earthquake
do not qualify as an extraordinary item for an insurance enterprise that insures
against such risks.

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 7.16 ADVANCED ACCOUNTING

Examples of events or transactions that generally give rise to extraordinary items

for most enterprises are:

– attachment of property of the enterprise

– an earthquake

(c) Exceptional items 1

When items of income and expense within profit or loss from ordinary activities
are of such size, nature or incidence that their disclosure is relevant to explain the
performance of the enterprise for the period, the nature and amount of such
items should be disclosed separately.

Circumstances which may give rise to the separate disclosure of items of income
and expense include:

(a) The write-down of inventories to net realisable value as well as the reversal
of such write-downs

(b) A restructuring of the activities of an enterprise and the reversal of any

provisions for the costs of restructuring

(c) Disposals of items of property, plant and equipment

(d) Disposals of long-term investments

(e) Legislative changes having retrospective application

(f) Litigation settlements

(g) Other reversals of provisions

1
There is no such term as ‘exceptional item’ under AS 5 and Schedule III to the Companies Act,
2013, however, the same has been used for better understanding of the requirement. Students
may provide a suitable note in this regard in the examination.

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Net Profit or Loss for the Period

Ordinary Items

Extra Ordinary Items

Prior Period Items

Changes in Accounting
Estimates
Changes in Accounting
Polices

2.3 PRIOR PERIOD ITEMS

Prior period items are 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.
Errors may occur as a result of mathematical mistakes, mistakes in applying
accounting policies, mis-interpretation of facts, or oversight.
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.
Prior period items are generally infrequent in nature and can be distinguished
from changes in accounting estimates. Accounting estimates by their nature are
approximations that may need revision as additional information becomes known.
For example, income or expense recognised on the outcome of a contingency
which previously could not be estimated reliably does not constitute a prior
period item.
Prior period items are normally included in the determination of net profit or loss
for the current period. An alternative approach is to show such items in the
statement of profit and loss after determination of current net profit or loss. In
either case, the objective is to indicate the effect of such items on the current
profit or loss.

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Illustration
From the past 5 financial years, an old outstanding balance of `50,000 was still
appearing as sundry creditor in the current year balance sheet of People Ltd. The
company is certain that this amount is not payable due to one or more reasons.
Therefore, it decided to write off the said amount in its current year’s books of
accounts and recognize it as income. The company treated the amount of ` 50,000
written off as a prior period item and made the adjustments accordingly.
The company is of the view that since sundry balances were recognized in the prior
period(s), its related written-off amount should be treated as a prior period item.

Solution
No, the company is not correct in treating the amount written off as a prior
period item. As per AS 5, prior period items are income or expenses which arise in
a current year due to errors or omissions in the preparation of the financial
statements of one or more prior period(s).
Writing off an old outstanding balance in the current year which is appearing in
its books of accounts from the past 5 financial years does not mean that there has
been an error or omission in the preparation of financial statements of prior
period(s). It is just a practice adopted by the company to write off the old
outstanding balances of more than 5 years in its current year books of accounts.
Therefore, the amount written off is not treated as a prior period item.
Hence, adjusting the amount `50,000 written off as a prior period item on the
basis that sundry balances were recognized in prior period(s) is not in line with
AS 5.

2.4 CHANGES IN ACCOUNTING ESTIMATES

An estimate may have to be revised if changes occur in the circumstances based
on which the estimate was made, or as a result of new information, more
experience or subsequent developments. The revision of the estimate, by its
nature, does not bring the adjustment within the definitions of an extraordinary
item or a prior period item.

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STATEMENTS
Accounting estimates by their nature are approximations that may need revision
as additional information becomes known. For example, income or expense
recognised on the outcome of a contingency which previously could not be
estimated reliably does not constitute a prior period item.

For example, Sachin purchased a new machine costing ` 10 lacs. Useful life was
taken to be for 10 years, therefore, depreciation was charged at 10% on original
cost each year. After 5 years when carrying amount was ` 5 lacs for the machine,
management realises that machine can work for another 2 years only. In this case
machine will be depreciated by ` 2.5 lacs each year for next 2 years. This is not
an example of prior period item but change in accounting estimate.

In the same example, let us suppose there is no change in useful life of the
machine after 5 years. The management by mistake calculated the depreciation in
the fifth year as 10% of ` 6,00,000 i.e. ` 60,000 instead of ` 1,00,000 and in the
next year i.e. sixth year decides to charge depreciation of ` 1,40,000. In such a
case, ` 1,00,000 would be the depreciation of sixth year and ` 40,000 depreciation
charged by the management in the sixth year will be considered as a prior period
item.

As per AS 10 (Revised), Property, Plant and Equipment, residual value and the
useful life of an asset should be reviewed at least at each financial year-end and,
if expectations differ from previous estimates, the change should be accounted
for as a change in an accounting estimate in accordance with AS 5 ‘Net Profit or
Loss for the Period, Prior Period Items and Changes in Accounting Policies’.

The effect of a change in an accounting estimate should be included in the

determination of net profit or loss in:

(a) The period of the change, if the change affects the period only; or

(b) The period of the change and future periods, if the change affects both.

For example, a change in the estimate of the amount of bad debts is recognised
immediately and therefore affects only the current period. However, a change in
the estimated useful life of a depreciable asset affects the depreciation in the
current period and in each period during the remaining useful life of the asset.

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The effect of a change in an accounting estimate should be classified using the

same classification in the statement of profit and loss as was used previously for
the estimate.
To ensure the comparability of financial statements of different periods, the effect
of a change in an accounting estimate which was previously included in the profit
or loss from ordinary activities is included in the same component of net profit or
loss. The effect of a change in an accounting estimate that was previously
included as an extraordinary item is reported as an extraordinary item.

The nature and amount of a change in an accounting estimate which has a

material effect in the current period, or which is expected to have a material effect
in subsequent periods, should be disclosed. If it is impracticable to quantify the
amount, this fact should be disclosed.
Sometimes, it is difficult to distinguish between a change in an accounting policy
and a change in an accounting estimate. In such cases, the change is treated as a
change in an accounting estimate, with appropriate disclosure.

2.5 CHANGES IN ACCOUNTING POLICIES

Accounting policies are the specific accounting principles and the methods of
applying those principles adopted by an enterprise in the preparation and
presentation of financial statements.

Accounting Policies can be changed only:

• when the adoption of a different accounting policy is required by statute; or

• for compliance with an Accounting Standard; or

• when it is considered that the change would result in a more appropriate

presentation of the financial statements of the enterprise.

The following are not changes in accounting policies:

(a) The adoption of an accounting policy for events or transactions that differ in
substance from previously occurring events or transactions, e.g.,
introduction of a formal retirement gratuity scheme by an employer in place
of ad hoc ex-gratia payments to employees on retirement;

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(b) The adoption of a new accounting policy for events or transactions which
did not occur previously or that were immaterial.
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.
A change in accounting policy consequent upon the adoption of an Accounting
Standard should be accounted for in accordance with the specific transitional provisions,
if any, contained in that Accounting Standard. However, disclosures required by
paragraph 32 of this Standard should be made unless the transitional provisions of any
other Accounting Standard require alternative disclosures in this regard.
Illustration 1
Fuel surcharge is billed by the State Electricity Board at provisional rates. Final bill
for fuel surcharge of ` 5.30 lakhs for the period October, 20X1 to September, 20X7
has been received and paid in February, 20X8. However, the same was accounted in
the year 20X8-X9. Comment on the accounting treatment done in the said case.
Solution
The final bill having been paid in February, 20X8 should have been accounted for
in the annual accounts of the company for the year ended 31st March, 20X8.
However, it seems that as a result of error or omission in the preparation of the
financial statements of prior period i.e., for the year ended 31st March 20X8, this
material charge has arisen in the current period i.e., year ended 31st March, 20X9.
Therefore, it should be treated as 'Prior period item' as per AS 5. As per AS 5,
prior period items are normally included in the determination of net profit or loss
for the current period. An alternative approach is to show such items in the
statement of profit and loss after determination of current net profit or loss. In
either case, the objective is to indicate the effect of such items on the current
profit or loss.

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It may be mentioned that it is an expense arising from the ordinary course of

business. Although abnormal in amount or infrequent in occurrence, such an
expense does not qualify an extraordinary item as per AS 5. For better
understanding, the fact that power bill is accounted for at provisional rates billed
by the state electricity board and final adjustment thereof is made as and when
final bill is received may be mentioned as an accounting policy.
Illustration 2
(i) During the year 20X1-20X2, a medium size manufacturing company wrote
down its inventories to net realisable value by ` 5,00,000. Is a separate
disclosure necessary?
(ii) A company signed an agreement with the Employees Union on 1.9.20X2 for
revision of wages with retrospective effect from 30.9.20X1. This would cost the
company an additional liability of ` 5,00,000 per annum. Is a disclosure
necessary for the amount paid in 20X2-X3?
Solution
(i) Although the case under consideration does not relate to extraordinary
item, but the nature and amount of such item may be relevant to users of
financial statements in understanding the financial position and
performance of an enterprise and in making projections about financial
position and performance. AS 5 on ‘Net Profit or Loss for the Period, Prior
Period Items and Changes in Accounting Policies’ states that:
“When items of income and expense within profit or loss from ordinary
activities are of such size, nature or incidence that their disclosure is
relevant to explain the performance of the enterprise for the period, the
nature and amount of such items should be disclosed separately.”
Circumstances which may require separate disclosure of items of income
and expense in accordance with AS 5 include the write-down of inventories
to net realisable value as well as the reversal of such write-downs.
(ii) It is given that revision of wages took place on 1st September, 20X2 with
retrospective effect from 30.9.20X1. Therefore wages payable for the half
year from 1.10.20X2 to 31.3.20X3 cannot be taken as an error or omission in
the preparation of financial statements and hence this expenditure cannot

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STATEMENTS

be taken as a prior period item. Additional wages liability of ` 7,50,000 (for

1½ years @ ` 5,00,000 per annum) should be included in current year’s
wages.
It may be mentioned that additional wages is an expense arising from the
ordinary activities of the company. Such an expense does not qualify as an
extraordinary item. However, as per AS 5, when items of income and
expense within profit or loss from ordinary activities are of such size, nature
or incidence that their disclosure is relevant to explain the performance of
the enterprise for the period, the nature and amount of such items should
be disclosed separately.
Illustration 3
The company finds that the inventory sheets of 31.3.20X1 did not include two pages
containing details of inventory worth ` 14.5 lakhs. State, how you will deal with the
following matters in the accounts of Omega Ltd. for the year ended 31st March,
20X2.
Solution
AS 5 on ‘Net Profit or Loss for the Period, Prior Period Items and Changes in
Accounting Policies’, defines Prior Period items as "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”.
Rectification of error in inventory valuation is a prior period item vide AS 5.
Separate disclosure of this item as a prior period item is required as per AS 5.
Illustration 4
Explain whether the following will constitute a change in accounting policy or not
as per AS 5.
(i) Introduction of a formal retirement gratuity scheme by an employer in place
of ad hoc ex-gratia payments to employees on retirement.
(ii) Management decided to pay pension to those employees who have retired
after completing 5 years of service in the organisation. Such employees will
get pension of ` 20,000 per month. Earlier there was no such scheme of
pension in the organisation.

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 7.24 ADVANCED ACCOUNTING

Solution
As per AS 5 ‘Net Profit or Loss for the Period, Prior Period Items and Changes in
Accounting Policies’, the adoption of an accounting policy for events or
transactions that differ in substance from previously occurring events or
transactions, will not be considered as a change in accounting policy.

(i) Accordingly, introduction of a formal retirement gratuity scheme by an

employer in place of ad hoc ex-gratia payments to employees on retirement
is not a change in an accounting policy.

(ii) Similarly, the adoption of a new accounting policy for events or transactions
which did not occur previously or that were immaterial will not be treated as
a change in an accounting policy.

Illustration 5
In the current year, A Ltd. changed the depreciation method from the Straight Line
Method (SLM) to Written Down Value (WDV) method. When A Ltd. recomputed
depreciation retrospectively as per the new method, deficiency arose in
depreciation in respect of past years. Therefore, it reduced the carrying amount of
the asset by the amount of deficiency and such change in carrying amount
(deficiency amount) has been debited to the statement of profit and loss as an
extraordinary expense.

Whether the change in the carrying amount of assets due to the change in
depreciation method should be treated as an extraordinary item?

Solution
No.

As per AS 5, "Net Profit or Loss for the Period, Prior Period Items and Changes in
Accounting Policies" extraordinary items are income or expenses that arise from
events or transactions that are clearly distinct from the ordinary activities of the
enterprise and, therefore, are not expected to recur frequently or regularly.
A change in the method of charging depreciation is not an event that is clearly
distinct from the ordinary activities of the entity. In the instant case, A Ltd. has
changed the depreciation method and treated the reduction in carrying amount

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(or amount of deficiency in depreciation) of the asset as an extraordinary expense.

This is not correct. Such deficiency should be treated as a normal expense.
A change in the estimated useful life of a depreciable asset (i.e. change in
depreciation method) affects the depreciation in the current period and in each
period during the remaining useful life of the asset. In both cases, the effect of
the change relating to the current period is recognised as income or expense in
the current period. The effect, if any, on future periods, is recognised in future
periods.
The change in depreciation method is considered as a change in accounting
estimate as per the provisions of AS 5.

Reference: The students are advised to refer the full text of AS 5” Net Profit or
Loss for the Period, Prior Period Items and Changes in Accounting Policies”.

TEST YOUR KNOWLEDGE

Multiple Choice Questions
1. A change in the estimated life of the asset, which necessitates adjustment in
the depreciation is an example of
(a) Prior period item.
(b) Ordinary item.
(c) Extraordinary item.
(d) Change in accounting estimate.
2. Which of the following is considered as an extraordinary item as per AS 5?
(a) Write down or write-off of receivables, inventory and intangible assets.
(b) Gains and losses from sale or abandonment of equipment used in a
business.
(c) Effects of a strike, including those against competitors and major
suppliers.

(d) Flood damage from unusually heavy rain or a normally dry

environment.

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3. Which one of the following is an example of extraordinary item?

(a) The write down of inventories to their net realisable value
(b) Reversal of write down of inventories
(c) Government grants become refundable
(d) Reversal of provisions.
4. Extraordinary items are income or expenses
(a) That arise from events clearly distinct from the ordinary activities of the
enterprise.
(b) That are not expected to recur frequently or regularly.
(c) Both (a) and (b).
(d) None of the three.
5. An audit stock verification during the year ended 31st March, 20X1 revealed
that opening stock of the year was understated by ` 5 lakhs due to wrong
counting. While finalizing accounts, your opinion will be
(a) It is not a prior period item and no separate disclosure is required
(b) It should be treated as a prior period adjustment and should be
separately disclosed in the current year’s financial statement
(c) The adjustment of ` 5 lakhs in both opening stock of current year and
profit brought forward from previous year should be made
(d) Both (b) and (c).

Answer to Scenario based Questions

6. A company (Z Ltd.) is engaged in the business of providing consultancy
services. A few days back, it received a notice from GST department raising a
demand of GST on consultancy services provided by it for ` 500,000. Recently
Z Ltd. paid the demand. In the books, the payment is recorded as an
extraordinary expenditure.
Whether payment of tax demand raised by the taxation authority can be
recognised as an extraordinary item?

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ANSWERS/SOLUTION
Answer to the Multiple Choice Questions
1. (d) 2. (d) 3. (c) 4. (c) 5. (d)

Answer to the Scenario based Questions

6. No, payment of tax cannot be recognised as an extraordinary item.
As per AS 5, "Net Profit or Loss for the Period, Prior Period Items and
Changes in Accounting Policies" an extraordinary item is income or expenses
that arise from events or transactions that are clearly distinct from ordinary
activities of the enterprise and, therefore, are not expected to recur
frequently or regularly.
In the given case, providing consultancy service is an ordinary activity of Z
Ltd. Thus, GST paid pursuant to the demand raised by GST department is
also a part of an ordinary activity of Z Ltd. Recognising such payments as an
extra-ordinary item is contrary to AS 5.

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UNIT 3: ACCOUNTING STANDARD 11 THE EFFECTS

OF CHANGES IN FOREIGN EXCHANGE RATES

LEARNING OUTCOMES
After studying this unit, you will be able to comprehend the –
♦ Foreign Currency Transactions
• Initial Recognition
• Reporting at Subsequent Balance Sheet Dates
• Recognition of Exchange Differences
♦ Net Investment in a Non-integral Foreign Operation
♦ Classification of Foreign Operations
• Integral Foreign Operations
• Non-integral Foreign Operations
• Disposal of a Non-integral Foreign Operation
• Change in the Classification of a Foreign Operation
• Accounting for Forward Exchange Contracts
• Disclosures

3.1 INTRODUCTION
An enterprise may carry on activities involving foreign exchange in two ways. It
may have transactions in foreign currencies (e.g., export sales in denominated in
USD) or it may have foreign operations (e.g., foreign branch of reporting entity
outside India). At the time of preparing the financial statements, these
transactions and/or operations must be reported by the entity in the reporting
currency i.e., INR. Hence, such foreign currency transactions and foreign
operations should be translated into the reporting currency (i.e., INR) in order to
be included in the financial statements of the entity.

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STATEMENTS
The standard deals with the issues involved in accounting for foreign currency
transactions and foreign operations i.e., to decide which exchange rate to use and
how to recognise the financial effects of changes in exchange rates in the
financial statements.
Scope
This Standard should be applied:
(a) In accounting for transactions in foreign currencies.
(b) In translating the financial statements of foreign operations.
(c) This Statement also deals with accounting for foreign currency transactions
in the nature of forward exchange contracts.
This Standard does not:
(a) Specify the currency in which an enterprise presents its financial statements.
However, an enterprise normally uses the currency of the country in which it
is domiciled. If it uses a different currency, the Standard requires disclosure
of the reasons for using that currency. The Standard also requires disclosure
of the reason for any change in the reporting currency.
For example, all Indian companies are required to present their financial
statements in INR. Thus, for such entities, INR is the reporting currency.
Alternatively, in case an Indian company is a subsidiary of a company
located in the United States, the parent may require the company to present
the financial statements in USD. In such cases, the company is required to
disclose the reasons for presenting the financial statements in USD (a
currency other than INR, the currency of the place where the company is
domiciled i.e., India).
In both the cases discussed above, it may be pertinent to note that
Accounting Standard 11 does not prescribe the currency to be used to
present the financial statements. However, for all practical purposes (Income
Tax Act, Indirect Tax Requirements etc.), every company domiciled in India
will present financial statements in INR.
(b) Deal with the presentation in a cash flow statement of cash flows arising
from transactions in a foreign currency and the translation of cash flows of a
foreign operation, which are addressed in AS 3 ‘Cash flow statement’.

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(c) Deal with exchange differences arising from foreign currency borrowings to
the extent that they are regarded as an adjustment to interest costs.

(d) Deal with the restatement of an enterprise’s financial statements from its
reporting currency into another currency for the convenience of users
accustomed to that currency or for similar purposes.

Considering the example above, the Indian subsidiary of the US Parent will
present its financial statements in INR for the Indian regulators. However,
since the US parent needs to consolidate the Indian subsidiary, it will
require the Indian company to also restate the INR Financial Statements to
USD. Such restatement is not covered under Accounting Standard 11.

3.2 DEFINITIONS OF THE TERMS USED IN THE

STANDARD
A foreign currency transaction is a transaction which is denominated in or
requires settlement in a foreign currency, including transactions arising when an
enterprise either:
(a) Buys or sells goods or services whose price is denominated in a foreign
currency.
(b) Borrows or lends funds when the amounts payable or receivable are
denominated in a foreign currency.
(c) Becomes a party to an unperformed forward exchange contract or
(d) Otherwise acquires or disposes of assets, or incurs or settles liabilities,
denominated in a foreign currency.
Monetary items are money held and assets and liabilities to be received or paid
in fixed or determinable amounts of money. For example, cash, receivables and
payables.
Non-monetary items are assets and liabilities other than monetary items. For
example, fixed assets, advances for purchase of goods / fixed assets, inventories
and investments in equity shares.

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STATEMENTS
Foreign operation is a subsidiary, associate, joint venture or branch of the
reporting enterprise, the activities of which are based or conducted in a country
other than the country of the reporting enterprise.
Integral foreign operation is a foreign operation, the activities of which are an
integral part of those of the reporting enterprise. A foreign operation that is
integral to the operations of the reporting enterprise carries on its business as if it
were an extension of the reporting enterprise's operations.
Non-integral foreign operation is a foreign operation that is not an integral
foreign operation. When there is a change in the exchange rate between the
reporting currency and the local currency, there is little or no direct effect on the
present and future cash flows from operations of either the non-integral foreign
operation or the reporting enterprise. The change in the exchange rate affects the
reporting enterprise's net investment in the non-integral foreign operation rather
than the individual monetary and non-monetary items held by the non-integral
foreign operation.
‘Net investment in a non-integral foreign operation’ is the reporting enterprise’s
share in the net assets of that operation.
Forward exchange contract means an agreement to exchange different
currencies at a forward rate.
Forward rate is the specified exchange rate for exchange of two currencies at a
specified future date.
‘Foreign currency’ is a currency other than the reporting currency of an enterprise.

3.3 INITIAL RECOGNITION

A foreign currency transaction should be recorded, on initial recognition in the
reporting currency, by applying to the foreign currency amount the exchange rate
between the reporting currency and the foreign currency at the date of the
transaction.

A rate that approximates the actual rate at the date of the transaction is often
used, for example, an average rate for a week or a month might be used for all
transactions in each foreign currency occurring during that period. However, if
exchange rates fluctuate significantly, the use of the average rate for a period is
unreliable.

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3.4 REPORTING AT EACH BALANCE SHEET

DATE
The treatment of foreign currency items at the balance sheet date depends on
whether the item is:
• monetary or non-monetary; and
• carried at historical cost or fair value (for non-monetary items).

(a) Foreign currency monetary items should be reported using the closing rate.
However, in certain circumstances, the closing rate may not reflect with
reasonable accuracy the amount in reporting currency that is likely to be
realised from, or required to disburse, a foreign currency monetary item at
the balance sheet date, e.g., where there are restrictions on remittances or
where the closing rate is unrealistic and it is not possible to effect an
exchange of currencies at that rate at the balance sheet date. In such
circumstances, the relevant monetary item should be reported in the
reporting currency at the amount which is likely to be realised from or
required to disburse, such item at the balance sheet date.
(b) Non-monetary items which are carried in terms of historical cost
denominated in a foreign currency should be reported using the exchange
rate at the date of the transaction.
(c) Non-monetary items which are carried at fair value or other similar
valuation denominated in a foreign currency should be reported using the
exchange rates that existed when the values were determined.
(d) The contingent liability denominated in foreign currency at the balance
sheet date is disclosed by using the closing rate.

3.5 RECOGNITION OF EXCHANGE DIFFERENCES

Exchange differences arising on the settlement of monetary items or on reporting
an enterprise’s monetary items at rates different from those at which they were
initially recorded during the period, or reported in previous financial statements,
should be recognised as income or as expenses in the period in which they arise.

An exchange difference results when there is a change in the exchange rate

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AS BASED ON ITEMS IMPACTING FINANCIAL
STATEMENTS
between the transaction date and the date of settlement of any monetary items
arising from a foreign currency transaction. When the transaction is settled within
the same accounting period as that in which it occurred, all the exchange
difference is recognised in that period. However, when the transaction is settled
in a subsequent accounting period, the exchange difference recognised in each
intervening period up to the period of settlement is determined by the change in
exchange rates during that period.

Note: Central Government in consultation with National Advisory Committee on

Accounting Standards made an amendment to AS 11 “The Effects of Changes in
Foreign Exchange Rates” in the form of Companies (Accounting Standards)
Amendment Rules, 2009 and 2011.

According to the Notification, exchange differences arising on reporting of long-

term foreign currency monetary items at rates different from those at which they
were initially recorded during the period, or reported in previous financial
statements, insofar as they relate to the acquisition of a depreciable capital asset,
can be added to or deducted from the cost of the asset and should be
depreciated over the balance life of the asset, and in other cases, can be
accumulated in the Foreign Currency Monetary Item Translation Difference
(FCMITD) Account and should be written off over the useful life of the assets
(amortised over the balance period of such long term assets or liability, by
recognition as income or expense in each of such periods) but not beyond 31st
March, 2020.
Any difference pertaining to accounting periods which commenced on or after
7th December, 2006, previously, recognised in the profit and loss account before
the exercise of the option should be reversed insofar as it relates to the
acquisition of a depreciable capital asset by addition or deduction from the cost
of the asset and in other cases by transfer to Foreign Currency Monetary Item
Translation Difference (FCMITD) Account, and by debit or credit, as the case may
be, to the general reserve.

If the above option is exercised, disclosure should be made of the fact of such
exercise of such option and of the amount remaining to be amortised in the
financial statements of the period in which such option is exercised and in every
subsequent period so long as any exchange difference remains unamortised.

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 7.34 ADVANCED ACCOUNTING

For the purposes of exercise of this option, an asset or liability should be

designated as a long-term foreign currency monetary item, if the asset or liability
is expressed in a foreign currency and has a term of 12 months or more at the
date of origination of the asset or liability.
Further in December, 2011, the Ministry of Corporate Affairs inserted paragraph
46A in AS 11 of the Companies (Accounting Standards) Rules, 2006. According to
it, in respect of accounting periods commencing on or after the 1st April, 2011, an
enterprise which had earlier exercised the option under paragraph 46 and at the
option of any other enterprise, the exchange differences arising on reporting of
long-term foreign currency monetary items at rates different from those at which
they were initially recorded during the period, or reported in previous financial
statements, in so far as they relate to the acquisition of a depreciable capital
assets, can be added to or deducted from the cost of the assets and should be
depreciated over the balance life of the assets, and in other cases, can be
accumulated in a “Foreign Currency Monetary Item Translation Difference
Account” in the enterprise’s financial statements and amortised over the
balance period of such long term assets or liability, by recognition as income
or expense in each of such periods.
Such option is irrevocable and should be applied to all such foreign currency
monetary items. The enterprise exercising such option should disclose the fact of
such option and of the amount remaining to be amortised in the financial
statements of the period in which such option is exercised and in every
subsequent period so long as any exchange difference remains unamortised.

3.6 CLASSIFICATION OF FOREIGN OPERATIONS

AS INTEGRAL OR NON-INTEGRAL
The method used to translate the financial statements of a foreign operation
depends on the way in which it is financed and operates in relation to the
reporting enterprise. For this purpose, foreign operations are classified as either
‘integral foreign operations’ or ‘non-integral foreign operations’.
An integral foreign operation carries on its business as if it were an extension of
the reporting enterprise’s operations. For example, such an operation might only
sell goods imported from the reporting enterprise and remits the proceeds to the

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reporting enterprise. In such cases, a change in the exchange rate between the
reporting currency and the currency in the country of foreign operation has an
almost immediate effect on the reporting enterprise’s cash flow from operations.
Therefore, the change in the exchange rate affects the individual monetary items
held by the foreign operation rather than the reporting enterprise’s net
investment in that operation.
In contrast, a non-integral foreign operation accumulates cash and other
monetary items, incurs expenses, generates income and perhaps arranges
borrowings, all substantially in its local currency. It may also enter into
transactions in foreign currencies, including transactions in the reporting
currency. When there is a change in the exchange rate between the reporting
currency and the local currency, there is little or no direct effect on the present
and future cash flows from operations of either the non-integral foreign
operation or the reporting enterprise. The change in the exchange rate affects the
reporting enterprise’s net investment in the non-integral foreign operation rather
than the individual monetary and non- monetary items held by the non-integral
foreign operation.

3.7 TRANSLATION OF FOREIGN INTEGRAL

OPERATIONS
The individual items in the financial statements of the foreign operation are
translated as if all its transactions had been entered into by the reporting
enterprise itself. The cost and depreciation of tangible fixed assets is translated
using the exchange rate at the date of purchase of the asset or, if the asset is
carried at fair value or other similar valuation, using the rate that existed on the
date of the valuation. The cost of inventories is translated at the exchange rates
that existed when those costs were incurred. The recoverable amount or realisable
value of an asset is translated using the exchange rate that existed when the
recoverable amount or net realisable value was determined. For example, when
the net realisable value of an item of inventory is determined in a foreign
currency, that value is translated using the exchange rate at the date as at which
the net realisable value is determined. The rate used is therefore usually the
closing rate.

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 7.36 ADVANCED ACCOUNTING

3.8 TRANSLATION OF NON-INTEGRAL

FOREIGN OPERATIONS
The translation of the financial statements of a non-integral foreign operation is
done using the following procedures:
(a) The assets and liabilities, both monetary and non-monetary, of the non-
integral foreign operation should be translated at the closing rate;
(b) Income and expense items of the non-integral foreign operation should be
translated at exchange rates at the dates of the transactions; and
(c) All resulting exchange differences should be accumulated in a foreign
currency translation reserve until the disposal of the net investment.
(d) For practical reasons, a rate that approximates the actual exchange rates, for
example an average rate for the period is often used to translate income
and expense items of a foreign operation.
(e) Any goodwill or capital reserve arising on the acquisition of a non-integral
foreign operation is translated at the closing rate.
(f) A contingent liability disclosed in the financial statements of a non-integral
foreign operation is translated at the closing rate for its disclosure in the
financial statements of the reporting enterprise.
(g) The incorporation of the financial statements of a non-integral foreign
operation in those of the reporting enterprise follows normal consolidation
procedures, such as the elimination of intra-group balances and intra-group
transactions of a subsidiary. However, an exchange difference arising on an
intra-group monetary item, whether short-term or long-term, cannot be
eliminated against a corresponding amount arising on other intra-group
balances because the monetary item represents a commitment to convert
one currency into another and exposes the reporting enterprise to a gain or
loss through currency fluctuations.
(h) When the financial statements of a non-integral foreign operation are
drawn up to a different reporting date from that of the reporting enterprise,
the non-integral foreign operation often prepares, for purposes of
incorporation in the financial statements of the reporting enterprise,
statements as at the same date as the reporting enterprise (AS 21 (Revised).

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AS BASED ON ITEMS IMPACTING FINANCIAL
STATEMENTS
(i) The translation of the financial statements of a non-integral foreign
operation results in the recognition of exchange differences arising from:
1. translating income and expense items at the exchange rates at the
dates of transactions and assets and liabilities at the closing rate;
2. translating the opening net investment in the non-integral foreign
operation at an exchange rate different from that at which it was
previously reported; and
3. other changes to equity in the non-integral foreign operation.
These exchange differences are not recognised as income or expenses for
the period because the changes in the exchange rates have little or no
direct effect on the present and future cash flows from operations of either
the non-integral foreign operation or the reporting enterprise. When a non-
integral foreign operation is consolidated but is not wholly owned,
accumulated exchange differences arising from translation and attributable
to minority interests are allocated to, and reported as part of, the minority
interest in the consolidated balance sheet.
(j) On the disposal of a non-integral foreign operation, the cumulative amount
of the exchange differences which have been deferred and which relate to
that operation should be recognised as income or as expenses.
(k) An enterprise may dispose of its interest in a non-integral foreign operation
through sale, liquidation, repayment of share capital, or abandonment of all,
or part of, that operation. The payment of a dividend forms part of a
disposal only when it constitutes a return of the investment. Remittance
from a non-integral foreign operation by way of repatriation of accumulated
profits does not form part of a disposal unless it constitutes return of the
investment €. In the case of a partial disposal, only the proportionate share
of the related accumulated exchange differences is included in the gain or
loss. A write-down of the carrying amount of a non-integral foreign
operation does not constitute a partial disposal. Accordingly, no part of the
deferred foreign exchange gain or loss is recognized at the time of a write-
down".

€
MCA amended this paragraph, by notification dated 18 th June, 2018, which is relevant for
companies.

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 7.38 ADVANCED ACCOUNTING

The following are indications that a foreign operation is a non-integral foreign

operation rather than an integral foreign operation:

(a) While the reporting enterprise may control the foreign operation, the
activities of the foreign operation are carried out with a significant degree
of autonomy from those of the reporting enterprise.

(b) Transactions with the reporting enterprise are not a high proportion of the
foreign operation's activities.
(c) The activities of the foreign operation are financed mainly from its own
operations or local borrowings rather than from the reporting enterprise.
(d) Costs of labour, material and other components of the foreign operation's
products or services are primarily paid or settled in the local currency rather
than in the reporting currency.
(e) The foreign operation's sales are mainly in currencies other than the
reporting currency.

(f) Cash flows of the reporting enterprise are insulated from the day-to-day
activities of the foreign operation rather than being directly affected by the
activities of the foreign operation.

(g) Sales prices for the foreign operation’s products are not primarily
responsive on a short-term basis to changes in exchange rates but are
determined more by local competition or local government regulation.
(h) There is an active local sales market for the foreign operation’s products,
although there also might be significant amounts of exports.
Illustration 1
Classify the following items as monetary or non-monetary item:
Inventories
Trade Receivables
Investment in Equity shares
Property, Plant and Equipment.

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AS BASED ON ITEMS IMPACTING FINANCIAL
STATEMENTS
Solution
Inventories Non-monetary
Trade receivables Monetary
Investment in equity shares Non-monetary
Property, Plant and Equipment Non-monetary

Illustration 2
Exchange Rate per $

Goods purchased on 1.1.20X1 for US $ 15,000 ` 75

Exchange rate on 31.3.20X1 ` 74
Date of actual payment 7.7.20X1 ` 73

You are required to ascertain the loss/gain to be recognized for financial years
ended 31st March, 20X1 and 31st March, 20X2 as per AS 11.

Solution
As per AS 11 on ‘The Effects of Changes in Foreign Exchange Rates’, all foreign
currency transactions should be recorded by applying the exchange rate on the
date of transactions. Thus, goods purchased on 1.1.20X1 and corresponding
creditors would be recorded at ` 11,25,000 (i.e. $15,000 × ` 75)

According to the standard, at the balance sheet date all monetary transactions
should be reported using the closing rate. Thus, creditors of US $15,000 on
31.3.20X1 will be reported at ` 11,10,000 (i.e. $15,000 × ` 74) and exchange profit
of ` 15,000 (i.e. 11,25,000 – 11,10,000) should be credited to Profit and Loss
account in the year ended 31st March, 20X1.

On 7.7.20X1, creditors of $15,000 is paid at the rate of ` 73. As per AS 11,

exchange difference on settlement of the account should also be transferred to
Profit and Loss account. Therefore, ` 15,000 (i.e. 11,10,000 – 10,95,000) will be
credited to Profit and Loss account in the year ended 31st March, 20X2.

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 7.40 ADVANCED ACCOUNTING

Illustration 3
Kalim Ltd. borrowed US$ 4,50,000 on 01/01/20X1, which will be repaid as on
31/07/20X1. Kalim Ltd. prepares financial statement ending on 31/03/20X1. Rate of
exchange between reporting currency (INR) and foreign currency (USD) on different
dates are as under:
01/01/20X1 1 US$ = ` 48.00
31/03/20X1 1 US$ = ` 49.00
31/07/20X1 1 US$ = ` 49.50
Solution
Journal Entries in the Books of Kalim Ltd.

Date Particulars ` (Dr.) ` (Cr.)

20X1 216,00,000
Jan. 01 Bank Account (4,50,000 x 48) Dr.

To Foreign Loan Account 216,00,000

March 31 Foreign Exchange Difference Account Dr. 4,50,000

To Foreign Loan Account 4,50,000
[4,50,000 x (49-48)]

July 01 Foreign Exchange Difference Account Dr. 2,25,000

[4,50,000 x (49.5-49)]
Foreign Loan Account Dr. 220,50,000
To Bank Account 2,22,75,000

3.9 CHANGE IN THE CLASSIFICATION OF A

FOREIGN OPERATION
When a foreign operation that is integral to the operations of the reporting
enterprise is reclassified as a non-integral foreign operation, exchange differences
arising on the translation of non-monetary assets at the date of the
reclassification are accumulated in a foreign currency translation reserve.

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AS BASED ON ITEMS IMPACTING FINANCIAL
STATEMENTS
When a non-integral foreign operation is reclassified as an integral foreign
operation, the translated amounts for non-monetary items at the date of the
change are treated as the historical cost for those items in the period of change
and subsequent periods. Exchange differences which have been deferred are not
recognised as income or expenses until the disposal of the operation.

3.10 TAX EFFECTS OF EXCHANGE DIFFERENCES

Gains and losses on foreign currency transactions and exchange differences
arising on the translation of the financial statements of foreign operations may
have associated tax effects which are accounted for in accordance with AS 22.

3.11 FORWARD EXCHANGE CONTRACT

An enterprise may enter into a forward exchange contract or another financial
instrument that is in substance a forward exchange contract, which is not
intended for trading or speculation purposes, to establish the amount of the
reporting currency required or available at the settlement date of a transaction.
The premium or discount arising at the inception of such a forward exchange
contract should be amortised as expense or income over the life of the contract.
Exchange differences on such a contract should be recognised in the statement of
profit and loss in the reporting period in which the exchange rates change. Any
profit or loss arising on cancellation or renewal of such a forward exchange
contract should be recognised as income or as expense for the period.
Illustration 4
Rau Ltd. purchased a plant for US$ 1,00,000 on 01st February 20X1, payable after
three months. Company entered into a forward contract for three months
@ ` 49.15 per dollar. Exchange rate per dollar on 01 st Feb. was ` 48.85. How will
you recognise the profit or loss on forward contract in the books of Rau Ltd.?

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 7.42 ADVANCED ACCOUNTING

Solution
Forward Rate ` 49.15

Less: Spot Rate (` 48.85)

Premium on Contract ` 0.30
Contract Amount US$ 1,00,000
Total Loss (1,00,000 x 0.30) ` 30,000
Contract period 3 months (2 months falling in the year ended 31st March, 20X1)
Loss to be recognised (30,000/3) x 2 = ` 20,000 in the year ended 31st March,
20X1. Rest ` 10,000 will be recognised in the following year.
In recording a forward exchange contract intended for trading or speculation
purposes, the premium or discount on the contract is ignored and at each
balance sheet date, the value of the contract is marked to its current market value
and the gain or loss on the contract is recognised.
Illustration 5
Mr. A bought a forward contract for three months of US$ 1,00,000 on 1st December
at 1 US$ = ` 47.10 when exchange rate was US$ 1 = ` 47.02. On 31st December
when he closed his books exchange rate was US$ 1 = ` 47.15. On 31st January, he
decided to sell the contract at ` 47.18 per dollar. Show how the profits from
contract will be recognised in the books.
Solution
Since the forward contract was for speculation purpose the premium on contract
i.e. the difference between the spot rate and contract rate will not be recorded in
the books. Only when the contract is sold the difference between the contract
rate and sale rate will be recorded in the Profit & Loss Account.
Sale Rate ` 47.18
Less: Contract Rate (` 47.10)

Premium on Contract ` 0.08

Contract Amount US$ 1,00,000
Total Profit (1,00,000 x 0.08) ` 8,000

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AS BASED ON ITEMS IMPACTING FINANCIAL
STATEMENTS
Illustration 6
Assets and liabilities and income and expenditure items in respect of foreign
branches (integral foreign operations) are translated into Indian rupees at the
prevailing rate of exchange at the end of the year. The resultant exchange
differences in the case of profit, is carried to other Liabilities Account and the Loss, if
any, is charged to the statement of profit and loss. Comment.
Solution
The financial statements of an integral foreign operation (for example, dependent
foreign branches) should be translated using the principles and procedures
described in AS 11. The individual items in the financial statements of a foreign
operation are translated as if all its transactions had been entered into by the
reporting enterprise itself.
Individual items in the financial statements of the foreign operation are translated
at the actual rate on the date of transaction. For practical reasons, a rate that
approximates the actual rate at the date of transaction is often used, for example,
an average rate for a week or a month may be used for all transactions in each
foreign currency during the period. The foreign currency monetary items (for
example cash, receivables, payables) should be reported using the closing rate at
each balance sheet date. Non-monetary items (for example, fixed assets,
inventories, investments in equity shares) which are carried in terms of historical
cost denominated in a foreign currency should be reported using the exchange
date at the date of transaction. Thus the cost and depreciation of the tangible
fixed assets is translated using the exchange rate at the date of purchase of the
asset if asset is carried at cost. If the fixed asset is carried at fair value, translation
should be done using the rate existed on the date of the valuation. The cost of
inventories is translated at the exchange rates that existed when the cost of
inventory was incurred and realizable value is translated applying exchange rate
when realizable value is determined which is generally closing rate.
Exchange difference arising on the translation of the financial statements of
integral foreign operation should be charged to profit and loss account. Exchange
difference arising on the translation of the financial statement of foreign
operation may have tax effect which should be dealt as per AS 22 ‘Accounting for
Taxes on Income’.

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 7.44 ADVANCED ACCOUNTING

Thus, the treatment by the management of translating all assets and liabilities;
income and expenditure items in respect of foreign branches at the prevailing
rate at the year end and also the treatment of resultant exchange difference is not
in consonance with AS 11.
Illustration 7
A business having the Head Office in Kolkata has a branch in UK. The following is
the trial balance of Branch as at 31.03.20X4:

Account Name Amount in £

Dr. Cr.
Machinery (purchased on 01.04.20X1) 5,000
Debtors 1,600
Opening Stock 400
Goods received from Head Office Account 6,100
(Recorded in HO books as ` 4,02,000)
Sales 20,000
Purchases 10,000
Wages 1,000
Salaries 1,200
Cash 3,200
Remittances to Head Office (Recorded in HO books as 2,900
` 1,91,000)
Head Office Account (Recorded in HO books as 7,400
` 4,90,000)
Creditors 4,000
• Closing stock at branch is £ 700 on 31.03.20X4.
• Depreciation @ 10% p.a. is to be charged on Machinery.
• Prepare the trial balance after been converted in Indian Rupees.

• Exchange rates of Pounds on different dates are as follow:

01.04.20X1– ` 61; 01.04.20X3– ` 63 & 31.03.20X4 – ` 67

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AS BASED ON ITEMS IMPACTING FINANCIAL
STATEMENTS
Solution
Trial Balance of the Foreign Branch converted into Indian Rupees as on
March 31, 20X4

Particulars £ (Dr.) £ (Cr.) Conversion Basis ` (Dr.) ` (Cr.)

Transaction date
Machinery 5,000 rate 3,05,000
Debtors 1,600 Closing Rate 1,07,200
Opening Stock 400 Opening Rate 25,200
Goods Received from HO 6,100 Actuals 4,02,000
Sales 20,000 Average Rate 13,00,000
Purchases 10,000 Average Rate 6,50,000
Wages 1,000 Average Rate 65,000
Salaries 1,200 Average Rate 78,000
Cash 3,200 Closing Rate 2,14,400
Remittance to HO 2,900 Actuals 1,91,000
HO Account 7,400 Actuals 4,90,000
Creditors 4,000 Closing Rate 2,68,000
Exchange Rate Difference Balancing Figure 20,200
31,400 31,400 20,58,000 20,58,000
Closing Stock 700 Closing Rate 46,900
Depreciation 500 Fixed Asset Rate 30,500

3.12 DISCLOSURE
An enterprise should disclose:
(a) The amount of exchange differences included in the net profit or loss for
the period.

(b) Net exchange differences accumulated in foreign currency translation

reserve as a separate component of shareholders’ funds, and a
reconciliation of the amount of such exchange differences at the beginning
and end of the period.

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 7.46 ADVANCED ACCOUNTING

When the reporting currency is different from the currency of the country in
which the enterprise is domiciled, the reason for using a different currency should
be disclosed. The reason for any change in the reporting currency should also be
disclosed.
When there is a change in the classification of a significant foreign operation, an
enterprise should disclose:
(a) The nature of the change in classification;
(b) The reason for the change;
(c) The impact of the change in classification on shareholders' funds; and
(d) The impact on net profit or loss for each prior period presented had the
change in classification occurred at the beginning of the earliest period
presented.

3.13 PRESENTATION OF FOREIGN CURRENCY

MONETARY ITEM TRANSLATION
DIFFERENCE ACCOUNT (FCMITDA)
In the format of Schedule III to the Companies Act, 2013, no line item has been
specified for the presentation of “Foreign Currency Monetary Item Translation
Difference Account (FCMITDA)”. Since the balance in FCMITDA represents foreign
currency translation loss, it does not meet the above definition of ‘asset’ as it is
neither a resource nor any future economic benefit would flow to the entity
therefrom. Therefore, such balance cannot be reflected as an asset. Therefore,
debit or credit balance in FCMITDA should be shown on the “Equity and
Liabilities” side of the balance sheet under the head ‘Reserves and Surplus’ as a
separate line item.
Illustration 8
A Ltd. purchased fixed assets costing ` 3,000 lakhs on 1.1.20X1 and the same was
fully financed by foreign currency loan (U.S. Dollars) payable in three annual equal
instalments. Exchange rates were 1 Dollar = ` 40.00 and ` 42.50 as on 1.1.20X1
and 31.12.20X1 respectively. First instalment was paid on 31.12.20X1. The entire
difference in foreign exchange has been capitalised.
You are required to state, how these transactions would be accounted for.

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AS BASED ON ITEMS IMPACTING FINANCIAL
STATEMENTS
Solution
As per AS 11 ‘The Effects of Changes in Foreign Exchange Rates’, exchange
differences arising on the settlement of monetary items or on reporting an
enterprise’s monetary items at rates different from those at which they were
initially recorded during the period, or reported in previous financial statements,
should be recognised as income or expenses in the period in which they arise.
Thus exchange differences arising on repayment of liabilities incurred for the
purpose of acquiring fixed assets are recognised as income or expense.
Calculation of Exchange Difference:
` 3,000 lakhs
Foreign currency loan = = 75 lakhs US Dollars
` 40
Exchange difference = 75 lakhs US Dollars × (42.50 – 40.00) = `187.50 lakhs
(including exchange loss on payment of first instalment)
Therefore, entire loss due to exchange differences amounting ` 187.50 lakhs
should be charged to profit and loss account for the year.

Note: The above answer has been given on the basis that the company has not
exercised the option of capitalisation available under paragraph 46 of AS 11.
However, if the company opts to avail the benefit given in paragraph 46A, then
nothing is required to be done since the company has done the correct
treatment.

Illustration 9
A Ltd. has borrowed USD 10,000 in foreign currency on April 1, 20X1 at 5% p.a.
annual interest and acquired a depreciable asset. The exchange rates are as under:
01/04/20X1 1 US$ = ` 48.00
31/03/20X2 1 US$ = ` 51.00
You are required to pass the journal entries in the following cases:
(i) Option under Para 46A is not availed.
(ii) Option under Para 46A is availed.
(iii) The loan was taken to finance the operations of the entity (and not to procure
a depreciable asset).
In all cases, assume interest accrued on 31 March 20X2 is paid on the same date.

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 7.48 ADVANCED ACCOUNTING

Solution
Journal Entries in the Books of A Ltd.

(i) Option under Para 46A is not availed

Date Particulars ` (Dr.) ` (Cr.)

20X1
Apr. 01 Bank Account (10,000 x 48) Dr. 4,80,000
To Foreign Loan Account 4,80,000

Mar 31 Finance Cost (USD 10,000 x 5% x ` 51) 25,500

To Bank Account 25,500
Mar 31 Foreign Exchange Difference Account (P/L) Dr. 30,000

To Foreign Loan Account [10,000 x (51-48)] 30,000

In this case, since the option under Para 46A is NOT availed, the Exchange Loss of
` 30,000 is recognised as an expense in the Statement of Profit and Loss for the
year ending 31 March 20X2.
(ii) Option under Para 46A is availed

Date Particulars ` (Dr.) ` (Cr.)

20X1

Apr. 01 Bank Account (10,000 x 48) Dr. 4,80,000

To Foreign Loan Account 4,80,000

Mar 31 Finance Cost (USD 10,000 x 5% x ` 51) 25,500

To Bank Account 25,500

Mar 31 Foreign Exchange Difference Account Dr. 30,000

To Foreign Loan Account [10,000 x (51-48)] 30,000

Mar 31 Property, Plant and Equipment Dr. 30,000

To Foreign Exchange Difference Account 30,000

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AS BASED ON ITEMS IMPACTING FINANCIAL
STATEMENTS
In this case, since the option under Para 46A is availed, the Exchange Loss
of ` 30,000 is capitalized in the cost of Property, Plant and Equipment,
which will indirectly get recognized in the Profit & Loss A/c by way of
increased depreciation over the remaining useful life of the asset.
(iii) Option under Para 46A is availed
Date Particulars ` (Dr.) ` (Cr.)

20X1

Apr. 01 Bank Account (10,000 x 48) Dr. 4,80,000

To Foreign Loan Account 4,80,000
Mar 31 Finance Cost (USD 10,000 x 5% x ` 51) 25,500

To Bank Account 25,500

Mar 31 Foreign Exchange Difference Account Dr. 30,000
To Foreign Loan Account [10,000 x (51-48)] 30,000

Mar 31 Foreign Currency Monetary Item Translation 30,000

Difference A/c (FCMITDA) Dr.
To Foreign Exchange Difference Account 30,000

In this case, since the option under Para 46A is availed, the Exchange Loss of
` 30,000 is accumulated in the FCMITD A/c, which will be subsequently spread
over and debited to P&L A/c over the tenure of the loan.

Reference: The students are advised to refer the full text of AS 11 “The Effects
of Changes in Foreign Exchange Rates”.

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TEST YOUR KNOWLEDGE

Multiple Choice Questions
1. As per AS 11 assets and liabilities of non-integral foreign operations should
be converted at __________ rate.

(a) Opening

(b) Average

(c) Closing

(d) Transaction

2. The debit or credit balance of “Foreign Currency Monetary Item Translation

Difference Account”

(a) Is shown as “Miscellaneous Expenditure” in the Balance Sheet

(b) Is shown under “Reserves and Surplus” as a separate line item

(c) Is shown as “Other Non-current” in the Balance Sheet

(d) Is shown as “Current Assets” in the Balance Sheet

3. If asset of an integral foreign operation is carried at cost, cost and

depreciation of tangible fixed asset is translated at

(a) Average exchange rate

(b) Closing exchange rate

(c) Exchange rate at the date of purchase of asset

(d) Opening exchange rate

4. Which of the following can be classified as an integral foreign operation?

(a) Branch office serving as an extension of the head office in terms of

operations

(b) Independent subsidiary of the parent company

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(c) Branch office independent of the head office in terms of operational
decisions

(d) None of the above

5. Which of the following items should be converted to closing rate for the
purposes of financial reporting?
(a) Items of Property, Plant and Equipment
(b) Inventory
(c) Trade Payables, Trade Receivables and Foreign Currency Borrowings
(d) All of the above

Theoretical Questions
6. Explain “monetary item” as per Accounting Standard 11. How are foreign
currency monetary items to be recognized at each Balance Sheet date?
7. Distinguish Non-Integral Foreign Operation (NFO) with Integral Foreign
Operation (IFO) as per AS 11.

Scenario based Questions

8. Explain briefly the accounting treatment needed in the following cases as per
AS 11 as on 31.3. 20X1.
Trade receivables include amount receivable from Umesh ` 5,00,000 recorded
at the prevailing exchange rate on the date of sales, transaction recorded at
US $ 1= `58.50.
Long term loan taken from a U.S. Company, amounting to ` 60,00,000. It was
recorded at US $ 1 = ` 55.60, taking exchange rate prevailing at the date of
transaction. US $ 1 = `61.20 was on 31.3. 20X1.

ANSWERS/SOLUTION
Answer to the Multiple Choice Questions
1. (c) 2. (b) 3. (c) 4. (a) 5. (c)

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Answer to the Theoretical Questions

6. As per AS 11 ‘The Effects of Changes in Foreign Exchange Rates’, Monetary
items are money held and assets and liabilities to be received or paid in
fixed or determinable amounts of money.

Foreign currency monetary items should be reported using the closing rate
at each balance sheet date. However, in certain circumstances, the closing
rate may not reflect with reasonable accuracy the amount in reporting
currency that is likely to be realized from, or required to disburse, a foreign
currency monetary item at the balance sheet date. In such circumstances,
the relevant monetary item should be reported in the reporting currency at
the amount which is likely to be realized from or required to disburse, such
item at the balance sheet date.

7. As per AS 11, Integral foreign operation (IFO) is a foreign operation, the

activities of which are an integral part of those of the reporting enterprise. A
foreign operation that is integral to the operations of the reporting
enterprise carries on its business as if it were an extension of the reporting
enterprise's operations. In contrast, a non-integral foreign operation (NFO)
is a foreign operation that is not an integral operation. For details, refer
para 2.5 of chapter.

Answer to the Scenario based Questions

8. As per AS 11 “The Effects of Changes in Foreign Exchange Rates”, exchange
differences arising on the settlement of monetary items or on reporting an
enterprise’s monetary items at rates different from those at which they were
initially recorded during the period, or reported in previous financial
statements, should be recognised as income or as expenses in the period in
which they arise.

However, at the option of an entity, exchange differences arising on

reporting of long-term foreign currency monetary items at rates different
from those at which they were initially recorded during the period, or

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reported in previous financial statements, in so far as they relate to the
acquisition of a depreciable capital asset can be added to or deducted from
the cost of the asset and should be depreciated over the balance life of the
asset, and in other cases, can be accumulated in a “Foreign Currency
Monetary Item Translation Difference Account” in the enterprise’s financial
statements and amortised over the balance period of such long-term asset/
liability, by recognition as income or expense in each of such periods.

Trade receivables Foreign `

Currency Rate
Initial recognition US $8,547 1 US $ = ` 58.50 5,00,000
(5,00,000/58.50)
Rate on Balance sheet date 1 US $ = ` 61.20
Exchange Difference Gain US $ 8,547 X 23,077
(61.20-58.50)
Treatment: Credit Profit and Loss A/c by
` 23,077
Long term Loan
Initial recognition US $ 1,07,913.67 1 US $ = ` 55.60 60,00,000
(60,00,000/55.60)
Rate on Balance sheet date 1 US $ = ` 61.20
Exchange Difference Loss US $ 6,04,317
1,07,913.67 X (61.20 – 55.60)
Treatment: Credit Loan A/c
And Debit FCMITD A/C or Profit and Loss
A/c by ` 6,04,317

Thus Exchange Difference on Long term loan amounting ` 6,04,317 may

either be charged to Profit and Loss A/c or to Foreign Currency Monetary
Item Translation Difference Account but exchange difference on debtors
amounting ` 23,077 is required to be transferred to Profit and Loss A/c.

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UNIT 4: ACCOUNTING STANDARD 22

ACCOUNTING FOR TAXES ON INCOME

LEARNING OUTCOMES
After studying this chapter, you will be able to comprehend the:
♦ What is the Objective of AS 22
♦ What is the Recognition criteria for Deferred Tax
♦ Re-assessment of Unrecognised Deferred Tax Assets
♦ Measurement of Deferred Tax
♦ Review of Deferred Tax Assets
♦ Presentation and Disclosure
♦ Solve the practical problems based on application of Accounting
Standards.

4.1 INTRODUCTION
This standard prescribes the accounting treatment of taxes on income and follows
the concept of matching expenses against revenue for the period. The concept of
matching is more peculiar in cases of income taxes since in a number of cases, the
taxable income may be significantly different from the income reported in the
financial statements due to the difference in treatment of certain items under
taxation laws and the way it is reflected in accounts.

4.2 OBJECTIVE
Matching of such taxes against revenue for a period poses special problems
arising from the fact that in a number of cases, taxable income may be
significantly different from the accounting income. This divergence between
taxable income and accounting income arises due to two main reasons.

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Firstly, there are differences between items of revenue and expenses as appearing
in the statement of profit and loss and the items which are considered as revenue,
expenses or deductions for tax purposes.
Secondly, there are differences between the amount in respect of a particular
item of revenue or expense as recognised in the statement of profit and loss and
the corresponding amount which is recognised for the computation of taxable
income.

4.3 DEFINITIONS
Accounting income (loss) is the net profit or loss for a period, as reported in the
statement of profit and loss, before deducting income-tax expense or adding
income tax saving.
Taxable income (tax loss) is the amount of the income (loss) for a period,
determined in accordance with the tax laws, based upon which income-tax
payable (recoverable) is determined.
Tax expense (tax saving) is the aggregate of current tax and deferred tax
charged or credited to the statement of profit and loss for the period.
Current Tax + Deferred Tax = Tax expense (Tax saving)
Current tax is the amount of income tax determined to be payable (recoverable)
in respect of the taxable income (tax loss) for a period.

Deferred tax is the tax effect of timing differences.

The differences between taxable income and accounting income can be classified
into permanent differences and timing differences.
Timing differences are the differences between taxable income and accounting
income for a period that originate in one period and are capable of reversal in
one or more subsequent periods.
For example, machinery purchased for scientific research related to business is
fully allowed as deduction in the first year for tax purposes whereas the same
would be charged to the statement of profit and loss as depreciation over its
useful life. The total depreciation charged on the machinery for accounting
purposes and the amount allowed as deduction for tax purposes will ultimately be

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the same, but periods over which the depreciation is charged and the deduction
is allowed will differ. This may lead to recognition of deferred tax in the books.
Permanent differences are the differences between taxable income and
accounting income for a period that originate in one period and do not reverse
subsequently. Generally permanent differences leads to increase in current tax &
have no impact on Deferred Tax.
For Example, XYZ has been charged with the fine on the late payment of the tax
amount due to authorities. This would be considered as an expense in the profit
and loss account, however this is specifically a disallowed expense for
computation of taxable income. This will be treated as permanent difference as
this difference will never reverse.

4.4 RECOGNITION
Tax expense for the period, comprising current tax and deferred tax, should be
included in the determination of the net profit or loss for the period.
Taxes on income are considered to be an expense incurred by the enterprise in
earning income and are accrued in the same period as the revenue and expenses
to which they relate. Such matching may result into timing differences. The tax
effects of timing differences are included in the tax expense in the statement of
profit and loss and as deferred tax assets or as deferred tax liabilities, in the
balance sheet.
While recognising the tax effect of timing differences, consideration of prudence
cannot be ignored. Therefore, deferred tax assets are recognised and carried
forward only to the extent that there is a reasonable certainty of their realisation.
This reasonable level of certainty would normally be achieved by examining the
past record of the enterprise and by making realistic estimates of profits for the
future. Where an enterprise has unabsorbed depreciation or carry forward of
losses under tax laws, deferred tax assets should be recognised only to the extent
that there is virtual certainty supported by convincing evidence that sufficient
future taxable income will be available against which such deferred tax assets can
be realised.
Permanent differences do not result in deferred tax assets or deferred tax
liabilities.

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4.5 MEASUREMENT
Current tax should be measured at the amount expected to be paid to (recovered
from) the taxation authorities, using the applicable tax rates and tax laws.
Deferred tax assets and liabilities are usually measured using the tax rates and tax
laws that have been enacted by the balance sheet date.
However, certain announcements of tax rates and tax laws by the government
may have the substantive effect of actual enactment. In these circumstances,
deferred tax assets and liabilities are measured using such announced tax rate
and tax laws.
Deferred tax assets and liabilities should not be discounted to their present
value.

4.6 RE-ASSESSMENT OF UNRECOGNISED

DEFERRED TAX ASSETS
At each balance sheet date, an enterprise re-assesses unrecognised deferred tax
assets. The enterprise recognises previously unrecognised deferred tax assets to
the extent that it has become reasonably certain or virtually certain, as the case
may be, that sufficient future taxable income will be available against which such
deferred tax assets can be realised.

4.7 REVIEW OF PREVIOUSLY RECOGNISED

DEFERRED TAX ASSETS
The carrying amount of deferred tax assets should be reviewed at each balance
sheet date. An enterprise should write-down the carrying amount of a deferred
tax asset to the extent that it is no longer reasonably certain or virtually certain, as
the case may be, that sufficient future taxable income will not be available against
which deferred tax asset can be realised. Any such write-down may be reversed to
the extent that it becomes reasonably certain or virtually certain, as the case may
be, that sufficient future taxable income will be available.

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4.8 Virtual certainty supported by

CONVINCING EVIDENCE
Determination of virtual certainty that sufficient future taxable income will be
available is a matter of judgement and will have to be evaluated on a case-to-
case basis. Virtual certainty refers to the extent of certainty, which, for all practical
purposes, can be considered certain. Virtual certainty cannot be based merely on
forecasts of performance such as business plans. Virtual certainty is not a matter
of perception and it should be supported by convincing evidence. Evidence is a
matter of fact. To be convincing, the evidence should be available at the reporting
date in a concrete form, for example, a profitable binding export order,
cancellation of which will result in payment of heavy damages by the defaulting
party. On the other hand, a projection of the future profits made by an enterprise
based on the future capital expenditures or future restructuring etc., submitted
even to an outside agency, e.g., to a credit agency for obtaining loans and
accepted by that agency cannot, in isolation, be considered as convincing
evidence.

4.9 DISCLOSURE
Statement of profit and loss
Under AS 22, there is no specific requirement to disclose current tax and deferred
tax in the statement of profit and loss. However, considering the requirements
under the Companies Act, 2013, the amount of income tax and other taxes on
profits should be disclosed.
AS 22 does not require any reconciliation between accounting profit and the tax
expense.
Balance sheet
The break-up of deferred tax assets and deferred tax liabilities into major
components of the respective balance should be disclosed in the notes to
accounts.

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Deferred tax assets and liabilities should be distinguished from assets and
liabilities representing current tax for the period. Deferred tax assets and liabilities
should be disclosed under a separate heading in the balance sheet of the
enterprise, separately from current assets and current liabilities.
The nature of the evidence supporting the recognition of deferred tax assets
should be disclosed, if an enterprise has unabsorbed depreciation or carry
forward of losses under tax laws.

An enterprise should offset assets and liabilities representing current tax if the
enterprise:
a. Has a legally enforceable right to set off the recognised amounts and
b. Intends to settle the asset and the liability on a net basis.
An enterprise should offset deferred tax assets and deferred tax liabilities if:
a. The enterprise has a legally enforceable right to set off assets against
liabilities representing current tax; and
b. The deferred tax assets and the deferred tax liabilities relate to taxes on
income levied by the same governing taxation laws.

4.10 RELEVANT EXPLANATIONS TO AS 22

Accounting for Taxes on Income in the situations of Tax Holiday under
sections 80-IA and 80-IB of the Income Tax Act, 1961
The deferred tax in respect of timing differences which reverse during the tax
holiday period should not be recognised to the extent the enterprise’s gross total
income is subject to the deduction during the tax holiday period as per the
requirements of the Act. Deferred tax in respect of timing differences which
reverse after the tax holiday period should be recognised in the year in which the
timing differences originate. However, recognition of deferred tax assets should
be subject to the consideration of prudence as laid down in AS 22.
For the above purposes, the timing differences which originate first should be
considered to reverse first.

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Accounting for Taxes on Income in the situations of Tax Holiday under

sections 10A and 10B of the Income Tax Act, 1961
The deferred tax in respect of timing differences which originate during the tax
holiday period and reverse during the tax holiday period, should not be
recognised to the extent deduction from the total income of an enterprise is
allowed during the tax holiday period as per the provisions of sections 10A and
10B of the Act. Deferred tax in respect of timing differences which originate
during the tax holiday period but reverse after the tax holiday period should be
recognised in the year in which the timing differences originate. However,
recognition of deferred tax assets should be subject to the consideration of
prudence as laid down in AS 22.

For the above purposes, the timing differences which originate first should be
considered to reverse first.
Accounting for Taxes on Income in the context of section 115JB of the
Income Tax Act, 1961
The payment of tax under section 115JB of the Act is a current tax for the period.
In a period in which a company pays tax under section 115JB of the Act, the
deferred tax assets and liabilities in respect of timing differences arising during
the period, tax effect of which is required to be recognised under AS 22, should
be measured using the regular tax rates and not the tax rate under section 115JB
of the Act. In case an enterprise expects that the timing differences arising in the
current period would reverse in a period in which it may pay tax under section
115JB of the Act, the deferred tax assets and liabilities in respect of timing
differences arising during the current period, tax effect of which is required to be
recognised under AS 22, should be measured using the regular tax rates and not
the tax rate under section 115JB of the Act.

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Illustration 1
Rama Ltd., has provided the following information:

`
Depreciation as per accounting records = 2,00,000
Depreciation as per income tax records = 5,00,000
Unamortised preliminary expenses as per tax record = 30,000
There is adequate evidence of future profit sufficiency. How much net deferred tax
asset/liability should be recognised as transition adjustment? Tax rate 50%.
Solution
Table showing calculation of deferred tax asset / liability

Particulars Amount Timing Deferred Amount

differences tax @ 50%
` `
Excess depreciation as per tax 3,00,000 Timing Deferred 1,50,000
records (` 5,00,000 – ` 2,00,000) tax liability
Unamortised preliminary 30,000 Timing Deferred
expenses as per tax records tax asset (15,000)
Net deferred tax liability 1,35,000

Illustration 2
From the following details of A Ltd. for the year ended 31-03-20X1, calculate the
deferred tax asset/ liability as per AS 22 and amount of tax to be debited to the
Profit and Loss Account for the year.

Particulars `
Accounting Profit 6,00,000
Book Profit as per MAT 3,50,000
Profit as per Income Tax Act 60,000
Tax rate 20%
MAT rate 7.50%

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Solution
Tax as per accounting profit 6,00,000×20% = ` 1,20,000
Tax as per Income-tax Profit 60,000×20% = ` 12,000
Tax as per MAT 3,50,000×7.50% = ` 26,250
Tax expense= Current Tax +Deferred Tax
` 1,20,000 = ` 12,000+ Deferred tax
Therefore, Deferred Tax liability as on 31-03-20X1
= ` 1,20,000 – ` 12,000 = ` 1,08,000
Amount of tax to be debited in Profit and Loss account for the year 31-03-20X1
Current Tax + Deferred Tax liability + Excess of MAT over current tax
= ` 12,000 + ` 1,08,000 + ` 14,250 (26,250 – 12,000) = ` 1,34,250
Illustration 3
PQR Ltd.'s accounting year ends on 31st March. The company made a loss of
` 2,00,000 for the year ending 31.3.20X1. For the years ending 31.3.20X2 and
31.3.20X3, it made profits of ` 1,00,000 and ` 1,20,000 respectively. It is assumed
that the loss of a year can be carried forward for eight years and tax rate is 40%. By
the end of 31.3.20X1, the company feels that there will be sufficient taxable income
in the future years against which carry forward loss can be set off. There is no
difference between taxable income and accounting income except that the carry
forward loss is allowed in the years ending 20X2 and 20X3 for tax purposes. Prepare
a statement of Profit and Loss for the years ending 20X1, 20X2 and 20X3.
Solution
Statement of Profit and Loss

31.3.20X1 31.3.20X2 31.3.20X3

` ` `
Profit (Loss) (2,00,000) 1,00,000 1,20,000
Less: Current tax (20,000 x 40%) (8,000)
Deferred tax:
Tax effect of timing differences 80,000
originating during the year (2,00,000 x
40%)

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Tax effect of timing differences
reversed/adjusted during the year (40,000) (40,000)
(1,00,000 x 40%)
Profit (Loss) After Tax Effect (1,20,000) 60,000 72,000

Illustration 4
Omega Limited is working on different projects which are likely to be completed
within 3 years period. It recognises revenue from these contracts on percentage of
completion method for financial statements during 20X0-20X1, 20X1-20X2 and
20X2-20X3 for ` 11,00,000, ` 16,00,000 and ` 21,00,000 respectively. However, for
Income-tax purpose, it has adopted the completed contract method under which it
has recognised revenue of ` 7,00,000, ` 18,00,000 and ` 23,00,000 for the years
20X0-20X1, 20X1-20X2 and 20X2-20X3 respectively. Income-tax rate is 35%.
Compute the amount of deferred tax asset/liability for the years 20X0-20X1, 20X1-
20X2 and 20X2-20X3.
Solution
Calculation of Deferred Tax Asset/Liability in Omega Limited

Year Accounting Taxable Timing Timing Deferred Deferred

Income Income Difference Difference Tax Tax
(balance) Liability
(balance)
20X0- 11,00,000 7,00,000 4,00,000 4,00,000 1,40,000 1,40,000
20X1
20X1- 16,00,000 18,00,000 (2,00,000) 2,00,000 (70,000) 70,000
20X2
20X2- 21,00,000 23,00,000 (2,00,000) NIL (70,000) NIL
20X3
48,00,000 48,00,000

Reference: The students are advised to refer the full text of AS 22 “Accounting
for Taxes on Income”

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TEST YOUR KNOWLEDGE

Multiple Choice Questions
1. As per AS 22 on ‘Accounting for Taxes on Income’, tax expense is:

(a) Current tax + deferred tax charged to profit and loss account
(b) Current tax-deferred tax credited to profit and loss account
(c) Either (a) or (b)
(d) Deferred tax charged to profit and loss account
2. G Ltd. has provided the following information:
Depreciation as per accounting records = ` 2,00,000

Depreciation as per tax records = ` 5,00,000

There is adequate evidence of future profit sufficiency.
How much deferred tax asset/liability should be recognized as transition
adjustment when the tax rate is 45%?
(a) Deferred Tax asset = ` 2,70,000.
(b) Deferred Tax asset = ` 1,35,000.

(c) Deferred Tax Liability = ` 2,70,000

(d) Deferred Tax Liability = ` 1,35,000.
3. State which of the followings statements are correct:
(1) There are no pre-conditions required to recognize deferred tax liability,
(2) Deferred tax asset under all circumstances can only be created if and
only if there is reasonable certainty that future taxable income will
arise.
(a) Both are correct.
(b) Only (1) is correct.

(c) Only (2) is correct.

(d) None of the statements are correct.

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4. Which of the following statement are incorrect:

(a) Only timing differences result in creation of deferred tax.

(b) Permanent differences do not result in recognition of deferred tax.
(c) The tax rate used for measurement of deferred tax is substantively
enacted tax rate.
(d) The entity has to recognize deferred tax liability/asset arising out of
timing difference. There are no conditions which are required to
evaluated for their recognition.

Theoretical Questions
5. Write short note on Timing differences and Permanent differences as per AS
22.

Scenario based Questions

6. Y Ltd. is a full tax free enterprise for the first ten years of its existence and is
in the second year of its operation. Depreciation timing difference is INR 200
lakhs and INR 400 lakhs respectively which will result in a tax liability in year
1 and 2. From the third year it is expected that the timing difference would
reverse each year by INR 10 lakhs. Assuming tax rate of 40%, find out the
deferred tax liability at the end of the second year and any charge to the
Profit and Loss account.
7. Ultra Ltd. has provided the following information:
Depreciation as per accounting records =INR 4,00,000

Depreciation as per tax records =INR 10,00,000

Unamortized preliminary expenses as per tax record = INR 30,000
There is adequate evidence of future profit sufficiency. How much deferred tax
asset/liability should be recognized as transition adjustment when the tax
rate is 50%?
8. Saras Ltd. closes its books as on 31st March 20X2. They have accrued
` 5,00,000 towards GST Liability for the month of March 20X2 by debiting
their Profit and loss statement which is expected to be paid off by 21st April

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20X2 . As per the provisions of Section 43B of the Income Tax Act, 1961 – Any
expenditure of the nature mentioned in section 43B (e.g. taxes, duty, cess,
fees, etc.) accrued in the statement of profit and loss on mercantile basis will
be allowed for tax purposes in subsequent years on payment basis only.
Assuming a Tax rate of 30% determine the Deferred Tax Asset/Liability as at
31st March 20X2.
9. ABC Company limited had an investment in Venture Capital amounting ` 10
Crores. Venture capital in turn had invested in the below portfolio companies
(New Start- ups) on behalf of ABC Limited:

Amount of investment
Portfolio Companies (` in Crores)
Oscar Limited 2
Zee Limited 3
Star Limited 4
Sony Limited 1
Total 10
During the FY 2019-2020, Venture Capital had sold their investment in Star
Limited and realised an amount of ` 8 Crores on sale of shares of star Limited
and entire proceeds of ` 8 Crores have been transferred by Venture Capital to
ABC Company Limited.
The accounts manager has received the following additional information from
venture capital on 31.03.2020:
(1) 8 Crores has been deducted from the cost of investment and carrying
amount of investment as at year end is 2 Crores.
(2) Company had to pay a capital gain tax @ 20% on the net sale
consideration of ` 4 Crores.
(3) Due to COVID-19, the remaining start- ups (i.e. Oscar Limited, Zee
Limited, and Sony Limited) are not performing well and will soon wind
up their operations. Venture capital is monitoring the situation and if
required they will provide an impairment loss in June 2020 Quarter.
You need to suggest the accounts manager what should be the correct
accounting treatment as per AS 22 “Accounting for Taxes on Income”.

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ANSWERS/SOLUTIONS
Answer to the Multiple Choice Questions
1. (c) 2. (d) 3. (a) 4. (d)

Answer to the Theoretical Questions

5. In current practices, companies, in general, prepare books of accounts as
per Companies Act, 2013 generating Accounting Profit/Loss and Income-tax
Act, 1961 generating Taxable Profit/Loss. Accounting income and taxable
income for a period are seldom the same. Permanent differences are those
which arise in one period and do not reverse subsequently. For e.g., an
income exempt from tax or an expense that is not allowable as a deduction
for tax purposes. Timing differences are those which arise in one period and
are capable of reversal in one or more subsequent periods. For e.g.,
Depreciation etc.

Answer to the Scenario based Questions

6. As per AS 22, ‘Accounting for Taxes on Income’, deferred tax in respect of
timing differences which originate during the tax holiday period and reverse
during the tax holiday period, should not be recognised to the extent
deduction from the total income of an enterprise is allowed during the tax
holiday period as per the provisions of sections 10A and 10B of the Income-
tax Act. Deferred tax in respect of timing differences which originate during
the tax holiday period but reverse after the tax holiday period should be
recognised in the year in which the timing differences originate. However,
recognition of deferred tax assets should be subject to the consideration of
prudence. For this purpose, the timing differences which originate first
should be considered to reverse first.
Out of 200 lakhs timing difference due to depreciation, difference
amounting 80 lakhs (10 lakhs x 8 years) will reverse in the tax holiday period
and therefore, should not be recognised. However, for 120 lakhs (200 lakhs
– ` 80 lakhs), deferred tax liability will be recognised for 48 lakhs (40% of
120 lakhs) in first year. In the second year, the entire amount of timing
difference of ` 400 lakhs will reverse only after tax holiday period and

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 7.68 ADVANCED ACCOUNTING

hence, will be recognised in full. Deferred tax liability amounting 160 lakhs
(40% of 400 lakhs) will be created by charging it to profit and loss account
and the total balance of deferred tax liability account at the end of second
year will be 208 lakhs (48 lakhs + 160 lakhs).
7. Calculation of difference between taxable income and

accounting income

Particulars Amount (` )
Excess depreciation as per tax ` (10,00,000 – 4,00,000) 6,00,000
Less: Expenses unamortized in tax records (30,000)
Timing difference 5,70,000

Tax expense is more than the current tax due to timing difference.
Therefore deferred tax liability = 50% x 5,70,000 = 2,85,000
8. Calculation of difference between taxable income and
accounting income

Particulars Amount
(`)
GST Liability debited in books 5,00,000
Less: GST Liability allowed under Income Tax Act (Section 43B) Nil
Timing difference 5,00,000
Tax expense is less than the current tax due to timing difference.
Therefore, deferred tax Asset = 30% x 5,00,000 = 1,50,000
9. As company had to pay capital gain tax @ 20% on the net sale
consideration as per income tax laws, the company has to recognise a
current tax liability of 0.8 Crores computed as under:

Particulars Amount (` in Crores)

Sales Consideration 8
Cost of Investment 4
Net gain on Sale 4
Tax @ 20% 0.8

© The Institute of Chartered Accountants of India

 AS BASED ON ITEMS IMPACTING FINANCIAL 7.69
STATEMENTS
As per AS 22, Timing differences are those differences between taxable
income and accounting income for a period that originate in one period and
are capable of reversal in one or more subsequent periods.

Particulars Amount (` in Crores) Rationale

Taxable Income 4 As per income tax laws

Accounting Nil As the same is deducted

Income from the cost of investment

Timing Difference 4

As per AS 22, deferred tax assets should be recognised and carried forward
only to the extent that there is a reasonable certainty that sufficient future
taxable income will be available against which such deferred tax assets can
be realised.
Since in current scenario, due to Covid 19 the portfolio companies are not
performing well, thus the company may not have sufficient future taxable
income which will reverse deferred tax assets. Therefore, the company
should not recognise DTA of ` 0.8 Crores and company should recognise
only current tax liability of ` 0.8 Crores.

© The Institute of Chartered Accountants of India

*
CHAPTER
CHAPTER a
8
REVENUE BASED
ACCOUNTING
STANDARDS
UNIT 1 : ACCOUNTING STANDARD 7
CONSTRUCTION CONTRACTS

LEARNING OUTCOMES
❑
After studying this unit, you will be able to comprehend the provisions
of AS 7 related with:

 Introduction and Scope of Construction Contract

 Combining and Segmenting Construction Contracts

 What is included in Contract Revenue

 What is included and excluded in Contract Costs

 Recognition of Contract Revenue and Expenses

 Recognition of Expected Losses

 Changes in Estimates

 Disclosures.

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 8.2 ADVANCED ACCOUNTING
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1.1 SIGNIFICANCE OF THE STANDARD

The need to have a standard for construction contracts and their accounting
arises since the construction contracts generally cover more than one accounting
period. Common examples of construction include construction of flyovers, dams,
metro line, buildings etc. For example, if entity XY submits a tender to construct a
flyover for a state government, the construction of that flyover might take 2 to 3
years of time, depending on the scope of the contract. This standard addresses
the requirements for recognition & measurement (i.e., the timing and amount) of
construction revenue and construction costs.

Work in Progress

Start of construction End of construction

(Year 1) (Year 3)

The entity that is required to complete the construction is referred to as

Contractor and the customer who requires the construction to be completed is
referred to as Contractee/Customer.

Takes more than one

accounting year to
complete

Final outcome
determined after
Long term Peculiar no. of years from
projects Features of year of
Construction commencement of
construction
contracts

Allocation of contract
revenue and contract cost
tothe accounting period in
which construction work is
performed

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 REVENUE BASED ACCOUNTING STANDARDS 8.3
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The above discussion clearly indicates that there are two parties to the
construction contract. Thus, if there is an entity which requires its engineering
division to construct a machine for the production division, this would not meet
the scope of AS 7. It will be addressed by AS 10 (Property, plant and equipment)
and will be accounted as a case of self-constructed asset.

1.2 INTRODUCTION
Accounting Standard 7 prescribes the principles of accounting for construction
contracts in the financial statements of contractors. The focus of the standard is
to determine when the contractor should recognise contract revenue and contract
costs in the statement of profit and loss.

A construction contract is a contract specifically negotiated for the construction

of an asset or a combination of assets that are closely interrelated or
interdependent in terms of their design, technology and function or their ultimate
purpose or use.
A construction contract may be negotiated for the construction of a single asset
such as a bridge, building, dam, pipeline, road, ship or tunnel. A construction
contract may also deal with the construction of a number of assets which are
closely interrelated or interdependent in terms of their design, technology and
function or their ultimate purpose or use; examples of such contracts include
those for the construction of refineries and other complex pieces of plant or
equipment.
For the purposes of this Standard, construction contracts also include:

(a) contracts for the rendering of services which are directly related to the
construction of the asset, for example, those for the services of project
managers and architects; and

(b) contracts for destruction or restoration of assets, and the restoration of the
environment following the demolition of assets.

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 8.4 ADVANCED ACCOUNTING
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What are construction

Contracts?

Contracts specifically
Contracts for
negotiated for the Contracts for
rendering of services
construction of an asset or destruction or
related to
combination of assets that restoration of assets.
construction of assets
are closely interrelated

Example 1
Entity XY contracts with AB to construct 2 residential buildings in the same
premises. The construction of both buildings will begin simultaneously. Building
material, construction work, and other related activities will go on in parallel to
provide cost savings to entity XY. This also helps AB achieve a timely completion of
the two buildings and negotiate a consolidated price for the two buildings.
The above example suggests that there is a single contract negotiated to construct
two buildings that are closely interrelated and interdependent in terms of their
ultimate purpose and use. Therefore, this represents a Construction Contract.
Example 2
H, a sole-proprietor, contracts with M/s DM Construction, to dismantle his office
premises and construct it from scratch.
In the given case, the construction contract includes both demolition as well as
construction of a new building.

1.3 COMBINING AND SEGMENTING

CONSTRUCTION CONTRACTS
A contractor may undertake a number of contracts.
The standard identifies certain cases where for the purposes of accounting, it is
necessary to apply the Standard to the separately identifiable components of a
single contract or to a group of contracts together in order to reflect the
substance of a contract or a group of contracts.

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 REVENUE BASED ACCOUNTING STANDARDS 8.5
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(a) When a contract covers a number of assets, the construction of each asset
should be treated as a separate construction contract when:

(i) separate proposals have been submitted for each asset;

(ii) each asset has been subject to separate negotiation and the
contractor and customer have been able to accept or reject that part of the
contract relating to each asset; and

(iii) the costs and revenues of each asset can be identified.

(b) A group of contracts, whether with a single customer or with several

customers, should be treated as a single construction contract when:

(i) the group of contracts is negotiated as a single package;

(ii) the contracts are so closely interrelated that they are, in effect, part of
a single project with an overall profit margin; and

(iii) the contracts are performed concurrently or in a continuous sequence.

(c) A contract may provide for the construction of an additional asset at the
option of the customer or may be amended to include the construction of
an additional asset. The construction of the additional asset should be
treated as a separate construction contract when:

(i) the asset differs significantly in design, technology or function from

the asset or assets covered by the original contract; or

(ii) the price of the asset is negotiated without regard to the original
contract price.
Illustration 1
XYZ construction Ltd, a construction company undertakes the construction of an
industrial complex. It has separate proposals raised for each unit to be
constructed in the industrial complex. Since each unit is subject to separate
negotiation, he is able to identify the costs and revenues attributable to each
unit. Should XYZ Ltd, treat construction of each unit as a separate construction
contract according to AS 7?

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 8.6 ADVANCED ACCOUNTING
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Solution
As per AS 7 ‘Construction Contracts’, when a contract covers a number of assets,
the construction of each asset should be treated as a separate construction
contract when:
(a) separate proposals have been submitted for each asset;

(b) each asset has been subject to separate negotiation and the contractor and
customer have been able to accept or reject that part of the contract
relating to each asset; and

(c) the costs and revenues of each asset can be identified.

Therefore, XYZ Ltd. is required to treat construction of each unit as a separate
construction contract.

1.4 TYPES OF CONSTRUCTION CONTRACTS

Types of construction contracts

Fixed price contract Cost plus contract

Contractor agrees to a fixed contract Contractor is reimbursed for allowable

price or fixed rate per unit of output, or otherwise defined costs, plus
which in some cases is subject to cost percentage of these costs or a fixed fee.
escalation.

In a fixed price contract, the price is agreed as fixed sum or a fixed rate per unit
of output. In some cases, the contract may require the customer to pay additional
sums to compensate the contractor against cost escalations.
Fixed price contracts are common in case of public tenders (construction of roads,
flyovers, office buildings). Such constructions usually have a budgeted costs and
the public entity does not intend to spend more than the tender amount. At the
same time, there can be various reasons where the cost of construction may
increase. For example, a sudden increase in wage rates, construction material

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 REVENUE BASED ACCOUNTING STANDARDS 8.7
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costs, may require the contractor to add cost-escalation clauses and recover
from the contractee. These cost escalations still meet the category of fixed price
contracts.
A cost-plus contract is a construction contract in which the contractor is
reimbursed for allowable or otherwise defined costs, plus percentage of these
costs or a fixed fee.
Cost-plus contracts are common in case there is uncertainty of measurement of
costs or time of completion. In such cases, a contractor does not expect to bear
the loss due to those uncertainties. For example, if the scope of the contract
cannot be fully assessed in the contract, both parties may agree to cost-plus
contracts.
Under such contracts, the contractor is compensated for the costs incurred by
him plus agreed profit-margin.

1.5 CONTRACT REVENUE AND COSTS

(A) Contract revenue should comprise:
(i) the initial amount of revenue agreed in the contract; and
(ii) variations in contract work, claims and incentive payments to the
extent that it is probable that they will result in revenue and they are
capable of being reliably measured.
Contract revenue includes:
Agreed price (fixed / Cost-plus price)
Plus: Agreed Cost escalation
Plus: Claims (reimbursement for costs not included in the contract price)
Plus: Incentive payments (usually for early completion)
Less: Penalties (usually for late completion)
Adjusted for Variations


Claims are only included in contract revenue when it is probable that the customer will accept the
claim and such claim amount can be measured reliably

Incentives are only included in the contract revenue when it is probable that the specified
performance standards will be met or exceeded, and such incentive payment can be measured
reliably)

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 8.8 ADVANCED ACCOUNTING
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Contract Revenue

Initially agreed amount

variations in contract work, claims and
incentive payments (if capable of being
recognized as revenue)

Illustration 2

AB contactors enters into a contract on 1 st January 20X1 with XY to construct a 5-

storied building. Under the contract, AB is required to complete the construction in
3 years (i.e., by 31st December 20X3). The following information is relevant:
Fixed price (agreed) ₹5 crore
Material cost escalation (to the extent of 20% of increase in material cost)
Labour cost escalation (up to 30% of increase in minimum wages)
In case AB is able to complete the construction in less than 2 years and 10 months,
it will be entitled for an additional incentive of ₹50 lakh. However, in case the
construction is delayed beyond 3 years and 2 months, XY will charge a penalty of
₹20 lakh. At the start of the contract, AB has a reason to believe that construction
will be completed in 2 years and 8 months. Assume that the construction was
actually completed in 2 years 9 months.
Labour cost was originally estimated to be ₹1.20 crore (based on initial minimum
wages). However, the costs have increased by 25% during the construction period.
Material costs have increased by 40% due to short-supply. The total increase in
material cost due to the 40% escalation is ₹80 lakh.
You are required to suggest what should be the contract revenue in above case?
Assume that in year 20X2, XY has requested AB to increase the scope of the
contract. An additional floor is required to be constructed and there is an increase
in contract fee by ₹1 crore.
AB has incurred a cost of ₹20 lakh for getting the local authority approvals which it
will be entitled to claim from XY in addition to the increase in the fixed fee.
Also measure the total contract revenue in this case.

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 REVENUE BASED ACCOUNTING STANDARDS 8.9
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Solution
Total Revenue after considering the escalation costs, claims and incentives:
`
Fixed Price: 5.00 crore
Incentive for early completion 0.50 crore
Material costs recovery (to the extent of 20%) 0.40 crore
Labour costs recovery (Actual increase is less than 30%) 0.30 crore
[1.20 crore x 25%]
Total Contract Revenue 6.20 crore
Add: Variation to the contract 1.00 crore
Add: Claims recoverable from XY 0.20 crore
Total Contract Revenue 7.40 crore
(B) Contract costs should comprise:
(i) costs that relate directly to the specific contract;
(ii) costs that are attributable to contract activity in general and can be
allocated to the contract; and
(iii) such other costs as are specifically chargeable to the customer under
the terms of the contract.

Contract Costs

costs that are

costs that other costs as are
attributable to contract
relate directly specifically
activity in general and
to the specific chargeable to the
can be allocated to the
contract; customer under the
contract;
terms of the contract.

NOTE:
1. Examples of costs that relate directly to a specific contract include:
(a) site labour costs, including site supervision
(b) costs of materials used in construction

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 8.10 ADVANCED ACCOUNTING
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(c) depreciation of plant and equipment used on the contract

(d) costs of moving plant, equipment and materials to and from the
contract site
(e) costs of hiring plant and equipment
(f) costs of design and technical assistance that is directly related to the
contract
(g) the estimated costs of rectification and guarantee work, including
expected warranty costs
(h) claims from third parties
Note: Direct costs can be reduced by incidental income that is not included
in contract revenue, e.g., sale of surplus material and disposal of plant and
equipment.
2. Example of costs that may be attributable to contract activity in general and
can be allocated to specific contracts include:
(a) insurance
(b) costs of design and technical assistance that is not directly related to a
specific contract
(c) construction overheads
The allocation of indirect costs should be based on normal levels of
construction activity. The allocable costs may include borrowing costs
as per AS 16.
3. Examples of costs that cannot be attributed to contract activity or cannot be
allocated to a contract are excluded from the costs of a construction
contract. Such costs include:
(a) general administration costs for which reimbursement is not specified
in the contract
(b) selling costs
(c) research and development costs for which reimbursement is not
specified in the contract
(d) depreciation of idle plant and equipment that is not used on a
particular contract

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 REVENUE BASED ACCOUNTING STANDARDS 8.11
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Example 3: Cost-Plus contract

The language can be changed as under (Entire Question):
ABC Constructions has a contract to build an office building.
The terms and conditions are as under:
1. ABC’s profit is agreed at:
• 25% on expected contract’s cost; For this purpose, the expected cost
cannot exceed ₹ 22 crores.
2. The agreed price will be revised depending upon the actual cost incurred.
• The cost for fixation will be taken actual cost or ₹ 22 crores whichever
is less.
Price fixation based on expected cost:
Assume that the costs expected to be incurred by ABC are ₹16 crore. Thus, ABC
can charge a profit of ₹ 4 crores (25% on actual cost).
The contract price will be ₹ 20 crores. (₹16 crores plus ₹ 4 crores)
Price fixation based on actual cost incurred – Scenario 1:
However, if cost incurred by ABC is ₹15 crore, in that case, it would be able to
charge a profit of:
= 25% on ₹15 crore = 15 x 25% = ₹ 3.75 crore
Thus, Total Value of the contract will stand revised as follows:
= Actual Costs + Profit (25% of costs) = ₹ 15 crore + ₹ 3.75 crore = ₹ 18.75
crores.
Price fixation based on actual cost incurred – Scenario 2:
For any unavoidable reasons, if total cost incurred by ABC is ₹ 25 crore, it can only
charge a profit on the expected costs of ₹22 crore as under:
Thus, Total Value of the contract will stand revised as follows:
= Expected Costs + Profit (20% of costs) = ₹ 22 crore + ₹ 5.50 crore = ₹ 27.50
crores.
Analysis of the above scenario:
Cost actually incurred by ABC = ₹ 25 crores.
Actual profit earned by ABC = Total Value of the contract – Actual costs incurred
= ₹ 27.50 Crores – ₹ 25 Crores = ₹ 2.50 Crores.

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1.6 PERCENTAGE COMPLETION METHOD

As discussed in the beginning, Construction contracts are mostly long term, i.e.,
they take more than one accounting year to complete. This means, the final
outcome (profit/ loss) of a construction contract can be determined only after a
number of years from the year of commencement of construction are over. It is
nevertheless possible to recognise revenue annually in proportion of progress of
work to be matched with corresponding construction costs incurred in that year.
This method of accounting, called the stage of completion method (percentage
completion method), provides useful information on the extent of contract
activity and performance during an accounting period.
The method is consistent with Accrual and Matching concepts of accounting.

AS 7 prescribes that the percentage completion method should not be used

unless it is possible to make a reasonable estimate of the final outcome of the
contract.

In reality, the actual profit or loss that is expected to be earned in such contracts
is not possible. Therefore, companies make use of different estimates to arrive at
the possible costs they are likely to incur for the construction. Large infra-
structure companies, builders expect to carry the required industry-experience.
On that basis, the pricing quoted by these companies for tenders take care of all
possible costs and expected profit. Therefore, in substance, a reasonable estimate
of the final outcome is possible in many such cases.
As per AS 7, the outcome of fixed price contracts can be estimated reliably when
all the following conditions are satisfied:

(i) total contract revenue can be measured reliably;

(ii) it is probable that the economic benefits associated with the contract will
flow to the enterprise;
(iii) both the contract costs to complete the contract and the stage of contract
completion at the reporting date can be measured reliably; and
(iv) the contract costs attributable to the contract can be clearly identified and
measured reliably so that actual contract costs incurred can be compared
with prior estimates.

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 REVENUE BASED ACCOUNTING STANDARDS 8.13
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The outcome of a cost-plus contract can be estimated reliably when all the
following conditions are satisfied:
(i) it is probable that the economic benefits associated with the contract will
flow to the enterprise; and
(ii) the contract costs attributable to the contract, whether or not specifically
reimbursable, can be clearly identified and measured reliably.
Flowchart depicting the conditions under which the outcome of a construction
contract can be reliably estimated:

Total contract revenue can be measured

reliably.

It is probable that the economic benefits

associated with the contract will flow to the
enterprise.
In fixed
price
contract
Both contract costs to complete the contract
and the stage of contract completion at the
reporting date can be measured reliably.

Outcome of Contract costs attributable to contract can be

clearly identified and measured reliably so that
contracts can be actual contract costs incurred can be
estimated reliably compared with prior estimates.

It is probable that the economic benefits

associated with the contract will flow to the
enterprise.
In cost
plus
contract
Contract costs attributable to the contract,
whether or not specifically reimbursable, can
be clearly identified and measured reliably.

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 8.14 ADVANCED ACCOUNTING
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Also, AS 7 provides that whenever total contract cost is expected to exceed the
total contract revenue, the loss should be recognised as an expense immediately.

We may argue that why would an entity enter into a loss-making contract. It can
happen that after having entered into the construction contract, there is a sudden
rise in the costs which was not expected, nor are these covered under the cost-
escalation clause. Another reason, is that, an entity may enter into a loss-making
contract is to penetrate the market. Therefore, it is not uncommon for companies
to sometimes enter into loss-making contracts.

Under the prudence concept, we must always make a provision for all
expected losses.

If the final oucome of the

contract

Can be estimated Cannot be estimated

reliably reliably

Revenue and costs Contract costs should be recognised as an expense

recognised as per Revenue should be recognised in the period in which they are incurred
percantage of completion only to the extent of contrct and
costs incurred, of which An expected loss on the construction contract
method considering the recovery is probable should be recognised asan expense immediately in
stage of completion of accordance with paragraph 35.
contract at reporting date.

Illustration 3 (Percentage completion method)

X Ltd. commenced a construction contract on 01-04-20X1. The fixed contract price

agreed was ₹2,00,000. The company incurred ₹81,000 in 20X1-X2 for 45% work
and received ₹79,000 as progress payment from the customer. The cost incurred in
20X2-X3 was ₹89,000 to complete the rest of work. Show the extract of the Profit
and Loss Account and Customer’s Account for the related years.

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 REVENUE BASED ACCOUNTING STANDARDS 8.15
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Solution
Profit & Loss Account

Year ` 000 Year ` 000

20X1-X2 To Construction 81 20X1-X2 By Contract Price 90

Costs (for 45% (45% of Contract
work) Price)
To Net profit 9
(for 45% work)

90 90
20X2-X3 To Construction 89 20X2-X3 By Contract Price 110
costs (55% of Contract
(for 55% work) Price)
To Net Profit 21
(for 55% work)
110 110

Customer’s Account

Year ` 000 Year ` 000

20X1-X2 To Contract 90 20X1-X2 By Bank 79
Price
By Balance 11
c/d
90 90
20X2-X3 To Balance b/d 11 20X2-X3
To Contract 110 By Bank 121
Price
121 121

AS 7 provides that the percentage completion method should not be applied if

the outcome of a construction contract cannot be estimated reliably. In such
cases:

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 8.16 ADVANCED ACCOUNTING
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(a) revenue should be recognised only to the extent of contract costs incurred
of which recovery is probable; and

(b) contract costs should be recognised as an expense in the period in which

they are incurred.
An expected loss on the construction contract should be recognised as an
expense immediately in accordance with paragraph 35.

Illustration 4
PQ & Associates undertakes a construction contract the details of which are
provided below:
Total Contract Value ₹40 lakh
Costs incurred to date ₹3 lakh
Estimated future costs of completion ₹30 lakh
Work completed 10%

The work has started some time ago and there is an uncertainty with respect to the
outcome of the contract due to expected changes in regulations. PQ is certain that
it would be able to recover the costs incurred to date.

Solution

In the given case, revenue and costs can only be recognised to the extent of the
costs incurred and those which are expected to be recovered. Therefore, the
profit & loss statement would appear as under:

Contract Revenue ₹3 lakh

Contract Costs ₹3 lakh

Contract Profit Nil

When the uncertainties that prevented the outcome of the contract being
estimated reliably cease to exist, revenue and expenses associated with the
construction contract should be recognised by the percentage completion
method.

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Example 4

X Ltd. commenced a construction contract on 01/04/X1. The contract price agreed was
reimbursable cost plus 10%. The company incurred ₹1,00,000 in 20X1-X2, of which cost
of ₹90,000 is reimbursable. The further non-reimbursable costs to be incurred to
complete the contract are estimated at ₹5,000. The other costs to complete the contract
could not be estimated reliably. The Profit & Loss A/c extract of X Ltd. for 20X1-X2 is
shown below:
Solution
Profit & Loss Account

` 000 ` 000
By Contract Price
To Construction Costs 100 99
(90+9)
To Provision for loss 5 Net loss 6
105 105

1.7 TREATMENT OF COSTS RELATING TO

FUTURE ACTIVITY
Under the percentage of completion method, contract revenue is recognised as
revenue in the statement of profit and loss in the accounting periods in which the
work is performed. Contract costs are usually recognised as an expense in the
statement of profit and loss in the accounting periods in which the work to which
they relate is performed. The contract costs that relate to future activity on the
contract are however recognised as an asset provided it is probable that they will
be recovered. Such costs represent an amount due from the customer and are
often classified as contract work in progress.

1.8 UNCOLLECTABLE CONTRACT REVENUE

When an uncertainty arises about the collectability of an amount already included
in contract revenue, and already recognised in the statement of profit and loss,
the uncollectable amount or the amount in respect of which recovery has ceased

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to be probable is recognised as an expense rather than as an adjustment of the

amount of contract revenue.

1.9 STAGE OF COMPLETION

The stage of completion of a contract may be determined in a variety of ways.
The enterprise uses the method that measures reliably the work performed.
Depending on the nature of the contract, the methods may include:
(a) the proportion that contract costs incurred for work performed up to the
reporting date bear to the estimated total contract costs; or

(b) surveys of work performed; or

(c) completion of a physical proportion of the contract work.
Progress payments and advances received from customers may not necessarily
reflect the work performed.
Calculation of Stage of completion under proportion of costs incurred
method.

This method may be useful in case of contracts where cost is closely monitored by
the contractor. This method could be more commonly used in case of private
contracts to construct office buildings, machinery or equipment.
Actual cost incurred
= ×100
Estimated total cost

Actual cost incurred

= ×100
Actual cost incurred + Estimated future costs

Calculation of Stage of completion under Surveyor of work performed

method
Generally, in case of government projects, a surveyor is appointed to oversee
various parameters like quality of work, material used, etc. Based on these
parameters, the surveyor would assess the percentage of work completed. The
certification done by the appointed surveyor is used as the percentage of work
completed.

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Calculation of Stage of completion of a physical proportion of the contract

work method
This method is commonly used in case of construction work which is not very
complicated. For example, a contract to place tiles can be regarded as complete
on the basis of area covered as a proportion of total area expected to be covered.
Thus, for example If the area to be covered is 1,000 sq. ft., and the total area
already covered is 300 sq.ft., this implies that 30% of the work is completed.

Illustration 5 (Stage of completion for a loss-making contract)

Show Profit & Loss A/c (Extract) in books of a contractor in respect of the following
data for Year 1.

Information for Year 1 ` 000

Contract price (Fixed) 600
Cost incurred to date 390
Estimated cost to complete 260

Assume that the contract period is 2 years. The contract is 100% completed by
Year 2. Actual costs incurred is the same as total estimated costs to complete
(Cost incurred to date plus estimated cost to complete).
Solution

Amount INR ` 000

Year Total up to Year 2

(1) Year2 (2) (2) – (1)

A. Cost incurred to date (390) (650) (260)

B. Estimate of cost to completion (260) - -
C. Estimated total cost (650) 650 650
D. Degree of completion (A/C) 60% 100% 40%
E. Revenue Recognised
(60% of 600) 360
(100% of 600) 600 240

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Total foreseeable loss (650 – 600) 50

Less: Loss for current year (E – A) (30)
Expected loss to be recognised immediately (20)
Reversal of Loss provision in Year 2 20

Profit & Loss A/c (Year 1)

` `
To Construction costs 390 By Contract Price 360
To Provision for loss 20 By Net Loss 50
410 410

Profit & Loss A/c (Year 2)

` `
To Construction costs 260 By Contract Price 240
By Reversal of Provision 20
for loss
260 260

1.10 CHANGES IN ESTIMATES

The percentage of completion method is applied on a cumulative basis in each
accounting period to the current estimates of contract revenue and contract
costs. Therefore, the effect of a change in the estimate of contract revenue or
contract costs, or the effect of a change in the estimate of the outcome of a
contract, is accounted for as a change in accounting estimate in accordance with
AS 5. The changed estimates are used in determination of the amount of revenue
and expenses recognised in the statement of profit and loss in the period in
which the change is made and in subsequent periods.

1.11 DISCLOSURE
(a) An enterprise should disclose:

(i) the amount of contract revenue recognised as revenue in the period;

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(ii) the methods used to determine the contract revenue recognised in

the period; and
(iii) the methods used to determine the stage of completion of contracts
in progress.
(b) An enterprise should disclose following in respect of contracts in progress at
the reporting date:
(i) the aggregate amount of costs incurred and recognised profits (less
recognised losses) upto the reporting date;
(ii) the amount of advances received; and
(iii) the amount of retentions.
• Retentions are amounts of progress billings which are not paid
until the satisfaction of conditions specified in the contract for
the payment of such amounts or until defects have been
rectified.
• Progress billings are amounts billed for work performed on a
contract whether or not they have been paid by the customer.
• Advances are amounts received by the contractor before the
related work is performed.
(c) An enterprise should present:
(i) the gross amount due from customers for contract work as an asset; and
(ii) the gross amount due to customers for contract work as a liability.

Particulars `
Costs incurred xxx
Plus: Recognised profits xxx
Less: Recognised losses xxx
Less: Progress billings xxx
Amount xxx
If above amount is positive- Gross amount due from
customers
If above amount is negative- Gross amount due to

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customers

Disclosures in Financial Statements

General Specific for contracts in progress

Amount of contract revenue recognised Aggregate amount of costs incurred

as revenue in the period and recognised profits (less recognised
losses) upto the reporting date
Methods used to determine the
contract revenue recognised in the
period Amount of advances received

Methods used to determine the stage

of completion of contracts in progress
Amount of retentions.

Illustration 6
A firm of contractors obtained a contract for construction of bridges across river
Revathi. The following details are available in the records kept for the year ended
31st March, 20X1.

( ` in lakhs)
Total Contract Price 1,000
Work Certified for the cost incurred 500
Work yet not Certified for the cost incurred 105
Estimated further Cost to Completion 495
Progress Payment Received 400
To be Received 140

The firm seeks your advice and assistance in the presentation of accounts keeping
in view the requirements of AS 7 issued by your institute.

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Solution

(a) (` in lakhs)
Amount of foreseeable loss:
Total cost of construction (500 + 105 + 495) 1,100
Less: Total contract price (1,000)
Total foreseeable loss to be recognized as expense 100

According AS 7, when it is probable that total contract costs will exceed total
contract revenue, the expected loss should be recognized as an expense
immediately.
(b) (` in lakhs)
Contract work-in-progress i.e. cost incurred to date
are ₹ 605 lakhs
Work certified 500
Work not certified 105
605
This is 55% (605/1,100  100) of total costs of
construction.
(c) Proportion of total contract value recognized as revenue:

55% of ` 1,000 lakhs = ` 550 lakhs

(d) Gross Amount due from/to customers = (Contract costs + Recognized

profits – Recognized
Losses) – (Progress payments
received + Progress payments to be
received)
= (605 + Nil – 100) – (400 + 140)
` in lakhs
= [505 – 540] ` in lakhs
Amount due to customers = ` 35 lakhs
The amount of ` 35 lakhs will be shown in the balance sheet as liability.

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(e) The relevant disclosures under AS 7 are given below:

` in lakhs
Contract revenue 550
Contract expenses 605
Recognised profits less recognised losses (100)
Progress billings ` (400 + 140) 540
Retentions (billed but not received from contractee) 140
Gross amount due to customers 35
Method of revenue recognition (use of percentage completion method)
Method of determining state of completion (based on proportionate cost

Illustration 7
On 1st December, 20X1, Vishwakarma Construction Co. Ltd. undertook a contract
to construct a building for ` 85 lakhs. On 31st March, 20X2, the company found
that it had already spent ` 64,99,000 on the construction. Prudent estimate of
additional cost for completion was ` 32,01,000. What amount should be recognized
in the statement of profit and loss for the year ended 31st March, 20X2 as per
provisions of Accounting Standard 7 (Revised)?

Solution

`
st
Cost incurred till 31 March, 20X2 64,99,000
Prudent estimate of additional cost for completion 32,01,000
Total cost of construction 97,00,000
Less: Contract price (85,00,000)
Total foreseeable loss 12,00,000

According to AS 7, the amount of ` 12,00,000 is required to be recognised as an

expense.
` 64, 99, 000 ×100
Contract work in progress = = 67%
97, 00, 000

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Proportion of total contract value recognised as turnover:

= 67% of ` 85,00,000 = ` 56,95,000.

The amount of expected loss will be split as under:

Particulars Workings Amount

Expected Loss 97,00,000– 85,00,000 12,00,000
Contract revenue 67% of 85,00,000 56,95,000
Contract cost Given 64,99,000
Actual loss 56,95,000– 64,99,000 8,04,000
Amount of provision required 12,00,000– 8,04,000 3,96,000
[As per Para 35]

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TEST YOUR KNOWLEDGE

Multiple Choice Questions
The below information relates to Questions 1 – 3:

XY Ltd. agrees to construct a building on behalf of its client GH Ltd. on 1 st April

20X1. The expected completion time is 3 years. XY Ltd. incurred a cost of ` 30 lakh
up to 31 st March 20X2. It is expected that additional costs of ` 90 lakh. Total
contract value is ` 112 lakh. As at 31st March 20X2, XY Ltd. has billed GH Ltd. for
` 42 lakh as per the agreement. Assume that the work is completed to the extent of
75% by the end of Year 2.

1. Revenue to be recognized by XY Ltd. for the year ended 31st March 20X2 is
(a) ` 28 lakh
(b) ` 42 lakh
(c) ` 30 lakh
(d) ` 32 lakh
2. Total expense to be recognised in Year 1 is

(a) ` 30 lakh
(b) ` 120 lakh
(c) ` 38 lakh
(d) ` 36 lakh
3. Revenue to be recognised for year 2 is
(a) ` 84 lakh
(b) ` 42 lakh
(c) ` 56 lakh
(d) ` 28 lakh
Below information relates to Questions 4 – 5
M/s AV has presented the information for Contract No. XY123:
Total contract value ` 370 lakh

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Certified work completed ` 320 lakh

Costs incurred to date ` 360 lakh
Progress Payments received ` 300 lakh
Expected future costs to be incurred ` 50 lakh. The revenue to be recognised based on
the certified work completed.
4. Revenue to be recognised by M/s AV is
(a) ` 320 lakh
(b) ` 370 lakh
(c) ` 360 lakh
(d) ` 400 lakh
5. Total expense to be recognised by M/s AV is
(a) ` 380 lakh
(b) ` 400 lakh
(c) ` 320 lakh
(d) ` 360 lakh
6. LP Contractors undertakes a fixed price contract of ` 200 lakh. Transactions
related to the contract include:
Material purchased: ` 80 lakh
Unused material: ` 30 lakh
Labour charges: ` 60 lakh
Machine used for 3 years for the contract. Original cost of the machine is ` 100
lakh. Expected useful life is 15 years.
Estimated future costs to be incurred to complete the contract: ` 80 lakh.

Loss on contract to be recognised is:

(a) ` 40 lakh
(b) ` 10 lakh
(c) ` 90 lakh
(d) ` 50 lakh

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Theoretical Questions
7. It is argued that profit on construction contracts should not be recognised
until the contract is completed. Please explain whether you believe that this
suggestion would improve the quality of financial reporting for long-term
construction contracts.

8. A contractor has entered into a contract with a municipal body for

construction of a flyover. As per the contract terms, the contractor will receive
an additional ` 2 Crore as incentive if the construction of the flyover were to
be finished within a period of two years from the start of the contract. The
contractor wants to recognize this revenue since in the past he has been able
to meet similar targets very easily.
Explain whether the contractor’s view-point is correct?

Scenario based Questions

9. A construction contractor has a fixed price contract for ` 9,000 lakhs to
build a bridge in 3 years time frame. A summary of some of the
financial data is as under:

(Amount ` in lakhs)
Year 1 Year 2 Year 3
Initial Amount for revenue agreed in 9,000 9,000 9,000
contract
Variation in Revenue (+) - 200 200
Contracts costs incurred up to the reporting 2,093 6,168* 8,100**
date
Estimated profit for whole contract 950 1,000 1,000

*Includes ` 100 lakhs for standard materials stored at the site to be used in
year 3 to complete the work.

**Excludes ` 100 lakhs for standard material brought forward from year 2.
The variation in cost and revenue in year 2 has been approved by customer.

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Compute year wise amount of revenue, expenses, contract cost to complete

and profit or loss to be recognized in the Statement of Profit and Loss as per
AS-7 (revised).
10. Akar Ltd. Signed on 01/04/X1, a construction contract for ` 1,50,00,000.
Following particulars are extracted in respect of contract, for the year ended
31/03/X2.
- Materials used ` 71,00,000
- Labour charges paid ` 36,00,000

- Hire charges of plant ` 10,00,000

- Other contract cost incurred ` 15,00,000
- Labour charges of ` 2,00,000 are still outstanding on 31.3.X2.
- It is estimated that by spending further ` 33,50,000 the work can be
completed in all respect.
You are required to compute profit/loss for the year to be taken to Profit &
Loss Account and any provision for foreseeable loss to be recognized as per
AS 7.

11. RT Enterprises has entered into a fixed price contract for construction of a
tower with its customer. Initial tender price agreed is ` 220 crore. At the start
of the contract, it is estimated that total costs to be incurred will be
` 200 crore. At the end of year 1, this estimate stands revised to ` 202 crore.
Assume that the construction is expected to be completed in 3 years.

During year 2, the customer has requested for a variation in the contract. As a
result of that, the total contract value will increase by ` 5 crore and the costs
will increase by ` 3 crore.

RT has decided to measure the stage of completion on the basis of the

proportion of contract costs incurred to the total estimated contract costs.
Contract costs incurred at the end of each year is:

Year 1: ` 52.52 crore

Year 2: ` 154.20 crore (including unused material of 2.5 crore)

Year 3: ` 205 crore.

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You are required to calculate:

(a) Stage of completion for each year.

(b) Profit to be recognised for each year.

12. On 1st December, 20X1, GR Construction Co. Ltd. undertook a contract to
construct a building for ` 45 lakhs. On 31 st March, 20X2, the company found
that it had already spent ` 32.50 lakhs on the construction. Additional cost of
completion is estimated at ` 15.10 lakhs. What amount should be charged to
revenue in the final accounts for the year ended 31 st March, 20X2 as per
provisions of AS-7?

ANSWERS/SOLUTIONS
Answer to the Multiple Choice Questions
1. (a) 2. (c) 3. (c) 4. (a) 5. (d) 6. (b)

Answer to the Theoretical Questions

7. Usually, construction contracts are long term nature i.e., the contracts are entered
in one accounting period, however, the work performed will flow into more than
one accounting year. If the profit on construction contracts is not recognised over
the construction period, then the costs incurred during the earlier years of the
contract would be recognised without any corresponding revenue. This will result
in losses for initial years followed high profits in future years.
The current treatment under AS 7 results in matching of revenue and
associated costs as they are recognised during the same period. Also, the
current accounting incorporates the prudence concept as any foreseeable
losses are accounted for immediately.
Therefore, AS 7 results in a fair representation of the underlying financial
substance of the transaction.
8. The contractor’s view is not entirely correct in considering the variation as a
part of contract revenue. There is an argument that he has been able to
complete similar contracts within stipulated time. However, each contract
needs to be assessed in isolation with respect to the specific challenges
associated with the timing and uncertainty in completion.

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Accordingly, the contractor needs to validate the assumptions with respect to

the specific contract. Only after that assessment is done, the incentive of ` 2
crore may be included within the contract revenue.

Answer to the Scenario based Questions

9. The amounts of revenue, expenses and profit recognized in the statement of
profit and loss in three years are computed below:
(Amount in ` lakhs)
Up to the Recognized in Recognized in
reporting previous years current year
date
Year 1
Revenue (9,000 x 26%) 2,340 - 2,340
Expenses (8,050 x 26%) 2,093 - 2,093
Profit 247 - 247
Year 2
Revenue (9,200 x 74%) 6,808 2,340 4,468
Expenses (8,200 x 74%) 6,068 2,093 3,975
Profit 740 247 493
Year 3
Revenue (9,200 x 100%) 9,200 6,808 2,392
Expenses (8,200 x 100%) 8,200 6,068 2,132
Profit 1,000 740 260

Working Note:

Year 1 Year 2 Year 3

Revenue after considering 9,000 9,200 9,200
variations 950 1,000 1,000
Less: Estimated profit for whole
contract
Estimated total cost of the 8,050 8,200 8,200
contract (A)

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Actual cost incurred upto the 2,093 6,068 8,200

reporting date (B) (6,168-100) (8,100+100)
Degree of completion (B/A) 26% 74% 100%

10. Statement showing the amount of profit/loss to be taken to Profit and Loss
Account and additional provision for the foreseeable loss as per AS 7

Cost of Construction ` `
Material used 71,00,000
Labour Charges paid 36,00,000
Add: Outstanding on 31.03.20X2 38,00,000
2,00,000
Hire Charges of Plant 10,00,000
Other Contract cost incurred 15,00,000
Cost incurred upto 31.03.20X2 1,34,00,000
Add: Estimated future cost 33,50,000
Total Estimated cost of construction 1,67,50,000
Degree of completion (1,34,00,000/1,67,50,000 x 100) 80%
Revenue recognized (80% of 1,50,00,000) 1,20,00,000
Total foreseeable loss (1,67,50,000 - 1,50,00,000) 17,50,000
Less: Loss for the current year (1,34,00,000 - 1,20,00,000) 14,00,000
Loss to be provided for 3,50,000
11. (a) Stage of completion = Costs incurred to date / Total estimated costs
Year 1: 52.52 crore / 202 crore = 26%
Year 2: (154.20 crore – 2.50 crore) / 205 crore = 74%
Year 3: 205 crore / 205 crore = 100%
(b) Profit for the year

Year 1 Year 2 Year 3

Contract 57.20 crore 109.30 crore 58.50 crore
Revenue (1)

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(220 crore x 26%) (225 crore x 74% - (225 crore x 100% -

57.20 crore) 109.30 crore –
57.20 crore)
Contract 52.52 crore 99.18 crore 53.30 crore
Cost (2)
(202 crore x 26%) (205 crore x 74% - (205 crore x 100% -
52.52 crore) 99.18 crore – 52.52
crore)
Contract 4.68 crore 10.12 crore 5.20 crore
Profit (1) –
(2)

12.

` in lakhs
Cost of construction incurred till date 32.50
Add: Estimated future cost 15.10
Total estimated cost of construction 47.60

Percentage of completion till date to total estimated cost of construction

= (32.50/47.60)  100 = 68.28%
Proportion of total contract value recognised as revenue for the year ended
31st March, 20X2 per AS 7 (Revised)
= Contract price x percentage of completion
= ` 45 lakh x 68.28% = ` 30.73 lakhs.

(` in lakhs)
Total cost of construction 47.60
Less: Total contract price (45.00)
Total foreseeable loss to be recognized as expense 2.60

According to of AS 7, when it is probable that total contract costs will

exceed total contract revenue, the expected loss should be recognized as an
expense immediately.

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UNIT 2: ACCOUNTING STANDARD 9

REVENUE RECOGNITION

LEARNING OUTCOMES

After studying this unit, you will be able to comprehend the provisions
of AS 9 related with–
 Recognition of revenue in case of:

▪ Sale of Goods

▪ Rendering of Services

▪ The Use by Others of Enterprise Resources Yielding Interest,

Royalties and Dividends

 Effect of Uncertainties on Revenue Recognition

 Required Disclosures.

2.1 INTRODUCTION
Revenue (also called as Top Line), or Sales is the backbone for any business. A
higher revenue would normally reflect an increase in market share, higher
prospects, and eventually an increased value of the business. You would notice
that many start-up entities are more focused to increase their market penetration
and revenue without initially focusing on the profitability.

As a result, it is critical to have a standard that addresses how entities must

recognised the revenue, with respect to the amount and timing in a particular
accounting period.
AS 9 deals with the bases for recognition of revenue in the statement of profit
and loss of an enterprise. AS 9 is mandatory for all enterprises. The Standard is

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concerned with the recognition of revenue arising in the course of the ordinary
activities of the enterprise from
• the sale of goods
• the rendering of services

• the use by others of enterprise resources yielding interest, royalties and

dividends
AS 9 does not deal with the following aspects of revenue recognition to which
special considerations apply:
i. Revenue arising from construction contracts;
ii. Revenue arising from hire-purchase, lease agreements;
iii. Revenue arising from government grants and other similar subsidies;
iv. Revenue of insurance companies arising from insurance contracts.

Examples of items not included within the definition of “revenue” for the purpose
of AS 9 are:
i. Realized gains resulting from the disposal of, and unrealized gains resulting
from the holding of, non-current assets, e.g., appreciation in the value of
fixed assets;
ii. Unrealized holding gains resulting from the change in value of current
assets, and the natural increases in herds and agricultural and forest
products;

iii. Realized or unrealized gains resulting from changes in foreign exchange

rates and adjustments arising on the translation of foreign currency financial
statements;
iv. Realized gains resulting from the discharge of an obligation at less than its
carrying amount;
v Unrealized gains resulting from the restatement of the carrying amount of
an obligation.

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2.2 DEFINITION OF REVENUE

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 dividends.

Revenue is the gross inflow of cash, receivables or other

consideration arising from

Use by others of
enterprise resources
Sale of goods Rendering of services
yielding Interest,
royalties and dividends

Example 1
Entity XY sells a machine being used at its factory at a price of ` 2 lakh. The
carrying value of the machine is ` 1.80 lakh. The sale of the machine does not
increase the revenue of XY but is an example of a capital receipt since transaction
does not take place in the normal course of business. Such gain on sale of
` 20,000 (` 2 lakhs – ` 1.80 lakhs) is recognised as a part of profit & loss statement
under Gain/(Loss) on disposal of asset.
Example 2
ST Ltd is a real-estate developer and builder. It is into the business of buying and
selling properties. In 20X1, ST Ltd purchased a unit of land for ₹ 150 crore. It sold
off that land after few months at a price of ₹ 240 crore.
In the above case, the sale of land is a transaction that happens in the ordinary
course of business (as he is a real estate developer and builder – properties will be
an item of inventory in the financial statements) for ST Ltd. Hence, it should
recognise a revenue of ₹ 240 crore when the land is sold.

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Example 3
DL Ltd, a pharma company, has been conducting research on new medicine since
last 2 years to increase the immunity levels of the people consuming it without any
side effects. During the current year, it decides to sell the outcome of the research
undertaken so far to another competitor, GH Ltd for ` 50 crore. DL has already
incurred ` 30 crore on the ongoing research.
In the above example, the sale of the research findings does not represent an
increase in revenue. This is because DL Ltd’s business is not to sell these research
findings in the ordinary course of business. The amount of ₹ 50 crore will be a part
of Other Income in the profit & loss statement.

2.3 AGENCY RELATIONSHIP

In an agency relationship, the revenue is the amount of commission and not the
gross inflow of cash, receivables or other consideration.

The criteria of principal-agency relationship is significant to understand how

much revenue can be recognised by an entity for a sale transaction. The key
principle is whether the sale transaction is made by an entity on its own, or on
behalf of someone else. Whether the risks and rewards pertaining to the goods or
services are with the entity or with someone else, would determine the seller’s
capacity as principal or agency (agent).

When another party is involved in providing goods or services to a customer, the

entity shall determine whether it has an obligation to sell or provide the specified
goods or services itself (i.e., the entity is a principal) or to arrange for those goods
or services to be sold or provided by the other party (i.e., the entity is an agent).
Illustration 1
Zigato runs a food-delivery business. As per the arrangement, Zigato allows
customers to order food from local restaurants and is responsible the delivery of the
food within stipulated time. During a particular year, it collects the money on
orders made online as under:

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Total price for the food item - ` 200 lakhs

Delivery charges - ` 60 lakhs
GST - ` 40 lakhs
Total - ` 300 lakhs
Zigato has received ` 300 lakhs for the above orders from customers and the orders
were delivered to the customer in stipulated time.
How much revenue should be recognised by restaurants and how much revenue
should be recognised by Zigato for the year?
Solution
The risks and rewards associated with the food item are not with Zigato. When a
customer has ordered a food item, whether the item will be prepared or not is the
responsibility of the restaurant and not Zigato. Similarly, the responsibility to
deliver the food item is with Zigato and the restaurant does not undertake
responsibility for the same.

Therefore, the restaurant undertakes the principal’s responsibility to prepare the

food and ensure its quality. Zigato, on the other hand, is only responsible to
deliver the food. Thus, Zigato is acting as an agent. Hence, it can only recognize
revenue relating to that activity (which it does in the ordinary course of business).
The revenue for Zigato, therefore, is ` 60 lakhs, whereas, the revenue for
restaurants will be ` 200 lakhs.
It may be noted that the GST of ` 40 lakhs is a liability payable to the Government
(third party), hence it does not form part of revenue.
Example 4
Trip Deal is a website that allows people to book airlines tickets. As a part of the
business, it agrees to buys 100 tickets from an airline on a particular date and
resells those tickets to customers. However, Trip Deal bears the loss for any unsold
tickets.
In the above example, the risks and rewards relating to tickets are borne by Trip
Deal. Hence, sales made for the tickets will be fully recognized as part of its
revenue. Any unsold tickets will be charged as loss by the entity.

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2.4 SALE OF GOODS

Revenue from sales transactions should be recognised when the requirements as
to performance set out in below in para 2.5 ‘Timing of Recognition of Revenue
from Sale of Goods’ are satisfied, provided that at the time of performance it is
not unreasonable to expect ultimate collection. If at the time of raising of any
claim it is unreasonable to expect ultimate collection, revenue recognition should
be postponed.
Illustration 2
AB sells goods to CD on 1 st March 20X1. CD is having significant cash flows issues
since last few months. However, it is trying to raise funding through bank loan to be
able to run its operations in future. On 5th of May 20X1, CD is able to seek the
funding and is expected to be able to pay for the goods in future.
At the time of sale, it is difficult for AB to ascertain whether it will be able to collect
the amount from CD due to poor financial conditions.
Explain how the recognition of revenue be done by AB?
Solution
In the above case, AB should not recognise any revenue on 1st of March and until
that uncertainty of recovery is clear. Hence, the revenue can only be recognised
by AB on 5th of May 20X1. The inventory transferred to CD until that date is
required to be shown as its own inventory [inventory lying with customers].

2.5 TIMING OF RECOGNITION OF REVENUE

FROM SALE OF GOODS
In a transaction involving the sale of goods, performance should be regarded as
being achieved when the following conditions have been fulfilled:
(i) the seller of goods has transferred to the buyer the property in the goods
for a price or
(ii) 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; and

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(iii) no significant uncertainty exists regarding the amount of the consideration

that will be derived from the sale of the goods.
Note:
The transfer of property in goods, in most cases, results in or coincides with the
transfer of significant risks and rewards of ownership to the buyer. However, there
may be situations where transfer of property in goods does not coincide with the
transfer of significant risks and rewards of ownership. Revenue in such situations
is recognised at the time of transfer of significant risks and rewards of ownership
to the buyer.
Such cases may arise where delivery has been delayed through the fault of either
the buyer or the seller and the goods are at the risk of the party at fault as
regards any loss which might not have occurred but for such fault. Further,
sometimes the parties may agree that the risk will pass at a time different from
the time when ownership passes
Illustration 3
AB sells goods to CD on 1 st January 20X1 for ` 2 lakhs. After the sale was made, CD
is having significant cash flows issues. It is trying to raise funding through bank
loan to be able to run its operations in future. However, it is unable to do so and
has gone under liquidation on 15 th of March 20 X1.
At the time of sale, there was no reason for AB to believe that it will not be able to
collect the amount from CD in future.
Explain how the recognition of revenue be done by AB for the year ended 31 st
March 20X1?
Solution
In the above case, at the time of sale, it was not unreasonable for AB to expect
ultimate collection from CD. Therefore, AB should recognise the revenue of ` 2
lakhs on 1 st of January 20X1 and recognise a receivable for the same amount.
Later, since CD went into liquidation, AB should write off the receivables and book
a loss in his books.

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 REVENUE BASED ACCOUNTING STANDARDS 8.41 a

Accounting in the books of AB

1st January 20X1

CD A/c (Receivables) Dr. ` 2 lakhs

To Revenue A/c ` 2 lakhs
(Being goods sold to CD Ltd)

15th March 20X1

Bad Debts A/c Dr. ` 2 lakhs

To CD A/c (Receivables)A/c ` 2 lakhs
(Being receivables from CD written off due
to its liquidation)

2.6 RENDERING OF SERVICES

Revenue from service transactions is usually recognised as the service is
performed. There are two methods of recognition of revenue from service
transaction, viz,

Methods of recognition of revenue

Proportionate completion Completed service contract

method method

Proportionate Completion Method is a method of accounting which recognises

revenue in the statement of profit and loss proportionately with the degree of
completion of services under a contract. Here performance consists of the
execution of more than one act. Revenue is recognised proportionately by
reference to the performance of each act.
Completed Service Contract Method is a method of accounting which
recognises revenue in the statement of profit and loss only when the rendering of

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8.42 ADVANCED ACCOUNTING

services under a contract is completed or substantially completed. In this method

performance consists of the execution of a single act e.g., installation of a
machine, or repair service,
Alternatively, services are performed in more than a single act, and the services
yet to be performed are so significant in relation to the transaction taken that
performance cannot be deemed to have been completed until the execution of
those acts.
The completed service contract method is relevant to these patterns of
performance and accordingly revenue is recognised when the sole or final act
takes place and the service becomes chargeable.
Revenue from sales or service transactions should be recognised when the service
is performed provided that at the time of performance it is not unreasonable to
expect ultimate collection. If at the time of raising of any claim it is unreasonable
to expect ultimate collection, revenue recognition should be postponed.

2.7 INCOME FROM OTHER SOURCES - INTEREST,

ROYALTIES AND DIVIDENDS
Use by others of such enterprise resources gives rise to:

i. Interest: charges for the use of cash resources or amounts due to the
enterprise. Revenue is recognized on a time proportion basis taking into
account the amount outstanding and the rate applicable.

ii. Royalties: charges for the use of such assets as know-how, patents, trade
marks and copyrights. Revenue is recognized on an accrual basis in
accordance with the terms of the relevant agreement.

iii. Dividends: rewards from the holding of investments in shares. Revenue is

recognized when the owner’s right to receive payment is established.

Revenue arising from the use by others of enterprise resources yielding interest,
royalties and dividends should only be recognized when no significant uncertainty
as to measurability or collectability exists.

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 REVENUE BASED ACCOUNTING STANDARDS 8.43 a

Illustration 4
During the year ended 31 st March 20X1, ZX Enterprises has recognized ` 100 lakhs
on accrual basis income from dividend on units of mutual funds held by it. The
dividends on mutual funds were declared on 15th June, 20X1. The dividend was
proposed on 10th April, 20X1.

Whether the above treatment is as per the relevant Accounting Standard?

Solution

Dividends from investments in shares are not recognized in the statement of

profit and loss until a right to receive payment is established. In the given
situation, the dividend is proposed on 10th April, 20X1, while it is declared on
15th June, 20X1. Thus, the right to receive the payment of dividend gets
established on 15th June, 20X1.

The recognition of ` 100 lakhs on accrual basis in the financial year 20X0-20X1 is
not correct as per AS 9 'Revenue Recognition'.

Illustration 5

Y Ltd., used certain resources of X Ltd. In return X Ltd. received ₹ 10 lakhs and ₹ 15
lakhs as interest and royalties respective from Y Ltd. during the year 20 X1-X2. You
are required to state whether and on what basis these revenues can be recognized
by X Ltd.

Solution

As per AS 9 on Revenue Recognition, revenue arising from the use by others of

enterprise resources yielding interest and royalties should only be recognized
when no significant uncertainty as to measurability or collectability exists. These
revenues are recognized on the following bases:

(i) Interest: on a time proportion basis taking into account the amount
outstanding and the rate applicable. Therefore X Ltd. should recognize
interest revenue of ₹ 10 Lakhs

(ii) Royalties: on an accrual basis in accordance with the terms of the relevant
agreement. X Ltd. therefore should recognize royalty revenue of ₹ 15 Lakhs.

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8.44 ADVANCED ACCOUNTING

2.8 CONDITIONS FOR SALE OF GOODS

1. Delivery is delayed at buyer’s request and buyer takes title and
accepts billing

Sometimes, the buyer may purchase goods and requests the seller to hold the
goods on his behalf for some reason, for example, due to lack of storage or
transportation delays. In such cases, the risks and rewards associated with the
ownership seem to have been transferred to the buyer and the sale should be
considered as complete. This is true even if the physical possession of the goods
is with the seller. The conditions to be met to account for the sale are:

- the goods must be specifically identified, and cannot be transferred to

another customer;

- the delivery is delayed at buyer’s request; and

- the goods are ready to be delivered to the buyer

Example 5

XY Ltd sells goods worth ` 50 lakh on 20 February 20X1 to AB Ltd. AB Ltd is facing
storage capacity constraints at their warehouse. AB Ltd instructs XY Ltd to hold the
goods at XY Ltd’s warehouse and arrange for delivery on 15 March 20X1. However,
all the risks and rewards associated with the sold goods are deemed transferred to
AB Ltd.

In the current scenario, delivery of goods sold is delayed at the request of buyer. XY
Ltd can recognize revenue for sale of goods to AB Ltd on 20 February 20X1 provided
that the goods sold to AB Ltd are held in XY Ltd’s warehouse separately and are not
clubbed with other inventory.

2. Sale on approval basis

Revenue should not be recognized until the goods have been formally accepted
by the buyer or the buyer has done an act adopting the transaction or the time
period for rejection has elapsed or where no time has been fixed, a reasonable
time has elapsed.

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 REVENUE BASED ACCOUNTING STANDARDS 8.45 a

Example 6
M/s XY sells goods worth ` 5 lakh on 30th of March 20X1 to M/s FT under Sale on
approval basis. Under the arrangement, FT can return the goods back to XY within
next 3 months. XY cannot reasonably determine whether FT will give the
acceptance of goods before the expiry of 3 months.

Under these circumstances, XY cannot recognize revenue until the goods are
accepted by FT or on completion of 3 months, whichever is earlier.
3. Goods sold subject to inspection / installation
In case the installation is complex and is significant to be able to use the goods in
the intended manner, revenue should not be recognized until the installation is
satisfactorily completed. However, in case the installation is simple (for example, a
refrigerator needs to be plugged to a power connection after delivery to
customer’s place), revenue is recognized when the customer has agreed to
purchase the goods.

4. Sale and repurchase arrangement

Such arrangements are considered to be financing arrangement, and no sale can
be recognized. Instead, a borrowing should be recognized in the books of the
seller.
Example 7
On 1st January 20X1, M/s KJ sells goods at invoice value of ₹ 5 lakhs to M/s TH. At
the time of sale, M/s KJ has agreed to repurchase these goods back from M/s TH
on 31st March at a price of ` 6 Lac.
You are required to do the accounting for above transactions in the books of M/s
KJ.
Solution
1st Jan 20X1:

Bank A/c Dr. `5 lakhs

To Loan from M/s TH A/c `5 lakhs
(Being borrowing made under the Sale &
Repurchase arrangement)

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8.46 ADVANCED ACCOUNTING

31st March 20X1

Interest expense A/c Dr. `1 lakhs

To Loan from M/s TH A/c `1 lakhs

(Being interest cost recognised on the borrowing)

31st March 20X1:

Loan from M/s TH A/c Dr. `6 lakhs

To Bank A/c `6 lakhs

(Being repayment of loan taken from TH)

5. Trade discounts and volume rebates

Trade discounts and volume rebates received are not encompassed within the
definition of revenue, since they represent a reduction of cost. Trade discounts
and volume rebates given should be deducted in determining revenue.
6. Cash discounts
Definition of revenue under AS 9 represents the gross inflow of cash from sale of
goods or provision of services. Any cash discount given should not be deducted
in determining the revenue. Revenue is therefore recognized at gross amount and
cash discount is recorded as an expense as an when the seller receives the
payment net of discount.
7. Consignment Sale
Consignment sales is a sale where a delivery is made whereby the recipient
undertakes to sell the goods on behalf of the consignor.
In such case revenue should not be recognized until the goods are sold to a third
party
Example 8
In the year 20X1-X2, XYZ supplied goods on Consignment basis to ABC – a retail
outlet worth ` 10,00,000. As per the terms, ABC will only pay XYZ for the goods
which are sold by them to the third party. Rest of the goods can be returned back to
XYZ and ABC will not have any further liability for these goods.

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 REVENUE BASED ACCOUNTING STANDARDS 8.47 a

During the year 20X1-X2, ABC has sold goods worth ` 5,50,000 only and rest of the
goods are still lying in its store which may get sold by next year. Advise XYZ, how
much revenue it can recognize in its books for period 20X1-X2.

Solution
As per AS 9, consignment risk and rewards are not transferred to the customer on
just delivery of the goods and no revenue should be recognized until the goods are
sold to a third party. Therefore, XYZ can recognize revenue of ` 5,50,000 only.

2.9 EFFECT OF UNCERTAINTIES ON REVENUE

RECOGNITION
Where the ability to assess the ultimate collection with reasonable certainty is
lacking at the time of raising any claim, revenue recognition is postponed to the
extent of uncertainty involved.

When the uncertainty relating to collectability arises subsequent to the time of

sale or the rendering of the service, it is more appropriate to make a separate
provision to reflect the uncertainty rather than to adjust the amount of revenue
originally recorded.

An essential criterion for the recognition of revenue is that the consideration

receivable for the sale of goods, the rendering of services or from the use by
others of enterprise resources is reasonably determinable. When such
consideration is not determinable within reasonable limits, the recognition of
revenue is postponed.

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8.48 ADVANCED ACCOUNTING

Revenue Recognition

*Sale of *Rendering *Use by others of

Goods of Services Enterprise Resources

when seller proportionate Complete Dividends

Interest Royalties
has completion d service
transferred method method
the property Revenue is
Revenue is
to the buyer Revenue is recognised
performance recognised
generally recognised on when right to
consists of the time
performance the basis of receive the
for execution of basis
consists of the terms of payment is
consideration more than one
execution of a agreement established
act
single act
transfer of
significant practically
revenue is revenue is
risk &
recognised recognised when
rewards to
the buyer on SLM basis the final act is
completed &
services are
chargeable

* Provided there exists no significant uncertainty regarding the ultimate collection

of consideration
(A key criterion for determining when to recognise revenue from a transaction
involving the sale of goods is that the seller has transferred the property in the
goods to the buyer for a consideration and there exists no significant uncertainty
regarding the ultimate collection of consideration).

2.10 DISCLOSURE
In addition to the disclosures required by AS 1 on ‘Disclosure of Accounting
Policies’, an enterprise should disclose the circumstances in which revenue
recognition has been postponed pending the resolution of significant
uncertainties.
Illustration 6
The Board of Directors decided on 31.3.20X2 to increase the sale price of certain
items retrospectively from 1st January, 20X2. In view of this price revision with
effect from 1st January 20X2, the company has to receive ` 15 lakhs from its
customers in respect of sales made from 1st January, 20X2 to 31st March, 20X2.

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 REVENUE BASED ACCOUNTING STANDARDS 8.49 a

Accountant cannot make up his mind whether to include ` 15 lakhs in the sales for
20X1-20X2.Advise.
Solution
Price revision was effected during the current accounting period 20X1-20X2. As a
result, the company stands to receive ` 15 lakhs from its customers in respect of
sales made from 1st January, 20X2 to 31st March, 20X2. If the company is able to
assess the ultimate collection with reasonable certainty, only then additional
revenue arising out of the said price revision may be recognized in 20X1-20X2.
If the company is not reasonably certain on ultimate collection ` 15 lakhs from its
customers in respect of sales made from 1st January, 20X2 to 31st March, 20X2, it
shall postpone recognition of revenue and disclose it in financial statements for
year 20X1-20X2 as per AS 1
Illustration 7
A claim lodged with the Railways in March, 20X1 for loss of goods of ` 2,00,000 had
been passed for payment in March, 20X3 for ` 1,50,000. No entry was passed in the
books of the Company, when the claim was lodged. Advise P Co. Ltd. about the
treatment of the following in the Final Statement of Accounts for the year ended
31st March, 20X3.
Solution
AS 9 on ‘Revenue Recognition’ states that where the ability to assess the ultimate
collection with reasonable certainty is lacking at the time of raising any claim,
revenue recognition is postponed to the extent of uncertainty involved. When
recognition of revenue is postponed due to the effect of uncertainties, it is
considered as revenue of the period in which it is certain to be collected. In this
case it may be assumed that collectability of claim was not certain in the earlier
periods. This is supposed from the fact that only ` 1,50,000 were collected against
a claim of ` 2,00,000. So this transaction can not be taken as a Prior Period Item.
Hence receipt of ` 1,50,000 shall be recognized as revenue in year ended 31st
March, 20X3
In the light of AS 5, it will not be treated as extraordinary item. However, AS 5
states that when items of income and expense within profit or loss from ordinary
activities are of such size, nature, or incidence that their disclosure is relevant to
explain the performance of the enterprise for the period, the nature and amount
of such items should be disclosed separately. Accordingly, the nature and amount
of this item should be disclosed separately.

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8.50 ADVANCED ACCOUNTING

TEST YOUR KNOWLEDGE

Multiple Choice Questions
1. Which of the conditions mentioned below must be met to recognize revenue
from the sale of goods?
(i) the entity selling does not retain any continuing influence or control
over the goods;

(ii) when the goods are dispatched to the buyer;

(iii) revenue can be measured reliably;
(iv) the supplier is paid for the goods;

(v) it is reasonably certain that the buyer will pay for the goods;
(vi) the buyer has paid for the goods.
(a) (i), (ii) and (v)

(b) (ii), (iii) and (iv)

(c) (i), (iii) and (v)
(d) (i), (iv) and (v)

2. Consignment inventory is an arrangement whereby inventory is held by one

party but owned by another party. Which of the following indicates that the
inventory in question is a consignment inventory?

(a) Manufacturer cannot require the dealer to return the inventory

(b) Dealer has the right to return the inventory
(c) Manufacture is responsible for the pricing of goods and any changes in
the pricing can only be approved by the manufacturer .
(d) Manufacture is responsible for the holding the goods and any changes
in the pricing can only be approved by the dealer
3. Which of the following transactions qualify as revenue for M/s AB Enterprises?
(a) Sales of ` 20 lakhs made under consignment sales.
(b) Sale of an old machine amounting ` 5 lakhs

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 REVENUE BASED ACCOUNTING STANDARDS 8.51 a

(c) Services provided to the customer in the normal course of business.

Sales recorded is ` 50,000.
(d) Sales of ` 25 lakhs made under consignment sales
4. The Accounting Club has 100 members who are required to pay an annual
membership fee of ` 5,000 each. During the current year, all members have
paid the fee. However, 5 members have paid an amount of ` 10,000 each. Of
these, 3 members paid the current year’s fee and also the previous year’s
dues. Remaining 2 members have paid next years’ fee of ` 5,000 in advance.
Revenue from membership fee for the current year to be recognised will be:
(a) ` 5,25,000
(b) ` 5,10,000
(c) ` 5,00,000
(d) ` 5,15,000
5. FlixNet International offers a subscription fee model to allow the paid
subscribers an annual viewing of movies, sports events and other content. It
allows users to register for free and have access to limited content for one
month without any charges. The customer has a right to cancel the
subscription within a month’s time but is required to pay for 1 year
subscription fee after the free period.
XY has subscribed for free viewing on 1 st March 20X1. After 1 month, he has
agreed to pay the annual membership and has paid ` 1,200 on 31st March
20X1 for the subscription that is valid up to 31 st of March 20X2.

Revenue that can be recognized by FlixNet for the year ended 31 st March
20X2 is
(a) ` 100
(b) ` 1,200
(c) Nil
(d) ` 1,100

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8.52 ADVANCED ACCOUNTING

Scenario based Questions

6. GH manufactures and sells televisions. The televisions are shipped to the
customer by sea. In order to transfer risk related to the shipment of the
televisions, GH also gets an insurance coverage for the goods while they are
in transit from the factory to customer’s location.

The insurance policy will reimburse GH for the value of the goods in the event
of loss or damage arising anytime up to these goods reaching customer’s
location. The legal title passes when the goods arrive at the customer’s
premises one month later.
When should Entity GH recognize revenue in its books?
7. The following information of Meghna Ltd. is provided:
(i) Goods of ` 60,000 were sold on 20-3-20X2 but at the request of the
buyer these were delivered on 10-4-20X2.
(ii) On 15-1-20X2 goods of ` 1,50,000 were sent on consignment basis of
which 20% of the goods unsold are lying with the consignee as on
31-3-20X2.
(iii) ` 1,20,000 worth of goods were sold on approval basis on 1-12-20X1.
The period of approval was 3 months after which they were considered
sold. Buyer sent approval for 75% goods up to 31-1-20X2 and no
approval or disapproval received for the remaining goods till 31-3-
20X2.
(iv) Apart from the above, the company has made cash sales of ` 7,80,000
(gross). Trade discount of 5% was allowed on the cash sales.

You are required to advise the accountant of Meghna Ltd., with valid reasons,
the amount to be recognized as revenue in above cases in the context of AS 9.
8. For the year ended 31 st March 20X1, KY Enterprises has entered into the
following transactions.
On 31 March 20X1, KY supplied two machines to its customer ST. Both
machines were accepted by ST on 31 March 20X1. Machine 1 was a machine
that was routinely supplied by KY to many customers and the installation
process was very simple.

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 REVENUE BASED ACCOUNTING STANDARDS 8.53 a

Machine 1 was installed on 2 April 20X1 by ST’s employees.

Machine 2 being more specialised in nature requires an installation process

which is more complicated, requiring significant assistance from KY. Machine
2 was installed between 2 and 5 April 20X1. Details of costs and sales prices
are as follows:
Machine 1 Machine 2
Sale Price 3,20,000 3,00,000
Cost of production 1,60,000 1,50,000

Installation fee nil 10,000

How should above transactions be recognized by KY Enterprises for the
year ended 31 st March 20X1?

9 PQR Ltd., sells agriculture products to dealers. One of the conditions of sale
is that interest is at the rate of 2% p.m., for delayed payments. Percentage
of interest recovery is only 10% on such overdue outstanding due to various
reasons. During the year 20X1-X2 the company wants to recognize the
entire interest receivable. Do you agree?

ANSWERS/SOLUTIONS
Answer to the Multiple Choice Questions
1. (a) 2. (c) 3. (c) 4. (c) 5. (b)

Answer to the Scenario based Questions

6. GH should recognize revenue for the sale when the goods arrive at the
customer’s premises. GH has not transferred the televisions’ significant risks
and rewards of ownership to the customer when the goods depart from the
factory. This is evidenced by the fact that any insurance proceeds received
from the goods’ damage or destruction will be repaid to GH. Further, the
legal title does not pass until the goods arrive at the customer’s premises.

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8.54 ADVANCED ACCOUNTING

7. As per AS 9 “Revenue Recognition”, in a transaction involving the sale of

goods, performance should be regarded as being achieved when the
following conditions are fulfilled:
(i) the seller of goods has transferred to the buyer the property in the
goods for a price or 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; and
(ii) no significant uncertainty exists regarding the amount of the
consideration that will be derived from the sale of the goods.
Case (i) The sale is complete but delivery has been postponed at buyer’s
request. The entity should recognize the entire sale of ` 60,000 for the year
ended 31st March, 20X2.
Case (ii) 20% goods lying unsold with consignee should be treated as
closing inventory and sales should be recognized for ` 1,20,000 (80% of
` 1,50,000). In case of consignment sale revenue should not be recognized
until the goods are sold to a third party.
Case (iii) In case of goods sold on approval basis, revenue should not be
recognized until the goods have been formally accepted by the buyer or the
buyer has done an act adopting the transaction or the time period for
rejection has elapsed or where no time has been fixed, a reasonable time
has elapsed. Therefore, revenue should be recognized for the ` 90,000 upon
receipt of approval on 31-02-20X1 and for the balance ` 30,000 on 01-03-
20X1 as the time period for rejecting the goods had expired.
Case (iv) Trade discounts given should be deducted in determining revenue.
Thus ` 39,000 should be deducted from the amount of turnover of ₹
7,80,000 for the purpose of recognition of revenue.
Thus, revenue should be ` 7,41,000.
8. Machine 1: As the installation process is simple, revenue from Machine 1
will be recognized on 31 March 20X1.
Revenue (Machine 1) ` 3,20,000
Cost of Goods Sold ` 1,60,000
Profit during the period ` 1,60,000

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Since the question specifies that the machine is already accepted by ST on

31 March 20X1, the revenue arising from sale of the machine needs to be
recognized for the year ending 31 March 20X1. This is because acceptance
of the machine indicates that the risks and rewards pursuant to the
ownership are transferred to ST.
Machine 2: Installation process for Machine 2 is more complicated,
requiring significant assistance from KY Ltd. However, question specifies
that the machine is already accepted by ST on 31 March 20X1. Assuming
that there is no further approval/acceptance required from the buyer for the
Machine sold, revenue from sale of Machine 2 can be recognized for the
year ending 31 March 20X1.
Revenue (Machine 2) ` 3,00,000
Cost of Goods Sold ` 1,50,000

Profit during the period ` 1,50,000

However, installation fee which is for rendering installation services cannot
be recognized until the installation is complete. Since the machine is
pending installation, the revenue in respect of installation charges `10,000
needs to be recognized on 5 April 20X1 once the installation process gets
completed.
9. As per AS 9 ‘Revenue Recognition’, where the ability to assess the ultimate
collection with reasonable certainty is lacking at the time of raising any
claim, e.g. for escalation of price, export incentives, interest etc., revenue
recognition is postponed to the extent of uncertainty involved. In such
cases, it may be appropriate to recognise revenue only when it is reasonably
certain that the ultimate collection will be made. Where there is no
uncertainty as to ultimate collection, revenue is recognised at the time of
sale or rendering of service even though payments are made by instalments.
Thus, PQR Ltd. cannot recognise the interest amount unless the company
actually receives it. 10% rate of recovery on overdue outstanding is also an
estimate based on previous record and is not certain. Hence, the company is
advised to recognise interest receivable only on receipt basis.

© The Institute of Chartered Accountants of India

 CHAPTER a
9 1.1

OTHER ACCOUNTING
STANDARDS

UNIT 1: ACCOUNTING STANDARD 12 ACCOUNTING

FOR GOVERNMENT GRANTS

LEARNING OUTCOMES
After studying this unit, you will be able to comprehend the –
 Accounting Treatment of Government Grants
 Capital Approach versus Income Approach

 Recognition of Government Grants

 Non-monetary Government Grants
 Presentation of Grants:

▪ Related to Specific Fixed Assets

▪ Related to Revenue
▪ In the nature of Promoters’ contribution

 Refund of Government Grants

 Disclosures.

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 a 9.2 ADVANCED ACCOUNTING

1.1. INTRODUCTION
AS 12 deals with accounting for government grants such as subsidies, cash
incentives, duty drawbacks, etc. and specifies that the government grants should
not be recognised until there is reasonable assurance that the enterprise will
comply with the conditions attached to them, and the grant will be received.
The standard also describes the treatment of non-monetary government grants;
presentation of grants related to specific fixed assets and revenue and those in
the nature of promoters’ contribution; treatment for refund of government grants
etc.
This Standard does not deal with:
(i) The special problems arising in accounting for government grants in
financial statements reflecting the effects of changing prices or in
supplementary information of a similar nature.
(ii) Government assistance other than in the form of government grants.
(iii) Government participation in the ownership of the enterprise.
The receipt of government grants by an enterprise is significant for preparation of
the financial statements for two reasons. Firstly, if a government grant has been
received, an appropriate method of accounting therefore is necessary. Secondly, it is
desirable to give an indication of the extent to which the enterprise has benefited
from such grant during the reporting period. This facilitates comparison of an
enterprise’s financial statements with those of prior periods and with those of other
enterprises.

1.2 GOVERNMENT GRANTS

Government grants are assistance by government in cash or kind to an enterprise
for past or future compliance with certain conditions. They exclude those forms of
government assistance which cannot reasonably have a value placed upon them
and transactions with government which cannot be distinguished from the normal
trading transactions of the enterprise.

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 OTHER ACCOUNTING STANDARDS 9.3 a

1.3 ACCOUNTING TREATMENT OF GOVERN-

MENT GRANTS
Two broad approaches may be followed for the accounting treatment of
government grants:
 the ‘capital approach’, under which a grant is treated as part of
shareholders’ funds, and
 the ‘income approach’, under which a grant is taken to income over
one or more periods.
It is generally considered appropriate that accounting for government grant
should be based on the nature of the relevant grant. Grants which have the
characteristics similar to those of promoters’ contribution should be treated as
part of shareholders’ funds. Income approach may be more appropriate in the
case of other grants.

1.4 RECOGNITION OF GOVERNMENT GRANTS

A government grant is not recognised until there is reasonable assurance that:
 the enterprise will comply with the conditions attaching to it; and
 the grant will be received.
Receipt of a grant is not of itself conclusive evidence that the conditions
attaching to the grant have been or will be fulfilled.
Example:
X Ltd applies for a grant from the local authority towards a social cause. X Ltd. is
required to meet certain conditions to be eligible for the receipt of grant. There is
a reasonable assurance that X Ltd will receive the grant in time. However, after
having applied for the grant, there is a likelihood that X Ltd may not be able to
meet all the conditions attached to the grant.
In such case, X Ltd should not recognise the grant in its books until there is a
reasonable assurance that it would be able to meet all conditions attached to the
grant.

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 a 9.4 ADVANCED ACCOUNTING

1.5 NON-MONETARY GOVERNMENT GRANTS

Government grants may take the form of non-monetary assets, such as land or
other resources, given at concessional rates. In these circumstances, it is usual to
account for such assets at their acquisition cost. Non-monetary assets given free
of cost are recorded at a nominal value.
Example
X Convent wishes to open a school in locality A. It applies to the State authority
for grant of land. The State authority grants the land for construction of the the
purposes of the school construction. The market value of the land is ` 20 crore
whereas However, the authority provides the land at a nominal cost of ` 50 lakhs
including cost of registration. The State authority requires that free education
must be provided to the poor children by way of reserving 20% of the seats in the
school for such children. There is a reasonable assurance that X Convent has a
reason to believe it can will meet that the above stated condition attached to the
grant.
Thus, X Convent needs to would recognise the cost of the land at its acquisition
cost of ` 50 lakhs.

1.6 PRESENTATION OF GRANTS RELATED TO

SPECIFIC FIXED ASSETS
Grants related to specific fixed assets are government grants whose primary
condition is that an enterprise qualifying for them should purchase, construct or
otherwise acquire such assets. Other conditions may also be attached restricting
the type or location of the assets or the periods during which they are to be
acquired or held.
Example
The Central Government is planning to generate large employment in rural and
backward regions. Thus, it is planning to give grants for the same to entities who
will meet the required conditions. F Ltd applied for a grant to the Central
Government. The Government will give the grant on the condition that, F Ltd will
be required to construct a factory where it would need to employ at least 500

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 OTHER ACCOUNTING STANDARDS 9.5 a

workers for 5 years. Total cost of the construction is expected to be ` 50 crore.

The amount of the grant is ` 30 crore.
F Ltd will be able to recognise the grant only if there is reasonable assurance that
it will meet o the condition of employing 500 workers for next 5 years.
Two methods of presentation in financial statements of grants related to specific
fixed assets are regarded as acceptable alternatives.
Method I :
 The grant is shown as a deduction from the gross value of the asset
concerned in arriving at its book value.
 The grant is thus recognised in the profit and loss statement over the
useful life of a depreciable asset by way of a reduced depreciation
charge.
 Where the grant equals the whole, or virtually the whole, of the cost
of the asset, the asset is shown in the balance sheet at a nominal
value.
Illustration 1
Z Ltd. purchased a fixed asset for ` 50 lakhs, which has the estimated useful life of 5
years with the salvage value of ` 5,00,000. On purchase of the assets government
granted it a grant for ` 10 lakhs. Pass the necessary journal entries in the books of
the company for first two years if the grant amount is deducted from the value of
fixed asset.
Solution
Journal in the books of Z Ltd.

Year Particulars ` (Dr.) ` (Cr.)

1st Fixed Assets Account Dr. 50,00,000
To Bank Account 50,00,000
(Being Fixed Assets purchased)
Bank Account Dr. 10,00,000
To Fixed Assets Account 10,00,000
(Being grant received from the government)

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 a 9.6 ADVANCED ACCOUNTING

Depreciation Account Dr. 7,00,000

To Fixed Assets Account 7,00,000
(Being Depreciation charged on SLM)
Profit & Loss Account Dr. 7,00,000
To Depreciation Account 7,00,000
(Being Depreciation transferred to P&L Account)
2nd Depreciation Account Dr. 7,00,000
To Fixed Assets Account 7,00,000
(Being Depreciation charged on SLM)
Profit & Loss Account Dr. 7,00,000
To Depreciation Account 7,00,000
(Being Depreciation transferred to P&L Account)

Method II:
 Grants related to depreciable assets are treated as deferred income
which is recognised in the profit and loss statement on a systematic
and rational basis over the useful life of the asset.
 Grants related to non-depreciable assets are credited to capital reserve
under this method, as there is usually no charge to income in respect
of such assets.
 If a grant related to a non-depreciable asset requires the fulfilment of
certain obligations, the grant is credited to income over the same
period over which the cost of meeting such obligations is charged to
income.
Illustration 2
Z Ltd. purchased a fixed asset for ` 50 lakhs, which has the estimated useful life of 5
years with the salvage value of ` 5,00,000. On purchase of the assets government
granted it a grant for ` 10 lakhs. Pass the necessary journal entries in the books of
the company for first two years if the grant is treated as deferred income.

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 OTHER ACCOUNTING STANDARDS 9.7 a

Solution
Journal in the books of Z Ltd.

Year Particulars ` (Dr.) ` (Cr.)

1st Fixed Assets Account Dr. 50,00,000
To Bank Account 50,00,000
(Being fixed assets purchased)
Bank Account Dr. 10,00,000
To Deferred Government Grant Account 10,00,000
(Being grant received from the government)
Depreciation Account Dr. 9,00,000
To Fixed Assets Account 9,00,000
(Being depreciation charged on SLM)
Profit & Loss Account Dr. 9,00,000
To Depreciation Account 9,00,000
(Being depreciation transferred to P/L Account)
Deferred Government Grants Account Dr. 2,00,000
To Profit & Loss Account 2,00,000
(Being proportionate government grant taken to P/L
2nd Account)
Depreciation Account Dr. 9,00,000
To Fixed Assets Account 9,00,000
(Being depreciation charged on SLM)
Profit & Loss Account Dr. 9,00,000
To Depreciation Account 9,00,000
(Being depreciation transferred to P/L Account)
Deferred Government Grant Account Dr. 2,00,000
To Profit & Loss Account 2,00,000
(Being proportionate government grant taken to P/L
Account)
Illustration 3
Santosh Ltd. has received a grant of ` 8 crores from the Government for setting up a
factory in a backward area. Out of this grant, the company distributed ` 2 crores as
dividend. Also, Santosh Ltd. received land free of cost from the State Government
but it has not recorded it at all in the books as no money has been spent. In the
light of AS 12 examine, whether the treatment of both the grants is correct.

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 a 9.8 ADVANCED ACCOUNTING

Solution
As per AS 12 ‘Accounting for Government Grants’, when government grant is
received for a specific purpose, it should be utilised for the same. So the grant
received for setting up a factory is not available for distribution of dividend.
In the second case, even if the company has not spent money for the acquisition
of land, land should be recorded in the books of accounts at a nominal value. The
treatment of both the elements of the grant is incorrect as per AS 12.

1.7 PRESENTATION OF GRANTS RELATED TO

REVENUE
Grants related to revenue are sometimes presented as a credit in the profit and
loss statement, either separately or under a general heading such as ‘Other
Income’. Alternatively, they are deducted in reporting the related expense.
Illustration 4
X Ltd. runs a charitable hospital. It incurs salary of doctors, staff etc to the extent
of ` 30 lakhs per annum. As a support, the local Government grants a lumpsum
payment of `90 lakhs to meet the salary expense for a period of next 5 years.
You are required to pass the necessary journal entries in the books of the
company for first year of the grant and present in the statement of profit & loss
when the grant is:
(a) Shown separately as Other Income; and
(b) Deducted against the Salary costs.
Solution
Journal Entries

Particulars ` (Dr.) ` (Cr.)

Bank Account Dr. 90,00,000
To Deferred Income Account 90,00,000
(Being receipt of grant from government)
Salary Expense Account Dr. 30,00,000
To Bank Account 30,00,000

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 OTHER ACCOUNTING STANDARDS 9.9 a

(Being Salary expense paid for the year)

Deferred Income Account Dr. 18,00,000
To Profit & loss Account 18,00,000
(Being Year 1 Grant income recognised in Profit &
Loss)

Note: The grant has been spread on a straight-line basis over a period of 5
years [`90,00,000/5 years = ` 18,00,000].

Statement of Profit & Loss Account (Extract)

(a) Shown separately as Other Income:

Particulars Notes (` )

Other Income 18,00,000

(b) Deducted against the Salary costs:

Particulars (` )

Salary cost 30,00,000

Less: Deferred Government Grant (18,00,000) 12,00,000

1.8 PRESENTATION OF GRANTS OF THE

NATURE OF PROMOTERS’ CONTRIBUTION
Where the government grants are of the nature of promoters’ contribution, i.e.,
they are given with reference to the total investment in an undertaking or by way
of contribution towards its total capital outlay (for example, central investment
subsidy scheme) and no repayment is ordinarily expected in respect thereof, the
grants are treated as capital reserve which can be neither distributed as dividend
nor considered as deferred income.
Illustration 5
Top & Top Limited has set up its business in a designated backward area which
entitles the company to receive from the Government of India a subsidy of 20% of
the cost of investment, for which no repayment was ordinarily expected. Moreover,

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 a 9.10 ADVANCED ACCOUNTING

there was no condition that the company should purchase any specified assets for
this subsidy. Having fulfilled all the conditions under the scheme, the company on
its investment of ` 50 crore in capital assets received ` 10 crore from the
Government in January, 20X2 (accounting period being 20X1-20X2). The company
wants to treat this receipt as an item of revenue and thereby reduce the losses on
profit and loss account for the year ended 31st March, 20X2.
Keeping in view the relevant Accounting Standard, discuss whether this action is
justified or not.
Solution
As per para 10 of AS 12 ‘Accounting for Government Grants’, where the
government grants are of the nature of promoters’ contribution, i.e. they are
given with reference to the total investment in an undertaking or by way of
contribution towards its total capital outlay (for example, central investment
subsidy scheme) and no repayment is ordinarily expected in respect thereof, the
grants are treated as capital reserve which can be neither distributed as dividend
nor considered as deferred income.
In the given case, the subsidy received is neither in relation to specific fixed asset
nor in relation to revenue. Thus, it is inappropriate to recognise government
grants in the profit and loss statement, since they are not earned but represent an
incentive provided by government without related costs. The correct treatment is
to credit the subsidy to capital reserve. Therefore, the accounting treatment
desired by the company is not proper.
Illustration 6
How would you treat the following in the accounts in accordance with AS 12
'Government Grants'?
(i) ` 35 Lakhs received from the Local Authority for providing medical facilities to
the employees.
(ii) ` 100 Lakhs received as Subsidy from the Central Government for setting up a
unit in notified backward area. This subsidy is in nature of nature of
promoters’ contribution.

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 OTHER ACCOUNTING STANDARDS 9.11 a

Solution
(i) ` 35 lakhs received from the local authority for providing medical facilities
to the employees is a grant received in nature of revenue grant. Such
grants are generally presented as a credit in the profit and loss statement,
either separately or under a general heading such as ‘Other Income’.
Alternatively, ` 35 lakhs may be deducted in reporting the related expense
i.e. employee benefit expenses.
(ii) As per AS 12 ‘Accounting for Government Grants’, where the government
grants are in the nature of promoters’ contribution, i.e. they are given with
reference to the total investment in an undertaking or by way of
contribution towards its total capital outlay and no repayment is ordinarily
expected in respect thereof, the grants are treated as capital reserve which
can be neither distributed as dividend nor considered as deferred income. In
the given case, the subsidy received from the Central Government for
setting up a unit in notified backward area is neither in relation to specific
fixed asset nor in relation to revenue. Thus, amount of ` 100 lakhs should
be credited to capital reserve.

1.9 REFUND OF GOVERNMENT GRANTS

 Government grants sometimes become refundable because certain
conditions are not fulfilled and are treated as an extraordinary item (AS 5).
 The amount refundable in respect of a government grant related to
revenue is applied first against any unamortised deferred credit
remaining in respect of the grant. To the extent that the amount
refundable exceeds any such deferred credit, or where no deferred
credit exists, the amount is charged immediately to profit and loss
statement.
 The amount refundable in respect of a government grant related to a
specific fixed asset is recorded by increasing the book value of the
asset or by reducing the deferred income balance, as appropriate, by
the amount refundable. In the first alternative, i.e., where the book
value of the asset is increased, depreciation on the revised book value
is provided prospectively over the residual useful life of the asset.

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 a 9.12 ADVANCED ACCOUNTING

 Where a grant which is in the nature of promoters’ contribution

becomes refundable, in part or in full, to the government on non-
fulfillment of some specified conditions, the relevant amount
recoverable by the government is reduced from the capital reserve.

1.10 DISCLOSURE
(i) The accounting policy adopted for government grants, including the
methods of presentation in the financial statements;
(ii) The nature and extent of government grants recognised in the financial
statements, including grants of non-monetary assets given at a concessional
rate or free of cost.
Illustration 7
Z Ltd. purchased a fixed asset for ` 50 lakhs, which has the estimated useful life of 5
years with the salvage value of ` 5,00,000. On purchase of the assets government
granted it a grant for ` 10 lakhs (This amount was reduced from the cost of fixed
asset). Grant was considered as refundable in the end of 2 nd year to the extent of
` 7,00,000. Pass the journal entry for refund of the grant as per the first method.
Solution
Fixed Assets Account Dr. ` 7,00,000
To Bank Account ` 7,00,000
(Being government grant on asset refunded)
Illustration 8
A fixed asset is purchased for ` 20 lakhs. Government grant received towards it is
` 8 lakhs. Residual Value is ` 4 lakhs and useful life is 4 years. Assume depreciation
on the basis of Straight Line method. Asset is shown in the balance sheet net of
grant. After 1 year, grant becomes refundable to the extent of ` 5 lakhs due to non-
compliance with certain conditions. Pass journal entries for first two years.

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 OTHER ACCOUNTING STANDARDS 9.13 a

Solution
Journal Entries

Year Particulars ` in lakhs ` in lakhs

(Dr.) (Cr.)

1 Fixed Asset Account Dr. 20

To Bank Account 20
(Being fixed asset purchased)

Bank Account Dr. 8

To Fixed Asset Account 8
(Being grant received from the
government reduced the cost of fixed
asset)

Depreciation Account (W.N.1) Dr. 2

To Fixed Asset Account 2
(Being depreciation charged on Straight
Line method (SLM))

Profit & Loss Account Dr. 2

To Depreciation Account 2
(Being depreciation transferred to Profit
and Loss Account at the end of year 1)

2 Fixed Asset Account Dr. 5

To Bank Account 5
(Being government grant on asset partly
refunded which increased the cost of fixed
asset)

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 a 9.14 ADVANCED ACCOUNTING

Depreciation Account (W.N.2) Dr. 3.67

To Fixed Asset Account 3.67
(Being depreciation charged on SLM on
revised value of fixed asset prospectively)
Profit & Loss Account Dr. 3.67
To Depreciation Account 3.67
(Being depreciation transferred to Profit
and Loss Account at the end of year 2)

Working Notes:
1. Depreciation for Year 1

` in lakhs
Cost of the Asset 20
Less: Government grant received (8)
12
12-4 
Depreciation  
 4  2

2. Depreciation for Year 2

` in lakhs
Cost of the Asset 20
Less: Government grant received (8)
12
 12 − 4 
Less: Depreciation for the first year  
 4  2
10
Add: Government grant refundable 5
15
 15 − 4 
Depreciation for the second year  
 3  3.67

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 OTHER ACCOUNTING STANDARDS 9.15 a

Illustration 9
On 1.4.20X1, ABC Ltd. received Government grant of ` 300 lakhs for acquisition of
machinery costing ` 1,500 lakhs. The grant was credited to the cost of the asset. The
life of the machinery is 5 years. The machinery is depreciated at 20% on WDV basis.
The Company had to refund the grant in May 20X4 due to non-fulfillment of certain
conditions.
How you would deal with the refund of grant in the books of ABC Ltd. assuming
that the company did not charge any depreciation for year 20X4?
Solution
According to para 21 of AS 12 on Accounting for Government Grants, the amount
refundable in respect of a grant related to a specific fixed asset should be
recorded by increasing the book value of the asset or by reducing deferred
income balance, as appropriate, by the amount refundable. Where the book value
is increased, depreciation on the revised book value should be provided
prospectively over the residual useful life of the asset.

(` in lakhs)

1st April, 20X1 Acquisition cost of machinery (` 1,500 –

` 300) 1,200.00
31st March, 20X2 Less: Depreciation @ 20% (240.00)

Book value 960.00

31st March, 20X3 Less: Depreciation @ 20% (192.00)

Book value 768.00

31st March, 20X4 Less: Depreciation @ 20% (153.60)

1st April, 20X4 Book value 614.40

May, 20X4 Add: Refund of grant 300.00

Revised book value 914.40

Depreciation @ 20% on the revised book value amounting ` 914.40 lakhs is to be

provided prospectively over the residual useful life of the asset.

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 a 9.16 ADVANCED ACCOUNTING

Illustration 10
A Ltd. purchased a machinery for ` 40 lakhs. (Useful life 4 years and residual value
` 8 lakhs) Government grant received is ` 16 lakhs.
Show the Journal Entry to be passed at the time of refund of grant in the third year
and the value of the fixed assets, if:
(1) the grant is credited to Fixed Assets A/c.
(2) the grant is credited to Deferred Grant A/c.
Solution
In the books of A Ltd.
Journal Entries (at the time of refund of grant)
(1) If the grant is credited to Fixed Assets Account:

` `
I. Fixed Assets A/c Dr. 16 lakhs
To Bank A/c 16 lakhs
(Being grant refunded)

II. The balance of fixed assets after two years depreciation will be `16
lakhs (W.N.1) and after refund of grant it will become (`16 lakhs + `16
lakhs) = `32 lakhs on which depreciation will be charged for remaining
two years. Depreciation = (32-8)/2 = `12 lakhs p.a. will be charged for
next two years.
(2) If the grant is credited to Deferred Grant Account:

As per para 14 of AS 12 ‘Accounting for Government Grants,’ income from

Deferred Grant Account is allocated to Profit and Loss account usually over
the periods and in the proportions in which depreciation on related assets is
charged. Accordingly, in the first two years (`16 lakhs /4 years) = `4 lakhs
p.a. x 2 years = `8 lakhs were credited to Profit and Loss Account and `8
lakhs was the balance of Deferred Grant Account after two years.

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 OTHER ACCOUNTING STANDARDS 9.17 a

Therefore, on refund in the 3 rd year, following entry will be passed:

` `
I Deferred Grant A/c Dr. 8 lakhs
Profit & Loss A/c Dr. 8 lakhs
To Bank A/c 16 lakhs
(Being Government grant refunded)

II Deferred grant account will become Nil. The fixed assets will continue
to be shown in the books at `24 lakhs (W.N.2) and depreciation will
continue to be charged at `8 lakhs per annum for the remaining two
years.
Working Notes:
1. Balance of Fixed Assets after two years but before refund (under
first alternative)
Fixed assets initially recorded in the books = `40 lakhs – `16 lakhs
= `24 lakhs

Depreciation p.a. = (`24 lakhs – `8 lakhs)/4 years = `4 lakhs per year

Value of fixed assets after two years but before refund of grant
= `24 lakhs – (`4 lakhs x 2 years) = `16 lakhs

2. Balance of Fixed Assets after two years but before refund (under
second alternative)
Fixed assets initially recorded in the books = `40 lakhs

Depreciation p.a. = (`40 lakhs – `8 lakhs)/4 years = `8 lakhs per year

Book value of fixed assets after two years = `40 lakhs – (`8 lakhs x 2 years)
= `24 lakhs

Note: Value of fixed assets given above is after refund of government

grant.

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 a 9.18 ADVANCED ACCOUNTING

Illustration 11
Co X runs a charitable hospital. It incurs salary of doctors, staff etc to the extent of `
30 lakhs per annum. As a support, the local govt grants a lumpsum payment of `90
lakhs to meet the salary expense for a period of next 5 years.
At the start of Year 4, Co X is unable to meet the conditions attached to the grant
and is required to refund the entire grant of 90 lakhs.
You are required to pass the necessary journal entries in the books of the company
for refund of the grant if the grant was shown separately as Other Income.
Solution
` `
Deferred Grant A/c Dr. 36 lakhs
Profit & Loss A/c Dr. 54 lakhs
To Bank A/c 90 lakhs
(Being Government grant refunded)

Workings:

Total grant received: ` 90 Lakhs

Grant recognised as income for first 3 years: ` 18 lakhs × 3
= ` 54 lakhs

Remaining Deferred Income = ` 90 Lakhs – 54 lakhs

= ` 36 lakhs

Reference: The students are advised to refer the full text of AS 12 “Accounting
for Government Grants”.

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 OTHER ACCOUNTING STANDARDS 9.19 a

TEST YOUR KNOWLEDGE

Multiple Choice Questions
1. To encourage industrial promotion, IDCI offers subsidy worth ` 50 lakhs to all
new industries set up in the specified industrial areas. This grant is in the
nature of promoter’s contribution. How such subsidy should be accounted in
the books?
(a) Credit it to capital reserve
(b) Credit it as ‘other income’ in the profit and loss account in the year of
commencement of commercial operations
(c) Both (a) and (b) are permitted
(d) Credit it to general reserve
2. Government grants that are receivable as compensation for expenses or losses
incurred in a previous accounting period or for the purpose of giving
immediate financial support to the enterprise with no further related costs,
should be
(a) recognised and disclosed in the Statement of Profit and Loss of the
period in which they are receivable as an ordinary item.
(b) recognised and disclosed in the Statement of Profit and Loss of the
period in which the losses or expenses were incurred.
(c) recognised and disclosed in the Statement of Profit and Loss of the
period in which they are receivable, as an extraordinary item if
appropriate as per AS 5.
(d) disclosed in the Statement of Profit and Loss of the period in which they
are receivable, as an extraordinary item
3. Which of the following is an acceptable method of accounting presentation
for a government grant relating to an asset?
(a) Credit the grant immediately to Income statement
(b) Show the grant as part of Capital Reserve
(c) Reduce the grant from the cost of the asset or show it separately as a
deferred income on the Liability side of the Balance Sheet.
(d) Show the grant as part of general Reserve

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 a 9.20 ADVANCED ACCOUNTING

4. X Ltd. has received a grant of ` 20 crore for purchase of a qualified machine

costing ` 80 crore. X Ltd has a policy to recognise the grant as a deduction
from the cost of the asset. The expected remaining useful life of the machine
is 10 years. Assume that there is no salvage value and the depreciation
method is straight-line. The amount of annual depreciation to be charged as
an expense in Profit and Loss Statement will be:
(a) ` 10 crore
(b) ` 6 crore
(c) ` 2 crore
(d) ` 8 crore
5. X Ltd has received a grant of ` 20 crore for purchase of a qualified machine
costing ` 80 crore. X Ltd. has a policy to recognise the grant as deferred
income. The expected remaining useful life of the machine is 10 years.
Assume that there is no salvage value and the depreciation method is
straight-line. The amount of other income to be to be recognised in Profit and
Loss Statement will be:
(a) ` 10 crore
(b) ` 6 crore
(c) ` 2 crore
(d) ` 8 crore

Theoretical Questions
6. AS 12 deals with recognition and measurement of government grants. Please
elaborate the parameters which are required to be met before an entity can
recognise government grants in its books?

Scenario based Questions

7. Supriya Ltd. received a grant of ` 2,500 lakhs during the accounting year 20X1-
20X2 from government for welfare activities to be carried on by the company for
its employees. The grant prescribed conditions for its utilisation. However, during
the year 20X2-20X3, it was found that the conditions of grants were not
complied with and the grant had to be refunded to the government in full.

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Elucidate the current accounting treatment, with reference to the provisions of

AS-12
8. Hygiene Ltd. had received a grant of ` 50 lakh in 2012 from a State
Government towards installation of pollution control machinery on fulfilment
of certain conditions. The company, however, failed to comply with the said
conditions and consequently was required to refund the said amount in 2024.
The company debited the said amount to its machinery account in 2024 on
payment of the same. It also reworked the depreciation for the said machinery
from the date of its purchase and passed necessary adjusting entries in the
year 2024 to incorporate the retrospective impact of the same. State whether
the treatment done by the company is correct or not.

ANSWERS/SOLUTIONS
Answer to the Multiple Choice Questions

1. (a) 2. (c) 3. (c) 4. (b) 5. (c)

Answer to the Theoretical Questions

6. A government grant is recognised when there is reasonable assurance that:
• the enterprise will comply with the conditions attaching to it;
and
• the grant will be received.
Receipt of a grant is not of itself conclusive evidence that the conditions
attaching to the grant have been or will be fulfilled.

Answer to the Scenario based Questions

7. As per AS 12 ‘Accounting for Government Grants’, Government grants
sometimes become refundable because certain conditions are not fulfilled.
A government grant that becomes refundable is treated as an extraordinary
item as per AS 5.
The amount refundable in respect of a government grant related to revenue
is applied first against any unamortised deferred credit remaining in respect
of the grant. To the extent that the amount refundable exceeds any such

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 a 9.22 ADVANCED ACCOUNTING

deferred credit, or where no deferred credit exists, the amount is charged

immediately to profit and loss statement.
In the present case, the amount of refund of government grant should be
first adjusted against the unamortised deferred income in the books and the
excess if any will be debited to profit & loss account of the company as an
extraordinary item in the year 20X2-20X3.
8. As per the facts of the case, Hygiene Ltd. had received a grant of ` 50 lakh
in 2012 from a State Government towards installation of pollution control
machinery on fulfilment of certain conditions. However, the amount of
grant has to be refunded since it failed to comply with the prescribed
conditions. In such circumstances, AS 12, “Accounting for Government
Grants”, requires that the amount refundable in respect of a government
grant related to a specific fixed asset is recorded by increasing the book
value of the asset or by reducing the capital reserve or the deferred income
balance, as appropriate, by the amount refundable. The Standard further
makes it clear that in the first alternative, i.e., where the book value of the
asset is increased, depreciation on the revised book value should be
provided prospectively over the residual useful life of the asset.
Accordingly, the accounting treatment given by Hygiene Ltd. of increasing
the value of the plant and machinery is quite proper. However, the
accounting treatment in respect of depreciation given by the company of
adjustment of depreciation with retrospective effect is improper and
constitutes violation of AS 12.

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 OTHER ACCOUNTING STANDARDS 9.23 a

UNIT 2: ACCOUNTING STANDARD 14 ACCOUNTING

FOR AMALGAMATIONS

LEARNING OUTCOMES
After studying this unit, you will be able to comprehend the –
 Types of amalgamation – merger and purchase;
 Accounting for amalgamation – Pooling of interest method and
purchase method;
 Computation of Purchase consideration;
 Amalgamation post balance sheet date;
 Disclosure requirements of AS 14;

2.1 INTRODUCTION
AS 14 (Revised) deals with the accounting to be made in the books of Transferee
company in the case of amalgamation and the treatment of any resultant
goodwill or reserve.
An amalgamation may be either in the nature of merger or purchase. The
standard specifies the conditions to be satisfied by an amalgamation to be
considered as amalgamation in nature of merger or purchase.
An amalgamation in nature of merger is accounted for as per pooling of interests
method and in nature of purchase is dealt under purchase method.

Pooling of Interest
Merger
Method
Types of
Amalgamation

Purchase Purchase Method

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 a 9.24 ADVANCED ACCOUNTING

The standard describes the disclosure requirements for both types of

amalgamations in the first financial statements. We will discuss the other
amalgamation aspects in detail in subsequent paragraphs of this unit.

Note:
AS 14 (Revised) does not deal with cases of acquisitions. The distinguishing
feature of an acquisition is that the acquired company is not dissolved and its
separate entity continues to exist.

2.2 DEFINITION OF THE TERMS USED IN THE

STANDARD
 Amalgamation means an amalgamation pursuant to the provisions of the
Companies Act, 2013 or any other statute which may be applicable to
companies and includes ‘merger’.
 Transferor company means the company which is amalgamated into
another company.
 Transferee company means the company into which a transferor company is
amalgamated.

2.3 TYPES OF AMALGAMATIONS

Amalgamations fall into two broad categories.

Types of amalgamations

Merger Purchase

 Merger - In amalgamations where there is a genuine pooling not merely of

the assets and liabilities of the amalgamating companies but also of the
shareholders’ interests and of the businesses of these companies.
 Purchase - In amalgamations which are in effect a mode by which one
company acquires another company and as a consequence:

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 OTHER ACCOUNTING STANDARDS 9.25 a

 the shareholders of the company which is acquired normally do not

continue to have a proportionate share in the equity of the combined
company, or
 the business of the company which is acquired is not intended to be
continued. Such amalgamations are amalgamations in the nature of
'purchase'.

2.4 AMALGAMATION IN THE NATURE OF

MERGER
Amalgamation in the nature of merger is an amalgamation which satisfies all the
following conditions.
(i) All the assets and liabilities of the transferor company become, after
amalgamation, the assets and liabilities of the transferee company.
(ii) Shareholders holding not less than 90% of the face value of the equity
shares of the transferor company (other than the equity shares already held
therein, immediately before the amalgamation, by the transferee company
or its subsidiaries or their nominees) become equity shareholders of the
transferee company by virtue of the amalgamation.
(iii) The consideration for the amalgamation receivable by those equity
shareholders of the transferor company who agree to become equity
shareholders of the transferee company is discharged by the transferee
company wholly by the issue of equity shares in the transferee company,
except that cash may be paid in respect of any fractional shares.
(iv) The business of the transferor company is intended to be carried on, after
the amalgamation, by the transferee company.
(v) No adjustment is intended to be made to the book values of the assets and
liabilities of the transferor company when they are incorporated in the
financial statements of the transferee company except to ensure uniformity
of accounting policies.
Example: X Ltd and Y Ltd are both in telecom business. As per the arrangement
X Ltd will get merged with Y Ltd and their shareholders will get shares in Y Ltd.
X Ltd operations will going to be continued under Y ltd.

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 a 9.26 ADVANCED ACCOUNTING

2.5 AMALGAMATION IN THE NATURE OF

PURCHASE
Amalgamation in the nature of purchase is an amalgamation which does not
satisfy any one or more of the conditions specified above for “Amalgamation in
the nature of merger”.

2.6 METHODS OF ACCOUNTING FOR

AMALGAMATIONS
There are two main methods of accounting for amalgamations.
 For an amalgamation in the nature of merger - pooling of interests method
and
 For an amalgamation in the nature of purchase - purchase method.

2.6.1 Pooling of Interests Method

Pooling of interests is a method of accounting for amalgamations the object of
which is to account for the amalgamation as if the separate businesses of the
amalgamating companies were intended to be continued by the transferee
company. Accordingly, only minimal changes are made in aggregating the
individual financial statements of the amalgamating companies.
Under this method, the assets, liabilities and reserves of the transferor company
are recorded by the transferee company at their existing carrying amounts
If, at the time of the amalgamation, the transferor and the transferee companies
have conflicting accounting policies, a uniform set of accounting policies is
adopted following the amalgamation. The effects on the financial statements of
any changes in accounting policies are reported in accordance with AS 5.

2.6.2 Purchase Method

Under the purchase method, the transferee company accounts for the
amalgamation either

 By incorporating the assets and liabilities at their existing carrying amounts or

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 OTHER ACCOUNTING STANDARDS 9.27 a

 By allocating the consideration to individual identifiable assets and liabilities

of the transferor company on the basis of their fair values at the date of
amalgamation. The identifiable assets and liabilities may include assets and
liabilities not recorded in the financial statements of the transferor company.

2.7 CONSIDERATION
Consideration for the amalgamation means the aggregate of the shares and other
securities issued and the payment made in the form of cash or other assets by the
transferee company to the shareholders of the transferor company. In
determining the value of the consideration, an assessment is made of the fair
value of its elements.
Clarification Chart:

Method I – Net Payment Method Method II – Net Assets Method

Note: We need to compute P.C. by Net Payment Method only. If it cannot be

computed by Net Payment Method – then Net Assets Method will be
applicable.

Situation I – If it is a Merger Situation I – if it is a Merger

Equity shares issued to ESH (cash may Assets at Book value

be paid in case fraction arises) -
+ Liabilities at Book value
Any form of payment given to PSH -
Reserves and Surplus
=
ESC + PSC
Situation II – If it is a case of Situation II – If it is a case of
Purchase Purchase

Any form of payment given to ESH Assets at agreed value

+ -
Any form of payment given to PSH Liabilities at agreed value

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 a 9.28 ADVANCED ACCOUNTING

Many amalgamations recognise that adjustments may have to be made to the

consideration in the light of one or more future events. When the additional
payment is probable and can reasonably be estimated at the date of
amalgamation, it is included in the calculation of the consideration. In all other
cases, the adjustment is recognised as soon as the amount is determinable

2.8 TREATMENT OF RESERVES OF THE

TRANSFEROR COMPANY ON AMALGAMA-
TION
If the amalgamation is an ‘amalgamation in the nature of merger’, the identity of
the reserves is preserved and they appear in the financial statements of the
transferee company in the same form in which they appeared in the financial
statements of the transferor company.
Thus, for example, the General Reserve of the transferor company becomes the
General Reserve of the transferee company, the Capital Reserve of the transferor
company becomes the Capital Reserve of the transferee company and the
Revaluation Reserve of the transferor company becomes the Revaluation Reserve
of the transferee company. As a result of preserving the identity, reserves which
are available for distribution as dividend before the amalgamation would also be
available for distribution as dividend after the amalgamation.

2.9 ADJUSTMENTS TO RESERVES -

AMALGAMATION IN THE NATURE OF
MERGER
When an amalgamation is accounted for using the pooling of interests method,
the reserves of the transferee company are adjusted to give effect to the
following:
 A uniform set of accounting policies should be adopted following the
amalgamation and, hence, the policies of the transferor and the transferee
are aligned.

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 OTHER ACCOUNTING STANDARDS 9.29 a

 Difference between the amount recorded as share capital issued (plus any
additional consideration in the form of cash or other assets) and the amount
of share capital of the transferor company.

2.10 ADJUSTMENTS TO RESERVES -

AMALGAMATION IN THE NATURE OF
PURCHASE
If the amalgamation is an ‘amalgamation in the nature of purchase’, the identity
of the reserves, other than the statutory reserves is not preserved. The amount of
the consideration is deducted from the value of the net assets of the transferor
company acquired by the transferee company. If the result of the computation is
negative, the difference is debited to goodwill arising on amalgamation and if the
result of the computation is positive, the difference is credited to Capital Reserve.
Certain reserves may have been created by the transferor company pursuant to
the requirements of, or to avail of the benefits under, the Income-tax Act, 1961;
for example, Development Allowance Reserve, or Investment Allowance Reserve
or any other statutory reserve. The Act requires that the identity of the reserves
should be preserved for a specified period. Likewise, certain other reserves may
have been created in the financial statements of the transferor company in terms
of the requirements of other statutes. Though normally, in an amalgamation in
the nature of purchase, the identity of reserves is not preserved, an exception is
made in respect of reserves of the aforesaid nature (referred to hereinafter as
‘statutory reserves’) and such reserves retain their identity in the financial
statements of the transferee company in the same form in which they appeared in
the financial statements of the transferor company, so long as their identity is
required to be maintained to comply with the relevant statute. This exception is
made only in those amalgamations where the requirements of the relevant
statute for recording the statutory reserves in the books of the transferee
company are complied with.
In such cases the statutory reserves are recorded in the financial statements of
the transferee company by a corresponding debit to a suitable account head (e.g.,
‘Amalgamation Adjustment Reserve’) which is presented as a separate line item.
When the identity of the statutory reserves is no longer required to be
maintained, both the reserves and the aforesaid account are reversed.

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 a 9.30 ADVANCED ACCOUNTING

The Standard gives a title, which reads as "Reserve". This gives rise to following
requirements.
1. The corresponding debit is "also" to a Reserve Account

2. That Reserve account will show a negative balance

3. But it has to be shown as a separate line item - Which implies, that this debit
"cannot be set off against Statutory reserve taken over".
So the presentation will be as follows:
Notes to Accounts for “Reserves and Surplus”

Description Amount Amount

(Current year) (Previous Year)

Statutory Reserve (taken over from

transferor company)
General Reserve
Profit and Loss or Retained Earnings
Amalgamation Adjustment Reserve (--) (--)
(negative balance)

2.11 TREATMENT OF GOODWILL ARISING ON

AMALGAMATION
Goodwill arising on amalgamation represents a payment made in anticipation of
future income and it is appropriate to treat it as an asset to be amortised to
income on a systematic basis over its useful life. Due to the nature of goodwill, it
is frequently difficult to estimate its useful life with reasonable certainty. Such
estimation is, therefore, made on a prudent basis. Accordingly, it is considered
appropriate to amortise goodwill over a period not exceeding five years unless a
somewhat longer period can be justified.
Factors which may be considered in estimating the useful life of goodwill arising
on amalgamation include:
(a) the foreseeable life of the business or industry

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 OTHER ACCOUNTING STANDARDS 9.31 a

(b) the effects of product obsolescence, changes in demand and other

economic factors
(c) the service life expectancies of key individuals or groups of employees

(d) expected actions by competitors or potential competitors

(e) legal, regulatory or contractual provisions affecting the useful life

2.12 BALANCE OF PROFIT AND LOSS ACCOUNT

In the case of an ‘amalgamation in the nature of merger’, the balance of the Profit
and Loss Account appearing in the financial statements of the transferor company
is aggregated with the corresponding balance appearing in the financial
statements of the transferee company. Alternatively, it is transferred to the
General Reserve, if any.

In the case of an ‘amalgamation in the nature of purchase’, the balance of the

Profit and Loss Account appearing in the financial statements of the transferor
company, whether debit or credit, loses its identity.

2.13 DISCLOSURES
For all amalgamations, the following disclosures are considered appropriate in the
first financial statements following the amalgamation:
a. Names and general nature of business of the amalgamating companies;
b. Effective date of amalgamation for accounting purposes;

c. The method of accounting used to reflect the amalgamation; and

d. Particulars of the scheme sanctioned under a statute.
For amalgamations accounted for under the pooling of interests method, the
following additional disclosures are considered appropriate in the first financial
statements following the amalgamation:
a. Description and number of shares issued, together with the percentage of
each company’s equity shares exchanged to effect the amalgamation;

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 a 9.32 ADVANCED ACCOUNTING

b. The amount of any difference between the consideration and the value of
net identifiable assets acquired, and the treatment thereof.
For amalgamations accounted for under the purchase method, the following
additional disclosures are considered appropriate in the first financial statements
following the amalgamation:
a. Consideration for the amalgamation and a description of the consideration
paid or contingently payable; and
b. The amount of any difference between the consideration and the value of
net identifiable assets acquired, and the treatment thereof including the
period of amortisation of any goodwill arising on amalgamation.

2.14 AMALGAMATION AFTER THE BALANCE

SHEET DATE
When an amalgamation is effected after the balance sheet date but before the
issuance of the financial statements of either party to the amalgamation
disclosure is made in accordance with AS 4 ‘Contingencies and Events Occurring
After the Balance Sheet Date’ but the amalgamation is not incorporated in the
financial statements. In certain circumstances the amalgamation may also
provide additional information affecting the financial statements themselves for
instance by allowing the going concern assumption to be maintained.

Illustration 1
A Ltd. take over B Ltd. on April 01, 20X1 and discharges consideration for the
business as follows:
(i) Issued 42,000 fully paid equity shares of ` 10 each at par to the equity
shareholders of B Ltd.
(ii) Issued fully paid up 15% preference shares of ` 100 each to discharge the
preference shareholders ( ` 1,70,000) of B Ltd. at a premium of 10%.

(iii) It is agreed that the debentures of B Ltd. ( ` 50,000) will be converted into
equal number and amount of 13% debentures of A Ltd.
Determine the amount of purchase consideration as per AS 14.

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 OTHER ACCOUNTING STANDARDS 9.33 a

Solution

Particulars `
Equity Shares (42,000 x 10) 4,20,000
15% Preference Share Capital 1,70,000
Add: Premium on Redemption 17,000
Purchase Consideration 6,07,000

Note: As per AS 14, consideration for the amalgamation means the aggregate of
the shares and other securities issued and the payment made in the form of cash
or other assets by the transferee company to the shareholders of the transferor
company. Thus, payment to debenture holders are not covered by the term
‘consideration’.

Illustration 2
A Ltd. and B Ltd. were amalgamated on and from 1st April, 20X1. A new company C
Ltd. was formed to take over the business of the existing companies. A Ltd. and
B Ltd. have the following ledger balances as on 31st March, 20X1:

A Ltd. B Ltd.
(` in lakhs) (` in lakhs)
Land and Building 550 400
Plant and Machinery 350 250
Investments (Non-current) 150 50
Inventory 350 250
Trade Receivables 300 350
Cash and Bank 300 200
Share Capital:
Equity Shares of ` 100 each 800 750
12% Preference shares of ` 100 each 300 200
Reserves and Surplus:
Revaluation Reserve 150 100
General Reserve 170 150
Investment Allowance Reserve 50 50

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 a 9.34 ADVANCED ACCOUNTING

Profit and Loss Account 50 30

Secured Loans:
10% Debentures ( ` 100 each) 60 30
Trade Payables 420 190

Additional Information:
(1) 10% Debenture holders of A Ltd. and B Ltd. are discharged by C Ltd. issuing
such number of its 15% Debentures of ` 100 each so as to maintain the same
amount of interest.
(2) Preference shareholders of the two companies are issued equivalent number
of 15% preference shares of C Ltd. at a price of ` 150 per share (face value of
` 100).
(3) C Ltd. will issue 5 equity shares for each equity share of A Ltd. and 4 equity
shares for each equity share of B Ltd. The shares are to be issued @ ` 30 each,
having a face value of ` 10 per share.
(4) Investment allowance reserve is to be maintained for 4 more years.
Prepare the Balance Sheet of C Ltd. as on 1st April, 20X1 after the amalgamation
has been carried out on the basis of Amalgamation in the nature of purchase.
Solution
Balance Sheet of C Ltd. as at 1st April, 20X1

Particulars Note No. (` in lakhs)

I. Equity and Liabilities
(1) Shareholder's Funds
(a) Share Capital 1 1,200
(b) Reserves and Surplus 2 1,650
(2) Non-Current Liabilities
Long-term borrowings 3 60
(3) Current Liabilities
Trade payables 8 610
Total 3,520

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 OTHER ACCOUNTING STANDARDS 9.35 a

II. Assets
(1) Non-current assets
(a) Property, Plant and 4 1,550
Equipment
(b) Intangible assets 5 20
(c) Non-current investments 6 200
(2) Current assets
(a) Inventory (350 + 250) 600
(b) Trade receivables 7 650
(c) Cash and bank balances
(300 + 200) 500
Total 3,520

Notes to Accounts

(` in lakhs) (` in lakhs)
1. Share Capital
Equity share capital (W.N.1)
70,00,0001 Equity shares of ` 10 each 700
5,00,0002 Preference shares of 500
` 100 each
(all the above shares are allotted as 1,200
fully paid-up pursuant to contracts
without payment being received in
cash)
2. Reserves and surplus
Securities Premium Account (W.N.3)
(950 + 700) 1,650

1
40,00,000 + 30,00,000
2
3,00,000 + 2,00,000

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 a 9.36 ADVANCED ACCOUNTING

Investment Allowance Reserve (50 + 100

50)
Amalgamation Adjustment Reserve
(50 + 50) (100) 1,650
3. Long-term borrowings
15% Debentures 60
4. Property, Plant and Equipment
Land and Building (550 + 400) 950
Plant and Machinery (350 + 250) 600 1,550
5. Intangible assets
Goodwill [W.N. 2] (110 – 90) 20
6. Non-current Investments
Investments (150 + 50) 200
7. Trade receivables (300 + 350) 650
8. Trade payables (420 + 190) 610
Working Notes:

(` in lakhs)
A Ltd. B Ltd.
(1) Computation of Purchase consideration
(a) Preference shareholders:
 3,00,00,000 
 i.e. 3,00,000 shares  × ` 150 each 450
 100 
 2,00,00,000 
 i.e. 2,00,000 shares  × ` 150 each 300
 100 
(b) Equity shareholders:
 8,00,00,000 × 5 
 i.e. 40,00,000 shares  × ` 30 each 1,200
 100 
 7,50,00,000 × 4 
 i.e. 30,00,000 shares  × ` 30 each _____ 900
 100 
Amount of Purchase Consideration 1,650 1,200

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 OTHER ACCOUNTING STANDARDS 9.37 a

(2) Net Assets Taken Over

Assets taken over:
Land and Building 550 400
Plant and Machinery 350 250
Investments 150 50
Inventory 350 250
Trade receivables 300 350
Cash and bank 300 200
2,000 1,500
Less: Liabilities taken over:
Debentures 40 20
Trade payables 420 190
460 210
Net assets taken over 1,540 1,290
Purchase consideration 1,650 1,200
Goodwill 110 ____
Capital reserve 90
(3) Computation of securities premium
On preference share capital
A Ltd.- 3,00,000 x 50 150
B Ltd.- 2,00,000 x 50 100
On equity share capital
A Ltd.- 40,00,000 x 20 800
B Ltd.- 30,00,000 x 20 ____ 600
Total 950 700

Note: For problems based on practical application of AS 14 (Revised)

students are advised to refer Chapter 14 ‘Accounting for Amalgamation of
Companies’ of the study material.

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 a 9.38 ADVANCED ACCOUNTING

TEST YOUR KNOWLEDGE

Multiple Choice Questions
1. Which of the following statement is correct:
(a) In case of merger – ESH can be issued only equity shares as a part of
Purchase consideration.
(b) In case of purchase – ESH can be issued Preference shares also as a part
of Purchase consideration.

(c) Both (a) and (b) are correct.

(d) Both (a) and (b) are incorrect.
2. State which statement is correct:

(a) In case of merger – assets and liabilities can only be taken over at book
values.
(b) In case of purchase – assets and liabilities can be taken over at book
values or agreed values.
(c) Both (a) and (b) are correct.
(d) Both (a) and (b) are incorrect.

3. State which statement is correct:

(a) In case of merger – All Reserves and surplus of vendor company are
taken over by Purchasing company.

(b) In case of Purchase – None of the Reserves and surplus of vendor

company are taken over by Purchasing company.
(c) Both (a) and (b) are correct.

(d) Only (a) is correct.

4. State which statement is correct:
(a) In case of merger – We use pooling of interest method for accounting.

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 OTHER ACCOUNTING STANDARDS 9.39 a

(b) In case of Purchase We use purchase method or pooling of interest

method depending upon whether it is take over at agreed values or
book values.

(c) Both (a) and (b) are correct.

(d) Only (a) is correct.
5. State which statement is incorrect:
(a) In case of merger – We can issue either preference shares or equity
shares to PSH.
(b) In case of Purchase – We can issue either preference shares or equity
shares to PSH.
(c) In case of merger – We can issue only preference shares to PSH.
(d) none of the above.

Theoretical Questions
6. Briefly describe the disclosure requirements for amalgamation including
additional disclosure, if any, for different methods of amalgamation as per AS
14 (Revised).
7. List the conditions to be fulfilled as per AS 14 (Revised) for an amalgamation
to be in the nature of merger, in the case of companies.

8. Briefly explain the methods of accounting for amalgamation as per

Accounting Standard-14.

Scenario based Questions

9. X Co. Ltd. having share capital of ` 50 lakhs divided into equity shares of ` 10
each was taken over by Y Co. Ltd. Y Co. Ltd. issued 11 equity shares of ` 10
each for every 10 shares of X Co. Ltd.
Explain how the difference will be adjusted in the books of Y Co. Ltd. for the
shares issued under the 'Pooling of interests method' of amalgamation as per
AS 14.

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 a 9.40 ADVANCED ACCOUNTING

10. On 1st April, 2018, Tina Ltd. take over the business of Rina Ltd. and
discharged purchase consideration as follows:
(i) Issued 50,000 fully paid Equity shares of ` 10 each at a premium of ` 5
per share to the equity shareholders of Rina Ltd.
(ii) Cash payment of ` 50,000 was made to equity shareholders of Rina Ltd.
(iii) Issued 2,000 fully paid 12% Preference shares of ` 100 each at par to
discharge the preference shareholders of Rina Ltd.
(iv) Debentures of Rina Ltd. 20,000) will he converted into equal number
and amount of 10% debentures of Tina Ltd.

Calculate the amount of Purchase consideration as per AS-14 and pass

Journal Entry relating to discharge of purchase consideration in the books of
Tina Ltd.

ANSWERS/SOLUTIONS
Answer to the Multiple Choice Questions
1. (b) 2. (c) 3. (d) 4. (d) 5. (c)

Answer to the Theoretical Questions

6. The disclosure requirements for amalgamations have been prescribed in
paragraphs 43 to 46 of AS 14 (Revised) on Accounting for Amalgamation.
Refer Para 2.5 for details.
7. According to AS 14 "Accounting for Amalgamations", Amalgamation in the
nature of merger is an amalgamation which satisfies all the following
conditions:
(i) All the assets and liabilities of the transferor company become, after
amalgamation, the assets and liabilities of the transferee company.
(ii) Shareholders holding not less than 90% of the face value of the equity
shares of the transferor company (other than the equity shares already
held therein, immediately before the amalgamation, by the transferee
company or its subsidiaries or their nominees) become equity

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 OTHER ACCOUNTING STANDARDS 9.41 a

shareholders of the transferee company by virtue of the

amalgamation.
(iii) The consideration for the amalgamation receivable by those equity
shareholders of the transferor company who agree to become equity
shareholders of the transferee company is discharged by the
transferee company wholly by the issue of equity shares in the
transferee company, except that cash may be paid in respect of any
fractional shares.
(iv) The business of the transferor company is intended to be carried on,
after the amalgamation, by the transferee company.
(v) No adjustment is intended to be made to the book values of the
assets and liabilities of the transferor company when they are
incorporated in the financial statements of the transferee company
except to ensure uniformity of accounting policies.
8. As per AS 14 on 'Accounting for Amalgamations', there are two main
methods of accounting for amalgamations:

The Pooling of Interest Method

Under this method, the assets, liabilities and reserves of the transferor
company are recorded by the transferee company at their existing carrying
amounts (after making the necessary adjustments).
If at the time of amalgamation, the transferor and the transferee companies
have conflicting accounting policies, a uniform set of accounting policies is
adopted following the amalgamation. The effects on the financial
statements of any changes in accounting policies are reported in
accordance with AS 5 on 'Net Profit or Loss for the Period, Prior Period
Items and Changes in Accounting Policies'.

The Purchase Method

Under the purchase method, the transferee company accounts for the
amalgamation either by incorporating the assets and liabilities at their
existing carrying amounts or by allocating the consideration to individual
identifiable assets and liabilities of the transferor company on the basis of

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 a 9.42 ADVANCED ACCOUNTING

their fair values at the date of amalgamation. The identifiable assets and
liabilities may include assets and liabilities not recorded in the financial
statements of the transferor company.

Answer to the Scenario based Questions

9. Particulars `
Purchase consideration = 5,00,000 x 11/10 = 55,000 shares 55,00,000
of ` 10 each 50,00,000
Less: Share capital of X Co. Ltd.
Difference Adjusted through General Reserve 5,00,000

10. As per AS 14, consideration for the amalgamation means the aggregate of
the shares and other securities issued and the payment made in the form of
cash or other assets by the transferee company to the shareholders of the
transferor company.

Computation of Purchase Consideration

Particulars `
Equity Shares (50,000x 15) 7,50,000
Cash payment 50,000
12% Preference Share Capital 2,00,000
Purchase Consideration 10,00,000

Note: Payment to debenture holders are not covered by the term

‘consideration’.

Journal entry

Particulars ` `
Liquidation of Rina Ltd. A/c 10,00,000
To Equity share capital A/c 5,00,000
To 12% Preference share capital A/c 2,00,000
To Securities premium A/c 2,50,000
To Bank/Cash A/c 50,000
(Being payment of cash and issue of shares for
discharge of purchase consideration)

© The Institute of Chartered Accountants of India

CHAPTER 10
ACCOUNTING STANDARDS
FOR CONSOLIDATED
FINANCIAL
STATEMENTS
UNIT 1 ACCOUNTING STATDARD 21
CONSOLIDATED FINANCIAL STATEMENTS

LEARNING OUTCOMES
After studying this chapter, you will be able to:
♦ Understand the concepts of Group, holding company and subsidiary
company.
♦ Apply the consolidation procedures for consolidation of financial
statements of subsidiaries with the holding companies.
♦ Prepare the consolidated financial statements and solve related
problems

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 10.2 ADVANCED ACCOUNTING

UNIT OVERVIEW

Concept of
Purpose and Minority
Group, Components Calculation Elimination of
method of Interests;
Holding of of Goodwill/ Intra-Group
preparing Profit or
Company Consolidated Transactions and
consolidated Capital Loss of
and Financial other
financial Reserve Subsidiary
Subsidiary Statements Adjustments
statements Company
Company

Note: As per the syllabus, the unit covers simple problems on consolidated financial
statements with single subsidiary and excludes problems involving acquisition of
Interest in Subsidiary at Different Dates, Cross holding, Disposal of a Subsidiary and
Foreign Subsidiaries.

1.1 CONCEPT OF GROUP, HOLDING COMPANY

AND SUBSIDIARY COMPANY
In an era of business growth, many organizations are growing into large
corporations by the process of acquisition, mergers, gaining control by one
company over the other company, restructuring etc. Acquisitions and mergers
ultimately lead to either cost reduction or controlling the market or sharing the
material supplies or product diversification or availing tax benefits or synergy.
Whatever the motto behind these ventures is, the ultimate result is the large-scale
corporation. Formation of holding company is the most popular device for
achieving these objectives.

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FINANCIAL STATEMENTS

Group of Companies
Many a time, a company expands by keeping intact its separate corporate identity.
In this situation, a company (i.e. holding company) gains control over the other
company (subsidiary company). This control is exercised by one company over the
other by-
1. Purchasing specified number of shares i.e. ownership through voting power
of that company or
2. Exercising control over the board of directors.
The companies connected in these ways are collectively called as a Group of
Companies.
Holding Company and Subsidiary Company have also been defined in Section 2 of
the Companies Act, 2013.
Holding company
As per Section 2(46) of the Companies Act, 2013,
“Holding company”, in relation to one or more other companies, means a company
of which such companies are subsidiary companies.
It may be defined as one, which has one or more subsidiary companies and enjoys
control over them. Legally a holding company and its subsidiaries are distinct and
separate entities. However, in substance holding and subsidiary companies work as
a group. Accordingly, users of holding company’s accounts need financial
information of subsidiaries also to understand the performance and financial
position of the group (i.e. holding company and subsidiaries on a consolidated
basis).
Subsidiary Company
Section 2(87) of the Companies Act, 2013 defines “subsidiary company” as a
company in which the holding company -
(i) controls the composition of the Board of Directors; or
(ii) exercises or controls more than one-half of the total share capital either at its
own or together with one or more of its subsidiary companies:

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A company shall be deemed to be a subsidiary company of the holding company

even if there is indirect control through the subsidiary company (ies).
The control over the composition of a subsidiary company’s Board of Directors
means exercise of power to appoint or remove all or a majority of the directors of
the subsidiary company.
Section 19 of the Companies Act, 2013 prohibits a subsidiary company from
holding shares in the holding company. According to this section, no company
shall, either by itself or through its nominees, hold any shares in its holding
company and no holding company shall allot or transfer its shares to any of its
subsidiary companies and any such allotment or transfer of shares of a company to
its subsidiary company shall be void.
However, a subsidiary may continue to be a member of its holding company when
(a) the subsidiary company holds such shares as the legal representative of a
deceased member of the holding company; or
(b) the subsidiary company holds such shares as a trustee; or
(c) the subsidiary company is a shareholder even before it became a subsidiary
company of the holding company.
The subsidiary company shall have a right to vote at a meeting of the holding
company only in respect of the shares held by it as a legal representative or as a
trustee, as mentioned above in point (a) and (b).
Applicable Accounting Standard
Accounting Standard (AS) 21: Consolidated Financial Statements provides guidance
on preparation of Consolidated Financial Statements, the purpose of which is
discussed in Para 3 below.
This Standard came into effect in respect of accounting periods commenced on or
after 1-4-2001. AS 21 lays down principles and procedures for preparation and
presentation of consolidated financial statements. Consolidated financial
statements are presented by the parent (holding company) to provide financial
information about the economic activities of the group as a single economic entity.
The parent presenting consolidated financial statements should present such
statements in accordance with this standard but in its separate financial statements,
investments in subsidiaries would be accounted as per AS 13.

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FINANCIAL STATEMENTS

1.2 OBJECTIVES OF AS 21
The objective of this Standard is to lay down principles and procedures for
preparation and presentation of consolidated financial statements. Consolidated
Financial Statements are prepared by the holding/parent company to provide
financial information regarding the economic resources controlled by its group and
results achieved with these resources. These consolidated financial statements are
prepared by the parent company in addition to the financial statement prepared
by the parent company for only its own affairs. Hence parent company prepares
two financial statements, one for only its own affairs and one for taking the whole
group as one unit in the form of consolidated financial statements. Consolidated
financial statements usually comprise the following:

 Consolidated Balance Sheet

 Consolidated Profit & Loss Statement
 Notes to Accounts, other statements and explanatory material

 Consolidated Cash Flow Statement, if parent company presents its own cash
flow statement.
While preparing the consolidated financial statement, all other ASs and Accounting
Policies will be applicable as they are applied in parent company’s own financial
statements.
A parent which presents consolidated financial statements should consolidate all
subsidiaries, domestic as well as foreign. Where an enterprise does not have a
subsidiary but has an associate and/or a joint venture such an enterprise should
also prepare consolidated financial statements in accordance with Accounting
Standard (AS) 23, Accounting for Associates in Consolidated Financial Statements,
and Accounting Standard (AS) 27, Financial Reporting of Interests in Joint Ventures
respectively.
Definitions as per Accounting Standard (AS) 21
Parent:
A parent is an enterprise that has one or more subsidiaries.
Subsidiary is an enterprise that is controlled by another enterprise (known as the
parent).

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 10.6 ADVANCED ACCOUNTING

Control:
(a) the ownership, directly or indirectly through subsidiary(ies), of more than
one-half of the voting power of an enterprise; or
(b) control of the composition of the board of directors in the case of a company
or of the composition of the corresponding governing body in case of any
other enterprise so as to obtain economic benefits from its activities.
Group:
A group is a parent and all its subsidiaries.
Minority interest is that part of the net results of operations and of the net assets
of a subsidiary attributable to interests which are not owned, directly or indirectly
through subsidiary(ies), by the parent.
Equity is the residual interest in the assets of an enterprise after deducting all its
liabilities.
Consolidated financial statements are the financial statements of a group
presented as those of a single enterprise.
Circumstances under which Consolidated Financial Statements are
prepared
AS 21 should be applied in the preparation and presentation of consolidated
financial statements for a group of enterprises under the control of a parent.
Consolidated financial statements are the financial statements of a group
presented as those of a single enterprise.
AS 21 does not mandate which enterprises are required to prepare consolidated
financial statements – but specifies the rules to be followed where such financial
statements are prepared.
Consolidated Financial Statements will be prepared by the parent company for all
the companies that are controlled by the parent company either directly or
indirectly, situated in India or abroad except in certain cases.

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.7
FINANCIAL STATEMENTS

1.3 WHOLLY OWNED AND PARTLY OWNED

SUBSIDIARIES
S. No. Wholly owned subsidiary Partly owned subsidiary company
company

1. A wholly owned subsidiary In a partly owned subsidiary, all the

company is one in which all the shares of subsidiary company are not
shares are owned by the acquired by the holding company i.e.
holding company. only the majority of shares (i.e., more
than 50%) are owned by the holding
company.
2. 100% voting rights are vested Voting rights of more than 50% but
by the holding company. less than 100% are vested by the
holding company.
3. There is no minority interest There is a minority interest because
because all the shares with less than 50% shares with voting
voting rights are held by the rights are held by outsiders other
holding company. than the holding company.

1.4 PURPOSE OF PREPARING THE

CONSOLIDATED FINANCIAL STATEMENTS
Consolidated financial statements (CFS) are the financial statements of a ‘group’
presented as those of a single enterprise, where a ‘group’ refers to a parent and all
its subsidiaries. Parent company needs to inform the users about the financial
position and results of operations of not only of their enterprise itself but also of
the group as a whole. For this purpose, consolidated financial statements are
prepared and presented by a parent/holding enterprise to provide financial
information about a parent and its subsidiary(ies) as a single economic entity.

CFS are intended to show the financial position of the group as a whole - by
showing the economic resources controlled by them, by presenting the obligations
of the group and the results the group achieves with its resources.

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 10.8 ADVANCED ACCOUNTING

CFS normally include consolidated balance sheet, consolidated statement of profit

and loss, and notes, other statements and explanatory material that form an
integral part thereof. Consolidated cash flow statement is presented in case a
parent presents its own cash flow statement. The consolidated financial statements
are presented, to the extent possible, in the same format as that adopted by the
parent for its separate financial statements.

The logic for presentation of Consolidated Financial Statements can be appreciated

with the help of an example below:

Assume that you are holding 10 shares of Reliance Industries Limited, one of the
largest conglomerates in India. If you look at Reliance Industries Limited’s separate
(standalone) balance sheet, you can see investments in subsidiaries like Jio
Platforms Limited, Reliance Jio Infocomm Limited, Reliance Retail Limited etc. Now,
if we see the standalone financials of Reliance Industries Limited, the revenue is
generated from Oil & Gas Business. However, we all know that equally significant
for Reliance Industries Limited is the revenue generated from its subsidiary
companies. Further, being a holding company, all operational decisions of the
subsidiary companies are taken by Reliance Industries Limited. In other words,
though the holding company and its subsidiaries are legally different entities, in
substance, all the operations of the subsidiaries are merely an extension of the
holding company, and the assets and liabilities of the subsidiaries are controlled by
the holding company.

Technically, Investments appearing in the balance sheet of Reliance Industries

Limited represents proportionate share in the net worth of the respective subsidiary
as well as is also a proportionate share in the profits earned by such subsidiaries.
Accordingly, consolidating the incomes and expenses, as well as the assets and
liabilities of the subsidiary companies with that of the parent company will result
in a better presentation of the operations as well as the financial position of
Reliance Industries Limited.
Relevant provisions of the Companies Act 2013
Where a company has one or more subsidiaries or associate companies, it shall, in
addition to the standalone financial statements, prepare a consolidated financial

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.9
FINANCIAL STATEMENTS

statement of the company and of all the subsidiaries and associate companies in
the same form and manner as that of its own and in accordance with applicable
accounting standards, which shall also be laid before the annual general meeting
(AGM) of the company along with the laying of its financial statement.

The company shall also attach along with its financial statement, a separate
statement containing the salient features of the financial statement of its subsidiary
or subsidiaries in Form AOC-1 as per Rule 5 of the Companies (Accounts) Rules,
2014.

For the purpose of section 129, ‘subsidiary’ includes ‘associate company’ and ‘joint
venture’ which means that the company would be required to prepare consolidated
financial statements including associate/ joint venture even if there is no subsidiary
of a company.

The consolidation of financial statements of the company shall be made in

accordance with the provisions of Schedule III of the Companies Act 2013 and the
applicable accounting standards.

In case of a company covered under sub-section (3) of section 129 which is not
required to prepare consolidated financial statements under the Accounting
Standards, it shall be sufficient if the company complies with provisions of
consolidated financial statements provided in Schedule III of the Act.

Exemptions from preparation of CFS:

As per Companies (Accounts) Amendment Rules, 2016, preparation of consolidated
financial statements by a company is not required if it meets the following
conditions:
(i) it is a wholly-owned subsidiary, or is a partially-owned subsidiary of another
company and all its other members, including those not otherwise entitled to
vote, having been intimated in writing and for which the proof of delivery of
such intimation is available with the company, do not object to the company
not presenting consolidated financial statements;
(ii) it is a company whose securities are not listed or are not in the process of
listing on any stock exchange, whether in or outside India; and

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 10.10 ADVANCED ACCOUNTING

(iii) its ultimate or any intermediate holding company files consolidated financial
statements with the Registrar which are in compliance with the applicable
Accounting Standards.
AS21 also lays down the accounting principles and procedures for preparation and
presentation of consolidated financial statements which have been covered in the
later part of this chapter.
It may be pertinent to note that in certain countries outside India, presentation of
standalone financial statements is not mandatory. In fact, it is the preparation and
presentation of consolidated financial statements that are mandatory, given the
reasoning behind Consolidated Financial Statements already discussed in the
example of Reliance Industries Limited above.
In India, the statutory framework (such as the Companies Act, 2013 or the Income
Tax Act, 1961) mandate presentation of standalone financial statements, thereby
making standalone financial statements equally important as consolidated financial
statements.

1.5 SCOPE OF AS 21
1. This Standard should be applied in the preparation and presentation of
consolidated financial statements for a group of enterprises under the control
of a parent.
2. This Standard should also be applied in accounting for investments in
subsidiaries in the separate financial statements of a parent.
3. In the preparation of consolidated financial statements, other Accounting
Standards also apply in the same manner as they apply to the separate
statements.
4. This Standard does not deal with:
a. methods of accounting for amalgamations and their effects on
consolidation, including goodwill arising on amalgamation (see AS 14,
Accounting for Amalgamations);

b. accounting for investments in associates (governed by AS 13,

Accounting for Investments); and

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.11
FINANCIAL STATEMENTS

c. accounting for investments in joint ventures (governed by AS 13,

Accounting for Investments).

Note: AS 21 is mandatory if an enterprise presents consolidated financial

statements. In other words, the accounting standard does not mandate an
enterprise to present consolidated financial statements but, if the enterprise
presents consolidated financial statements for complying with the requirements of
any statute or otherwise, it should prepare and present consolidated financial
statements in accordance with AS 21.

1.6 CONTROL
The consolidated financial statements are prepared on the basis of financial
statements of parent and all enterprises that are controlled by the parent, other
than those subsidiaries excluded for the reasons set out in paragraph 11 of AS 21.

Control exists when the parent owns, directly or indirectly through subsidiary(ies),
more than one-half of the voting power of an enterprise. Control also exists when
an enterprise controls the composition of the board of directors (in the case of a
company) or of the corresponding governing body (in case of an enterprise not
being a company) so as to obtain economic benefits from its activities.

An enterprise may control the composition of the governing bodies of entities such
as gratuity trust, provident fund trust etc. Since the objective of control over such
entities is not to obtain economic benefits from their activities, these are not
considered for the purpose of preparation of consolidated financial statements.

For the purpose of this Standard, an enterprise is considered to control the

composition of

(i) the board of directors of a company, if it has the power, without the consent
or concurrence of any other person, to appoint or remove all or a majority of
directors of that company. An enterprise is deemed to have the power to
appoint a director, if any of the following conditions is satisfied:

a. a person cannot be appointed as director without the exercise in his

favour by that enterprise of such a power as aforesaid; or

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 10.12 ADVANCED ACCOUNTING

b. a person’s appointment as director follows necessarily from his

appointment to a position held by him in that enterprise; or
c. the director is nominated by that enterprise or a subsidiary thereof.
(ii) the governing body of an enterprise that is not a company, if it has the power,
without the consent or the concurrence of any other person, to appoint or
remove all or a majority of members of the governing body of that other
enterprise. An enterprise is deemed to have the power to appoint a member,
if any of the following conditions is satisfied:
a. a person cannot be appointed as member of the governing body
without the exercise in his favour by that other enterprise of such a
power as aforesaid; or
b. a person’s appointment as member of the governing body follows
necessarily from his appointment to a position held by him in that other
enterprise; or
c. the member of the governing body is nominated by that other
enterprise.

Note: It is possible that an enterprise is controlled by two enterprises – one controls

by virtue of ownership of majority of the voting power of that enterprise and the
other controls, by virtue of an agreement or otherwise, the composition of the
board of directors so as to obtain economic benefits from its activities. In such a
rare situation, when an enterprise is controlled by two enterprises as per the
definition of ‘control’, the first mentioned enterprise will be considered as
subsidiary of both the controlling enterprises within the meaning of AS 21 and,
therefore, both the enterprises need to consolidate the financial statements of that
enterprise.

1.7 EXCLUSION FROM PREPARATION OF

CONSOLIDATED FINANCIAL STATEMENTS
As per AS 21, a subsidiary should be excluded 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

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FINANCIAL STATEMENTS

(b) it operates under severe long-term restrictions which significantly impair its
ability to transfer funds to the parent.

In consolidated financial statements, investments in such subsidiaries should be

accounted for in accordance with AS 13 ‘Accounting for Investments’. The reasons
for not consolidating a subsidiary should be disclosed in the consolidated financial
statements.
Where an enterprise owns majority of voting power by virtue of ownership of the
shares of another enterprise and all the shares are held as ‘stock-in-trade’ and are
acquired and held exclusively with a view to their subsequent disposal in the near
future, the control by the first mentioned enterprise is considered to be temporary.
It would be pertinent to note that merely holding all the shares as 'stock-in-trade',
is not sufficient to be considered as temporary control. It is only when all the shares
held as 'stock-in-trade' are acquired and held exclusively with a view to their
subsequent disposal in the near future, that control would be considered to be
temporary within the meaning of point (a) above.
The period of time, which is considered as “near future” as mentioned above,
primarily depends on the facts and circumstances of each case. However, ordinarily,
the meaning of the words ‘near future’ is considered as not more than twelve
months from acquisition of relevant investments unless a longer period can be
justified on the basis of facts and circumstances of the case. The intention with
regard to disposal of the relevant investment is considered at the time of
acquisition of the investment. Accordingly if the relevant investment is acquired
without an intention to its subsequent disposal in near future, and subsequently, it
is decided to dispose off the investments, such an investment is not excluded from
consolidation, until the investment is actually disposed off.
Conversely, if the relevant investment is acquired with an intention to its
subsequent disposal in near future, but, due to some valid reasons, it could not be
disposed off within that period, the same will continue to be excluded from
consolidation, provided there is no change in the intention.
Exclusion of a subsidiary from consolidation on the ground that its business
activities are dissimilar from those of the other enterprises within the group is not
justified because better information is provided by consolidating such subsidiaries
and disclosing additional information in the consolidated financial statements

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about the different business activities of subsidiaries. Extending the above Reliance
Industries Limited example, though the parent company is in the Oil and Gas
Business, and its subsidiaries operate in industries such as telecom, retail trade,
fashion and lifestyle, media etc., all the entities have to be consolidated as such
consolidated financial statements will then provide better picture of the business
and financial position of Reliance Industries Limited. For example, the disclosures
required by AS 17 ‘Segment Reporting’, help to explain the significance of different
business activities within the group.
Consolidation of a subsidiary which is a Limited Liability Partnership (LLP) or
a Partnership Firm
As per rule 6 of Companies (Accounts) Rules, 2014, under the heading ‘Manner of
consolidation of accounts’ it is provided that consolidation of financial statements
of a company shall be done in accordance with the provisions of Schedule III to the
Companies Act, 2013 and the applicable Accounting Standards.
It is noted that relevant Indian Accounting Standard i.e., Ind AS 110, Consolidated
Financial Statements provides that where an entity has control on one or more
other entities, the controlling entity is required to consolidate all the controlled
entities. Since, the word ‘entity’ includes a company as well as any other form of
entity, therefore, LLPs and partnership firms are required to be consolidated.
Similarly, under Accounting Standard (AS) 21, as per the definition of subsidiary, an
enterprise controlled by the parent is required to be consolidated. The term
‘enterprise’ includes a company and any enterprise other than a company.
Therefore, under AS also, LLPs and partnership firms are required to be
consolidated.
Accordingly, in the given case, holding company is required to consolidate its
subsidiary which is an LLP or a partnership firm.
Consolidation of Limited Liability Partnership (LLP) which is an Associate or
Joint Venture
If LLP or a partnership firm is an associate or joint venture of holding company,
even then the LLP and the partnership firm need to be consolidated in accordance
with the requirements of applicable Accounting Standards.

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FINANCIAL STATEMENTS

1.8 ADVANTAGES OF CONSOLIDATED

FINANCIAL STATEMENTS

Acquisition
of
Subsidiary

Evaluation
Single Advantages of of Holding
Source
Document Consolidation Company in
the market

Intrinsic
value of
share

The main advantages of consolidation are given below:

(i) Single source document: From the consolidated financial statements, the
users of accounts can get an overall picture of the Group (i.e. holding
company and its subsidiaries). Consolidated profit and loss account gives the
overall profitability of the group.
(ii) Intrinsic value of share: Intrinsic share value of the holding company can be
calculated directly from the Consolidated Balance Sheet.
(iii) Acquisition of subsidiary: The minority interest data of the consolidated
financial statement indicates that the amount payable to the outside
shareholders of the subsidiary company at book value which is used as the
starting point of bargaining at the time of acquisition of a subsidiary by the
holding company.
(iv) Evaluation of holding company in the market: The overall financial health
of the holding company can be judged using consolidated financial
statements. Those who want to invest in the shares of the holding company
or acquire it, need such consolidated statement for evaluation.

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1.9 COMPONENTS OF CONSOLIDATED

FINANCIAL STATEMENTS
As per AS 21, consolidated financial statements normally include the following:
consolidated financial statements

Consolidated Balance Sheet

Consolidated Statement of
Profit and Loss Account

Consolidated Cash Flow

Statement (in case parent
presents cash flow statement)

Notes and statements and

explanatory schedules

♦ The consolidated financial statements are presented to the extent possible in

the same format as that adopted by the parent for its separate financial
statements.
All the notes appearing in the separate financial statements of the parent enterprise
and its subsidiaries need not be included in the notes to the consolidated financial
statement. For preparing consolidated financial statements, the following principles
may be observed in respect of notes and other explanatory material that form an
integral part thereof:
(a) Notes which are necessary for presenting a true and fair view of the
consolidated financial statements are included in the consolidated financial
statements as an integral part thereof.
(b) Only the notes involving items which are material need to be disclosed.
Materiality for this purpose is assessed in relation to the information

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FINANCIAL STATEMENTS

contained in consolidated financial statements. In view of this, it is possible

that certain notes which are disclosed in separate financial statements of a
parent or a subsidiary would not be required to be disclosed in the
consolidated financial statements when the test of materiality is applied in
the context of consolidated financial statements.
(c) Additional statutory information disclosed in separate financial statements of
the subsidiary and/or a parent having no bearing on the true and fair view of
the consolidated financial statements need not be disclosed in the
consolidated financial statements.
In addition, the consolidated financial statements shall disclose the information as
per the requirements specified in the applicable Accounting Standards including
the following as per the requirements of Schedule III to the Companies Act, 2013
which contains the ‘General Instructions for Preparation of Consolidated Financial
Statements’:
(i) Profit or loss attributable to “minority interest” and to owners of the parent
in the statement of profit and loss shall be presented as allocation for the
period.
(ii) “Minority interests” in the balance sheet within equity shall be presented
separately from the equity of the owners of the parent.
Students are also advised to refer the Schedule III to the Companies Act, 2013.

It may be noted that companies do not maintain any separate set of journal entries
for ‘Consolidated Set of Accounts’. Continuing the example of Reliance Industries
Limited, Consolidated Financial Statements of Reliance Industries Limited is not
based on “double entry book-keeping in the ‘group books of accounts’”, as there
is no concept of ‘group books of accounts’. Practically, Consolidated Financial
Statements are prepared from the separate / standalone financial statements of
each entity (parent / subsidiary) to which consolidation adjustments are made in
accordance with AS 21. Accordingly, the financial statements of each entity are
finalized in accordance with the applicable Accounting Standards, and based on
such financial statements, consolidation procedures are performed in accordance
with AS 21.

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1.10 CONSOLIDATION PROCEDURES

Rule 6 of the Companies (Accounts) Rules, 2014 states that the manner of
consolidation of financial statements of the company shall be in accordance with
the provisions of Schedule III of the Act and the applicable accounting standards.
AS 21, lays down the procedure for consolidation of financial statements of the
companies within the group.
When preparing consolidated financial statements, the individual balances of the
parent and its subsidiaries are combined or consolidated on a line-by-line basis,
and then certain consolidation adjustments are made.
For example, the cash, trade receivables and prepayments of the parent and each
subsidiary are added together to arrive at the cash, trade receivables and
prepayments of the group, before consolidation adjustments are made.
The objective is that the consolidated financial statements should present the
information contained in the consolidated financial statements of a parent and its
subsidiaries as if they were the financial statements of a single economic entity.
The various steps involved in the consolidation process are as follows:
1. the cost to the parent of its investment (cost of acquisition) in each subsidiary
and the parent’s portion of equity of each subsidiary (acquirer’s interest), at
the date on which investment in each subsidiary is made, should be
eliminated. In case, cost of acquisition exceeds or is less than the acquirer’s
interest, at the date on which investment in the subsidiary is made, goodwill
or capital reserve should be recognized respectively in the CFS.
2. intragroup transactions, including sales, expenses and dividends, are
eliminated, in full;
3. Adjustments in respect of unrealised profits/ losses should be made;
4. minority interest in the net income of consolidated subsidiaries for the
reporting period are identified and adjusted against the income of the group
in order to arrive at the net income attributable to the owners of the parent;
and
5. minority interests in the net assets of consolidated subsidiaries should be
identified and presented in the consolidated balance sheet separately from

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FINANCIAL STATEMENTS

liabilities and the equity of the parent’s shareholders. Minority interests in the
net assets consist of:

(i) the amount of equity attributable to minorities at the date on which

investment in a subsidiary is made; and
(ii) the minorities share of movements in equity since the date the parent-
subsidiary relationship came in existence.

Note: Where the carrying amount of the investment in the subsidiary is

different from its cost, the carrying amount is considered for the purpose of
above computations.

6. The results of operations of a subsidiary are included in the CFS as from the
date on which parent-subsidiary relationship came in existence.
The results of operations of a subsidiary with which parent-subsidiary
relationship ceases to exist are included in the consolidated statement of
profit and loss until the date of cessation of the relationship.
The difference between the proceeds from the disposal of investment in a
subsidiary and the carrying amount of its assets less liabilities as of the date
of disposal is recognised in the consolidated statement of profit and loss as
the profit or loss on the disposal of the investment in the subsidiary.
In order to ensure the comparability of the financial statements from one
accounting period to the next, supplementary information is often provided
about the effect of the acquisition and disposal of subsidiaries on the financial
position at the reporting date and the results for the reporting period and on
the corresponding amounts for the preceding period.
7. An investment in an enterprise should be accounted for in accordance with
AS 13, Accounting for Investments, from the date that the enterprise ceases
to be a subsidiary and does not become an associate.
8. The carrying amount of the investment at the date that it ceases to be a
subsidiary is regarded as cost thereafter.

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Thus, Consolidation Adjustments are broadly categorized as under:

Consolidation Adjustments

MAJOR ADJUSTMENTS INTRA-GROUP ADJUSTMENTS

Those which 'drive' the double entry: 1. Intra-group balances
1. Goodwill / Capital Reserve (i.e., 2. Unrealized profit
cost of Control) 3. Inventory
2. Minority Interests 4. Non-Current Asset transfers
3. Consolidated Reserves 5. Minority Interests
4. Disposal of Subsidiary*

* Disposal of Subsidiary is not examined at the Intermediate Level.

1.11.CALCULATION OF GOODWILL/CAPITAL
RESERVE (COST OF CONTROL)
As on the date of investment, the cost of investment and the equity in the subsidiary
needs to be calculated.

Equity is defined as the ‘residual interest in the assets of an enterprise after

deducting all its liabilities.’ In other words, it is equal to the net worth of the
enterprise.

Once the above is calculated, goodwill or capital reserve is calculated as under:

Goodwill = Cost of Investment - Parent’s share in the equity of the

subsidiary on date of investment

Capital Reserve = Parent’s share in the equity of the subsidiary on date of

investment – Cost of investment
The parent’s portion of equity in a subsidiary, at the date on which investment is
made, is determined on the basis of information contained in the financial
statements of the subsidiary as on the date of investment.

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.21
FINANCIAL STATEMENTS

However, if the financial statements of a subsidiary as on the date of investment

are not available and if it is impracticable to draw the financial statements of the
subsidiary as on that date, financial statements of the subsidiary for the
immediately preceding period are used as a basis for consolidation.
Adjustments are made to these financial statements for the effects of significant
transactions or other events that occur between the date of such financial
statements and the date of investment in the subsidiary.
It may be mentioned that positive or negative differential is separately recognised
only in purchase method. This differential calculated as cost of control is shown in
the consolidated balance sheet.
A detailed illustration below will help in understanding the concept of goodwill /
capital reserve.
Example 1
The following information is given as at 31 March 20X1

P Ltd. S Ltd.
Non-current Assets:
PPE 2,000 500
Investment in Subsidiary 1,000
Net Current Assets 2,000 500
5,000 1,000
Issued Capital 500 1,000
Reserves and Surplus 4,500
5,000 1,000

P Ltd. acquired 100% of shares of S Ltd. on 31 March 20X1 for ` 1,000.

Since P Ltd. has acquired S Ltd., we will have to determine goodwill / capital reserve.
Let us understand why goodwill / capital reserve arises in case of consolidation, and
what would be the interpretation of the same.

In the given case, P Ltd. acquired all the shares of S Ltd. by paying ` 1,000. This
payment (i.e., purchase consideration) would be made by P Ltd. to the shareholder(s)
of S Ltd. (hence the transfer of this amount would not appear in the books of S Ltd.).

© The Institute of Chartered Accountants of India

 10.22 ADVANCED ACCOUNTING

By paying ` 1,000, P Ltd. has acquired ‘control’ over S Ltd. This acquisition is quite
different from the concept of amalgamation done in accordance with AS 14, though
the concept of goodwill / capital reserve is similar. Under AS 14, the target company
would generally liquidate, and all assets and liabilities would be transferred from the
Selling Company to the Purchasing Company. In case of consolidation, P Ltd. is
acquiring ‘control’ i.e., by way of acquiring equity shares in S Ltd.. Thus, S Ltd.
continues to exist, and the assets and liabilities of S Ltd. are not transferred to P Ltd.,
but instead continue to remain with S Ltd. only. However, since in substance,
acquisition has taken place (albeit through transfer of control), the purchase
consideration of ` 1,000 will be compared with the net worth of
S Ltd., which is ` 1,000. Since amount paid (i.e., purchase consideration) equals the
net worth, no goodwill / capital reserve is recognized. In case the amount paid (i.e.,
purchase consideration) would be higher / lower than the net worth of S Ltd., such
difference would be recognized in Goodwill / Capital Reserve respectively.

The calculation of goodwill is presented below:

Tangible Assets 500

Net Current Assets 500
1,000
Less: Liabilities NIL
Net Worth of S Ltd. 1,000
Investment in S Ltd. (purchase consideration) 1,000
Goodwill / (Capital Reserve) NIL

Example 2
Modifying example 1, the following information is given as at 31 March 20X1

P Ltd. S Ltd.
Non-current Assets:
PPE 2,000 500
Investment in Subsidiary 1,000
Net Current Assets 2,000 500
5,000 1,000

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.23
FINANCIAL STATEMENTS

Issued Capital 500 700#

Reserves and Surplus 4,500 300#
5,000 1,000
# As compared to Example 1 – There is a difference in the break-up of net worth of S
Ltd. (Example 1 – Issued capital was 1,000 and Reserves and Surplus was Nil; The Net
worth is 1,000).
P Ltd. acquired 100% of shares of S Ltd. on 31 March 20X1 for ` 1,000.
Like Example 1 above P Ltd. has acquired ‘control’ over S Ltd. by paying ` 1,000.
Accordingly, the purchase consideration of ` 1,000 will be compared with the net
worth of S Ltd. which is ` 1,000. Since amount paid (i.e., purchase consideration)
equals the net worth, no goodwill / capital reserve is recognized. In case the amount
paid (i.e., purchase consideration) would be higher / lower than the net worth of S
Ltd., such difference would be recognized in Goodwill / Capital Reserve respectively.

The calculation of goodwill is presented below:

Tangible Assets 500

Net Current Assets 500

1,000
Less: Liabilities NIL

Net Worth of S Ltd. 1,000

Investment in S Ltd. (purchase consideration) 1,000
Goodwill / (Capital Reserve) NIL

Example 3
Modifying example 2, the following information is given as at 31 March 20X1

P Ltd. S Ltd.
Non-current Assets:
PPE 2,000 500
Investment in Subsidiary 1,200

© The Institute of Chartered Accountants of India

 10.24 ADVANCED ACCOUNTING

Net Current Assets 2,000 500

5,200 1,000
Issued Capital 700 700
Reserves and Surplus 4,500 300
5,200 1,000

P Ltd. acquired 100% of shares of S Ltd. on 31 March 20X1 for ₹ 1,200.

Like Examples 1 and 2 above P Ltd. has acquired ‘control’ over S Ltd. by paying
` 1,200. Accordingly, the purchase consideration of ` 1,200 will be compared with
the net worth of S Ltd. which is ` 1,000. Since amount paid (i.e., purchase
consideration) exceeds the net worth, such excess of is recognized as goodwill. In case
the amount paid (i.e., purchase consideration) would be lower than the net worth of
S Ltd., such difference would be credited to Capital Reserve.
The calculation of goodwill is presented below:

Tangible Assets 500

Net Current Assets 500
1,000
Less: Liabilities NIL
Net Worth of S Ltd. 1,000
Investment in S Ltd. (purchase consideration) 1,200
Goodwill / (Capital Reserve) 200

1.12 MINORITY INTERESTS

Minority interest is that part of the net assets of a subsidiary attributable to interest
which is held by outsiders.
Minority interests in the net income of consolidated subsidiaries for the reporting
period are identified and adjusted against the income of the group in order to
arrive at the net income attributable to the shareholders of the holding company.
Minority interests should be presented in the consolidated balance sheet separately
from liabilities and the equity of the parent’s shareholders.

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.25
FINANCIAL STATEMENTS

Minority interest in the income of the group should be separately presented in the
consolidated income statement.

Minority interests in the net assets consist of:

(i) The amount of equity attributable to minorities at the date on which
investment in a subsidiary is made and

(ii) The minorities’ share of movements in equity since the date the parent-
subsidiary relationship came in existence.
The losses applicable to the minority in a consolidated subsidiary may exceed the
minority interest in the equity of the subsidiary. The excess, and any further losses
applicable to the minority, are adjusted against the majority interest except to the
extent that the minority has a binding obligation to and is able to make good the
losses. If the subsidiary subsequently reports profit, all such profits are allocated to
the majority interest until the minority’s share of losses previously absorbed by the
majority has been recovered.

Example 4
Modifying Example 2, the following information is given as at 31 March 20X1:

P Ltd. S Ltd.
Non-current Assets:
Tangible Assets 2,000 500
Investment in Subsidiary 1,000
Net Current Assets 2,000 500
5,000 1,000
Issued Capital 500 700
Reserves and Surplus 4,500 300
5,000 1,000
P Ltd. acquired 80% of shares of S Ltd. on 31 March 20X1 for ` 1,000.

In the given case, P Ltd. acquired 80% of the shares of S Ltd. by paying ` 1,000. This
payment (i.e., purchase consideration) would be made by P Ltd. to the shareholder(s)
of S Ltd.

© The Institute of Chartered Accountants of India

 10.26 ADVANCED ACCOUNTING

By paying ` 1,000, P Ltd. has acquired ‘control’ over S Ltd. We cannot say that P Ltd.
has acquired only ‘80% control’, since its shareholding in S Ltd. will enable it to take
all the decisions regarding S Ltd.’s operations and usage of assets and repayment of
liabilities. However, the fact remains that 20% stake does NOT belong to S Ltd. It
belongs to outsiders, who are called ‘Minority Interest’ in accordance with AS 21.
Accordingly, in this case, the purchase consideration of ` 1,000 will be compared with
80% of the net worth of S Ltd. Any excess or deficit would be recorded as goodwill /
capital reserve respectively. 20% of the net worth on the date of acquisition would be
recorded separately as Minority Interest.

AS 21 defines Minority Interest as that part of the net results of operations and of the
net assets of a subsidiary attributable to interests which are not owned, directly or
indirectly through subsidiary(ies), by the parent. As per Schedule III to the Companies
Act, 2013, “Minority Interests” in the balance sheet within equity shall be presented
separately from the equity of the owners of the parent.
In the given case, the calculation of goodwill is presented below:

Tangible Assets: 80% being share of parent 400

Net Current Assets: 80% being share of parent 400

800

Less: Liabilities NIL

Net Worth of S Ltd.: attributable to the parent's shareholding 800

Investment in S Ltd. (purchase consideration) 1,000

Goodwill / (Capital Reserve) 200

1.13.PROFIT OR LOSS OF SUBSIDIARY COMPANY

For the purpose of consolidated balance sheet preparation, all reserves and profits
(or losses) of subsidiary company should be classified into pre and post-
acquisition reserves and profits (or losses).

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.27
FINANCIAL STATEMENTS

Profits (or losses) earned (or incurred) by subsidiary company up to the date of
acquisition of the shares by the holding company are pre acquisition or capital
profits (or loss).

Similarly, all reserves of subsidiary company up to the date of acquisition are capital
reserves from the view point of holding company. If the holding interest in
subsidiary is acquired during the middle or some other period of the current year,
pre-acquisition profit should be calculated accordingly.

The minority interest in the reserves and profits (or losses) of subsidiary company
should be transferred to minority interest account which will also include share
capital of subsidiary company held by outsiders / minority shareholders.
Minority Interest = Share Capital of subsidiary belonging to outsiders + Minority
interest in reserves and profits of subsidiary company

The holding company’s interest in the pre-acquisition reserves and profits (or
losses) should be adjusted against cost of control to find out goodwill or capital
reserve on consolidation. The reserves and profits (or loss) of subsidiary company,
representing holding company’s interest in post-acquisition or revenue reserves
and profits (or losses), should be added to the reserves and profits (or losses) of
holding company.

1.14 CONSOLIDATION ADJUSTMENTS

A. Revaluation of Assets of Subsidiary Company
It may be possible that the fair value of the assets of the subsidiary may be different
from the book value. Hence, the parent may choose to perform a revaluation of the
assets of the subsidiary for the purposes of consolidation. It may be noted that
such revaluation is not performed in the standalone / separate financial statements
of the subsidiary. The profit or loss on revaluation of fixed assets of subsidiary
should also be treated as capital profit or loss. But if the fall in the value of the
asset occurs after the date of acquisition, the loss should be treated as revenue
loss. Adjustment for depreciation would be made in the profit and loss account of
the subsidiary.

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 10.28 ADVANCED ACCOUNTING

Depreciation on changed value of the assets shall be given effect to. Depreciation
on revalued assets will be taken as capital or revenue depending on the period for
which the depreciation belongs to. Hence the period for depreciation is important
to be considered.
Property, Plant and Equipment (PPE)

Initial Recognition Subsequent Measurement

Fair Value (-) Carrying Amount Additional Depreciation would arise
in case of initial upward or Reversal of
(As on the date of acquisition)
excess depreciation would arise in
case of initial downward valuation.

PPE A/c Dr. xxx Post P/L Dr. xxx

To Pre- P/L xxx To PPE xxx
(In case of upward revaluation) (Additional depreciation)
Pre- P/L Dr. xxx PPE Dr. xxx
To PPE xxx To Post P/L xxx
(In case of downward revaluation) (Reversal of excess depreciation)
1. The above entries are not recorded in the standalone books of either the
subsidiary or the parent. These entries are only for understanding the impact
in the consolidated financial statements and as such, only the effect of such
entries will appear in the consolidated financial statements (and not the
standalone / separate financial statements).
2. It is presumed that the subsidiary does not follow the revaluation model for
accounting of fixed assets. If it had to follow, then the standalone balance
sheet of the subsidiary would already contain the impact of the revaluation.
The debit /credit on account of revaluation could alternatively be taken to the
Revaluation Reserve or the P/L depending on whether it is a first-time upward
/ downward revaluation. However, as ultimately the reserves have to be
analyzed between pre- and post-acquisition for the purposes of consolidation,
the nature of reserves is irrelevant.

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.29
FINANCIAL STATEMENTS

Example 5
H Ltd. acquires 70% of the equity shares of S Ltd. on 1.1.20X1. On that date, paid up
capital of S Ltd. was 10,000 equity shares of ` 10 each; accumulated reserve balance
was ` 1,00,000. H Ltd. paid ` 1,60,000 to acquire 70% interest in the S Ltd. Assets of
S Ltd. were revalued on 1.1.20X1 and a revaluation loss of ` 20,000 was ascertained.
The book value of shares of S Ltd. is calculated as shown below:

`
70% of the Equity Share Capital ` 1,00,000 70,000
70% of Accumulated Reserve ` 1,00,000 70,000
70% of Revaluation Loss ` 20,000 (14,000)
1,26,000
So, H Ltd. paid a positive differential of ` 34,000 i.e. ` (1,60,000 – 1,26,000). This
differential is called goodwill and is shown in the balance sheet under the head
intangibles.
Example 6
A Ltd. acquired 70% interest in B Ltd. on 1.1.20X1. On that date, B Ltd. had paid-up
capital of ` 1,00,000 consisting of 10,000 equity shares of ` 10 each and accumulated
balance in reserve and surplus of `1,00,000. On that date, assets and liabilities of B
Ltd. were also revalued and revaluation profit of ` 20,000 was calculated. A Ltd. paid
` 1,30,000 to purchase the said interest.
In this case, the book value of Shares of B Ltd. is calculated as shown below:

`
70% of the Equity Share Capital `1,00,000 70,000
70% of Reserves and Surplus ` 1,00,000 70,000

70% of Revaluation Profit ` 20,000 14,000

1,54,000

In this case, a negative differential of ` 24,000 arises i.e. (1,54,000 – 1,30,000) which
is called and presented as capital reserve.

© The Institute of Chartered Accountants of India

 10.30 ADVANCED ACCOUNTING

Example 7

H Ltd. acquired 16,000 equity shares of ` 10 each, in S Ltd. on October 1, 20X1 for
` 3,06,800. The profit and loss account of S Ltd. showed a balance of `10,000 on April
1,20X1. The plant and machinery of S Ltd. which stood in the books at
` 1,50,000 on April 1,20X1 was considered worth ` 1,80,000 on the date of
acquisition.

The information of the two companies as at 31-3-20X2 was as follows:

H Ltd.(` ) S Ltd. (` )

Shares capital (fully paid equity shares of ` 10 5,00,000 2,00,000

each)

General reserve 2,40,000 1,00,000

Profit and loss account 57,200 82,000

Current Liabilities 1,69,800 33,000

Land and building 1,80,000 1,90,000

Plant and machinery 2,40,000 1,35,000

Investments 3,06,800

Current assets 2,40,200 90,000

In this case,

Percentage of holding:
No. of Shares Percentage
Holding Co. : 16,000 (80%)

Minority shareholders : 4,000 (20%)

TOTAL SHARES : 20,000

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.31
FINANCIAL STATEMENTS

Impact of Revaluation of Plant and Machinery will be as -

`
Book value of Plant and Machinery as on 01-04-20X1 1,50,000

Depreciation Rate
(1,50,000-1,35,000)
= 15,000/1,50,000 X100 10%
1,50,000

Book value of Plant and Machinery as on 01-10-20X1 after six months 1,42,500
depreciation @10% (1,50,000-7,500)
Revalued at 1,80,000
Revaluation profit (1,80,000-1,42,500) 37,500
Share of H Limited in Revaluation Profit (80%) 30,000
Share of Minority in Revaluation profit (20%) 7,500
Additional Depreciation on appreciated value to be charged from post-
acquisition profits
(10% of ` 1,50,000 for 6 months) + (10% of ` 1,80,000 for 6 months) 1500
less ` 15,000 (as already charged)
Share of H Limited in additional depreciation that will reduce its share 1,200
(80%) in post-acquisition profit by
Share of Minority Interest in additional depreciation 300

B. Dividend Received From SubsidiarY(IES)

As per AS 13, ‘Accounting for Investments’, Interest, dividends and rentals
receivables in connection with an investment are generally regarded as income,
being the return on the investment.
However, in some circumstances, such inflows represent a recovery of cost and do
not form part of income.

Example: When unpaid interest has accrued before the acquisition of an interest-
bearing investment and is therefore included in the price paid for the investment,
the subsequent receipt of interest is allocated between pre-acquisition and post-
acquisition periods; the pre-acquisition portion is deducted from cost.
When dividends on equity are declared from pre-acquisition profits, a similar
treatment (i.e. as mentioned above) may apply. If it is difficult to make such an

© The Institute of Chartered Accountants of India

 10.32 ADVANCED ACCOUNTING

allocation except on an arbitrary basis, the cost of investment is normally reduced

by dividends receivable only if they clearly represent a recovery of a part of the
cost.
When holding company receives dividend from a subsidiary company, it must
distinguish between the part received out of capital profits (i.e. pre-acquisition
profits) and revenue profits (i.e. post-acquisition profits); capital profits are credited
to Investment account (being capital receipts) and revenue profits are credited to
the Profit & Loss Account.

If the controlling interest was acquired during the course of a year, profit for that
year must be apportioned into the pre-acquisition and post-acquisition portions,
on the basis of time in the absence of information on the point.
It must be understood that the term ‘capital profit’, in this context, apart from the
generic meaning of the term, connotes profit earned by the subsidiary company till
the date of acquisition. As a result, profits which may be of revenue nature for the
subsidiary company may be capital profits so far as the holding company is
concerned.
Treatment in case of post-acquisition dividend

Post acquisition dividend

Accounted by the Not accounted by the

In the books of the
subsidiary subsidiary
holding company

No further adjustment Adjusted at the time of

required consolidation Accounted by crediting
P&L A/c of the holding
company

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.33
FINANCIAL STATEMENTS

Treatment in case of pre-acquisition dividend

Accounted by holding Not accounted by Not accounted by

company holding company subsidiary company

If correctly accounted If wrongly accounted Adjust the same at Adjust the same at
as reduction to the by crediting to P&L the time of the time of
cost of investment A/c consolidation consolidation

Reverse the entry Account for as Reduce the pre-

No further passed and credit reduction to cost of acquisition profit of
adjustment required investment in investment subsidiary and then
subsidiary distribute it into holding
and minority interest

Also reduce the cost

of investment

Dividends received out of profits earned before purchase of investments normally

also are credited to the Investment Account.
Example 8
If shares in X Ltd., are purchased in January 20X2 and in April 20X2, X Ltd., declares
a dividend in respect of 20X1, the dividend received by the holder of the shares
correctly should not be treated as income but as capital receipt and credited to
Investment Account.

Note: In case of issue of bonus shares by the subsidiary company, the holding
company, like other holders, record no entry; only the number of shares held is
increased.

Illustration 1
From the following data, determine in each case:
(1) Minority interest at the date of acquisition and at the date of consolidation.
(2) Goodwill or Capital Reserve.

© The Institute of Chartered Accountants of India

 10.34 ADVANCED ACCOUNTING

(3) Amount of holding company’s profit in the consolidated Balance Sheet

assuming holding company’s own Profit & Loss Account to be ` 2,00,000 in
each case:

Subsidiary % Cost Date of Consolidation

Company shares acquisition Date
owned

1.1.20X1 31.12.20X1

Case Share Profit & Share Profit &

Capital Loss Capital Loss
Account Account

` ` ` ` `
Case 1 A 90% 1,40,000 1,00,000 50,000 1,00,000 70,000
Case 2 B 85% 1,04,000 1,00,000 30,000 1,00,000 20,000
Case 3 C 80% 56,000 50,000 20,000 50,000 20,000
Case 4 D 100% 1,00,000 50,000 40,000 50,000 55,000

Solution
(1) Minority Interest = Equity attributable to minorities
Equity is the residual interest in the assets of an enterprise after deducting all
its liabilities i.e. in this case it should be equal to Share Capital + Profit & Loss
A/c

Minority % Minority Minority interest

Shares interest as at as at the date of
Owned the date of consolidation
acquisition
[E] [E] x [A + B] ` [E] X [C + D] `

Case 1 [100-90] 10 % 15,000 17,000

Case 2 [100-85] 15 % 19,500 18,000

Case 3 [100-80] 20 % 14,000 14,000
Case 4 [100-100] NIL Nil Nil

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.35
FINANCIAL STATEMENTS

A = Share capital on 1.1.20X1

B = Profit & loss account balance on 1.1.20X1
C = Share capital on 31.12.20X1
D = Profit & loss account balance on 31.12.20X1
(2) Calculation of Goodwill or Capital Reserve

Shareholding Cost Total Equity Parent’s Goodwill Capital

Portion Reserve
of equity
% [F] [G] [A] + [B] = [F] x [C] ` [G] – ` [H] –
[C] =H [H] [G]

Case 1 90 % 1,40,000 1,50,000 1,35,000 5,000 —

Case 2 85 % 1,04,000 1,30,000 1,10,500 — 6,500
Case 3 80 % 56,000 70,000 56,000 Nil Nil

Case 4 100 % 1,00,000 90,000 90,000 10,000 —

(3) The balance in the Profit & Loss Account on the date of acquisition (1.1.20X1)
is Capital profit, as such the balance of Consolidated Profit & Loss Account
shall be equal to Holding Co.’s profit.
On 31.12.20X1 in each case the following amount shall be added or deducted
from the balance of holding Co.’s Profit & Loss account.

% Share P & L as on P & L as on P & L post Amount to be

holding 1.1.20X1 consolidati acquisition added /
on date (deducted) from
holding’s P & L
[M]
[K] [L] [N] = [M]-[L]
[O] = [K] x [N]

1 90 % 50,000 70,000 20,000 18,000

2 85 % 30,000 20,000 (10,000) (8,500)
3 80 % 20,000 20,000 NIL NIL

4 100 % 40,000 55,000 15,000 15,000

© The Institute of Chartered Accountants of India

 10.36 ADVANCED ACCOUNTING

Illustration 2
XYZ Ltd. purchased 80% shares of ABC Ltd. on 1st January, 20X1 for ` 1,40,000. The
issued capital of ABC Ltd., on 1st January, 20X1 was ` 1,00,000 and the balance in
the Profit & Loss Account was ` 60,000.
During the year ended 31st December, 20X1, ABC Ltd. earned a profit of ` 20,000
and at year end, declared and paid a dividend of ` 15,000.
Show by an entry how the dividend should be recorded in the books of XYZ Ltd.
What is the amount of minority interest as on 1st January, 20X1 and
31st December, 20X1? Also please check whether there should be any goodwill/
capital reserve at the date of acquisition.
Solution
Total dividend paid is ` 15,000 (assumed to be out of post-acquisition profits),
hence dividend received by XYZ will be credited to P & L.
XYZ Ltd.’s share of dividend = ` 15,000 X 80% = ` 12,000

In the books of XYZ Ltd.

` `
Bank A/c Dr. 12,000
To Profit & Loss A/c 12,000
(Dividend received from ABC Ltd credited to
P&L A/c being out of post-acquisition profits –
as explained above)
Goodwill on consolidation (at the date of ` `
acquisition):
Cost of shares 1,40,000
Less: Face value of capital i.e. 80% of capital 80,000
Add: Share of capital profits [60,000X 80 %] 48,000 (1,28,000)
Goodwill 12,000

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.37
FINANCIAL STATEMENTS

Minority interest on:

- 1st January, 20X1:

20% of ` 1,60,000 [1,00,000 + 60,000] 32,000

- 31st December, 20X1: 33,000
20% of ` 1,65,000 [1,00,000 + 60,000 +
20,000 – 15,000]

Illustration 3
Exe Ltd. acquires 70% of equity shares of Zed Ltd. as on 31st March, 20X1 at a cost
of ` 70 lakhs. The following information is available from the balance sheet of Zed
Ltd. as on 31st March, 20X1:

` in lakhs
Property, plant and equipment 120

Investments 55
Current Assets 70
Loans & Advances 15

15% Debentures 90
Current Liabilities 50

The following revaluations have been agreed upon (not included in the above figures):

Property, plant and equipment Up by 20%

Investments Down by 10%
Zed Ltd. declared and paid dividend @ 20% on its equity shares as on 31 st March,
20X1 (Face value - ` 10 per share). Exe Ltd. purchased the shares of Zed Ltd. @
` 20 per share.
Calculate the amount of goodwill/capital reserve on acquisition of shares of Zed Ltd.

© The Institute of Chartered Accountants of India

 10.38 ADVANCED ACCOUNTING

Solution
Revalued net assets of Zed Ltd. as on 31st March, 20X1

` in lakhs ` in lakhs

Property, plant and equipment [120 X 120%] 144.0

Investments [55 X 90%] 49.5
Current Assets 70.0
Loans and Advances 15.0

Total Assets after revaluation 278.5

Less: 15% Debentures 90.0
Current Liabilities 50.0 (140.0)

Equity / Net Worth 138.5

Exe Ltd.’s share of net assets (70% of 138.5) 96.95
Exe Ltd.’s cost of acquisition of shares of Zed Ltd.

(` 70 lakhs – ` 7 lakhs*) 63.00

Capital reserve 33.95

* Total Cost of 70 % Equity of Zed Ltd ` 70 lakhs

Purchase Price of each share ` 20
Number of shares purchased [70 lakhs /` 20] 3.5 lakhs
Dividend @ 20 % i.e. ` 2 per share ` 7 lakhs
Since dividend received is for pre-acquisition period, it has been reduced from the
cost of investment in the subsidiary company.
Illustration 4
A Ltd. acquired 70% of equity shares of B Ltd. on 1.4.20X1 at cost of ` 10,00,000 when
B Ltd. had an equity share capital of ` 10,00,000 and reserves and surplus of
` 80,000. In the four consecutive years, B Ltd. fared badly and suffered losses of
` 2,50,000, ` 4,00,000, ` 5,00,000 and ` 1,20,000 respectively. Thereafter in 20X5-
X6, B Ltd. experienced turnaround and registered an annual profit of ` 50,000. In the

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.39
FINANCIAL STATEMENTS

next two years i.e. 20X6-X7 and 20X7-X8, B Ltd. recorded annual profits of
` 1,00,000 and ` 1,50,000 respectively. Show the minority interests and cost of
control at the end of each year for the purpose of consolidation.
Solution
The losses applicable to the minority in a consolidated subsidiary may exceed the
minority interest in the equity of the subsidiary. In such cases, AS 21 prescribes that
the excess, and any further losses applicable to the minority, are adjusted against
the majority interest except to the extent that the minority has a binding obligation
to, and is able to, make good the losses. If the subsidiary subsequently reports
profits, all such profits are allocated to the majority interest until the minority's
share of losses previously absorbed by the majority has been recovered.
Where the minority interest has a binding obligation (say by way of a shareholders’
agreement), then the share of losses will be attributed to the minority interest even
if it exceeds the minority interest in the equity (i.e., debit balance in minority
interest). Since information on the existence of a binding obligation is not given in
the question, we solve as if such obligation does not exist, and hence the minority
interests will be computed as follows:

Year Profit/(Loss) Minority Additional Minority's Share Cost of

Interest Consolidated of losses borne Control
(30%) P & L (Dr.) by A Ltd.
Cr. (for the
year ended
balance)

` Balance

At the time of -
acquisition in 3,24,000
20X1
-
(W.N.)

© The Institute of Chartered Accountants of India

 10.40 ADVANCED ACCOUNTING

20X1-X2 (2,50,000) (75,000) (1,75,000) 2,44,000

(W.N.)

Balance 2,49,000

20X2-X3 (4,00,000) (1,20,000) (2,80,000) 2,44,000

Balance 1,29,000

20X3-X4 (5,00,000) (1,50,000) (3,50,000) 2,44,000

(21,000)

Loss of 21,000 (21,000) 21,000 21,000

minority
borne by
Holding Co.

Balance Nil (3,71,000)

20X4-X5 (1,20,000) (36,000) (84,000) 2,44,000

Loss of
minority 36,000 (36,000) 36,000 57,000
borne by
Holding Co.

Balance Nil (1,20,000)

20X5-X6 50,000 15,000 35,000 2,44,000

Profit share (15,000) 15,000 (15,000) 42,000

of minority
adjusted
against
losses of
minority
absorbed by
Holding Co.
Balance Nil 50,000

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.41
FINANCIAL STATEMENTS

20X6-X7 1,00,000 30,000 70,000

Profit share (30,000) 30,000 (30,000) 12,000 2,44,000

of minority
adjusted
against
losses of
minority
absorbed by
Holding Co.

Balance Nil 100,000

20X7-X8 1,50,000 45,000 1,05,000 (12,000) Nil 2,44,000

(12,000) 12,000

Balance 33,000 1,17,000

Working Note:
Calculation of Minority interest and Cost of control on 1.4.20X1

Share of Minority
Holding Interest
Co.

100% 70% 30%

(`) (`) (`)

Share Capital 10,00,000 7,00,000 3,00,000

Reserve 80,000 56,000 24,000

7,56,000 3,24,000

Less: Cost of investment (10,00,000)

Goodwill 2,44,000

Illustration 5
Variety Ltd. holds 46% of the paid-up share capital of VR Ltd. The shares were
acquired at a market price of ` 17 per share. The balance of shares of VR Ltd. are

© The Institute of Chartered Accountants of India

 10.42 ADVANCED ACCOUNTING

held by a foreign collaborating company. A memorandum of understanding has been

entered into with the foreign company providing for the following:
(a) The shares held by the foreign company will be sold to Variety Ltd. The price
per share will be calculated by capitalising the yield at 15%. Yield, for this
purpose, would mean 40% of the average of pre-tax profits for the last 3 years,
which were ` 30 lakhs, ` 40 lakhs and ` 65 lakhs.
(b) The actual cost of the shares to the foreign company was ` 5,40,000 only. The
profit that would accrue to them would be taxable at an average rate of 30%.
The tax payable will be deducted from the proceeds and Variety Ltd. will pay it
to the Government.
(c) Out of the net consideration, 50% would be remitted to the foreign company
immediately and the balance will be an unsecured loan repayable after two
years.
The above agreement was approved by all concerned for being given effect to on
1.4.20X1. The total assets of VR Ltd. as on 31st March, 20X1 was ` 1,00,00,000. It
was decided to write down Property, Plant and Equipment by ` 1,75,000. Current
liabilities of VR Ltd. as on the same date were ` 20,00,000. The paid-up share capital
of VR Ltd. was ` 20,00,000 divided into 2,00,000 equity shares of ` 10 each.
Find out goodwill/capital reserve to Variety Ltd. on acquiring wholly the shares of VR
Ltd.
Solution
1. Computation of Purchase Consideration

(a) Yield of VR Ltd.:  40 × 30 + 40 +65  ` 18 lakhs

 100 3 

(b) Price per share of VR Ltd.:

Capitalized Yield: 18 lakhs  ` 120 lakhs

 0.15 

No. of shares 2 lakhs

Therefore, price per share ` 60

(c) Purchase Consideration for 54% shares in VR Ltd.

2 lakh shares x 54% x ` 60 per shares ` 64.80 lakhs

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.43
FINANCIAL STATEMENTS

(d) Discharge of Purchase Consideration:

30
Tax at source (` 64.80 lakhs – ` 5.40 lakhs) × 100 ` 17.82 lakhs
50% of purchase consideration (net of tax) in cash ` 23.49 lakhs
[` (64.80 – 17.82) x 50%]

Balance – Unsecured Loan ` 23.49 lakhs

2. Goodwill / Capital Reserve to Variety Ltd.

` in lakhs
Total Assets 100.00
Less: Reduction in Value of Property, Plant and (1.75)
Equipment
98.25
Less: Current Liabilities (20.00)
Net Assets of VR Ltd. on Date of Acquisition 78.25
Purchase Consideration: 54% purchased from Foreign 64.80
Co.
Investment: 46% existing stake 15.64 (80.44)
Goodwill on Date of Acquisition 2.19

Illustration 6
A Ltd. acquired 60% shares of B Ltd. @ ` 20 per share. Following is the extract of
Balance Sheet of B Ltd.:
`
10,00,000 Equity Shares of ` 10 each 1,00,00,000
10% Debentures 10,00,000
Trade Payables 55,00,000
Property, Plant and Equipment 70,00,000
Investments 45,00,000
Current Assets 68,00,000
Loans and Advances 22,00,000

© The Institute of Chartered Accountants of India

 10.44 ADVANCED ACCOUNTING

On the same day B Ltd. declared dividend at 20% and as agreed between both the
companies Property, Plant and Equipment were to be depreciated @ 10% and
investment to be taken at market value of ` 60,00,000. Calculate the Goodwill or
Capital Reserve to be recorded in Consolidated Financial Statements.
Solution
Since dividend is declared by B Ltd. on the date of acquisition itself, it would be out
of the divisible profits of B Ltd. existing on the date of acquisition i.e., pre-
acquisition profits from the perspective of A Ltd. Accordingly, as per AS 13, such
pre-acquisition dividend would be reduced from the cost of investment, as seen
below in the determination of Goodwill on the date of acquisition.

` `
Assets
Property, Plant and Equipment 70,00,000
Less: Value written off (` 70 lakhs x 10%) (7,00,000)
63,00,000
Investments at Market Value 60,00,000
Current Assets 68,00,000
Loans and Advances 22,00,000 2,13,00,000
Less: Liabilities
Trade Payables 55,00,000
10% Debentures 10,00,000 (65,00,000)
Net Assets of B Ltd. 1,48,00,000
Share of A Ltd. in Net Assets of B Ltd.: 60% 88,80,000
Less: Cost of Investment in B Ltd. (60% stake):
10,00,000 Equity Shares x 60% x ` 20 per share 1,20,00,000
Less: Pre-acquisition dividend: 6,00,000 shares x
`2 (12,00,000) (1,08,00,000)
Goodwill on Date of Acquisition 19,20,000

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.45
FINANCIAL STATEMENTS

Illustration 7
H Ltd. acquired 3,000 shares in S Ltd., at a cost of ` 4,80,000 on 31.7.20X1. The capital
of S Ltd. consisted of 5,000 shares of ` 100 each fully paid. The Profit & Loss Account
of this company for 20X1 showed an opening balance of ` 1,25,000 and profit for the
year was ` 3,00,000. At the end of the year, it declared a dividend of 40%. Record the
entry in the books of H Ltd., in respect of the dividend. Assume the profit is accruing
evenly and calendar year as financial year.
Solution
The profits of S Ltd., have to be divided between capital and revenue profits from
the point of view of the holding company:

Capital Revenue
Profit (Pre- Profit (Post-
acquisition) acquisition)

` `

Balance on 1.1.20X1 1,25,000 —

Profit for 20X1 (3,00,000 × 7/12) 1,75,000 (3,00,000×5/12) 1,25,000

Total 3,00,000 1,25,000

Proportionate share of H Ltd. (3/5) 1,80,000 75,000

Total dividend declared = ` 5,00,000 X 40 % = ` 2,00,000

H Ltd.’s share in the dividend = ` 2,00,000 X 3/5 = ` 1,20,000

There can be two situations as regards the treatment of dividend of ` 1,20,000:
(1) The profit for 20X1 has been utilised to pay the dividend.

The share of H Ltd in profit for the first seven months of S Ltd = ` 1,05,000
(i.e. ` 1,75,000 × 3/5)
Profit for the remaining five months = ` 75,000
(i.e.` 1,25,000 × 3/5).

© The Institute of Chartered Accountants of India

 10.46 ADVANCED ACCOUNTING

The dividend of ` 1,20,000 will be adjusted in this ratio of 1,05,000: 75,000 =

` 70,000 out of profits up to 31.7.20X1 and ` 50,000 out of profits after that
date.
The dividend out of profits subsequent to 31.7.20X1 will be revenue income
and that out of earlier profits will be capital receipt. Hence the entry will be:

` `
Bank Dr. 1,20,000

To Investment Account 70,000

To Profit and Loss Account 50,000
(2) Later profits have been utilised first and then pre- acquisition profits.
In such a case, the whole of ` 75,000 (share of H Ltd. in profits of S Ltd., after
31.7.20X1) would be received and treated as revenue income; the remaining
dividend, `45,000 (`1,20,000 less ` 75,000) would be capital receipt. The entry
would be:

` `
Bank Dr. 1,20,000
To Investment Account 45,000
To Profit & Loss Account 75,000

Note: Point (2) discussed above can arise only if there is definite information
about the profits utilized. In practice, such treatment is rare.

Illustration 8

A Ltd. and B Ltd. provide the following information:

` ‘000s
A Ltd. B Ltd.
Equity Shares 6,000 5,000
6% Preference Shares NIL 1,000
General Reserve 1,200 800

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.47
FINANCIAL STATEMENTS

Profit and Loss Account 1,020 1,790

Trade Payables 3,850 3,410
Dividend Payable 600 500
Goodwill 100 20
Property, Plant and Equipment 3,850 2,750
Investment 1,620 1,100
Inventory 1,900 4,150
Trade Receivables 4,600 4,080
Cash & Bank 600 400

A Ltd. purchased 3/4th interest in B Ltd. at the beginning of the year at the premium
of 25%. Following other information is available:
a. Profit & Loss Account of B Ltd. includes ₹ 1,000 thousands bought forward from
the previous year.
b. The General Reserve balance is brought forward from the previous year.
c. The directors of both the companies have declared a dividend of 10% on equity
share capital for the previous and current year.
From the above information calculate Pre- and Post-acquisition Profits, Minority
Interest and Cost of Control.
Solution
Calculation of Pre- and Post-Acquisition Profits:

Pre-Acquisition Post-Acquisition
Profits (₹) Profits (₹)
Profit & Loss Account 10,00,000 7,90,000
General Reserve 8,00,000 NIL
18,00,000 7,90,000
Less: Share of Minority Interest: (¼) (4,50,000) (1,97,500)
Attributable to Parent 13,50,000 5,92,500
(Cost of Control) (Post-acquisition
Profits)

© The Institute of Chartered Accountants of India

 10.48 ADVANCED ACCOUNTING

Calculation of Minority Interest:

Particulars ₹
Paid-up Equity Share Capital (₹ 50,00,000 x ¼) 12,50,000
Paid-up Preference Share Capital 10,00,000
Share in Reserves:
Profit & Loss Account: ₹ 17,90,000 x ¼ 4,47,500
General Reserve: ₹ 8,00,000 x ¼ 2,00,000
Minority Interest 28,97,500

Calculation of Goodwill/Capital Reserve

₹ ₹

Cost of Investment in Subsidiary: 46,87,500

₹ 50,00,000 x 75% x 125% (cost + 25% premium)

Less: Pre-acquisition dividend (3,75,000) 43,12,500

Less: Net Worth of B Ltd. on Date of Acquisition

(attributable to A Ltd.):

Paid-up Capital 37,50,000

Pre-acquisition Reserves 13,50,000 (51,00,000)

Capital Reserve 7,87,500

Illustration 9
On 31st March, 20X1, P Ltd. acquired 1,05,000 shares of Q Ltd. for ` 12,00,000. The
position of Q Ltd. on that date was as under:

`
Property, plant and equipment 10,50,000
Current Assets 6,45,000
1,50,000 equity shares of ` 10 each fully paid 15,00,000

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.49
FINANCIAL STATEMENTS

Pre-incorporation profits 30,000

Profit and Loss Account 60,000
Trade payables 1,05,000

P Ltd. and Q Ltd. give the following information on 31st March, 20X3:

P Ltd. Q Ltd.
` `
Equity shares of ` 10 each fully paid (before bonus issue) 45,00,000 15,00,000
Securities Premium 9,00,000 –
Pre-incorporation profits – 30,000
General Reserve 60,00,000 19,05,000
Profit and Loss Account 15,75,000 4,20,000
Trade payables 5,55,000 2,10,000
Property, plant and equipment 79,20,000 23,10,000
Investment: 1,05,000 Equity shares in Q Ltd. at cost 12,00,000 –
Current Assets 44,10,000 17,55,000

Directors of Q Ltd. made bonus issue on 31.3.20X3 in the ratio of one equity share of
` 10 each fully paid for every two equity shares held on that date. Bonus shares were
issued out of post-acquisition profits by using General Reserve.
Calculate as on 31st March, 20X3 (i) Cost of Control/Capital Reserve; (ii) Minority
Interest; (iii) Consolidated Profit and Loss Account in each of the following cases:
(a) Before issue of bonus shares;
(b) Immediately After issue of bonus shares.
Solution
Shareholding pattern

Particulars Number of Shares % of holding

a. P Ltd.
(i) Purchased on 31.03.20X1 1,05,000
(ii) Bonus Issue (1,05,000/2) 52,500

© The Institute of Chartered Accountants of India

 10.50 ADVANCED ACCOUNTING

Total 1,57,500 70%

b. Minority Interest 67,500 30%

Calculations of (i) Cost of Control/Capital Reserve; (ii) Minority Interest; (iii)

Consolidated Profit and Loss Account as on 31st March, 20X3:
(a) Before issue of bonus shares

(i) Cost of control/capital reserve ` `

Investment in Q Ltd. 12,00,000

Less: Face value of investments (Share 10,50,000
Capital)
Capital profits (W.N.) 63,000 (11,13,000)
Cost of control (i.e., Goodwill) 87,000
(ii) Minority Interest `

Share Capital 4,50,000

Capital profits (W.N.) 27,000
Revenue profits (W.N.) 6,79,500
11,56,500
(iii) Consolidated profit and loss account – P `
Ltd.
Balance 15,75,000
Add: Share in revenue profits of Q Ltd. (W.N.) 15,85,500
31,60,500
(b) Immediately after issue of bonus shares

(i) Cost of control/capital reserve ` `

Face value of investments (` 10,50,000 +

` 5,25,000) 15,75,000
Capital Profits (W.N.) 63,000 16,38,000
Less: Investment in Q Ltd. (12,00,000)
Capital reserve 4,38,000

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.51
FINANCIAL STATEMENTS

(ii) Minority Interest `

Share Capital (` 4,50,000 + ` 2,25,000) 6,75,000

Capital Profits (W.N.) 27,000
Revenue Profits (W.N.) 4,54,500
11,56,500
(iii) Consolidated Profit and Loss Account – `
P Ltd.
Balance 15,75,000
Add: Share in revenue profits of Q Ltd.
(W.N.) 10,60,500
26,35,500

Working Note:
Analysis of Profits of Q Ltd.

Capital Profits Revenue Profits

(Pre-acquisition) (Post-acquisition)
(Before and after Before After Bonus
issue of bonus Bonus Issue
shares) Issue
` `
`
Pre-incorporation profits 30,000
Profit and loss account on 60,000
31.3.20X1
90,000
General reserve* 19,05,000 19,05,000
Less: Bonus shares (7,50,000)
11,55,000
Profit for period of 1st
April, 20X1 to 31st March, 3,60,000 3,60,000

© The Institute of Chartered Accountants of India

 10.52 ADVANCED ACCOUNTING

20X3
(` 4,20,000 – ` 60,000)
22,65,000 15,15,000
P Ltd.’s share (70%) 63,000 15,85,500 10,60,500
Minority’s share (30%) 27,000 6,79,500 4,54,500
*Share of P Ltd. in General reserve has been adjusted in Consolidated Profit
and Loss Account.
Illustration 10
Prepare consolidated balance sheet of H Ltd. and its subsidiary as at 31 March, 20X1
from the following information:

H Ltd. S Ltd.
` `
PPE 5,00,000 3,00,000
Investments
(20,000 equity shares of S Ltd.) 2,20,000
Current Assets 1,55,000 1,00,000
Share capital (Fully paid equity shares of ` 10 each) 5,00,000 2,50,000
Profit and loss account 2,00,000 1,00,000
Trade Payables 1,75,000 50,000
H Ltd. acquired the shares of S Ltd. on 31 March, 20X1.
st

Solution
Percentage of holding:
No. of Shares Percentage
Holding Co : 20,000 (80%)
Minority shareholders : 5,000 (20%)
TOTAL SHARES : 25,000

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.53
FINANCIAL STATEMENTS

Consolidated Balance Sheet of H Ltd. and its subsidiary S Ltd.

as at 31st March,20X1

Note No Amount (`)

I EQUITY AND LIABILITIES
1 Shareholder’s Fund
(a) Share Capital 1 5,00,000
(b) Reserve and Surplus 2 2,60,000

2 Minority interest 3
3 Current Liabilities 70,000
(a) Trade payables 4 2,25,000

Total 10,55,000
II ASSETS
1. Non-Current Assets
PPE 5 8,00,000
2. Current Assets 6 2,55,000
Total 10,55,000
Notes to Accounts

Amounts (`)
1 Share capital
50,000 Equity Shares @ `10 each 5,00,000
2 Reserve and Surplus
Capital Reserve (W.N. ) 60,000
Profit and loss account 2,00,000
2,60,000
3 Minority Interest
Paid up value of shares 50,000
Add: Share in Profit and loss account 20,000 70,000
4 Trade payables
H Ltd. 1,75,000
S Ltd. 50,000
2,25,000

© The Institute of Chartered Accountants of India

 10.54 ADVANCED ACCOUNTING

5 PPE
H Ltd. 5,00,000
S Ltd. 3,00,000
8,00,000
6 Current Assets
H Ltd. 1,55,000
S Ltd. 1,00,000
2,55,000
Working Note:

Determination of Goodwill/(Capital Reserve) (`)

Cost of investment 2,20,000

Less: Paid up value of shares (80% of 2,50,000) 2,00,000
Share in pre-acquisition profits (80% of 1,00,000) 80,000
(2,80,000)
Capital Reserve (60,000)

Illustration 11
H Ltd. and S Ltd. provide the following information as at 31st March,20X2:

H Ltd. S Ltd.
` `
PPE 1,00,000 1,30,000
Investments (8,000 equity shares of S Ltd.) 1,26,000
Current Assets 74,000 70,000
Share capital (Fully paid equity shares of `10 each) 1,50,000 1,00,000
Profit and loss account 50,000 40,000
Trade Payables 1,00,000 60,000
Additional information:
H Ltd. acquired the shares of S Ltd. on 1-7-20X1 and Balance of profit and loss
account of S Ltd. on 1-4-20X1 was 30,000.

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.55
FINANCIAL STATEMENTS

Prepare consolidated balance sheet of H Ltd. and its subsidiary as at 31st March,
20X2.
Solution
Percentage of holding:

No. of Shares Percentage

Holding Co. : 8,000 (80%)
Minority shareholders : 2,000 (20%)
TOTAL SHARES : 10,000
Consolidated Balance Sheet of H Ltd. and its subsidiary S Ltd.
as at 31st March, 20X2

Note No Amount (`)

I EQUITY AND LIABILITYES
1 Shareholder’s Fund
(a) Share Capital 1 1,50,000
(b) Reserve and Surplus 2 56,000
2 Minority interest 3 28,000
3 Current Liabilities
(a) Trade payables 4 1,60,000
Total 3,94,000
II ASSETS
1 Non-Current Assets:
PPE 5 2,30,000
Intangible Asset 6 20,000
2 Current Assets 7 1,44,000
Total 3,94,000

© The Institute of Chartered Accountants of India

 10.56 ADVANCED ACCOUNTING

Notes to Accounts

Amount
(`)

1 Share capital 1,50,000

15,000 Equity Shares @ `10 each
2 Reserve and Surplus
Profit and loss account (` 50,000+ 80% of 9/12 x 10,000) 56,000
3 Minority Interest
Share capital (20% of ` 1,00,000) 20,000
Share in Profit and loss account (` 40,000 X 20%) 8,000 28,000
4 Trade payables
H Ltd. 1,00,000
S Ltd. 60,000
1,60,000
5 PPE
H Ltd. 1,00,000
S Ltd. 1,30,000
2,30,000
6 Intangible Asset
Cost of Investment 1,26,000
Less: Paid up value of shares (80% of ` 1,00,000)
Share in pre-acquisition profits (80,000)
80% of [30,000+3/12(40,000-30,000)] (26,000)
Goodwill 20,000
7 Current Assets
H Ltd. 74,000
S Ltd. 70,000
1,44,000

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.57
FINANCIAL STATEMENTS

Illustration 12
From the Balance Sheets and information given below, prepare Consolidated Balance
Sheet of Virat Ltd. and Anushka Ltd. as at 31 st March. Virat Ltd. holds 80% of Equity
Shares in Anushka Ltd. since its (Anushka Ltd.’s) incorporation.
Balance Sheet of Virat Ltd. and Anushka Ltd. as at 31st March, 20X1

Particulars Note Virat Ltd. Anushka Ltd.

No. (` ) (` )

I. Equity and Liabilities

(1) Shareholder's Funds
(a) Share Capital 1 6,00,000 4,00,000
(b) Reserves and Surplus 2 1,00,000 1,00,000
(2) Non-current Liabilities
Long Term Borrowings 2,00,000 1,00,000
(3) Current Liabilities
(a) Trade Payables 1,00,000 1,00,000
Total 10,00,000 7,00,000
II. Assets
(1) Non-current assets
(a) Property, Plant and 4,00,000 3,00,000
Equipment
(b) Non-current 3 3,20,000 -
investments
(2) Current Assets
(a) Inventories 1,60,000 2,00,000
(b) Trade Receivables 80,000 1,40,000
(c) Cash & Cash Equivalents 40,000 60,000
Total 10,00,000 7,00,000

© The Institute of Chartered Accountants of India

 10.58 ADVANCED ACCOUNTING

Notes to Accounts

Particulars (`) Virat Ltd. Anushka Ltd.

(` ) (` )

1. Share capital
60,000 equity shares of ` 10 each fully
paid up
6,00,000 --
40,000 equity shares of ` 10 each fully
paid up
-- 4,00,000
Total 6,00,000 4,00,000
2. Reserves and Surplus

General Reserve 1,00,000 1,00,000

Total 1,00,000 1,00,000
3. Non-current investments

Shares in Anushka Ltd 3,20,000 --

Solution
Consolidated balance Sheet of Virat Ltd. and its Subsidiary Anushka Ltd.
as at 31st March, 20X1

Particulars Note Amount (`)

I EQUITY AND LIABILITIES:

(1) Shareholders’ Funds:
(a) Share Capital 1 6,00,000

(b) Reserve and Surplus 2 1,80,000

(2) Minority Interest 3 1,00,000
(3) Non-Current Liabilities:

Long Term Borrowings 4 3,00,000

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.59
FINANCIAL STATEMENTS

(4) Current Liabilities:

Trade Payables 5 2,00,000
Total 13,80,000
II ASSETS:
(1) Non-Current Assets
Property, Plant & Equipment 6 7,00,000
(2) Current Assets:
(a) Inventories
(b) Trade receivables 7 3,60,000
(c) Cash and Cash Equivalents 8 2,20,000
9 1,00,000

Total 13,80,000

Notes to Accounts

Particulars ` `
1. Share capital
60,000 equity shares of `10 each fully paid up 6,00,000
2. Reserves and Surplus
General Reserve 1,00,000
Add: General reserve of Anushka Ltd (80%) 80,000
Total 1,80,000
3. Minority interest
20% share in Anushka Ltd (WN 3) 1,00,000
4 Long term borrowings
Long term borrowings of Virat 2,00,000
Add: Long term borrowings of Anushka 1,00,000
Total 3,00,000

© The Institute of Chartered Accountants of India

 10.60 ADVANCED ACCOUNTING

5. Trade payables

Trade payables of Virat 1,00,000

Add: Trade payables of Anushka 1,00,000

Total 2,00,000

6. Property, Plant and Equipment (PPE)

PPE of Virat Ltd 4,00,000

Add: PPE of Anushka Ltd 3,00,000

Total 7,00,000

7. Inventories

Inventories of Virat Ltd 1,60,000

Add: Inventories of Anushka Ltd 2,00,000

Total 3,60,000

8. Trade receivables

Trade receivables of Virat Ltd 80,000

Add: Trade receivables of Anushka Ltd 1,40,000

Total 2,20,000

9 Cash and cash equivalents

Cash and cash equivalents of Virat Ltd 40,000

Add: Cash and cash equivalents of Anushka Ltd 60,000

Total 1,00,000

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.61
FINANCIAL STATEMENTS

Working Notes:
1. Basic Information

Company Status Dates Holding Status

Holding Co. = Virat Ltd. Acquisition: Holding Company = 80%

Anushka’s
Subsidiary = Anushka Minority Interest = 20%
Incorporation
Ltd.
Consolidation:
31st March, 20X1

2. Analysis of General Reserves of Anushka Ltd

Since Virat holds shares in Anushka since its incorporation, the entire Reserve
balance of `1,00,000 will be Revenue.
3. Consolidation of Balances

Holding- 80%, Total Minority Holding Company

Minority - Interest
20%

Equity Capital 4,00,000 80,000 3,20,000 -

General
Reserves 1,00,000 20,000 Nil (pre-acq) 80,000 (post-acq)

Total 1,00,000 3,20,000 80,000

Cost of
Investment (3,20,000) -
Goodwill/capit
NIL
al reserve
Parent’s 1,00,000
Balance
Amount for 1,80,000
Consolidated
Balance Sheet

© The Institute of Chartered Accountants of India

 10.62 ADVANCED ACCOUNTING

Illustration 13
From the following balance sheets of H Ltd. And its subsidiary S Ltd. drawn up at
31st March, 20X1, prepare a consolidated balance sheet as at that date, having regard
to the following:
(i) Reserves and Profit and Loss Account of S Ltd. stood at ` 25,000 and ` 15,000
respectively on the date of acquisition of its 80% shares by H Ltd. on 1st April,
20X0.
(ii) Machinery (Book-value ` 1,00,000) and Furniture (Book value ` 20,000) of
S Ltd. were revalued at ` 1,50,000 and ` 15,000 respectively on 1st April, 20X0
for the purpose of fixing the price of its shares. [Rates of depreciation computed
on the basis of useful lives: Machinery 10%, Furniture 15%.]

Balance Sheet of H Ltd. and S Ltd. as at 31st March, 20X1

Particulars Note H Ltd. (`) S Ltd. (`)
No.

I. Equity and Liabilities

(1) Shareholder’s Funds

(a) Share Capital 1 6,00,000 1,00,000

(b) Reserves and Surplus 2 3,00,000 1,00,000
(2) Current Liabilities
(a) Trade Payables 1,50,000 57,000

Total 10,50,000 2,57,000

II. Assets
(1) Non-current assets
(a) Property, Plant and 3 4,50,000 1,07,000
Equipment
(b) Other non- current 4 6,00,000 1,50,000
investments

Total 10,50,000 2,57,000

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.63
FINANCIAL STATEMENTS

Notes to Accounts

` H Ltd. S Ltd.

(` ) (` )

1. Share capital
6,000 equity shares of ` 100 each, fully paid up 6,00,000 --
1,000 equity shares of ` 100 each, fully paid up
Total -- 1,00,000

6,00,000 1,00,000
2. Reserves and Surplus
General reserves 2,00,000 75,000

Profit and loss account 25,000

1,00,000
Total 3,00,000 1,00,000

3. Property, Plant and Equipment

Machinery 3,00,000 90,000
Furniture 1,50,000 17,000

Total 4,50,000 1,07,000

4. Other Non-current investments
Non-current Investments 4,40,000 1,50,000
Shares in S Ltd.
1,60,000 --
(800 shares at `200 each)
6,00,000 1,50,000
Total

© The Institute of Chartered Accountants of India

 10.64 ADVANCED ACCOUNTING

Solution
Consolidated Balance Sheet of H Ltd. and its Subsidiary S Ltd.
as at 31st March, 20X1

Particulars Note (`)

No.

I. Equity and Liabilities

(1) Shareholder's Funds

(a) Share Capital 1 6,00,000

(b) Reserves and Surplus 2 3,44,600
(2) Minority Interest 3 48,150

(3) Current Liabilities

(a) Trade Payables 2,07,000

Total 11,99,750

II. Assets
(1) Non-current assets

(a) Property, Plant and Equipment 4 5,97,750

(b) Intangible assets 5 12,000
(c) Other non-current investments 6 5,90,000

Total 11,99,750

Notes to Accounts

`
1. Share capital
6,000 equity shares of ` 100 each,
fully paid up
6,00,000
Total 6,00,000

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.65
FINANCIAL STATEMENTS

2. Reserves and Surplus

Reserves 2,00,000
Add: 4/5th share of S Ltd.’s post-
acquisition reserves (W.N.3) 40,000 2,40,000
Profit and Loss Account 1,00,000
Add: 4/5th share of S Ltd.’s post-
acquisition profits (W.N.4) 4,600 1,04,600
Total 3,44,600
3. Minority interest in S Ltd. (WN 5) 48,150
4. Property, plant and equipment
Machinery
H. Ltd. 3,00,000
S Ltd. 1,00,000
Add: Appreciation 50,000
1,50,000
Less: Depreciation (1,50,000 X 10%)* (15,000) 1,35,000
Furniture
H. Ltd. 1,50,000
S Ltd. 20,000
Less: Decrease in value (5,000)
15,000
Less: Depreciation (15,000 X 15%)* (2,250) 12,750 5,97,750
5. Intangible assets
Goodwill [WN 6] 12,000
6. Other non-current investments
H Ltd. 4,40,000
S Ltd. 1,50,000
Total 5,90,000
* As an alternative manner of presentation, the solution contains only the
‘additional depreciation’.

© The Institute of Chartered Accountants of India

 10.66 ADVANCED ACCOUNTING

Working Notes:

1. Pre-acquisition profits and reserves of S Ltd. `

Reserves 25,000
Profit and Loss Account 15,000
40,000

H Ltd.’s = 4/5 (or 80%) × 40,000 32,000

Minority Interest= 1/5 (or 20%) × 40,000 8,000
2. Profit on revaluation of assets of S Ltd.
Profit on Machinery ` (1,50,000 – 1,00,000) 50,000
Less: Loss on Furniture ` (20,000 – 15,000) 5,000
Net Profit on revaluation 45,000
H Ltd.’s share 4/5 × 45,000 36,000
Minority Interest 1/5 × 45,000 9,000
3. Post-acquisition reserves of S Ltd.
Post-acquisition reserves (Total reserves less pre-acquisition 50,000
reserves = ` 75,000 – 25,000)
H Ltd.’s share 4/5 × 50,000 40,000
Minority interest 1/5 × 50,000 10,000
4. Post -acquisition profits of S Ltd.
Post-acquisition profits (Profit & loss account balance less 10,000
pre-acquisition profits = ` 25,000 – 15,000)
Add: Excess depreciation charged on furniture @ 15%
on ` 5,000 i.e. (20,000 – 15,000) 750

10,750

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.67
FINANCIAL STATEMENTS

Less: Under depreciation on machinery @ 10%

on ` 50,000 i.e. (1,50,000 – 1,00,000) (5,000)
Adjusted post-acquisition profits 5,750
H Ltd.’s share 4/5 × 5,750 4,600
Minority Interest 1/5 × 5,750 1,150
5. Minority Interest
Paid-up value of (1,000 – 800) = 200 shares
held by outsiders i.e. 200 × ` 100 (or 1,00,000 X 20%) 20,000
Add: 1/5th share of pre-acquisition profits and reserves 8,000
1/5th share of profit on revaluation 9,000
1/5th share of post-acquisition reserves 10,000
1/5th share of post-acquisition profit 1,150
48,150
6. Cost of Control or Goodwill
Price paid by H Ltd. for 800 shares (A) 1,60,000
Intrinsic value of the shares-
Paid-up value of 800 shares held by H Ltd. i.e. 800 × ` 100 80,000
(or 1,00,000 X 80%)
Add: 4/5th share of pre-acquisition profits and reserves 32,000
4/5th share of profit on the revaluation 36,000
Intrinsic value of shares on the date of acquisition (B) 1,48,000
Cost of control or Goodwill (A – B) 12,000

C. Elimination of Intra-Group Transactions

Consolidated Financial Statements reflect the financial position and operations of
the group as a single entity. Accordingly, the statements must contain only those
transactions and balances with entities ‘external’ to the group, thereby requiring
elimination of intra-group transactions.

© The Institute of Chartered Accountants of India

 10.68 ADVANCED ACCOUNTING

In order to present financial statements for the group in a consolidated format, the
effect of transactions between group enterprises should be eliminated. Para 16 of
AS 21 states that intragroup balances and intragroup transactions and resulting
unrealized profits should be eliminated in full. Unrealized losses resulting from
intragroup transactions should also be eliminated unless cost cannot be recovered.
Liabilities due to one group enterprise by another will be set off against the
corresponding asset in the other group enterprise’s financial statements; sales
made by one group enterprise to another should be excluded both from turnover
and from cost of sales or the appropriate expense heading in the consolidated
statement of profit and loss.
To the extent that the buying enterprise has further sold the goods in question to
a third party, the eliminations to sales and cost of sales are all that is required, and
no adjustments to consolidated profit or loss for the period, or to net assets, are
needed. However, to the extent that the goods in question are still on hand at year
end, they may be carried at an amount that is in excess of cost to the group and
the amount of the intra-group profit must be eliminated, and assets are reduced
to cost to the group.
For transactions between group enterprises, unrealized profits resulting from intra-
group transactions that are included in the carrying amount of assets, such as
inventories and tangible fixed assets, are eliminated in full. The requirement to
eliminate such profits in full applies to the transactions of all subsidiaries that are
consolidated – even those in which the group’s interest is less than 100%.
Unrealized profit in inventories: Where a group enterprise sells goods to another,
the selling enterprise, as a separate legal enterprise, records profits made on those
sales. If these goods are still held in inventory by the buying enterprise at the year
end, the profit recorded by the selling enterprise, when viewed from the standpoint
of the group as a whole, has not yet been earned, and will not be earned until the
goods are eventually sold outside the group. On consolidation, the unrealized
profit on closing inventories will be eliminated from the group’s profit, and the
closing inventories of the group will be recorded at cost to the group.

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.69
FINANCIAL STATEMENTS

Here, the point to be noted is that one has to see whether the intragroup
transaction is “upstream” or “down-stream”. Upstream transaction is a transaction
in which the subsidiary company sells goods to holding company. While in the
downstream transaction holding company is the seller and subsidiary company is
the buyer.

Sells goods Co.

Subsidiary
Holding Co. Downstream Sales
to Co.

Sells goods Co.

Subsidiary Holding Co. Upstream Sales
Co. to

In the case of upstream transaction, since the goods are sold by the subsidiary to
holding company; profit is made by the subsidiary company, which is ultimately
shared by the holding company and the minority shareholders. In such a
transaction, if some goods remain unsold at the balance sheet date, the unrealized
profit on such goods should be eliminated from minority interest as well as from
consolidated profit on the basis of their share-holding besides deducting the same
from unsold inventory.
But in the case of downstream transaction, the whole profit is earned by the holding
company, therefore, whole unrealized profit should be adjusted from unsold
inventory and consolidated profit and loss account only irrespective of the
percentage of the shares held by the parent.
Intra-group
transaction

Upstream Downstream

Unrealised profit
Unrealised profit Corresponding Corresponding
eliminated from
eliminated from decrease of holding decrease of
holding and inventories company’s P&L in inventories
minority interest full

© The Institute of Chartered Accountants of India

 10.70 ADVANCED ACCOUNTING

Unrealized profit on transfer of non-current asset: Similar to the treatment

described above for unrealized profits in inventories, unrealized inter-company
profits arising from intra-group transfers of fixed assets are also eliminated from
the consolidated financial statements.
Unrealized losses: Unrealized losses resulting from intra-group transactions that
are deducted in arriving at the carrying amount of assets are also eliminated unless
cost cannot be recovered.
Example:
If net realizable value (NRV) expected from sale of such goods is more than the
actual cost of the goods, then unrealized loss should be reversed during
consolidation process. However, if it is expected that NRV would not be sufficient
to recover the loss incurred on transfer of goods from one entity to another, the
unrealized loss should not be reversed.
Illustration 14
a. A Ltd. holds 80% of the equity capital and voting power in B Ltd. A Ltd. sells
inventories costing ` 180 lacs to B Ltd at a price of ` 200 lacs. The entire
inventories remain unsold with B Ltd. at the financial year end i.e. 31 March
20X1.
b. A Ltd. holds 75% of the equity capital and voting power in B Ltd. A Ltd.
purchases inventories costing ` 150 lacs from B Ltd at a price of ` 200 lacs. The
entire inventories remain unsold with A Ltd. at the financial year end i.e. 31
March 20X1.
Suggest the accounting treatment for the above mentioned transactions in the
consolidated financial statements of A Ltd. giving reference of the relevant
guidance/standard.

Solution
As per para 16 and 17 of AS 21, intragroup balances and intragroup transactions
and resulting unrealized profits should be eliminated in full. Unrealized losses
resulting from intragroup transactions should also be eliminated unless cost cannot
be recovered.

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.71
FINANCIAL STATEMENTS

Intragroup balances and intragroup transactions, including sales, expenses and

dividends, are eliminated in full. Unrealized profits resulting from intragroup
transactions that are included in the carrying amount of assets, such as inventory
and fixed assets, are eliminated in full. Unrealized losses resulting from intragroup
transactions that are deducted in arriving at the carrying amount of assets are also
eliminated unless cost cannot be recovered.

One also needs to see whether the intragroup transaction is “upstream” or “down-
stream”. Upstream transaction is a transaction in which the subsidiary company
sells goods to holding company. While in the downstream transaction, holding
company is the seller and subsidiary company is the buyer.

In the case of upstream transaction, since the goods are sold by the subsidiary to
holding company; profit is made by the subsidiary company, which is ultimately
shared by the holding company and the minority shareholders. In such a
transaction, if some goods remain unsold at the balance sheet date, the unrealized
profit on such goods should be eliminated from minority interest as well as from
consolidated profit on the basis of their share-holding besides deducting the same
from unsold inventory.

But in the case of downstream transaction, the whole profit is earned by the holding
company, therefore, whole unrealized profit should be adjusted from unsold
inventory and consolidated profit and loss account only irrespective of the
percentage of the shares held by the parent.
Using above mentioned guidance, following adjustments would be required:
a. This would be the case of downstream transaction. In the consolidated profit
and loss account for the year ended 31 March 20X1, entire transaction of sale
and purchase of ` 200 lacs each, would be eliminated by reducing both sales
and purchases (cost of sales).

Further, the unrealized profits of ` 20 lacs (i.e. ` 200 lacs – ` 180 lacs), would
be eliminated from the consolidated financial statements for financial year
ended 31 March 20X1, by reducing the consolidated profits/ increasing the
consolidated losses, and reducing the value of closing inventories as of 31
March 20X1.

© The Institute of Chartered Accountants of India

 10.72 ADVANCED ACCOUNTING

b. This would be the case of upstream transaction. In the consolidated profit

and loss account for the year ended 31 March 20X1, entire transaction of sale
and purchase of ` 200 lacs each, would be eliminated by reducing both sales
and purchases (cost of sales).

Further, the unrealized profits of ` 50 lacs (i.e. ` 200 lacs – ` 150 lacs), would
be eliminated in the consolidated financial statements for financial year
ended 31 March 20X1, by reducing the value of closing inventories by ` 50
lacs as of 31 March 20X1. In the consolidated balance sheet as of 31 March
20X1, A Ltd.’s share of profit from B Ltd will be reduced by ` 37.50 lacs (being
75% of ` 50 lacs) and the minority’s share of the profits of B Ltd would be
reduced by ` 12.50 lacs (being 25% of ` 50 lacs).

D. ALIGNMENT OF REPORTING DATES

The financial statements used in the consolidation should be drawn up to the same
reporting date. If it is not practicable to draw up the financial statements of one or
more subsidiaries to such date and, accordingly, those financial statements are
drawn up to different reporting dates, adjustments should be made for the effects
of significant transactions or other events that occur between those dates and the
date of the parent’s financial statements.

In any case, the difference between reporting dates should not be more than six
months.

The financial statements of the parent and its subsidiaries used in the preparation
of the consolidated financial statements are usually drawn up to the same date.
When the reporting dates are different, the subsidiary often prepares, for
consolidation purposes, statements as at the same date as that of the parent.

When it is impracticable to do this, financial statements drawn up to different

reporting dates may be used provided the difference in reporting dates is not more
than six months.

The consistency principle requires that the length of the reporting periods and any
difference in the reporting dates should be the same from period to period.

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.73
FINANCIAL STATEMENTS

1.15 PREPARATION OF CONSOLIDATED

STATEMENT OF PROFIT AND LOSS
All the items of profit and loss account are to be added on line by line basis and
inter-company transactions should be eliminated from the consolidated figures.
For example, a holding company may sell goods or services to its subsidiary, receive
consultancy fees, commission, royalty etc. These items are included in sales and
other income of the holding company and in the expense items of the subsidiary.
Alternatively, the subsidiary may also sell goods or services to the holding
company. These inter-company transactions are to be eliminated in full.

If there remains any unrealized profit in the inventory, of any of the Group
Company, such unrealized profit is to be eliminated from the value of inventory to
arrive at the consolidated profit.
Illustration 15
H Ltd and its subsidiary S Ltd provide the following information for the year ended
31st March, 20X3:

H Ltd. S Ltd.
(` in lacs) (` in lacs)

Sales and other income 5,000 1,000

Increase in Inventory (closing less opening) 1,000 200

Raw material consumed 800 200

Wages and Salaries 800 150

Production expenses 200 100

Administrative Expenses 200 100

Selling and Distribution Expenses 200 50

Interest 100 50

Depreciation 100 50

© The Institute of Chartered Accountants of India

 10.74 ADVANCED ACCOUNTING

Other Information:
H Ltd. sold goods to S Ltd. of ` 120 lacs at cost plus 20%. Inventory of S Ltd. includes
such goods valuing ` 24 lacs. Administrative expenses of S Ltd. include
` 5 lacs paid to H Ltd. as consultancy fees. Selling and distribution expenses of
H Ltd. include ` 10 lacs paid to S Ltd. as commission.

H Ltd. holds 80% of equity share capital of ` 1,000 lacs in S Ltd. prior to 20X1-20X2.
H Ltd. took credit to its Profit and Loss Account, the proportionate amount of dividend
declared and paid by S Ltd. for the year 20X1-20X2.
Prepare a consolidated statement of profit and loss..
Solution
Consolidated statement of profit and loss of H Ltd. and its subsidiary S Ltd.
for the year ended on 31st March, 20X3

Particulars Note No. ` in Lacs

I. Revenue from operations 1 5,865

II. Total Income 5,865

III. Expenses

Cost of material purchased/consumed 2 1,180

Changes of inventories of finished goods 3 (1,196)

Employee benefit expense 4 950

Finance cost 5 150

Depreciation and amortization expense 6 150

Other expenses 7 535

Total expenses 1,769

IV. Profit before tax (II-III) 4,096

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.75
FINANCIAL STATEMENTS

Notes to Accounts

` in Lacs ` in Lacs

1. Revenue from operations

Sales and other income
H Ltd. 5,000
S Ltd. 1,000
6,000

Less: Inter-company sales (120)

Consultancy fees received by H Ltd. from S Ltd. (5)
Commission received by S Ltd. from H Ltd. (10) 5,865

2. Cost of material purchased/consumed

H Ltd. 800
S Ltd. 200

1,000
Less: Purchases by S Ltd. from H Ltd. (120) 880
Direct expenses (Production)

H Ltd. 200
S Ltd. 100 300
1,180
3. Changes of inventories of finished goods
H Ltd. 1,000
S Ltd. 200
20
Less: Unrealized profits ` 24 lacs × (4) 1,196
120

© The Institute of Chartered Accountants of India

 10.76 ADVANCED ACCOUNTING

4. Employee benefits and expenses

Wages and salaries:
H Ltd. 800
S Ltd. 150 950
5. Finance cost
Interest:
H Ltd. 100
S Ltd. 50 150
6. Depreciation
H Ltd. 100
S Ltd. 50 150
7. Other expenses
Administrative expenses
H Ltd. 200
S Ltd. 100
Less: Consultancy fees received by H Ltd. from S Ltd. (5) 295
Selling and distribution Expenses:
H Ltd. 200
S Ltd. 50
Less: Commission received by S Ltd. from H Ltd. (10) 240
535

1.16 PREPARATION OF CONSOLIDATED CASH

FLOW STATEMENT
As per AS 21, Consolidated cash flow statement is presented in case a parent
presents its own cash flow statement.
For the purpose of preparation of consolidated cash flow statement, all the items
of cash flow from operating activities, investing activities and financing activities
are to be added on line by line basis and from the consolidated items, inter-
company transactions should be eliminated. Below given is an illustrative
consolidated cash flow statement with hypothetical figures:

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.77
FINANCIAL STATEMENTS

Consolidated Cash Flow Statement (Illustrative only)

(` in million)

A B Total
Company Company

Cash Flows from Operating Activities

Change in Reserve 8 2 10

Change in P & L A/c - 1 1

Dividend Paid 22 - 22

Tax Provision 20 1 21

Depreciation 10 5 15

Interest (10) 10 -

50 19 69

Less: Tax payment (20) (1) (21)

30 18 48

Working capital adjustment (13) 12 (1)

(A) 17 30 47

Cash Flows from Investment Activities

Sale of fixed assets 30 - 30

Purchase of fixed assets (30) (20) (50)

(B) - (20) (20)

Cash Flows from Financing Activities (5) (10) (15)

(C)

Net cash flows (A+B+C) 12 - 12

© The Institute of Chartered Accountants of India

 10.78 ADVANCED ACCOUNTING

1.17 UNIFORM ACCOUNTING POLICIES

Para 20 of AS 21 states that consolidated financial statements shall be prepared
using uniform accounting policies for like transactions and other events in similar
circumstances.
If any company in the same group uses accounting policies other than those
adopted in consolidated financial statements for like transactions and events in
similar circumstances, appropriate adjustments are made to its financial statements
when they are used in preparing the consolidated financial statements.
If it is not practicable to use uniform accounting policies in preparing the
consolidated financial statements, the fact should be disclosed together with the
proportions of items to which different accounting policies have been applied.
For example, if the subsidiary company follows weighted average method for
valuation of inventories and the holding company follows FIFO method, the
financial statements of subsidiary company should be restated by adjusting the
value of inventories to bring the same in line with the valuation procedure adopted
by the holding company. After that consolidation should be done.
Illustration 16
Subsidiary B Ltd. provides the following balance sheet:

Particulars Note 20X0 20X1

No. (` ) (` )
I. Equity and Liabilities
(1) Shareholder's Funds
(a) Share Capital 1 5,00,000 5,00,000
(b) Reserves and Surplus 2 2,86,000 7,14,000
(2) Current Liabilities
(a) Short term borrowings 3 -- 1,70,000
(b) Trade Payables 4,90,000 4,94,000
(c) Short-term provisions 4 3,10,000 4,30,000
Total 15,86,000 23,08,000

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.79
FINANCIAL STATEMENTS

II. Assets
(1) Non-current assets
(a) Property, Plant and 5 2,72,000 2,24,000
Equipment
(b) Non-current Investment 4,00,000
(2) Current assets
(a) Inventories 5,97,000 7,42,000
(b) Trade Receivables 5,94,000 8,91,000
(c) Cash & Cash Equivalents 51,000 3,000
(d) Other current assets 6 72,000 48,000
Total 15,86,000 23,08,000
20X0 20X1
(` ) (` )
1. Share capital
5,000 equity shares of `10 each, fully paid up 5,00,000 5,00,000
2. Reserves and Surplus
General Reserves 2,86,000 7,14,000
3. Short term borrowings
Bank overdraft -- 1,70,000
4. Short term provisions
Provision for taxation 3,10,000 4,30,000
5. Property, plant and equipment
Cost 3,20,000 3,20,000
Less: Depreciation (48,000) (96,000)
Total 2,72,000 2,24,000
6. Other current Assets
Prepaid expenses 72,000 48,000

© The Institute of Chartered Accountants of India

 10.80 ADVANCED ACCOUNTING

Also consider the following information:

(a) B Ltd. is a subsidiary of A Ltd. Both the companies follow calendar year as the
accounting year.
(b) A Ltd. values inventory on weighted average basis while B Ltd. used FIFO basis.
To bring B Ltd.’s values in line with those of A Ltd, its value of inventory is
required to be reduced by `12,000 at the end of 20X0 and ` 34,000 at the end
of 20X1.
(c) B Ltd. deducts 1% from Trade Receivables as a general provision against
doubtful debts.
(d) Prepaid expenses in B Ltd. include advertising expenditure carried forward of
` 60,000 in 20X0 and` 30,000 in 20X1, being part of initial advertising
expenditure of ` 90,000 in 20X0 which is being written off over three years.
Similar amount of advertising expenditure of A Ltd. has been fully written off
in 20X0.
Restate the balance sheet of B Ltd. as at 31st December, 20X1 after considering the
above information, for the purpose of consolidation. Would restatement be necessary
to make the accounting policies adopted by A Ltd. and B Ltd. uniform.
Solution
As per para 20 and 21 of AS 21, Consolidated financial statements:
Consolidated financial statements should be prepared using uniform accounting
policies for like transactions and other events in similar circumstances. If it is not
practicable to use uniform accounting policies in preparing the consolidated
financial statements, that fact should be disclosed together with the proportions of
the items in the consolidated financial statements to which the different accounting
policies have been applied.
If a member of the group uses accounting policies other than those adopted in the
consolidated financial statements for like transactions and events in similar
circumstances, appropriate adjustments are made to its financial statements when
they are used in preparing the consolidated financial statements.
Accordingly in the given case, restatement would be required to make the
accounting policies of A Ltd and B Ltd uniform.

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.81
FINANCIAL STATEMENTS

Adjusted reserves of B Ltd.:

` `
Reserves as given 7,14,000
Add: Provision for doubtful debts
{[8,91,000 / 99 X 100]-8,91,000} 9,000
7,23,000
Less: Reduction in value of Inventory 34,000
Advertising expenditure to be written off 30,000 (64,000)
Adjusted reserves 6,59,000

Note: No adjustment would be required in respect of opening inventory of B Ltd

as that will not have any impact on P&L.

Restated Balance Sheet of B Ltd.

as at 31st December, 20X1

Particulars Note No. (`)

I. Equity and Liabilities
(1) Shareholder's Funds
(a) Share Capital 1 5,00,000
(b) Reserves and Surplus 2 6,59,000
(2) Current Liabilities
(a) Short term borrowings 3 1,70,000
(b) Trade Payables 4,94,000
(c) Short-term provision 4 4,30,000
Total 22,53,000
II. Assets
(1) Non-current assets
(a) Property, Plant and Equipment 5 2,24,000
(b) Non-current Investment 4,00,000
(2) Current assets
(a) Inventories 6 7,08,000

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 10.82 ADVANCED ACCOUNTING

(b) Trade Receivables 7 9,00,000

(c) Cash & Cash Equivalents 3,000
(d) Other current assets 8 18,000
Total 22,53,000
Notes to Accounts

20X1
(`)
1. Share capital
5,000 equity shares of Rs 10 each, fully paid up 5,00,000
2. Reserves and Surplus
General Reserves (refer to WN) 6,59,000
3. Short term borrowings
Bank overdraft 1,70,000
4. Short term provisions
Provision for taxation 4,30,000
5. Property, plant and equipment
Cost 3,20,000
Less: Depreciation (96,000)
Total 2,24,000
6. Inventory
Actual inventory 7,42,000
Less: Change in method of valuation (34,000)
Total 7,08,000
7. Trade receivables
Actual trade receivables 8,91,000
Add: Adjustment for provision 9,000
Total 9,00,000
8. Other current Assets
Prepaid expenses 48,000

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.83
FINANCIAL STATEMENTS

1.18 TREATMENT OF SUBSIDIARY COMPANY

HAVING PREFERENCE SHARE CAPITAL
While preparing CFS, outstanding cumulative preference shares issued by a
subsidiary are considered in the same manner as any other liability, such as
debentures etc. Accordingly, the cost associated with such cumulative preference
shares needs to be adjusted for.
Therefore, while computing its share of profits or losses of the subsidiary, the
parent should make adjustments in respect of preference dividends on outstanding
cumulative preference shares issued by a subsidiary and held outside the group
since, for the group, such preference shares represent external liabilities. It would
be appropriate for the parent to compute its share of profits or losses after
adjusting for subsidiary’s cumulative preference dividends, whether or not profits
are available or dividends have been declared.
However, in case of non-cumulative preference shares, no such adjustment is
required unless the dividend is actually received.

SUMMARY
• “Holding company”, in relation to one or more other companies, means a
company of which such companies are subsidiary companies; “subsidiary
company” or “subsidiary”, in relation to any other company (that is to say the
holding company), means a company in which the holding company—
o controls the composition of the Board of Directors; or
o exercises or controls more than one-half of the total share capital either
at its own or together with one or more of its subsidiary companies:
Provided that such class or classes of holding companies as may be
prescribed shall not have layers of subsidiaries beyond such numbers
as may be prescribed.
• ‘Total share capital’, as defined in section 2(87) (ii) above, has been further
clarified by the Rule 2(1)(r) of the Companies (Specification of Definitions
Details) Rules, 2014. As per the Rule, total share capital includes
o paid up equity share capital
o convertible preference share capital.

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 10.84 ADVANCED ACCOUNTING

• Consolidated financial statements are prepared and presented by a

parent/holding enterprise to provide financial information about a parent and
its subsidiary (ies) as a single economic entity.
• Distinction must be made from the point of view of the holding company,
between revenue and capital profit of the subsidiary. In the absence of
information, profits of a year may be treated as accruing from day to day.
Preparation of Consolidated Statement of Profit and Loss
• All the revenue items are to be added on line by line basis and from the
consolidated revenue items, inter-company transactions should be
eliminated.
• If there remains any unrealized profit in the inventory of goods, of any of the
Group Company, such unrealized profit should be eliminated from the value
of inventory to arrive at the consolidated profit.
Preparation of Consolidated Cash Flow Statement
All the items of Cash flow from operating activities, investing activities and
financing activities are to be added on line by line basis and from the consolidated
items, inter-company transactions should be eliminated.
The financial statements used in the consolidation should be drawn up to the same
reporting date. If it is not practicable to draw up the financial statements of one or
more subsidiaries to such date and, accordingly, those financial statements are
drawn up to different reporting dates, adjustments should be made for the effects
of significant transactions or other events that occur between those dates and the
date of the parent’s financial statements.

In any case, the difference between reporting dates should not be more than six
months.

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.85
FINANCIAL STATEMENTS

TEST YOUR KNOWLEDGE

Multiple Choice Questions
1. Minority interest should be presented in the consolidated balance sheet

(a) As a part of liabilities.

(b) As a part of equity of the parent’s shareholders.
(c) Separately from liabilities and the equity of the parent’s shareholders.
(d) As a part of assets.
2. Minority of the subsidiary is entitled to
(a) Capital profits of the subsidiary company.
(b) Revenue profits of the subsidiary company.
(c) Both capital and revenue profits of the subsidiary company.
(d) Neither capital nor revenue profits of the subsidiary..

3. In consolidation of accounts of holding and subsidiary company _________ is

eliminated in full.
(a) Current liabilities of subsidiary company.
(b) Reserves and surplus of both holding and subsidiary company.
(c) Mutual indebtedness.
(d) Nothing.

4. In consolidated balance sheet, the share of the outsiders in the net assets of the
subsidiary must be shown as
(a) Minority interest.
(b) Capital reserve.
(c) Current liability.
(d) Current assets.

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 10.86 ADVANCED ACCOUNTING

5. Provision for Tax made by the subsidiary company will appear in the
consolidated balance sheet as an item of

(a) Current liability.

(b) Revenue profit.
(c) Capital profit.
(d) Current assets.

Scenario-based Questions
6. Hemant Ltd. purchased 80% shares of Power Ltd. on 1st January, 20X1 for
` 2,10,000. The issued capital of Power Ltd., on 1st January, 20X1 was ` 1,50,000
and the balance in the Profit & Loss Account was ` 90,000. During the year
ended 31st December, 20X1, Power Ltd. earned a profit of ` 30,000 and at year
end, declared and paid a dividend of ` 22,500. What is the amount of minority
interest as on 1st January, 20X1 and 31st December, 20X1? Also compute
goodwill/ capital reserve at the date of acquisition.
7. King Ltd. acquires 70% of equity shares of Queen Ltd. as on 31st March, 20X1
at a cost of ` 140 lakhs. The following information is available from the balance
sheet of Queen Ltd. as on 31st March, 20X1:
` in lakhs
Property, plant and equipment 240
Investments 110
Current Assets 140
Loans & Advances 30
15% Debentures 180
Current Liabilities 100

The following revaluations have been agreed upon (not included in the above
figures):
Property, plant and equipment- up by 20% and Investments- down by 10%.
King Ltd. purchased the shares of Queen Ltd. @ `20 per share (Face
value - `10).

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.87
FINANCIAL STATEMENTS

Calculate the amount of goodwill/capital reserve on acquisition of shares of

Queen Ltd.

8. From the following information, determine Minority Interest on the date of

acquisition and on the date of consolidation in each case:

Case Subsidiary % of Cost Date of Consolidation date

Company Share Acquisition
owned

01-01-20X1 31-12-20X1

Share Profit Share Profit and

Capital and Loss Capital Loss A/c
A/c

` ` ` `

Case-A X 90% 2,00,000 1,50,000 75,000 1,50,000 85,000

Case-B Y 75% 1,75,000 1,40,000 60,000 1,40,000 20,000

Case-C Z 70% 98,000 40,000 20,000 40,000 20,000

Case-D M 95% 75,000 60,000 35,000 60,000 55,000

9. A Ltd acquired 1,600 ordinary shares of `100 each of B Ltd on 1st July, 20X1.
On 31st December, 20X1, the balance sheets of the two companies were as
given below:
Balance Sheet of A Ltd. and its subsidiary, B Ltd.
as at 31st December, 20X1

Particulars Note A Ltd. B Ltd.

No. (` ) (` )

I. Equity and Liabilities

(1) Shareholder's Funds

(a) Share Capital 1 5,00,000 2,00,000

(b) Reserves and Surplus 2 2,97,200 1,82,000
(2) Current Liabilities

(a) Trade Payables 47,100 17,400

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 10.88 ADVANCED ACCOUNTING

(b) Short term borrowings 3 80,000

Total 9,24,300 3,99,400

II. Assets
(1) Non-current assets
(a) Property, Plant and 4 3,90,000 3,15,000
Equipment
(b) Non-current 5 3,40,000 --
Investments
(2) Current assets
(a) Inventories 1,20,000 36,400

(b) Trade receivables 59,800 40,000

(c) Cash & Cash 6 14,500 8,000
equivalents

Total 9,24,300 3,99,400

Notes to Accounts

A Ltd. B Ltd.
` `
1. Share Capital
5,000 shares of ` 100 each, fully paid up 5,00,000 -
2,000 shares of ` 100 each, fully paid up - 2,00,000
Total 5,00,000 2,00,000
2. Reserves and Surplus
General Reserves 2,40,000 1,00,000
Profit & loss 57,200 82,000
Total 2,97,200 1,82,000
3. Short term borrowings
Bank overdraft 80,000 --

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.89
FINANCIAL STATEMENTS

4. Property plant and equipment

Land and building 1,50,000 1,80,000
Plant & Machinery 2,40,000 1,35,000
Total 3,90,000 3,15,000
5. Non-current Investments
Investment in B Ltd (at cost) 3,40,000 --
6. Cash & Cash equivalents
Cash 14,500 8,000

The Profit & Loss Account of B Ltd. showed a credit balance of `30,000 on
1st January, 20X1 out of which a dividend of 10% was paid on 1st August, 20X1;
A Ltd. credited the dividend received to its Profit & Loss Account. The Plant &
Machinery which stood at ` 1,50,000 on 1st January, 20X1 was considered as
worth ` 1,80,000 on 1st July, 20X1; this figure is to be considered while
consolidating the Balance Sheets. The rate of depreciation on plant &
machinery is 10% (computed on the basis of useful lives).
Prepare consolidated Balance Sheet as at 31st December, 20X1.
10. On 31st March, 20X1, the Balance Sheets of H Ltd. and its subsidiary S Ltd.
stood as follows:
Balance Sheet of H Ltd.
and its subsidiary S Ltd. as at 31st March, 20X1

Particulars Note H Ltd. S Ltd.

No. (` in Lacs) (` in Lacs)
I. Equity and Liabilities
(1) Shareholder's Funds
(a) Share Capital 1 12,000 4,800
(b) Reserves and Surplus 2 5,499 3,000
(2) Current Liabilities
(a) Trade payables 3 1,833 1,014
(b) Short term provisions 4 855 394

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 10.90 ADVANCED ACCOUNTING

(c) Other current 1,200 -

liabilities (Dividend
payable)
Total 21,387 9,208
II. Assets
(1) Non-current assets
(a) Property, Plant and 5 9,468 5,486
Equipment
(b) Non-current 3,000
Investments
(Shares in S Ltd.)
(2) Current assets
(a) Inventories 3,949 1,956
(b) Trade receivables 6 2,960 1,562
(c) Cash and cash 1,490 204
equivalents
(d) Short term loans and 7 520
advances
Total 21,387 9,208
Notes to Accounts

H Ltd. S Ltd.
(` in lacs) (` in lacs)

1. Share Capital

Authorized share capital 15,000 6,000

Equity shares of ` 10 each, fully paid up

Issued and Subscribed:

Equity shares of ` 10 each, fully paid up 12,000 4,800

© The Institute of Chartered Accountants of India

 ACCOUNTING STANDARD FOR CONSOLIDATED 10.91
FINANCIAL STATEMENTS

2. Reserves and surplus

General Reserve 2,784 1,380

Profit and Loss Account: 2,715 1,620

Total 5,499 3,000

3. Trade Payables

Creditors 1,461 854

Bills Payable 372 160

1,833 1,014

4. Short term provisions

Provision for Taxation 855 394

5. Property, plant and equipment

Land and Buildings 2,718 -

Plant and Machinery 4,905 4,900

Furniture and Fittings 1,845 586

Total 9,468 5,486

6. Trade receivables

Debtors 2,600 1,363

Bills Receivable 360 199

Total 2,960 1,562

7. Short term loans and advances

Sundry Advances 520 --

The following information is also provided to you:

(a) H Ltd. purchased 180 lakh shares in S Ltd. on 31 st March, 20X0 when the
balances of General Reserve and Profit and Loss Account of S Ltd. stood
at ` 3,000 lakh and ` 1,200 lakh respectively.

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 10.92 ADVANCED ACCOUNTING

(b) On 1st April, 20X0, S Ltd. declared a dividend @ 20% for the year ended
31st March, 20X0. H Ltd. credited the dividend received by it to its Profit
and Loss Account.
(c) On 1st January, 20X1, S Ltd. issued 3 fully paid-up bonus shares for every
5 shares held out of balances of its general reserve as on
31st March, 20X0.
(d) On 31st March, 20X1, all the bills payable in S Ltd.’s balance sheet were
acceptances in favour of H Ltd. But on that date, H Ltd. held only ` 45
lakh of these acceptances in hand, the rest having been endorsed in
favour of its trade payables.
(e) On 31st March, 20X1, S Ltd.’s inventory included goods which it had
purchased for ` 100 lakh from H Ltd. which made a profit @ 25% on cost.
Prepare a Consolidated Balance Sheet of H Ltd. and its subsidiary S Ltd. as at
31st March, 20X1.
11. Chand Ltd. and its subsidiary Sitara Ltd. provided the following information for
the year ended 31st March, 20X4:

Particulars Chand Ltd (`) Sitara Ltd. (`)

Equity Share Capital 20,00,000 6,00,000
Finished Goods Inventory as 4,20,000 3,01,000
on 01.04.2022
Finished Goods Inventory as 8,57,500 3,76,250
on 31.03.2023
Dividend Income 1,68,000 43,750
Other non-operating Income 35,000 10,500
Raw material consumed 13,93,000 4,72,500
Selling and Distribution 3,32,500 1,57,500
Expenses
Production Expenses 3,15,000 1,40,000
Loss on sale of investments 26,250 Nil
Sales and other operating 33,25,000 19,07,500
income

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.93
FINANCIAL STATEMENTS

Wages and Salaries 13,30,000 2,45,000

General and Administrative 2,80,000 1,22,500
Expenses
Royalty paid Nil 5,000
Depreciation 31,500 14,000
Interest expense 17,500 5,250

Other information
♦ On 1st September 20X1 Chand Ltd., acquired 5,000 equity shares of
` 100 each fully paid up in Sitara Ltd.
♦ Sitara Ltd. paid a dividend of 10% for the year ended 31st March 20X3.
The dividend was correctly accounted for by Chand Ltd.
♦ Chand Ltd. sold goods of ` 1,75,000 to Sitara Ltd. at a profit of 20% on
selling price. Inventory of Sitara Ltd. includes goods of ` 70,000 received
from Chand Ltd.
♦ Selling and Distribution expenses of Sitara Ltd. include ` 21,250 paid to
Chand Ltd. as brokerage fees.
♦ General and Administrative expenses of Chand Ltd. include ` 28,000 paid
to Sitara Ltd. as consultancy fees.
♦ Sitara Ltd. used some resources of Chand Ltd., and Sitara Ltd. paid
` 5,000 to Chand Ltd. as royalty.
Consultancy fees, Royalty and brokerage received is to be considered as
operating revenues.
Prepare Consolidated Statement of Profit and Loss of Chand Ltd. and its
subsidiary Sitara Ltd. for the year ended 31st March, 20X4 as per Schedule III to
the Companies Act, 2013.

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 10.94 ADVANCED ACCOUNTING

ANSWERS/SOLUTION
Answer to the Multiple Choice Questions

1. (c) 2. (c) 3. (c) 4. (a) 5. (a)

Answer to the Scenario-based Questions

6. Total dividend paid is ` 22,500 (out of post-acquisition profits), hence
dividend received by Hemant will be credited to P & L account. Hemant Ltd.’s
share of dividend = ` 22,500 X 80% = ` 18,000
Goodwill on consolidation (at the date of ` `
acquisition):
Cost of shares 2,10,000
Less: Face value of capital i.e. 80% of capital 1,20,000
Add: Share of capital profits [90,000 X 80 %] 72,000 (1,92,000)
Goodwill 18,000
Minority interest on:
- 1st January, 20X1:
20% of ` 2,40,000 [1,50,000 + 90,000] 48,000
- 31st December, 20X1:
49,500
20% of ` 2,47,500 [1,50,000 + 90,000 + 30,000 –
22,500]

7. Revalued net assets of Queen Ltd. as on 31st March, 20X1

` in lakhs ` in lakhs
PPE [240 X 120%] 288
Investments [110 X 90%] 99
Current Assets 140
Loans and Advances 30

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.95
FINANCIAL STATEMENTS

Total Assets after revaluation 557

Less: 15% Debentures 180.0
Current Liabilities 100.0 (280)
Equity / Net Worth 277
King Ltd.’s share of net assets (70% of 277) 193.9
King Ltd.’s cost of acquisition of shares of Queen
Ltd.
(`140 lakhs) (140)
Capital reserve 53.9

8. Minority Interest = Equity attributable to minorities

Equity is the residual interest in the assets of an enterprise after deducting all
its liabilities i.e. in this case, it should be equal to Share Capital + Profit &
Loss A/c
A = Share capital on 1.1.20X1
B = Profit & loss account balance on 1.1.20X1
C = Share capital on 31.12.20X1
D = Profit & loss account balance on 31.12.20X1

Minority Minority Minority interest as

% Shares interest as at the at the date of
Owned date of consolidation
acquisition
[E] [E] x [A + B] ` [E] X [C + D] `
Case A [100-90] 10 % 22,500 23,500
Case B [100-75] 25 % 50,000 40,000
Case C [100-70] 30 % 18,000 18,000
Case D [100-95] 5% 4,750 5,750

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 10.96 ADVANCED ACCOUNTING

9. Consolidated Balance Sheet of A Ltd. and its subsidiary, B Ltd.

as at 31st December, 20X1

Particulars Note No. (`)

I. Equity and Liabilities
(1) Shareholder's Funds
(a) Share Capital 1 5,00,000
(b) Reserves and Surplus 2 3,08,800
(2) Minority Interest 83,600
(3) Current Liabilities
(a) Trade Payables 3 64,500
(b) Short term borrowings 4 80,000
Total 10,36,900
II. Assets
(1) Non-current assets
(a) Property, Plant and 5 7,41,000
Equipment
(b) Intangible assets 6 17,200
(2) Current assets
(a) Inventories 7 1,56,400
(b) Trade receivables 8 99,800
(c) Cash & Cash equivalents 9 22,500
Total 10,36,900

Notes to Accounts

`
1. Share Capital
5,000 shares of ` 100 each 5,00,000

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.97
FINANCIAL STATEMENTS

2. Reserves and Surplus

Reserves 2,40,000
Profit & loss (Refer to W.N 8) 68,800
Total 3,08,800
3. Trade Payables
A Ltd. 47,100
Add: B Ltd 17,400
Total 64,500

4. Short term borrowings

Bank overdraft 80,000
5. Property, plant and equipment

Land and building- A Ltd 1,50,000

Add: Land and building- B Ltd 1,80,000 3,30,000
Plant & Machinery (Refer to W.N 7) 4,11,000

Total 7,41,000
6. Intangible assets
Goodwill (refer to W.N 6) 17,200
7. Inventories
A Ltd. 1,20,000
B Ltd. 36,400
Total 1,56,400
8 Trade Receivables
A Ltd. 59,800
B Ltd. 40,000
Total 99,800

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 10.98 ADVANCED ACCOUNTING

9 Cash & Cash equivalents

Cash of A Ltd 14,500
Add: cash of B Ltd. 8,000
Total 22,500

Share holding Pattern

Total Shares of B Ltd 2,000 shares
Shares held by A Ltd 1,600 shares i.e. 80 %
Minority Shareholding 400 shares i.e. 20 %
Working Notes:
1. The dividend @ 10% on 1,600 shares - ` 16,000 received by A Ltd.
should have been credited to the investment A/c, being out of
pre-acquisition profits. A Ltd., must pass a rectification entry, viz.
Profit & Loss Account Dr. ` 16,000
To Investment ` 16,000
2. The Plant & Machinery of B Ltd. would stand in the books at
` 1,42,500 on 1st July, 20X1, considering only six months’ depreciation
on ` 1,50,000 total depreciation being ` 15,000. The value put on the
assets being ` 1,80,000, there is an appreciation to the extent of
` 37,500 (1,80,000 – 1,42,500).
3. Capital profits of B Ltd.

` `

Reserve on 1st January, 20X1 (Assumed there 1,00,000

is no movement in reserves during the year and
hence balance as on 1st January 20X1 is same
as of 31st December 20X1)

Profit & Loss Account Balance on 1st January, 30,000

20X1

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.99
FINANCIAL STATEMENTS

Less: Dividend paid (20,000) 10,000

Profit for 20X1:

Total ` 82,000
Less: `10,000

` 72,000

Proportionate upto 1st July, 20X1 on time basis

(` 72,000/2) 36,000

Appreciation in value of Plant & Machinery 37,500

1,83,500

Less: 20% due to outsiders (36,700)

Holding company’s share 1,46,800

4. Revenue profits of B Ltd.:

Profit after 1st July, 20X1 [(82,000 – 10,000) x ½] 36,000

Less: Depreciation
10% depreciation on `1,80,000 for 6 months 9,000
Less: Depreciation already charged for 2nd half
year on 1,50,000 (7,500) (1,500)
34,500
Less: 1/5 due to outsiders (6,900)

Share of A Ltd. 27,600

5. Minority interest:

Par value of 400 shares (2,00,000 X 20%) 40,000

Add: 1/5Capital Profits [WN 3] 36,700
1/5 Revenue Profits [WN 4] 6,900
83,600

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 10.100 ADVANCED ACCOUNTING

6. Cost of Control:

Amount paid for 1,600 shares 3,40,000

Less: Dividend out of pre-acquisition profits (16,000) 3,24,000
Par value of shares 1,60,000
Capital Profits –share of A Ltd. [WN 3] 1,46,800 (3,06,800)
Cost of Control or Goodwill 17,200

7. Value of plant & Machinery:

2,40,000
B Ltd. 1,35,000
Add: Appreciation on 1st July, 20X1 [1,80,000 –
(1,50,000 – 7,500)] 37,500
1,72,500
Add: Deprecation for 2nd half charged on pre-
revalued value 7,500
Less: Depreciation on `1,80,000 for 6 months (9,000) 1,71,000
4,11,000

8. Profit & Loss Account (Consolidated):

A Ltd. as given 57,200

Less: Dividend transferred to Investment A/c (16,000) 41,200
Share of A Ltd. in revenue profits of B Ltd. (WN 27,600
4)
68,800

10. Consolidated Balance Sheet of H Ltd.

and its subsidiary S Ltd. as at 31st March, 20X1

Particulars Note No. (` in Lacs)

I. Equity and Liabilities
(1) Shareholder's Funds

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.101
FINANCIAL STATEMENTS

(a) Share Capital 1 12,000

(b) Reserves and Surplus 2 7,159
(2) Minority Interest [W.N.6] 3,120
(3) Current Liabilities
(a) Trade payables 3 2,802
(b) Short term provisions 4 1,249
(c) Other current liabilities 5 1,200
Total 27,530
II. Assets
(1) Non-current assets
Property, Plant and Equipment 6 14,954
(2) Current assets
(a) Inventories 7 5,885
(b) Trade receivables 8 4,477
(c) Short term loans and advances 9 520
(d) Cash and cash equivalents 10 1,694
Total 27,530

Notes to Accounts

(` in lacs) (` in lacs)

1. Share Capital

Authorized share capital 15,000

Equity shares of `10 each, fully paid up

Issued and Subscribed:

Equity shares of ` 10 each, fully paid up 12,000

Total 12,000

2. Reserves and surplus

Capital Reserve (Note 5) 1,320

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 10.102 ADVANCED ACCOUNTING

General Reserve (2,784 + 108) 2,892

Profit and Loss Account:

H Ltd. 2,715
Less: Dividend wrongly credited 360

Unrealized Profit 20 (380)

2,335

Add: Share in S Ltd.’s Revenue profits 612 2,947

Total 7,159

3. Trade payables

Creditors

H Ltd. 1,461

S Ltd. 854 2,315

Bills Payable

H Ltd. ` 372

S Ltd. ` 160

` 532

Less: Mutual owing ` (45) 487 2,802

4. Short term provisions

Provision for Taxation

H Ltd. 855

S Ltd. 394

Total 1,249

5. Other current liabilities

Dividend payable

H Ltd. 1,200

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.103
FINANCIAL STATEMENTS

6. Property, plant and equipment

Land and Buildings

H Ltd. 2,718

Plant and Machinery

H Ltd. ` 4,905

S Ltd. ` 4,900 9,805

Furniture and Fittings

H Ltd. ` 1,845

S Ltd. ` 586 2,431

Total 14,954

7. Inventories

Stock

H Ltd. 3,949

S Ltd. 1,956

5,905

Less: Unrealized profit (20) 5,885

8. Trade receivables

Debtors

H Ltd. ` 2,600

S Ltd. ` 1,363 3,963

Bills Receivable

H Ltd. ` 360

S Ltd. ` 199

` 559

Less: Mutual Owing ` (45) 514 4,477

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 10.104 ADVANCED ACCOUNTING

9. Short term loans and advances

Sundry Advances 520

10. Cash and cash equivalents

Cash and Bank Balances 1,694

Share holding pattern of S Ltd.

Shares as on 31st March, 20X1 (Includes 480 lakh shares (4,800 lakhs/
bonus shares issued on 1st January, 20X1) ` 10)
H Ltd.’s holding as on 1st April, 20X0 180 lakhs
Add: Bonus received on 1st January, 20X1 108 lakhs (180 / 5 × 3)
Total H Ltd.’s holding as on 31st March, 20X1 288 lakhs i.e. 60 %
[288/480×100]
Minority Shareholding 40%

Working Notes:
1. S Ltd.’s General Reserve Account

` in lakhs ` in lakhs
To Bonus to equity By Balance b/d 3,000
shareholders (WN-8) 1,800 By Profit and Loss A/c 180
To Balance c/d 1,380 (Balancing figure) _
3,180 3,180

2. S Ltd.’s Profit and Loss Account

` in lakhs ` in lakhs
To General Reserve By Balance b/d 1,200
[WN 1] 180 By Net Profit for the
To Dividend paid year* 1,200
(20% on `3,000 lakhs) 600 (Balancing figure)
To Balance c/d 1,620
2,400 2,400

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.105
FINANCIAL STATEMENTS

*Out of ` 1,200 lakhs profit for the year, ` 180 lakhs has been transferred to
reserves.

3. Distribution of Revenue profits

` in lakhs
Revenue profits (W. N. 2) 1,200
Less: Share of H Ltd. 60% (General Reserve ` 108 + Profit (720)
and Loss Account ` 612)

Share of Minority Shareholders (40%) 480

Note: The question can also be solved by taking ` 1,020 lakhs as post
acquisition Profit and Loss balance and ` 180 lakhs as post acquisition
General Reserve balance. The final answer will be same.

4. Calculation of Capital Profits

` in lakhs

General Reserve on the date of acquisition less bonus shares 1,200

(` 3,000 – ` 1,800)
Profit and loss account on the date of acquisition less 600
dividend paid (` 1,200 – ` 600)
1,800

H Ltd.’s share = 60% of ` 1,800 lakhs = ` 1,080 lakhs

Minority interest = ` 1,800 – ` 1,080 = ` 720 lakhs
5. Calculation of capital reserve

` in lakhs
Paid up value of shares held (60% of `4,800) 2,880
Add: Share in capital profits [WN 4] 1,080
3,960
Less: Cost of shares less dividend received (` 3,000 – ` 360) (2,640)
Capital reserve 1,320

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 10.106 ADVANCED ACCOUNTING

6. Calculation of Minority Interest

III III` in lakhs

40% of share capital (40% of ` 4,800) 1,920

Add: Share in revenue profits [WN 3] 480
Share in capital profits [WN 4] 720
3,120

7. Unrealized profit in respect of inventory

25
×
` 100 lakhs 125 = ` 20 lakhs

8. Computation of bonus to equity shareholders

` In lakhs
Shares as on 31 March 20X1 including bonus share
issued on 1 January 20X1 4,800
3 8
Or we can say these are 1 + or
5 5
4,800
i.e. Shares before bonus issue should have been = 3,000
8 /5

Accordingly, bonus issue would be (4,800-3,000) 1,800

11. Consolidated statement of profit and loss of Chand Ltd. and its
subsidiary Sitara Ltd. for the year ended on 31st March, 20X4

Particulars Note `
No.
Revenue from operations 1 50,03,250
Other Income 2 1,81,000
Total revenue (I) 51,84,250
Expenses:
Cost of material purchased/consumed 3 21,45,500

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.107
FINANCIAL STATEMENTS

Changes (Increase) in inventories of finished 4 (4,98,750)

goods
Employee benefit expense 5 15,75,000
Finance cost 6 22,750
Depreciation and amortization expense 7 45,500
Other expenses 8 8,43,250
Total expenses (II) 41,33,250
Profit before tax (II-III) 10,51,000

Notes to Accounts:
` `
1. Revenue from operations
Sales and other operating revenues
Chand Ltd. 33,25,000
Sitara Ltd. 19,07,500
52,32,500
Less: Inter-company sales (1,75,000)
Consultancy fees received by (28,000)
Sitara Ltd. from Chand Ltd.
Royalty received by Chand Ltd. (5,000)
from Sitara Ltd.
Brokage received by Chand Ltd. (21,250) 50,03,250
from Sitara Ltd.
2. Other Income
Dividend income:
Chand Ltd. 1,68,000
Sitara Ltd. 43,750 2,11,750
Loss on sale of investments Sitara (26,250)
Ltd.
Other Non-operating Income
Chand Ltd. 35,000

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 10.108 ADVANCED ACCOUNTING

Sitara Ltd. 10,500

Less: Dividend realized from Sitara (50,000) 4,500 1,81,000
Ltd. (5,00,000 x 10%)

3. Cost of material
purchased/consumed
Chand Ltd. 13,93,000
Sitara Ltd. 4,72,500
18,65,500
Less: Purchases by Sitara Ltd. From
Chand Ltd. (1,75,000) 16,90,500
Direct expenses (Production)
Chand Ltd. 3,15,000
Sitara Ltd. 1,40,000 4,55,000 21,45,500
4. Changes (Increase) in inventories of
finished goods
Chand Ltd. 4,37,500
Sitara Ltd. 75,250
5,12,750
Less: Unrealized profits ` 7,00,00 ×
20/100 (14,000) 4,98,750

5. Employee benefits and expenses

Wages and salaries:
Chand Ltd. 13,30,000
Sitara Ltd. 2,45,000 15,75,000
6 Finance cost
Interest:
Chand Ltd. 17,500
Sitara Ltd. 5,250 22,750

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 ACCOUNTING STANDARD FOR CONSOLIDATED 10.109
FINANCIAL STATEMENTS

7. Depreciation
Chand Ltd. 31,500
Sitara Ltd. 14,000 45,500
8. Other expenses
General & Administrative expenses:
Chand Ltd. 2,80,000
Sitara Ltd. 1,22,500
4,02,500
Less: Consultancy fees received by (28,000) 3,74,500
Sitara Ltd. from Chand Ltd.
Royalty:
Sitara Ltd. 5,000
Less: Received by Chand Ltd. (5,000) Nil
Selling and distribution Expenses:
Chand Ltd. 3,32,500
Sitara Ltd. 1,57,500
4,90,000
Less: Brokerage received by Chand (21,250) 4,68,750 8,43,250
Ltd. from Sitara Ltd.

© The Institute of Chartered Accountants of India

 10.110 ADVANCED ACCOUNTING

UNIT 2: ACCOUNTING STANDARD 23

ACCOUNTING FOR INVESTMENTS IN ASSOCIATES
IN CONSOLIDATED FINANCIAL STATEMENTS

LEARNING OUTCOMES
After studying this unit, you will be able to:
♦ Define the terms ‘Associates’, ‘Significant influence’, ‘Control’, ‘Equity
method’ and other related terms used in the standard.
♦ Examine the circumstances under which the Equity Method is used.
♦ Apply the Equity Method in the accounting of investments in the
associates.
♦ Disclose the contingences in the consolidated financial statements.
♦ Comply with other disclosure requirements as stated in the standard.

2.1 INTRODUCTION
AS 23, came into effect in respect of accounting periods commenced on or after
1-4-2002. AS 23 describes the principles and procedures for recognizing
investments in associates (in which the investor has significant influence, but not
a subsidiary or joint venture of investor) in the consolidated financial statements
of the investor. An investor which presents consolidated financial statements
should account for investments in associates as per equity method in accordance
with this standard but in its separate financial statements, AS 13 will be
applicable.

2.2 OBJECTIVE
The objective of this Standard is to lay down principles and procedures for
recognizing the investments in associates and its effect on the financial
operations of the group in the consolidated financial statements. Reference to AS
23 is compulsory for the companies following AS 21 and preparing consolidated

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 ACCOUNTING STANDARDS FOR CONSOLIDATED 10.111
FINANCIAL STATEMENTS

financial statement for their group. For disclosing investment in associates in the
separate financial statement of the investor itself, one should follow AS 13.

2.3 DEFINITIONS OF THE TERMS USED IN THE

ACCOUNTING STANDARD
1. A subsidiary is an enterprise that is controlled by another enterprise
(known as the parent).
2. A parent is an enterprise that has one or more subsidiaries.
3. A group is a parent and all its subsidiaries.
4. The equity method is a method of accounting whereby the investment is
initially recorded at cost, identifying any goodwill/capital reserve arising at
the time of acquisition. The carrying amount of the investment is adjusted
thereafter for the post acquisition change in the investor’s share of net
assets of the investee. The consolidated statement of profit and loss reflects
the investor’s share of the results of the operations of the investee.
5. Equity is the residual interest in the assets of an enterprise after deducting
all its liabilities.
6. Consolidated financial statements are the financial statements of a group
presented as those of a single enterprise.
7. An associate is an enterprise in which the investor has significant influence
and which is neither a subsidiary nor a joint venture of the investor.
8. Significant influence is the power to participate in the financial and/or
operating policy decisions of the investee but not control over those
policies.
This definition excludes the subsidiaries or joint venture from the scope of an
associate but apart from these any other enterprises, which are significantly
influenced by the investor, is an associate for the purpose of this standard. Any
enterprise having 20% or more of the voting power or any interest directly or
indirectly in any other enterprise will be assumed to have significantly influence
the other enterprise unless proved otherwise. Significant influence may be gained
by share ownership, statute or agreement. Similarly any enterprise that does not

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 10.112 ADVANCED ACCOUNTING

have 20% or more control then it is assumed not having significant influence on
the enterprise unless proved otherwise.

An enterprise can influence the significant economic decision making by many

ways like:
♦ Having some voting power.

♦ Representation on the board of directors or governing body of the investee.

♦ Participation in policy-making processes.
Material transactions between the investor and the investee (Influencing inter-
company transactions i.e. sale of goods and services, sharing technical knowledge
etc.
♦ Interchange of managerial personnel.
♦ Provision of essential technical information.
As a general rule, significant influence is presumed to exist when an investor
holds, directly or indirectly through subsidiaries, 20% or more of the voting power
of the investee.
As with the classification of any investment, the substance of the arrangement in
each case should be considered. If it can be clearly demonstrated that an investor
holding 20% or more of the voting power of the investee does not have
significant influence, the investment will not be accounted for as an associate.
A substantial or majority ownership by another investor does not necessarily
preclude an investor from having significant influence.
If the investor holds, directly or indirectly through subsidiaries, less than 20% of
the voting power of the investee, it is presumed that the investor does not have
significant influence, unless such influence can be clearly demonstrated. The
presence of one or more of the indicators as above may indicate that an investor
has significant influence over a less than 20% owned corporate investee.
Control exists when parent company has either:
a. The ownership, directly or indirectly through subsidiary(ies), of more than
one-half of the voting power of an enterprise.

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 ACCOUNTING STANDARDS FOR CONSOLIDATED 10.113
FINANCIAL STATEMENTS

b. Or control of the composition of the board of directors in the case of a

company or of the composition of the corresponding governing body in
case of any other enterprise so as to obtain economic benefits from
subsidiary company’s activities.
If any company is controlling the composition of governing body of gratuity trust,
provident fund trust etc., since the objective is not the economic benefit and
therefore it will not be included in consolidated financial statement.
An enterprise is considered to control the composition of the board of directors
of a company or governing body in case of an enterprise other than a company, if
it has the power, without the consent or concurrence of any other person, to
appoint or remove all or a majority of directors of that company or members of
the body. An enterprise is deemed to have the power to appoint a
director/member, if any of the following conditions is satisfied:
(i) A person cannot be appointed as director/member without the exercise in his
favour by that enterprise of such a power as aforesaid; or
(ii) A person’s appointment as director/member follows necessarily from his
appointment to a position held by him in that enterprise; or
(iii) The director/member is nominated by that enterprise or a subsidiary thereof.
To understand the above definitions let us take few examples:
Example 1
A Ltd. has 70% holding in C Ltd. and B Ltd. also has 28% holding in the same
company. So, A Ltd. with the majority holding i.e. more than 50% is the parent
company i.e. a holding company. Since B Ltd. holds more than 20% but not more
than 50% in C Ltd., C Ltd. will be an associate of B Ltd.
Example 2
A Ltd. is holding 90% share in B Ltd. and 10% shares in C Ltd., and B Ltd. is holding
11%shares in C Ltd. In this case, A Ltd. is parent of B Ltd.
As far as the relationship between A Ltd. and C Ltd. is concerned; A Ltd. has a total
of direct and indirect holding of (10 + 11) 21% in C Ltd., Thus, C Ltd. is an associate
of A Ltd. It may however be noted that for consolidated financial statement
purposes, the holding will be 19.9% (10% + 90% of 11%),.

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 10.114 ADVANCED ACCOUNTING

2.4 ASSOCIATES ACCOUNTED FOR USING THE

EQUITY METHOD
The equity method is a method of accounting whereby the investment is initially
recorded at cost, identifying any goodwill/capital reserve arising at the time of
acquisition. The carrying amount of the investment is adjusted thereafter for the
post acquisition change in the investor’s share of net assets of the investee. The
consolidated statement of profit and loss reflects the investor’s share of the
results of operations of the investee.
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.
From the definition, following broad conclusions can be drawn:
a. In CFS, investment is to be recorded at cost.
b. Any surplus or deficit in cost and net asset to be recorded as goodwill or
capital reserve.
c. Distributions received from an investee reduce the carrying amount of the
investment.
d. Any subsequent change in share in net asset is adjusted in cost of
investment and goodwill/capital reserve.
e. Consolidated Profit & Loss shows the investor’s share in the results of
operations of the investee.
Illustration 1
A Ltd. acquire 45% of B Ltd. shares on April 01, 20X1, the price paid was
` 15,00,000. Following are the extracts of balance sheet of B Ltd. as of 1 April 20X1:
Paid up Equity Share Capital ` 10,00,000
Securities Premium ` 1,00,000
Reserve & Surplus ` 5,00,000
B Ltd. has reported net profits of ` 3,00,000 and paid dividends of ` 1,00,000 for the
year ended 31 March 20X2. Calculate the amount at which the investment in B Ltd.
should be shown in the consolidated balance sheet of A Ltd. as on March 31, 20X2.

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 ACCOUNTING STANDARDS FOR CONSOLIDATED 10.115
FINANCIAL STATEMENTS

Solution
Calculation of Goodwill/Capital Reserve under Equity Method

Particulars ` `
Investment in B Ltd. (A) 15,00,000
Equity Shares 10,00,000
Security Premium 1,00,000
Reserves & Surplus 5,00,000
Net Assets 16,00,000
45% of Net Asset (B) 7,20,000
Goodwill (A-B) 7,80,000
Calculation of Carrying Amount of Investment in the year ended on
31st March, 20X2

Particulars `
Investment in Associate as per AS 23:
Share of Net Assets on 1 April 20X1 7,20,000
Add: Goodwill 7,80,000
Cost of Investment 15,00,000
Add: Profit during the year (3,00,000 x 45%) 1,35,000
Less: Dividend paid (1,00,000 x 45%) (45,000)
Carrying Amount of Investment 15,90,000

2.5 CIRCUMSTANCES UNDER WHICH EQUITY

METHOD IS FOLLOWED
Equity method of accounting is to be followed by all the enterprises having
significant influence on their associates except in the following cases:
a. Control is intended to be temporary because the investment is acquired and
held exclusively with a view to its subsequent disposal in the near future.
The term ‘Near Future’ is explained with AS 21.

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 10.116 ADVANCED ACCOUNTING

b. Or it operates under severe long-term restrictions, which significantly impair

its ability to transfer funds to the investor.

In both the above cases, investment of investor in the share of the investee
is treated as investment according to AS 13.
An investor should discontinue the use of the equity method from the date that:

a. It ceases to have significant influence in an associate but retains, either in

whole or in part, its investment.
b. The use of the equity method is no longer appropriate because the
associate operates under severe long-term restrictions that significantly
impair its ability to transfer funds to the investor.
From the date of discontinuing the use of the equity method, investments in such
associates should be accounted for in accordance with AS 13, Accounting for
Investments. For this purpose, the carrying amount of the investment at that date
should be regarded as cost thereafter. The reasons for not applying the equity
method in accounting for investments in an associate should be disclosed in the
consolidated financial statements.

2.6 APPLICATION OF THE EQUITY METHOD

♦ Many of the rules followed under equity method for an associate is similar
to consolidated financial statement rules as in case of subsidiary i.e. AS 21.
♦ Investment in an associate should be recorded as per the equity method
from the date when such relation comes in effect.
♦ Investment in the associate is recorded at cost and any difference in the
cost and investor’s share in equity on the date of acquisition is shown as
goodwill or capital reserve.
Case 1:
A Ltd. holds 22% share of B Ltd. on 1st April of the year and following are
the relevant information as available on the date are Cost of Investment
` 33,000 and Total Equity on the date of acquisition ` 2,00,000.

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 ACCOUNTING STANDARDS FOR CONSOLIDATED 10.117
FINANCIAL STATEMENTS

A Ltd.’s share in equity (2,00,000 x 22%) ` 44,000

Less: Cost of Investment ` (33,000)
Capital Reserve ` 11,000
Extract of Balance Sheet: ASSETS

Investment in Associate as per AS 23 ` `

Share of Net Assets as on 1 April 44,000
Less: Capital reserve (11,000) 33,000

Case 2:
A Ltd. holds 22% share of B Ltd. on 1st April of the year and following are
the relevant information as available on the date are Cost of Investment
` 55,000 and Total Equity on the date of acquisition ` 2,00,000.
Cost of Investment ` 55,000
Less: A Ltd.’s share in equity (2,00,000 x 22%) ` 44,000
Goodwill ` 11,000
Extract of Balance Sheet: ASSETS

Investment in Associate as per AS 23 ` `

Share of Net Assets as on 1 April 44,000
Add: Goodwill 11,000 55,000

♦ Step Acquisition in case of an associate:

An enterprise having share of profits of more than 50% in other company,
they are said to be in Parent-Subsidiary relationship. However, if the share
in profits is more than 20% but upto 50% then this relationship is termed as
of associate. This stake of 20% can be acquired either in one go or in more
than one transaction. This stake can be increased further say from 25% to
30%. Adjustment should be made with each transaction.

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 10.118 ADVANCED ACCOUNTING

Case 1 Conversion from a passive investor to an associate in the same

year:
A Ltd. acquired 10% stake of B Ltd. on April 01 and further 15% on
October 01 during the same year. Other information is as follow:
Cost of Investment for 10% ` 1,00,000 and for 15% ` 1,45,000
Net asset on April 01 ` 8,50,000 and on October 01 ` 10,00,000.
Calculations for April 01:

`
Cost of investment (8,50,000 x 10%) 1,00,000
Less: 10% share in net asset ( 85,000)

Goodwill 15,000

Calculations for October 01:

`
15% share in net asset (10,00,000 x 15%) 1,50,000
Less: Cost of investment (1,45,000)
Capital Reserve 5,000
Total goodwill (15,000 – 5,000) 10,000

Case 2 - Conversion from a passive investor to an associate in the same

year:
A Ltd. acquired 10% stake of B Ltd. on April 01 and further 15% on October
01 of the same year. Other information is as follow:
Cost of Investment for 10% ` 1,00,000 and for 15% ` 1,55,000
Net asset on April 01 ` 8,50,000 and on October 01 ` 10,00,000.
Calculations for April 01:

`
Cost of investment 1,00,000

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 ACCOUNTING STANDARDS FOR CONSOLIDATED 10.119
FINANCIAL STATEMENTS

Less: 10% share in net asset ( 85,000)

Goodwill 15,000

Calculations for October 01:

`
Cost of investment 1,55,000
Less: 15% share in net asset ( 1,50,000)

Goodwill 5,000
Total goodwill (15,000 + 5,000) 20,000

Case 3 – Further acquisition in an associate in the same year:

A Ltd. acquired 25% stake of B Ltd. on April 01 and further 5% on October
01 of the same year. Other information is as follow:
Cost of Investment for 25% ` 1,50,000 and for 5% ` 20,000
Net asset on April 01 ` 5,00,000.
Profit for the year ` 90,000 earned in the ratio 2:1 respectively.
Calculations for April 01:

`
Cost of investment 1,50,000
Less: 25% share in net asset (5,00,000 x2 5%) (1,25,000)
Goodwill 25,000

Calculations for October 01:

`
Profits for the first half (90,000/3) x 2 60,000
Additional share of A Ltd. 5%
Pre-acquisition profits i.e. capital reserve (60,000 x 5%) 3,000
5% share in net asset 25,000

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 10.120 ADVANCED ACCOUNTING

Total share of net assets for 5% stake (5,00,000+60,000)x5% 28,000

Cost of investment 20,000
Capital Reserve 8,000
Cost of Investment on April 01 1,50,000
Less: Goodwill ` 25,000
1,25,000
Calculation of net assets of associates as on 31st March
Carrying Amount on April 01 1,25,000

Add: Additional Share in Net Asset on October 01 25,000

Add: Capital share of Profits for first half 3,000
Add: Revenue shares of Profits for first half (60,000 x 25%) 15,000

Add: Revenue shares of Profits for second half (30,000 x 9,000

30%)
Net Assets Of Associate As On 31st March 1,77,000

Alternatively

Balance sheet `
Investment in associate (inclusive of goodwill of 25,000) 1,25,000
Add: Further investment 28,000
Add: (90,000 x 25% + 30,000 x 5 %)
i.e (22,500+1,500) 24,000
or (60,000 x 25% +30,000 x30%) 1,77,000

♦ If there is any transaction between the Investor Company and investee

concern then the unrealised profits on such goods to the extent of
investor’s share should be eliminated from consolidated financial statement.
♦ Any loss on such transactions are not eliminated to the extent that such loss
is not recoverable. Otherwise such losses are written off from consolidated
financial statement fully.

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 ACCOUNTING STANDARDS FOR CONSOLIDATED 10.121
FINANCIAL STATEMENTS

Illustration 2
A Ltd. acquired 40% share in B Ltd. on April 01, 20X1 for ` 10 lacs. On that date
B Ltd. had 1,00,000 equity shares of ` 10 each fully paid and accumulated profits of
` 2,00,000. During the year 20X1-20X2, B Ltd. suffered a loss of ` 10,00,000; during
20X2-20X3 loss of ` 12,50,000 and during 20X3-20X4 again a loss of ` 5,00,000.
Show the extract of consolidated balance sheet of A Ltd. on all the four dates
recording the above events.
Solution
Calculation of Goodwill/Capital Reserve under Equity Method

Particulars `
Equity Shares 10,00,000
Reserves & Surplus 2,00,000
Net Assets 12,00,000

40% share of Net Assets 4,80,000

Less: Cost of Investment (10,00,000)
Goodwill 5,20,000

Consolidated Balance Sheet (Extract) as on April 01, 20X1: ASSETS

Investment in Associate as per AS 23 ` `

Share of Net Assets on April 1 4,80,000

Add: Goodwill 5,20,000 10,00,000

Calculation of Carrying Amount of Investment as at 31 March 20X2:

Investment in Associate as per AS 23 `

Share of Net Assets on 1 April, 20X1 4,80,000

Add: Goodwill 5,20,000

Cost of Investment 10,00,000

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 10.122 ADVANCED ACCOUNTING

Less: Loss for the year (10,00,000 x 40%) (4,00,000)

Carrying Amount of Investment 6,00,000

Consolidated Balance Sheet (Extract) as on March 31, 20X2: ASSETS

Investment in Associate as per AS 23 ` `

Share of Net Assets on 1 April, 20X1 4,80,000

Less: Share of Loss as above (4,00,000)

80,000

Add: Goodwill 5,20,000 6,00,000

Calculation of Carrying Amount of Investment as at 31 March 20X3:

Investment in Associate as per AS 23 `

Carrying Amount of Investment as on 31 March 20X2 6,00,000

Less: Loss for the year (12,50,000 x 40%) (5,00,000)

Carrying Amount of Investment 1,00,000

Consolidated Balance Sheet (Extract) as on March 31, 20X3: ASSETS

Investment in Associate as per AS 23 ` `

Share of Net Assets on 1 April, 20X1 4,80,000
Less: Share of Loss as above (` 4,00,000 +
` 5,00,000) (4,20,000)
Add: Goodwill 1,00,000
Calculation of Carrying Amount of Investment as at 31 March 20X4:

Investment in Associate as per AS 23 `

Carrying Amount of Investment 1,00,000
Less: Loss for the year (5,00,000 x 40% = 2,00,000, restricted to
Carrying amount of Investment in B Ltd.) -refer note below
Carrying Amount of Investment

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 ACCOUNTING STANDARDS FOR CONSOLIDATED 10.123
FINANCIAL STATEMENTS

Consolidated Balance Sheet (Extract) as on March 31, 20X4: ASSETS

Investment in Associate as per AS 23 `

Investment in B Ltd. -
♦ If, under the equity method, an investor’s share of losses of an associate
equals or exceeds the carrying amount of the investment, the investor
ordinarily discontinues recognising its share of further losses and the
investment is reported at nil value. Additional losses are provided for to the
extent that the investor has incurred obligations or made payments on
behalf of the associate to satisfy obligations of the associate that the
investor has guaranteed or to which the investor is otherwise committed. If
the associate subsequently reports profits, the investor resumes including
its share of those profits only after its share of the profits equals the share
of net losses that have not been recognised.
♦ As far as possible the reporting date of the financial statements should be
same for consolidated financial statement. If practically it is not possible to
draw up the financial statements of one or more enterprise to such date
and, accordingly, those financial statements are drawn up to reporting dates
different from the reporting date of the investor, adjustments should be
made for the effects of significant transactions or other events that occur
between those dates and the date of the consolidated financial statements.
In any case, the difference between reporting dates of the concern and
consolidated financial statement should not be more than six months.
♦ Accounting policies followed in the preparation of the financial statements
of the investor, investee and consolidated financial statement should be
uniform for like transactions and other events in similar circumstances.
If accounting policies followed by different enterprises in the group are not
uniform, then adjustments should be made in the items of the individual
financial statements to bring it in line with the accounting policy of the
consolidated statement.
♦ The carrying amount of investment in an associate should be reduced to
recognise a decline, other than temporary, in the value of the investment,
such reduction being determined and made for each investment
individually.

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 10.124 ADVANCED ACCOUNTING

2.7 CONTINGENCIES
In accordance with AS 4, the investor discloses in the consolidated financial
statements:
a. Its share of the contingencies and capital commitments of an associate for
which it is also contingently liable; and

b. Those contingencies that arise because the investor is severally liable for the
liabilities of the associate.

2.8 WHY IS EQUITY METHOD OF ACCOUNTING

ADOPTED FOR INVESTMENT IN
ASSOCIATES?
♦ Investments in associates cannot be treated as a normal investment under
AS 13. The intent of investing to such an extent (i.e.; 20% or more but less
than 50% of equity) in an associate is an expression of the fact that the
investor is not merely interested in the dividend distribution, but also is
interested in the participation of decision-making process in the associate.
♦ Thus, recognition of income on the basis of distributions received may not
be an adequate measure of the income earned by an investor on an
investment in an associate because the distributions received may bear little
relationship to the performance of the associate. As the investor has
significant influence over the associate, the investor has a measure of
responsibility for the associate’s performance and, as a result, the return on
its investment. The investor accounts for this stewardship by extending the
scope of its consolidated financial statements to include its share of results
of such an associate and so provides an analysis of earnings and investment
from which more useful ratios can be calculated. As a result, application of
the equity method in consolidated financial statements provides more
informative reporting of the net assets and net income of the investor.

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2.9 DISCLOSURE
♦ In addition to the disclosures required above, an appropriate listing and
description of associates including the proportion of ownership interest
and, if different, the proportion of voting power held should be disclosed in
the consolidated financial statements.
♦ Investments in associates accounted for using the equity method should be
classified as long-term investments and disclosed separately in the
consolidated balance sheet. The investor’s share of the profits or losses of
such investments should be disclosed separately in the consolidated
statement of profit and loss. The investor’s share of any extraordinary or
prior period items should also be separately disclosed.

♦ The name(s) of the associate(s) of which reporting date(s) is/are different

from that of the financial statements of an investor and the differences in
reporting dates should be disclosed in the consolidated financial
statements.
♦ In case an associate uses accounting policies other than those adopted for
the consolidated financial statements for like transactions and events in
similar circumstances and it is not practicable to make appropriate
adjustments to the associate’s financial statements, the fact should be
disclosed along with a brief description of the differences in the accounting
policies.
♦ If an associate is not accounted for using the equity method the reasons for
not doing the same.
♦ Goodwill/capital reserve arising on the acquisition of an associate by an
investor should be disclosed separately though it is included in the carrying
amount of the investment.

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2.10 RELEVANT EXPLANATIONS TO AS 23

2.10.1 Treatment of Proposed Dividend in Associates in
Consolidated Financial Statements
In case an associate has made a provision for proposed dividend (i.e. dividend
declared after the reporting period but it pertains to that reporting year) in its
financial statements, the investor's share of the results of operations of the
associate should be computed without taking into consideration the proposed
dividend.

2.10.2 Consideration of Potential Equity Shares for

Determining whether an Investee is an Associate
The potential equity shares of the investee held by the investor should not be
taken into account for determining the voting power of the investor.

Reference: The students are advised to refer the full text of AS 23 “Accounting
for Investments in Associates in Consolidated Financial Statements” (issued 2001).

TEST YOUR KNOWLEDGE

Multiple Choice Questions

1. Identity which of the statements are correct.
An enterprise can influence the significant economic decision making by
many ways like:
(i) Representation on the board of directors or governing body of the
investee.
(ii) Participation in policy-making processes.
(iii) Interchange of managerial personnel.

(iv) Provision of essential technical information.

(a) Statement (i) and (ii) are correct.

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(b) Statement (i), (ii) and (iii) are correct.

(c) Statement (i), (ii), (iii) and (iv) are correct.
(d) Statement (ii) and (iii) are correct.
2. A Ltd. is holding 90% share in B Ltd. and 10% shares in C Ltd., and B Ltd. is
holding 11% shares in C Ltd.
Identity which of the statements are incorrect.
(i) In this case, A Ltd. is parent of B Ltd.
(ii) As far as the relationship between A Ltd. and C Ltd. is concerned; A Ltd.
has a total of direct and indirect holding of (10% + 90% of 11%) 19.9 %
in C Ltd.
(iii) C Ltd. is an associate of A Ltd.
(a) Statement (ii) is incorrect.
(b) Statement (iii) is incorrect.
(c) Statement (ii) and (iii) both are incorrect.
(d) All statements are incorrect.
3. A Ltd. acquired 10% stake of B Ltd. on April 01 and further 15% on
October 01 of the same year. Other information is as follows:
Cost of Investment for 10% ` 1,00,000 and for 15% ` 1,55,000
Net asset on April 01 ` 8,50,000 and on October 01 ` 10,00,000.
What is the amount of goodwill or capital reserve arising on significant
influence?
(a) Goodwill = ` 10,000.
(b) Goodwill = ` 20,000.

(c) Capital Reserve = ` 10,000.

(d) Capital Reserve = ` 20,000.
4. A Ltd. acquired 10% stake of B Ltd. on April 01 and further 15% on October
01 during the same year. Other information is as follow:

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Cost of Investment for 10% ` 1,00,000 and for 15% ` 1,45,000

Net asset on April 01 ` 8,50,000 and on October 01 ` 10,00,000.

What is the amount of goodwill or capital reserve arising on significant

influence?
(a) Goodwill = ` 10,000.
(b) Goodwill = ` 20,000.
(c) Capital Reserve = ` 10,000.
(d) Capital Reserve = ` 20,000.

5. Identity which of the statements are correct.

(i) In case an associate has made a provision for proposed dividend (i.e.
dividend declared after the reporting period but it pertains to that
reporting year) in its financial statements, the investor's share of the
results of operations of the associate should be computed without
taking into consideration the proposed dividend.
(ii) In case an associate has made a provision for proposed dividend (i.e.
dividend declared after the reporting period but it pertains to that
reporting year) in its financial statements, the investor's share of the
results of operations of the associate should be computed after taking
into consideration the proposed dividend.
(iii) The potential equity shares of the investee held by the investor should
not be taken into account for determining the voting power of the
investor.
(iv) The potential equity shares of the investee held by the investor should
be taken into account for determining the voting power of the investor.

(a) Statement (i) and (iii).

(b) Statement (ii) and (iv).
(c) Statement (i) only.
(d) Statement (iii) only.

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Theoretical Questions
6. Describe the cases when AS 23 does not allow the use of equity method of
accounting?
7. When is an investor required to discontinue the use of the equity method of
accounting?

Scenario based Questions

8. Bright Ltd. acquired 30% of East India Ltd. shares for ` 2,00,000 on
01-06-20X1. By such an acquisition Bright can exercise significant influence
over East India Ltd. During the financial year ending on 31-03-20X1 East
India earned profits ` 80,000 and declared a dividend of ` 50,000 on
12-08-20X1. East India reported earnings of ` 3,00,000 for the financial year
ending on 31-03-20X2 (assume profits to accrue evenly) and declared
dividends of ` 60,000 on 12-06-20X2.
Calculate the carrying amount of investment in:
(i) Separate financial statements of Bright Ltd. as on 31-03-20X2;
(ii) Consolidated financial statements of Bright Ltd.; as on 31-03-20X2;
(iii) What will be the carrying amount as on 30-06-20X2 in consolidated
financial statements?
9. A Ltd. acquired 25% of shares in B Ltd. as on 31.3.20X1 for ` 3 lakhs. The
Balance Sheet of B Ltd. as on 31.3.20X1 is given below:

`
Share Capital 5,00,000
Reserves and Surplus 5,00,000
10,00,000
Property, Plant and Equipment 5,00,000
Investments 2,00,000
Current Assets 3,00,000

10,00,000

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During the year ended 31.3.20X2 the following are the additional information
available:

(i) On 30.4.20X1 A Ltd. received a dividend from B Ltd. for the year ended
31.3.20X1 at 40% from the Reserves. The above balance sheet is before
the adjustment of dividend.

(ii) B Ltd. made a profit after tax of ` 7 lakhs for the year ended 31.3.20X2.
(iii) B Ltd. declared a dividend @ 50% for the year ended 31.3.20X2 on
30.4.20X2.
A Ltd. is preparing Consolidated Financial Statements for 20X1-X2 in
accordance with AS 21 for its various subsidiaries. Calculate:
(i) Goodwill if any on investment in shares of B Ltd.’s .
(ii) How the dividend received for 31.3.20X2 on 30.4.20X2 from B Ltd. will be shown in
the Consolidated Financial Statements?
(iii) How A Ltd. will reflect the value of investment in B Ltd., in its
Consolidated Financial Statements?

ANSWERS/SOLUTION
Answer to the Multiple Choice Questions
1. (c) 2. (a) 3. (b) 4. (a) 5. (a)

Answer to the Theoretical Questions

6. Equity method of accounting is to be followed by all the enterprises having
significant influence on their associates except in the following cases:
a. Control is intended to be temporary because the investment is
acquired and held exclusively with a view to its subsequent disposal in
the near future.
The term ‘Near Future’ is explained with AS 21.

Or;

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b. It operates under severe long-term restrictions, which significantly

impair its ability to transfer funds to the investor.

In both the above cases, investment of investor in the share of the

investee is treated as investment according to AS 13.

7. An investor should discontinue the use of the equity method from the date
that:

a. It ceases to have significant influence in an associate but retains,

either in whole or in part, its investment.

b. The use of the equity method is no longer appropriate because the

associate operates under severe long-term restrictions that
significantly impair its ability to transfer funds to the investor.

From the date of discontinuing the use of the equity method, investments in
such associates should be accounted for in accordance with AS 13,
Accounting for Investments. For this purpose, the carrying amount of the
investment at that date should be regarded as cost thereafter.

Answer to the Scenario based Questions

8. (i) Carrying amount of investment in Separate Financial Statement of
Bright Ltd. as on 31.03.20X2
`
Amount paid for investment in Associate (on 1.06.20X1) 2,00,000
Less: Pre-acquisition dividend (` 50,000 x 30%) (15,000)
Carrying amount as on 31.3.20X2 as per AS 13 1,85,000
(ii) Carrying amount of investment in Consolidated Financial
Statements ∗ of Bright Ltd. as on 31.3.20X2 as per AS 23

Carrying amount as per separate financial statements 1,85,000

∗
It is assumed that Bright Ltd. has a subsidiary company and it is preparing Consolidated
Financial Statements.

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Add: Proportionate share of 10-month profit of

investee as per equity method (30% of
` 3,00,000 x 10/12) 75,000

Carrying amount as on 31.3.20X2 2,60,000

(iii) Carrying amount of investment in Consolidated Financial
Statement of Bright Ltd. as on 30.6.20X2 as per AS 23

Carrying amount as on 31.3.20X2 2,60,000

Less: Dividend received (` 60,000 x 30%) (18,000)

Carrying amount as on 30.6.20X2 2,42,000

9. In terms of AS 23, B Ltd. will be considered as an associate company of

A Ltd. as shares acquired represent to more than 20%.
(i) Calculation of Goodwill (` in lakhs)
Amount paid towards acquisition of stake in B Ltd. 3.00
Less: Pre-acquisition dividend (` 5,00,000 x 40% x 25%) 0.50

Cost of Investment in B Ltd. 2.50

Less: Share in the value of Equity of B Ltd.
as at the date of investment
[25% of ` 8 lakhs (` 5 lakhs + ` 5 lakhs – ` 2 lakhs)] (2.00)
Goodwill 0.50
(ii) A Ltd.
Consolidated Profit and Loss Account for the year ended
31st March, 20X2 (An extract)

` in lakhs
Other income:
Share of profits in B Ltd. (7x 25%) 1.75
Pre-acquisition Dividend received from

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B Ltd. 0.50
Transfer to investment A/c (0.50) Nil
(iii) A Ltd.
Consolidated Balance Sheet as on 31.3.20X2 (An extract)

` in lakhs
Non-current investments
Investment in B Ltd. 2.50
(including goodwill)
Share of profit for year 20X1 – 20X2 1.75 4.25

Working Notes:
1. Pre-acquisition dividend received from B Ltd. amounting to
` 0.50 lakhs will be reduced from investment value in the books
of A Ltd.
2. B Ltd. made a profit of ` 7 lakhs for the year ended 31st March,
20X2. A Ltd.’s share in the profits of ` 7 lakhs is ` 1.75 lakhs.
Investment in B Ltd. will be increased by ` 1.75 lakhs and
consolidated profit and loss account of A Ltd. will be credited
with ` 1.75 lakhs in the consolidated financial statement of A
Ltd.
3. Dividend declared on 30.4.20X2 will not be recognized in the
consolidated financial statement of A Ltd.

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UNIT 3: ACCOUNTING STANDARD 27

FINANCIAL REPORTING OF INTERESTS
IN JOINT VENTURES

LEARNING OUTCOMES
After studying this unit, you will be able to:
♦ Define ‘Joint venture’ ‘joint Control’, ‘control’, ‘venturer’ and investor.
♦ Appreciate different forms of joint venture
♦ Examine the contractual arrangements which will differentiate the
control as of Associate or Joint venture
♦ Evaluate the nitty-gritty of different forms of Joint ventures and
differentiate among them
♦ Present the separate and consolidated financial statements of the
venturers
♦ Accounting for transactions between the venturer and Joint venture
♦ Comply with the disclosure requirements as stated in the standard.

3.1 INTRODUCTION
You would have come across many examples where 2 or more entities would have
worked together to achieve a certain purpose. Hindustan Unilever Ltd (HUL), Tata
Starbucks Ltd, Tata SIA Airlines Ltd. (Vistara), etc. are a few popular examples of
Joint Ventures. Entities enter into such arrangements considering sharing of risk
and expense, collaboration of know-how and skill-set, while also impacted by
different work-cultures and management style. Depending on the contractual
arrangement, the accounting and reporting for Joint Ventures is done.
AS 27, came into effect in respect of accounting periods commenced on or after
01.04.2002. This standard set out principles and procedures for accounting of
interests in joint venture and reporting of joint venture assets, liabilities, income

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and expenses in the financial statements of venturers and investors regardless of

the structures or forms under which the joint venture activities take place.
The standard deals with three broad types of joint ventures –
1. Jointly controlled operations,
2. Jointly controlled assets and
3. Jointly controlled entities.
The requirements relating to accounting for joint ventures in consolidated
financial statements according to proportionate consolidation method, as
contained in AS 27, apply only when consolidated financial statements are
prepared by venturer Similarly existence of a contractual arrangement
distinguishes interests which involve joint control from investments in associates
in which the investor has significant influence (see Accounting Standard (AS) 23,
Accounting for Investments in Associates in Consolidated Financial Statements).
An investor in joint venture, which does not have joint control, should report its
interest in a joint venture in its consolidated financial statements in accordance
with AS 13, AS 21 and AS 23.

3.2 SCOPE
This Standard should be applied in accounting for interests in joint ventures and
the reporting of joint venture assets, liabilities, income and expenses in the
financial statements of venturers and investors, regardless of the structures or
forms under which the joint venture activities take place.
The provisions of this AS need to be referred to for consolidated financial
statement only when CFS is prepared and presented by the venturer.

3.3 DEFINITIONS
1. A joint venture is a contractual arrangement whereby two or more parties
undertake an economic activity, which is subject to joint control.
From the above definition we conclude that the essential conditions for any
business relation to qualify as joint venture are:
♦ Two or more parties coming together: Parties can be an individual
or any form of business organization say, BOI, AOP, Company, firm.

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♦ Venturers undertake some economic activity: Economic activity

means activities with the profit-making motive. Joint venture is
separate from the regular identity of the venturers, it may be in the
form of independent and separate legal organization other than
regular concern of the venturer engaged in the economic activity.
♦ Venturers have joint control on the economic activity: The
operating and financial decisions are influenced by the venturers and
they also share the results of the economic activity.

♦ There exists a contractual agreement: The relationship between

venturers is governed by the contractual agreement. This agreement
can be in the form of written and signed agreement or as minutes of
venturer meeting or in any other written form.
2. Joint control is the contractually agreed sharing of control over an
economic activity.

3. Control is the power to govern the financial and operating policies of an

economic activity so as to obtain benefits from it.
4. A venturer is a party to a joint venture and has joint control over that joint
venture.
5. An investor in a joint venture is a party to a joint venture and does not have
joint control over that joint venture.
6. Proportionate consolidation is a method of accounting and reporting
whereby a venturer’s share of each of the assets, liabilities, income and
expenses of a jointly controlled entity is reported as separate line items in
the venturer’s financial statements.

3.4 CONTRACTUAL ARRANGEMENT

The joint venture covered under this statement is governed on the basis of
contractual agreement. Non-existence of contractual agreement will disqualify
an organization to be covered in AS 27. Joint ventures with contractual agreement
will be excluded from the scope of AS 27 only if the investment qualifies as
subsidiary under AS 21, in this case, it will be covered by AS 21. Contractual
agreement can be in the form of written contract, minutes of discussion between

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FINANCIAL STATEMENTS

parties (venturers), articles of the concern or by-laws of the relevant joint venture.
Irrespective of the form of the contract, the content of the contract ideally should
include the following points:
♦ The activity, duration and reporting obligations of the joint venture.
♦ The appointment of the board of directors or equivalent governing body of
the joint venture and the voting rights of the venturers.
♦ Capital contributions by the venturers.
♦ The sharing by the venturers of the output, income, expenses or results of
the joint venture.
The main object of contractual agreement is to distribute the economic control
among the venturers, it ensures that no venturer should have unilateral control.
The arrangement identifies those decisions in areas essential to the goals of the
joint venture which require the consent of all the venturers and those decisions
which may require the consent of a specified majority of the venturers. If
contractual agreement is signed by a party to safeguard its right, such agreement
will not make the party a venturer.
The contractual arrangement may identify one venturer as the operator or
manager of the joint venture. The operator does not control the joint venture but
acts within the financial and operating policies which have been agreed to by the
venturers in accordance with the contractual arrangement and delegated to the
operator
Example 1
IDBI gave loan to the joint venture entity of L&T and Tantia Construction, they
signed an agreement according to which IDBI will be informed for all important
decisions of the joint venture entity. This agreement is to protect the right of the
IDBI, hence just signing the contractual agreement will not make investor a
venturer.
Example 2
X Ltd invested ` 200 crore as initial capital along with Y Ltd and Z Ltd in GFH Ltd.
The purpose of X Ltd making this investment is to grow the business of GFH Ltd
along with the other investors. All investors have a right to attend to the meetings

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and to take decisions with respect to the business of GFH Ltd. All investors are
actively involved in running the business of GFH Ltd and have a share in the returns
generated by GFH Ltd in an agreed proportion.
GFH Ltd is an example of a Joint Venture and X Ltd, Y Ltd and Z Ltd are all
Venturers.

Similarly, just because contractual agreement has assigned the role of a manager
to any of the venturer will not disqualify him as venturer.
Example 3
Mr. A, M/s. B & Co. and C Ltd. entered into a joint venture, where according to the
agreement, all the policies making decisions on financial and operating activities
will be taken in a regular meeting attended by them or their representatives.
Implementation and execution of these policies will be the responsibility of Mr. A.
Here Mr. A is acting as venturer as well as manager of the concern.

3.5 FORMS OF JOINT VENTURES

Joint ventures may take many forms and structures, this Statement identifies them
in three broad types –
• Jointly Controlled Operations (JCO),

• Jointly Controlled Assets (JCA) and

• Jointly Controlled Entities (JCE).
Any structure which satisfies the following characteristics can be classified as joint
ventures:
(a) Two or more venturers are bound by a contractual arrangement and
(b) The contractual arrangement establishes joint control.

3.6 JOINTLY CONTROLLED OPERATIONS (JCO)

Under this set up, venturers do not create a separate entity for their joint venture
business but they use their own resources for the purpose. They raise any funds
required for joint venture on their own, they incur any expenses and sales are also
realised individually. They use same set of assets and employees for joint venture
business and their own business. The joint venture agreement usually provides

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means by which the revenue from the jointly controlled operations and any
expenses incurred in common are shared among the venturers.
Since there is no separate legal entity and venturers don’t recognize the
transactions separately, they do not maintain a separate set of books for joint
venture. All the transactions of joint venture are recorded in their books only.
Following are the key features of JCO:
a. Each venturer has his own separate business.
b. There is no separate entity for joint venture business.
c. All venturers are creating their own assets and maintain them.
d. Each venturer record only his own transactions without any separate set of
books maintained for the joint venture business.
e. There is a common agreement between all of them.
f. Venturers use their assets for the joint venture business.
g. Venturers met the liabilities created by them for the joint venture business.
h. Venturers met the expenses of the joint venture business from their funds.
i. Any revenue generated or income earned from the joint venture is shared
by the venturers as per the contract.
Since the jointly controlled operation is not purchasing assets or raising finance in
its own right, the assets and liabilities used in the activities of the joint venture
are those of the ventures. As such, they are accounted for in the financial
statements of the venture to which they belong. The only accounting issue that
arises is that the output from the project is to be shared among the venturers
and, therefore, there must be some mechanism for specifying the allocation of
the proceeds and the sharing of any joint expenses.
In respect of its interests in jointly controlled operations, a venturer should
recognise in its separate financial statements and consequently in its consolidated
financial statements:
(a) the assets that it controls and the liabilities that it incurs; and

(b) the expenses that it incurs and its share of the income that it earns from the
joint venture.

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Separate accounting records may not be required for the joint venture itself and
financial statements may not be prepared for the joint venture. However, the
venturers may prepare accounts for internal management reporting purposes so
that they may assess the performance of the joint venture.

Example 4
Mr. A (dealer in tiles and marbles), Mr. B (dealer in various building materials) and
Mr. C (Promoter) enters into a joint venture business, where any contract for
construction received will be completed jointly, say, Mr. A will supply all tiles and
marbles, Mr. B will supply other materials from his godown and Mr. C will look after
the completion of construction. As per the contractual agreement, they will share
any profit/loss in a predetermined ratio. None of them are using separate staff or
other resources for the joint venture business and neither do they maintain a
separate account. Everything is recorded in their personal business only.

Venturer doesn’t maintain a separate set of books but they record only their own
transactions of the joint venture business in their books. Any transaction of joint
venture recorded separately is only for internal reporting purpose. Once all
transactions recorded in venturer financial statement, they don’t need to be
adjusted for in consolidated financial adjustment.

Illustration 1
Mr. A, Mr. B and Mr. C entered into a joint venture to purchase a land, construct
and sell flats. Mr. A purchased a land for ` 60,00,000 on 01.01.20X1 and for the
purpose he took loan from a bank for ` 50,00,000 @ 8% interest p.a. He also paid
registering fees ` 60,000 on the same day. Mr. B supplied the materials for
` 4,50,000 from his godown and further he purchased the materials for
` 5,00,000 for the joint venture. Mr. C met all other expenses of advertising, labour
and other incidental expenses which turnout to be ` 9,00,000. On 30.06.20X1 each
of the venturer agreed to take away one flat each to be valued at ` 10,00,000 each
flat and rest were sold by them as follow: Mr. A for ` 40,00,000; Mr. B for
` 20,00,000 and Mr. C for ` 10,00,000. Loan was repaid on the same day by Mr. A
along with the interest and net proceeds were shared by the partners equally.

You are required to prepare the draft Consolidated Profit & Loss Account and Joint
Venture Account in the books of each venturer.

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FINANCIAL STATEMENTS

Solution
Draft Consolidated Profit & Loss Account

Particulars ` ` Particulars ` `
To Purchase of By Sale of
Land: Flats:
Mr. A 60,00,000 Mr. A 40,00,000
To Registration Mr. B 20,00,000
Fees:
Mr. A 60,000 Mr. C 10,00,000 70,00,000
To Materials: By Flats taken
by Venturers:
Mr. B 9,50,000 Mr. A 10,00,000
To Other Mr. B 10,00,000
Expenses:
Mr. C 9,00,000 Mr. C 10,00,000 30,00,000
To Bank
Interest:
Mr. A 2,00,000
To Profits:
Mr. A 6,30,000
Mr. B 6,30,000
Mr. C 6,30,000 18,90,000
1,00,00,000 1,00,00,000

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In the Books of Mr. A

Joint Venture Account

Particulars ` Particulars `
To Bank Loan (Purchase of 50,00,000 By Bank (Sale of Flats) 40,00,000
Land)
To Bank:(Purchase of Land) By Land & Building 10,00,000
10,00,000
To Bank (Registration Fees) By Bank (Received from 14,20,000
60,000 Mr. B)
To Bank (Bank Interest) 2,00,000 By Bank (Received from 4,70,000
Mr. C)
To Profit on JV 6,30,000
68,90,000 68,90,000

In the Books of Mr. B

Joint Venture Account

Particulars ` Particulars `
To Purchases (Material 4,50,000 By Bank (Sale of
Supplied) Flats) 20,00,000
To Bank (Materials) 5,00,000 By Land & Building 10,00,000
To Profit on JV 6,30,000
To Bank (Paid to Mr. A) 14,20,000
30,00,000 30,00,000

In the Books of Mr. C

Joint Venture Account

Particulars ` Particulars `
To Bank (Misc. Expenses) 9,00,000 By Bank (Sale of 10,00,000
Flats)
To Profit on JV 6,30,000 By Land & Building 10,00,000
To Bank (Paid to Mr. A) 4,70,000
20,00,000 20,00,000

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3.7 JOINTLY CONTROLLED ASSETS (JCA)

Separate legal entity is not created in this form of joint venture but venturer owns
the assets jointly, which are used by them for the purpose of generating
economic benefit to each of them. They take up any expenses and liabilities
related to the joint assets as per the contract. We can conclude the following
points:
♦ There is no separate legal identity.
♦ There is a common control over the joint assets.
♦ Venturers use this asset to derive some economic benefit to themselves.
♦ Each venturer incurs separate expenses for their transactions.
♦ Expenses on jointly held assets are shared by the venturers as per the
contract.
♦ In their financial statement, venturer shows only their share of the asset and
total income earned by them along with total expenses incurred by them.
♦ Since the assets, liabilities, income and expenses are already recognised in
the separate financial statements of the venturer and consequently in its
consolidated financial statements, no adjustments or other consolidation
procedures are required in respect of these items when the venturer
presents consolidated financial statements.
♦ Financial statements may not be prepared for the joint venture, although
the venturers may prepare accounts for internal management reporting
purposes so that they may assess the performance of the joint venture.
Example 5
ABC Ltd., BP Ltd. and HP Ltd. having the same point of oil refinery and same place
of customers agreed to spread a pipeline from their unit to customers place jointly.
They agreed to share the expenditure on the pipeline construction and maintenance
in the ratio 3:3:4 respectively and the time allotted to use the pipeline was in the
ratio 4:3:3 respectively.
For the joint venture, each venturer will record his share of joint assets as classified
according to the nature of the assets rather than as an investment and any
expenditure incurred or revenue generated will be recorded with other items similar
to JCO.

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Following are the few differences between JCO and JCA for better
understanding:

♦ In JCO, venturers use their own assets for joint venture business but in JCA
they jointly own the assets to be used in joint venture.
♦ JCO is an agreement to joint carry on the operations to earn income
whereas, JCA is an agreement to jointly construct and maintain an asset to
generate revenue to each venturer.
♦ Under JCO all expenses and revenues are shared at an agreed ratio, in JCA
only expenses on joint assets are shared at the agreed ratio.
Illustration 2
A Ltd., B Ltd. and C Ltd. decided to jointly construct a pipeline to transport the gas
from one place to another that was manufactured by them. For the purpose
following expenditure was incurred by them: Buildings ` 12,00,000 to be
depreciated @ 5% p.a., Pipeline for ` 60,00,000 to be depreciated @ 15% p.a.,
computers and other electronics for ` 3,00,000 to be depreciated @ 40% p.a. and
various vehicles of ` 9,00,000 to be depreciated @ 20% p.a.
They also decided to equally bear the total expenditure incurred on the
maintenance of the pipeline that comes to ` 6,00,000 each year.
You are required to show the consolidated balance sheet and the extract of
Statement of Profit & Loss and Balance Sheet for each venturer.
Solution
Consolidated Balance Sheet

Note (` )
I Equity and liabilities
Shareholders’ funds:
Share Capital 1 71,40,000
71,40,000
II Assets
Non-current Assets
Property, Plant and Equipment: 2 71,40,000
71,40,000

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Notes to Accounts

(`)

1. Share capital
A Ltd. 23,80,000
B Ltd. 23,80,000
C Ltd. 23,80,000 71,40,000
2. Property, Plant and Equipment

Land & Building:

A Ltd. 3,80,000
B Ltd. 3,80,000

C Ltd. 3,80,000 11,40,000

Plant & Machinery:
A Ltd. 17,00,000

B Ltd. 17,00,000
C Ltd. 17,00,000 51,00,000
Computers:

A Ltd. 60,000
B Ltd. 60,000
C Ltd. 60,000 1,80,000
Vehicles:
A Ltd. 2,40,000
B Ltd. 2,40,000
C Ltd. 2,40,000 7,20,000

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In the Books of A Ltd.

Extract of statement of Profit & Loss
Particulars Note No. `
Depreciation and amortisation expense 1 4,20,000
Other operating Expenses (Pipeline Expenses) 200,000

Extract of Balance Sheet

Note No. `
Assets
Non-current assets
Property, Plant and Equipment 2 23,80,000
Notes to Accounts

` `
1. Depreciation and amortisation expense
Land & Building 20,000
Plant & Machinery 3,00,000
Computers 40,000
Vehicles 60,000 4,20,000
2. Land & Building 4,00,000
Less: Depreciation (20,000) 3,80,000
Plant & Machinery 20,00,000
Less: Depreciation (3,00,000) 17,00,000
Computers 1,00,000
Less: Depreciation (40,000) 60,000
Vehicles 3,00,000
Less: Depreciation (60,000) 2,40,000
23,80,000

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In the Books of B Ltd.

Extract of draft Profit & Loss Account

Particulars Note No. `

Depreciation and amortisation expense 1 4,20,000
Other operating Expenses (Pipeline Expenses) 200,000

Extract of Balance Sheet

Note No. `
Assets
Non-current assets
Property, Plant and Equipment 2 23,80,000
Notes to Accounts

` `
1. Depreciation and amortisation expense

Land & Building 20,000

Plant & Machinery 3,00,000
Computers 40,000

Vehicles 60,000 4,20,000

2. Land & Building 4,00,000
Less: Depreciation (20,000) 3,80,000
Plant & Machinery 20,00,000
Less: Depreciation (3,00,000) 17,00,000
Computers 1,00,000
Less: Depreciation (40,000) 60,000
Vehicles 3,00,000
Less: Depreciation (60,000) 2,40,000
23,80,000

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In the Books of C Ltd.

Extract of Draft Profit & Loss Account Note No. `
Depreciation and amortisation expense 1 4,20,000
Other operating Expenses (Pipeline Expenses) 200,000

Extract of Balance Sheet

Note No. `
Assets
Non-current assets
Property, Plant and Equipment 2 23,80,000

Notes to Accounts

` `
1. Depreciation and amortisation expense
Land & Building 20,000

Plant & Machinery 3,00,000

Computers 40,000
Vehicles 60,000 4,20,000
2. Land & Building 4,00,000
Less: Depreciation (20,000) 3,80,000
Plant & Machinery 20,00,000
Less: Depreciation 17,00,000
(3,00,000)
Computers 1,00,000
Less: Depreciation (40,000) 60,000
Vehicles 3,00,000
Less: Depreciation (60,000) 2,40,000
23,80,000

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3.8 JOINTLY CONTROLLED ENTITIES (JCE)

This is the format where venturer creates a new entity for their joint venture
business. A jointly controlled entity is a joint venture which involves the
establishment of a corporation, partnership or other entity in which each venturer
has an interest. The entity operates in the same way as other enterprises, except
that a contractual arrangement between the venturers establishes joint control
over the economic activity of the entity. All the venturers pool their resources
under new banner and this entity purchases its own assets, create its own
liabilities, expenses are incurred by the entity itself and sales are also made by
this entity. The net result of the entity is shared by the venturers in the ratio
agreed upon in the contractual agreement. This contractual agreement also
determines the joint control of the venturer. Each venturer usually contributes
cash or other resources to the jointly controlled entity. These contributions are
included in the accounting records of the venturer and are recognised in its
separate financial statements as an investment in the jointly controlled entity.
A jointly controlled entity maintains its own accounting records and prepares and
presents financial statements in the same way as other enterprises in conformity
with the requirements applicable to that jointly controlled entity
Example
A Ltd and B Ltd are two infrastructure companies operating in City A. The local
authority has issued a tender to construct a metro stretch for ` 2,000 crore and had
invited bidders to apply for the tender. A Ltd and B Ltd, jointly form a new entity AB
Ltd that bids for the tender. All machinery and equipment will be the responsibility
of A Ltd. All funding will be managed and controlled by B Ltd. Revenue and
operating expenses will be shared jointly by A Ltd and B Ltd in the proportion of
60:40.
In the above example AB Ltd constitutes a Jointly Controlled Entity (JCE).
Example (Jointly Controlled Entity (JCE))
Three separate aerospace companies form a separate entity, Aero Ltd, to jointly
manufacture an aircraft. They carry responsibility for different areas of expertise,
such as: manufacturing engines; manufacturing fuselage and wings; and
aerodynamics.

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The companies carry out different parts of the manufacturing process, each using
its own resources and expertise in order to manufacture, market and distribute
the aircraft jointly. The three entities share the revenues from the sale of aircraft
and jointly incur expenses.
The revenues and common costs are shared, as agreed in the consortium
contract. Parties also incur their own separate costs, such as labour costs,
manufacturing costs, supplies, inventory of unused parts and work in progress.
Each party recognises its separately incurred costs in full.

Aero Ltd maintains separate accounting records. The consortium agreement

comprises the following:
Aero Ltd will invoice the customers on the investors’ behalf. The allocation of
revenue from the aircraft’s sale is in proportion to the investors’ interests.
All administrative costs incurred by Aero Ltd are shared by the parties in
proportion to their interests; Aero Ltd will recharge these, with no additional
margin.
The companies carry out different parts of the manufacturing process, each using
its own resources and expertise to manufacture, market and distribute the aircraft
jointly.
Each company incurs its own separate costs, such as labour costs, manufacturing
costs, supplies, inventory of unused parts and work in progress. Each company
recognises its separately incurred costs in full.
Being a separate entity, separate set of books is maintained for the joint venture
and in the individual books of venturers the investment in joint venture is
recorded as investment (AS 13). Joint venture can be a foreign company
operating in India through an Indian concern say Gremo Insurance of Germany
contributes 49% of the assets in joint venture in India with Indo Bank Ltd. of India.
They agreed to share the net results in 1:1 ratio. The main objective of the joint
venture is to exploit the technical expertise of Gremo Insurance and Goodwill of
Indo Bank Ltd. It can also be two or more local concerns opening an organization
or firm or company contributing their assets to this new joint venture concern and
share the profits of the operation in the agreed ratio.

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Illustration 3
A Ltd. a UK based company entered into a joint venture with B Ltd. in India,
wherein B Ltd. will import the goods manufactured by A Ltd. on account of joint
venture and sell them in India. A Ltd. and B Ltd. agreed to share the expenses &
revenues in the ratio of 5:4 respectively whereas profits are distributed equally. A
Ltd. invested 49% of total capital but has equal share in all the assets and is equally
liable for all the liabilities of the joint venture. Following is the trial balance of the
joint venture at the end of the first year:

Particulars Dr. (` ) Cr. (` )

Purchases 9,00,000

Other Expenses 3,06,000

Sales 13,05,000
Property, Plant and Equipment 6,00,000

Current Assets 2,00,000

Unsecured Loans 2,00,000
Current Liabilities 1,00,000

Capital 4,01,000

Closing inventory was valued at ` 1,00,000.

You are required to prepare the Consolidated Financial Statement.
Solution
Consolidated Profit & Loss Account

Particulars Note No. (` )

Revenue from operations 1 13,05,000

Total Revenue (A) 13,05,000

Less: Expenses
Purchases 2 9,00,000
Other expenses 3 3,06,000

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Changes in inventories of finished goods 4 (1,00,000)

Total Expenses (B) 11,06,000

Profit Before Tax (A-B) 1,99,000

Consolidated Balance Sheet

Note No. (`)

I Equity and liabilities
1. Shareholders’ funds:
Share Capital 5 4,01,000
Reserves and Surplus 6 1,99,000
2. Non-current liabilities
Long term borrowings 7 2,00,000
3. Current Liabilities 8 1,00,000
9,00,000
II Assets
Non-current Assets
Property, Plant and Equipment 9 6,00,000
Current Assets
Inventories 10 1,00,000
Other current assets 11 2,00,000
9,00,000
Notes to Accounts

Particulars (` )

1. Revenue from operations

Sales:

A Ltd. 7,25,000
B Ltd. 5,80,000 13,05,000

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2. Purchases
A Ltd. 5,00,000

B Ltd. 4,00,000 9,00,000

3. Other expenses
A Ltd. 1,70,000

B Ltd. 1,36,000 3,06,000

4. Closing Inventory
A Ltd. 50,000
B Ltd. 50,000 1,00,000
5. Share Capital
A Ltd. 1,96,490
B Ltd. 2,04,510 4,01,000
6. Reserves and Surplus
Profit & Loss Account:
A Ltd. 99,500
B Ltd. 99,500 1,99,000
7. Long Term Borrowings
Unsecured Loans:
A Ltd. 1,00,000
B Ltd. 1,00,000 2,00,000
8. Current Liabilities
A Ltd. 50,000
B Ltd. 50,000 1,00,000
9. Property, Plant and Equipment

A Ltd. 3,00,000
B Ltd. 3,00,000 6,00,000

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10. Inventories
A Ltd. 50,000

B Ltd. 50,000 1,00,000

11. Other Current Assets
A Ltd. 1,00,000

B Ltd. 1,00,000 2,00,000

3.9 CONSOLIDATED FINANCIAL STATEMENTS

OF A VENTURER
Proportionate consolidation is a method of accounting and reporting whereby a
venturer's share of each of the assets, liabilities, income and expenses of a jointly
controlled entity is reported as separate line items in the venturer's financial
statements.
Proportionate consolidation method of accounting is to be followed except in the
following cases:
a. Investment is intended to be temporary because the investment is acquired
and held exclusively with a view to its subsequent disposal in the near
future. And
b. joint venture operates under severe long-term restrictions, which
significantly impair its ability to transfer funds to the venturers.
In both the above cases, investment of venturer in the share of the investee
is treated as investment according to AS 13.
A venturer should discontinue the use of the proportionate consolidation method
from the date that:
a. It ceases to have joint control in the joint venture but retains, either in
whole or in part, its investment.
b. The use of the proportionate consolidation method is no longer appropriate
because the joint venture operates under severe long-term restrictions that
significantly impair its ability to transfer funds to the venturers.

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From the date of discontinuing the use of the proportionate consolidation

method,
a. If interest in entity is more than 50%, investments in such joint ventures
should be accounted for in accordance with AS 21, Consolidated Financial
Statement.
b. If interest is 20% or more but upto 50%, investments are to be accounted
for in accordance with AS 23, Accounting for Investment in Associates in
Consolidated Financial Statement.
c. For all other cases investment in joint venture is treated as per AS 13,
Accounting for Investment.
d. For this purpose, the carrying amount of the investment at the date on
which joint venture relationship ceases to exist should be regarded as cost
thereafter.
Following are the features of Proportionate Consolidation Method:
a. Stress is given on substance over form i.e., more importance is given to the
share of venturers in the profit or loss of the venture from the share of
assets and liabilities rather than the nature and form of the joint venture.
b. Venturer’s share of joint assets, liabilities, expenses and income are shown
on the separate lines in the consolidated financial statement.
For example, Mr. A enters into a joint venture with Mr. B and has
contributed 33% of the total Property, Plant and Equipment and has share
of 40% in current assets and current liabilities. Its share in net result is 50%.
Consolidated Balance Sheet will be prepared by Mr. A as follow:
Consolidated Balance Sheet

Note No. (` )

I Equity and liabilities

1. Shareholders’ funds:
Share Capital 1 1,00,000
2. Current Liabilities 2 50,000
1,50,000

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II Assets
Non-current Assets

Property, Plant and Equipment 3 75,000

Current Assets 4 75,000
1,50,000

Notes to Accounts

1. Share Capital *:
A (25,000 + 30,000 - 20,000) 35,000
B (50,000 + 45,000 - 30,000) 65,000 1,00,000
2. Current Liabilities:
A 20,000
B 30,000 50,000
3. Property, Plant and Equipment:
A 25,000
B 50,000 75,000
4. Current Assets:
A 30,000
B 45,000 75,000

* Contribution to Share capital taken as a balancing figure in absence of

information in this regard in the example
Similar to above all the items of expenses and income will also be classified
line by line for each item. The whole basis of this provision is to bring
transparency in the books of account. If there is any special clause for
sharing of expenses, income or any other item that should be clearly
disclosed in the consolidated financial statement.
c. Most of the provisions of Proportionate Consolidation Method are similar to
the provisions of AS 21.

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d. As far as possible the reporting date of the financial statements of jointly

controlled entity and venturers should be same. If practically it is not
possible to draw up the financial statements to such date and, accordingly,
those financial statements are drawn up to different reporting dates,
adjustments should be made in joint venturer’s books for the effects of
significant transactions or other events that occur between the jointly
controlled entity’s date and the date of the venturer’s financial statements.
In any case, the difference between reporting dates should not be more
than six months.
e. Accounting policies followed in the preparation of the financial statements
of the jointly controlled entity and venturer should be uniform for like
transactions and other events in similar circumstances.
If accounting policies followed by venturer and jointly controlled entity are
not uniform, then adjustments should be made in the items of the venturer
to bring it in line with the accounting policy of the joint venture.
f. Any asset or liability should not be adjusted by another liability or asset.
Similarly any income or expense cannot be adjusted with another expense
or income. Such adjustment can be made only when legally it is allowed to
adjust them and such items does lead to settlement of obligation or writing
off of assets.
g. On the date when interest in joint entity is acquired, if the interest of
venturer in net assets of the entity is less than the cost of investment in joint
entity, the difference will be recognized as goodwill in the consolidated
financial statement and if net asset is more than cost of investment, then
the difference is recognized as capital reserve.
In case the carrying amount of investment is different than cost of
investment, we take carrying amount for the purpose of the above
calculation.
h. An investor who don’t have joint control in the entity is like associate as
discussed in AS 23, therefore the treatment of losses will be similar to AS 23.
If investor’s share in loss of the joint entity is in excess of his interest in net
asset, this excess loss will be recognized by the venturers. In future when
entity starts reporting profits, investor’s share of profits will be provided to
venturer till total amount is equivalent to absorbed losses.

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Illustration 4
A Ltd. entered into a joint venture with B Ltd. on 1:1 basis and a new company C
Ltd. was formed for the same purpose and following is the balance sheet of all the
three companies:

Particulars A Ltd. B Ltd. C Ltd.

Share Capital 10,00,000 7,50,000 5,00,000

Reserve & Surplus 18,00,000 16,00,000 12,00,000

Loans 3,00,000 4,00,000 2,00,000

Current Liabilities 4,00,000 2,50,000 1,00,000
Property, Plant and Equipment 30,50,000 26,25,000 19,50,000

Investment in JV 2,50,000 2,50,000 -

Current Assets 2,00,000 1,25,000 50,000

Prepare the balance sheet of A Ltd. and B Ltd. under proportionate consolidation
method.
Solution
Balance Sheet of A Ltd.

Note No. (`)

I Equity and liabilities

1. Shareholders’ funds:
Share Capital 10,00,000
Reserves and Surplus 1 24,00,000

2. Non-current liabilities 2 4,00,000

3. Current Liabilities 3 4,50,000
TOTAL 42,50,000

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II Assets
Non-current Assets
Property, Plant and Equipment: 4 40,25,000
Current Assets 5 2,25,000
42,50,000
Notes to Accounts

` `
1. Reserves and Surplus
A Ltd. 18,00,000
C Ltd. 6,00,000 24,00,000
2. Long Term Borrowings
Loans:
A Ltd. 3,00,000
C Ltd. 1,00,000 4,00,000
3. Current Liabilities:
A Ltd. 4,00,000
C Ltd. 50,000 4,50,000
4. Property, Plant and Equipment:
A Ltd. 30,50,000
C Ltd. 9,75,000 40,25,000
5. Current Assets:
A Ltd. 2,00,000
C Ltd. 25,000 2,25,000
Balance Sheet of B Ltd.

Note No. (`)

I Equity and liabilities
1. Shareholders’ funds:
Share Capital 7,50,000
Reserves and Surplus 1 22,00,000
2. Non-current liabilities 2 5,00,000
3. Current Liabilities 3
3,00,000
37,50,000

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II Assets
1. Non-current Assets
Property, Plant and Equipment 4 36,00,000
2. Current Assets 5
1,50,000
37,50,000

Notes to Accounts

` `
1. Reserves and Surplus
A Ltd. 16,00,000
C Ltd. 6,00,000 22,00,000

2. Long Term Borrowings

Loans:
A Ltd. 4,00,000

C Ltd. 1,00,000 5,00,000

3. Current Liabilities:
A Ltd. 2,50,000
C Ltd. 50,000 3,00,000
4. Property, Plant and Equipment:
A Ltd. 26,25,000
C Ltd. 9,75,000 36,00,000
5. Current Assets:
A Ltd. 1,25,000
C Ltd. 25,000 1,50,000

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3.10 TRANSACTIONS BETWEEN A VENTURER

AND JOINT VENTURE
When venturer transfers or sells assets to Joint Venture, the venturer should
recognise only that portion of the gain or loss which is attributable to the
interests of the other venturers. The venturer should recognise the full amount of
any loss only when the contribution or sale provides evidence of a reduction in
the net realisable value of current assets or an impairment loss.
When the venturer from the joint venture purchases the assets, venturer will not
recognized his share of profits in the joint venture of such transaction unless he
disposes off the assets. A venturer should recognise his share of the losses
resulting from these transactions in the same way as profits except that losses will
be recognised in full immediately only when they represent a reduction in the net
realisable value of current assets or an impairment loss.
In case the joint venture is in the form of separate entity (i.e., JCE) then provisions
of above the Para will be followed only for consolidated financial statement and
not for venturer’s own financial statement. In the books of venturer, profit or loss
from such transactions are recognised in full.
Example
A and B established a separate vehicle i.e. entity J, wherein each operator has a
50% ownership interest and each takes 50% of the output. On formation of the joint
venture, A contributed a property with fair value of ` 110 crore and agreed to
contribute his experience over the years towards this venture; and
B contributed equipment with a fair value of ` 120 crore. The carrying values of the
contributed assets were ` 100 crore and ` 80 crore, respectively.
Answer
A – Gain in consolidated financial statements
A’s share in the fair value of assets contributed by entity

B (50% × 120) 60
A’s share in the carrying value of asset contributed by
A to the joint venture (50% × 100) (50)

Gain recognised by A 10

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3.11 REPORTING INTERESTS IN JOINT

VENTURES IN THE FINANCIAL
STATEMENTS OF AN INVESTOR
The investors who don’t have joint control over the entity recognized his share of
net results and his investments in joint venture as per AS 13. In the consolidated
financial statement it is recognized as per AS 13, AS 21 or AS 23 as appropriate.

3.12 OPERATORS OF JOINT VENTURES

Payment to operators is recognized as expense in CFS and in the books of the
operators as per AS 9, Revenue Recognition. The operator may be any of the
venturers, in this case any amount received by him, as management fees for the
service will be recognized as stated above in this Para.

3.13 DISCLOSURE
A venturer should disclose the aggregate amount of the following contingent
liabilities, unless the probability of loss is remote, separately from the amount of
other contingent liabilities:
a. Any contingent liabilities that the venturer has incurred in relation to its
interests in joint ventures and its share in each of the contingent liabilities
which have been incurred jointly with other venturers;

b. Its share of the contingent liabilities of the joint ventures themselves for
which it is contingently liable; and
c. Those contingent liabilities that arise because the venturer is contingently
liable for the liabilities of the other venturers of a joint venture.
A venturer should disclose the aggregate amount of the following commitments
in respect of its interests in joint ventures separately from other commitments:

a. Any capital commitments of the venturer in relation to its interests in joint

ventures and its share in the capital commitments that have been incurred
jointly with other venturers; and

b. Its share of the capital commitments of the joint ventures themselves.

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A venturer should disclose a list of all joint ventures and description of interests in
significant joint ventures. In respect of jointly controlled entities, the venturer
should also disclose the proportion of ownership interest, name and country of
incorporation or residence. A venturer should disclose, in its separate financial
statements, the aggregate amounts of each of the assets, liabilities, income and
expenses related to its interests in the jointly controlled entities.

Reference: The students are advised to refer the full text of AS 27 “Financial
Reporting of Interests in Joint Ventures”

TEST YOUR KNOWLEDGE

Multiple Choice Questions

1. State which of the following statements are incorrect.
(i) The requirements relating to accounting for joint ventures in
consolidated financial statements according to proportionate
consolidation method, as contained in AS 27, applies only when
consolidated financial statements are prepared by venturer.
(ii) The requirements relating to accounting for joint ventures in
consolidated financial statements according to proportionate
consolidation method, as contained in AS 27, applies irrespective
whether consolidated financial statements are prepared by venturer or
not.
(iii) An investor in joint venture, which does not have joint control, should
report its interest in a joint venture in its consolidated financial
statements in accordance with AS 13, AS 21 and AS 23as the case may
be.
(a) Point (i) is incorrect.
(b) Point (ii) is incorrect.

(c) Point (iii) is incorrect.

(d) None of the above.

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2. Identify which of the following is not a feature of a Jointly controlled

operations (JCO):

(a) Each venturer has his own separate business.

(b) There is a separate entity for joint venture business.
(c) Each venturer record only his own transactions without any separately
set of books maintained for the joint venture business.
(d) There is a common agreement between all of them.
3. Identify which of the following is/are not a feature of a Jointly controlled
assets (JCA):
(i) There is a separate legal identity.
(ii) There is a common control over the joint assets.
(iii) Expenses on jointly held assets are shared by the venturers as per the
contract.

(iv) In their financial statement, venturer shows only their share of the asset
and total income earned by them along with total expenses incurred by
them.
(a) Point no. (i) only.
(b) Point no. (i) and (iii).
(c) Point no. (iii) and (iv).
(d) Point (i) and (ii).

4. Identify which is/ are features of a Jointly controlled entity (JCE):

(i) Venturer creates a new entity for their joint venture business.

(ii) All the venturers pool their resources under new banner and this entity
purchases its own assets, create its own liabilities, expenses are incurred
by the entity itself and sales are also made by this entity.

(iii) The revenues and expenses of the entity is shared by the venturers in
the equal ratio only.
(a) Point no. (i) only.

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FINANCIAL STATEMENTS

(b) Point no. (i) and (ii).

(c) Point no. (ii).
(d) Point no. (iii).

5. Identify the correct statements.

From the date of discontinuing the use of the proportionate consolidation

method:

(i) If interest in entity is more than 50%, investments in such joint ventures
should be accounted for in accordance with AS 21, Consolidated
Financial Statements.
(ii) If interest is 20% or more but upto 50%, investments are to be
accounted for in accordance with AS 23, Accounting for Investment in
Associates in Consolidated Financial Statements.
(iii) For all other cases investment in joint venture is treated as per AS 13,
Accounting for Investments.
(iv) For this purpose, the fair value of the investment at the date on which
joint venture relationship ceases to exist should be regarded as cost
thereafter.
(a) Point no. 1 and 2.
(b) Point no. 1, 2 and 3.
(c) Point no. 1, 2, 3 and 4.
(d) None of the above.

Theoretical Questions
6. Describe the cases when AS 27 does not allow the use of Proportionate
consolidation method of accounting?
7. When is a venturer required to discontinue the use of the proportionate
consolidation method?

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Scenario based Questions

8. JVR Limited has made investments of ` 97.84 crores in equity shares of
QSR Limited in pursuance of Joint Venture agreement till 20X1-X2 (i.e., more
than 12 months). The investment has been made at par. QSR Limited has
been in continuous losses for the last 2 years. JVR Limited is willing to
reassess the carrying amount of its investment in QSR Limited and wish to
provide for diminution in value of investments. However, QSR Limited has a
futuristic and profitable business plans and projection for the coming years.
Discuss whether the contention of JVR Limited to bring down the carrying
amount of investment in QSR Limited is in accordance with the Accounting
Standard.

ANSWERS/SOLUTION
Answer to the Multiple Choice Questions
1. (b) 2. (b) 3. (a) 4. ( b) 5. (b)

Answer to the Theoretical Questions

6. Proportionate consolidation method of accounting is to be followed except
in the following cases:
a. Investment is intended to be temporary because the investment is
acquired and held exclusively with a view to its subsequent disposal in
the near future.
The term ‘Near Future’ is explained with AS 21.
Or
b. joint venture operates under severe long-term restrictions, which
significantly impair its ability to transfer funds to the venturers.
In both the above cases, investment of venturer in the share of the investee
is treated as investment according to AS 13.
7. A venturer should discontinue the use of the proportionate consolidation
method from the date that:
a. It ceases to have joint control in the joint venture but retains, either in
whole or in part, its investment.

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b. The use of the proportionate consolidation method is no longer

appropriate because the joint venture operates under severe long-
term restrictions that significantly impair its ability to transfer funds to
the venturers.
From the date of discontinuing the use of the proportionate consolidation
method,
a. If interest in entity is more than 50%, investments in such joint
ventures should be accounted for in accordance with AS 21,
Consolidated Financial Statement.
b. If interest is 20% or more but up to 50%, investments are to be
accounted for in accordance with AS 23, Accounting for Investment in
Associates in Consolidated Financial Statement.
c. For all other cases investment in joint venture is treated as per AS 13,
Accounting for Investment.
d. For this purpose, the carrying amount of the investment at the date on
which joint venture relationship ceases to exist should be regarded as
cost thereafter.

Answer to the Scenario based Questions

8. As per para 26 of AS 27 “Financial Reporting of Interests in Joint Ventures”,
in a venturer’s separate financial statements, interest in a jointly controlled
entity should be accounted for as an investment in accordance with AS 13
‘Accounting for Investments’.
As per para 17 of AS 13 “Accounting for Investments”, long-term
investments are usually carried at cost. However, when there is a decline,
other than temporary, in the value of a long-term investment, the carrying
amount is reduced to recognize the decline. Indicators of the value of an
investment are obtained by reference to its market value, the investee’s
assets and results and the expected cash flows from the investment. The
type and extent of the investor’s stake in the investee are also taken into
account. However, where there is a decline, other than temporary, in the
carrying amounts of long-term investments, the resultant reduction in the
carrying amount is charged to the profit and loss statement.

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Since the investment was made in the year 20X1-20X2 i.e., more than a year,
it is a long-term investment. In the given case, though the QSR Ltd. is in
continuous losses for past 2 years, yet it has a futuristic and profitable
business plans and projections for the coming years. Here, one of the
indicators i.e. ‘losses incurred to the company’ may lead to diminution in
the value of the shares while the other indicator that ‘the company has
positive expected cash flows from its business plans’ does not lead to
decline in the value of shares.
Considering both the facts, in case the expectation of profitable business
plans and positive cash flows is based reliable presumptions (such as tender
in favour of QSR Ltd., strong order book etc.), the decline will be regarded
as temporary in nature and the investment in equity shares will continue to
be carried at cost only.
However, should the aforesaid presumptions be based on projections
without reasonable evidence backing the claims, the decline could be
regarded as non-temporary in nature in which case the write down of the
carrying amount become necessary in line with AS 13, thereby implying the
contention of QSR Ltd. to be correct.

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 CASE SCENARIOS

Case Scenario 1
RTS Ltd, (“RTS” or the “Company”), is engaged in the business of manufacturing of
equipments/components. The Company has a contract with the Indian Railways for
a brake component which is structured such that:
♦ The Company’s obligation is to deliver the component to the Railways’
stockyard, while the delivery terms are ex-works, the Company is responsible
for engaging a transporter for delivery.
♦ Railways sends an order for a defined quantity.
♦ The Company manufactures the required quantity and informs Railways for
carrying out the inspection.
♦ Railways representatives visit the Company’s factory and inspect the
components, and mark each component with a quality check sticker.
♦ Goods once inspected by Railways, are marked with a hologram sticker to
earmark for delivery identification by the customer when they are delivered
to the customer’s location.
♦ The Company raises an invoice once it dispatches the goods.
The management of RTS is under discussion with the auditors of the Company in
respect of accounting of a critical matter as regards its accounting with respect
subsequent events i.e. events after the reporting period. They have been checking
as to which one of the following events after the reporting period provide evidence
of conditions that existed at the end of the reporting period?

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i. Nationalisation or privatization by government

ii. Out of court settlement of a legal claim
iii. Rights issue of equity shares

iv. Strike by workforce

v. Announcing a plan to discontinue an operation
The Company has received a grant of ` 8 crores from the Government for setting
up a factory in a backward area. Out of this grant, the Company distributed ` 2
crores as dividend. The Company also received land, free of cost, from the State
Government but it has not recorded this at all in the books as no money has been
spent.
RTS has a subsidiary, A Ltd, which is evaluating its production process wherein
normal waste is 5% of input. 5,000 MT of input were put in process resulting in
wastage of 300 MT. Cost per MT of input was ` 1,000. The entire quantity of waste
was on stock at the end of the financial year.
(i) When should RTS Ltd recognize revenue as per the Accounting Standards
notified under the Companies (Accounting Standards) Rules, 2006? Would
your answer be different if inspection is normally known to lead to no quality
rejections?
(a) Revenue should be recognized on dispatch of components. The
assessment would not change even in case where inspection is normally
known to lead to no quality rejections.
(b) Revenue should be recognized on completion of inspection of
components. The assessment would not change even in case where
inspection is normally known to lead to no quality rejections.
(c) Revenue should be recognized on dispatch of components. The
assessment would change where inspection is normally known to lead
to no quality rejections.
(d) Revenue should be recognized on delivery of the component to the
Railways’ stockyard. The assessment would change where inspection is
normally known to lead to no quality rejections.

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 CASE SCENARIOS CS.3

(ii) In respect of A Ltd, state with reference to Accounting Standards notified

under the Companies (Accounting Standards) Rules, 2006, what would be
value of the inventory to be recorded in the books of accounts?
(a) ` 4,700,000.
(b) ` 5,000,000.
(c) ` 4,950,000.
(d) ` 4,947,368.
(iii) Please guide regarding the accounting treatment of both the grants
mentioned above in line with the requirements of Accounting Standard 12.

(a) Distribution of dividend out of grant is correct. In the second case also
not recording land in the books of accounts is correct.
(b) Distribution of dividend out of grant is incorrect. In the second case,
not recording land in the books of accounts is correct.
(c) Distribution of dividend out of grant is correct. In the second case, land
should be recorded in the books of accounts at a nominal value.
(d) Distribution of dividend out of grant is incorrect. In the second case,
land should be recorded in the books of accounts at a nominal value.

Answers
(i) (b) (ii) (d) (iii) (d)

Case Scenario 2
Suman Ltd. is in the business of manufacturing electronics equipment and selling
these at its various outlets. It provides installation services for the equipment sold
and also provide free 1 year warranty on all the sold products.
Beach Resorts are leading resorts in the city. It purchased 5 air conditioners (AC)
from Suman Ltd. for its resort. Suman Ltd. sold 5 AC to Beach resort for ` 45,000
each which includes installation fees of ` 1,000 for each AC. The Company also
offers 1 year warranty for any repair etc. The Company also offered ` 500 per AC
as trade discount. Beach resort placed order on March 15, 2024 and made payment
on March 20, 2024. The ACs were delivered on March 27, 2024 and the installation
was completed on April 5, 2024.

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(i) How much revenue should be recognised by the Company as on March 31,
2024:
(a) ` 2,25,000
(b) ` 2,17,500
(c) ` 2,00,000
(d) ` 2,30,000
(ii) How much revenue should be recognised by the Company in the financial
year 2024-25:
(a) ` 5000
(b) ` 2,20,000
(c) ` 10,000
(d) ` 2,40,000
(iii) What will be the accounting for trade discount:
(a) The same will be recognised separately in the profit and loss.
(b) The trade discounts are deducted in determining the revenue.
(c) Trade discount will be recognised after one year, when the warranty will
be over.
(d) Trade discount will be recognised after installation is complete.
(iv) Is the Company required to do any accounting for 1 year warranty provided
by it:
(a) No accounting treatment is required till some warranty claim is actually
received by the Company.
(b) As there exist a present obligation to provide warranty to customers for
1 year, the Company should estimate the amount that it may have to
incur considering various factors including past trends and create a
provision as per AS 29.
(c) Accounting for claims will be done on cash basis i.e. expense will be
recognised when expense is made.

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 CASE SCENARIOS CS.5

(d) As the Company is not charging separately for the warranty provided,
there is no need to create any provision.

Answers
(i) (b) (ii) (a) (iii) (b) (iv) (b)

Case Scenario 3
Mars Ltd. is a manufacturing enterprise which is starting a new manufacturing plant
at X Village. It has commenced construction of the plant on April 1, 2023 and has
incurred following expenses:
♦ It has acquired land for installing Plant for ` 50,00,000

♦ It incurred ` 35,00,000 for material and direct labour cost for developing the
Plant.
♦ The Company incurred ` 10,00,000 for head office expenses at New Delhi
which included rent, employee cost and maintenance expenditure.
♦ The Company borrowed ` 25,00,000 for construction work of Plant @12% per
annum on April 1, 2023. Director finance of the Company incurred travel and
meeting expenses amounting to ` 5,00,000 during the year for arranging this
loan.
♦ On November 1, 2023, the construction activities of the plant were
interrupted as the local people alongwith the activists have raised issues
relating to environmental impact of plant being constructed. Due to agitation
the construction activities came to standstill for 3 months.
♦ With the help of Government and NGOs, the agitation was over by February
28, 2024 and the work resumed. However, to balance the impact on
environment, government ordered the company to install certain devices for
which the Company had to incur ` 6,00,000 in March 2024.
♦ The rate of depreciation on Plant is 10%.
Based on the above information, answer the following questions.
(i) Which of the following expenses cannot be included in the cost of plant:

(a) Cost of Land

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 CS.6 ADVANCED ACCOUNTING

(b) Construction material and labour cost

(c) Head office expenses
(d) Borrowing cost

(ii) How much amount of borrowing cost can be capitalised with the plant:
(a) ` 300,000
(b) ` 2,00,000

(c) ` 7,00,000
(d) ` 6,00,000
(iii) The total cost of plant as on march 31, 2024 will be:
(a) ` 85,00,000
(b) ` 98,00,000
(c) ` 93,00,000
(d) ` 95,00,000
(iv) The amount of depreciation to be charged for the year end March 31, 2024
(a) ` 4,30,000
(b) ` 9,30,000
(c) ` 9,80,000
(d) Nil

Answers
(i) (c) (ii) (b) (iii) (c) (iv) (d)

Case Scenario 4
Beloved Finance Ltd. is a financial enterprise which is in the business of lending
loan to small businesses and earn interest on loans.
♦ During the year the Company has lend 50 crores and earned ` 1.5 crore as
interest on loans.

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 CASE SCENARIOS CS.7

♦ The Company had surplus funds during the year and invested then in Fixed
Deposits with bank and earned interest on fixed deposits of ` 20 lacs.
♦ The Company also acquired a gold loan unit for ` 10 crore during the year
and the Company provided interest free loan of ` 15 crore to its wholly-
owned subsidiary.
♦ The Company paid a total income tax of ` 75 lacs for the year.
Based on the above information, answer the following questions.
(i) In the Cash Flow Statement as per AS 3, the interest income of ` 1.5 crore
earned on earned on loans given by the Company will be disclosed as:
(a) Cash Flow from Operating Activities
(b) Cash Flow from Investing Activities
(c) Cash Flow from Financing Activities
(d) Non-cash Items
(ii) In the Cash Flow Statement as per AS 3, the interest income of ` 20 Lacs
earned fixed deposits with bank will be disclosed as:
(a) Cash Flow from Operating Activities

(b) Cash Flow from Investing Activities

(c) Cash Flow from Financing Activities
(d) Non-cash Items
(iii) In the Cash Flow Statement as per AS 3, amount paid for acquiring gold loan
unit will be disclosed as:
(a) Cash Flow from Operating Activities
(b) Cash Flow from Investing Activities
(c) Cash Flow from Financing Activities
(d) Non-cash Items
(iv) In the Cash Flow Statement as per AS 3, total income tax of ` 75 lacs paid for
the year will be disclosed as:
(a) Cash Flow from Operating Activities

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 CS.8 ADVANCED ACCOUNTING

(b) Cash Flow from Investing Activities

(c) Cash Flow from Financing Activities
(d) Non-cash Items

(v) Is any specific disclosures required to made in relation to the interest free
loan of ` 15 crore provided by the Company to its wholly-owned subsidiary,
if yes, as per which Accounting Standard:
(a) Yes, disclosure is required to be made as per AS 3, Cash Flow
Statements.
(b) Yes, disclosure is required to be made as per AS 18, Related Party
Disclosures
(c) Yes, disclosure is required to be made as per AS 13, Accounting for
Investments
(d) No specific disclosures are required.

Answers
(i) (a) (ii) (a) (iii) (b) (iv) (a) (v) (b)

Case Scenario 5
Venus Limited received a parcel of land at no cost from the government for the
purpose of developing a factory in an outlying area. The land is valued at ` 75 lakhs,
while the nominal value is ` 10 lakhs. Additionally, the company received a
government grant of ` 30 lakhs, which represents 25% of the total investment
needed for the factory development. Furthermore, the company received ` 15 lakhs
with the stipulation that it be used to purchase machinery. There is no expectation
from the government for the repayment of these grants.
Answer the following questions based on the above information:
(i) The land received from Government, free of cost should be presented at:
(a) ` 75 Lakhs
(b) ` 30 Lakhs

(c) ` 10 Lakhs
(d) ` 45 Lakhs

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(ii) As per AS 12, how the Government Grant of ` 30 Lakhs should be presented:
(a) It should be recognised in the profit and loss statement as per the
related cost.
(b) It will be treated as capital reserve.
(c) It will be treated as deferred income.
(d) It will not be recognised in the financial statements.
(iii) As per AS 12, how the Government Grant of ` 15 Lakhs with a condition to
purchase machinery may be presented as:
(a) Capital Reserve
(b) Shareholders Fund
(c) Deferred Income
(d) Income in statement of profit and loss as received.
(iv) Which of the above grants are required to be recognised in the statement of
profit and loss on a systematic and rational basis over the useful life of the
asset:

(a) Land received as Grant

(b) Government Grant of ` 30 Lakhs
(c) Government Grant of ` 15 Lakhs with a condition to purchase machinery
(d) Noe of the above

Answers
(i) (c) (ii) (b) (iii) (c) (iv) (c)

Case Scenario 6
Axis limited is a manufacturing company. It purchased a machinery costing
` 10 Lakhs in April 2023. It paid ` 4 lakhs upfront and paid the remaining
` 6,00,000 as deferred payment by paying instalment of ` 1,05,000 for the next 6
months. During the year, the Company sold a land which was classified as its
‘property, plant and equipment’ for ` 25,00,000 and paid ` 1,00,000 as income tax
as long term capital gain on such sale. During the year, the Company also received

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income tax refund along with interest.

(i) As per the requirements of AS 3, ‘Cash Flow Statements’, how the amount for
purchase of machinery should be presented:
(a) ` 10 lakhs as ‘Cash flows from Investing Activities’ and ` 30,000 will
simply be booked in profit and loss with no presentation if Cash Flow
Statement.
(b) ` 10.30 lakhs as ‘Cash flows from Investing Activities’ as entire amount
is spend on purchase of machinery.
(c) ` 10 lakhs as ‘Cash flows from Investing Activities’ and ` 30,000 as ‘Cash
flows from Financing Activities’.
(d) ` 10.30 lakhs as ‘Cash flows from Financing Activities’ as the machinery
has been purchased on finance.
(ii) At what amount, the machinery should be recognised in the financial
statements:
(a) ` 400,000
(b) ` 10,30,000

(c) ` 600,000
(d) ` 10,00,000
(iii) How should the income tax paid on sale of land should be disclosed in the
Cash Flows Statement:
(a) Cash flows from Operating Activities
(b) Cash flows from Investing Activities

(c) Cash flows from Financing Activities

(d) No disclosure in Cash Flow Statement
(iv) How should the interest on income tax refunds should be disclosed in the
Cash Flows Statement:
(a) Cash flows from Operating Activities
(b) Cash flows from Investing Activities

(c) Cash flows from Financing Activities

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(d) No disclosure in Cash Flow Statement

Answers
(i) (c) (ii) (d) (iii) (b) (iv) (b)

Case Scenario 7
SEAS Ltd., the “Company”, is in the business of tours and travels. It sells holiday
packages to the customers. The Company negotiates upfront with the Airlines for
specified number of seats in flight. The Company agrees to buy a specific number
of tickets and pay for those tickets regardless of whether it is able to resell all of
those in package.
The rate paid by the Company for each ticket purchased is negotiated and agreed
in advance. The Company also assists the customers in resolving complaints with
the service provided by airlines. However, each airline is responsible for fulfilling
obligations associated with the ticket, including remedies to a customer for
dissatisfaction with the service.
The Company bought a forward contract for three months of US$ 1,00,000 on 1
March 2024 at 1 US$ = INR 83.10 when exchange rate was US$ 1 = INR 83.02. On
31 March 2024, when the Company closed its books, exchange rate was US$ 1 =
INR 83.15. On 1 April 2024, the Company decided for premature settlement of the
contract due to some exceptional circumstances.
The Company is evaluating below mentioned schemes:
i. Introduction of a formal retirement gratuity scheme by an employer in place
of ad hoc ex-gratia payments to employees on retirement.
ii. Management decided to pay pension to those employees who have retired
after completing 5 years of service in the organization. Such employees will
get pension of ` 20,000 per month. Earlier there was no such scheme of
pension in the organization.
SEAS Ltd. has a subsidiary, ADI Ltd., which is in the business of construction
having turnover of ` 200 crores. SEAS Ltd. and ADI Ltd. hold 9% and 23%
respectively in an associate company, ASOC Ltd. Both SEAS Ltd. and ADI Ltd.
prepare consolidated financial statements as per Accounting Standards
notified under the Companies (Accounting Standards) Rules, 2021.

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(i) What would be the basis of revenue recognition for SEAS Ltd. as per the
requirements of Accounting Standards?
(a) Gross basis.
(b) Net basis.
(c) Depends on the accounting policy of the Company.
(d) Indian GAAP allows a choice to the Company to recognize revenue on
gross basis or net basis.
(ii) Please suggest accounting treatment of forward contract for the year ended
31 March 2024 as per Accounting Standard 11.

(a) MTM (marked to market value) of contract will be recorded on 31 March

2024.
(b) MTM (marked to market value) of contract will be computed as at 31
March 2024 and only if there is loss, it will be recorded during the year
ended 31 March 2024.
(c) No accounting will be done during the year ended 31 March 2024.
(d) Premium on contract will be amortized over the life of the contract.
(iii) You are requested to advise the Company in respect of the accounting
requirements of above schemes related to employee benefits as to which one
of those schemes should be considered as a change in accounting policy
during the year.
(a) 1 – Change in accounting policy. 2 – Change in accounting policy.
(b) 1– Not a change in accounting policy. 2 – Change in accounting policy.
(c) 1 – Not a change in accounting policy. 2 – Not a change in accounting
policy.

(d) 1– Change in accounting policy. 2 – Not a change in accounting policy.

(iv) Please comment regarding consolidation requirements for SEAS Ltd. and ADI
Ltd. using the below mentioned options as to which one should be correct.
(a) ADI Ltd. would using equity method of accounting for 23% in ASOC Ltd.
SEAS Ltd. would consolidate ADI Ltd. and consequently automatically

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equity account 23% and separately account for the balance 9% as per
AS 13.
(b) ADI Ltd. would account for 23% in ASOC Ltd. as per AS 13. SEAS
Ltd. would consolidate ADI Ltd. and consequently automatically
account 23% and separately account for the balance 9%.
(c) ADI Ltd. would account for 23% share in ASOC Ltd using equity method
of accounting. SEAS Ltd. would consolidate ADI Ltd. and consequently,
automatically account for ASOC Ltd 23% share and separately account
for 9% share in ASOC Ltd. using equity method of accounting in
consolidated financial statements.
(d) ADI Ltd. would account for 23% in ASOC Ltd. as per AS 13. SEAS Ltd.
would consolidate ADI Ltd. and using equity method of accounting 23%
in ASOC Ltd. and separately account for the balance 9% as per AS 13.

Answers
(i) (a) (ii) (d) (iii) (c) (iv) (c)

Case Scenario 8
On 1st April, 2022, Shubham Limited purchased some land for ` 30 lakhs for the
purpose of constructing a new factory. This cost of 30 lakhs included legal cost of
` 2 lakhs incurred for the purpose of acquisition of this land. Construction work
could start on 1st May, 2022 and Shubham Limited provides you the details of the
following costs incurred in relation to its construction:
`
Preparation and levelling of the land 80,000
Employment costs of the construction workers (per month) 29,000
Purchase of materials for the construction 21,24,000
Cost of relocating employees to new factory for work 60,000
Costs of inauguration ceremony on 1 January, 2023 st
80,000
Overhead costs incurred directly on the construction of the factory 25,000
(per month)

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General overhead costs allocated to construction project by the Manager is `

30,000. However, as per company’s normal overhead allocation policy, it should
be ` 24,000. The auditor of the company has support documentation for the cost
of ` 15,000 only) and raised objection for the balance amount.
The construction of the factory was completed on 31st December, 2022 and
production could begin on 1st February, 2023. The overall useful life of the factory
building was estimated at 40 years from the date of completion. However, it was
estimated that the roof will need to be replaced 20 years after the date of
completion and that the cost of replacing the roof at current prices would be 25%
of the total cost of the building.
The construction of the factory was partly financed by a loan of ` 28 lakhs borrowed
on 1st April, 2022. The loan was taken at an annual rate of interest of 9%. During
the period when the loan proceeds had been fully utilized to finance the
construction, Shubham Limited received investment income of ` 25,000 on the
temporary investment of the proceeds.
You are required to assume that all of the net finance costs to be allocated to the
cost of factory (not land) and interest cost to be capitalized based on nine months’
period.
Based on the information given in the above scenario, answer the following
multiple choice questions:
(i) Which of the following cost (incurred directly on construction) will be
capitalized to the cost of factory building?
(a) ` 2,00,000 incurred as legal cost
(b) ` 60,000 – costs of relocating employees
(c) ` 80,000 costs of inauguration ceremony
(d) ` 24,000 – allocated general overhead cost
(ii) What amount of employment cost of construction workers will be capitalized
to the cost of factory building?

(a) ` 2,90,000
(b) ` 3,48,000
(c) ` 2,32,000

(d) ` 29,000

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 CASE SCENARIOS CS.15

(iii) What is the amount of net borrowing cost capitalized to the cost of the
factory?
(a) ` 1,89,000
(b) ` 1,68,000
(c) ` 1,44,000
(d) ` 1,64,000
(iv) What will be the carrying amount (i.e. value after charging depreciation) of
the factory in the Balance Sheet of Shubham Limited as at 31st March, 2023?
(a) ` 30,00,000

(b) ` 57,78,125
(c) ` 27,78,125
(d) ` 58,00,000

Answers
(i) (a) (ii) (c) (iii) (d) (iv) (b)

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