# Accounting Standards – Advanced Accounts CA Inter Study Material

Accounting Standards – CA Inter Advanced Accounting Study Material is designed strictly as per the latest syllabus and exam pattern.

## Accounting Standards – CA Inter Advanced Accounting Study Material

AS 4
Contingencies And Events Occurring After Balance Sheet Date

Adjustment Events (Based On Para Nos. 3, 8.1 And 8.2)

Question 1.
A company entered into an agreement to sell its immovable property to another company for 35 lakhs. The property was shown in the Balance Sheet at ₹ 7 lakhs. The agreement to sell was concluded on 15th February, 2008 and sale deed was registered on 30th April, 2008. The financial statements for the year 2007-08 were approved by the board on 12th May, 2008.

You are required to state, how this transaction would be dealt with in the financial statements for the year ended 31st March, 2008. (Nov. 2009) (2 Marks)
According to para 13 of AS 4 “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.

Analysis:
In the above case, sale of immovable property was carried out before the closure of the books of account. This is clearly an event occurring after the balance sheet date but agreement to sell was affected on 15th February 2009 i.e. before the balance sheet date.

Registration of the sale deed on 30th April, 2009, simply provides additional information relating to the conditions existing at the balance sheet date.

Conclusion:
Thus, adjustment to assets for sale of immovable property is necessary in the financial statements for the year ended 31st March, 2009.

Question 2.
While preparing its final accounts for the year ended 31st March 2010, a company made a provision for bad debts @ 4% of its total debtors (as per trend follows from the previous years). In the first week of March 2010, a debtor for ₹ 3,00,000 had suffered heavy loss due to an earthquake; the loss was not covered by any insurance policy. In April, 2010 the debtor became a bankrupt. Can the company provide for the full loss arising out of insolvency of the debtor in the final accounts for the year ended 31st March, 2010? (Nov. 2010) (5 Marks)
As per para 8 of AS 4 ‘Contingencies and Events Occurring After the Balance Sheet Date’ adjustment 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.

Analysis:
A debtor for ₹ 3,00,000 suffered heavy loss due to earthquake in the first week of March, 2010 and he became bankrupt in April, 2010 (after the balance sheet date). The loss was also not covered by any insurance policy.

Conclusion:
Therefore, full provision for bad debts amounting ₹ 3,00,000 should be made, to cover the loss arising due to the insolvency of a debtor, in the final accounts for the year ended 31st March, 2010.

Question 3.
MEC Limited could not recover an amount of ₹ 8 lakhs from a debtor. The company is aware that the debtor is in great financial difficulty. The accounts of the company for the year ended 31-3-2011 were finalized by making a provision @ 25% of the amount due from that debtor. In May 2011, the debtor became bankrupt and nothing is recoverable from him. Do you advise the company to provide for the entire loss of ₹ 8 lakhs in books of account for the year ended 31-3-2011? (Nov. 2011) (4 Marks)
As per para 8 of AS 4, ‘Contingencies and Events Occurring After the Balance Sheet Date’, adjustments to assets and liabilities are required for events occurring after the balance sheet date if such event provides/relates to additional information to the conditions existing at the balance sheet date and is also materially affecting the valuation of assets and liabilities on the balance sheet date.

Analysis:
As per the information given in the question, the debtor was already in a great financial difficulty at the time of closing of accounts. Bankruptcy of the debtor in May 2011 is only an additional information to the condition existing on the balance sheet date. Also, the effect of a debtor becoming bankrupt is material as total amount of ₹ 8 lakhs will be a loss to the company.

Conclusion:
Thus, the company is should provide for the entire amount of ₹ 8 lakhs in the books of account for the year ended 31st March, 2011.

Question 4.
Cashier of A-One Limited embezzled cash amounting to ₹ 6,00,000 during March, 2012. However same comes to the notice of Company management during April, 2012 only financial statements of the company are not yet approved by the Board of Directors of the company. With the help of provisions of AS 4 “Contingencies and Events Occurring after the Balance Sheet Date” decide, whether the embezzlement of cash should be adjusted in the books of account for the year ending March, 2012?

What will be your reply, if embezzlement of cash comes to the notice of company management only after approval of financial statements by the Boar Directors of the company? (May 2012) (4 Marks)
As per para no. 13 of AS 4, assets and liabilities should be adjusted for events occurring after the balance sheet date that provide additional evidence to assist the estimation of amounts relating to conditions existing at the balance sheet date.

Analysis:
Though the theft, by the cashier ₹ 6,00,000, was detected after the balance sheet date (before approval of financial statements) but it is an additional information materially affecting the determination of the cash amount relating to conditions existing at the balance sheet date.

Conclusion:
Therefore, it is necessary to make the necessary adjustments in the financial statements of the company for the year ended 31st March, 2012 for recognition of the loss amounting ₹ 6,00,000.

Question 5.
In its Final Accounts for the year ended 31st March, 2014, Z Ltd. made a provision of 3% of its total debtors. On 10th March, 2014, a debtor of ₹ 5 lakhs suffered a heavy loss and became insolvent in April 2014. The loss was not insured.
State giving reasons, if the company may provide for the full loss in its accounts for the year ended 31st March, 2014. (May 2014) (5 Marks)
According to para 8.2 of Accounting Standard 4 “Contingencies and Events Occurring after the Balance Sheet Date”, adjustments to assets and liabilities are required for events occurring after the balance sheet date that provide additional information materially affecting the determination of the amounts relating to conditions existing at the balance sheet date.

Analysis:
In the above case, though the debtor became insolvent after balance sheet date, yet he had suffered heavy loss (not covered by the insurance), before the balance sheet date and this loss was the cause of the insolvency of the debtor.

Conclusion:
Thus, the company must make full provision for bad debts amounting X 5 lakhs in its final accounts for the year ended 31st March, 2014.

Question 6.
While preparing its final accounts for the year ended 31st March, 2016, a company made provision for bad debts @ 5% of its total debtors. In the last week of February, 2016, a debtor for ₹ 20 lakhs had suffered heavy loss due to an earthquake; the loss was not covered by any insurance policy. In April, 2016 the debtor became a bankrupt. Can the company provide for the full loss arising out of insolvency of the debtor in the final accounts for the year ended 31st March, 2016?
Comment with reference to relevant Accounting Standard. (Nov. 2016) (5 Marks)
As per AS 4 ‘Contingencies and Events Occurring After the Balance Sheet Date adjustment 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.

Analysis:
A debtor for ₹ 20,00,000 suffered heavy loss due to earthquake in the last week of February, 2016 which was not covered by insurance. This information with its implications was already known to the company. The fact that he became bankrupt in April, 2016 (after the balance sheet date) is only an additional information related to the condition existing on the balance sheet date. However, bankruptcy of debtors is an adjusting event.

Conclusion:
Thus, full provision for bad debts amounting ₹ 20,00,000 should be made, to cover the loss arising due to the insolvency of a debtor, in the final accounts for the year ended 31st March 2016.
Since the company has already made 5% provision of its total debtors, additional provision amounting ₹ 19,00,000 shall be made (20,00,000 x 95%).

Non-Adjusting Events (Based On Para Nos. 3, 8.1, 8.3 And 8.4)

Question 7.
A company deals in petroleum products. The sale price of petrol is fixed by the government. After the Balance Sheet date, but before the finalization of the company’s accounts, the government unexpectedly increased the price retrospectively. Can the company account for additional revenue at the close of the year? Discuss in line with provisions of AS 4. (RTP)
Analysis:
According to para 8 of AS 4, the unexpected increase in sale price of petrol by the government after the balance sheet date cannot be regarded as an event occurring after the Balance Sheet date, which requires an adjustment at the Balance Sheet date, since it does not represent a condition present at the balance sheet date.

Conclusion:
The revenue should be recognized only in the subsequent year with proper disclosures.

Question 8.
With reference to AS 4 “Contingencies and Events Occurring after the Balance Sheet Date”, state whether the following events will be treated as contingencies, adjusting events or non-adjusting events occurring after balance sheet date in case of a company which follows April to March as its financial year.
(i) A major fire has damaged the assets in a factory on 5th April, 5 days after the year end. However, the assets are fully insured and the books have not been approved by the Directors.
(ii) A suit against the company’s advertisement was filed by a party on 10th April, 10 days after the year end claiming damages of ₹ 20 lakhs. (RTP)
Accordingto AS 4 on ‘Contingencies and Events Occurring after the Balance Sheet Date’, adjustments to assets and liabilities are required for events occurring after the balance sheet date that provide additional information materially affecting the determination of the amounts relating to conditions existing at the balance sheet date. However, adjustments to assets and liabilities are not appropriate for events occurring after the balance sheet date, if such events do not relate to conditions existing at the balance sheet date. “Contingencies”used in the Standard is restricted to conditions or situations at the balance sheet date, the financial effect of which is to be determined by future events which may or may not occur.

(i) Analysis:
Fire has occurred after the balance sheet date and also the loss is totally insured.
Conclusion:
Therefore, the event becomes immaterial and the event is non-adjusting in nature.

(ii) Analysis:
The contingency is restricted to conditions existing at the balance sheet date. However, in the given case, suit was filed against the company’s advertisement by a party on 10th April for amount of ₹ 20 lakhs.

Conclusion:
Therefore, it does not fit into the definition of a contingency and hence is a non-adjusting event.

Question 9.
A Company follows April to March as its financial year. The Company recognizes cheques dated 31st March or before, received from customers after balance sheet date, but before approval of financial statement by debiting ‘Cheques in hand account’ and crediting ‘Debtors account’. The ‘cheques in hand’ is 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 normal course after deposit in the bank. State with reasons, whether the collection of cheques bearing date 31st March or before, but received after Balance Sheet date is an adjusting event and how this fact is to be disclosed by the company? (May 2010) (2 Marks)
Analysis:
Even if the cheques bear the date 31st March or before, the cheques received after 31st March do not represent any condition existing on the balance sheet date i.e. 31st March.

Conclusion:
Thus, the collection of cheques after balance sheet date is not an adjusting event.

Question 10.
With reference to AS 4 “Contingencies and Events Occurring after the Balance Sheet Date”, identify whether the following events will be treated as contingencies, adjusting events or non-adjusting events occurring after balance sheet date in case of a company which follows April to March as its financial year.
(i) A major fire has damaged the assets in a factory on 5th April, 5 days after the year end. However, the assets are fully insured and the books have not been approved by the Directors.
(ii) A suit against the company’s advertisement was filed by a party on 10th April, 10 days after the year end claiming damages of ₹ 20 lakhs. (RTP)
According to AS 4 on ‘Contingencies and Events Occurring after the Balance Sheet Date’, adjustments to assets and liabilities are required for events occurring after the balance sheet date that provide additional information materially affecting the determination of the amounts relating to conditions existing at the balance sheet date. However, adjustments to assets and liabilities are not appropriate for events occurring after the balance sheet date, if such events do not relate to conditions existing at the balance sheet date. “Contingencies ” used in the Standard is restricted to conditions or situations at the balance sheet date, the financial effect of which is to be determined by future events which may or may not occur.

(i) Analysis:
Fire has occurred after the balance sheet date and also the loss is totally insured.
Conclusion:
Therefore, the event becomes immaterial and the event is non-adjusting in nature.

(ii) Analysis:
The contingency is restricted to conditions existing at the balance sheet date. However, in the given case, suit was filed against the company’s advertisement by a party on 10th April for amount of ₹ 20 lakhs.
Conclusion:
Therefore, it does not fit into the definition of a contingency and hence is a non-adjusting event.

Events After Approval Of Financial Statements (Based On Para No. 3)

Question 11.
A Limited Company dosed its accounting year on 30.6.2017 and the accounts for that period were considered and approved by the board of directors on 20th August, 2017. The company was engaged in laying pipe line for an oil company deep beneath the earth. While doing the boring work on 1.9.2017 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 30.6.2017.
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’.

Analysis:
In the above case the incidence, which was expected to push up cost, became evident after the date of approval of the accounts.

Conclusion:
Therefore, it is not an ‘event occurring after the balance sheet date’. However, this may be mentioned in the Report of Approving Authority.

Question 12.
During the year 2015-16, R Ltd. was sued by a competitor for ₹ 15 lakhs for infringement of a trademark. Based on the advice of the company’s legal counsel, R Ltd. provided for a sum of ₹ 10 lakhs in its financial statements for the year ended 31st March, 2016. On 18th May, 2016, the Court decided in favour of the party alleging infringement of the trademark and ordered R Ltd. to pay the aggrieved party a sum of ₹ 14 lakhs. The financial statements were prepared by the company’s management on 30th April, 2016, and approved by the board on 30th May 2016.
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.

Analysis:
In the given case, since R Ltd. was sued by a competitor for infringement of a trademark during the year 2015-16 for which the provision was also made by it, the decision of the Court on 18th May, 2016, for payment of the penalty will constitute as an adjusting event because it is an event occurred before approval of the financial statements.

Conclusion:
Therefore, R 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.

Mix Questions

Question 13.
Neel Limited has its corporate office in Mumbai and sells its products to stockists all over India. On 31st March, 2013, the company wants to recognize receipt of cheques bearing date 31st March, 2013 or before, as “Cheques in Hand” by reducing “Trade Receivables”. The “Cheques in Hand” ¡s shown in the Balance Sheet as an item of cash and cash equivalents. All cheques are presented to the bank in the month of April 2013 and are also realized in the same month in normal course after deposit in the bank. State with reasons, whether each of the following Is an adjusting event and how this fact is to be
disclosed by the company, with reference to the relevant accounting standard.
(i) Cheques collected by the marketing personnel of the company from the stockists on or before 31st March, 2013.
(ii) Cheques sent by the stockists through courier on or before 31st March,
2013. (May 2013) (4 Marks)
(i) Analysis:
Cheques collected by the marketing personnel of the company is an adjusting event as the marketing personnel are employees of the company and therefore, are representatives of the company. Handing over of cheques by the stockist to the marketing employees discharges the liability of the stockist. Therefore, cheques collected by the marketing personnel of the company on or before 31st March, 2013 require ad-justment from the stockists’ accounts i.e. from ‘Trade Receivables A/c’ even though these cheques (dated on or before 31st March, 2013) are presented in the bank in the month of April, 2013 in the normal course.

Conclusion:
Hence, collection of cheques by the marketing personnel is an adjusting event as per AS 4 ‘Contingencies and Events Occurring after the Balance Sheet Date’. Such ‘cheques in hand’ will be shown in the Balance Sheet as ‘Cash and Cash equivalents’ with a disclosure in the Notes to accounts about the accounting policy followed by the company for such cheques.

(ii) Analysis:
Even if the cheques bear the date 31st March or before and are sent by the stockists through courier on or before 31st March, 2013, it is presumed that the cheques will be received after 31st March. Collection of cheques after 31 st March, 2013 does not represent any condition existing on the balance sheet date i.e. 31st March.

Conclusion:
Thus, the collection of cheques after balance sheet date is not an adjusting event. Cheques that are received after the balance sheet date should be accounted for in the period in which they are received even though the same may be dated 31st March or before as per AS 4. Moreover, the collection of cheques after balance sheet date does not represent any material change affecting financial position of the enterprise, so no disclosure in the Director’s Report is necessary.

Question 14.
State with reasons, how the following events would be dealt with in the financial statements of Pradeep Ltd. for the year ended 31st March, 2013:
(i) An agreement to sell a land for 30 lakh to another company was entered into on 1st March, 2013. The value of land is shown at ₹ 20 lakh in the Balance Sheet as on 31st March, 2012. However, the Sale Deed was registered on 15th April, 2013.
(ii) The negotiation with another company for acquisition of its business was started on 2nd February, 2013. Pradeep Ltd. invested ₹ 40 lakh on 12th April, 2013. (Nov. 2013) (4 Marks)
(i) Analysis:
In the given case, sale of immovable property was carried out before the closure of the books of account. This is clearly an event occurring after the balance sheet date hut agreement to sell was effected on 1st March, 2013 i.e. before the balance sheet date. Registration of the sale deed on 15th April, 2013, simply provides additional information relating to the conditions existing at the balance sheet date.

Conclusion:
Therefore, adjustment to assets for sale of land is necessary in the financial statements of Pradeep Ltd. for the year ended 31st March, 2013.

(ii) Analysis:
The acquisition of another company is an event occurring after the balance sheet date. However, 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 31 st March, 2013.

Conclusion:
The investment of ₹ 40 lakhs in April, 2013 in the acquisition of another company should be disclosed in the report of the Board of Directors to enable users of financial statements to make proper evaluations and decisions.

Question 15.
With reference to AS 4 “Contingencies and events occurring after the balance sheet date”, state whether the following events will be treated as contingencies, adjusting events or non-adjusting events occurring after balance sheet date in case of a company which follows April to March as its financial year.
(i) A major fire has damaged the assets in a factory on 5th April, 5 days after the year end. However, the assets are fully insured and the books have not been approved by the Directors.
(ii) A suit against the company’s advertisement was filed by a party on 10th April, 10 days after the year end claiming damages of ₹ 20 lakhs.
(iii) It sends a proposal to purchase an immovable property for ₹ 30 lakhs in March. The book value of the property is ₹ 20 lakhs as on year end date. However, the deed was registered as on 15th April.
(iv) The terms and conditions for acquisition of business of another company have been decided by March end. But the financial resources were arranged in April and amount invested was ₹ 40 lakhs.
(v) Theft of cash of ₹ 2 lakhs by the cashier on 31 st March but was detected the next day after the financial statements have been approved by the Directors. (May 2016) (5 Marks)
(i) Analysis:
Fire has occurred after the balance sheet date and also the loss is totally insured.
Conclusion:
Thus, the event becomes immaterial and the event is non-adjusting in nature.

(ii) Analysis:
The contingency is restricted to conditions existing at the balance sheet date. However, in the given case, suit was hied against the company’s advertisement by a party on 10th April for amount of t 20 lakhs.
Conclusion:
Thus, it does not fit into the definition of a contingency and hence is a non-adjusting event.

(iii) Analysis:
In the given case, proposal for deal of immovable property was sent before the closure of the books of account.
Conclusion:
This is a non-adjusting event as only the proposal was sent and no agreement was effected in the month of March i.e. before the balance sheet date.

(iv) Analysis and conclusion:
As the term and conditions of acquisition of business of another com-pany had been decided by the end of March, acquisition of business is an adjusting event occurring after the balance sheet date.
Adjustment to assets and liabilities is required since the event affects the determination and the condition of the amounts stated in the financial statements for the financial year ended on 31st
March.

(v) Analysis and conclusion:
Since the financial statements have been approved before detection of theft by the cashier of ₹ 2,00,000, it becomes a non-adjusting event and no disclosure is required in the report of the Approving Authority.

Dividends (Based On Para No. 8.5)

Question 16.
The Board of Directors of M/s. New Graphics Ltd. in Its Board Meeting held on 18th April, 2017, considered and approved the Audited Financial results along with Auditors Report for the Financial Year ended 31st March, 2017 and recommended a dividend of 2 per equity share (on 2 crore fully paid up equity shares of 10 each) for the year ended 31st March, 2017 and if approved by the members at the forthcoming Annual General Meeting of the company on 18th June, 2017, the same will be paid to all the eligible shareholders.

Discuss on the accounting treatment and presentation of the said proposed dividend in the annual accounts of the company for the year ended 31st March, 2017 as per the applicable Accounting Standard and other Statutory Requirements. (May 2017) (5 Marks)
Analysis:
Dividends declared after the balance sheet date but before approval of financial statements are not recognized as a liability at the balance sheet date because no statutory obligation exists at that time. Hence such dividends are disclosed in the notes to financial statements.

No, provision for proposed dividends is not required to be made. Such proposed dividends are to be disclosed in the notes to financial statements.

Conclusion:
Accordingly, the dividend of ₹ 4 crores recommended by New Graphics Ltd. in its Board meeting on 18th April, 2017 shall not be accounted for in the books for the year 2016-17 irrespective of the fact that it pertains to the year 2016-17 and will be paid after approval in the Annual General Meeting of the members/shareholders.

Going Concern (Based On Para No. 8.6)

Question 17.
An earthquake destroyed a major warehouse of P Ltd. on 30.4.2014. The accounting year of the company ended on 31.3.2014. The accounts were approved on 30.6.2014. The loss from earthquake is estimated at ₹ 25 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. (RTP)
Para 8.3 of AS 4 Contingencies and Events Occurring after the Balance Sheet Date states that adjustments to assets and liabilüies 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.

Analysis:
The destruction of warehouse due to earthquake did not exist on the balance sheet date i.e. 3 1.3.2014. Therefore, loss occurred due to earthquake is not to bë recognised in the financial year 2013-14.

However, according to para 8.6 of 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.

Conclusion:
Therefore, fundamental accounting assumption of going concern is impacted. Hence, the fact of earthquake together with an estimated loss of ₹ 25 lakhs should be disclosed in the Report of the Directors for the financial year 2013-14.

Question 18.
The accounting year of Dee Limited ended on 31st March, 2018 but the accounts were approved on 30th April, 2018. On 15th April, 2018 a fire occurred in the factory and office premises. The loss by fire is of such a magnitude that it was not possible to expect the enterprise Dee Limited to start operation again.
State with reasons, whether the loss due to fire is an adjusting or non- adjusting event and how the fact of loss is to be disclosed by the company in the context of the provisions of AS 4 (Revised). (Nov. 2018) (5 Marks)
As per AS 4 (Revised) “Contingencies and Events occurring after the Balance Sheet Date”, an event occurring after the balance sheet date should be an adjusting event even if it does not reflect any condition existing on the balance sheet date, if the event is such as to indicate that the fundamental accounting assumption of going concern is no longer appropriate.

Analysis:
The fire occurred in the factory and office premises of an enterprise after 31st March, 2018 but before approval of financial statement of 30.4.2018. The loss by fire is of such a magnitude that it is not reasonable to expect the Dee Ltd. to start operations again, i.e., the going concern assumption is not valid. Since the fire occurred after 31/03/18, the loss on fire is not a result of any condition existing on 31/03 /18.

Conclusion:
Loss due to fire is an adjusting event the entire accounts need to be prepared on a liquidation basis with adequate disclosures by the company by way of note in its financial statements as under:

Draft Notes to Account:
“Major fire occurred in the factory and office premises on 15th April, 2018 which has made impossible for the enterprise to start operations again.
Therefore, the financial statements have been prepared on liquidation basis.”

AS 5
Net Profit Or Loss For The Period, Prior Period
Items And Changes In Accounting Policies

Extraordinary Items (Based On Para Nos. 4 And 8 To 11)

Question 1.
B Ltd. has a vacant land measuring 20,000 sq. mts., which it had no intention to use in the future. The Company decided to sell the land to tide over its liquidity problems and made a profit of ₹ 10 Lakhs by selling the said land. Moreover, there was a fire in the factory and a part of the unused factory shed valued at ₹ 8 Lakhs was destroyed. The loss from fire was set off against the profit from sale of land and profit of ₹ 2 lakhs was disclosed as net profit from sale of assets.
You are required to examine the treatment and disclosure done by the company and advise the company in line with AS 5. (RTP)
As per AS 5 “Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies” Extraordinary items should be disclosed in the statement of profit and loss as a part of net profit or loss for the period. The nature and the amount of each extraordinary item should be separately disclosed in the statement of profit and loss in a manner that its impact on current profit or loss can be perceived.

Analysis:
In the above case the selling of land to tide over liquidation problems as well as fire in the Factory does not constitute ordinary activities of the Company. These items are distinct from the ordinary activities of the business. Both the events are material in nature and expected not to recur frequently or regularly.
Thus, these are Extraordinary Items.

Conclusion:
Thus, disclosing net profits by setting off fire losses against profit from sale of land is not correct. The profit on sale of land, and loss due to fire should be disclosed separately in the statement of profit and loss.

Exceptional Items (Based On Para Nos. 12 To 14)

Question 2.
A company signed an agreement with the employees’ union on 01-092010 for revision of wages with retrospective effect from 01-04-2009. This would cost the company an additional liability of ₹ 10 lakhs per annum. Is a disclosure necessary for the amount paid in 2010-11? (May 2011) (4 Marks)
As per AS 5 (Revised), “Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies”, 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.

Analysis:
The revision of wages took place on 1st September, 2010 with retrospective effect from 1.4.2009. The arrear of wages payable for the period 01.4.2009 to 31.3.2010, cannot be taken as an error or omission in the preparation of financial statement and hence this expenditure cannot be taken as a prior period item. Additional wages liability of ₹ 20 lakhs should be included in current years’ wages.

Conclusion:
Additional wages are an expense arising from the ordinary activities of the company. Although abnormal in amount, such an expense does not qualify as an extraordinary item.
Accordingly, necessary disclosure should be made for the additional liability amounting ₹ 20 lakhs.

Question 3.
Tiger Motor Car Limited signed an agreement with its employee’s union for revision of wages on 01.07.2011. The revision of wages is with retrospective effect from 01.04.2008. The arrear wages up to 31.3.2011 amounts to ₹ 40,00,000 and that for the period from 01.04.2011 to 01.07.2011 amount to ₹ 3,50,000. In view of the provisions of AS 5 “Net Profit or Loss for the period, Prior Period Items and Changes in Accounting Policies”, decide whether a separate disclosure of arrear wages is required while preparing financial statements for the year ending 31.3.2012. (May 2012) (4 Marks)
As per para no. 12 of 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.

Analysis:
The revision of wages took place in July, 2011 with retrospective effect from 1.4.2008. The arrear wages payable for the period from 1.4.2008 to 31.3.2011 cannot be taken as an error or omission in the preparation of financial statements and hence this expenditure cannot be taken as a prior period item.
Additional wages liability of ₹ 40,00,000 (from 1.4.2008 to 31.3.2011) should be included in current year’s wages.

Conclusion:
Additional wages are an expense arising from the ordinary activities of the company. Although abnormal in amount, such an expense does not qualify as an extraordinary item. However, wages payable for the current year (from 1.4.2011 to 1.7.2011) amounting ₹ 3,50,000 is not a prior period item hence need not be disclosed separately. This may be shown as current year wages.

Prior Period Items (Based On Para Nos. 4 And 15 To 19)

Question 4.
The company finds that the inventory sheets of 31.3.2013 did not include two pages containing details of inventory worth ₹ 20 lakhs.
State, how you will deal with the above matter in the accounts of B Ltd. for the year ended 31st March, 2014 with reference to Accounting Standards. (RTP)
Paragraph 4 of Accounting Standard 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”.

Analysis and conclusion:
Rectification of error in inventory valuation is a prior period item vide provisions of AS 5. ₹ 20 lakhs must be added to the opening inventory of 1/4/2013. It is also necessary to show ₹ 20 lakhs as a prior period adjustment in the Profit and loss Account.
Separate disclosure of this item as a prior period item is required as per Para 15 of AS 5.

Question 5.
Goods of ₹ 5,00,000 were destroyed due to flood in September, 2015. A claim was lodged with insurance company, but no entry was passed in the books for insurance claim.
In March, 2018, the claim was passed and the company received a payment of ₹ 3,50,000 against the claim. Explain the treatment of such receipt in final accounts for the year ended 31st March, 2018. (RTP)
As per the provisions of AS 5 “Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies”, prior period items are income or expenses, which arise, in the current period as a result of error or omissions in the preparation of financial statements of one or more prior periods. Further, 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 current profit or loss can be perceived.

Analysis and conclusion:
In the above case, it is clearly a case of error in preparation of financial statements for the year 2015-16. Hence, claim received in the financial year 2017-18 is a prior period item and should be separately disclosed in the statement of Profit and Loss.

Changes In Accounting Policies (Based On Para Nos. 4 And 28 To 33)

Question 6.
G Ltd. had to pay delayed cotton clearing charges over and above the negotiated price for taking delayed delivery of cotton from the supplier’s godown. Upto 2010-11, the company has regularly included such charges in the valuation of closing stock. This charge, being in the nature of interest, the company has decided to exclude it from closing stock valuation. This would result in decrease of profit by ₹ 8.60 lakhs. What will be its treatment in the financial statements for the year ended 31st March, 2012? (RTP)
AS 5 (Revised) “Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies”states that a change in an accounting policy should be made only if:
(a) It is required by statute, or
(b) for compliance with an accounting standard, or
(c) if it is considered that the change would result in a more appropriate presentation of the financial statements of an enterprise.

Analysis:
The change in the method of stock valuation is justified in view of the fact that the change is in line with the recommendations of AS 2 (Revised) ‘Valuation of Inventories’ and would result in more appropriate preparation of the financial statements.

Conclusion:
Accordingly, cost formula used for inventory valuation will exclude the delayed clearing charges being in the nature of interest. Due to change in the cost formula, the value of inventory and resulting profit will decrease by ₹ 8.60 lakhs. Appropriate disclosures should be made in the financial statements for this change.

Question 7.
X Limited was making provisions up to 31-3-2012 for non-moving inventories based on no issues for the last 12 months. Based on a technical evaluation the company wants to make provisions during the year 31 -03-2013 in the following manner:
Total value of inventory ₹ 3 crores.
Provision required based on 12 months ₹ 8 lakhs.
Provision required based on technical evaluation ₹ 7.50 lakhs.
Does this amount to change in accounting policy?
Can the company change the method of provision? (RTP)
As per AS 5, due to uncertainties inherent in business activities, many financial statement items cannot be measured with precision but can only be estimated. The estimation process involves judgments based on the latest information available. An estimate may have to be revised if changes occur regarding the circumstances on which the estimate was based, or as a result of new information, more experience or subsequent developments.

Analysis and conclusion:
Basis of provisioning whether on no issues or on technical evaluation is the basis of making estimates and cannot be considered as Accounting Policy. The basis of change in provisioning is a guideline and the better way of estimating the provision for non-moving inventory on account of change. Hence, it is not a change in accounting policy. Accounting policy is the valuation of inventory on cost or on net realizable value or on lower of cost or net realizable value. Any interchange of this valuation base would have constituted change in accounting policy.

Question 8.
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 organization? (RTP)
As per para 31 of 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.

Analysis and conclusion:

(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) Also, 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.

Question 9.
The Accountant of Mobile Limited has sought your opinion with relevant reasons, whether the following transactions will be treated as change in Accounting Policy or not for the year ended 31st March, 2017. Please advise him in the following situations in accordance with the provisions of relevant Accounting Standard:
(i) Provision for doubtful debts was created @ 2% till 31st March, 2016. From the Financial year 2016-17, the rate of provision has been changed to 3%.
(ii) During the year ended 31st March, 2017, the management has introduced a formal gratuity scheme in place of ad-hoc ex-gratia payments to employees on retirement.
(iii) Till the previous year the furniture was depreciated on straight line basis over a period of 5 years. From current year, the useful life of furniture has been changed to 3 years.
(iv) Management decided to pay pension to those employees who have retired after completing 5 years of service in the organization. Such employees will get pension of 20,000 per month. Earlier there was no such scheme of pension in the organization.
(v) During the year ended 31st March, 2017, there was change in cost formula in measuring the cost of inventories. (Nov. 2017) (5 Marks)
(i) Analysis:
In the given case, Mobile limited created 2% provision for doubtful debts till 31st March, 2016. Subsequently in 2016-17, the company revised the estimates based on the changed circumstances and wants to create 3% provision.

Conclusion:
Therefore, change in rate of provision of doubtful debt is change in estimate and is not change in accounting policy. This change will affect only current year.
As per AS 5, the adoption of an accounting policy for events or transactions that differ in substance from previously occurring events or transactions, will not be considered as a change in accounting policy.

Analysis and conclusion:
Introduction of a formal retirement gratuity scheme by an employer in place of ad hoc ex-gratia payments to employees on retirement is a transaction which is substantially different from the previous policy, will not be treated as change in an accounting policy.

(iii) Analysis and conclusion:
Change in useful life of furniture from 5 years to 3 years is a change in estimate and is not a change in accounting policy.

(iv) Analysis:
Adoption of a new accounting policy for events or transactions which did not occur previously should not be treated as a change in an accounting policy.

Conclusion:
Thus, introduction of new pension scheme is not a change in accounting policy.

(v) Analysis and conclusion:
Change in cost formula used in measurement of cost of inventories is a change in accounting policy.

Changes In Accounting Estimates (Based On Para Nos. 20 To 27)

Question 10.
Closing stock for the year ending on 31.3.2010 is ₹ 50,000 which includes stock damaged in a fire in 2008-09. On 31.3.2009, the estimated net realisable value of the damaged stock was ₹ 12,000. The revised estimate of net realisable value of damaged goods amounting ₹ 4,000 has been included in closing stock of ₹ 50,000 as on 31.3.2010.
Find the value of closing stock to be shown in Profit and Loss account for the year 2009-10. (Nov. 2009) (2 Marks)
As per AS 5 ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies the effect of a change in accounting estimate should be classified using the same classification in the statement of profit and loss as was used previously for the estimate.

Analysis:
The fall in estimated net realisable value of damaged stock ₹ 8,000 is the effect of change in accounting estimate.

Conclusion:
Thus, the value of closing stock for the year 2009-10 will be as follows:

Question 11.
Closing stock for the year ending on 31.3.2010 is ₹ 50,000 which includes stock damaged in a fire in 2008-09. On 31.3.2009, the estimated net realisable value of the damaged stock was ₹ 12,000. The revised estimate of net realisable value of damaged goods amounting ₹ 4,000 has been included in closing stock of ₹ 50,000 as on 31.3.2010.
Find the value of closing stock to be shown in Profit and Loss account for the year 2009-10.
(May 2010) (2 Marks)
As per AS 5 ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies the effect of a change in accounting estimate should be classified using the same classification in the statement of profit and loss as was used previously for the estimate.

Analysis:
The fall in estimated net realisable value of damaged stock ₹ 8,000 is the effect of change in accounting estimate.

Conclusion:
Thus, the value of closing stock for the year 2009-10 will be as follows:

Question 12.
Closing Stock for the year ending on 31st March, 2013 is ₹ 1,50,000 which includes stock damaged in a fire in 2011 -12. On 31 st March, 2012, the estimated net realizable value of the damaged stock was ₹ 12,000. The revised estimate of net realizable value of damaged stock included in closing stock at 2012-13 is ₹ 4,000. Find the value of closing stock to be shown in Profit and Loss Account for the year 2012-13, using provisions of Accounting Standard 5. (May 2013) (5 Marks)
As per para 25 of AS 5 ‘Net Profit or Loss the Period, Prior Period Items and Changes in Accounting Policies’, the effect of a change in accounting estimate should be classified using the same classification in the statement of profit and loss as was used previously for the estimate.

Analysis:
The fall in estimated net realisable value of damaged stock ₹ 8,000 is the effect of change in accounting estimate. It is presumed that the loss by fire in the year ended 31.3.2012, i.e. difference of cost and NRV was shown in the profit and loss account as an extraordinary item.

Conclusion:
Therefore, in the year 2012-13, revision in accounting estimate should also be classified as extraordinary item in the profit and loss account and closing stock should be shown excluding the value of damaged stock.

Value of closing stock for the year 2012-13 will be as follows:

Question 13.
HIL Ltd. was making provision for non-moving stocks based on no issues having occurred for the last 12 months upto 31.03.2017. The company now wants to make provision based on technical evaluation during the year ending 31.03.2018.
Total value of stock ₹ 120 lakhs
Provision required based on technical evaluation ₹ 3.00 lakhs.
Provision required based on 12 months no issues ₹ 4.00 lakhs.
You are requested to discuss the following points in the light of Accounting Standard (AS)-1:
(i) Does this amount to change in accounting policy?
(ii) Can the company change the method of accounting? (Nov. 2018) (5 Marks)
Analysis:
The decision of making provision for non-moving inventories on the basis of technical evaluation does not amount to change in accounting policy. Accounting policy of a company may require that provision for non-moving inventories should be made but the basis for making provision will not constitute accounting policy. The method of estimating the amount of provision may be changed in case a more prudent estimate can be made.

In the given case, considering the total value of inventory, the change in the amount of required provision of non-moving inventory from ₹ 4 lakhs to ₹ 3 lakhs are also not material.

The disclosure can be made for such change in the notes to the accounts for the year 2017-18 as under:

“The company has provided for non-moving inventories on the basis of technical evaluation unlike preceding years. Had the same method been followed as in the previous year, the profit for the year and the value of net assets at the end of the year would have been lower by ₹ 1 lakh.”

Mix Questions [Prior Period Items; Changes In Accounting Polices; Changes In Accounting Estimates; Extraordinary Items; Exceptional Items]

Question 14.
(i) Goods worth ₹ 5,00,000 were destroyed due to flood in September, 2006. A claim was lodged with insurance company. But no entry was passed in the books for insurance claim in the financial year 2006-07. In March, 2008, the claim was passed and the company received a payment of ₹ 3,50,000 against the claim. Explain the treatment of such receipt in final accounts for the year ended 31st March, 2008.
(ii) A company created a provision of ₹ 75,000 for staff welfare while pre-paring the financial statements for the year 2007-08. On 31st March, in a meeting with staff welfare association, it was decided to increase the amount of provision for staff welfare to ₹ 1,00,000. The accounts were approved by Board of Directors on 15th April, 2008.
Explain the treatment of such revision in financial statements for the year ended 31st March, 2008.
(Nov. 2009) (2 × 2 = 4 Marks)
(i) As per the provisions, of AS 5 “Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies”, prior period items are income or expenses, which arise in the current period as a result of error or omissions in the preparation of financial statements of one or more prior periods. Further, the nature and amount of prior period items should be separately disclosed in the statement of profit and loss.

Analysis and conclusion:
It is clearly a case of error in preparation of financial statements for the financial year 2006-07. Hence claim received in the financial year 2007-08 is a prior period item and should be separately disclosed in the statement of profit and loss for the year ended 31st March, 2008.

(ii) As per AS 5, normally, all items of income and expense which are rec-ognised in a period are included in the determination of the net profit or loss for the period. This includes extraordinary items and the effects of changes in accounting estimates. However, the effect of such change in accounting estimate should be classified using the same classification in the statement of profit and loss, as was used previously, for the estimate.

Analysis and conclusion:
The change in amount of staff welfare provision amounting ₹ 25,000 is neither a prior period item nor an extraordinary item. It is a change in estimate, which has been occurred in the year 2007-2008.

Question 15.
Give two examples on each of the following items:
(i) Change in Accounting Policy
(ii) Change in Accounting Estimate
(iii) Extraordinary Items
(iv) Prior Period Items. (Nov. 2012) (4 Marks)
(i) Examples of Changes in Accounting Policy:
(a) Change of depreciation method from WD V to SLM and vice-versa.
(b) Change in cost formula in measuring the cost of inventories.
(ii) Examples of Changes in Accounting Estimates:
(a) Change in estimate of provision for doubtful debts on sundry debtors.
(b) Change in estimate of useful life of fixed assets.
(iii) Examples of Extraordinary items:
(a) Loss due to earthquakes/fire/strike
(b) Attachment of property of the enterprise by government
(iv) Examples of Prior period items:
(a) Applying incorrect rate of depreciation in one or more prior pe-riods.
(b) Omission to account for income or expenditure in one or more prior periods.

Question 16.
Give two examples of each of the following items:
(i) Change in Accounting Policy
(ii) Change in Accounting Estimate
(iii) Extraordinary Items
(iv) Prior Period Item (Nov. 2014) (4 Marks)
(i) Examples of Changes in Accounting Policy:
(a) Change of depreciation method from WD V to SLM and vice-versa.
(b) Change in cost formula in measuring the cost of inventories.

(ii) Examples of Changes in Accounting Estimates:
(a) Change in estimate of provision for doubtful debts on sundry debtors.
(b) Change in estimate of useful life of fixed assets.

(iii) Examples of Extraordinary items:
(a) Loss due to earthquakes/fire/strike
(b) Attachment of property of the enterprise by government

(iv) Examples of Prior period items:
(a) Applying incorrect rate of depreciation in one or more prior pe-riods.
(b) Omission to account for income or expenditure in one or more prior periods.

Question 17.
PQR Ltd. is in the process of finalizing its accounts for the year ended 31st March, 2018. The company seeks your advice on the following:
(i) Goods worth ₹ 5,00,000 were destroyed due to flood in September, 2015. A claim was lodged with insurance company. But no entry was passed in the books for insurance claim in the financial year 2015-16. In March, 2018, the claim was passed and the company received a payment of ₹ 3,50,000 against the claim. Explain the treatment of such receipt in final account for the year ended 31st March, 2018.
(ii) Company created a provision for bad and doubtful debts at 2.5% on debtors in preparing the financial statements for the year 2017-18. Subsequently, on a review of the credit period allowed and financial capacity of the customers, the company decides to increase the provision to 8% on debtors as on 31.03.2018. The accounts were not approved by the Board of Directors till the date of decision. While applying the relevant accounting standard, can this revision be considered as an extraordinary item or prior period item? (May 2018) (5 Marks)
(i) As per the provisions of AS 5 “Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies”, prior period items are income or expenses, which arise, in the current period as a result of error or omissions in the preparation of financial statements of one or more prior periods. Further, the nature and amount of prior period items should he separately disclosed in the statement of profit and loss in a manner that their impact on current profit or loss can be perceived.
Analysis:
It is clearly a case of error/omission in preparation of financial statements for the year 2015-16.
Conclusion:
Hence, claim received in the financial year 2017-18 is a prior period item and should be separately disclosed in the statement of Profit and Loss.

(ii) Analysis:
The company created 2.5% provision for doubtful debts for the year 2017-18. Subsequently, the company revised the estimates based on the changed circumstances and wants to create 8% provision.

Conclusion:
As per AS 5, the revision in rate of provision for doubtful debts will be considered as change in estimate and is neither a prior period item nor an extraordinary item.
The effect of such change should be shown in the profit and loss account for the year ending 31st March, 2018.

As 7
Construction Contracts
Combining And Segmenting Construction Contracts (Based On Para Nos. 6 To 9)

Question 1.
GTI Ltd. negotiates with Bharat Oil Corporation Ltd. (BOCL), for construction of ‘Retail Petrol & Diesel Outlet Stations’. Based on proposals submitted to different Regional Offices of BOCL, the final approval for one outlet each in Region X, Region Y, Region Z is awarded to GTI Ltd. A single agreement is entered into between two. The agreement lays down values for each of the three outlets i.e. ₹ 102 lacs, ₹ 150 lacs, ₹ 130 lacs for Region X, Region Y, Region Z respectively. Agreement also lays down completion time for each Region.
Comment whether GTI Ltd. will treat it as single contract or three separate contracts with reference to AS-7? (Nov 2016) (5 Marks)
As per AS 7 ‘Construction Contracts’, when a contract covers 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.

Analysis : In the given case, each outlet is submitted as a separate proposal to different Zonal Offices, which can be separately negotiated, and costs and revenues thereof can be separately identified. Hence, each asset will be treated as a ‘single contract’ even if there is one single agreement for contracts.

Conclusion : Therefore, three separate contract accounts must be recorded and maintained in the books of GTI Ltd. For each contract, principles of revenue and cost recognition must be applied separately and net income will be determined for each asset as per AS 7.

Contract Revenue (Based On Para Nos. 10 To 14)

Question 2.
Mr. ‘M’ as a contractor has just entered into a contract with a local municipal body for building a flyover. As per the contract terms, Mr. ‘M’ will receive an additional ₹ 2 crore if the construction of the flyover were to be finished within a period of two years of the commencement of the contract. Mr. ‘M’ wants to recognize this revenue since in the past he has been able to meet similar targets very easily.
Is Mr. ‘M’ correct in his proposal? Discuss.
According to para 14 of AS 7 (Revised) ‘Construction Contracts’, incentive payments are additional amounts payable to the contractor if specified performance standards are met or exceeded. For example, a contract may allow for an incentive payment to the contractor for early completion of the contract. Incentive payments are included in contract revenue when:

1. the contract is sufficiently advanced that it is probable that the specified performance standards will be met or exceeded; and
2. the amount of the incentive payment can be measured reliably.

Analysis & Conclusion : In the given problem, the contract has not even begun and hence the contractor (Mr. M) should not recognize any revenue of this contract.

Contract Costs (Based On Para Nos. 15 To 20)

Question 3.
Explain contract costs as per Accounting Standard 7 related to ‘Construction Contracts’. {Nov 2009) (2 Marks)
As per para 15 of AS 7 ‘Construction Contracts (revised 2002)’, contract cost should comprise:
(a) costs that relate directly to the specific contract;
(b) costs that are attributable to contract activity in general and can be allocated to the contract; and
(c) such other costs as are specifically chargeable to the customer under the terms of the contract

Recognition Of Contract Revenue And Expenses (Based On Para Nos. 21 To 34)

Question 4.
M/s Excellent Construction Company Limited under took a contract to construct a building for ₹ 3 crore on 1st September, 2011. On 31st March, 2012 the company found that it had already spent ₹ 1 crore 80 lakhs on the construction. Prudent estimate of additional cost for completion was ₹ 1 crore 40 lakhs. What amount should be charged, to revenue in the final accounts for the year ended on 31st March, 2012, as per the provisions of Accounting Standard 7 ‘Construction Contracts (Revised)’?
(May 2012) (5 Marks)
Computation of Estimated Cost of Construction

Percentage of completion of contract till date to total estimated cost of construction
= ₹ (1.80/3.20) × 100 = 56.2596
Proportion of total contract value recognised as revenue as per AS 7 (Revised) = Contract price x percentage of completion = ₹ 3 crores × 56.25% = ₹ 1.6875 crores

Question 5.
An amount of ₹ 9,90,000 was incurred on a contract work upto 31-3-2010. Certificates have been received to date to the value of ₹ 12,00,000 against which ₹ 10,80,000 has been received in cash. The cost of work done but not certified amounted to ₹ 22,500. It is estimated that by spending an additional amount of ₹ 60,000 (including provision for contingencies) the work can be completed in all respects in another two months. The agreed contract price of work is ₹ 12,50,000. Compute a conservative estimate of the profit to be taken to the Profit and Loss Account as per AS 7. (Nov. 2010) (4 Marks)
Analysis Computation of estimate of profit as per AS 7

Computation of estimate of the profit to be taken to Profit and Loss Account:

According to para 21 of AS 7 ‘Construction Contracts’, when the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract should be recognised as revenue and expenses respectively by reference to stage of completion of the contract activity at the reporting date.
Conclusion: Thus estimated profit amounting ₹ 1,88,571 should be recognised as revenue in the statement of profit and loss.

Question 6.
Uday Constructions undertake to construct abridge for the Government of Uttar Pradesh. The construction commenced during the financial year ending 31.03.2016 and is likely to be completed by the next financial year. The contract is for a fixed price of ₹ 12 crores with an escalation clause. The costs to complete the whole contract are estimated at ₹ 9.50 crores of rupees. You are-given the following information for the year ended 31.03.2016:
Cost incurred upto 31.03.2016 ₹ 4 crores
Cost estimated to complete the contract ₹ 6 crores
Escalation in cost by 5% and accordingly the contract price is increased by 5%.
You are required to ascertain the state of completion and state the revenue and profit to be recognized for the year as per AS-7. (May 2016) (5 Marks)

Stage of completion
Percentage of completion till date to total estimated cost of construction
= (4/10) × 100 = 40%
Revenue and Profit to be recognized for the year ended 31st March, 2016 as per AS 7
Proportion of total contract value recognized as revenue = Contract price x percentage of completion
= ₹ 12.60 crore × 40% = ₹ 5.04 crore
Profit for the year ended 31st March, 2016 = ₹ 5.04 crore less ₹ 4 crore = 1.04 crore

Recognition Of Expected Losses (Based On Para Nos. 35 And 36)

Question 7.
P & Sons Ltd. are Heavy Engineering contractors specializing in construction of dams. From the records of the company, the following data is available pertaining to year ended on 31st March, 2014. Using this data and applying the relevant Accounting Standard you are required to:
(i) Compute the amount of profit/loss for the year ended 31st March, 2014.
(ii) Arrive at the contract work in progress (cost incurred till date) as at the end of financial year 2013-14.
(iii) Determine the amount of revenue to be recognized out of the total contract value.

According to para 35 of AS 7 (Revised 2002) ‘Construction Contracts’, when it is probable that total contract costs will exceed total contract revenue, the expected loss should be recognized as an expense immediately.

(iii) Proportion of total contract value recognised as revenue
Percentage of completion of contract to total estimated cost of construction
= (1,500/3,250) × 100 = 46.15%
Revenue to be recognized till date = 46.15% of ₹ 2,400 crores = ₹ 1,107.60 crores.

Question 8.
From the following data, show Profit and Loss A/c (Extract) as would appear in the books of a contractor following Accounting Standard 7:

(Nov 2011) (4 Marks)
Analysis:
Computation of Estimated Total Cost

Percentage of completion (300/500) × 100 = 60%
Revenue recognised as a percentage to contract price
= 60% of ₹ 480 lakhs = ₹ 288 lakhs
As per para 35 of AS 7 ‘Construction Contracts’, when it is probable that total contract costs will exceed total contract revenue, the expected loss shoidd be recognised as an expense immediately.

Conclusion : Accordingly, expenses to be recognized in the Profit and Loss Account will be computed as under :

Profit and Loss A/c (An Extract)

Question 9.
M/s Highway. Constructions undertook the construction of a highway on 01.04.2013. The contract was to be completed in 2 years. The contract price was estimated at ₹ 150 crores. Up to 31.03.2014 the company incurred ₹ 120 crores on the construction. The engineers involved in the project estimated that a further ₹ 45 crores would be incurred for completing the work.
What amount should be charged to revenue for the year 2013-14 as per the provisions of Accounting Standard 7 ‘Construction Contracts’? Show the extract of the Profit & Loss A/c in the books of M/s. Highway Constructions. (May 2014) (5 Marks)
Statement showing computation of amount to be reorgnised as Revetiue as per AS 7

Profit and Loss Account (Extract)

Question 10.
Akar Ltd. Signed on 01/04/16, a construction contract for ₹ 1,50,00,000. Following particulars are extracted in respect of contract, for the period ending 31/03/17.

• Materials issued ₹ 75,00,000
• Labour charges paid ₹ 36,00,000
• Hire charges of plant ₹ 10,00,000
• Other contract cost incurred ₹ 15,00,000
• Out of material issued, material lying unused at the end of period is ₹ 4,00,000
• Labour charges of ₹ 2,00,000 are still outstanding on 31.3.17.
• 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 to be taken to Profit & Loss Account and additional provision for foreseeable loss as per AS 7. (May 2017) (5 Marks)
Statement showing the amount of profit/loss to be taken to Profit and Loss Account

W note : Unused material amounting ₹ 4,00,000 is considered to be included in amount of ₹ 33,50,000 (estimated future cost).

Question 11.
Sarita Construction Co. obtained a contract for construction of a dam. The following details are available in records of company for the year ended 31st March, 2018:

Applying the provisions of Accounting Standard 7 ‘Accounting for Construction Contracts’ you are required to compute:
(i) Profit/Loss for the year ended 31st March, 2018.
(ii) Contract work in progress as at end of financial year 2017-18.
(iii) Revenue to be recognized out of the total contract value.
(iv) Amount due from/to customers as at the year end. (May 2018 – New Course) (5 Marks)

According to AS 7, when it is probable that total contract costs will exceed total contract revenue, the expected loss should be recognised as an expense immediately.
Loss for the year ended, 31 st March, 2018 amounting ₹ 4,250 will be recognized.

(iii) Revenue to be recognised
Cost incurred till 31.3.18 is 46.15% (7,500/16,250 × 100) of total costs of construction.
Proportion of total contract value recognised as revenue:
46.15% of ₹ 12,000 lakhs = ₹ 5,538 lakhs
(iv) Amount due from/to customers at year end
(Contract costs + Recognised profits – Recognised Losses) – (Progress payments received + Progress payments to be received)
= (7,500 + Nil – 4,250) – (5,500 + 1,500) ₹ in lakhs
= [3,250 – 7,000] 7 in lakhs
Amount due to customers = ₹ 3,750 lakhs

Disclosure (Based On Para Nos. 38 To 43)

Question 12.
A firm of contractors obtained a contract for construction of bridges across river Yamuna. The following details are available in the records kept for the year ended 31st March, 2017.

The firm seeks your advice and assistance in the presentation of accounts keeping in view the requirements of AS 7 issued by your institute.

According AS 7, when it is probable that total contract costs will exceed total contract revenue, the expected loss should be recognised as an expense immediately.

This is 55% (605/1,100 × 100) of total costs of construction.

(c) Proportion of total contract value recognised as revenue:
55% of ₹ 1,000 lakhs = ₹ 550 lakhs

(d) Amount due from/to customers = (Contract costs + Recognised profits – Recognised 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.
(e) The relevant disclosures under AS 7 are given below:

As 9
Revenue Recognition
Sale Of Goods (Based On Para Nos. 6 And 11)

Question 1.
According to Accounting Standard 9, when revenue from sales should be recognised? (May 2010) (2 Marks)
As per para 11 of AS 9 ‘Revenue Recognition’, revenue from sales should be recognised only when requirements as to performance are satisfied provided that at the time of performance it is not unreasonable to expect ultimate collection. These requirements can be given as follows:

1. 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
2. no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods.

Question 2.
M/s. Moon Ltd. sold goods worth ₹ 6,50,000 to Mr. Star. Mr. Star asked for a trade discount amounting to ₹ 53,000 and same was agreed to by M/s. Moon Ltd. The sale was effected and goods were dispatched. On receipt of goods, Mr. Star has found that goods worth ₹ 67,000 are defective. Mr. Star returned defective goods to M/s. Moon Ltd. and made payment due amounting to ₹ 5,30,000. The accountant of M/s. Moon Ltd. booked the sale for ₹ 5,30,000. Discuss the contention of the accountant with reference to Accounting Standard (AS) 9. (May 2013) (4 Marks)
As per AS 9 Revenue Recognition’, revenue is the gross inflow of cash, receivable or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods. However, trade discounts and volume rebates given in the ordinary course of business should be deducted in determining revenue. Revenue from sales should be recognized at the time of transfer of significant risks and rewards. If the delivery of the sales is not subject to approval from customers, then the transfer of significant risks and rewards would take place when the sale is affected and goods are dispatched.

Analysis : In the given case, if trade discounts allowed by M/s. Moon Ltd. are given in the ordinary course of business, M/s. Moon Ltd. should record the sales at ₹ 5,97,000 (ie. ₹ 6,50,000 – ₹ 53,000) and goods returned worth ₹ 67,000 are to be recorded in the form of sales return. However, when trade discount allowed by M/s. Moon Ltd. is not in the ordinary course of business, M/s. Moon Ltd. should record the sales at gross value of ₹ 6,50,000. Discount of ₹ 53,000 in price and return of goods worth ₹ 67,000 are to be adjusted by suitable provisions. M/s Moon Ltd. might have sent the credit note of ₹ 1,20,000 to Mr. Star to account for these adjustments.

Conclusion : In both the cases, the contention of the accountant to book the sales for ₹ 5,30,000 is not correct.

Question 3.
A Ltd. entered into a contract with B Ltd. to despatch goods valuing ₹ 25,000 every month for 4 months upon receipt of entire payment. B Ltd. accordingly made the payment of ₹ 1,00,000 and A Ltd. started despatching the goods. In third month, due to a natural calamity, B Ltd. requested A Ltd. not to despatch goods until further notice though A Ltd. is holding the remaining goods worth ₹ 50,000 ready for despatch. A Ltd. accounted ₹ 50,000 as sales and transferred the balance to Advance Received against Sales. Comment upon the treatment of balance amount with reference to the provisions of Accounting Standard 9. (Nov 2013) (5 Marks)
As per para 11 of AS 9 ‘Revenue Recognition’, in a transaction involving the sale of goods, performance should he regarded as being achieved when the following conditions are fulfilled:

1. 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
2. no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods.

Analysis: In the given case, transfer of property in goods results in or coincides with the transfer of significant risks and rewards of ownership to the buyer. Also, the sale price has been recovered by the seller. Hence, the sale is complete but delivery has been postponed at buyer’s request.

Conclusion : A Ltd. should recognize the entire sale of ₹ 1,00,000 (₹ 25,000 × 4) and no part of the same is to be treated as Advance Receipt against Sales.

Question 4.
Given the following information of M/s. Paper Products Ltd.
(i) Goods of ₹ 60,000 were sold on 2Question 3-2015 but at the request of the buyer these were delivered on 10-4-2015.
(ii) On 15-1-2015 goods of ₹ 1,50,000 were sent on consignment basis of which 20% of the goods unsold are lying with the consignee as on 313-2015.
(iii) ₹ 1,20,000 worth of goods were sold on approval basis on 1-12-2014. The period of approval was 3 months after which they were considered sold. Buyer sent approval for 75% goods up to 31-1-2015 and no approval or disapproval received for the remaining goods till 31-3-2015.
(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 M/s. Paper Products Ltd., with valid reasons, the amount to be recognized as revenue in above cases in the context of AS-9 and also determine the total revenue to be recognized for the year ending 31-3-2015. (May 2015) (4 Marks)
As per Para 11 of 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:

1. 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
2. no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods.

Analysis & Conclusion :

In case (i):

Analysis : The sale is complete but delivery has been postponed at buyer’s request.
Conclusion : M/s Paper Products Ltd. should recognize the entire sale of ₹ 60,000 for the year ended 31st March, 2015.

In case (ii):

Analysis: 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).

Conclusion : In case of consignment sale revenue should not be recognized until the goods are sold to a third party.

In case (iii):

Analysis : 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.

Conclusion: Therefore, in case (iii) revenue should be recognized for the total sales amounting ₹ 1,20,000 as the time period for rejecting the goods had expired.

In case (iv):

Analysis : Trade discounts given should be deducted in determining revenue.

Conclusion : 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.
Thus total revenue amounting ₹ 10,41,000 (60,000 + 1,20,000 + 1,20,000 + 7,41,000) will be recognized for the year ended 31st March, 2015 in the books of M/ s Paper Products Ltd.

Question 5.
A manufacturing company has the following stages of production and sale in manufacturing Fine paper rolls:

Explain the stage on which you think revenue will be generated and state how much would be net profit for year ending 31.3.16 on this product according to AS-9. (Nov 2016) (5 Marks)
According to AS 9 ‘Revenue Recognition’, in a transaction involving the sale of goods, performance should be regarded as being achieved when the following conditions have been fulfilled:

1. 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
2. no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods.

Analysis : Thus, sales will be recognized only when following two conditions are satisfied:

1. The sale value is fixed and determinable.
2. Property of the goods is transferred to the customer.

Conclusion : Both these conditions are satisfied only on 15.3.2016 when sales are agreed upon at a price and goods are allocated for delivery purpose through invoice. The amount of net profit ₹ 1,50,000 (3,50,000 – 2,00,000) would be recognized in the books for the year ending 31st March, 2016.

Question 6.
Raj Ltd. entered into an agreement with Heena Ltd. to dispatch goods valuing ₹ 5,00,000 every month for next 6 months on receipt of entire payment. Heena Ltd. accordingly made the entire payment of ₹ 30,00,000 and Raj Ltd. started dispatching the goods. In fourth month, due to fire in premise of Heena Ltd., Heena Ltd. requested to Raj Ltd. not to dispatch goods worth ₹ 15,00,000 ready for dispatch. Raj Ltd. accounted ₹ 15,00,000 as sales and transferred the balance to Advance received against Sales account.
Comment upon the above treatment by Raj Ltd. With reference to the provision of AS 9. (May 2017) (5 Marks)
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:

1. 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
2. no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods.

Analysis: In the given case, transfer of property in goods results in or coincides with the transfer of significant risks and rewards of ownership to the buyer. Also, the sale price has been recovered by the seller. Hence, the sale is complete but delivery has been postponed at buyer’s request.

Conclusion: Raj Ltd. should recognize the entire sale of ₹ 30,00,000 (5,00,000 × 6) and no part of the same is to be treated as Advance Received against Sales.

Question 7.
Fashion Limited is engaged in manufacturing of readymade garments. They provide you the following information on 31st March, 2011:
(i) On 15th January, 2017 garments worth ₹ 4,00,000 were sent to Anand on consignment basis of which 25% garments unsold were lying with Anand as on 31st March, 2017.
(ii) Garments worth ₹ 1,95,000 were sold to Shine boutique on 25th March, 2017 but at the request of Shine Boutique, these were delivered on 15th April, 2017.
(iii) On 1st November, 2016 garments worth ₹ 2,50,000 were sold on ap-proval basis. The period of approval was 4 months after which they were considered sold. Buyer sent approval for 75% goods up to 31st December, 2016 and no approval or disapproval received for the re-maining goods till 31st March, 2017.

You are required to advise the accountant of Fashion Limited, the amount to be recognised as revenue in above cases in the context of AS 9. (Nov 2017) (5 Marks)
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:

1. 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
2. no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods.

Case (i):
Analysis: 25% goods lying unsold with consignee should be treated as closing inventory and sales should be recognized for ₹ 3,00,000 (75% of ₹ 4,00,000) for the year ended on 31.3.17.
Conclusion : In case of consignment sale, revenue should not be recognized until the goods are sold to a third party.

Case (ii):
Analysis : The sale is complete but delivery has been postponed at buyer’s request.
Conclusion: Fashion Ltd. should recognize the entire sale of ₹ 1,95,000 for the year ended 31st March, 2017.

Case (iii):
Analysis : 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 accepting the transaction or the time period for rejection has elapsed or where no time has been fixed, a reasonable time has elapsed.

Conclusion : Therefore, revenue should be recognized for the total sales amounting ₹ 2,50,000 as the time period for rejecting the goods had expired.
Thus total revenue amounting ₹ 7,45,000 (3,00,000 + 1,95,000 + 2,50,000) will be recognized for the year ended 31 st March, 2017 in the books of Fashion Ltd.

Rendering Of Services (Based On Para Nos. 7 And 12)

Question 8.
Sarita Publications publishes a monthly magazine on the 15th of every month. It sells advertising space in the magazine to advertisers on the terms of 80% sale value payable in advance and the balance within 30 days of the release of the publication. The sale of space for the March 2014 issue was made in February 2014. The magazine was published on its scheduled date. It received ₹ 2,40,000 on 10.3.2014 and ₹ 60,000 on 10.4.2014 for the March 2014 issue.

Discuss in the context of AS 9 the amount of revenue to be recognized and the treatment of the amount received from advertisers for the year ending 31.3.2014. What will be the treatment if the publication is delayed till 2.4.2014? (Nov. 2014) (5 Marks)
As per AS 9 ‘Revenue Recognition’, in a transaction involving the rendering of services, performance should be measured either under the completed service contract method or under the proportionate completion method as the service is performed, whichever relates the revenue to the work accomplished.

Analysis : In the given case, income accrues when the related advertisement appears before public. The advertisement service would be considered as performed on the day the advertisement is seen by public and hence revenue is recognized on that date. In this case, it is 15.03.2014, the date of publication of the magazine.

Conclusion : Hence, ₹ 3,00,000 (₹ 2,40,000 + ₹ 60,000) is recognized as income in March, 2014. The terms of payment are not relevant for considering the date on which revenue is to be recognized. ₹ 60,000 is treated as amount due from advertisers as on 31.03.2014 and ₹ 2,40,000 will be treated as payment received against the sale.

Note :
However, if the publication is delayed till 02.04.2014 revenue recognition will also be delayed till the advertisements get published in the magazine. In that case revenue of ₹ 3,00,000 will be recognized for the year ended 31.03.2015 after the magazine is published on 02.04.2014. The amount received from sale of advertising space on 10.03.2014 of ₹ 2,40,000 will be considered as an advance from advertisers as on 31.03.2014.

Interest, Royalties And Dividends (Based On Para Nos. 8 And 13)

Question 9.
R Ltd. sold goods through its agent. As per terms of sales, consideration is payable within one month. In the event of delay in payment, interest is chargeable @ 10% p.a. from the agent. The company has not realized interest from the agent in the past. For the year ended 31st March, 2017 interest due from agent (because of delay in payment) amounts to ₹ 5 lakhs. The accountant of R Ltd. booked ₹ 5 lakhs as interest income in the year ended 31st March, 2017.
Examine and discuss the contention of the accountant with reference to AS 9 ‘Revenue Recognition’.
As per AS 9 ‘Revenue Recognition ’, ‘where the ability to assess the ultimate collection with reasoriable certainty is lacking at the time of raising any claim, the revenue recognition is postponed to the extent of uncertainty involved. In such cases, the revenue is recognized only when it is reasonably certain that the ultimate collection will be made’.

Analysis : In this case, the company never realized interest for the delayed payments made by the agent. Hence, based on the past experience, the realization of interest for the delayed payments by the agent is very much uncertain. The interest should be recognized only if the ultimate collection is certain. Therefore, the interest income of ₹ 5 lakhs should not be recognized in the books for the year ended 31st March. 2017.

Conclusion : Thus the contention of accountant is incorrect. However, if the agents have agreed to pay the amount of interest and there is an element of certainty associated with these receipts, the accountant is correct regarding booking of ₹ 5 lakhs as interest amount.

Question 10.
Sarita Publications publishes a monthly magazine on the 15th of every month. It sells advertising space in the magazine to advertisers on the terms of 80% sale value payable in advance and the balance within 30 days of the release of the publication. The sale of space for the March 2014 issue was made in February 2014. The magazine was published on its scheduled date. It received ₹ 2,40,000 on 10.3.2014 and ₹ 60,000 on 10.4.2014 for the March 2014 issue.

Discuss in the context of AS 9 the amount of revenue to be recognized and the treatment of the amount received from advertisers for the year ending 31.3.2014. What will be the treatment if the publication is delayed till 2.4.2014? (Nov. 2014) (5 Marks)
As per AS 9 ‘Revenue Recognition’, in a transaction involving the rendering of services, performance should be measured either under the completed service contract method or under the proportionate completion method as the service is performed, whichever relates the revenue to the work accomplished.

Analysis : In the given case, income accrues when the related advertisement appears before public. The advertisement service would be considered as performed on the day the advertisement is seen by public and hence revenue is recognized on that date. In this case, it is 15.03.2014, the date of publication of the magazine.

Conclusion : Hence, ₹ 3,00,000 (₹ 2,40,000 + ₹ 60,000) is recognized as income in March, 2014. The terms of payment are not relevant for considering the date on which revenue is to be recognized. ₹ 60,000 is treated as amount due from advertisers as on 31.03.2014 and ₹ 2,40,000 will be treated as payment received against the sale.

Note :
However, if the publication is delayed till 02.04.2014 revenue recognition will also be delayed till the advertisements get published in the magazine. In that case revenue of ₹ 3,00,000 will be recognized for the year ended 31.03.2015 after the magazine is published on 02.04.2014. The amount received from sale of advertising space on 10.03.2014 of ₹ 2,40,000 will be considered as an advance from advertisers as on 31.03.2014.

Effect Of Uncertainties On Revenue Recognition (Based On Para Nos. 9 And 10)

Question 11.
The Board of Directors of X Ltd. decided on 31.3.2011 to increase sale price of certain items of goods sold retrospectively from 1st January, 2011. As a result of this decision the company has to receive ₹ 5 lakhs from its customers in respect of sates made from 1.1.2011 to 31.3.2011. But the Company’s Accountant was reluctant to make-up his mind. You are asked to offer your suggestion.
Analysis & conclusion : As per para 10 of AS 9 ‘Revenue Recognition’, the additional revenue on account of increase in sales price with retrospective effect, as decided by Board of Directors of X Ltd., of ₹ 5 lakhs to be recognised as income for financial year 2010-11, only if the company is able to assess the ultimate collection with reasonable certainty. If at the time of raising of any claim it is unreasonable to expect ultimate collection, revenue recognition should be postponed.

As 14
Accounting For Amalgamations
Methods Of Accounting For Amalgamation

Question 1.
As per Accounting Standard 14, what are the conditions which must be satisfied for an amalgamation in the nature of merger? (Nov 2009) (4 Marks)
According to AS 14 Accounting for Amalgamations’, Amalgamation in the nature of merger is an amalgamation which satisfies all the following conditions:

1. All the assets and liabilities of the transferor company become, after amalgamation, the assets and liabilities of the transferee company.
2. Shareholders holding not less than 90% of the face value of the equity shares of the transferor company (other than the equity shares already held therein, immediately before the amalgamation, by the transferee company or its subsidiaries or their nominees) become equity shareholders of the transferee company by virtue of the amalgamation.
3. 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.
4. The business of the transferor company is intended to be carried on, after the amalgamation, by the transferee company.
5. 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.

Question 2.
Briefly explain the types of Amalgamations? (May 2012) (5 Marks)
As per AS 14, Accounting for Amalgamations’ there are two types of amalgamation. In first type of amalgamation there is a genuine pooling not merely of assets and liabilities of the amalgamating companies but also of the shareholders’ interests and of the businesses of the companies. Such amalgamations are amalgamations which are in the nature of ‘merger’and the accounting treatment of such amalgamations should ensure that the resultant figures of assets, liabilities, capital and reserves more or less represent the sum of the relevant figures of the amalgamating companies.

In the second category are those amalgamations which are in effect a mode by which one company acquires another company and, as a consequence, the shareholders of the company which is acquired normally do not continue to have a proportionate share in the equity of the combined company, or the business of the company which is acquired is not intended to be continued. Such amalgamations are amalgamations in the nature of ‘purchase’.

Question 3.
A Ltd. is amalgamating with B Ltd. They are undecided on the method of accounting to be followed. You are required to advice the management of B Ltd. on the method of accounting that can be adopted under AS 14. (Nov 2013) (5 Marks)
Analysis: An amalgamation may be either – an amalgamation in the nature of merger, or an amalgamation in the nature of purchase. The selection of method of accounting for amalgamation (pooling of interests or purchase method) is to be judged after considering the intentions of the both the companies.

If genuine pooling of all assets, liabilities, shareholders’ interest is intended; separate businesses of both the companies are continued and their amalgamation scheme satisfies all the conditions necessary for merger as specified in AS 14 Accounting for Amalgamations, pooling of interests method is adopted.

However, if B Ltd. or A Ltd. wants to acquire the other company, then purchase method needs to be adopted. In that case, the shareholders of the acquired company don’t continue to have proportional share in equity of the combined company and the business of the acquired company is not intended to be continued. The object of the purchase method is to account for the amalgamation by applying the same principles as are applied in the normal purchase of assets.

Conclusion : Thus choice of accounting method depends on the fact whether B Ltd. wants to continue its business or not.

Computation Of Purchase Consideration

Question 4.
A and B decide to amalgamate themselves into Sharp Limited. The following are their Balance Sheets as on 31st December, 2009.

Compute the amount of purchase consideration for each of these companies under purchase method as per AS 14. (Nov 2010) (4 Marks)
Note : This is a question Based on into company holdings. To solve it we need to create simultaneous equations.
Let the net assets of A Ltd. be x and net assets of B Ltd. be y.
Then x = 7,70,000 – 2,00,000 + 1/4 y
x = 5,70,000 + 1/4 y
4x-y = 22,80,000 —– (i)
Similarly;
y = 4,40,00 – 1,50,000 + 2/5 x
y = 2,90,000 + 2/5 x
-2x + 5y = 14,50,000 ——- (ii)
By multiplying equation (ii) by 2, we get
-4x+10y = 29,00,000 —- (iii)
By adding equation (i) with equation (iii), we get

Putting the value of y in equation (i) we get
4x – 5,75,556 = 22,80,000
4x = 22,80,000 + 5,75,556
x – $$\frac{25,55,000}{4}$$ = 7,13,889

Assumption: Shares in Sharp Ltd. consist of ₹ 100 each, purchase consideration will be discharged as follows:

Question 5.
The abstract of the Balance Sheet of the AXE Ltd. as at 31st March 2011, are as follows:

On 31st March, 2011, BXE Ltd. agreed to takeover AXE Ltd. on the following terms:

(1) For each preference share in AXE Ltd., ₹ 10 in cash and one 9% pref-erence share of ₹ 100 in BXE Ltd.
(2) For each equity share AXE Ltd. ₹ 20 in cash and one equity share in BXE Ltd. of ₹ 100 each. It was decided that the share in BXE Ltd. will be issued at market price ₹ 140 per share.
(3) Liquidation expenses of AXE Ltd. are to be reimbursed by BXE Ltd. to the extent of ₹ 10,000. Actual expenses amounted to ₹ 12,500.
You are required to compute the amount of purchase consideration. (May 2011) (5 Marks)
Calculation of purchase consideration

Note: Re-imbursement of liquidation expenses of AXE Ltd. will not be included in the calculation of purchase consideration.

Question 6.
Anjana Ltd. is absorbed by Sanjana Ltd.; the consideration being the takeover of liabilities, the payment of cost of absorption not exceeding ₹ 10,000 (actual cost ₹ 9,000) the payment of the 9% debentures of ₹ 50,000 at a premium of 20% in 8% debentures issued at a premium of 25% at face value and the payment of ₹ 15 per share in cash and allotment of three 11% preference share of ₹ 10 each at a discount of 10% and four equity share of ₹ 10 each at a premium of 20% fully paid for every five shares in Anjana Ltd. The number of share of the vendor company are 1,50,000 of ₹ 10 each fully paid.
Calculate purchase consideration as per Accounting Standard 14. (May 2016) (4 Marks)
As per AS 14 on Accounting for Amalgamations, the term ‘consideration’ has been defined as 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

Note :
The payment made by transferee company to discharge the Debenture holders and outside liabilities and cost of winding up of transferor company shall not be considered as part of purchase consideration

Question 7.
A Ltd. decides to absorb B Ltd. The draft Balance Sheet of B Limited is as follows:

A Ltd. has agreed:

(i) To pay ₹ 20 per share in cash to equity shareholders of B Ltd. and will issue six equity shares of ₹ 100 each (Market value ₹ 125) in lieu of every five equity shares held in B Ltd.
(ii) To issue 9% Preference shares of ₹ 100 each, in the ratio of 3 shares of A Ltd. for 4 Preference shares in B Ltd.
(iii) To issue 8% debentures at ₹ 96 in lieu of 6% debentures in B Ltd. which are to be redeemed at a premium of 20%.
You are required to calculate the purchase consideration. (Nov 2017) (4 Marks)
According to 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.

Analysis : Therefore, debentures issued to the debenture holders will not be included in purchase consideration.
Computation of Purchase consideration

Question 8.
Som Ltd. agreed to takeover Dove Ltd. on 1st April, 2018. The terms and conditions of takeover were as follows:
(i) Som Ltd. issued 56,000 equity shares of ₹ 100 each at a premium of ₹ 15 per share to the equity shareholders of Dove Ltd.
(ii) Cash payment of ₹ 39,000 was made to equity shareholders of Dove Ltd.
(iii) 24,000 fully paid preference shares of ₹ 50 each issued at par to discharge the preference shareholders of Dove Ltd.
(iv) The 8% Debentures of Dove Ltd. (₹ 78,000) converted into equivalent value of 9% debentures in Som Ltd.
(v) The actual cost of liquidation of Dove Ltd. was ₹ 23,000. Liquidation cost is to be reimbursed by Som Ltd. to the extent of ₹ 15,000.
You are required to:
(1) calculate the amount of purchase consideration as per the provisions of AS 14 and
(2) pass Journal Entry relating to discharge of purchase consideration in books of Som Ltd. (May 2018) (5 Marks)
As per AS 14, ‘Accounting for Amalgamations’ consideration for the amalgamation means the aggregate of shares and other securities issued and ‘ payment made in form of cash or other assets by the transferee company to the shareholders of the transferor company.

(i) Computation of Purchase Consideration:

(ii) Journal entry

(Being Payment of cash and issue uf shares in satisfaction of purchase consideration)

Question 9.
On 1st April, 2018, Tina Ltd. takeover 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. (November 2018 – New Course) (5 Marks)
Computation of Purchase Consideration

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.

Analysis : Thus, payment to debenture holders are not covered by the term ‘consideration’.
Journal entry relating to discharge of consideration (in the books of Tina Ltd.)

Disclosures

Question 10.
What disclosures should be made in the first financial statements following the amalgamation? (Nov 2011) (4 Marks)
Para 24 of AS 14 ‘Accounting for Ainalgwnarions’ states thai for all amalganiatioi is (whether for amalgamazions accounted for under the pooling of interests met hod or amalgamations accounted/or tinder ¡he purchase method), the follo’ing disclosures are considered appropriate in the first financial statements following the amalgamation:
(a) Names and genera! nature of business of the unzalganzating companies;
(b) Effective date of a inalgamarion for accounting purposes;
(c) The method of accounting used to reflect the amalgamation; and
(d) Particulars of the scheme sanctioned under a statute.

As 17
Segment Reporting
Reportable Segment (Based On Para Nos. 27 To 29)

Question 1.
The Chief Accountant of H Ltd. gives the following data regarding its six segments:

The Chief accountant is of the opinion that segments “M” and “N” alone should be reported. Is he justified in his view? Discuss.
Turnover Criteria:
Segments M and N are reportable segments.
Result Criteria:
Segments M, N and R are reportable segments
(since their results in absolute amount is 10% or more of ₹ 200 lakhs).

Asset Criteria:
All segments except R are reportable segments.
Since all the segments are covered in at least one of the above criteria all segments have to be reported.
Thus, the opinion of chief accountant is wrong.

Question 2.
G Ltd. has identified business segment as its primary reporting format. It has identified India, USA and UK as three geographical segments. It sells its products in the Indian market, which constitutes 70 per cent of the Company’s sales. 25 per cent is sold in USA and the balance is sold in UK. Is G Ltd. as part of its geographical secondary segment information, required to disclose segment revenue from export sales, where such sales are not significant? (RTF)
As per AS 17 if primary format of an enterprise for reporting segment information is business segments, it should also report segment revenue from external customers by geographical area based on the geographical location of its customers, for each geographical segment whose revenue from sales to external customers is 10 per cent or more of enterprise revenue.

Analysis and conclusion:
Accordingly, for the purposes of disclosing secondary segment information, G Ltd. is not required to disclose segment revenue from export sales to UK, since that segment does not meet the 10 per cent or more of enterprise revenue threshold. However, other secondary segment information as per AS 17 should be disclosed in respect of this segment if the thresholds prescribed in the AS 17 are met.

Question 3.
Calculate the segment results of a manufacturing organization from the following information:

(RTP)
Computation of segment result

Miscellaneous Questions

Question 4.
M/s Nathan Limited has three segments namely P, Q and R. The assets of the company are ₹ 15 crores. Segment P has 4 crores, Segment Q has 6 crores and Segment R has 5 crores. Deferred tax assets included in the assets of each segment are P – ₹ 1 crore, Q – ₹ 0.90 crores and R – ₹ 0.80 crores. The accountant contends all these three segments are reportable segments. Comment.
(May 2018) (4 Marks)
According to AS 17 “Segment Reporting”, segment Assets do not include income tax assets.
Therefore, the revised total assets are 12.3 crores [₹ 15 – (₹ 1 +0.9 + 0.8)]. Details of Segment wise assets
Segment P holds total assets of ₹ 3 crores (₹ 4 crores – ₹ 1 crores);
Segment Q holds ₹ 5.1 crores (₹ 6 crores – 0.9 crores);
Segment R holds ₹ 4.2 crores (₹ 5 crores – ₹ 0.8 crores).
Thus, all the three segments hold more than 10% of the total assets, all segments are reportable segments.
Hence, the contention of the Accountant that all three segments are reportable segments is correct.

AS18
Related Party Disclosures
Identifying Related Parties(Based On Para Nos. 3 And 4)

Question 1.
S Ltd. sold goods for ₹ 50 lakhs to M Ltd. during financial year ended 31st March 2017 at normal selling price followed by S Ltd. The Managing Director of S Ltd. holds 75% shares of M Ltd. The Chief accountant of S Ltd. contends that these sales need not require a different treatment from the other sales made by the company and hence no disclosure is necessary as per the accounting standard. You are required to examine and advise whether the contention of the Chief Accountant is correct?
As per AS 18 ‘Related. Party Disclosures’, Enterprises over which a key management personnel is able to exercise significant influence are related parties. This includes enterprises owned by directors or major shareholders of the reporting enterprise and enterprise that have a member of key management in common with the reporting enterprise.

Analysis : In the given case, S Ltd. and M Ltd. are related parties and hence disclosure of transaction between them is required irrespective of whether the transaction was done at normal selling price.
Conclusion : Hence the contention of Chief Accountant of S. Ltd. is wrong.

Question 2.
Following transactions are disclosed as on 31st March, 2018:
(i) Mr. Sumit, a relative of Managing Director, received remuneration of ₹ 2,10,000 for his services in the company for the period from 1st April, 2017 to 30th June, 2017. He left the service on 1st July, 2017.
Should the relative be identified as a related party as on closing date i. e. on 31-3-2018 for the purpose of AS – 18.
(ii) Goods sold amounting to ₹ 50 lakhs to associate company during the 1st quarter ended on 30th June, 2017. After that related party relationship ceased to exist. However, goods were supplied as was supplied to any other ordinary customer.
Decide whether transactions of the entire year have to be disclosed as related party transactions. (November 2018 – New Course) (5 Marks)
(i) According to AS 18 ‘RelatedParty Disclosures’, parties are considered to be related if at any time during the reporting period, one party has the ability to control the other party or exercise significant influence over the other party in making financial and/or operating decisions.

Analysis & Conclusion . Hence, Mr. Sumit a relative of key management personnel should be identified as related party as at the closing date le. on 31.3.2018 as he received remuneration for his services in the company from 1st April, 2017 to 30th June, 2017 and this period comes under the reporting period.

(ii) As per provision of AS 18, the transactions only for the period in which related party relationships exist need to be reported.

Analysis : Hence, transactions of the entity with its associate company for the first quarter ending 30.06.2017 only are required to be disclosed as related party transactions. Transactions of the entire year need not be disclosed as related party transactions and transactions for the period (after 1st July) in which related party relationship did not exist need not be reported.

Conclusion : Hence transaction of sale of goods with the associate company for first quarter ending 30th June, 2017 for ₹ 50 Lakhs only are required to be disclosed as related party transaction on 31.3.2018.

As 19
Leases
Classification Of Lease (Based On Para Nos. 8 And 9)

Question 1.
Define the term Finance Lease. State any three situations when a lease would be classified as finance lease. (Nov 2012) (4 Marks)
As per AS 19 ‘leases’, a finance lease is a lease that transfers substantially all the risks and rewards incident to ownership of an asset.
As per para 8 of the standard, classification of lease into a finance lease or an operating lease depends on the substance of the transaction rather than its form. Three situations which would normally lead to a lease being classified as a finance lease are:
(a) the lessor 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;
(c) the lease term is for the major part of the economic life of the asset even if title is not transferred.

Question 2.
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’. (Nov 2013) (4 Marks)
Analysis & Conclusion

1. If it becomes certain at the inception of lease itself that the option will be exercised by the lessee, it is a Finance Lease.
2. 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.
3. Since the asset is procured only for the use of lessee, it is a finance lease.
4. The lease is a finance lease if X = Y, or where X substantially equals Y.

Question 3.
State any four situations when a lease would be classified as Finance Lease. (May 2015) (4 Marks)
Finance Lease is a lease, which transfers substantially all the risks and rewards incidental to ownership of an asset to the lessee by the lessor blit not the legal ownership.
As per AS 19, in following situations, the lease transactions would be classified as 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.
3. The lease term covers the major part of the life of asset ever: if title is not transferred.
4. At the beginning of lease term, present value of minimum lease rental covers the initial fair value.

Computation Of Implicit Rate Of Interest (Based On Para No. 3)

Question 4.
What do you understand by the term ‘Interest rate implicit on lease’? Calculate the interest rate implicit on lease from the following details:

Discounted rates for the first 5 years are as below:
At 10% 0.909, 0.826, 0.751, 0.683, 0.621
At 14% 0.877, 0.769, 0.675, 0.592, 0.519 (May 2014) (5 Marks)
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.
Present value at discount rate of 10%

Present value at discount rate of 14%

By interpolation :

Interest Rate Implicit on Lease = 10% + $$\frac{14 \%-10 \%}{3,42,944-3,07,776}$$ × (3,42,944 – 3,20,000)
= 10% + 2.609% = 12.609% or say 12.6

Finance Lease Accounting- Books Of Lessee (Based On Para Nos. 11, 16 And 18)

Question 5.
Lessee Ltd. took a machine on lease from Lessor Ltd., the fair value being ₹ 7,00,000. 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. (May 2011) (8 Marks)
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, theamount recorded as an asset and liability should be the present value of minimum lease payments from the standpoint of the lessee.

Value of machinery :
Fair value of the machinery is ₹ 7,00,000
Net present value of minimum lease payments is ₹ 6,99,054.
As the present value of the machine is less than the fair value of the machine, the machine will be recorded at value of ₹ 6,99,054.
Computation of finance charges for each year

*W Note Present value of minimum lease payments
Annual lease rental × PV factor + 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.
** “Note The difference between this figure and guaranteed residual value (₹ 22,000) is due to approximation in computing the interest rate implicit in the lease.

Question 6.
Annual lease rent = ₹ 40,000 at the end of each year
Lease period = 5 years
Guaranteed residual value = ₹ 14,000
Fair value at the inception (beginning) of lease = ₹ 1,50,000
Interest rate implicit on lease is 12.6%. The present value factors at 12.6% are 0.89, 0.79, 0.7, 0.622, 0.552 at the end of first, second, third, fourth and fifth year respectively.
Show the Journal entry to record the asset taken on finance lease in the books of the lessee. (Nov 2012) (4 Marks)
In the books of Lessee
Journal entry

Working Note:

Question 7.
A Ltd. took a machine on lease from X Ltd., the fair value being ₹ 10,00,000. The economic life of the machine as well as the lease term is 4 years. At the end of each year, A Ltd. pays ₹ 3,50,000. The lessee has guaranteed a residual value of ₹ 40,000 on expiry of the lease to the lessor. However, X Ltd. estimates that the residential value of the machinery will be ₹ 35,000 only. The implicit rate of return is 16% and PV factors at 16% for year 1, year 2, year 3 and year 4 are 0.8621, 0.7432, 0.6407 and 0.5523 respectively. You are required to calculate the value of machinery to be considered by ABC Ltd. and the finance charges for each year.
As per 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.

Value of machinery

Fair value of the machinery is ₹ 10,00,000
Net present value of minimum lease payments is ₹ 10,01,497 (Refer working Note).
As the present value of the machine is more than the fair value of the machine, the machine and the corresponding liability will be recorded at fair value of ₹ 10,00,000.

Computation of finance charges for each year

* Note : The difference between this figure and guaranteed residual value is due to rounding off.

Working Note:

Present value of minimum lease payments

Question 8.
S Limited wishes to obtain a machine costing ₹ 30 lakhs by way of lease. The effective life of the machine is 14 years, but the company requires it only for the first 5 years. It enters into an agreement with B Ltd., for a lease rental for ₹ 3 lakhs p.a. payable in arrears and the implicit rate of interest is 15%. The chief accountant of S Limited is not sure about the treatment of these lease rentals and seeks your advise. You are required to explain the necessary accounting treatment in line with AS 19. (use annuity factor at @ 15% for 3 years as 3.36)
As per AS 19 leases’, a lease will be classified as finance lease if at the inception of the lease, the present value of minimum lease payment amounts to at least substantially all of the fair value of leased asset.

Analysis : In the given case, the implicit rate of interest is given at 15%. The present value of minimum lease payments at 15% using PV – Annuity Factor can be computed as:

Conclusion : Thus present value of minimum lease payments is ₹ 10.08 lakhs and the fair value of the machine is ₹ 30 lakhs. In a finance lease, lease term should be for the major part of the economic life of the asset even if title is not transferred. However, in the given case, the effective useful life of the machine is 14 years while the lease is only for five year s. Therefore, lease agreement is an operating lease.

Suggested Accounting Treatment
Lease payments under an operating lease should be recognized as an expense in the statement of profit and loss on a straight line basis over the lease term unless another systematic basis is more representative of the time pattern of the user’s benefit.

Question 9.
ABC Ltd. took a machine on lease from XYZ Ltd., the fair value being ₹ 10,00,000. The economic life of the machine as well as the lease term is 4 years. At the end of each year, ABC Ltd. pays ₹ 3,50,000. The lessee has guaranteed a residual value of ₹ 50,000 on expiry of the lease to the lessor. However, XYZ Ltd. estimates that the residential value of the machinery will be ₹ 35,000 only. The implicit rate of return is 16% and PV factors at 16% for year 1, year 2, year 3 and year 4 are 0.8621,0.7432, 0.6407 and 0.5523 respectively.
You are required to calculate the value of machinery to be considered by ABC Ltd. and the finance charges for each year.
As per 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.

Value of machinery

Fair value of the machinery is ₹ 10,00,000
Net present value of minimum lease payments is ₹ 10,07,020 (Refer working Note).
As the present value of the machine is more than the fair value of the machine, the machine and the corresponding liability will be recorded at value of ₹ 10,00,000.
Computation of finance charges for each year

* Note : The difference between this figure and guaranteed residual value (₹ 50,000) is due to rounding off.

Working Note:
Present value of minimum lease payments

Finance Lease Accounting – Books Of Lessor (Based On Para Nos. 26 And 28)

Question 10.
A Limited has given a machinery on lease for 36 months, and its useful life is 60 months. Cost & fair market value of the machinery is ₹ 5,00,000. The amount will be paid in 3 equal annual instalments and the lessee will return the machinery to lessor at termination of lease. The unguaranteed residual value at the end of 3 years is ₹ 50,000. IRR of investment is 10% and present value of annuity factor of ₹ 1 due at the end of 3 years at 10% IRR is 2.4868 and present value of ₹ 1 due at the end 3rd year at 10% IRR is 0.7513.
You are required to comment with reason whether the lease constitute finance lease or operating lease. If it is finance lease, calculate unearned finance income.
Analysis : Classification of Lease
Present value of unguaranteed residual value at the end of 3rd year
= ₹ 50,000 × 0.7513 = ₹ 37,565
Present value of lease payments = ₹ 5,00,000 – ₹ 37,565
= ₹ 4,62,435
The percentage of present value of lease payments to fair value of the equipment is (₹ 4,62,435/₹ 5,00,000) × 100 = 92.487%.

Conclusion : Since, lease payments substantially covers the major portion of the fair value; the lease constitutes a finance lease.

Computation of Unearned Finance Income
Annual lease payment = ₹ 4,62,435/2.4868 = ₹ 1,85,956 (approx.)
Gross investment in the lease = Total minimum lease payments + unguaranteed
residual value
= (₹ 1,85,956 × 3) + ₹ 50,000 = ₹ 5,57,868 + ₹ 50,000 = ₹ 6,07,868 = Gross investment – Present value of minimum lease payments and unguaranteed residual value
= ₹ 6,07,868 – ₹ 5,00,000 = ₹ 1,07,868

Question 11.
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. Consider IRR = 10%.
The present value of Re. 1 due at the end of 3rd year at 10% rate of interest is Re. 0.7513.
The present value of annuity of Re. 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. (May 2010) (4 Marks)
(i) Computation of annual lease payment

Analysis & Conclusion :
The present value of lease payment Le., ₹ 9,24,870 equals 92.48% of the fair market value ie., 10,00,000. As the present value of minimum lease payments substantially covers the initial fair value of the leased asset and lease term (ie. 3 years) covers the major part of the life of asset (ie. 5 years). Therefore, it constitutes a finance lease.

(ii) Computation of Unearned Finance Income

Question 12.
An equipment having expected useful life of 5 years, is leased for 3 years. Both the cost and the fair value of the equipment are ₹ 6,00,000. The amount will be paid in 3 equal instalments and at the termination of lease, lessor will get back the equipment. The unguaranteed residual value at the end of 3rd year is ₹ 60,000. The IRR of the investment is 10%. The present value of annuity factor of ₹ 1 due at the end of 3rd year at 10% IRR is 2.4868. The present value of ₹ 1 due at the end of 3rd year at 10% rate of interest is 0.7513. State with reason whether the lease constitutes finance lease and also compute the unearned finance income. (Nov 2011) (5 Marks)
(i) Classification of lease
It is assumed that the fair value of the leased equipments is equal to the present value of minimum lease payments.
Present value of residual value at the end of 3rd year = ₹ 60,000 × 0.7513
= ₹ 45,078
Present value of lease payments = ₹ 6,00,000 – ₹ 45,078
= ₹ 5,54,922

Analysis & Conclusion :
The percentage of present value of lease payments to fair value of the equipment is (₹ 5,54,922/₹ 6,00,000) × 100 = 92.487%.
Since, it substantially covers the major portion of the lease payments, the lease constitutes a finance lease.

(ii) Calculation of Unearned Finance Income
Annual lease payment = ₹ 5,54,922/2.4868 = ₹ 2,23,147 (approx)
Gross investment in the lease = Total minimum lease payment + unguaranteed
residual value
= (₹ 2,23,147 × 3) + ₹ 60,000
= ₹ 6,69,441 + ₹ 60,000 = ₹ 7,29,441
Unearned finance income = Gross investment – Present value of minimum lease payments and unguaranteed residual value
= ₹ 7,29,441 – ₹ 6,00,000 = ₹ 1,29,441

Question 13.
A machine having expected useful life of 6 years, is leased for 4 years. Both the cost and the fair value of the machinery are ₹ 7,00,000. The amount will be paid in 4 equal instalments and at the termination of lease, lessor will get back the machinery. The unguaranteed residual value at the end of the 4th year is ₹ 70,000. The IRR of the investment is 10%. The present value of annuity factor of ₹ 1 due at the end of 4th year at 10% IRR is 3.169. The present value of ₹ 1 due at the end of 4th year at 10% rate of interest is 0.683.
State with reasons whether the lease constitutes finance lease and also compute the unearned finance income. (Nov 2014) (5 Marks)
(i) Classification of lease
Fair value of asset ₹ 7,00,000 Unguaranteed residual value ₹ 70,000
Present value of residual value at the end of 4th Year = ₹ 70,000 × 0.683 = ₹ 47,810
Present value of lease payment recoverable = ₹ 7,00,000 – ₹ 47,810
= ₹ 6,52,190

Analysis & Conclusion :
The percentage of present value of lease payment to fair value of the asset is = (₹ 6,52,190/₹ 7,00,000) × 100 = 93.1796
Since it substantially covers the major portion of lease payment and life of the asset, the lease constitutes a finance lease.

(ii) computation of Unearned finance income
Annual lease payment = ₹ 6,52,190/3.169
= ₹ 2,05,803 (approx.)
Gross investment in the lease = Total minimum lease payment + unguaranteed residual value.
= (₹ 2,05,803 × 4) + ₹ 70,000 = ₹ 8,23,212 + ₹ 70,000 = ₹ 8,93,212
Unearned finance income = Gross investment – Present value of minimum lease payment and unguaranteed residual value.
= ₹ 8,93,212 – ₹ 7,00,000 (₹ 6,52,190 + ₹ 47,810)
= ₹ 1,93,212

Question 14.
W Ltd. has entered into a three year lease arrangement with sports club in respect of Fitness Equipments costing ₹ 16,99,999.50. The annual lease payments to be made at the end of each year are structured in such a way that the sum of the Present Values of the lease payments and that of the residual value together equal the cost of the equipments leased out. The unguaranteed residual value of the equipment at the expiry of the lease is estimated to be ₹ 1,33,500. The assets would revert to the lessor at the end of the lease. Given that the implicit rate of interest is 10%.
You are required to calculate the amount of the annual lease payment and the unearned finance income. Discounting Factor at 10% for years 1, 2 and 3 are 0.909, 0.826 and 0.751 respectively.
(i) Computation of annual lease payment

(ii) Computation of Unearned Finance Income

Operating Lease – Books Of Lessee (Based On Para No. 23)

Question 15.
S Limited wishes to obtain a machine costing ₹ 30 lakhs by way of lease. The effective life of the machine is 14 years, but the company requires it only for the first 5 years. It enters into an agreement with B Ltd., for a lease rental for ₹ 3 lakhs p.a. payable in arrears and the implicit rate of interest is 15%. The chief accountant of S Limited is not sure about the treatment of these lease rentals and seeks your advise, (use annuity factor at @ 15% for 3 years as 3.36)
As per AS 19 ‘leases’, a lease will be classified as finance lease if at the inception of the lease, the present value of minimum lease payment*amounts to at least substantially all of the fair value of leased asset.

Analysis : In the given case, the implicit rate of interest is given at 15%. The present value of minimum lease payments at 15% using PV- Annuity Factor can be computed as:

Conclusion : Thus present value of minimum lease payments is ₹ 10.08 lakhs and the fair value of the machine is ₹ 30 lakhs. In a finance lease, lease term should be for the major part of the economic life of the asset even if title is not transferred. However, in the given case, the effective useful life of the machine is 14 years while the lease is only for five years. Therefore, lease agreement is an operating lease. Lease payments under an operating lease should be recognized as an expense in the statement of profit and loss on a straight line basis over the lease term unless another systematic basis is more representative of the time pattern of the user’s benefit.

Sale And Leaseback (Based On Para Nos. 47 To 52)

Question 16.
Write short note on Sale and Lease Back Transactions as per Accounting Standard 19.
As per AS 19 on ‘Leases’, a sale and leaseback transaction involves the sale of an asset by the vendor and the leasing of the asset back to the vendor. The lease payments and the sale price are usually interdependent, as they are negotiated as a package. The accounting treatment of a sale and lease back transaction depends upon the type of lease involved.

If a sale and leaseback transaction results in a finance lease, any excess or deficiency of sale proceeds over the carrying amount should be deferred and amortised over the lease term in proportion to the depreciation of the leased asset.

If sale and leaseback transaction results in a operating lease, and it is clear that the transaction is established at fair value, any prof t or loss should be recognised immediately. If the sale price is below fair value any profit or loss should be recognised immediately except that, if the loss is compensated by future lease payments at below market price, it should be defer red and amortised in proportion to the lease payments over the period for which the asset is expected to be used. If the sale price is above fair value, the excess over fair value should be deferred and amortised over the period for which the asset is expected to be used.

Question 17.
X Ltd. sold JCB Machine having WDV of ₹ 50 Lakhs to Y Ltd. for ₹ 60 Lakhs and the same JCB was leased back by Y Ltd. to X Ltd. The lease is operating lease
Comment according to relevant Accounting Standard if
(i) Sale price of ₹ 60 Lakhs is equal to fair value
(ii) Fair Value is ₹ 50 Lakhs and sale price is ₹ 45 Lakhs.
(iii) Fair value is ₹ 55 Lakhs and sale price is ₹ 62 lakhs
(iv) Fair value is ₹ 45 Lakhs and sale price is ₹ 48 Lakhs. (May 2012) (4 Marks)
Analysis & Conclusion :
(i) When sales price of ₹ 60 lakhs is equal to fair value, X Ltd. should im-mediately recognize the profit of ₹ 10 lakhs (i.e. 60 – 50) in its books.
(ii) When fair value of leased JCB machine is ₹ 50 lakhs & sales price is ₹ 45 lakhs, then loss of ₹ 5 lakhs (50 – 45) to be immediately recognized by X Ltd. in its books provided loss is not compensated by future lease payments.
(iii) When fair value is ₹ 55 lakhs & sales price is ₹ 62 lakhs, profit of ₹ 5 lakhs (55 – 50) to be immediately recognized by X Ltd. in its books and balance profit of ₹ 7 lakhs (62-55) is to be amortised/deferred over lease period.
(iv) When fair value is ₹ 45 lakhs & sales price is ₹ 48 lakhs, then the loss of ₹ 5 lakhs (50-45) to be immediately recognized by X Ltd. in its books and profit of ₹ 3 lakhs (48-45) should be amortised/deferred over lease period.

Question 18.
Ram Ltd. sold a machine having WDV of ₹ 725 lakhs to Shyam Ltd. for ₹ 150 lakhs and the same machine was leased back by Shyam Ltd. to Ram Ltd. under Operating lease system:
Comment according to relevant Accounting Standard if:
(i) Sale price of ₹ 150 lakhs is equal to fair value.
(ii) Fair value is ₹ 125 lakhs and Sale price is ₹ 112.50 lakhs.
(iii) Fair value is ₹ 137.50 lakhs and Sale price is ₹ 155 lakhs.
(iv) Fair value is ₹ 112.50 lakhs and Sale price is ₹ 120 lakhs. (May 2018) (5 Marks)
Analysis & Conclusion :
(i) When sales price of ₹ 150 lakhs is equal to fair value, Ram Ltd. should immediately recognize the profit of ₹ 25 lakhs (i.e. 150 – 125) lakhs in its books.
(ii) When fair value of leased machine is ₹ 125 lakhs & sales price is ₹ 112.50 lakhs, then loss of ₹ 12.5 lakhs (125 -112.50) lakhs to be immediately recognized by Ram Ltd. in its books provided loss is not compensated by future lease payments.
(iii) When fair value is ₹ 137.5 lakhs & sales price is ₹ 155 lakhs, profit of ₹ 12.5 lakhs (137.5 – 125) lakhs to be immediately recognized by Ram Ltd. in its books and balance profit of ₹ 17.5 lakhs (155 – 137.50) lakhs is to be amortised/deferred over lease period.
(iv) When fair value is ₹ 112.5 lakhs & sales price is ₹ 120 lakhs, then the loss of ₹ 12.5 lakhs (125-112.5) lakhs to be immediately recognized by Ram Ltd. in its books and profit of ₹ 7.5 lakhs (12Question 112.5) lakhs should be amortised/deferred over lease period.

Question 19.
A Ltd. sold JCB having WDV of ₹ 20 lakhs to B Ltd. for ₹ 24 lakhs and the same JCB was leased back by B Ltd. to A Ltd. The lease is operating lease. In context of Accounting Standard 19 ‘Leases’ explain the accounting treatment of profit or loss in the books of A Ltd. if
(i) Sale price of ₹ 24 lakhs is equal to fair value.
(ii) Fair value is ₹ 20 lakhs and sale price is ₹ 24 lakhs.
(iii) Fair value is ₹ 22 lakhs and sale price is ₹ 25 lakhs.
(iv) Fair value is ₹ 25 lakhs and sale price is ₹ 18 lakhs.
(v) Fair value is ₹ 18 lakhs and sale price is ₹ 19 lakhs. (May 2018 – New Course) (5 Marks)
Analysis & Conclusion :
(i) When sale price of ₹ 24 lakhs is equal to fair value, A Ltd. should immediately recognise the profit of ₹ 4 lakhs (i.e. 24 – 20) in its books.
(ii) When fair value is ₹ 20 lakhs & sale price is ₹ 24 lakhs then profit of ₹ 4 lakhs is to be deferred and amortised over the lease period.
(iii) When fair value is ₹ 22 lakhs & sale price is ₹ 25 lakhs, profit of ₹ 2 lakhs (22 – 20) to be immediately recognised in its books and balance profit of ₹ 3 lakhs (25-22) is to be amortised/deferred over lease period.
(iv) When fair value of leased machinery is ₹ 25 lakhs & sale price is ₹ 18 lakhs, then loss of ₹ 2 lakhs (20-18) to be immediately recognised by A Ltd. in its books provided loss is not compensated by future lease payment.
(v) When fair value is ₹ 18 lakhs & sale price is ₹ 19 lakhs, then the loss of ₹ 2 lakhs (20-18) to be immediately recognised by A Ltd. in its books and profit of ₹ 1 lakhs (19-18) should be amortised/deferred over lease period.

Question 20.
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. Explain the accounting treatment as per AS 19 in the following cases:
(i) Sale price of ₹ 50 lakhs is equal to fair value.
(ii) Fair value is ₹ 45 lakhs and sale price is ₹ 38 lakhs.
(iii) Fair value is ₹ 40 lakhs and sale price is ₹ 50 lakhs.
(iv) Fair value is ₹ 46 lakhs and sale price is ₹ 50 lakhs
(v) Fair value is ₹ 35 lakhs and sale price is ₹ 39 lakhs.
Analysis & Conclusion:
(i) When sales price of ₹ 50 lakhs is equal to fair value, A Ltd. should immediately recognise the proht of 10 lakhs (i.e. 50-40) in its books.
(ii) 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.
(iii) 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.
(iv) 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.
(v) 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.

AS 20
Earnings Per Share
Basic Eps (Based On Para Nos. 10 To 21) Weighted Average No. Of Shares

Question 1.
(i) Explain the concept of “Weighted average number of equity shares outstanding during the period”.
State how would you compute, based on AS-20 the weighted average number of equity shares in the following cases:

(ii) Compute adjusted earning per share and basic earning per share based on the following information:

Until 31st December, 2011
Bonus issue on 1st January, 2012
1 equity share for each equity share
outstanding as at 31st December, 2011 (May 12) (5 Marks)
(i) (a) As per para No. 16 of AS 20, the weighted average number of equity shares outstanding during the period reflects the fact that the amount of shareholders’ capital may have varied during the period as a result of a larger or lesser number of shares outstanding at any time. Therefore, For the purpose of calculating basic or diluted earnings per share, the number of equity shares should be the weighted average number of equity shares outstanding during the period.

(b) Computation of Weighted average number of equity shares

(ii) Computation of Earnings per share
Basic EPS 2010-11 = ₹ 11,40,000/5,00,000 shares = ₹ 2.28
Basic EPS 2011-12 = ₹ 22,50,000/10,00,000 shares = ₹ 2.25
Adjusted EPS 2010-11 = ₹ 11,40,000/10,00,000 shares = ₹ 1.14

Note:
Since the bonus issue is an issue without consideration, the issue is treated as if it had occurred prior to the beginning of the year 2010-11, the earliest period reported.

Eps Computation

Question 2.
Compute Basic Earnings per share from the following information:

Net profit for the year ended 31st March, 2009 was ₹ 2,75,000. (Nov 2009) (5 Marks)
Computation of weighted average number of shares outstanding during the period:

Basic Earnings Per Share =

Question 3.
As at 1st April, 2016 a company had 6,00,000 equity shares of ₹ 10 each (₹ 5 paid up by all shareholders). On 1st September, 2016 the remaining ₹ 5 was called up and paid by all shareholders except one shareholder having 60,000 equity shares. The net profit for the year ended 31st March, 2017 was ₹ 21,96,000 after considering dividend on preference shares and dividend distribution tax on such dividend totalling to ₹ 3,40,000.
Compute Basic EPS for the year ended 31st March, 2017 as per Accounting Standard 20 ‘Earnings Per Share’. (May 2018 – New Course) (5 Marks)
Basic Earnings per share (EPS) =

Working Note:

Computation of weighted average number of equity shares

As per AS 20 ‘Earnings Per Share’, partly paid equity shares are treated as a fraction of equity share to the extent that they were entitled to participate in dividend relative to a fully paid equity share during the reporting period. Assuming that the partly paid shares are entitled to participate in the dividend to the extent of amount paid, weighted average number of shares will be calculated as follows:

Special Issues Related To Basic Eps (Based On Para Nos. 22 To 25) Bonus Issue

Question 4.
Compute adjusted earnings per share and basic EPS based on the following information:

Bonus issue on 1st January, 2011, 2 equity shares for each equity share outstanding at 31st December, 2010.
Computation of Earning per share
Basic EPS 2010-11 = ₹ 24,00,000/24,00,000 = ₹ 1
Adjusted EPS 2009-10 = ₹ 7,20,000/24,00,000 = ₹ 0.30

Note:
Since the bonus issue is an issue without consideration, the issue is treated as if it had occurred prior to the beginning of the year 2009-10, the earliest period reported.

Question 5.
Net profit for the year 2016 ₹ 18,00,000
Net profit for the year 2017 ₹ 60,00,000
No. of equity shares outstanding until 30th September 2017 20,00,000
Bonus issue 1st October 2017 was 2 equity shares for each equity share outstanding at 30th September, 2017
Calculate Basic Earnings Per Share.
No. of Bonus Issue 20,00,000 × 2 = 40,00,000 shares
Earnings per share for the year 2017 = $$\frac{₹ 60,00,000}{(20,00,000+40,00,000)}$$
= ₹ 1.00
Adjusted earnings per share for the year 2016 = $$\frac{₹ 18,00,000}{(20,00,000+40,00,000)}$$
= ₹ 0.30

Special Issues Related To Basic Eps (Based On Para Nos. 22 To 25) Right Issue

Question 6.
The following information is available for R Ltd. for the accounting years 2009-10 and 2011
No. of shares outstanding prior to right issue 12,00,000 shares.
Right : One new share for each three outstanding i.e. 4,00,000 shares
issue : Right issue price ₹ 22
: Last date to exercise rights 30-6-2010
Fair value of one equity share immediately prior to exercise of rights on 306-2010 = ₹ 28.

You are required to compute the basic earnings per share for the years 2009-10 and 2010-11. ”
(a) Computation of basic earnings per share (EPS)

Working Notes:

1. Computation of theoretical ex-rights fair value per share

*Note: The number of equity shares to be used in calculating basic earnings per share for periods prior to the rights issue is the number of equity shares outstanding prior to the issue, multiplied by the adjustment factor. The adjustment factor has been calculated in Working Note 2.

Question 7.
Compute Basic and Adjusted Earnings per share from the following information:

All workings may be rounded off to two decimals.
Computation of earnings per share
EPS for the year 2015-16 (as originally reported)
= ₹ 22,00,000/1,10,000 shares = ₹ 20
EPS for the year 2015-16 (restated for rights issue)
= ₹ 22,00,000/(1,10,000 shares × 1.07) = ₹ 18.69
EPS for the year 2016-17 (including effects of rights issue)
Adjusted No. of Shares = (1,10,000 × 1.07 × 4/12) + (1,37,500 × 8/12) = 1,30,900
EPS = $$\frac{33,00,000}{1,33,900}$$
= 25.21

Working Note:

1. Calculation of Theoretical ex-rights fair value per share

Theoretical ex-rights fair value per share = ₹ 252

2. Calculation of Computation of adjustment factor:

Question 8.
The following information is available for T Ltd. for the accounting years 2015-16 and 2016-17:

No of shares outstanding prior to right issue 15,00,000 shares.

Right issue : One new share for each 3 shares outstanding i.e.
5,00,000 shares.
: Right Issue price ₹ 25
: Last date to exercise right 31st July, 2016
Fair value of one equity share immediately prior to exercise of rights on 31.07.2016 is ₹ 35.
You are required to compute:
(i) Basic earnings per share for the year 2015-16.
(ii) Restated basic earnings per share for the year 2015-16 for right issue,
(iii) Basic earnings per share for the year 2016-17.
Computation of Basic Earnings per Share

Working Notes:

1. Computation of theoretical ex-rights fair value per share =

[(₹ 35 × 15,00,000) + (₹ 25 × 5,00,000)]/(15,00,000 + 5,00,000) = ₹ 32.5

Question 9.
The following information is available for Raja Ltd. for the accounting years 2009-10 and 2010-11:

No. of shares outstanding prior to right issue 12,00,000 shares.
Right issue : One new share for each three outstanding i.e. 4,00,000 shares
: Right issue price ₹ 22
: Last date to exercise rights 30-6-2010
Fair value of one equity share immediately prior to exercise of rights on 306-2010 = ₹ 28.
You are required to compute the basic earnings per share for the years 2009-10 and 2010-11 (May 2011) (5 Marks)
Computation of basic earnings per share (EPS)

Note:
* The number of equity shares to be used in calculating basic earnings per share for periods prior to the rights issue is the number of equity shares outstanding prior to the issue, multiplied by the adjustment factor. The adjustment factor has been calculated in Working Note 2.

Working Notes:
1. Computation of theoretical ex-rights fair value per share

Question 10.
The following information is available for AB Ltd. for the accounting years 2012-13 and 2013-14:

No of shares outstanding prior to right issue 10,00,000 shares.
Right issue : One new share for each five shares outstanding i.e. 2,00,000 shares.
: Right Issue price ₹ 25
: Last date to exercise right 31st July, 2013
Fair value of one equity share immediately prior to exercise of rights on 31.07.2013 is ₹ 32.
You are required to compute:
(i) Basic earnings per share for the year 2012-13.
(ii) Restated basic earnings per share for the year 2012-13 for right issue.
(iii) Basic earnings per share for the year 2013-14. (May 2014) (5 Marks)
Computation of Basic Earnings per Share

Working Notes:
1. Computation of theoretical ex-rights fair value per share =

$$\frac{(₹ 32 \times 10,00,000)+(₹ 25 \times 2,00,000)}{10,00,000+2,00,000}$$
= ₹ 30.83

Question 11.
The following information is available for T Ltd. for the accounting years 2015-16 and 2016-17:

No. of shares outstanding prior to right issue 15,00,000 shares.
Right issue : One new share for each 3 shares outstanding i.e. 5,00,000 shares.
: Right Issue price ₹ 25
: Last date to exercise rights 31st July, 2016
Fair value of one equity share immediately prior to exercise of rights on 31.07.2016 is ₹ 35.

You are required to compute:
(i) Basic earnings per share for the year 2015-16.
(ii) Restated basic earnings per share for the year 2015-16 for right issue,
(iii) Basic earnings per share for the year 2016-17.
Computation of Basic Earnings per Share

Working Notes:

1. Computation of theoretical ex-rights fair value per share =

[(₹ 35 × 15,00,000) + [₹ 25 × 5,00,000)]/( 15,00,000 + 5,00,000) = ₹ 32.5

Fair value per share prior to exercise of rights Theoretical ex-rights value per share = ₹ 35/32.50 = 1.08 (approx.)

Question 12.
From the following information, you are required to compute the basic and adjusted Earnings per share:

(Nov. – 2017) – (5 Marks)
Computation of theoretical ex-rights fair value per share

Theoretical ex-rights fair value per share = ₹ 20.00

Computation of earnings per share

Diluted Eps (Based On Para Nos. 26 To 43) Theory Questions

Question 13.
Briefly describe, how do you calculate ‘Diluted Earnings per Share’ as per Accounting Standard 20.
For the purpose of calculating diluted earnings per share, the net profit or loss for the period attributable to equity shareholders and the weighted average number of shares outstanding during the period should be adjusted for the effects of all dilutive potential equity shares.

The amount of net profit or loss for the period attributable to equity shareholders should be adjusted, after taking into account any attributable change in tax expense for the period.

The number of equity shares should be the aggregate of the weighted average number of equity shares (as per paragraphs 15 and 22 of AS 20) and the weighted average number of equity shares which would be issued on the conversion of all the dilutive potential equity shares into equity shares. Dilutive potential equity shares should be deemed to have been converted into eqinty shares at the beginning of the period or, if issued later, the date of the issue of the potential equity shares.

An enterprise should assume the exercise of dilutive options and other dilutive potential equity shares of the enterprise. The assumed proceeds from these issues should be considered to have been received from the issue of shares at fair value. The difference between the number of shares issuable and the number of shares that would have been issued at fair value should be treated as an issue of equity shares for no consideration.

Only 1 Potential Equity Share

Question 14.
Ram Ltd. had 12,00,000 equity shares on April 1,2009. The company earned a profit of ₹ 30,00,000 during the year 2009-10. The average fair value per share during 2009-10 was ₹ 25. The company has given share option to its employees of 2,00,000 equity shares at option price of ₹ 15. Calculate basic E.P.S. and diluted E.P.S. (Nov 2010) (4 Marks)
Computation of Earnings Per Share

$$\left[\frac{30,00,000}{12,80,000}\right]$$

Working Note:
The earnings have not been increased as the total number of shares has been increased only by the number of shares (80,000) deemed for the purpose of the computation to have been issued for no considerations.

Question 15.
Net profit for the year 2012: ₹ 24,00,000
Weighted average number of equity shares outstanding during the year 2012: 10,00,000
Average fair value of one equity share during the year 2012: ₹ 25.00
Weighted average number of shares under option during the year 2012:2,00,000
Exercise price for shares under option during the year 2012: ₹ 20.00
Compute basic and diluted earnings per share. (May 2013) (5 Marks)
Computation of earnings per share

Note:
The earnings have not been increased as the total number of shares has been increased only by the number of shares (40,000) deemed for the purpose of computation to have been issued for no consideration.

Question 16.
M/s. A Ltd. had 8,00,000 Equity Shares outstanding on 1st April, 2013. The Company earned a profit of ₹ 20,00,000 during the year 2013-14. The average fair value per share during 2013-14 was ₹ 40. The Company has given Share Option to its employees of 1,00,000 Equity Shares at option price of ₹ 20.
Calculate Basic EPS and Diluted EPS. (May 2015) (5 Marks)
Computation of Earnings Per Share

Note: The earnings have not been increased as the total number of shares has been increased only by the number of shares (50,000) deemed for the purpose of the computation to have been issued for no consideration.

Question 17.
‘White calculating diluted EPS, effect is given to all dilutive potential equity shares that were outstanding during the period.’ Explain this statement in the light of relevant AS.
Also calculate the diluted EPS from the following information:

(Nov 2016) (5 Marks)
As per AS 20 ‘Earnings per Share’, the net profit or loss for the period attributable to equity shareholders and the weighted average number of shares outstanding during the period should be adjusted for the effects of all dilutive potential eqidty shares for calculation of diluted earnings per share. Hence, ‘in calculating diluted earnings per share, effect is given to all dilutive potential equity shares that were outstanding during the period. ’
Computation of diluted earnings per share =

Computation of Adjusted net profit for the current year

Computation of Weighted average number of equity shares
Number of equity shares resulting from conversion of debentures
= $$\frac{1,00,000 \times 100}{10}$$
= 10,00,000 Equity shares

Computation of Adjusted Weighted average number of equity shares to compute diluted earnings per share
= [(10,00,000 × 12) + (10,00,000 × 6)]/12 = 15,00,000 equity shares
Diluted earnings per share = ₹ 1,03,50,000/15,00,000 shares = ₹ 6.90 per share
Note: Interest on debentures for full year amounts to ₹ 10,00,000 (i.e. 10% of ₹ 1,00,00,000). However, interest expense amounting ₹ 5,00,000 has been given in the question. It may be concluded that debentures have been issued at the middle of the year and interest has been provided for 6 months.

Question 18.
The following information relates to M/s. XYZ Limited for the year ended 31st March, 2017:
Net Profit for the year after tax: ₹ 75,00,000
Number of Equity Shares of ₹ 10 each outstanding: ₹ 10,00,000
Convertible Debentures Issued by the Company (at the beginning of the year)

The Rate of Income Tax: 30%.
You are required to calculate Basic and Diluted Earnings Per Share (EPS).
Computation of basic earnings per share
Net profit for the current year/Weighted average number of equity shares outstanding during the year
₹ 75,00,000/10,00,000 – ₹ 7.50 per share

Computation of Adjusted net profit for the current year

Number of equity shares resulting from conversion of debentures = 1,10,000 Equity shares (given in the question)
Computation of Adjusted Weighted average number of equity shares to compute diluted earnings per share
= 11,10,000 shares (10,00,000 + 1,10,000)
Diluted earnings per share = 80,60,000/11,10,000 = ₹ 7.26 per share

Note: Conversion of convertible debentures into Equity Share will be dilutive potential equity shares. Hence, to compute the adjusted profit the interest paid on such debentures will be added back as the same would not be payable in case these are converted into equity shares.

Question 19.
The following information relates to M/s. XYZ Limited for the year ended 31st March, 2017:
Net Profit for the year after tax: ₹ 75,00,000
Number of Equity Shares of ₹ 10 each outstanding: 10,00,000
Convertible Debentures Issued by the Company (at the beginning of the year)

The Rate of Income Tax: 30%.
You are required to calculate Basic and Diluted Earnings Per Share (EPS).
Computation of basic earnings per share
Net profit for the current year/Weighted average number of equity shares outstanding during the year
₹ 75,00,000/10,00,000 = ₹ 7.50 per share
Computation of diluted earnings per share

Computation of Adjusted net profit for the current year

Number of equity shares resulting from conversion of debentures = 1,10,000 Equity shares (given in the question)
Computation of Adjusted Weighted average number of equity shares to compute diluted earnings per share
= 11,10,000 shares (10,00,000+ 1,10,000)
Diluted earnings per share = 80,60,000/11,10,000 = ₹ 7.26 per share

Note: Conversion of convertible debentures into Equity Share will be dilutive potential equity shares. Hence, to compute the adjusted profit the interest paid on such debentures will be added back as the same would not be payable in case these are converted into equity shares.

Question 20.
From the following information given by Sampark Ltd., Calculate Basis EPS and Diluted EPS as per AS 20:

(Nov. 2018 – New Course) (5 Marks)
(a) Calculation of Basic Earning Per Share
Basic EPS $$=\frac{\text { Net Profit for the current year }}{\text { No. of Equity Shares }}$$
= $$\frac{2,50,00,000}{50,00,000}$$
Basic EPS per share = ₹ 5

Calculation of Diluted Earning Per Share

Diluted EPS $$=\frac{\text { Adjusted net profit for the current year }}{\text { Weighted average no.of Equity Shares }}$$

Computation of Adjusted net profit for the current year

No. of equity shares resulting from conversion of debentures: 4,00,000 Shares
Computation of Adjusted Weighted average no. of equity shares to compute diluted EPS: (50,00,000 + 4,00,000) = 54,00,000 Equity Shares
Diluted earnings per share: (2,54,20,000/54,00,000) = ₹ 4.71 (Approx.)

Question 21.
‘While calculating diluted EPS, effect is given to all dilutive potential equity shares that were outstanding during the period.’ Explain this statement in the light of relevant AS.
Also calculate the diluted EPS from the following information:

As per AS 20 ‘Earnings per Share’, the net profit or loss for the period attributable to equity shareholders and the weighted average number of shares outstanding during the period should be adjusted for the effects of all dilutive potential equity shares for calculation of diluted earnings per share. Hence, ‘in calculating diluted earnings per share, effect is given to all dilutive potential equity shares that were outstanding during the period. ’
Computation of diluted earnings per share
$$=\frac{\text { Adjusted net profit for the current year }}{\text { Weighted average number of equity shares }}$$
Adjusted net profit for the current year

Computation of Weighted average number of equity shares
Number of equity shares resulting from conversion of debentures
= $$\frac{1,00,000 \times 100}{10}$$ = 10,00,000 Equity shares

Computation of Adjusted Weighted average number of equity shares to compute diluted earnings per share = [(10,00,000 × 12) + (10,00,000 × 6)]/12 = 15,00,000 equity shares
Diluted earnings per share = ₹ 1,03,50,000/15,00,000 shares = ₹ 6.90 per share

More Than 1 Potential Equity Share

Question 22.
Determine the Order in Which to Include Dilutive Securities in the Computation of diluted EPS
Accounting year 01-01-20XX to 31-12-20XX

Statement of Ranking to Compute Diluted EPS

Computation of Diluted Earnings Per Share

Conclusion : Since diluted earnings per share is increased when taking the convertible preference shares into account (from ₹ 3.06 to ₹ 3.34), the convertible preference shares are anti-dilutive and are ignored in the calculation of diluted earnings per share. Therefore, diluted earnings per share is ₹ 3.06.

AS 22
Accounting For Taxes On Income Basic Questions On Deferred Tax

Question 1.
Is it permissible not to recognize deferred tax liability on the ground that the Company expects that there will be losses both for accounting and tax purposes in near future? You are required to give advice to the company. (RTP)
The Company should provide for deferred tax liability on the timing differences irrespective for the fact that these timing differences will reverse in the period in which the Company expects to be in loss both from the accounting as well as tax point of view.

Question 2.
O Ltd., has provided the following information:

There is adequate evidence of future profit sufficiency.
You are required to calculate the amount of deferred tax asset/liability to be recognized as transition adjustment assuming Tax rate as 50%. (RTP)
Computation of deferred tax asset/liability

Question 3.
Rohit Ltd. has provided the following information

There is adequate evidence of future profit sufficiency. How much deferred tax assets/liability should be recognized as transition adjustment when the tax rate is 50%? (May 2018) (5 Marks)
Computation of deferred tax asset /liability

Question 4.
K Limited is working on different projects which are likely to be completed within 3 years period. It recognizes revenue from these contracts on percentage of completion method for financial statements during 2014-2015, 2015-2016 and 2016-2017 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 recognized revenue of ₹ 7,00,000, ₹ 18,00,000 and ₹ 23,00,000 for the years 2014-2015, 2015-2016 and 2016-2017 respectively. Income-tax rate is 35%.

You are required to compute the amount of deferred tax asset/liability for the years 2014-2015,2015-2016 and 2016-2017. Also describe how this amount of deferred tax asset/liability will be disclosed in the balance sheet of K Limited as per provisions of AS 22.
Computation of Deferred Tax Asset/Liability

Disclosure:

As per AS 22, 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 break-up of deferred tax assets and deferred tax liabilities into major components of the respective balances should be disclosed in the notes to accounts.

Mat And Deferred Tax

Question 5.
From the following details of A Ltd. for the year ended 31-03-2017, 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.

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
26,250 + [(6,00,000 – 60,000) × 20%] = 1,34,250

Tax Holiday Period

Question 6.
M 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 resuiting in a tax liability in year 1 and 2 is ₹ 1,000 lakhs and ₹ 2,000 lakhs respectively. From the third year it is expected that the timing difference would reverse each year by ₹ 50 lakhs. Assuming tax rate of 40%, you are required to compute to the deferred tax liability at the end of the second year and any charge to the Profit and Loss account. (RTF)
As per para 13 of Accounting Standard (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 recognized to the extent deduction from the total income of an enterprise is allowed during the tax holiday period as per the provisions of sections 10A and 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 recognized 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 ₹ 1,000 lakhs depreciation, timing difference amounting ₹ 400 lakhs (₹ 50 lakhs × 8 years) will reverse in the tax holiday period and therefore, should not be recognized.
However, for ₹ 600 lakhs 1,000 lakhs – ₹ 400 lakhs), deferred tax liability will be recognized for ₹ 240 lakhs (40% of ₹ 600 lakhs) in first year.

In the second year, the entire amount of timing difference of ₹ 2,000 lakhs will reverse only after-tax holiday period and hence, will be recognized in full.

Deferred tax liability amounting ₹ 800 lakhs (40% of ₹ 2,000 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 ₹ 1,040 lakhs (240 lakhs + 800 lakhs).

Transitional Provisions

Question 7.
PQR is an export-oriented unit and was enjoying tax holiday upto 31.3.2016. No provision for deferred tax liability was made in accounts for the year ended 31.3.2016. While finalising the accounts for the year ended 31.3.2017, the Accountant says that the entire deferred tax liability upto 31.3.2016 and current year deferred tax liability should be routed through Profit and Loss Account as the relevant Accounting Standard has already become mandatory from 1.4.2001. Do you agree?
AS 22 on “Accounting for Taxes on Income” relates to the transitional provisions. It says, “On the first occasion that the taxes on income are accounted for in accordance with this statement, the enterprise should recognise, in the financial statements, the deferred tax balance that has accumulated prior to the adoption of this statement as deferred tax asset/liability with a corresponding credit/charge to the revenue reserves, subject to the consideration of prudence in case of deferred tax assets.”

Further AS 22 lays down, “For the purpose of determining accumulated deferred tax in the period in which this statement is applied for the first time, the opening balances of assets and liabilities for accounting purposes and for tax purposes are compared and the differences, if any, are determined. The tax effects of these differences, if any, should be recognised as deferred tax assets or liabilities, if these differences are timing differences. ”

Analysis and conclusion:
In the above case, even though AS 22 has come into effect from 1.4.2001, the transitional provisions permit adjustment of deferred tax liability/asset upto the previous year to be adjusted from opening reserve. In other words, the deferred taxes not provided for alone can be adjusted against opening reserves. Provision for deferred tax asset/liability for the current year should be routed through profit and loss account like normal provision.

AS 24
Discontinuing Operations Discontinuing Operations (Based On Para Nos. 3 To 14)

Question 1.
A consumer goods producer has changed the product line as follows:

The company has enforced a gradual enforcement of change in product line on the basis of an overall plan. The Board of Directors has passed a resolution in March 2016 to this effect. The company follows calendar year as its accounting year. You are required to advise whether it should it be treated as discontinuing operation as per AS 24?
As per AS 24 ‘Discontinuing Operations’, a discontinuing operation is a . component of an enterprise:

1. that the enterprise, pursuant to a single plan, is:
1. disposing of substantially in its entirety,
2. disposing of piecemeal, or
3. terminating through abandonment; and
2. that represents a separate major line of business or geographical area of operations; and
3. that can be distinguished operationally and for financial reporting pur-poses.

As per provisions of the standard, business enterprises frequently close facilities, abandon products or even product lines, and change the size of their work force in response to market forces. While those kinds of terminations generally are not, in themselves, discontinuing operations, they can occur in connection with a discontinuing operation. Examples of activities that do not necessarily satisfy criterion of discontinuing operation are gradual or evolutionary phasing out of a product line or class of service, discontinuing, even if relatively abruptly, several products within an ongoing line of business;

Analysis & Conclusion :

In the given case, the company has enforced a gradual enforcement of change in product line and does not represent a separate major line of business and hence is not a discontinued operation. If it were a discontinuing operation, the initial disclosure event is the occurrence of one of the following, whichever occurs earlier:

1. the enterprise has entered into a binding sale agreement for substantially all of the assets attributable to the discontinuing operation; or
2. the enterprises board of directors or similar governing body has both approved a detailed, formal plan for discontinuance and made an an-nouncement of the plan.

Question 2.
What are the initial disclosure requirements of AS 24 for discontinuing operations? (Nov. 2018 New Course) (5 Marks)
An enterprise should include the following information relating to a discontinuing operation in its financial statements beginning with the financial statements for the period in which the initial disclosure event occurs:
A. A description of the discontinuing operation(s)
B. The business or geographical segment(s) in which it is reported as per AS 17
C. The date and nature of the initial disclosure event.
D. The date or period in which the discontinuance is expected to be com-pleted if known or determinable.
E. The carrying amounts, as of the balance sheet date, of the total assets to be disposed of and the total liabilities to be settled.
F. The amounts of revenue and expenses in respect of the ordinary activities attributable to the discontinuing operation during the current financial reporting period.
G. The amount of pre-tax profit or loss from ordinary activities attributable to the discontinuing operation during the current financial reporting period, and the income tax expense related thereto.
H. The amounts of net cash flows attributable to the operating, investing, and financing activities of the discontinuing operation during the current financial reporting period.

AS 26
Intangible Assets
Recognition Of Intangible Asset (Based On Para Nos. 20, 35, 50 And 56)

Question 1.
How is software acquired for internal use accounted for under AS 26?
Paragraphs 10 and 11 of Appendix A to the Accounting Standard 26 on Intangible Assets, lays down the following procedure for accounting of software acquired for internal use:

• The cost of a software acquired for internal use should be recognised as an asset if it meets the recognition criteria prescribed in paragraphs 20 and 21 of this statement.
• The cost of a software purchased for internal use comprises its purchase price, including 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 software ready for its use.
• Any trade discounts and rebates are deducted in arriving at the cost. In the determination of cost, matters stated in paragraphs 24 to 34 of the Statement which deal with the method of accounting for ‘Separate Ac-quisitions ‘ ‘Acquisitions as apart of Amalgamations ’ Acquisitions by way of Government Grant’, and ‘Exchanges of Assets’, need to be considered, as appropriate.

Recognition criteria as per paragraphs 20 and 21 of the standard are stated 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.

Question 2.
A Company with a turnover of ₹ 375 crores and an annual advertising budget of ₹ 3 crores had taken up the marketing of a new product. It was estimated that the company would have a turnover of ₹ 37.5 crores from the new product. The company had debited to its Profit and Loss account the total expenditure of ₹ 3 crores incurred on extensive special initial advertisement campaign for the new product.
Is the procedure adopted by the Company correct?
According to AS 26 ‘Intangible Assets’, ‘expenditure on an intangible item should be recognized as an expense when it is incurred unless it forms part of the cost of an intangible asset’.

Analysis : In the given case, advertisement expenditure of ₹ 3 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 ₹ 37.5 crores. Here, no intangible asset or another asset is acquired or created that can be recognized.

Conclusion : Therefore, the accounting treatment by the company of debiting the entire advertising expenditure of ₹ 3 crores to the Profit and Loss account of the year is correct.

Measurement Of Intangible Asset (Based On Para Nos. 24 To 34 And 58)

Question 3.
A company acquired for its internal use a software on 28.01.2012 from USA for US \$ 1,00,000. The exchange rate on that date was ₹ 52 per USD. The seller allowed trade discount @5%. The other expenditure were:
(i) Import Duty: 20%
(ii) Purchase Tax: 10%
(iii) Entry Tax: 5% (Recoverable later from tax department)
(iv) Installation expenses: ₹ 25,000
(v) Profession fees for Clearance from Customs: ₹ 20,000 Compute the cost of Software to be capitalized. (Nov. 2012) (5 Marks)
Calculation of cost of software (intangible asset) acquired for internal use

Note: Since entry tax has been mentioned as a recoverable/refundable tax, it is not included as part of the cost of the asset.

Research 8t Development (Based On Para Nos. 41 To 44 And 52)

Question 4.
What are the costs that are to be included in Research and Development costs as per AS 26.
According to paras 41 and 43 of AS 26, “No intangible asset arising from research (or from the research phase of an internal project) should be recognized in the research phase. Expenditure on research (or on the research phase of an internal project) should be recognized as an expense when it is incurred.
Examples of research costs are:

• Costs of activities aimed at obtaining new knowledge;
• Costs of the search for, evaluation and final selection of, applications of research findings or other knowledge;
• Costs of the search for alternatives for materials, devices, products, processes, systems or services; and
• Costs of the activities involved in formulation, design, evaluation and final selection of possible alternatives for new or improved materials, devices, products, processes systems or services. ”

According to paras 45 and 46 of AS 26, “In the development phase of a project, an enterprise can, in some instances, identify an intangible asset and demonstrate that future economic benefits from the asset are probable. This is because the development phase of a project is further advanced than the research phase.

Examples of development activities /costs are:

• Costs of the design, construction and testing of pre-production or pre-use prototypes and models;
• Costs of the design of tools, jigs, moulds and dies involving new technology;
• Costs of the design, construction and operation of a pilot plant that is not of a scale economically feasible for commercial production; and
• Costs of the design, construction and testing of a chosen alternative for new or improved materials, devices, products, processes, systems or services. ”

Question 5.
K. Ltd. is developing a new production process. During the financial year ending 31st March, 2012, the total expenditure incurred was ₹ 50 lakhs. This process met the criteria for recognition as an intangible asset on 1st December, 2011. Expenditure incurred till this date was ₹ 22 lakhs. Further expenditure incurred on the process for the financial year ending 31st March, 2013 was ₹ 80 lakhs. As at 31st March, 2013, the recoverable amount of know-how embodied in the process is estimated to be ₹ 72 lakhs. This includes estimates of future cash outflows as well as inflows.
You are required to calculate:
(i) Amount to be charged to Profit and Loss A/c for the year ending 31st March, 2012 and carrying value of intangible as on that date.
(ii) Amount to be charged to Profit and Loss A/c and carrying value of intangible as on 31st March, 2013.
Ignore depreciation.
(i) For the year ending 31.03.2012

(1) Carrying value of intangible as on 31.03.2012:
At the end of financial year 31st March 2012, the production process will be recognized (i.e. carrying amount) as an intangible asset at a cost of ₹ 28 lakhs (expenditure incurred since the date the recognition criteria was met, i.e., from 1st December 2011).

(2) Expenditure to be charged to Profit and Loss account:
The ₹ 22 lakhs is recognized as an expense because the recognition criteria was not met until 1st December 2012. This expenditure will not form part of the cost of the production process recognized in the balance sheet.

(ii) For the year ending 31.03.2013
(1) Expenditure to be charged to Profit and Loss account:

₹ 36 lakhs to be charged to Proht and loss account for the year ending 31.03.2013.
(2) Carrying value of intangible as on 31.03.2013:

Question 6.
During 2016-17, an enterprise incurred costs to develop and produce a routine, low risk computer software product, as follows:

What amount should be capitalized as software costs in the books of the company, on Balance Sheet date?
As per para 44 of AS 26, costs incurred in creating a computer software product should be charged to research and development expense when incurred until technological feasibility /asset recognition criteria has been established for the product.

Analysis & Conclusion: Technological feasibility /asset recognition criteria have been established upon completion of detailed programme design or working model. In this case, ₹ 45,000 would be recorded as an expense (₹ 25,000 for completion of detailed program design and ₹ 20,000 for coding and testing to establish technological feasibility/asset recognition criteria). Cost incurred from the point of technological feasibility/asset recognition criteria until the time when products costs are incurred are capitalized as software cost (₹ 42,000 + ₹ 12,000 + ₹ 13,000) ₹ 67,000.

Question 7.
M Ltd. launched a project for producing product A in Nov. 2008. The company incurred ₹ 30 lakhs towards Research and Development expenses upto 31st March, 2010. Due to unfavourable market conditions the management feels that it is not possible to manufacture and sold the product in the market for next so many years.
The management hance wants to defer the expenditure write off to future years. Advise the company as per the applicable Accounting Standard. (Nov 2010) (4 Marks)
As per para 41 of AS 26 ‘Intangible Assets’, expenditure on research should be recognised as an expense when it is incurred. An intangible asset arising from development (or from the development phase of an internal project) should be recognized if and only if, an enterprise can demonstrate all of the conditions specified in para 44 of the standard. An intangible asset (arising from development) should be derecognised when no future economic benefits are expected from its use according to the provisions of AS 26.

Analysis & Conclusion : Therefore, the management can not defer the expenditure write off to future years and the company is required to expense the entire amount of ₹ 30 lakhs in the Profit and Loss account of the year ended 31st March, 2010.

Question 8.
Plymouth Ltd. is engaged in research on a new process design for its product. It had incurred ₹ 10 lakh on research during first 5 months of the financial year 2012-13. The development of the process began on 1st September, 2012 and upto 31st March, 2013, a sum of ₹ 8 lakh was incurred as Development Phase Expenditure, which meets assets recognition criteria.

From 1st April, 2013, the Company has implemented the new process design and it is likely that this wilt result in after tax saving of ₹ 2 lakh per annum for next five years.

The cost of capital is 10%. The present value of annuity factor of 1 for 5 years @10% is 3.7908.
Decide the treatment of Research and Development Cost of the project as per AS 26. (Nov. 2013) (4 Marks)
Accounting Treatment of Research Expenditure – According to AS 26 ‘Intangible Assets’, the expenditure on research of new process design for its product ₹ 10 lakhs should be charged to Profit and Loss Account in the year in which it is incurred. It is presumed that the entire expenditure is incurred in the financial year 2012-13. Hence, it should be written off as an expense in that year itself.

Cost of internally generated intangible asset – it is given that development phase expenditure amounting ₹ 8 lakhs incurred upto 31st March, 2013 meets asset recognition criteria. As per AS 26, for measurement of such internally generated intangible asset, fair value can be estimated by discounting estimated future net cash flows.

The cost of an internally generated intangible asset would be lower of cost value ₹ 8 lakhs or present value of future net cash flows ₹ 7.582 lakhs.

Hence, cost of an internally generated intangible asset will be ₹ 7.582 lakhs.
The difference of ₹ 0.418 lakhs (i.e. ₹ 8 lakhs – ₹ 7.582 lakhs) will be amortized by Plymouth for the financial year 2012-13.

Amortisation – The company can amortise ₹ 7.582 lakhs over a period of five years by charging ₹ 1.5164 lakhs per annum from the financial year 2013-14 onwards.

Question 9.
K Ltd. launched a project for producing product X in October, 2016. The Company incurred ₹ 40 lakhs towards Research and Development expenses upto 31st March, 2018. 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
As per provisions of AS 26 ‘Intangible Assets’, expenditure on research should be recognized as an expense when it is incurred. An intangible asset arising from development (or from the development phase of an internal project) should be recognized if, and only if, an enterprise can demonstrate all of the conditions specified in para 44 of the standard. An intangible asset (arising from development) should be derecognized when no future economic benefits are expected from its use according to para 87 of the standard.

Analysis Conclusion : Thus, the manager cannot defer the expenditure write off to future years in the given case. Hence, the expenses amounting ₹ 40 lakhs incurred on the research and development project has to be written off in the current year ending 31st March, 2018.

Amortisation (Based On Para Nos. 63 To 78)

Question 10.
A Company had deferred research and development cost ₹ 450 Lakhs. Sales expected in the subsequent years are as under:

You are asked to suggest how should research and development cost be charged to Profit and Loss Account assuming entire cost of ₹ 450 Lakhs is development cost. If at the end of 3rd year, it is felt that no further benefit will accrue in the 4th year, how the unamortized expenditure would be dealt with in the accounts of the company? (May 2012) (5 Marks)
(i) Based on sales, research and development cost (assumed that entire cost of ₹ 450 lakhs is development cost) is allocated as follows:

(ii) If at the end of the 3rd year, the circumstances do not justify that further benefit will accrue in the 4th year, then the company has to charge the unamortised amount i.e. remaining ₹ 135 lakhs [450 – (180 + 135)] as an expense immediately.

Question 11.
An enterprise acquired patent right for ₹ 400 lakhs. The product life cycle has been estimated to be 5 years and the amortization was decided in the ratio of estimated future cash flows which are as under:

After 3rd year, it was ascertained that the patent would have an estimated balance future life of 3 years and the estimated cash flow after 5th year is expected to be ₹ 50 lakhs. Determine the amortization under Accounting Standard 26. (May 2013) (5 Marks)
Amortization of cost of patent (as per AS 26)

In the first three years, the patent cost will be amortised in the ratio of estimated future cash flows i.e. (200: 200: 200:100:100).

The unamortized amount of the patent after third year will be ₹ 100 (400-300) which will be amortised in the ratio of revised estimated future cash flows (100:100:50) in the fourth, fifth and sixth year.

Question 12.
A company is showing an intangible asset at ₹ 88 lakhs as on 01.04.2013. This asset was acquired for ₹ 120 lakhs on 01.04.2009 and the same was available for use from that date. The company has been following the policy of amortization of the intangible assets over a period of 15 years on straight line basis. Comment on the accounting treatment of the above with reference to the relevant Accounting Standard. (Nov. 2014) (5 Marks)
As per AS 26 ‘Intangible Assets’, the depreciable amount of an intangible asset should be allocated on systematic basis over the best estimates of its useful life. 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.

Analysis:
Company has been following the policy of amortisation of the intangible asset over a period of 15 years on straight line basis. The period of 15 years is more than the maximum period of 10 years specified as per AS 26.

Conclusion :
Accordingly, the company would be required to restate the carrying amount of intangible asset as on 01.04.2013 at ₹ 72 lakhs i.e. ₹ 120 lakhs less 48 lakhs

The difference of ₹ 16 Lakhs (₹ 88 lakhs – ₹ 72 lakhs) will be adjusted against the opening balance of revenue reserve. The carrying amount of ₹ 72 lakhs will be amortised over remaining 6 years by amortising ₹ 12 lakhs per year.

Question 13.
M/s. Mahesh Ltd. is developing a new production process. During the Financial Year ended 31st March, 2013, the total expenditure incurred on the process was ₹ 60 lacs. The production process met the criteria for recognition as an intangible asset on 1st December, 2012. Expenditure incurred till this date was ₹ 32 lacs.

Further expenditure incurred on the process for the Financial Year ending 31 st March, 2014 was ₹ 90 lacs. As on 31 -03-2014, the recoverable account of know-how embodied in the process is estimated to be ₹ 82 lacs. This includes estimates of future cash outflows and inflows:
You are required to work out:
(i) What is the expenditure to be charged to Profit & Loss Account for the year ended 31st March, 2013?
(ii) What is the carrying amount of the intangible asset as on 31st March, 2013?
(iii) What is the expenditure to be charged to Profit & Loss Account for the year ended 31st March, 2014?
(iv) What is the carrying amount of the intangible asset as on 31st March, 2014? (May 2015) (5 Marks)
(i) Expenditure to be charged to Profit and Loss account for the year ending 31.03.2013
₹ 32 lakhs is recognized as an expense because the recognition criteria were not met until 1st December 2012. This expenditure will not form part of the cost of the production process recognized as an intangible asset in the balance sheet.
(ii) Carrying value of intangible asset as on 31.03.2013
At the end of financial year, on 31st March, 2013, the production process will be recognized (i.e. carrying amount) as an intangible asset at a cost of ₹ 28 (60-32) lacs (expenditure incurred since the date the recognition criteria were met, i.e., from 1st December 2012).
(iii) Expenditure to be charged to Profit and Loss account for the year ended 31.03.2014

₹ 36 lakhs to be charged to Profit and loss account for the year ending 31.03.2014.

(iv) Carrying value of intangible asset as on 31.03.2014

Question 14.
Fast Ltd. acquired a patent at a cost of ₹ 40,00,000 for a period of five years and its product life-cycle is also five years. The company capitalized the cost and started amortising the asset at ₹ 5,00,000 per annum. After two years, it was found that the product life-cycle may continue for another 5 years from then. The net cash flows from the product during these 5 years are expected to be ₹ 18,00,000, ₹ 23,00,000, ₹ 22,00,000, ₹ 20,00,000 and ₹ 17,00,000. Find out the amortization cost of the patent for each of the years. (May 2017) (5 Marks)
Amortization by Fast Limited for the first two years (5,00,000 × 2) = ₹ 10,00,000.
Remaining carrying cost after two years = ₹ 40,00,000 – ₹ 10,00,000 – ₹ 30,00,000
Since after two years it was found that the product life-cycle may continue for another 5 years, hence the remaining carrying cost will be amortized during next 5 years in the ratio of net cash arising from the products of Fast Limited.
The amortization may be found as follows:

Note:

1. It has been assumed that the company has amortized the patent at ₹ 5,00,000 per annum (on a systematic manner) for the first 2 years.
2. It has been considered that the patent is renewable and fast Ltd. got it renewed after expiry of five years.

Question 15.
A company acquired patent right for 1200 lakhs. The product life cycle has been estimated to be 5 years and the amortization was decided in the ratio of estimated future cash flows which are as under:

After 3rd year, it was ascertained that the patent would have an estimated balance future life of 3 years and the estimated cash flow after 5th year is expected to be ₹ 150 lakhs. Determine the amortization under Accounting Standard 26. (May 2018) (5 Marks)
Amortization of cost of patent (as per AS 26)

In the first three years, the patent cost will be amortized in the ratio of estimated future cash flows i.e. (600: 600: 600: 300: 300).

The unamortized amount of the patent after third year will be ₹ 300 lakh (1,200-900) which will be amortized in the ratio of revised estimated future cash flows (300:300:150) in the fourth, fifth and sixth year.

Question 16.
D Ltd. acquired a patent at a cost of ₹ 1,00,00,000 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 on SLM. After two years it was found that the product life-cycle may continue for another 5 years from then. The net cash flows from the product during these 5 years were expected to be ₹ 45,00,000, ₹ 42,00,000, ₹ 40,00,000, ₹ 38,00,000 and ₹ 35,00,000. Patent is renewable and company changed amortization method from 3rd year (i.e. from SLM to ratio of expected new cash flows).
You are required to compute the amortization cost of the patent for each of the years (1st year to 7th year).
D Limited amortised ₹ 20,00,000 per annum for the first two years i.e. ₹ 40,00,000. The remaining carrying cost can be amortized 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:

It may be seen from above that from third year onwards, the balance of carrying amount ie., ₹ 60,00,000 has been amortized in the ratio of net cash flows arising from the product of D Ltd.

Question 17.
A company acquired a patent at a cost of ₹ 160 lakhs for a period of 5 years and the product life-cycle is also 5 years. The company capitalized the cost and started amortising the asset at ₹ 16 lakhs per year based on the economic benefits derived from the product manufactured under the patent. After 2 years it was found that the product life cycle may continue for another 5 years from then (the patent is renewable and the company can get it renewed after 5 years). The net cash flows from the product during these 5 years were expected to be ₹ 50 lakhs, ₹ 30 lakhs, ₹ 60 lakhs, ₹ 70 lakhs and ₹ 40 lakhs. Find out the amortization cost of the patent for each of the years. (May 2018 – New Course) (5 Marks)
Company amortized ₹ 16,00,000 per annum for the first two years. Hence, Amortization for the first two years (₹ 16,00,000 × 2) = ₹ 32,00,000.
Remaining carrying cost after two years = ₹ 1,60,00,000 – ₹ 32,00,000 = ₹ 1,28,00,000
Since after two years it was found that the product life-cycle may continue for another 5 years, hence the remaining carrying cost ₹ 128 lakhs will be amortized during next 5 years in the ratio of net cash arising from the sale of the products of Fast Limited.

The amortization cost of the patents may be computed as follows:

Question 18.
A Ltd. has got the license to manufacture particular medicines for 10 years at a license fee of ₹ 200 lakhs. Given below is the pattern of expected production and expected operating cash inflow:

Net operating cash flow has increased for third year because of better inventory management and handling method.
You are required to determine the amortization method in line with AS 26.
As per AS 26 ‘Intangibles Assets’, the amortization method used should reflect the pattern in which economic benefits are consumed by the enterprise. If pattern cannot be determined reliably, then straight-line method should be used.

Analysis & Conclusion : In the instant case, the pattern of economic benefit in the form of net operating cash flow vis-a-vis production is determined reliably. A Ltd. should amortize the license fee of ₹ 200 lakhs as under:

AS 29
Provisions, Contingent Liabilities And Contingent Assets
Recognition Of Provision (Based On Para Nos. 10 And 14)

Question 1.
An airline is required by law to overhaul its aircraft once in every five years. The pacific Airlines which operate aircrafts does not provide any provision as required by law in its final accounts. Discuss with reference to relevant Accounting Standard 29. (May 2012) (4 Marks)
Answer: A provision should be recognised only when an enterprise has a present obligation as a result of a past event. In the given case, there is no present obligation, therefore no provision is recognized as per AS 29.

Analysis : The cost of overhauling aircraft is not recognized as a provision because it is a future obligation and the incurring of the expenditure depends on the company’s decision to continue operating the aircrafts. Even a legal requirement to overhaul does not require the company to make a provision for the cost of overhaul because there is no present obligation to overhaul the aircrafts.

Further, the enterprise can avoid the future expenditure by its future action, for example by selling the aircraft. However, an obligation might arise to pay fines or penalties under the legislation after completion of five years. Assessment of probability of incurring fines and penalties depends upon the provisions of the legislation and the stringency of the enforcement regime.

Conclusion: A provision should be recognized for the best estimate of any fines and penalties if airline continues to operate aircrafts for more than five years.

Question 2.
The company has not made provision for warrantee in respect of certain goods considering that the company can claim the warranty cost from the original supplier.
You are required to examine in line with the provisions of AS 29.
As per provisions of AS 29 ‘Provisions, Contingent Liabilities and Contingent Assets’, where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement should be recognized when, and only when, it is virtually certain that reimbursement will be received if the enterprise settles the obligation. The reimbursement should be treated as a separate asset. The amount recognized for the reimbursement should not exceed the amount of the provision.

Analysis : It is apparent from the question that the company had not made provision for warranty in respect of certain goods considering that the company can claim the warranty cost from the original supplier. However, the provision for warranty should have been made as per AS 29 and the amount claimable as reimbursement should be treated as a separate asset in the financial statements of the company rather than omitting the disclosure of such liability.

Conclusion : Accordingly, it can be said that the accounting treatment adopted by the company with respect to warranty is not correct.

Question 3.
X Ltd. is in a dispute with a competitor company. The dispute is regarding alleged infringement of Copyrights. The competitor has filed a suit in the court of law seeking damages of ₹ 200 lakhs.
The Directors are of the view that the claim can be successfully resisted by the Company.
How would the matter be dealt in the annual accounts of the Company in the light of AS 29? You are required to explain in brief giving reasons for your answer.
As per AS 29, ‘Provisions, Contingent Liabilities and Contingent Assets’, a provision should be recognized 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 recognized.

Analysis : In the given situation, since, the directors of the company are of the opinion that the claim can be successfully resisted by the company, therefore there will be no outflow of the resources. Hence, no provision is required.

Disclosure : (Notes To Accounts)
“Litigation is in process against the company relating to a dispute with a competitor who alleges that the company has infringed copyrights and is seeking damages of ₹ 200 lakhs. However, the directors are of the opinion that the claim can be successfully resisted by the company.”

Question 4.
An airline is required by law to overhaul its aircraft once in every five years. The pacific Airlines which operate aircrafts does not provide any provision as required by law in its final accounts. Discuss with reference to relevant Accounting Standard 29.
A provision should be recognized only when an enterprise has a present obligation arising from a past event or obligation.

Analysis:
In the given case, there is no present obligation but a future one, therefore no provision is recognized as per AS 29.

The cost of overhauling aircraft is not recognized as a provision because it is a future obligation and the incurring of the expenditure depends on the company’s decision to continue operating the aircrafts. Even a legal requirement to overhaul does not require the company to make a provision for the cost of overhaul because there is no present obligation to overhaul the aircrafts.

Further, the enterprise can avoid the future expenditure by its future action, for example by selling the aircraft. However, an obligation might arise to pay fines or penalties under the legislation after completion of five years. Assessment of probability of incurring fines and penalties depends upon the provisions of the legislation and the stringency of the enforcement regime.

Conclusion: A provision should be recognized for the best estimate of any fines and penalties if airline continues to operate aircrafts for more than five years.

Question 5.
S Ltd. has entered into a sale contract of ₹ 5 crores with X Ltd. during 2015-2016 financial year. The profit on this transaction is ₹ 1 crore. The delivery of goods to take place during the first month of 2016-2017 financial year. In case of failure of S Ltd. to deliver within the schedule, a compensation of ₹ 1.5 crores is to be paid to X Ltd. S Ltd. planned to manufacture the goods during the last month of 2015-2016 financial year. As on balance sheet date (31.3.2016), the goods were not manufactured and it was unlikely that S Ltd. will be in a position to meet the contractual obligation.
(I) Should S Ltd. provide for contingency as per AS 29? Explain.
(II) Should provision be measured as the excess of compensation to be paid over the profit?
(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 recognised.

Analysis: S Ltd. has the obligation to deliver the goods within the scheduled time as per the contract. It is probable that S Ltd. will fail to deliver the goods within the schedule and it is also possible to estimate the amount of compensation.

Conclusion : Therefore, S Ltd. should provide for the contingency amounting ₹ 1.5 crores as per AS 29.

Analysis: (ii) Provision should not be measured as the excess of compensation to be paid over the profit. The goods wrere not manufactured before 31 st March, 2016 and no profit had accrued for the financial year 2015-2016.

Conclusion : Therefore, provision should be made for the full amount of compensation amounting ₹ 1.50 crores.

Question 6.
X Ltd. is in a dispute with a competitor company. The dispute is regarding alleged infringement of Copyrights. The competitor has filed a suit in the court of law seeking damages of ₹ 200 lacs.
The Directors are of the view that the claim can be successfully resisted by the Company.
How would the matter be dealt in the annual accounts of the Company in the light of AS 29? Explain in brief giving reasons for your answer.
As per AS 29, ‘Provisions, Contingent Liabilities and Contingent Assets’, a provision should be recognized 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 recognized.

Analysis: In the given situation, since, the directors of the company are of the opinion that the claim can be successfully resisted by the company, therefore there will be no outflow of the resources. Hence, no provision is required.

Disclosure : (Notes To Account)
“Litigation is in process against the company relating to a dispute with a competitor who alleges that the company has infringed copyrights and is seeking damages of ₹ 200 lakhs. However, the directors are of the opinion that the claim can be successfully resisted by the company.”

Measurement Of Provision (Based On Para No. 35)

Question 7.
A Ltd. manufactures engineering goods, provides after sales warranty for 2 years to its customers. Based on past experience, the company has been following the policy for making provision for warranties on the invoice amount, on the remaining balance warranty period:
Less than 1 year: 2% provision
More than 1 year: 3% provision
The company has raised invoices as under:

Calculate the provision to be made for warranty under Accounting Standard 29 as at 31st March, 2017 and 31st March, 2018. Also compute amount to be debited to profit and loss Account for the year ended 31st March, 2018. (May 2018) (5 Marks)
Provision to be made for warranty under AS 29
As at 31 st March, 2017 = ₹ 80,000 × .02 + ₹ 50,000 × .03
= ₹ 1,600 + ₹ 1,500 = ₹ 3,100
= ₹ 50,000 × .02 + ₹ 1,80,000 × .03 = ₹ 1,000 + ₹ 5,400 = ₹ 6,400
Amount debited to Profit and Loss Account for year ended 31st March, 2018

Note. No provision will be made on 31st March, 2018 in respect of sales amounting ₹ 80,000 made on 19th January, 2016 as the warranty period of 2 years has already expired.

Reimbursement (Based On Para Nos. 46 And 47)

Question 8.
M/s. Shishir Ltd., a public Sector Company, provides consultancy and engineering services to its clients. In the year 2014-15, the Government set up a commission to decide about the pay revision. The pay will be revised with respect from 1-1-2012 based on the recommendations of the commission. The company makes the provision of ₹ 1250 lakhs for pay revision in the financial year 2014-15 on the estimated basis as the report of the commission is yet to come. As per the contracts with client on cost plus job, the billing is done on the actual payment made to the employees and allocated to jobs based on hours booked by these employees on each job.
The company discloses through notes to accounts:

“Salaries and benefits include the provision of ₹ 7250 lakhs in respect of pay revision. The amount chargeable from reimbursable jobs will be billed as per the contract when the actual payment is made.”

The Accountant feels that the company should also book/recognize the income by ₹ 1250 lakhs in Profit & Loss Account as per the terms of the contract. Otherwise, it will be the violation of matching concept & understatement of profit.
Comment on the opinion of the Accountant with reference to relevant Accounting Standards. (May 2015) (5 Marks)
As per AS 29, ‘Provisions, Contingent Liabilities and Contingent Assets’, where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement should be recognized when, and only when, it is virtually certain that reimbursement will be received if the enterprise settles the obligation. The reimbursement should be treated as a separate asset. The amount recognized for the reimbursement should not exceed the amount of the provision.

Analysis:
Accordingly, potential loss to an enterprise may be reduced or avoided because a contingent liability is matched by a related counter-claim or claim against a third party. In such cases, the amount of the provision is determined after taking into account the probable recovery under the claim if no significant uncertainty as to its measurability or collectability exists.

In this case, the provision of salary to employees of ₹ 1,250 lakhs will be ultimately collected from the client, as per the terms of the contract. Therefore, the liability of ₹ 1,250 lakhs is matched by the counter claim from the client. Hence, the provision for salary of employees should be matched with the reimbursable asset to be claimed from the client. It appears that the whole amount of ₹ 1,250 lakhs is recoverable from client and there is no significant uncertainty about the collection. Hence, the net charge to profit and loss account should be nil.

Conclusion :
The opinion of the accountant regarding recognition of income of ₹ 1,250 lakhs is not as per AS 29 and also the concept of prudence will not be followed if ₹ 1,250 lakhs is simultaneously recognized as income. ₹ 1,250 lakhs is not the revenue at present but only reimbursement of claim for which an asset is created. However the accountant is correct to the extent as that non-recognition of ₹ 1,250 lakhs as income will result in the understatement of profit. To avoid this, in the statement of profit and loss, expense relating to provision may be presented net of the amount recognized for reimbursement.

Question 9.
S Ltd. (a Public Sector Company) provides consultancy and engineering services to its clients. In the year 2016-17, the Government has set up a commission to decide about the pay revision. The pay will be revised with respect from 1-1-2012 based on the recommendations of the commission. The company makes the provision of ₹ 680 lakhs for pay revision in the financial year 2016-17 on the estimated basis as the report of the commission is yet to come. As per the contracts with the client on cost plus job, the billing is done on the actual payment made to the employees and allocated to jobs based on hours booked by these employees on each job.

The company discloses through notes to accounts:
“Salaries and benefits include the provision of ₹ 680 lakhs in respect of pay revision. The amount chargeable from reimbursable jobs will be billed as per the contract when the actual payment is made”.

The accountant feels that the company should also book/recognise the income by X 680 lakhs in Profit and Loss Account as per the terms of the contract. Otherwise, it will be the violation of matching concept & understatement of profit. Comment on the opinion of the Accountant with reference to relevant accounting standards.
As per AS 29, ‘Provisions, Contingent Liabilities and Contingent Assets’, where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement should be recognised when, and only when, it is virtually certain that reimbursement will be received if the enterprise settles the obligation. The reimbursement should be treated as a separate asset. The amount recognised for the reimbursement should not exceed the amount of the provision.

Analysis : Accordingly, potential loss to an enterprise may be reduced or avoided because a contingent liability is matched by a related counter-claim or claim against a third party. In such cases, the amount of the provision is determined after taking into account the probable recovery under the claim if no significant uncertainty as to its measurability or collectability exists. In this case, the provision of salary to employees of ₹ 680 lakhs will be ultimately collected from the client, as per the terms of the contract.

Therefore, the liability of ₹ 680 lakhs is matched by the counter claim from the client. Hence, the provision for salary of employees should be matched with the reimbursable asset to be claimed from the client. It appears that the whole amount of ₹ 680 lakhs is recoverable from client and there is no significant uncertainty about the collection. Hence, the net charge to profit and loss account should be nil.

Conclusion : The opinion of the accountant regarding recognition of income of ₹ 680 lakhs is not as per AS-29 and also the concept of prudence will not be followed if ₹ 680 lakhs is simultaneously recognized as income. ₹ 680 lakhs is not the revenue at present but only reimbursement of claim for which an asset is created. However, the accountant is correct to the extent as that nonrecognition of ₹ 680 lakhs as income will result in the understatement of profit. To avoid this, in the statement of profit and loss, expense relating to provision may be presented net of the amount recognized for reimbursement.

Contingent Liability (Based On Para Nos. 10 And 26)

Question 10.
An engineering goods company provides after sales warranty for 2 years to its customers. Based on past experience, the company has been following policy for making provision for warranties on the invoice amount, on the remaining balance warranty period:
Less than 1 year: 2% provision
More than 1 year: 3% provision
The company has raised invoices as under:

Calculate the provision to be made for warranty under Accounting Standard 29 as at 31st March, 2012 and 31st March, 2013. Also compute amount to be debited to Profit and Loss Account for the year ended 31st March, 2013. (May 2013) (5 Marks)
Provision to be made for warranty under AS 29
As at 31 st March, 2012 = ₹ 40,000 × .02 + ₹ 2 5,000 × .03
= ₹ 800 + ₹ 750 = ₹ 1,550
As at 31st March, 2013 = ₹ 25,000 × .02 + ₹ 90,000 × .03
= ₹ 500 + ₹ 2,700 = ₹ 3,200
Amount debited to Profit and Loss Account for year ended 31st March, 2013

Note: No provision will be made on 31st March, 2013 in respect of sales amounting ₹ 40,000 made on 19th January, 2011 as the warranty period of 2 years has already expired.

Question 11.
E Ltd. is in the process of finalizing its accounts for the year ended 31st March, 2013. The company seeks your advice on the following:

The Company’s sales tax assessment for assessment year 2010-11 has been completed on 14th February, 2013 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.
Analysis & Conclusion : 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, 2013. The amount paid under protest can be kept in the books as an advance and disclosed along with the contingent liability of ₹ 2.10 crore.

Question 12.
X Ltd. is in a dispute with a competitor company. The dispute is regarding alleged infringement of Copyrights. The competitor has filed a suit in the court of law seeking damages of ₹ 200 lakhs.
The Directors are of the view that the claim can be successfully resisted by the Company.
How would the matter be dealt in the annual accounts of the Company in the light of AS 29? Explain in brief giving reasons for your answer.
As per AS 29, ‘Provisions, Contingent Liabilities and Contingent Assets’, a provision should be recognized 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 recognized.

Analysis : In the given situation, since, the directors of the company are of the opinion that the claim can be successfully resisted by the company, therefore there will be no outflow of the resources. Hence, no provision is required.

Disclosure : (Notes To Accounts)
“Litigation is in process against the company relating to a dispute with a competitor who alleges that the company has infringed copyrights and is seeking damages of ₹ 200 lakhs. However, the directors are of the opinion that the claim can be successfully resisted by the company.”

Question 13.
A company is in a dispute involving allegation of infringement of patents by a competitor company who is seeking damages of a huge sum of ₹ 900 lakhs. The directors are of the opinion that the claim can be successfully resisted by the company. How would you deal the same in the annual accounts of the company? (Nov. 2012) (4 Marks)
As per para 14 of AS 29, ‘Provisions, Contingent Liabilities and Contingent Assets’, 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, rro provision should be recognised.
If these conditions are not met, no provision should be recognised.

Analysis : In the given situation, since, the directors of the company are of the opinion that the claim can be successfully resisted by the company, therefore there will be no outflow of the resources.

Disclosure : (Notes To Account)

“Litigation is in process against the company relating to a dispute with a competitor who alleges that the company has infringed patents and is seeking damages of ₹ 900 lakhs. However, the directors are of the opinion that the claim can be successfully resisted by the company.”

Question 14.
WZ W Ltd. is in dispute involving allegation of infringement of patents by a competitor company who is seeking damages of a huge sum of ₹ 1000 Lakhs. The directors are of the opinion that the claim can be successfully resisted by the company. How would you deal the same in the Annual Accounts of the company? (Nov. 2014) (5 Marks)
As per AS 29 ‘Provisions, Contingent Liabilities and Contingent Assets’, a provision should be recognised when:

1. An enterprise has a present obligation as a result of past event;
2. It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
3. A reliable estimate can be made of the amount of the obligation.

If these conditions are not met, no provision should be recognised.

Analysis : A contingent liability is disclosed, unless the possibility of an out-flow of resources embodying economic benefits is remote. The possibility of an outflow of resources embodying economic benefits is remote in the given situation, since the directors of WZW Ltd. are of the opinion that the claim can be successfully resisted by the company.

Conclusion : Therefore, the company shall not disclose the same as contingent liability. However, following note in this regard may be given in annual accounts.

Disclosure : (Notes To Account)
“Litigation is in process against the company relating to a dispute with a competitor who alleges that the company has infringed patents and is seeking damages of ₹ 1,000 lakhs. However, the directors are of the opinion that the claim can be successfully resisted by the company”.

Question 15.
AB Ltd. is in the process of finalizing its account for the year ended 31st March, 2015. The company seeks your advice on the following:
(i) The company’s sale tax assessment for assessment year 2012-13 has been completed on 14th February, 2015 with a demand of ₹ 5.40 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 ₹ 3.70 crore.
(ii) The company has entered into a wage agreement in May 2015 whereby the labour union has accepted a revision in wage from June 2014. The agreement provides that the hike till May 2015 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 2015. (May 2016) (5 Marks)
Analysis & Conclusion :

(i) Since the company is not appealing against the addition of ₹ 1.70 crore ₹ 5.40 crore less ₹ 3.70 crore), therefore, the same should be provided/ expensed off in its accounts for the year ended on 31st March, 2015. However, the amount paid under protest can be kept under the heading ‘Long-term Loans & Advances/Short-term Loans and Advances’ as the case may be along with disclosure as contingent liability of ₹ 3.70 crore.

(ii) The arrears for the period from June, 2014 to March, 2015 are required to be provided for in the accounts of the company for the year ended on 31st March, 2015 assuming that negotiations for hike in wages had already started in the year 2014-15 Le. before the balance sheet date though the agreement was entered in May, 2015.

Question 16.
M/s. XYZ Ltd. is in a dispute with a competitor company. The dispute is regarding alleged infringement of Copyrights. The competitor has filed a suit in the court of law seeking damages of ₹ 200 lacs.
The Directors are of the view that the claim can be successfully resisted by the Company. (Nov. 2016) (4 Marks)
As per AS 29, ‘Provisions, Contingent Liabilities and Contingent Assets’, a provision should be recognized when :
(a) an enterprise has a present obligation as a residt 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 recognized.

Analysis : In the given situation, since, the directors of the company are of the opinion that the claim can be successfully resisted by the company, therefore there will be no outflow of the resources. Hence, no provision is required.

Disclosure : (Notes To Account)
“Litigation is in process against the company relating to a dispute with a competitor who alleges that the company has infringed copyrights and is seeking damages of ₹ 200 lakhs. However, the directors are of the opinion that the claim can be successfully resisted by the company.”

Question 17.
Legal department of XYZ Limited provides that as on 31st March 2017, there were 25 law suits pending which have not been settled till the approval of accounts by the Board of Directors. The possible outcome of suits are as follows:

Outcome of each case is to be taken as a separate one. Ascertain the amount of contingent loss to be reported in the Financial Statement. (Nov. 2017) (5 Marks)
According to AS 29 ‘Provisions, Contingent Liabilities and Contingent Assets’, contingent liability should be disclosed in the financial statements if following conditions are satisfied:

1. There is a present obligation arising out of past events but not recognized as provision.
2. It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation.
3. The possibility of an outflow of resources embodying economic benefits is also not remote.
4. The amount of the obligation cannot be measured with sufficient reliability to be recognized as provision.

Analysis & Conclusion: In this case, the probability of winning for first 7 cases is 100% and hence requirement of providing contingent loss does not arise. The probability of winning of next 12 cases is 60% and for remaining 6 cases is 50%. In other words, probability of losing the cases is 40% and 50% respectively. According to AS 29, we make a provision if the loss is probable. As the loss does not appear to be probable and the probability or possibility of an outflow of resources embodying economic benebts is not remote rather there is reasonable possibility of loss. Hence, disclosure will be made for contingent liability.

Disclosure by way of note of contingent liability
Expected loss in 12 cases = [₹ 1,50,000 × 0.3 + ₹ 2,50,000 × 0.1] × 12
= [₹ 45,000 + ₹ 25,000] × 12 = ₹ 70,000 × 12 = ₹ 8,40,000
Expected loss in remaining 6 cases = [₹ 1,25,000 × 0.35 + ₹ 3,00,000 × 0.15] × 6
= [₹ 43,750 + ₹ 45,000] × 6 = ₹ 5,32,500
Therefore, the overall expected loss of ₹ 13,72,500 (₹ 8,40,000 + ₹ 5,32,500) will be disclosed by way of contingent liability.

Contingent Assets (Based On Para Nos. 10 And 30)

Question 18.
With reference to AS 29 ‘Provisions, Contingent Liabilities and Contingent Assets’, define:
(i) A Provision
(ii) A Liability
(iii) A Contingent Asset
(iv) Present Obligation (May 2016) (4 Marks)