AS 1: Disclosure of Accounting Policies – CA Inter Accounts Study Material is designed strictly as per the latest syllabus and exam pattern.
AS 1: Disclosure of Accounting Policies – CA Inter Accounts Study Material
Fundamental Accounting Assumptions (Based On Para Nos. 9, 10 And 27)
Question 1.
A limited has sold its building for ₹ 50 lakhs and the purchaser has paid the full price. The Company has given possession to the purchaser. The book value of the building is ₹ 35 lakhs. As at 31st March 2017, documentation and legal formalities are pending. The company has not recorded the sale. It has shown the amount received as advance. Do you agree with this treatment?
What accounting treatment should the buyer give in its financial statements? (5 Mark) {November 2017)
Answer:
Analysis:
Although legal title has not been transferred, the economic reality and substance is that the rights and beneficial interest in the immovable property have been transferred.
Therefore, recording of acquisition /disposal (by the transferee and transferor respectively) would, in substance, represent the purchase/sale.
Conclusion:
Thus, A Ltd., should record the sales and recognize the profit of ₹ 15 lakhs in its profit and loss account. It should eliminate building from its balance sheet.
In notes to accounts, it should disclose that building has been sold, full consideration has been received, possession has been handed over to the buyer and documentation and legal formalities are pending.
The buyer should recognize the building as an asset in his balance sheet and charge depreciation on it. The buyer should disclose in his notes to account that possession has been received however documentation and legal formalities are pending.
Question 2.
What are the three fundamental accounting assumptions recognised by Accounting Standard (AS) 1? Briefly describe each one of them. (4 Marks) (May 2013)
Answer:
Accounting Standard (AS) 1 recognizes three fundamental accounting assumptions. These are as follows:
(i) Going Concern:
The financial statements are normally prepared on the assumption that an enterprise will continue its operations in the foreseeable future and neither there is intention, nor there is need to materially curtail the scale of operations.
(ii) Consistency:
The principle of consistency refers to the practice of using same account¬ing policies for similar transactions in all accounting periods unless the change is required (i) by a statute, (ii) by an accounting standard or (iii) for more appropriate presentation of financial statements.
(iii) Accrual basis of accounting:
Under this basis of accounting, transactions are recognised as soon as they occur, whether or not cash or cash equivalent is actually received or paid.
Question 3.
Briefly define the Fundamental Accounting Assumptions? (4 Marks) (November 2017)
Answer:
Accounting Standard (AS) 1 recognizes three fundamental accounting assumptions. These are as follows:
(i) Going Concern:
The financial statements are normally prepared on the assumption that an enterprise will continue its operations in the foreseeable future and neither there is intention, nor there is need to materially curtail the scale of operations.
(ii) Consistency:
The principle of consistency refers to the practice of using same account¬ing policies for similar transactions in all accounting periods unless the change is required (?) by a statute, (it) by an accounting standard or (iii) for more appropriate presentation of financial statements.
(iii) Accrual basis of accounting:
Under this basis of accounting, transactions are recognised as soon as they occur, whether or not cash or cash equivalent is actually received or paid.
Areas In Which Different Accounting Policies Are Encountered (Based On Para Nos. 14 And 15)
Question 4.
‘Recognizing the need to harmonize the diverse accounting policies and practices, accounting standards are framed.’ Give examples of areas in which different accounting policies may be adopted by the enterprise. (4 Marks) (November 2010)
Answer:
The following are examples of the areas in which different accounting policies may be adopted by different enterprise:
- Methods of depreciation, depletion and amortization.
- Valuation of inventories.
- Recognition of profit on long-term contracts.
- Valuation of PPE.
Considerations In Selection Of Accounting Policies (Based On Para Nos. 16 And 17)
Question 5.
ABC Financial Services Ltd. is engaged in the business of financial services and is undergoing tight liquidity position, since most of the assets of the company are blocked in various claims/petitions in a Special Court. ABC Financial Services Ltd. has accepted Inter Corporate Deposits (ICDs) and it is making its best efforts to settle the dues. There were claims at varied rates of interest, from lenders, from the due date of ICDs to the date of repayment. The company has provided interest, as per the terms of the contract till the due date and a note for non-provision of interest from the due date to date of repayment was mentioned in financial statements.
On account of uncertainties existing regarding the determination of the amount and in the absence of any specific legal obligation at present as per the terms of contracts, the company considers that these claims are in the nature of ‘claims against the company not acknowledged as debt’, and the same has been disclosed by way of a note in the accounts instead of making a provision in the Profit and Loss Account.
State whether the treatment done by the company is correct or not as per relevant accounting Standard. (5 Marks) (May 2017)
Answer:
AS 1 ‘Disclosure of Accounting Policies’ recognizes ‘prudence’as one of the major considerations governing the selection and application of accounting policies. In view of the uncertainty attached to future events, profits are not anticipated but recognized only when realized though not necessarily in cash. Provision is made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information.
As per AS 1, ‘accrual’ is one of the fundamental accounting assumptions.
Analysis:
Irrespective of the terms of the contract, so long as the principal amount of a loan is not repaid, the lender cannot be placed in a disadvantageous position for non-payment of interest in respect of overdue amount. From the facts given in the question, it is apparent that the company has an obligation to pay because of the overdue interest amount.
Conclusion:
Thus, the company should provide for the liability (since it is not waived bv the lenders) at an amount estimated or on reasonable basis based on facts and circumstances of each case. However, in respect of the overdue interest amounts, which are settled, the liability should be accrued to the extent of amounts settled. Non-provision of the overdue interest liability amounts to violation of accrual basis of accounting.
Therefore, the treatment, done by the company, of not providing the interest amount from due date to the date of repayment, is not correct.
Disclosure Of Accounting Policies (Based On Para Nos. 18 To 26)
Question 6.
Jagannath Ltd. had made a rights issue of shares in 2014. In the offer document to its members, it had projected a surplus of ₹ 40 crores during the accounting year to end on 31st March, 2015. The draft results for the year, prepared on the hitherto followed accounting policies and presented for perusal of the board of directors showed a deficit of ₹ 10 crores. The board in consultation with the managing director, decided on the following:
(i) Value year-end inventory at works cost (₹ 50 crores) instead of the hitherto method of valuation of inventory at prime cost (₹ 30 crores).
(ii) Provide depreciation for the year on straight line basis on account of substantial additions in gross block during the year, instead of on the reducing balance method, which was hitherto adopted. As a consequence, the charge for depreciation at ₹ 27 crores is lower than the amount of ₹ 45 crores which would have been provided had the old method been followed, by ₹ 18 crores.
(iii) Provide for permanent fall in the value of investments – which fall had taken place over the past five years – the provision being ₹ 10 crores.
As chief accountant of the company, you are asked by the managing director to draft the notes on accounts for inclusion in the annual report for 2014-15. (5 Marks) (November 2015)
Answer:
As per AS 1, any change in the accounting policies which has a material effect in the current period or which is reasonably expected to have a material effect in later periods should be disclosed. In the case of a change in accounting policies which has a material effect in the current period, the amount by which any item in the financial statements is affected by such change should also be disclosed to the extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact should be indicated. Accordingly, the notes on accounts should properly disclose the change and its effect.
Drafting of Notes to Accounts:
(i) During the year inventory has been valued at factory cost, against the practice of valuing it at prime cost as was the practice till last year. This has been done to take cognizance of the more capital-intensive method of production on account of heavy capital expenditure during the year. As a result of this change, the year-end inventory has been valued at ₹ 50 crores and the profit for the year is increased by ₹ 20 crores.
(ii) In view of the heavy capital-intensive method of production introduced during the year, the company has decided to change the method of providing depreciation from reducing balance method to straight line method.
As a result of this change, depreciation has been provided at ₹ 27 crores which is lower than the charge which would have been made had the old method and the old rates been applied, by ₹ 18 crores. To that extent, the profit for the year is increased.
(iii) The company has decided to provide ₹ 10 crores for the permanent fall in the value of investments which has taken place over the period of past five years.
The provision so made has reduced the profit disclosed in the accounts by ₹ 10 crores.
Question 7.
Mini Ltd. was making provision for non-moving stocks based on no issues for the last 12 months up to 31.3.2016.
The company wants to provide during the year ending 31.3.2016 based on technical evaluation:
Total value of stock – ₹ 100 lakhs
Provision required based on 12 months issue – ₹ 3.5 lakhs
Provision required based on technical evaluation – ₹ 2.5 lakhs
Does this amount to change in Accounting Policy? Can the company change the method of provision? (5 Marks) (May 2017)
Answer:
Analysis:
The decision of making provision for non-moving stocks on the basis of technical evaluation does not amount to change in accounting policy. Requirement to provide for non-moving stocks may be said as accounting policy but the basis for making provision will not constitute accounting policy. It will be considered as an accounting estimate. Further, the method of estimating the amount of provision may be changed in case a more prudent estimate can be made.
Conclusion:
In the given case, considering the total value of stock, the change in the amount of required provision of non-moving stock from ₹ 3.5 lakhs to ₹ 2.5 lakhs is also not material.
The disclosure can be made for such change by way of notes to the accounts in the annual accounts of Mini Ltd. for the year 2015-16:
Notes to Accounts: [DRAFT]
‘The company has provided for non-moving stocks on the basis of technical evaluation unlike preceding years. Had the same method been followed as in the previous year, the profit for the year and the corresponding effect on the year end net assets would have been higher by ₹ 1 lakh.’
Question 8.
J Ltd. had made a rights issue of shares in 2016. In the offer document to its members, it had projected a surplus of ₹ 40 crores during the accounting year to end on 31st March, 2017. The draft results for the year, prepared on the hitherto followed accounting policies and presented for perusal of the board of directors showed a deficit of ₹ 10 crores. The board in consultation with the managing director, decided on the following:
(i) Value year-end inventory at works cost (₹ 50 crores) instead of the hitherto method of valuation of inventory at prime cost (₹ 30 crores).
(ii) Provide for permanent fall in the value of investments – this fall had taken place over the past five years – the provision being ₹ 10 crores.
As chief accountant of the company, you are asked by the managing director to draft the notes on accounts for inclusion in the annual report for 2016-17. (5 Marks) (May 2018)
Answer:
As per AS 1, any change in the accounting policies which has a material effect in the current period or which is reasonably expected to have a material effect in later periods should be disclosed. In the case of a change in accounting policies which has a material effect in the current period, the amount by which any item in the financial statements is affected by such change should abo be disclosed to the extent ascertainable. Where such amount b not ascertainable, wholly or in part, the fact should be indicated. Accordingly, the notes on accounts should properly disclose the change and its effect.
Drafting of Notes on Accounts:
(i) During the year inventory has been valued at factory cost, against the practice of valuing it at prime cost as was the practice till last year. This has been done to take cognizance of the more capital-intensive method of production on account of heavy capital expenditure during the year. As a result of this change, the year-end inventory has been valued at ₹ 50 crores and the profit for the year is increased by ₹ 20 crores.
(ii) The company has decided to provide ₹ 10 crores for the permanent fall in the value of investments which has taken place over the period of past five years.
The provision so made has reduced the profit disclosed in the accounts by ₹ 10 crores.
Question 9.
State whether the following statements are ‘True’ or ‘False’. Also give reason for your answer.
(i) Certain fundamental accounting assumptions underline the preparation and presentation of financial statements. They are usually specifically stated because their acceptance and use are not assumed.
(ii) If fundamental accounting assumptions are not followed in presentation and preparation of financial statements, a specific disclosure is not required.
(iii) All significant accounting policies adopted in the preparation and presentation of financial statements should form part of the financial statements.
(iv) Any change in an accounting policy, which has a material effect should be disclosed. Where the amount by which any item in the financial statements is affected by such change is not ascertainable, wholly or in part, the fact need not to be indicated.
(v) There is no single list of accounting policies which are applicable to all circumstances. (5 Marks) (May 2018)
Answer:
(i) False.
As per AS 1 ‘Disclosure of Accounting Policies’, certain fundamental accounting assumptions underline the preparation and presentation of financial statements. They are usually not specifically stated because their acceptance and use are assumed. Disclosure is necessary if they are not followed.
(ii) False.
As per AS 1, if the fundamental accounting assumptions, viz. Going Concern, Consistency and Accrual are followed in financial statements, specific disclosure is not required. If a fundamental accounting assump¬tion is not followed, the fact should be disclosed.
(iii) True.
To ensure proper understanding of financial statements, it is necessary that all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. The disclosure of the significant accounting policies as such should form part of the financial statements and they should be disclosed in one place.
(iv) False.
Any change in the accounting policies which has a material effect in the current period or which is reasonably expected to have a material effect in later periods should be disclosed. Where such amount is not ascertainable, wholly or in part, the fact should be indicated.
(v) True.
As per AS 1, there is no single list of accounting policies which are applicable to all circumstances. The differing circumstances in which enterprises operate in a situation of diverse and complex economic activity make alternative accounting principles and methods of applying those principles acceptable.
Question 10.
A Ltd. had made a rights issue of shares in 2017. In the offer document to its members, it had projected a surplus of ₹ 40 crores during the accounting year to end on 31st March, 2017. The draft results for the year, prepared on the hitherto followed accounting policies and presented for perusal of the board of directors showed a deficit of ₹ 10 crores. The board in consultation with the managing director, decided not to provide for ‘after sales expenses’ during the warranty period. Till the last year, provision at 2% of sales used to be made under the concept of ‘matching of costs against revenue’ and actual expenses used to be charged against the provision. The board now decided to account for expenses as and when actually incurred. Sales during the year total to ₹ 600 crores.
As chief accountant of the company, you are asked by the managing director to prepare the notes on accounts for inclusion in the annual report for 2016-17.
Answer:
As per AS 1, any change in the accounting policies which has a material effect in the current period or which is reasonably expected to have a material effect in later periods should be disclosed. In the case of a change in accounting policies which has a material effect in the current period, the amount by which any item in the financial statements is affected by such change should also be disclosed to the extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact should be indicated. Accordingly, the notes on accounts should properly disclose the change and its effect.
Drafting of Notes on Accounts:
So far, the company has been providing 2% of sales for meeting after sales expenses during the warranty period. With the improved method of production, the probability of defects occurring in the products has reduced considerably.
Hence, the company has decided not to make provision for such expenses but to account for the same as and when expenses are incurred. Due to this change, the profit for the year is increased by ₹ 12 crores than would have been the case if the old policy were to continue.