B.COM UNIVERSITY OF CALICUT CORPORATE ACCOUNTING ( III SEMESTER ) (CORE COURSE : BC3B04) 2017 ADMISSION ONWARDS 329B SCHOOL OF DISTANCE EDUCATION

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1 UNIVERSITY OF CALICUT SCHOOL OF DISTANCE EDUCATION B.COM ( III SEMESTER ) BA POLIICAL SCIENCE CORPORATE ACCOUNTING (CORE COURSE : BC3B04) 329B 2017 ADMISSION ONWARDS

2 CORPORATE ACCOUNTING STUDY MATERIAL THIRD SEMESTER CORE COURSE : BC3B04 For BCOM (2017 ADMISSION ONWARDS) UNIVERSITY OF CALICUT SCHOOL OF DISTANCE EDUCATION Calicut University P.O, Malappuram, Kerala, India B

3 UNIVERSITY OF CALICUT SCHOOL OF DISTANCE EDUCATION STUDY MATERIAL THIRD SEMESTER BCOM (2017 ADMISSION ONWARDS) CORE COURSE: BC3B04 : CORPORATE ACCOUNTING Prepared by: Sri. Rajan.P Assistant Professor on Contract, University of Calicut Layout: H Section, SDE Reserved Page 2

4 CONTENTS PAGE NO. MODULE I 5 37 MODULE II MODULE III MODULE IV MODULE V Page 3

5 Page 4

6 MODULE-I ASSET BASED ACCOUNTING STANDARDS Assets are broadly classified into two tangible and intangible asset. Intangible asset cannot be seen and touched. But these have value. This chapter deals with the following assets-based accounting standards. 1. Inventories (IAS 2 & Ind AS 2) 2. Property, plant and equipment (Ind AS 16 & IAS 16) 3. Intangible assets (Ind AS 38 & IAS 38) 4. Impairment of Assets (Ind AS 36 & IAS 36) 5. Borrowing cost (IAS 23 & Ind AS 23) 6. Investment property (IAS 40 & Ind AS 40) Accounting for inventories Accounting for inventories is based on the matching concept. As per this concept, inventories should be accounted for an expense in the year in which it is sold. Till that time, it is accounted for as an asset, ie, closing stock. It is also credited in the statement of profit and loss. Ind AS 2 & IAS 2 prescribe accounting treatment for inventories. Objectives The objective of this standard is to prescribe the accounting treatment for inventories. This standard deals with determination of cost and its subsequent recognition as an expense, including any write down to net realizable value. Scope This standard applies to all inventories except the following a. Work in progress under a construction contract (dealt by Ind AS 11, construction contracts) b. Financial instruments, eg, share, debentures, bonds (governed by Ind AS 32, financial instrument) c. Biological assets related to agricultural activity and agricultural produce at the point of harvest. Definition of inventories Inventories are assets that are 1. Held for sale 2. Being prepared for sale 3. Materials to be used in the production process or provision or services. Inventory includes raw materials, production supplies, work in progress, finished goods and goods in saleable condition(ie, ready to sell goods that have been purchased for resale.) Accounting treatment Measurement of inventories Inventories must be measured at cost or net realizable value, whichever is less. Thus, the two components are cost and net realizable value. Cost of inventories The cost of inventories comprises of 1. Cost of purchase 2. Cost of conversion 3. Other costs incurred in bringing the inventories to their present location and condition. Page 5

7 a) Cost of purchase 1. Purchase price 2. Import duties and other taxes 3. Transport cost 4. Handling cost 5. Other cost directly attributable to the acquisition of finished goods, materials and services. Malabar Textiles is a trading company dealing in textiles. It incurred the following expenses for the purchase of textiles from New India Textiles: Amount paid to supplies 2,25,300 Transportation charges 14,500 GST 5% The purchase bill shows a value of 2,42,000 because New India Textiles allowed a special trade discount of 5% of billed value to Malabar Textiles. New India Textiles also allowed a cash discount of 2% for prompt payment. Calculate the cost of purchase. Solution Cost of purchase as per the bill 2,42,000 Less : Trade discount 5% 12,100 2,29,900 Add : GST (5% of 2,29,900) 11,495 Add: Transportation cost 14,500 Cost of purchase 2,55,895 Note : The amount paid to the supplier * 2,25,300 is after deducting trade discount K 12,100 (5% of 2,42,000) and cash discount 4,600 (2% of net purchase price, i.e., Rs 2,29,900) To arrive at purchase cost, only trade discount is deductible. Cash discount should not be deducted because it is not allowed on purchase (it is allowed for prompt payment). b) Cost of conversion: Costs of conversion of inventories include direct costs such as direct labour, and systematic allocation of production overhead incurred in converting materials into finished goods. Production overhead consists of fixed production overheads and variable production overheads. Fixed production overheads: Fixed production overheads are those indirect costs of production that remain constant irrespective of the volume of production. Examples are depreciation and maintenance of factory buildings and equipment, cost of factory management and administration etc. Fixed production overheads should be allocated on the basis of normal capacity. Normal capacity is the production expected to be achieved on average over a number of periods under normal circumstances. The capacity lost due to plant maintenance should be taken into account. When production is abnormally high, the fixed production overheads allocated to each unit will be reduced (to avoid over valuation of inventories). Variable production overhead: variable production overheads are those indirect cost of production that vary directly with the volume of production. Examples are indirect material and indirect labour. Example Fantacy toys, manufactures toys. It has incurred the following expenses: Cost of raw materials Rebate on purchase Page 6

8 Wages Depreciation of machinery Electricity charges(factory) Factory supervision charges Calculate cost of purchase and cost of conversion solution cost of raw material less rebate cost of purchase wages depreciation on machinery factory electricity charges factory supervision charges cost of conversion c) other cost Other cost to be included in the cost of inventory are those which are incurred in bringing the inventories to their present location and condition. These costs include inward transport and storage prior to completion of production and specific design work required for a special client. Example How will you value the inventory per kg. of finished goods which consisted of : Material cost :100 per kg Direct labour cost : 20 per kg Direct variable production oh : 10 per kg Fixed production charges for the year on normal capacity of kgs. Rs At the year end, 2000 kg. of finished goods are in stock. Solution The allocation of fixed production overheads is based on the normal capacity of the production facilities., thus cost per kg. of finished goods may be calculated as follows: Material cost 100 Direct labor cost 20 Direct variable production oh 10 Fixed production overhead Thus, the value of 2000 kgs. Of finished goods stock at the year end will be Rs (2000x140) Cost which are excluded a. Abnormal wastage of material, labor and overhead b. Storage cost, if they are not necessary prior to a further production process. c. Administrative overhead d. Selling cost e. Interest cost when inventories are purchased on deferred payment basis. Cost of inventories of a service provider To the extent that service providers have inventories, they measure them at thecosts of their production. These costs consist primarily of the labour and other costs of personnel directly engaged in providing the service, including supervisory personnel, and attributable Page 7

9 overheads. Labour and other costs relating to sales and 5 general administrative personnel are not included but are recognised as expenses in the period in which they are incurred. The cost of inventories of a service provider does not include profit margins or non-attributable overheads that are often factored into prices charged by service providers. Example Techniques for measurement of cost 1. Standard costing method 2. Retail costing method Standard costing method Standard costing involves setting costs in advance considering the normal production output. Management usually derive standards on the basis of past experience and use this method if cost remains fairly consistent and update the standards if situation changes. Usually such method is used for such material or labour which is hard to trace or measure its consumption or the benefits of such measurement are not much as compared to cost of conducting such measurement. For example cost of glue or nails consumed in production and entity still hold at the end of the period can be done standard costing basis. Retail costing method Retail method is an easy approach to determine cost by deducting profit from the sales price. This method is employed in situations where inventory has a fairly fast turnover rate. In such situations managing the records of costs incurred is not easy. So this retrograde approach help ease the pressure. Page 8

10 Cost formulas An entity shall use the same cost formula for all inventories having similar nature and use. For inventories with a different nature or use, different cost formulas may be justified. Following are the important cost formulas for the valuation of inventories: 1. Specific identification method Specific identification is a method of finding out ending inventory cost. It requires a detailed physical count, so that the company knows exactly how many of each goods brought on specific dates remained at year end inventory. When this information is found, the amount of goods are multiplied by their purchase cost at their purchase date, to get a number for the ending inventory cost. 2. Fifo method This method assumes that the first items bought are the first items sold. Therefore, at the end of the period, any items in inventory are the items purchased most recently 3. Weighted average method The weighted average method is an inventory costing method that assigns average costs to each piece of inventory when it is sold during the year. Net realizable value Estimation of net realizable value is necessary in the valuation of inventories. Net realizable value is the estimated selling price in the ordinary course of business, less the estimated cost of completion and the estimated costs necessary to make the sale. Written down of inventories The general rule is that inventories should not be carried in excess of amounts expected to e realized from their sale or use. In some situations, NRV is likely to be less than cost. Following are the situations 1. An increase in cost 2. Fall in selling price 3. Physical deterioration in the condition of inventory 4. Obsolescence 5. Errors in production or purchasing Recognition as an expense The following treatment is required when inventories are sold: a. The carrying amount of the inventory is recognized as an expense in the period in which the related revenue is recognized. b. The amount of any write down of inventories to its net realizable value and all losses of inventories are recognized as an expense in the period the write down or loss occurs c. If an inventory item which was written down previously, remains unsold and its NRV has subsequently increased, then in such a case, the previous write down should reversed and the inventory should be carried at cost. d. Some inventories may be allocated or transferred to other assets account. Presentation and disclosure The financial statements should disclose the following in respect of inventories a. Accounting policies adopted for measuring inventories and cost formula used. b. Total carrying amount of inventories and amount per category. c. Amount of inventory recognized as an expense during the period d. Amount of inventory carried at fair value less costs to sell. Page 9

11 e. Circumstances led to the reversal of a written down. f. Inventory pledged as security for liabilities. g. The amount of any written down of inventories recognized as an expense in the period. h. The amount of any reversal of any written down that is recognized in the period. Example Page 10

12 Example Example Page 11

13 PROPERTY, PLANT AND EQUIPMENT (Ind AS 16 and IAS 16) Objective: The objective of IAS 16 is to prescribe the accounting treatment for property, plant, and equipment. The principal issues are:a. the timing of recognition of asset;b. the determination of their carrying amounts; andc. the depreciation charges to be recognized. Scope Ind AS-16 applied to all Property, Plant & Equipment until and unless any other standard requires or permits a different accounting treatment. This Standard does not apply to : a) PPE classified as held for sale in accordance with Ind AS 105 b) Biological assets related to agricultural activity other than bearer plants c) The recognition and measurement of exploration and evaluation assets d) Mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources. Definition :Property, Plant & Equipment are tangible items that:a. are held for use in the production or supply of goods or services, or Page 12

14 b. for rental to others, or c. for administrative purposes; and d. are expected to be used during more than one period. Recognition: The cost of an item or Property, Plant & Equipment shall be recognized as an asset if, and only if: a) it is probable that future economic benefits associated with the item will flow to the entity; and b) The cost of the item can be measured reliably. Measurement at Recognition An item of Property, Plant & Equipment that qualifies for recognition as an asset shall be measured at its cost. Elements of Cost: a. Purchase price + (Import duties + Non refundable taxes) - (Trade Discounts + Rebates) b. Directly attributable costs. c. Initial estimate of the cost of dismantling and removing the item and restoring the site in which it is located. Costs that are not Costs of Property, Plant & Equipment: a. Costs of opening new facility; b. Costs of introducing new product or service; c. Costs of conducting business in new location or with new class of customer; d. Administration and other general overhead costs; e. Costs incurred in using or redeploying an item; f. Amounts related to certain incidental operations Costs that are not included in the cost of PPE a. Cost of opening a new facility b. New costs of introducing a new product or service c. Cost of conducting business in a new location or with a new class of customer. d. Administration and general overhead costs e. Cost incurred after an asset is ready for use, but has not yet been used or is not yet operating at full capacity f. Initial operating losses g. Relocation or reorganization costs h. In case of self constructed asset, the cost of any abnormal waste related to materials, labor or other resources Example Page 13

15 Measurement of element of cost a. Cost : cost is the amount of cash or cash equivalents paid to acquire an asset at the time of its acquisition or construction. b. When the payment is deferred: if payment is deferred beyond credit terms, the difference between the cash price equivalent and the total payment is recognized as interest over the period of credit unless such interest is capitalized in accordance with Ind AS 23, borrowing costs. Subsequent expenditures It refers to such costs which are incurred after the asset is recognized in the financial statement and brought to the location and condition intended. Examples of such expenditures include repair and maintenance, overhauling, upgradation, replacement costs etc. However, not all the subsequent costs can be capitalized in the carrying amount (carrying value or book value) of the asset in the statement of financial position. Cost of self-constructed Assets. Cost of these assets is determined using the same principal as for an asset acquired. As per Ind-AS:2 if an entity make the similar asset for sale in normal course of business, the cost of the asset is usually the same as the cost of constructing an asset for the sale. Therefore the internal profits are eliminated and abnormal cost is not included in the cost. subsequent measurement When those financial assets (like cash, bank accounts, accounts and notes receivable etc) are initially recognized, at every balance sheet date they need to be again measured. They Page 14

16 need to have a true and fair value on the balance sheet and it may not be the value it was initially recognized with. Cost model The cost model is used as an accounting policy to report carrying an amount of property, plant, and equipment (fixed assets) in the balance sheet. It requires an asset to be carried at its initial cost (also referred to as historical cost) less any accumulated depreciation and impairment losses. The revaluation of assets is not allowed, but some accounting standards allow recovery of impairment losses recognized in the past. Revaluation model under the revaluation model, an item of property, plant and equipment whose fair value can be measured reliably is carried at a revalued amount, which is its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Accounting method for revaluation under revaluation model Revaluation increase 1. If an assets carrying amount is increased as a result of revaluation, the increased amount is recognized in other comprehensive income and accumulated under equity under the head revaluation surplus, unless there is a previous revaluation decrease in respect of the same asset. Example A factory having the carrying value of rs. 20 million has been revalued at Rs. 23 million. Write the journal entry to record the revaluation surplus(asuem that ther is no previous revaluation decrease in respect of the same asset) Solution Revaluation surplus = 23 minus 20 = 3 million Journal entry Property, plant and equipment Dr 3 million To revaluation surplus 3million 2. If there is a previous revaluation decrease in respect of the same asset the increase in revaluation (gain) shall first be recorded in the statement of profit and loss to the extent of the previous revaluation decrease. The balance, if any, shall be recognized other comprehensive income under the head revaluation surplus. Thus, the revaluation gain is first used to reverse the previous revaluation los that was previously recognized in profit or loss. Example A factory has a carrying value of rs. 20 million. Two years ago the company reduced the carrying value from Rs. 22 million. This was taken as an expense in profit or loss. In the current year the factory is now worth Rs. 23 million. Show the accounting treatment for revaluation in the current year. Page 15

17 Revaluation decrease 1. If an asset s carrying amount is decreased as result of revaluation, then the decrease shall be recognized in statement of profit and loss, unless there is a previous revaluation increase in respect of the same asset. Example A factory has a carrying value of Rs. 20 million. It has been revalued at Rs. 19 million. How will you treat the decrease in value? Solution The decrease in value Rs. 1 million should be treated as expense in the statement of profit and loss. Profit and loss (expense) 1 million To accumulated depreciation (to be shown in the balancesheet) 1 million. 2. If there is a previous revaluation increase in respect of the same asset, the decrease in revaluation shall first be adjusted again the revaluation surplus to the extent of previous revaluation increase in respect of the same asset. The balance if any, shall be recognized in the statement of profit and loss. The decrease in revaluation reduces the amount accumulated in equity under the head revaluation surplus. Example A factory has a carrying value of Rs. 22 million. Two years ago, it was revalued upwards to rs. 23 million. The value has now fallen to Rs. 20 million. How will you account the revaluation decrease? Solution The revaluation decrease is Rs. 3 million. Of this, 1million will be charged against the previous revaluation surplus and the remaining Rs. 2 million will be charges as expenses in the statement of profit and loss. The entry is: Revaluation surplus 1 million Profit or loss dr. 2 million To property, plant and equipment 3 million Disposal of revalued asset when a revalued asset is disposed of, any revaluation surplus may be transferred directly to retain earnings. This means that the transfer to retain earnings should not be made through the statement of profit and loss. Page 16

18 Example Depreciation Usually fixed assets are expected to be used for more than one year. Therefore, the depreciable amount of a fixed asset is allocated over its useful life. The amount allocated to a particular accounting period is called depreciation. Thus, depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. The depreciable amount of an asset is the cost of an asset less its residual value. Example The policy of Akash Ltd. Is to keep company vehicles for 5 years. It has just bought new equipment for Rs Today s market price, less selling cost, of a similar equipment that is 5 years old is Rs. 9000, which is a reasonable estimate of the residual value of the new equipment. Calculate a. Depreciable amount b. Annual depreciation charge Solution a. Depreciable amount minus 9000 = b. Annual depreciation 21000/5 years = 4200 Depreciation of revalued asset In case of revaluation, the depreciation is calculated on the total revalued amount over a period of balance useful lives assessed on the date of revaluation. New cost for the purpose of depreciation will be gross cost less accumulated depreciation on the date of revaluation. Along with this, the revaluation reserve is amortised to the income statement based on the useful life of the asset to which it relates. This is done to ensure that depreciation on the revalued amounts shouldn t inflate/ deflate the income statement. Example Page 17

19 Shine ltd purchased an asset for Rs at the beginning of It had a useful life of 5 years. On Ist January 2016, the asset was revalued to Rs The expected useful life has remained unchanged. Show how revaluation is accounted. Also state the treatment for depreciation from 2016 onwards. Page 18

20 Example example Page 19

21 INTANGIBLE ASSETS (Ind AS 38 and IAS 38) Intangible assets are assets not having any physical substance. Therefore, they cannot be seen an touched. Objective The objective of this Standard is to prescribe the accounting treatment for intangible assets that are not dealt with specifically in another Standard. This Standard requires an entity to recognise an intangible asset if, and only if, specified criteria are met. The Standard also specifies how to measure the carrying amount of intangible assets and requires specified disclosures about intangible assets. Scope Ind AS 38 applies to all intangible assets other than: financial assets exploration and evaluation assets expenditure on the development and extraction of minerals, oil, natural gas, and similar resources intangible assets arising from insurance contracts issued by insurance companies intangible assets covered by another Ind AS, such as: intangibles held for sale deferred tax assets lease assets assets arising from employee benefits plan Goodwill acquired under business combination. Definition An intangible asset is an identifiable non-monetary asset without physical substance. Accounting treatment Initial recognition as an asset Page 20

22 c) Training costs d) Relocating or reorganizing costs. Initial measurement After intangible assets have been first recognized. They are to be measured. They should be initially measured at cost. But Subsequently, they can be carried at cost or at a revalued amount. Measurement of intangible assets acquired as a part of business, combinations In this case the intangible asset is measured at fair value at the date of acquisition. Measurement of internal project In case of internal project, expenditure of creating an intangible asset is treated differently. The research phase and development phase should be distinguished from one another. Research expenditure are treated as an expense. Development expenditure qualifying for recognition measured at cost and is capitalized. Measurement of intangible assets acquired in exchange for equity instruments If an intangible asset is acquired in exchange for equity instrument, the cost of the asset is the fair value of those equity instruments. Measurement in case of exchange of assets An intangible asset may be acquired in exchange for a similar asset with a similar fair value. No gain or loss is recorded on the transaction. Instead, the cost of the new asset is the carrying amount of the asset given up. Page 21

23 Example X ltd has a franchise, which ahs carrying value of rs. 10 million. It exchanges it for a similar franchise with a market value of Rs. 11 million. State whether there is surplus or gain. Solution Rs. 1 million may be treated as revaluation surplus, rather than a gain in the income statement. The journal entry is : Intangible asset (new) dr 11 million Revaluation surplus 1 million Tangible asset (old) 10 milliion Revaluation model Under the revaluation method, an intangible asset is carried at a revalued amount. This is the fair value of the intangible asset at the date of revaluation, less subsequent accumulated amortization and accumulated impairment. Revaluation increase (upward revaluation) When an intangible asset is revalued =upwards to a fair value, the revaluation increase is credited directly to equity under the head revaluation surplus, unless the asset was previously revalued downwards. If the asset was previously revalued downwards, the revaluation increase should be first used to set off the previous revaluation decrease. Revaluation decrease When the carrying amount of an intangible asset is revalued downwards, the amount of the downward revaluation should be charged as an expense in the income statement, unless the asset was previously revalued upwards. If the asset was previously revalued upwards the revaluation surplus in respect of that asset. Example Page 22

24 Elimination of intangible asset An intangible asset should be eliminated from th balance sheet when it is disposed of or when there is no further expected economic benefit from its future use. On disposal, the gain or loss should be taken to statement of profit and loss as gain or loss on disposal, ie, it should be treated as income or expense. Useful life An entity shall assess whether the useful life of an intangible asset is finite or indefinite and, if finite, the length of, or number of production or similar units constituting, that useful life. An intangible asset shall be regarded by the entity as having an indefinite useful life when, based on an analysis of all of the relevant factors, there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. Intangible assets with finite useful lives The depreciable amount of an intangible asset with a finite useful life shall be allocated on a systematic basis over its useful life. Amortisation shall begin when the asset is available for use, ie when it is in the location and condition necessary for it to be capable of operating in the manner intended by management. Amortisation shall cease at the earlier of the date that the asset is classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with Ind AS 105 and the date that the asset is derecognised. The amortisation method used shall reflect the pattern in which the asset s future economic benefits are expected to be consumed by the entity. If that pattern cannot be determined reliably, the straight-line method shall be used. The amortisation charge for each period shall be recognised in profit or loss unless this or another Standard permits or requires it to be included in the carrying amount of another asset. Page 23

25 Amortization An intangible asset with a finite useful life should be amortised over its expected useful life. Amortization is a systematic allocation of the cost or realued amount less any residual value, over the asset s useful life. Example Intangible asset with indefinite useful life An intangible asset with an indefinite useful life shall not be amortised. In accordance with Ind AS 36, an entity is required to test an intangible asset with an indefinite useful life for impairment by comparing its recoverable amount with its carrying amount (a) annually, and (b) whenever there is an indication that the intangible asset may be impaired. Residual value The residual value of an intangible asset with a finite useful life shall be assumed to be zero unless: (a) there is a commitment by a third party to purchase the asset at the end of its useful life; or (b) there is an active market (as defined in Ind AS 113) for the asset and: (i) residual value can be determined by reference to that market;and (ii) it is probable that such a market will exist at the end of the asset s useful life. Internally generated goodwill Internally generated goodwill shall not be recognised as an asset. In some cases, expenditure is incurred to generate future economic benefits, but it does not result in the creation of an intangible asset that meets the recognition criteria in this Standard. Such expenditure is often described as contributing to internally generated goodwill. Internally generated goodwill is not recognised as an asset because it is not an identifiable resource (ie it is not separable nor does it arise from contractual or other legal rights) controlled by the entity that can be measured reliably at cost. Differences between the fair value of an entity and the carrying amount of its identifiable net assets at any time may capture a range of Page 24

26 factors that affect the fair value of the entity. However, such differences do not represent the cost of intangible assets controlled by the entity. Internally generated intangible asset: it may be difficult to know whether an internally generated asset qualifies for recognition. This is because of it is often difficult to: a. Identify whether, and when, there is identifiable asset that will generate future benefits and b. Determine the cost of the asset. To assess whether an internally generated assets meet the criteria for recognition, an enterprise splits the generation of assets into Cost of an internally generated intangible asset:the cost of an internally generated asset is the total costs incurred from the date when the asset first meets the recognition criteria and that can be directly attributed or allocated to it on reasonable and consistent basis. The cost comprises of all expenditures for creating, producing, and preparing the assets for its intended use. Such costs include the following. Page 25

27 a. Expenditure on materials and services used in generating the asset. b. The employment costs of personnel directly engaged in producing the asset c. Any expenditure that is directly attributable to the asset, such as fees to register a legal right and the amortization of patents and licenses. d. Overheads that are necessary to generate the asset. e. Interest. Example IMPAIRMENT OF ASSETS (Ind AS 36 and IAS 36) There is an established principle that assets should not be carried at more than their recoverable amount. If the carrying value of an asset is more than its recoverable amount the asset is described as impaired. In such a case, the company should write down the carrying value of that asset to its recoverable amount. The amount written off is called impairment of loss. Page 26

28 Objectives Assets should be carried at no more than their recoverable amount, i.e. the amount expected to be recovered through use of the asset, or its fair value less cost to sale. Specify procedures to be followed to ensure that assets are not carried at more than recoverable amount Specify when an impairment loss should be reversed. Specify required disclosures. Scope This Standard shall be applied in accounting for the impairment of all assets, other than: (a) inventories (see Ind AS 2 Inventories); (b) assets arising from construction contracts (see Ind AS 11Construction Contracts); (c) deferred tax assets (see Ind AS 12 Income Taxes); (d) assets arising from employee benefits (see Ind AS 19 Employee Benefits); (e) financial assets that are within the scope of Ind AS 39 Financial Instruments: Recognition and Measurement (f) biological assets related to agricultural activity that are measured at fair value less costs to sell (see Ind AS 41 Agriculture. (g) deferred acquisition costs, and intangible assets, arising from an insurer s contractual rights under insurance contracts within the scope of Ind AS 104 Insurance Contracts; and (h) non-current assets (or disposal groups) classified as held for sale in accordance with Ind AS 105 Non-current Assets Held for Sale and Discontinued Operations. Definition of impairment Impairment is the fall in the value of asset, so that its recoverable amount is less than its carrying amount in the balance sheet. Accounting treatment The accounting treatment of impairment of asset involves the following steps. Step 1 Identifying an asset that may be impaired An entity should assess at the end of each reporting period, whether there is any indication of impairment. For assessing the indication of impairment, a firm should consider external sources of information and internal sources of information. a. External sources of indication of impairment Market value declines. Negative changes in technology, markets, economy, or laws Increase in market interest rates. Company stock price is below book value b. Internal sources of indication Obsolescence or physical damage Asset is part of a restructuring or held for disposal Worse economic performance than expected Adverse change in the use to which the asset is put. Step 2: measuring the recoverable amount For determining recoverable amount, it is necessary to calculate: Fair value less cost of disposal An assets fair value less cost of disposal is the amount that could obtained from the sale of the asset less selling costs. Cost of disposal simply refers to selling expenses Value in use Page 27

29 Value in use is the present value of the future cash flows expected to be derived from an asset or a cash generating unit. Step 3: recognizing and measuring impairment loss After having determined the recoverable amount we can now determine the impairment loss. An asset is impaired when its carrying amount exceeds its recoverable amount. In such a case, the carrying amount should be reduced to the recoverable amount. Step 4: recognition of impairment loss the impairment loss should be recognized immediately in the statement of profit and loss unless the asset has been revalued in accordance with Ind AS 16 or Ind AS 38. If the asset is revalued, the loss is treated as revaluation decrease in accordance with Ind AS 16 or Ind AS 38. The journal entries are as follows: Impairment loss account dr To asset account Profit or loss a/c dr Impairment loss Cash generating units Page 28

30 Recoverable amount of an asset should be estimated individually, if possible. In most situation, it is almost impossible to determine the recoverable amount of an individual asset. For example, an individual asset itself without the help of other asset cannot generate the cash flows. Hence, cash flows to be derived from individual asset cannot be calculated separately. Therefore, for the purpose of identifying cash flows, asset should be grouped into a smallest unit. This smallest unit is called cash generating unit. Impairment loss for a cash generating unit When an impairment loss is recognized for a cash generating unit, the loss should be allocated between the assets in the following order. a. First reduce the carrying amount of any assets that are individually destroyed or impaired b. Next reduce the carrying amount of any goodwill allocated to the cash generating unit. c. Then, reduce the carrying amount of the other assets of the cash generating unit pro rata basis. Allocating goodwill to cash generating units Internally generated goodwill is not recognized in financial statements. An entity recognizes goodwill if the purchase consideration in paid an acquisition exceeds the fair value of the identifiable assets and liabilities acquired in the transaction. Therefore goodwill recognized in financial statements must relate to one or more businesses acquired prior to the balance sheet date. For the purpose of impairment test, goodwill must be allocated to each of the acquirer cash generating units, or groups of cash generating units that are expected to benefit from the synergies of the combination. Example Page 29

31 Example Example Page 30

32 Reversing an impaired loss An entity should assess at the end of each reporting period whether there is any indication that an impairment loss recognized in prior periods for an asset other than goodwill may no longer exist or may have decreased. In such a cash, the entity should estimate the recoverable amount of that asset. Reversing an impairment loss for goodwill An impairment, loss recognized for goodwill should not be reversed in a subsequent period because Ind AS 38, intangible assets, prohibits the recognition of internally generated goodwill. In short, impairment loss of goodwill may never be reversed. BORROWING COST (IAS 23 & Ind AS 23) Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset form part of the cost of that asset. Other borrowing costs are recognised as an expense. Objective of IAS 23 The objective of IAS 23 is to prescribe the accounting treatment for borrowing costs. Borrowing costs include interest on bank overdrafts and borrowings, finance charges on finance leases and exchange differences on foreign currency borrowings where they are regarded as an adjustment to interest costs. Scope of IAS 23 Two types of assets that would otherwise be qualifying assets are excluded from the scope of IAS 23: Page 31

33 qualifying assets measured at fair value, such as biological assets accounted for under IAS 41 Agriculture inventories that are manufactured, or otherwise produced, in large quantities on a repetitive basis and that take a substantial period to get ready for sale (for example, maturing whisky) Definition of borrowing cost This Standard uses the following terms with the meanings specified: a. Borrowing costs are interest and other costs that an entity incurs in connection with the borrowing of funds. b. A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Accounting treatment Recognition 1. Borrowing cost to be capitalized Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalized when it is probable that they will bring future economic benefits to the entity and the costs can be measured reliably. 2. Borrowing cost to be charged as an expense Other borrowing costs are recognized as expenses and written off in the statement of profit and loss in the period in which they are incurred. Commencement of capitalization An entity should begin capitalizing borrowing costs on the date when all of the following conditions are met: a. Expenditure on qualifying asset has begun b. Borrowing costs are being incurred c. Activities to prepare the asset for its intended use or sale are in progress Suspension of capitalization Capitalization of borrowing cost is suspended during extended periods in which active development is interrupted. This means that borrowing cost should not be capitalized during the extended period. It also suspended when acquisition or construction activities are suspended intentionally. However, capitalization is not suspended in the following cases a. Temporary delays caused by external forces b. When substantial technical and administrative work is being carried out c. When temporary delay is a necessary part of the process of getting an asset ready for its intended use or sale. Cessation of capitalization an entity should cease capitalizing borrowing costs when : a. Substantially all the activities necessary to prepare the qualifying asset for the intended use or sale are complete. b. The construction is completed in part and the completed part can be independently used, eg, a business park comprising several buildings, each of which can be used individually. Page 32

34 Excess of the carrying amount The amount capitalized during the period should not exceed the amount of borrowing costs incurred during that period. If the carrying value of an asset exceeds the net realizable value, the asset should be written down to the NRV. Accrual basis Borrowing cost should be calculated on a accrual basis Example Borrowing cost recognized as an expense are: Interest payable: Opening interest payable rs Interest paid in cash during the year Rs Closing interest payable rs Calculate the amount of interest to be written off in the period Solution Interest charge for the year is calculated as below: Opening interest 5000 Add: interest paid ===== Page 33

35 Less closing interest ====== Example INVESTMENT PROPERTY (IAS 40 and Ind AS 40) Investment property is property (land or a building or part of a building or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both. [IAS 40.5] Objectives The objective of this Standard is to prescribe the accounting treatment for investment property and related disclosure requirements. Scope: The Standard applies to the measurement in a lessee s financial statements of investment property held under a finance lease and to the measurement in the lessor s financial statements of investment property leased out under an operating lease. However this Standard does not apply to: the matter covered in Ind AS-17, Leases. biological assets related to Page 34

36 agricultural activity (Ind AS-41) or, mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources. Investment property: It is a land and/or building, or part of a building, or both, held by the owner or the lessee under a finance lease to earn rentals and/or for capital appreciation, rather than for: use in production or supply of goods and services or use in administrative purposes or sale in the ordinary course of business. Owner-occupied property: It is a property held (by the owner or by the lessee under finance lease) for use in the production or supply of goods or services or for administrative purposes. One of the distinguishing characteristics of investment property (compared to owner-occupied property) is that it generates cash flows that are largely independent from other assets held by an entity. Owner-occupied property is accounted for under Ind AS-16, Property, Plant and Equipment. Examples of Investment Property: Land held for long-term capital appreciation rather than for short-term sale; A building owned by the entity and leased out under one or more operating leases; A building that is vacant but is held to be leased out under one or more operating leases; Property that is being constructed or developed for future use as investment property Partial own use. If the owner uses part of the property for its own use, and part to earn rentals or for capital appreciation, and the portions can be sold or leased out separately, they are accounted for separately. Therefore the part that is rented out is investment property. If the portions cannot be sold or leased out separately, the property is investment property only if the owneroccupied portion is insignificant. [IAS 40.10] Ancillary services. If the entity provides ancillary services to the occupants of a property held by the entity, the appropriateness of classification as investment property is determined by the significance of the services provided. If those services are a relatively insignificant component of the arrangement as a whole (for instance, the building owner supplies security and maintenance services to the lessees), then the entity may treat the property as investment property. Where the services provided are more significant (such as in the case of an ownermanaged hotel), the property should be classified as owner-occupied. [IAS 40.13] Recognition Investment property should be recognised as an asset when it is probable that the future economic benefits that are associated with the property will flow to the entity, and the cost of the property can be reliably measured. [IAS 40.16] Page 35

37 Initial measurement Investment property is initially measured at cost, including transaction costs. Such cost should not include start-up costs, abnormal waste, or initial operating losses incurred before the investment property achieves the planned level of occupancy. [IAS and 40.23] Measurement subsequent to initial recognition IAS 40 permits entities to choose between: [IAS 40.30] a fair value model, and a cost model. One method must be adopted for all of an entity's investment property. Change is permitted only if this results in a more appropriate presentation. IAS 40 notes that this is highly unlikely for a change from a fair value model to a cost model. Disposals An investment property is eliminated from the balance sheet on disposal, and when no future economic benefits are expected from it. The investment property may be disposed off by sale or by entering into a finance lease. The difference between the net sale proceeds and the carrying amount of the property represents the gain or loss on disposals. Example Page 36

38 Example ; Page 37

39 MODULE-II REVENUE AND LIABILITY BASED ACCOUNTING STANDARDS Scope An entity shall apply this Standard to all contracts with customers, except the following: (a) lease contracts within the scope of Ind AS 17, Leases; (b) insurance contracts within the scope of Ind AS 104, Insurance Contracts; 591 (c) financial instruments and other contractual rights or obligations within the scope of Ind AS109, Financial Instruments, Ind AS110, Consolidated Financial Statements, Ind AS111, Joint Arrangements, Ind AS 27,Separate Financial Statements and Ind AS 28, Investments in Associates and Joint Ventures; and (d) non-monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers. For example, this Page 38

40 Standard would not apply to a contract between two oil companies that agree to an exchange of oil to fulfill demand from their customers in different specified locations on a timely basis Definitions 1. contract: a contract is an agreement between two or more parties that creates enforeale rights and obligations. 2. Revenue; revenue is the income arising in the ordinary course of an entities activities. 3. Income: income is the increase in economic benefits in the form of inflows or enhancements of assets or decrease of liabilities that result in an increase in equity. 4. Stand along selling price: stand alone selling price is the price at which an entity would sell a promised good or service separately to a customer. Revenue recognition and measurement Under Ind AS 115 (IFRS 15), revenue is recognized and measured using a five step model. Step 1: Identify the contract with the customer The new standard defines a contract as an agreement between two or more parties that creates enforceable rights and obligations and specifies that enforceability is a matter of law. Contracts can be written, oral or implied by an entity s customary business practices. Step 2: Identify the performance obligation The new standard requires an entity to identify the performance obligations, i.e. the unit of account for revenue recognition. A promise to deliver a good or provide a service in a contract with a customer constitutes a performance obligation if the promised good or service is distinct. Step 3: Determine the transaction price Ind AS 115 requires an entity to consider the terms of the contract and its customary business practices to determine the transaction price. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring goods or services to a customer. The entity should consider the following when determining transaction price: Variable consideration and the constraint: If the consideration includes a variable amount, an entity should estimate the amount of consideration to which it will be entitled in exchange for transferring the promised goods or services to a customer. Items such as discounts, credits, price concessions, returns and performance bonuses may result in variable consideration. The existence of a significant financing component in the contract: In determining the transaction price, an entity should adjust the promised amount of consideration for the time value of money if significant financing components exist. Non-cash consideration: Non-cash consideration is measured at fair value, if that can be reasonably estimated. If not, an entity uses the stand-alone selling price of the good or service that was promised in exchange for non-cash consideration. Consideration payable to a customer: Entities need to determine whether consideration payable to a customer represents a reduction of the transaction price, a payment for a distinct good or service, or a combination of the two. Page 39

41 Step 4: Allocating the transaction price Under Ind AS 115, entities are required to allocate the transaction price to each performance obligation (or distinct good or service) in proportion to its stand- alone selling price i.e. the price at which an entity would sell the promised good or service separately to a customer. The best evidence of the stand-alone selling price is an observable price from standalone sales of that good or service to similarly situated customers. However, if the stand alone selling price is not directly observable then the entity should estimate the stand-alone selling price using the following methods: The adjusted market assessment approach Expected cost plus margin approach Residual approach (only in limited circumstances) Example Step 5: Recognise revenue As per the new standard, revenue may be recognised either at a point in time (when the customer obtains control over the promised service) or over a period of time (as the customer obtains control over the promised service). For the purposes of the standard, control refers to the customer s ability to direct the use of and obtain necessary benefits from the asset, i.e. the promised services. At the end of each reporting period, for each performance obligation satisfied over time, revenue should be recognised by measuring the progress towards complete satisfaction of that performance obligation. An entity should use a single method consistently for such measurement. Ind AS 115 specifies two types of methods: input method and output method, Page 40

42 which an entity should consider based on the nature of the goods or services. The objective is to use a method that depicts the transfer of control of goods or services to the customer. If a performance obligation is not satisfied over time, then an entity recognises revenue at the point in time at which it transfers control of the good or service to the customer. The new standard includes indicators of when the transfer of control occurs. Performance obligation satisfied at appoint in time If any entity does not satisfy its performance obligation over time, it satisfies it at a point in time. this will be the point in time at which the customer obtains control of the promised asset and the entity satisfies a performance obligation. Revenue will, therefore, be recognized when control is passed at a certain point in time. for this purpose, an entity has to consider the following indicators of transfer of control: a. The entity has a present right to payment for the asset. b. The customer has legal title to the asset; c. The entity has transferred physical possession of the asset; d. The customer has the significant risks and rewards related to the ownership of the asset; and Page 41

43 e. The customer has accepted the asset. Contract costs: Costs that would have been incurred regardless of whether the contract was obtained are recognized as an expense as incurred. Costs incurred in fulfilling a contract, unless within the scope of another standard are recognized as an asset if they meet all the following criteria. a. Cost relates directly to a contract b. The costs generate or enhance resources of the entity that will be used in satisfying the performance obligation in the future; and The costs are expected to be recovered. Example Page 42

44 Example Page 43

45 INCOME TAX (IAS 12 and Ind AS 12) IAS 12 Income Taxes implements a so-called 'comprehensive balance sheet method' of accounting for income taxes which recognises both the current tax consequences of transactions and events and the future tax consequences of the future recovery or settlement of the carrying amount of an entity's assets and liabilities. Differences between the carrying amount and tax base of assets and liabilities, and carried forward tax losses and credits, are recognised, with limited exceptions, as deferred tax liabilities or deferred tax assets, with the latter also being subject to a 'probable profits' test. Objectives Calculate taxes under Ind AS 12. Describe the recognition criteria for deferred tax liabilities and assets. Explain the deferred tax effects on business combinations. Detail the recognition of deferred tax assets arising from unused tax Detail the recognition of deferred tax assets arising from unused tax losses or credits. Detail presentation and disclosure requirements of income taxes Some Definitions 1. Accounting Profit Profit or loss for a period per the books of account. 2. Taxable Profit The profit (loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable (recoverable) 3. Tax expense The aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax 4. Current tax The amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period Recognition of current tax liabilities and Assets Current tax for current and prior periods shall, to the extent unpaid, be recognised as a liability. If the amount already paid in respect of current and prior periods exceeds the amount due for those periods, the excess shall be recognised as an asset. The benefit relating to a tax loss that can be carried back to recover current tax of a previous period shall be recognised as an asset. When a tax loss is used to recover current tax of a previous period, an entity recognises the benefit as an asset in the period in which the tax loss occurs because it is probable that the benefit will flow to the entity and the benefit can be reliably measured. Page 44

46 Example Recognition of current tax Current tax should be recorgnised when taxable profits are earned in the period which it relates in the following manner. a. A current tax expense or income item should be recognized in the income statement. b. A current tax liability should be recognized to the extent that the amounts owing are unpaid to tax authorities. c. A current tax asset should recognized to the extent that the amount already paid exceed the amount due. Measurement of current tax Current tax liabilities and assets are measured at the amount expected to be paid to or recovered from the taxation authorities. Tax base The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset. If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount. Examples determining tax base of an Asset 1. A machine cost Rs.100. For tax purposes, depreciation of Rs.30 has already been deducted in the current and prior periods and the remaining cost will be deductible in future periods, either as depreciation or through a deduction on disposal. Revenue generated by using the machine is taxable, any gain on disposal of the machine will be taxable and any loss on disposal will be deductible for tax purposes. Page 45

47 The tax base of the machine is Rs Interest receivable has a carrying amount of Rs.100. The related interest revenue will be taxed on a cash basis. The tax base of the interest receivable is nil 3. Trade receivables have a carrying amount of Rs.100. The related revenue has already been included in taxable profit (tax loss). The tax base of the trade receivables is Rs Dividends receivable from a subsidiary have a carrying amount of Rs.100. The dividends are not taxable. In substance, the entire carrying amount of the asset is deductible against the economic benefits. Consequently, the tax base of the dividends receivable is Rs.100.(a) Examples determining tax base of a liability The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue which is received in advance, the tax base of the resulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future periods. 1. Current liabilities include accrued expenses with a carrying amount of Rs.100. The related expense will be deducted for tax purposes on a cash basis. The tax base of the accrued expenses is nil. 2. Current liabilities include interest revenue received in advance, with a carrying amount of Rs.100. The related interest revenue was taxed on a cash basis. The tax base of the interest received in advance is nil. 3. Current liabilities include accrued expenses with a carrying amount of Rs.100. The related expense has already been deducted fosr tax purposes. The tax base of the accrued expenses is Rs Current liabilities include accrued fines and penalties with a carrying amount of Rs.100. Fines and penalties are not deductible for tax purposes. The tax base of the accrued fines and penalties is Rs.100.(a Difference in accounting profit and taxable profit:accounting profits form the basis for computing taxable profit, on which the tax liability for the year is calculated. However, accounting profits and taxable profit are different. There are two reasons for the differences, permanent differences and temporary differences. Permanent differences: Permanent differences occur when certain items of revenue or expenses are excluded from the computation of taxable profit. Page 46

48 Type of temporary differences Temporary differences may be either taxable temporary differences or deductible temporary differences. a. Taxable temporary differences : these are temporary differences that will result in taxable amounts in determining taxable profit of future periods when the carrying Page 47

49 amount of the asset or liability is recovered or settled. The following are examples of circumstances that give rise to taxable temporary differences. Transaction affecting profit or loss Transaction affecting balance sheet Deferred tax Deferred tax is difference in tax liability calculated for temporary difference between the taxable profit and accounting profit. Deferred tax liabilities Deferred tax liabilities generally arise where tax relief is provided in advance of an accounting expense/unpaid liabilities, or income is accrued but not taxed until received Recognition of deferred tax liabilities The general principle in IAS 12 is that a deferred tax liability is recognised for all taxable temporary differences. There are three exceptions to the requirement to recognise a deferred tax liability, as follows: liabilities arising from initial recognition of goodwill [IAS 12.15(a)] Page 48

50 liabilities arising from the initial recognition of an asset/liability other than in a business combination which, at the time of the transaction, does not affect either the accounting or the taxable profit [IAS 12.15(b)] liabilities arising from temporary differences associated with investments in subsidiaries, branches, and associates, and interests in joint arrangements, but only to the extent that the entity is able to control the timing of the reversal of the differences and it is probable that the reversal will not occur in the foreseeable future. [IAS 12.39] example Deferred tax assets Deferred tax assets generally arise where tax relief is provided after an expense is deducted for accounting purposes: a company may accrue an accounting expense in relation to a provision such as bad debts, but tax relief may not be obtained until the provision is utilized a company may incur tax losses and be able to "carry forward" losses to reduce taxable income in future years.. An asset on a company's balance sheet that may be used to reduce any subsequent period's income tax expense. Deferred tax assets can arise due to net loss carryover. Recognition of deferred tax assets A deferred tax asset is recognised for deductible temporary differences, unused tax losses and unused tax credits to the extent that it is probable that taxable profit will be available against which the deductible temporary differences can be utilised, unless the deferred tax asset arises from: [IAS 12.24] Page 49

51 the initial recognition of an asset or liability other than in a business combination which, at the time of the transaction, does not affect accounting profit or taxable profit. Measurement of deferred tax Deferred tax assets and liabilities are measured at the tax rates that are expected to apply to the period when the asset is realised or the liability is settled, based on tax rates/laws that have been enacted or substantively enacted by the end of the reporting period. [IAS 12.47] The measurement reflects the entity's expectations, at the end of the reporting period, as to the manner in which the carrying amount of its assets and liabilities will be recovered or settled. [IAS 12.51] IAS 12 provides the following guidance on measuring deferred taxes: Where the tax rate or tax base is impacted by the manner in which the entity recovers its assets or settles its liabilities (e.g. whether an asset is sold or used), the measurement of deferred taxes is consistent with the way in which an asset is recovered or liability settled [IAS 12.51A] Where deferred taxes arise from revalued non-depreciable assets (e.g. revalued land), deferred taxes reflect the tax consequences of selling the asset [IAS 12.51B] Deferred taxes arising from investment property measured at fair value under IAS 40 Investment Property reflect the rebuttable presumption that the investment property will be recovered through sale [IAS 12.51C-51D] If dividends are paid to shareholders, and this causes income taxes to be payable at a higher or lower rate, or the entity pays additional taxes or receives a refund, deferred taxes are measured using the tax rate applicable to undistributed profits [IAS 12.52A] Deferred tax assets and liabilities cannot be discounted. [IAS 12.53] Revalued asset Under IAS (Ind AS) 16 assets may be revalued to be shown at their fair values. The revaluation of an asset does not affect taxable profit in the period of the revaluation. As a result, the tax base of the asset is not adjusted. Example Page 50

52 Example Page 51

53 Example Page 52

54 Page 53

55 Employee benefits (IAS 19 and Ind AS 19) An employer provides a number of benefits to its employees for the services provided by them. The most important one is salary or wage. In addition to this, there are some other benefits, such as gratuity, leave encashment, maternity leaves, superannuation, medical benefits etc. Objectives The objective of IAS 19 is to prescribe the accounting and disclosure for employee benefits, requiring an entity to recognise a liability where an employee has provided service and an expense when the entity consumes the economic benefits of employee service. Scope IAS 19 applies to (among other kinds of employee benefits): wages and salaries compensated absences (paid vacation and sick leave) profit sharing and bonuses medical and life insurance benefits during employment non-monetary benefits such as houses, cars, and free or subsidised goods or services retirement benefits, including pensions and lump sum payments post-employment medical and life insurance benefits long-service or sabbatical leave 'jubilee' benefits deferred compensation programmes termination benefits. Page 54

56 Definition of employee benefit Employee benefits are all forms of considerations given by an entity in exchange for services rendered y employees. Other definitions 1. Equity compensation plans: equity compensation plans are formal or informal arrangement under which an entity provides equity compensation benefit for one or more employees. 2. Vested employee benefits: vested employee benefits are employee benefits that are not condition on future employment. 3. Plan asset: plan assets comprise assets held by the long term employee benefit fund and qualifying insurance policies. 4. Return on plan assets: return on plan assets comprises interest, dividends, and other revenue derived from the plan assets, together with realized and unrealized gains, or losses on the plan assets, less any cost of administering the plan and less any tax payable. Categories of employee benefits Short term employee benefits Post employment benefits Other long term benefits Termination benefits Short-term employee benefits Short-term employee benefits are those expected to be settled wholly before twelve months after the end of the annual reporting period during which employee services are rendered, but do not include termination benefits.[ias 19(2011).8] Examples include wages, salaries, profit-sharing and bonuses and non-monetary benefits paid to current employees. The undiscounted amount of the benefits expected to be paid in respect of service rendered by employees in an accounting period is recognised in that period. [IAS 19(2011).11] The expected cost of short-term compensated absences is recognised as the employees render service that increases their entitlement or, in the case of non-accumulating absences, when the absences occur, and includes any additional amounts an entity expects to pay as a result of unused entitlements at the end of the period. Profit-sharing and bonus payments An entity recognises the expected cost of profit-sharing and bonus payments when, and only when, it has a legal or constructive obligation to make such payments as a result of past events and a reliable estimate of the expected obligation can be made. Types of post-employment benefit plans Post-employment benefit plans are informal or formal arrangements where an entity provides post-employment benefits to one or more employees, e.g. retirement benefits (pensions or lump sum payments), life insurance and medical care. Page 55

57 The accounting treatment for a post-employment benefit plan depends on the economic substance of the plan and results in the plan being classified as either a defined contribution plan or a defined benefit plan: Defined contribution plans. Under a defined contribution plan, the entity pays fixed contributions into a fund but has no legal or constructive obligation to make further payments if the fund does not have sufficient assets to pay all of the employees' entitlements to post-employment benefits. The entity's obligation is therefore effectively limited to the amount it agrees to contribute to the fund and effectively place actuarial and investment risk on the employee Defined benefit plans These are post-employment benefit plans other than a defined contribution plans. These plans create an obligation on the entity to provide agreed benefits to current and past employees and effectively places actuarial and investment risk on the entity. Recognition and measurement of post employment benefits Defined contribution plans Rules for recognition measurement of defined contribution plans are given below a. Contributions to defined contribution plan should be recognized as an expense in the period they are payable. b. Any liability or unpaid contribution that are due as at the end of the period should be recognized as a liability c. Any excess contribution paid should be recognized as an asset, but only to the extent that prepayment will lead to a reduction in future payments or cash refund. Other long-term benefits the recognition and measurement of a surplus or deficit in an other long-term employee benefit plan is consistent with the requirements outlined above service cost, net interest and remeasurements are all recognised in profit or loss (unless recognised in the cost of an asset under another IFRS), i.e. when compared to accounting for defined benefit plans, the effects of remeasurements are not recognised in other comprehensive income. Recognition and measurement of other long term benefits Unlike post employee benefits, there is only less uncertainty relating to the recognition and measurement of other long term benefits. The net total of the following amounts should be recognized in the statement of profit and loss: a. service cost b. net interest on the net defined benefit liability (or asset) c. remeasurements of the net defined benefit liability d. actuarial gains and losses(should be recognized immediately) e. past service cost. Page 56

58 Termination benefits when the entity can no longer withdraw the offer of those benefits - additional guidance is provided on when this date occurs in relation to an employee's decision to accept an offer of benefits on termination, and as a result of an entity's decision to terminate an employee's employment when the entity recognises costs for a restructuring under IAS 37 Provisions, Contingent Liabilities and Contingent Assets which involves the payment of termination benefits. Example Page 57

59 PROVISIONS, CONTINGENT LIABILITIES, AND CONTINGENT ASSETS (IAS 37 and Ind AS 37) The accounting standards discussed so far are based on revenue. The IAS (Ind AS) 37 is based on liabilities and provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to enable users to understand their nature, timing and amount. Objective The objective of IAS 37 is to ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount. The key principle established by the Standard is that a provision should be recognised only when there is a liability i.e. a present obligation resulting from past events. The Standard thus aims to ensure that only genuine obligations are dealt with in the financial statements planned future expenditure, even where authorised by the board of directors or equivalent governing body, is excluded from recognition. Scope IAS 37 (Ind AS 37) shall be applied by all entities in accounting for provision, contingent liabilities and contingent assets, except those resulting from: 1. financial instrument carried at fair value 2. Executory contract 3. insurance contract with policy holders 4. events or transactions covered by any other IAS Definition of provision A provision is a liability of uncertain timing or amount. Examples are: a. income tax liability b. product warranty c. environment restoration d. post employment employee benefit e. dispute claim by customer f. dispute claim by the revenue department Difference between provisions and other liabilities IAS (Ind AS ) 37 distinguishes provisions from other liabilities such as trade payables and accruals. For a provision, there is uncertainty about the timing or amount of the future expenditure. In the case of other liabilities the uncertainty is generally much less than for provision. Page 58

60 Relationship between provisions and contingent liabilities All provisions are contingent because they are uncertain in timing or amount. However, the term contingent liabilities are not recognized in the financial statements because their existence will be confirmed only by the occurrence or non occurrence or one or more uncertain future events. Thus, they are not liabilities. Provisions, on the other hand, are recognized as liabilities. Thus, provisions are liabilities. Recognition of a provision An entity must recognise a provision if, and only if: [IAS 37.14] a present obligation (legal or constructive) has arisen as a result of a past event (the obligating event), payment is probable ('more likely than not'), and the amount can be estimated reliably. An obligating event is an event that creates a legal or constructive obligation and, therefore, results in an entity having no realistic alternative but to settle the obligation. [IAS 37.10] A constructive obligation arises if past practice creates a valid expectation on the part of a third party, for example, a retail store that has a long-standing policy of allowing customers to return merchandise within, say, a 30-day period. [IAS 37.10] A possible obligation (a contingent liability) is disclosed but not accrued. However, disclosure is not required if payment is remote. Measurement of provisions The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date, that is, the amount that an entity would rationally pay to settle the obligation at the balance sheet date or to transfer it to a third party. This means: Provisions for one-off events (restructuring, environmental clean-up, settlement of a lawsuit) are measured at the most likely amount Provisions for large populations of events (warranties, customer refunds) are measured at a probability-weighted expected value Both measurements are at discounted present value using a pre-tax discount rate that reflects the current market assessments of the time value of money and the risks specific to the liability Important considerations in measuring provisions 1. Present value Page 59

61 Where time value of money is important, the provision should be discounted. In other words, the amount of provision should be the present value of the expenditures expected to be required to settle the obligation. The discount rate should be the pre tax rate that reflects current market assessment. 2. Reimbursement Some or all of the expenditure required to settle an obligation is expected to be reimbursed from a third party. If so, the reimbursement should be recognized only when it is virtually certain that the reimbursement will be received if the entity settles the obligation. 3. Changes in provisions Provisions should be reviewed at the end of the reporting period and adjusted to reflect the current best estimate. If it no longer probable that an outflow of resources will e required to settle the obligation, the provision shall be reversed. 4. Use of provisions A provision should be used only for expenditure for which the provision was originally recognized and not for another purpose. 5. Future operating losses Provisions should not be recognized for future operating losses. This is because they do not meet the definition of a liability and the general recognition criteria. 6. Onerous contact Onerous contract is a contract in which the unavoidable costs of fulfilling the obligations under the contract exceed the economic benefits from it. 7. Restructuring (provision for restructuring) Restructuring is defined as a programme that is planned and controlled by management that materially changes either the scope of business or the manner in which that business is conducted. Recognition of restructuring cost A provision for restructuring costs is recognized only the general recognition criteria for recognizing a provision are met. Besides, the following criteria should also be met: a. An entity must have a detailed formal plan for the restructuring b. It must have raised a valid expectation that it will carry out the restructuring, by starting to implement that plan or announcing its main features. A restructuring provision should include only the direct expenditures arising from the restructuring that are both: a. Necessitated by the restructuring, and b. Not associated with the ongoing activities of the enterprise Page 60

62 Following costs should not be included in the restructuring provisions: a. Cost of retraining or relocating continuing staff b. Cost of marketing c. Cost of investment in new systems and distribution network Examples of possible provisions a. Warranties b. Major repairs c. Environmental contamination Contingent liabilities A contingent liability is a possible obligation that arises from past event and the existence of which will be confirmed only by the occurrence or non occurrence of one or more uncertain future event not wholly within the control of the enterprise. Examples of contingent liabilities a. Guarantees on behalf of associates and others b. Claims against firm c. Liabilities of case pending in the court d. Income tax demand under appeal e. Uncalled liability on partly paid up shares Contingent liability: a possible obligation depending on whether some uncertain future event occurs, or a present obligation but payment is not probable or the amount cannot be measured reliably Recognition of contingent liability An entity should not recognize contingent liabilities in the financial statements, intead, an entity should disclose them by way of notes below the balance sheet. If the possibility of an outflow of resources is remote, even the disclosure is not required. Contingent asset: a possible asset that arises from past events, and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity. Recognition of contingent asset Contingent assets are not recognized in financial statements because this may result in the recognition of income that may never be realized. However, when the realization of income is virtually certain, then the related asset is recognized. A contingent asset is disclosed, where an inflow of economic benefits is probable. Page 61

63 Example Page 62

64 IAS (Ind AS) 20, IAS (Ind AS) 17 & IFRS 2/Ind AS 102 Accounting for grants A government grant is recognised only when there is reasonable assurance that (a) the entity will comply with any conditions attached to the grant and (b) the grant will be received. [IAS 20.7] The grant is recognised as income over the period necessary to match them with the related costs, for which they are intended to compensate, on a systematic basis. [IAS 20.12] Non-monetary grants, such as land or other resources, are usually accounted for at fair value, although recording both the asset and the grant at a nominal amount is also permitted. [IAS 20.23] Even if there are no conditions attached to the assistance specifically relating to the operating activities of the entity (other than the requirement to operate in certain regions or industry sectors), such grants should not be credited to equity. [SIC-10] A grant receivable as compensation for costs already incurred or for immediate financial support, with no future related costs, should be recognised as income in the period in which it is receivable. Objective of IAS 20 The objective of IAS 20 is to prescribe the accounting for, and disclosure of, government grants and other forms of government assistance. Scope IAS 20 applies to all government grants and other forms of government assistance. However, it does not cover government assistance that is provided in the form of benefits in determining taxable income. It does not cover government grants covered by IAS 41 Agriculture, either The benefit of a government loan at a below-market rate of interest is treated as a government grant. Definitions Page 63

65 1. Government assistance: government assistance is direct action to provide economic benefits to a qualifying firm, or groups of firms. 2. Government grants: government grants are assistance by government in the form of transfer of resources to an entity in return for past or future compliance with certain conditions relating to the operating activities of the entity. Classification of government grants Government grants can be classified as: 1. Grants related to assets: these grants are given when tan entity purchases or constructs long term assets. For example, govt may offer 25% grant for purchase of machinery with a view to encourage investment in industrial machinery. Grants related to assets are also called capital gain. 2. Grants related to income: grants related to income are government grantws other than those related to assets. These are grants that boost income, or reduce costs, these are also called revenue grants Recognition of government grants Government grants (including non monetary grants) should be recognized only when there is reasonable assurance that: a. The firm will comply with the condition attached to the grant, and b. The grant will be received Grant related to asset a. Grants related to depreciable asset: grants related to depreciable assets are recognized as income over the periods in which its depreciation is charged and in the same proportion, it should treated as other income because it does not relate to any specific item of cost b. Grants related to non depreciable asset: in the case of grants for non depreciable assets, certain obligations may need to fulfilled. In such cases the grant should be recognized as income over the periods in which the cost of meeting the obligation is incurred, for example, if piece of land is granted as condition that a building is erected on it, then the grant should be recognized as income over the buildings life. Page 64

66 Example Grant related to income These grants are credited to statement of profit or loss either separately or under a general heading other income. Alternatively, it is debited against the related expense. Non - monetary government grants A government grant may take the form of a transfer of a non-monetary asset, such as land or other resources, for the use of the entity. In these circumstances, it is usual to assess the fair value of the non-monetary asset and to account for both grant and asset at that fair value. An alternative course that is sometimes followed is to record both asset and grant at a nominal amount. Page 65

67 Presentation of grants related to assets Government grants related to assets, including non-monetary grants at fair value, shall be presented in the statement of financial position either by setting up the grant as deferred income or by deducting the grant in arriving at the carrying amount of the asset. Forgivable loans Forgivable loans are loans which the lender undertakes to waive repayment under certain prescribed condition, for example, cheap loans may be made available to firms that operate in an undesirable region. Presentation of grants related to income Grants related to income are presented as part of profit or loss, either separately or under a general heading such as Other income ; alternatively, they are deducted in reporting the related expense. Repayment of government grants A government grant that becomes repayable shall be accounted for as a change in accounting estimate (see IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors). Repayment of a grant related: (a) to income shall be applied first against any unamortised deferred credit recognised in respect of the grant. To the extent that the repayment exceeds any such deferred credit, or when no deferred credit exists, the repayment shall be recognised immediately in profit or loss. (b) to an asset shall be recognised by increasing the carrying amount of the asset or reducing the deferred income balance by the amount repayable. The cumulative additional depreciation that would have been recognised in profit or loss to date in the absence of the grant shall be recognised immediately in profit or loss. Example Page 66

68 ACCONTIN FOR LEASE (IAS 17 and Ind AS 17) Leasing is a contract between the lessor and the lessee for the hire of an asset. The lessor retains the legal ownership of the asset. He gives to the lessee the right to use the asset for the agreed period of time in return for lease rental. Objectives The objective of this Standard is to prescribe, for lessees and lessors, the appropriate accounting policies and disclosure to apply in relation to leases. Scope IAS 17 applies to all leases other than lease agreements for minerals, oil, natural gas, and similar regenerative resources and licensing agreements for films, videos, plays, manuscripts, patents, copyrights, and similar items. Page 67

69 However, IAS 17 does not apply as the basis of measurement for the following leased assets: property held by lessees that is accounted for as investment property for which the lessee uses the fair value model set out in IAS 40 investment property provided by lessors under operating leases biological assets held by lessees under finance leases biological assets provided by lessors under operating leases Definitions Lease : a lease is an agreement whereby the lessor conveys to the lessee in return for rent the right to use an asset for an agreed period of time.. Accounting treatment of finance lease in the books of lessee: At commencement date, lessee should record financial lease as asset and liability in its balance sheet at fair value of Page 68

70 the leased property or the present value of the minimum lease payments at that date, whichever is less. Lessor and lessee should account for the transaction just like a credit sale. In the lessee s books, therefore, the leased asset is capitalized. The journal entry is Asset a/c dr To lessor (liability) a/c The proportion of interest payable (expense) is debited in the statement of profit or loss of the lessee. The journal entry is Interest a/c dr To cash The proportion of capital cost should be debited to the lessor s account. This reduces the outstanding liability. The journal entry is. Lessor s a/c To cash Example Page 69

71 Depreciation policy The depreciation policy for assets held under finance lease should be consistent with that for owned assets. The depreciation recognized shall be calculated in accordance with Ind AS (IAS) 16 property, plant and equipment and Ind AS (IAS) 38 Intangible assets. Disclosure requirements by lessee for finance lease Lessee should disclose the following for the finance lease 1. the net carrying amount at the reporting date for each class of asset. 2. A reconciliation between the total minimum lease payments at the reporting date, and their present value. 3. Contingent rents recognized as income in the period 4. Total of future minimum sublease payments, expected to be received under non cancellable subleases at the reporting date. 5. A general description of the lessee s material arising arrangements Accounting treatment of finance lease in the books of Lessor: If a lessor leases out an asset under finance lease, the asset cannot be seen in his premises. In other words, the asset cannot be used in his business again. Hence, the lessor cannot record such an asset as a non current asset. Interest receivable (portion of lease rental) should be credited in the statement of profit or loss. The journal entry is Cash a/c dr To interest The capital cost of lease rental should be credited in the lessee s account. This reduces the amount owing by the lessee. The journal entry is Cash a/c dr To lessee s a/c Example Page 70

72 Page 71

73 Disclosure requirements by lessor for finance lease The following should be disclosed in the financial statements of lessor in respect of finance lease: 1. A reconciliation between the total gross investment in the lease at the year end, and the present value of minimum lease payments receivable at the year end. In addition, an entity should disclose the total gross investment in the lease and the present value of minimum lease payments receivable at the year end, for each of the following periods: Not later than one year Later than one year and not later than five years. Later than five years 2. Unearned financial income 3. The unguaranteed residual values occurring to the benefit of the lessor 4. The accumulated allowance for uncollectible minimum lease payments receivable Page 72

74 5. Contingent rents recognized in income. 6. A general description of the lessor s material leasing arrangements Accounting treatment of operating lease in the books of lessee Under operating lease, the risks and rewards of ownership are not transferred to the lessee. The lessor is responsible for the repairs and maintenance of the asset. An operating lease is a short term rental agreement. Therefore, the accounting treatment is different. Asset is not recognized in the balancesheet. Operating lease is an arrangement in which the lessor gives an asset to the lessee on rent. The journal entries are as follows Lease rental a/c dr To lessor (lease rental due) Lessor a/c dr Cash (payment of lease rental) Profit ad loss a/c dr To lease rental (lease rental charged to statement of profit or loss) Disclosure requirements by lessee for operating lease For operating leases, the disclosures are as follows a. The total future minimum lease payments, under non cancellable operating leases for each of the following periods: Not later than one year\ Later than one year and not later than five year Later than five years b. The total of any future minimum sublease payments expected to be received at the end of the reporting period. c. Lease and sublease payments recognized as an expense in the period d. A general description of the lessee s significant leasing arrangement. Accounting treatment of operating lease in the books of lessor The lessor presents in its balance sheet an asset as fixed asset. Lessor s income from operating leases shall be recognized as income on a straight line basis over the lease term unless another basis is ore representative of asset. Initial direct costs incurred by lessor, in negotiating and arranging an operating lease, shall be added to the carrying amount of the leased asset, and recorded as an expense, spread over the lease term on the same basis as the lease income. The journal entries are as follows. Lessee a/c dr To lease rental (income) (income due from lease) Page 73

75 Cash a/c dr To lease (rental received from lessee) Lease rental dr To profit and loss (income credited to statement of profit or loss) Disclosure requirements by lessor for operating lease Lessor should disclose the following for operating leases. a. The furniture minimum lease payments under non cancellable operating leases in the aggregate and for each of the following period. Not later than one year Later than one year and not later than five years, Later than five years b. Total contingent rents recognized as income in the period. c. A general description of the lessor s leasing arrangements Sale and leaseback transactions In a sale and lease back transactions, an asset is sold by a vendor and then the same asset is leased back to the same vendor. The accounting treatment of a sale and leaseback transaction depends upon the type of lease involved. SHARE BASED PAYMENT When a firm purchases goods or services from other parties it usually makes payments in cash or through bank. Nowadays companies make payments by issuing their shares. Objectives the objective of Ind AS 102 is to specify the financial reporting by an entity when it undertake a share based payment transaction. Scope The concept of share-based payments is broader than employee share options. IFRS 2 encompasses the issuance of shares, or rights to shares, in return for services and goods. Examples of items included in the scope of IFRS 2 are share appreciation rights, employee share purchase plans, employee share ownership plans, share option plans and plans where the issuance of shares (or rights to shares) may depend on market or non-market related conditions. IFRS 2 applies to all entities. There is no exemption for private or smaller entities. Furthermore, subsidiaries using their parent's or fellow subsidiary's equity as consideration for goods or services are within the scope of the Standard Definition of share-based payment A share-based payment is a transaction in which the entity receives goods or services either as consideration for its equity instruments or by incurring liabilities for amounts based on the price of the entity's shares or other equity instruments of the entity. The accounting Page 74

76 requirements for the share-based payment depend on how the transaction will be settled, that is, by the issuance of (a) equity, (b) cash, or (c) equity or cash. Recognition and measurement The issuance of shares or rights to shares requires an increase in a component of equity. IFRS 2 requires the offsetting debit entry to be expensed when the payment for goods or services does not represent an asset. The expense should be recognised as the goods or services are consumed. For example, the issuance of shares or rights to shares to purchase inventory would be presented as an increase in inventory and would be expensed only once the inventory is sold or impaired. The issuance of fully vested shares, or rights to shares, is presumed to relate to past service, requiring the full amount of the grant-date fair value to be expensed immediately. The issuance of shares to employees with, say, a three-year vesting period is considered to relate to services over the vesting period. Therefore, the fair value of the share-based payment, determined at the grant date, should be expensed over the vesting period. As a general principle, the total expense related to equity-settled share-based payments will equal the multiple of the total instruments that vest and the grant-date fair value of those instruments. In short, there is truing up to reflect what happens during the vesting period. However, if the equity-settled share-based payment has a market related performance condition, the expense would still be recognised if all other vesting conditions are met. The various types of transactions may be discussed as follows 1. Equity settled share based payment transactions For equity-settled share-based payment transactions, the entity shall measure the goods or services received, and the corresponding increase in equity, directly, at the fair value of the goods or services received, unless that fair value cannot be estimated reliably. If the entity cannot estimate reliably the fair value of the goods or services received, the entity shall measure their value, and the corresponding increase in equity, indirectly, by reference to the fair value of the equity instruments granted. 2. Transactions in which services are received If the equity instruments granted vest immediately, the counterparty is not required to complete a specified period of service before becoming unconditionally entitled to those equity instruments. In the absence of evidence to the contrary, the entity shall presume that services rendered by the counterparty as consideration for the equity instruments have been received. In this case, on grant date the entity shall recognise the services received in full, with a corresponding increase in equity. 3. Cash settled share based payment transactions For cash - settled share- based payment transactions, the entity shall measure the goods or services acquired and the liability incurred at the fair value of the liability. Until the liability is settled, the entity shall remeasure the fair value of the liability at the end of each reporting period and at the date of settlement, with any changes in fair value recognised in profit or loss for the period. Page 75

77 ACCOUNTING FOR BONUS AND RIGHT ISSUE A company sometimes issues additional shares to existing shareholders. Shares may be issued to existing shareholders without any consideration. Such shares are called bonus shares. Similarly shares may be issued for cash in proportion to the shares held by the existing shareholders. Such shares are called right shares. This chapter deals with bonus issue as well as right issue. Meaning of Bonus Shares or Bonus Issue Bonus shares are those shares which are issued by a company free of cost to the existing shareholders of a company out of its large reserves created out of past profits. These are shares issued to existing equity shareholders without any consideration. Without paying cash, the existing shareholders get additional shares. Bonus share is a bonus in kind. It is a gift on pro-data basis. In short, bonus shares are free shares issued to the existing shareholders out of accumulated profits or reserves. When a company issues bonus shares out of profits or reserves, its reserves or proficts are converted into capital. That is why bonus issue is called Capitalisation of Profits or Capitalisation of Reserves. Circumstances Issuing Bonus Shares 1. When the company wishes to capitalise its huge undistributed profits or reserves built. 2. When the company has not sufficient cash reserves, it issues bonus shares without ; adversely affecting its working capital 3. When value of fixed assets of a company exceeded its capital, the difference is capitalised by issuing bonus shares. Circumstances under which Bonus Shares cannot be issued 1. If subscribed and paid up capital exceeds authorised capital. 2. Bonus shares can be issued only as additional or extra dividends and not as regular dividends.. Advantages of Issuing Bonus Shares A. To the shareholders 1. Shareholders get additional shares without paying cash for it. Partly paid shares get converted into fully paid without giving cash. 2. No tax is to be paid on the bonus shares received by a shareholder, 3. It increases liquidity of shares. B. To the company 1. As the bonus issue does not involve any cash payment, liquidity or working capital of the company is not affected. 2. Workers do not create problems of demanding higher wage or bonus as there are no more accumulated profits due to bonus issue. Disadvantages of Issuing Bonus Shares A. To the shareholders 1. By receiving bonus shares the shareholders do not gain actually. Because, when a company issues bonus shares, its total profits (which do not usually increase) will have to be distributed over a large number of shares. Hence dividend per share is reduced. Page 76

78 2. If the rate of dividend cannot be maintained, the market value of shares will fall B. To the company_ 1. Market value of shares may fall if the rate of dividend is not maintained. As a result, the company's reputation may suffer. 2. It encourages undesirable speculation. Conditions for Issue of Bonus Shares According to Companies Act, a company can issue bonus shares only if the following conditions are fulfilled: 1. Issue of bonus shares should be authorized by the Articles. 2. The proposal of the Board of Directors regarding issue of bonus shares should be approved by the members in the general meeting. 3. The company should have sufficient profits and reserves to permit the issue of bonus shares. 4. The bonus issue should satisfy the guidelines issued by SEBI. Funds or Sources for Bonus Issue As per Section 63 (1) of the Companies Act 2013, a company may issue fully paid up bonus shares to its members, in any manner whatsoever, out of the following reserves: A. Revenue Reserves/ Profits 1. Credit. balance in the profit and loss account. 2. General reserves. 3. Credit balance in the sinking fund account for the redemption of a liability (e.g. debentures) after the redemption of the liability. 4. Dividend equalisation reserve. B. Capital Reserves / Profits 1. Profit prior to incorporation. 2. Profit on sale of fixed assets or business. 3. Capital Redemption Reserve A/c created for redemption of preference share. 4. Security premium collected in cash only. Types of Bonus Issue 1. Fully paid bonus shares : When bonus shares are distributed free of cost in proportion of holding, it is called fully paid bonus shares. 2. Partly paid bonus shares : When bonus is applied for converting partly paid. The following are the journal entries in respect of issue of bonus shares. A. When fully paid bonus shares are issued. 1. When issued at par Capital Reserve A/c Security Premium A/c Capital Redemption Reserve A/c Debenture redemption reserve A/c General Reserve A/c ' Profit and Loss To Bonus to Shareholders A/c (On the declaration of bonus out of reserve and /or profit) Page 77

79 (b) Bonus to Shareholders A/c To Share Capital A/c (On issue of bonus shares) 2. When issued at premium : (a) Security Premium A/c Capital Redemption Reserve A/c Sinking Fund A/c ' General Reserve A/c Profitand Loss To Bonus to Shareholders A/c (On the declaration of bonus out of reserves / or profit) (b) Bonus to Shareholders A/c To Share Capital A/c To Security Premium A/c (Issue of bonus shares at premium) B. When Bonus is given to convert partly paid shares into fully paid shares: (a) Capital Reserve A/c Debenture Redemption Reserve A/c General Reserve A/c Prof it.& Loss To Bonus to Shareholders A/c (On the declaration of bonus out of reserve and/or profit) (b) Share Final Call A/c To Share Capital A/c ( On making due the final call) (c) Bonus to Shareholders A/c To Share Final Call A/c (On utilisation of bonus) Security Premium A/c and Capital Redemption Reserve Account cannot be utilised to convert.the partly paid shareg. into fully paid shares. When partly paid shareware converted into fully paid ones by applying bonus, the shareholders get converted their partly paid shares into fully paid without paying the final call money Similarly when fully paid bonus they get without aying cash. The impact of issue of fully paid bonus shares or conversion of partly paid shares into fully paid shares on the Balance Sheet is that the reserves and profit which are utilised for giving_ bonus, are reduced and the share capital (and sometimes security premium also) is increased. Thus, reserves are capitalised. Journal Entry for Cash Bonus In case of cash bonus the required journal entries are : 1) Profit & Loss. To Bonus Payable A/c 2) Bonus Payable A/c Page 78

80 To Bank A/c Example -1 (Bonus Shares at Par) X Ltd. with a paid up capital of? 5,00,000 divided into shares of f 10 each fully paid had resolved to capitalise? 80,000 of the accumulated reserves of f 1,25,000 by issuing bonus shares of f 10 each fully paid. Pass necessary journal entries. Solution: Journal Reserves A/c Rs. 80,000 To Bonus to Shareholders A/c Rs. 80,000 (Declaration of bonus out of reserve) Bonus to Shareholders A/c Rs.80,000 To Share Capital A/c Rs.80,000 (Issue of fully paid bonus shares) Example 2 (Bonus Shares at Premium) AB Ltd has a share capital of Rs. 20,00,000 in Equity shares of? 10 as fully paid. The company now declares a bonus out of its free reserves of Rs. 8,00,000. This bonus is to be paid by issue of the equity share of Rs.10 each at a premium of Rs.2 per share for every four shares held by the shareholders. The shares are quoted at Rs.15 on the date of allotment of bonus shares. Give journal entries to record the above transactions. Solution Journal Reserves A/c To Bonus to Shareholders A/c Rs. 6,00,000 (Declaration of bonus out of reserves) Bonus to shareholders A/c ' Rs. 6,00,000 6,00,000 To Equity Share Capital A/c 5,00,000 To Security Premium A/c 1,00,000 (Issue of 5000 fully paid bonus shares of? 10 each at a premium of? 2 per share) Working note: 1. Amount needed for issue of bonus share at a premium of Rs. 2 per share is:. For every 4 shares held 1 bonus share issued. For 2,00,000 shares held, shares issued. Amount needed is 50,000 x (10 + 2) = Rs. 6,00,000 This amount is to be appropriated out of free reserves of Rs.8,00,000 Page 79

81 2. Price quoted in the market is not considered while writing the entries because the company has issued the shares at face value plus premium. Example- 3 (Conversion of Partly paid Shares) XY Ltd. has a fully paid equity capital of? 5,00,000 divided into shares of? 10 each and 1,00,000 partly paid shares of? 10 each,? 7 paid up. It has an accumulated profit to the credit of its profit and loss account of? 2,00,000, free reserve of? 1,50,000 and security premium of? 50,000. It has decided to convert the partly paid equity shares into fully paid by applying bonus out of accumulated profit and free reserves. The bonus was declared at? 6 per share on the fully paid up capital. Pass necessary journal entries. Solution Journal Profit and Loss Reserve A/c To Bonus to Shareholders A/c (Declaration of bonus out of P&L and free reserves) Share Final Call A/c To Equity Share Capital A/c (Final call made on 1,00,000 per share) Bonus to Shareholders A/c To Share Final Call A/c (Utilisation of bonus) 2,00,000 1,00,000 3,00,000 3,00,000 3,00,000 3,00,000 3,00,000 Working Note: 1. Amount of bonus = 50,000 fully paid shares x 6 per share = Rs. 3,00, Amount required to convert 1,00,000 partly paid shares,? 7 paid up shares = 1,00,000 x 3 = Rs. 3,00, The required amount is utilised out of accumulated profit of Rs. 2,00,000 and Rs. 1,00,000 out of free reserves. Security premium cannot be utilised for the purpose. Example- 4 (Balance Sheet before Bonus Issue) Following is the B/S of A Ltd as on : Liabilities Assets Share Capital Sundry Assets 10,00,000 5,000 shares of Rs.100 each, Rs. 60 paid 3,00,000 Security Premium 40,000 Reserve 2,70,000 Profit and Loss 1,25,000 Sundry Creditors 2,65, ,00,000 10,00,000 ======= ======= Page 80

82 The company resolves to distribute f 1,50,000 as bonus to be utilised in paying up a call of? 30 per share. Minimum reduction is to be made from free reserves. Working Note: 1. Since the shares are partly paid, bonus issue cannot be made unless they are made fully paid by making a final call of Rs.40 per share. 2. Out of the call of Rs.40 bonus issue is only to the extent of Rs. 30. The balance of the amount Rs.50,000 (i.e., 10 x 5,000) is assumed to be received in cash. 3. Since minimum reduction is to be made from the free reserves, it is assumed that entire balance of profit and loss is utilised. 4. Security premium cannot be utilised for the purpose. Stock Split A share is generally split when it has a high price. Such a share is called a heavy share. This high price may discourage small investors. Generally, retail investors prefer to buy larger number of low priced shares. It is in this situation its shares. Stock splitisjhe process of rgducingjhe face value of the share (or stock) of a company by dividing one share into two or more parts. For example, if a stock has a face value Rs. 10, a two forone stock split will mean that there will be twice the number if shares as before with a face value of Rs. 5 each for the new share. RIGHT SHARES OR RIGHT ISSUES ' According to Section 62(1) of the Companies Act, 2013 when the company wants to increase the subscribed capital by issue of further shares, such shares must be issued first of all to existing shareholders in proportion of their existing shareholding. These shares are called Right Shares, Meaning of Right Shares or Right Issues In case a company wants to make a further issue of shares, the issue must first be offered to the existing equity shareholders. Thus, an issue of shares in which existing shareholders have a preemptive right to subscribe for the new shares is called 'Right Issue'. Advantages of Right Issue Advantages to companies a) Issue costs are lower, b) Issue is made at the direction of the directors, c) It improves the image of the company, d) Raising capital is more certain than in the case of public issue. e) Difference between Right Issue and Public Issue Right Issue Public Issue 1. A right issue is made to existing share holders 1. A public Issue is made to the public at large. 2. The floatation cost is low The price is much less than the existing market price. 3. The price is generally lower than the expected market price. The floatation cost Is high. Page 81

83 PRACTICAL PROBLEMS Illustration 1 Following are the extracts from the draft B/S of Ram Ltd. as on : Authorised capital: Rs. 2,00,000 Equity shares of Rs. 10 each Issued and subscribed capital: 50,000 Equity shares of Rs. 10 each ' Reserve fund P/L Account 20,00,000 5,00,000 1,00,000 80,000 A resolution was passed declaring the issue of bonus shares of 20% on equity shares, to be provided as to f 60,000 out of P/L Account and 40,000 out of Reserve Fund. The bonus shares were to be satisfied by issuing fully paid equity shares. Write the journal entries and show how they would affect the Balance Sheet. Solution Journal 2018 Reserve Fund A/c Rs. Rs. March 31 Profit or Loss To Bonus to Shareholders A/c (Declaration of 20% on equity shares) Bonus to Shareholders A/c To Equity Share Capital A/c (Issue of 1,000 bonus shares) Balance Sheet (extracts) Particulars 40,000 60,000 1,00,000 1,00,000 1,00,000 Rs. Note No. Equity & Liabilities Equity Share Capital: 60,000 shares of? 10 each fully paid Reserve fund (1,00,000-40,000) Profit and Loss A/c (80,000-60,000) 1 6,00,000 60,000 20,000 Notes to Accounts Note No. Particulars Amount Rs. 1 Share Capital Authorised Capital 20,00, ,000 Equity shares of Rs.10 each Issued and Subscribed capital 60,000 Equity Shares of Rs.10 each fully paid 6,00,000 (Of the above shares, 10,000 shares are allotted as fully paid up by way of bonus shares out of Reserve Fund and P/L a/c) Page 82

84 QUESTIONS FOR PRACTICE A. Objective Type Questions Fill in the blanks... shares are those shares which are issued free of cost to the existing shareholders shares are always fully paid Generally a company issues... shares when the market price of shares is higher than issue price. Illustration 5 X Ltd, decided to make a right issue to existing shareholders in proportion of 3 shares for every 4 held. Issue price per share is Rs. 150 and Market Price at the time of right issue is Rs.200. Calculate the Value of Right. Solution Value of Right is calculated as below: No. of New or Right Shares x (Market price - Issue price) Total No. of all Shares (i.e., Fresh + Existing Shares) Value of right = 3 x ( ) = Rs or Value of right = Market Price - Average Price Market price of existing shares + Issue price of proportionate right issue Average price of share = Total No. of Shares 4 x x = f Value of right = llustration 6 A Ltd. has offered right issue to its existing shareholders. The existing share capital of the company is Rs. 25,00,000. The market price of its share is Rs. 21. The company offers to its shareholders the right to buy 2 shares at Rs.5.50 each for every 5 shares held. You are required to calculate: i) Theoretical market price after rights issue ii) The value of right iii) Percentage increase in share capital Solution Average price or theoretical market price after right issue is calculated as below: Page 83

85 B. Short Answer Type 1. What is cash bonus? 2. What is capital bonus? 3. -'Define bonus share What are free reserves? 5. What is stock split? 6. What are right shares? 7. What is value of right? C. Short Essay Type 1. What are the different sources of bonus issues? 2. Define bonus shares. Distinguish between bonus shares and right shares. 3. What are the advantages of issuing bonus shares? 4. What are the restrictions regarding the bonus issue in India? 5. How will you calculate value of right? 6. What are the advantages of right issue? Page 84

86 REDEMPTION OF PREFERENCE SHARES A company limited by shares may (if so authorised by its Articles) issue preference shares which are liable to be redeemed within a period not exceeding 20 years from the date of their issue. Redeemable preference shares are those shares which are repayable after a fixed period or earlier at the discretion of the company. Section 55(i) of the Companies Act, 2013 prohibits the issue of any preference share that is irredeemable. Redemption of Preference Shares Redemption means repayment of capital. Thus, redemption of preference share means repayment of preference share capital to the preference shareholders. Condition of Redemption of Preference Shares According to Section 55 of the Companies Act, 2013, a company limited by shares, If authorised by its Articles, can redeem the preference shares, subject to the following conditions: 1. The shares to be redeemed must be fully paid up. 2. The shares should redeemed either out of profits of the company available for distribution as dividend or out of the proceeds of fresh issue of shares made for the purpose of redempe6n. 3. Any premium payable on redemption must be provided out of the profits of the company or out of the company s security premium account (from fresh issue r existing balance). Generally, It is provided out of security premium, if there is existing security premium or premium on fresh issue. 4. Where any such shares are redeemed out of profits available for dividend, an amount equal to the nominal value of shares to be redeemed must be transferred out of the divisible profits to Capital Redemption Reserve Account 5. The capital redemption reserve account can be utilised only for the issue of fully paid up bonus shares. This means that partly paid up shares cannot be made fully paid up out of Capital Redemption Reserve A/c. Methods of Redemption There are three methods of redemption of preference shares. They are: (a) Redemption out of fresh issue of shares. (b) Redemption out of Profits. (c) Redemption partly out of fresh issue and partly out of profit. Accounting procedure For solving problems, the following procedure is to be followed: 1. First see whether the redeemable preference shares are fully paid up or partly paid up. If they are partly paid up, pass the following journal entries to make them fully paid. (a) Preference Share Final Call A/c Dr To Preference Share Capital A/c (b) Bank A/c Page 85

87 To Preference Share Final Call A/c 2. Make journal entry for fresh issue of shares when company issues new shares: (a) At Par Bank A/c To Share Capital A/c (b) At Premium Bank A/c To Share Capital A/c To Security Premium A/c (c) At Discount Bank A/c Discount on Issue of Share A/c To Share Capital A/c 3. Write journal entry for redemption of preference shares (a) When Redemption is at Par Redeemable Preference Share Capital A/c To Preference Shareholders A/c (For transferring the capital to preference shareholders) Preference Shareholders A/c Dr To Bank A/c (For paying the amount due to preference shareholders) (b) When Redemption is at Premium Security Premium A/c / Profit and Loss A/c To Premium on Redemption of Preference Shares A/c / (For providing premium on redemption out of security premium or profit and loss) Redeemable Preference Share Capital A/c Premium on Redemption of Preference Share A/c To Preference Shareholders A/c (For transferring the capital and premium to preference shareholders) Preference Shareholders A/c To Bank A/c (For paying the amount due to preference shareholders) Note: If the preference shares are redeemed at a premium, such premium on redemption is provided out of Security Premium Account (existing or fresh issue) or Profit and Loss or General Reserve. Example - 1 (Fresh Issue of Shares at Par and Redemption, at Par) A Ltd had 10,000, 8% redeemable preference shares of Rs. 100 each, fully paid up. The company decided to redeem these preference shares at par by issue of sufficient number of equity shares of Rs. 10 each fully paid at par. Write journal entries in the books of the company. Page 86

88 Solution Working Note: Face value of share to be redeemed (10,000 x 100) = 10,00,000 Proceeds per new share = Rs. 10 No.of shares to be issued = 10,00,000 = 1,00,000 shares 10 Example -2 (Fresh Issue of Shares at Premium and Redemption at Par) B Ltd had 3,000, 9% preference shares of f 200 each fully paid up. The company decided to redeem these preference shares at par, by issue of sufficient number of ordinary shares of f 25 each at a premium of? 2 per share as fully paid. Write journal entries in the books of the company. Working Note: Value of shares to be redeemed (3,000 x 200) = 6,00,000 Proceeds per new share = Rs No.of shares to be issued = 6,00,000 = 24,000 shares 25 Example - 3 (Fresh Issue of Shares at Discount and Redemption at Par) C Ltd had 9,000,8% Redeemable Preference Shares of 20 each, fully paid up. The company decided to redeem these shares by issue of sufficient No. of equity shares of Rs.10 each fully paid at 10% discount. Pass necessary journal entries in company s book. Working Note: Value of shares to be redeemed (9,000 x 20) = Rs. 1,80,000 When shares are issued at discount, the proceeds must be sufficient to cover the face value of preference shares to be redeemed, i.e., Rs. 1,80,000. Proceeds per new share = 10-10% = Rs. 9 No.of Shares = " 1,80,000 = 20,000 shares 9 or 1,80,000 x 100 = 2,00,000 = 20,000 shares Redemption of Partly Paid up Shares If the preference shares are partly paid, they will have to be made fully paid before redemption. The journal entries have already been given. Page 87

89 In case there are two categories of redeemable preference shares (one fully paid \and another partly paid) and there is no instruction regarding redemption, only fully /paid preference shares may be redeemed. Sometimes there are calls in arrears in case of redeemable preference shares. In. such a case, it is necessary to follow the instructions given in the question. If nothing is mentioned in the question, there are two options. They are: (a) Preference shares having calls in arrears should not be redeemed, (b) It is presumed that calls in arrears are collected and all the preference shares are redeemed. Note: Students are advised to give the assumption on which the problem is solved, by way of a note. Example - 5 (Partly Paid up Shares) E Ltd had 8,000,8% redeemable preference shares of X 25 each, f 20 called up. The company decided to redeem the preference shares at 5% premium by the issue of sufficient number of equity shares of f 10 each fully paid up at a premium of 10%. Pass journal entries relating to redemption In the Books of E Ltd. Journal Preference Shares Final Call A/c To 8% Redeemable Preference Share Capital A/c (Preference share final call due on 8,000 shares at? 5 each to make the shares fully paid up) 40,000 Bank A/c To Preference Share Final Call A/c (Final call money received on 8,000 shares) 40,000 Bank A/c (20,000 x 11) To Equity Share Capital A/c " Security Premium A/c (Issue of 20,000 shares of? 10 each at 10% premium for the purpose of redemption) 2,20,000 40,000 40,000 2,00,000 20,000 Security Premium A/c 10,000 To Premium on Redemption A/c (Provided premium on redemp. at 5% out of security premium A/c) 8% Redeemable Preference Share Capital A/c Premium on Redemption A/c To Preference Shareholders A/c (Amount including redemption premium due to preference shareholders) Dr 2,00,000 10,000 Preference Shareholders A/c To Bank (Payment to preference shareholders) Dr 10,000 2,10,000 2,10,000 2,10,000 Page 88

90 Working Note: 1. Nominal value of shares to be redeemed (8,000 x 25): redemption 5% 10,000 Total amount required for redemption 2,00,000 Premium on 2,10, No.of Shares to be issued 2,00,000 = 20, 000 shares Security Premium = 10% of 2,00,000 or (20,000 x 1) = 20, Only face value of shares issued can be used for the redemption but not premium. The premium can be used for providing redemption premium. Redemption out of Profits Redeemable preference shares can be redeemed out of the divisible profits. Divisible profits for dividend. The examples of divisible or undistributed profits include general reserve, reserve fund, dividend equalisation reserve, investment fluctuation reserve, insurance fund, workmen's compensation fund, workmen's accident fund, debenture redemption reserve, reserve for contingencies, any other revenue reserve, profit and loss account balance etc. In the case of shares so redeemed should be transferred from divisible profits to Capital Redemption Reseive Account. Reasons for Creating CRR CRR is created for the following reasons : 1) Capital maintenance: The important purpose of creating CRR is to maintain the capital intact. By creating CRR, it is possible to protect capital structure and components of capital as it is. If much variation is taking place in components and volume of capital, business activities would be reduced. This causes dissatisfaction among shareholders. 2) Safeguard of creditors: The other reason for creating CRR is to protect the interest of creditors. If CRR is not created, the directors may distribute the entire amount of profits by way of dividend. This will adversely affect the interest of creditors. Note: For calculating CRR, the premium on redemption and security premium are totally ignored. Accounting Treatment The following journal entries are required to be passed the books of the company. 1. When Shares are Redeemed at Par (a) On transfer to Capital Redemption Reserve Alc Profit and Loss A/c / General Reserve A/c To Capital Redemption Reserve A/c (b)(on the redemption of shares Preference Share Capital A/c To Preference Shareholders A/c (c) On Payment to Preference Shareholders Pref erence Shareholders A/c To Bank A/c Note: First see whether the preference shares are fully paid up or partly paid up. If the shares are partly paid up they must be made fully paid up. The journal entries have already been given. Page 89

91 3. When Shares are Redeemed at Premium a) Same entry as under 1 (a) above for transfer to Capital Redemption Reserve A/c from divisible profits. (b)on providing Premium Payable on Redemption Security Premium A/c / Profit & Loss A/c / Capital Reserve A/c To Premium on Redemption A/c (c) On making money due to preference shareholders Preference Share Capital A/c Premium on Redemption A/c To Preference Shareholders A/c (d) On payment to Shareholders Same entry as under 1(c) above Example - 6 (Redemption out of Profits) The following extract from the B/S of Sun Ltd as at , is given to you: Share Capital R S. 10,000 Equity Shares of RS. 10 each 1,00,000 10,000 8% Preference Shares of F 10 each 1,00,000 Capital Reserve. 50,000 General Reserve 30,000 Profit & Loss 85,000 The company exercises its option to redeem the preference shares on 1st January Give journal entries to record the redemption. Redemption out of Fresh Issue of Shares and Profits This is the most practical method of redemption. Under this method the company can redeem the preference shares partly from the fresh issue of shares and partly out of revenue profits (undistributed profits). Steps ' " 1. Determine the amount payable on redemption of preference shares. 2. Decide the amount of fresh issue of shares to be made (i.e., the portion of redemption out of fresh issue). 3. Ascertain the amount to be transferred to Capital Redemption Reserve A/c out of revenue profits (i.e., the portion of redemption out of profit). It can be ascertained in the following manner: Rs. Face value of shares redeemed xxxx Less: Proceeds from fresh issue of share xxx.'. Redemption out of profits (i.e., the amount to be transferred to C.R.R. A/c xxx 4. If proceeds to be collected from fresh issue is not decided, it can be ascertained as follows: Face value of shares redeemed xxxx Less: Redemption out of profits (known) xxx.'. Proceeds to be collected from fresh issue xxx Page 90

92 Note: If nothing is mentioned specially in the question regarding the fund (proceeds) v/ out of which redeemable preference shares have to be redeemed, students should always assume that the redemption has to be made out of profits. Example - 8 (Combination of fresh issue and profit) X Ltd has a part of its share capital in 1000 Redeemable Preference Shares of Rs. 100 each. The shares have now become due for redemption. It has been discovered that the company's Reserve Fund amounts to Rs. 75,000, Rs. 50,000 out of which has been decided to be utilised in connection with the redemption, the balance being met out of a fresh issue of sufficient number of equity shares of Rs. 20 each fully paid. You are requested to give the journal entries recording the above transactions. Working Note: 1. Value of preference shares to be redeemed (1,000 x 100) 2. 1,00,000 50, ,000 Redemption out of profit Redemption out of fresh issue (balance) Value per share X 20 each No.of shares to be issued = 50,000 = 2,500 shares PRACTICAL PROBLEMS Ltd company has part of its share capital in 1,000 8% Redeemable Preference shares of? 100 each. The shares have now become ready for redemption. It is decided that the whole amount will be redeemed out of fresh issue of equal amount of equity of shares of f 10 each. Show the necessary journal entries in the company's books. Illustration- 2 A. Ltd. has a part of its share capital in 1,000 7% redeemable preference shares of? 100 each. These are now redeemable out of the accumulated reserve of? 1,50,000. 7% Redeemable Preference Share Capital A/c 1,00,000 1,00,000 To Preference Shareholders A/c (Amount due to preference shareholder) Preference Shareholders A/c 1,00,000 1,00,000 (Payment made to preference shareholders) Illustration. 3 the entries in the journal of the company Show A Ltd. issued 50,000 Equity shares of X10 each and 3,00010% Preference shares of?100 each, all shares being fully called up and paid up. On Profit & Loss A/c showed an undistributed profit of X 50,000 and General Reserve Account stood at X 1,20,000. On the Directors decided to issue 1,500 11% Preference Shares of X100 each for cash Page 91

93 and to redeem the existing Preference Shares at X 105 utilising as much profits as would be required for the purpose. Show the Journal entries to record these transactions. Prepare also a summarised Balance Sheet showing the position of the company on completion of the redemption. On cash balance amounted to X 1,85,000 and Sundry Creditors stood at X 87,000. QUESTIONS FOR PRACTICE A. Objective Type Questions Fill in the blanks 1. Preference shares cannot be redeemed unless they are 2. Capital redemption reserve can be used to issue fully paid shares 3. At present, a company limited by shares cannot issue preference shares which are No company limited by shares shall issue any preference share which is redeemable after the expiry of years from the date of issue 5. Any premium payable on the redemption of preference shares must be from the......account or from the divisible profits of the company. 6. The face value of preference shares redeemed from revenue reserve is transferred to Divisible profit means that which would otherwise be available for When a fresh issue of shares brought out for the purpose of redemption of preference shares, it does not amount to All the profits are not available for the purpose of redemption of preference shares._ ^ Ans: 1-fully paid up, 2-bonus, 3-irredeemable, 4-twenty, 5-security premium, 6-capital redemption reserve, 7-dividend, 8-increase, 9-capital Choose the correct answer 1. Capital redemption reserve is created (a) out of security premium account, (b) out of share forfeited account, (c) to meet legal requirements, (d) voluntarily. 2. Capital redemption reserve account can be utilised for (a) writing off capital losses, (b) writing off past losses, (c) issuing partly paid bonus shares, (d) issuing fully paid bonus shares. 3. When preference shares are redeemed, it amounts to (a) increase in share capital, (b) decrease in share capital (c) both (a) and (b), (d) none of these. 4. Amount due to untraceable share holder may be (a) transferred to P/L account, (b) kept as general reserve, (c) transferred to CRR, (d) shown as current liability in the balance sheet. 5. Profit not available for dividend includes (a) CRR, (b) P/L A/c. credit balance, (c) Security premium, (d) share forfeited account 6. Redeemable preference shares can be redeemed by (a) selling investment (b) borrowing funds from bank (c) issue of debentures (d) issue of shares. Page 92

94 7. Profit available for dividend excludes (a) P/L A/c, (b) general reserve, (c) share forfeited account (d) dividend equalisation reserve. Ans: 1 - c, 2 - c, 3 - d, 4 - d, 5 - b, 6 - d, 7 - c Short Answer Type C Define redeemable preference shares What is divisible profit? What js capital redemption reserve account? C. Short Answer Type What are the conditions to be fulfilled under the Companies Act for the redemption... of preference shares? What is divisible profit? What is not considered as divisible profit? What is capital redemption reserve account? How is it created and how is it utilised? What is capital redemption reserve account? What is the logic of creation of capital redemption reserve? Discuss the various methods of redemption of preference share. Explain the accounting procedure on redemption of preference share Problems 1. Hindustan Construction Company Ltd, had 5,000 8% Redeemable Preference Shares of f 100 each, fully paid up. The company decided to redeem these preference shares at par by the issue of sufficient number of equity shares of? 10 each fully paid up at par. You are required to pass necessary journal entries including cash transactions in the books of the company. 2. The issued and paid-up capital of XY Ltd. included 2,000,8% Preference shares of Rs.100 each. The company decided to redeem the Preference shares at par. You are required to give journal entries separately in the following cases: (a) When the shares are redeemed out of profits. (b) When the shares are redeemed out of proceeds of new issue of Equity Shares of? 10 each at par, 3. A B C Ltd. has issued 10,000 equity shares of Rs.100 each fully paid and 6,000 redeemable preference shares of Rs.100 each fully paid. On 31st Dec the Profit and Loss Statement showed undistributed profit of Rs.50,000 and the General Reserve A/c stood at Rs.2,80,00. On , the directors decided to issue 3000, 6% preference shares of Rs.100 each at 20% premium- and to redeem the existing redeemable preference shares at Rs.110 utilising as less profit as possible for the purpose. Pass necessary journal entries to record the above transaction. There was a bank balance of Rs. 4,00,000 on that date. (Amount transferred to C.R.R A/c? 3,00,000) 4. A Ltd. had issued 50,000 redeemable preference shares of Rs.10 each, Rs.8 paid. In order to redeem these shares now being redeemable, the company issued for cash 30,000 equity shares of Rs. 10 each at a premium of Rs.2 per share. Out of the cash proceeds, the redeemable preference shares were paid and the balance was met out of the reserve fund which stood at Rs. 2,50,000. Show the journal entries in the books of the company. Page 93

95 REDEMPTION OF DEBENTURES Companies are allowed to issue only redeemable debentures. Redeemable debentures are redeemed either at the expiry of the period of debentures or before the expiry. Meaning of Redemption of Debentures Redemption of debentures simply means repayment of debentures. It is the discharging of the liability on account of debentures. They may be redeemed at par or at premium. Methods of Redeeming Debentures Following are some of the important methods of redeeming debentures: 1. Drawing lots (Lottery) and redeeming by instalment (Redemption by annual drawings). 2. Redemption by payment in lumpsum after a specified date. 3. By converting debentures into new shares / debentures. 4. By purchase of own debentures in the open market. Sources of Redemption of Debentures The various sources out of which the debentures may be redeemed are: 1. Redemption out of fresh issue 2. Redemption out of capital 3. Redemption out of profit 4. Redemption by sinking fund or insurance policy fund Redemption by Periodical Drawings Under this method a certain portion of the debentures are redeemed periodically. This means that the debentures are redeemed in instalments. This method is also called "Lottery Method" of redeeming debentures (i.e., drawing by lots). The following journal entries are passed when debentures are redeemed and interest is paid. (a) Debentures A/c To Debenture holders A/c (Amount due to debenture holders) Debenture holders A/c To Bank A/c (Payment to debentureholders) (b) Interest on Debentures A/c To Bank A/c (Payment of interest on debentures) These entries will continue as long as debentures are repaid and the interest is paid regularly on the balance of debentures. Redemption in Lumpsum after a Specified Date Sometimes debentures will not be redeemed in instalments. Instead, they will be redeemed in one lumpsum after a certain period. They may be redeemed at; par or at premium according to the terms of issue. The following journal entries are passed when debentures are redeemed and interest is paid: (a) When debentures are redeemed at par Debentures A/c To Debenture holders A/c (Amount due to debentureholders) Page 94

96 Debentureholders A/c debentureholders) (b) To Bank A/c (Payment to When debentures are redeemed at premium Debentures A/c Dr Premium on Redemption A/c To Debentureholders A/c (Amount due to debentureholders, including premium) Security Premium/ General Reserve/ P/L To Premium on Redemption A/c (Premium on redemption provided out of security premium or general reserve or P/L) Debenture holders A/c To Bank A/c (Payment due to debenture holders). Note: The above entries are given on the assumption that the premium on redemption has not been provided at the time of issue. Redemption out of the Proceeds of Fresh Issue A company may issue new shares or new debentures or both for redeeming its existing debentures. In such cases, the working capital of the company is not at all affected. The only change is that new share capital or debentures take place in the place of the old debentures. It may be noted that when debentures are redeemed out of the fresh issue, there is no need to create debenture redemption reserve. Example 5 Rani Ltd. had 10%, 5,000 debentures of X 100 each due for redemption on The debenture trust deed provided that the company may redeem the debentures at a premium of 5% at any time before maturity. The directors decided to exercise this option and issued 40,000 equity shares of X 10 each at 10% premium and 1,000 9% debentures of f 100 each at par for the purpose of redemption. Write journal entries. Solution Journal 10% Debentures A/c Premium on Redemption A/c 5,00,000 To Debenture holders A/c (10% debentures due for 25,000 redemption) 5,25,000 Bank A/c 4,40,000 To Equity Share Capital A/c 4,00,000 To Security Premium A/c (Issue of 40,000 equity shares of 40,000 Rs.10 each at 10% premium for the purpose of redemption). Bank A/c 1,00,000 To 9% Debentures A/c 1,00,000 (Issue of 1,000 debentures of f 100 each for the purpose of redemption). Security Premium A/c 25,000 Page 95

97 To Premium on Redemption A/c (Premium on redemption provided out of security premium) Debenture holders A/c To Bank A/c 25,000 5,25,000 5,25,000 (Payment due to debenture holders). Note: It is assumed that the premium on redemption has not been provided at the time of issue. Redemption out of Capital If profits are not utilized to redeem debentures, debentures are said to be redeemed. out of capital. Thus, when, at the time of redemption, adequate profits are not transferred to Debenture Redemption Reserve A/c, such type of redemption is called redemption out of capital. Since the profits are not utilized for the redemption of debentures, the assets of the company are reduced by the amount paid. This would affect the working capital of the company. Redemption out of Profit When sufficient profits are transferred from Statement of Profit and Loss to the Debenture Redemption Reserve Account at the time of redemption of debentures, such redemption is said to be out of profits. This Is called redemption out of profit because it reduces the amount of profit available for dividend. The amount thus saved because of non payment of dividends is utilized for the redemption of debentures. Companies Act, 2013, requires every company to create debenture redemption reserve (DRR) every year with sufficient amount out of its profits, until such debentures are redeemed. However, the Act does not specify the percentage or amount to be transferred to DRR. As per the guidelines issued by SEBI, a company which wants to redeem debentures out of profit should transfer an amount equal to 50% of the amount of debentures issued to 'Debenture Redemption Reserve7, before the commencement of redemption of debentures (if the debentures are for a period of more than 18 months). This provision is applicable only in case of non-convertible debentures or for non-convertible portion of partly convertible debentures. When an amount equal to 50% of the amount of debentures is transferred to DRR A/c, it means that 50% of debentures is redeemed out of capital. Infrastructure companies and company issuing debentures with maturity not more than 18 months are exempted from the guidelines of SEBI. But as per Companies Act, all companies should create DRR. The following journal entries are required: (1) On creation of DRR Profit or Loss To Debenture Redemption Reserve A/c On Debentures becoming due (a) If redeemed at par: Debentures A/c (with nominal value) To Debenture holders A/c (b) If redeemed at a Premium: Page 96

98 Note: As per SEBI guidelines, creation of DRR (before redemption commences) iscompulsory for debentures with maturity period of more than 18 months. This means that DRR is not compulsory for debentures with maturity period of 18 months or less. The debenture redemption reserve is shown in "Equity and Liabilities"' under the head 'Other Equity' (i.e., Reserves and Surplus) in the Balance Sheet. On the completion of redemption of all debentures, the debenture redemption reserve account is closed by transferring it to general reserve. The journal entry is: Debenture Redemption Reserve A/c To General Reserve A/c Difference between Debenture Redemption Fund and Debenture Redemption Reserve If the amount appropriated from profit is invested outside the business for the purpose of redemption, it is known as 'Debenture Redemption Fund7. If it is retained in the business (i.e., invested in the business itself), it is known as Debenture Redemption Reserve. Example 6 A Ltd. issued 10,000,8% Debentures of? 10 each on April 1,2017 redeemable at par on June 30, Applications were received for 12,000 debentures and the allotment was made to all applicants on pro-rata basis. The debentures are redeemed on due date. How much reserve is to be created before redemption is carried out? Record necessary journal entries regarding issue and redemption. Date Particulars LF Amount Amount 2017 Bank A/c 1,20,000 Apr.l To Debenture Application A/c (Application money 1,20,000 received on 12, each) Debentures Application A/c 1,20,000 To 8% Debenture 1,00,000 To Bank A/c 20,000 (Transfer of application money and refund of excess application money) 2018 Profit or Loss 1,00,000 Jun30 To Debenture Redemption Reserve A/c (Creation of DRR) 1,00,000 8% Debentures A/c 1,00,000 To Debentureholders A/c (Amount due to 1,00,000 debentureholders as per redem.) Debentureholders A/c 1,00,000 To Bank (Payment to debentureholders) 1,00,000 Debenture Redemption Reserve A/c 1,00,000 To General Reserve A/c -ffransfer of DRR to GR) 1,00,000 Note: (1) DRR has not been created before the commencement of redemption because debentures were issued for a period of less than 18 months (as per SEBI guidelines). Here an amount equal to the nominal value of debentures to be redeemed has been transferred from Statement of Profit or Loss to DRR. This is done as per Companies ' Act. Since the whole Page 97

99 amounts of debentures are redeemed on maturity, DRR has been created for full amount. (2) Entries relating to interest on debentures have been ignored. Example 7 A Ltd has issued 15,000 debentures of f 100 each payable full on application on Applications were received for 12,000 debentures. The terms of redemption provide that onethird of the debentures are redeemable every six months. Write necessary journal entries. Date Particulars Debit Credit Amount? Amount? 2016 Bank A/c 12,00,000 Oct.l To 8% Debentures (Issue of 12,000, 8% 12,00,000 debentures of? 100 each) 2017 Profit or Loss 4,00,000 Mar.3 To DRR A/c (Transfer of amount equal to 4,00,000 1 debentures to be redeemed to DRR) 8% Debentures A/c 4,00,000 To Debentureholders A/c 4,00,000 (Amount due to debentureholders) Debentureholders A/c 4,00,000 To Bank A/c 4,00,000 (Payment to debentureholders) jm.7 8% Debentures A/c 4,00,000 Sep.30 To Debentureholders A/c (Amount due to 4,00,000 debentureholders) Debentureholders A/c 4,00,000 To Bank A/c 4,00,000 (Payment to debentureholders) 2018 Profit or Loss 8,00,000 Mar31 To DRR A/c (DRR created out of profit) 8,00,000 8% Debentures A/c 4,00,000 To Debentureholders A/c 4,00,000 (Amount due to debentureholders) Date 2016 April Particulars Debit Amt. T Bank A/c 11,00,000 To 8% Debentures A/c To Security Premium A/c (Issue of 1,00,000 debentures of? 10 each at 10% premium) 2017,. -Interest A/c 80,000 -Mar31 To Debentureholders A/c (Interest due to debentureholders) Debentureholders A/c 80,000 Credit Amt? 10,00,000 1,00,000 80,000 Page 98

100 To Bank A/c 80,000 (Payment of interest) Profit or Loss 80,000 To Interest A/c 80,000 (Interest written off to P/L) Note: (1) It is assumed that the "Premium payable on redemption" has been provided at the time of issue. (2) The amount of debentures issued and period of maturity are not known. Hence, DRR cannot be created as per SEBI guidelines; redemption by Sinking Fund Debentures may be redeemed by creating a sinking fund. Under this method of redemption, every year a part of the profit (fixed installment) is set aside and sinking fund is created. The sinking fund (also called debenture redemption fund) is invested, in outside securities (like shares, debentures, bonds of other companies or corporations). The interest received on such investments along with annual amount set aside from profit will again be invested as usual. This process continues till the date of redemption of debentures. The investment will be sold and the cash thus received will be used to repay the debentures. The working capital of the company will not be affected as the cash is separately made available for redemption. Under this method of redemption sinking fund account, and sinking fund investment account will be opened. After the debentures have been redeemed, the balance of sinking fund account is transferred to general reserve. Merits of Sinking Fund Method The chief merits of sinking fund method are: (i) As the funds required for redemption accumulates outside the business, liquid cash is available at the time of redemption. Hence debentures can be repaid without disturbing the financial position of the company. (ii) In the interim period, the security may be pledged or sold out to get liquid cash in case of any emergency. Demerits of Sinking Fund Method The demerits of the method are: (i) There may be losses in realising the investments. (ii) The rate of returns on investments may be less than the earning rate of the business. (iii) As a part of the profit is set aside for creating a sinking fund, shareholders get a comparatively low rate of dividend during the currency of debentures. Demerits of Sinking Fund Method The demerits of the method are: (i) There may be losses in realising the investments. (ii) The rate of returns on investments may be less than the earning rate of the business. Page 99

101 (iii) As a part of the profit is set aside for creating a sinking fund, shareholders get a comparatively low rate of dividend during the currency of debentures. Accounting Entries The journal entries which are required to be passed under sinking fund method are summarised as follows: I. At the end of the First Year (1) When annual amount is set aside Profit or Loss To Sinking Fund/Debenture Redemption Fund A/c (2) When Sinking Fund is invested Sinking Fund Investment or Debenture Redemption Fund Investment A/c To Bank A/c IL At the end of Second and Subsequent Year (3) For receiving interest on investment Bank A/c To Interest on Sinking Fund Investment A/c (4) For transferring the interest to Sinking Fund Interest on Sinking Fund Investment A/c To Sinking Fund A/c (5) For setting aside the amount of profit Profit or Loss To Sinking Fund A/c (6) When Sinking Fund along with interest is invested Sinking Fund Investment A/c To Bank A/c III. At the end of Last Year, (7) For receiving interest on investment Bank A/c To Interest on Sinking Fund Investment A/c (8) For transferring the interest to Sinking Fund Interest on Sinking Fund Investment A/c To Sinking Fund A/c (9) For setting aside the amount of profit Profit or Loss To Sinking Fund A/c (10) For sale of investment Bank A/c Page 100

102 To Sinking Fund Investment A/c (with the sale proceeds) (11) For transferring profit on sale of investment Sinking Fund Investment A/c To Sinking Fund A/c In case of loss, the above entry will be reversed. IV. For Redemption (For Making due (a) If debentures are to be redeemed at par: Debentures A/c To Debentureholders A/c (b) If debentures are to be redeemed at Premium: Debentures A/c Premium on Redemption A/c To Debentureholders A/c (13) For making payment Debentureholders A/c To Bank A/c (14) For transferring the balance in Sinking Fund Sinking Fund A/c To General Reserve A/c Points to Remember As per SEBI guidelines, it is compulsory to create sinking fund, i.e., Debenture Redemption Reserve equivalent to 50% of the debenture issue. A company can create the reserve more than this minimum amount if it so desires. Sinking Fund Investment A/c should always be shown at cost. However, a separate column may be prepared to show the nominal value of investments made in securities, if so desired. Interest on investment is calculated on the opening balance of nominal value of investments and not on the cost of investments. Technically, the exact amount set aside will be invested. Therefore, the balance of Sinking Fund A/c and Sinking Fund Investment A/c will be exactly the same. But in practice, the amount may be invested in the multiple of ^ 10 or ^ 100. In that case, investment will be in multiple of ^ 10 or ^ 100 as the case may be. But amount invested should not be less than the amount set aside. In the last year, annual instalment set aside together with interest will not be invested. This is because there is no meaning in making investment in the last year and then immediately realising the same. Debenture Redemption Fund A/c shall appear under equity and liabilities in the sub head 'Reserves and Surplus' till the redemption. Page 101

103 7. Debenture Redemption Fund Investment A/c shall appear under assets in the B/S under the sub head "Investments" till redemption. 8. The amount to be set aside from the profit is ascertained with reference to "Sinking Fund Tables" 9. The amount of profit to be set aside is to be calculated as follows: (a) If the Debentures are to be redeemed at par Nominal Value of Debentures to be redeemed x Present value of f 1 for given number of years at a given rate of interest Example 10 The 1,000 9% Debentures of? 100 each issued at par are to be redeemed after 4 years. Investments are expected to realise 12% p.a. The table shows that? ^invested at the end of each year at 12% compound interest will amount to ^ 1 at the end of 4 years and? 1 p.a at 12% interest amounts to T in 4 years. Calculate the amount to be set aside annually from profit: (a) if Debentures are repayable at par, (b) if Debentures are repayable at 10% premium. Solution (a) If Debentures are Redeemable at par : Amount of profit to set aside 1,00,000 x = Rs. 20, or Rs. 1,00,000 / = Rs. 20, (b) If Debentures are Redeemable at 10% premium Amount to be set aside = (1,00, ,000) x = Rs or 1,10,000 = 23, Example 11 On A Ltd issued? 1,00,000 8% Debentures of? 100 each at par redeemable in 5 years. The necessary funds for redemption are to be provided by v_jcfe1iting a sinking fund and having an annual investment to yield 5% compound interest. The sinking fund table shows that investment of? annually over 5 years fetches? 1 at 5%. Write necessary accounts and show the redemption of debentures. Solution The yearly amount of profit set aside = 1,00,000 x =f 18, Insurance Policy Method This is an alternative to Sinking Fund method. Under the Sinking Fund method, annual contribution is invested in outside securities. Under insurance policy method, an Page 102

104 insurance policy is purchased by paying annual premium. Such policy will mature on the date when the Debentures become redeemable. The total premium paid will amount to less than the policy amount, but the policy amount will be equal to the amount required for redemption. Thus the difference between the policy amount and premium paid will be interest on premiums (or profit on realisation of policy). This method: (a) provides funds for redemption, and (b) covers the risk involved in the transaction. The following journal entries are required to be passed: 1. During all the years till the maturity of the policy (a) For payment of premium at the beginning of the year. Debenture Redemption Policy A/c (with annual premium) To Bank A/c (b) For setting aside the amount of profit at the end of the year Profit and Loss Appropriation A/c (with the amount of profit set aside) To Debenture Redemption Fund A/c 2. (c) During the last year in addition to the above two entries For realising the policy amount Bank A/c (with the amount realised) To Debenture Redemption Policy A/c (d) (i) For the transfer of profit I loss, on the realisation of policy In case of profit Debenture Redemption Policy A/c To Debenture Redemption Fund A/c (ii) In case of loss - Reverse of the above entry (e) For making the amount due and for payment usual entries are to be passed. (f) The balance of Debenture Redemption Fund Ale will be transferred to general reserve by passing the following entry: Debenture Redemption Fund A/c To General Reserve A/c Page 103

105 Redemption by Conversion This is another method of redeeming debentures. Redemption by conversion means redeeming the debentures by converting them into new debentures and/or shares within a stipulated period at the option of the debentureholders. The new shares or debentures may be issued either at par, or at a premium or at a discount. At the time of conversion, the following entries are to be passed: 1. Old Debentures A/c Premium on Redemption of Debentures A/c (If redeemed at premium) To Debentureholders A/c (To close the old debentures) 2. (i) Debenture holders A/c Discount on issue of Deb/Shares A/c (If new debentures/shares at discount) To New Debentures/Share Capital A/c (Issue of new shares / debentures at discount) (ii) Debentureholders A/c To New Debentures/Share Capital A/c To Securities Premium A/c (If new debentures/shares at premium) (Issue of new shares / debentures at premium) In this connection, it is essential that if the debentures to be converted were originally issued at a discount, the actual amount realised from them at the time of issue (and not the face value) is to be taken into consideration for determining the number of shares to be issued in exchange of the debentures to be converted. For example, if debentures of? 5,00,000 were originally issued at a discount of 10% and if such debentures are to be converted into shares, the paid up value of shares to be issued for conversion should not exceed T 4,50,000. If this rule is not applied, the provisions of the Companies Act would be violated. Example 13 A Ltd. had issued 2000,10% debentures of? 100 each at a discount of 10%. These debentures were given the option to convert their debentures into equity shares of? 100 each. The holders of 400 debentures out of the above exercised the option. Write journal entry for conversion if: (a) new equity shares are issued at par, (b) new equity shares are issued at 20% premium, and (c) new equity shares are issued at 10% discount. Solution (a) If new equity shares are issued at par The number of equity shares to be issued in lieu of debentures will be calculated as below: Page 104

106 Face value (nominal value) of debentures to be converted Less: Discount allowed on issue 10% 4,000 X40,000 Actual amount received on issue 36,000 The new shares to be issued = 36, = The journal entry for conversion is Debentures A/c To Equity share capital (360 x 100) 36,000 To Discount on issue of debentures 4,000 (b) 40,000 If new equity shares are issued at 20% premium The number of equity shares to be issued in lieu of debentures will be calculated as below: The new shares to be Issued = 36, = The journal entry for conversion is: Debentures A/c To Equity share capital (360 x 100) 40,000 30,000 To Security premium 6,000 To Discount on issue of debentures 4,000 (c) If new equity shares are issued at 10% discount The number of equity shares to be issued in lieu of debentures is calculated as below: The new shares to be Issued = 36, = The journal entry for conversion is: Debentures A/c 40,000 Discount on issue of equity shares 4,000 To Equity share capital (360 x 100) 40,000 To Discount on issue of debentures 4,000 Note: When the debentures which were originally issued at discount are converted into new shares, Discount on Issue of Debentures Account will be credited in the entry for conversion. Purchase of Debentures in the Open Market A company can buy Its own debentures if it is authorised by its Articles. A company purchases its own debentures from the open market when the price of debentures falls below the face value or redemption price. The debentures may be purchased either for (a) immediate Page 105

107 cancellation, or for (b) investment. Debentures when purchased for investment are popularly called Own Debentures. When a company purchases own debentures it will amount to redemption of debentures. This is because the old debentures are withdrawn or taken back from the debentureholders by paying them either at par or at premium. The purchase of debentures may be paid from sinking fund or out of profit or out of capital. The debentures purchased for investment may be cancelled or reissued later on when the market price is higher. When purchased for investment, the company steps into the shoes of the general investor, and the own debentures so purchased are treated like a normal investment. Therefore, it is shown under assets in the balance sheet. Redemption by purchase of debenture has the following advantages: The purchase is made when the market price of the debenture is the lowest. Hence, less amount is spent for their redemption (profit on cancellation or on redemption). This reduces the interest burden. This avoids to pay premium on redemption. 3. Purchase of Debentures for Immediate Cancellation A company may purchase its debentures for the purpose of immediate cancellation. This results in reduction of debenture liability to the extent of par value of debentures cancelled. Accounting Treatment The following journal entries are required to be passed: (a) When Debentures are purchased at par Debentures A/c (with nominal value) To Bank A/c (b) When Debentures are purchased at a discount Debentures A/c \ (with nominal value) To Bank A/c (with purchase price) To Profit on Purchase (or Redemption) of Deb. A/c (profit on purchase) 'Profit on redemption/purchase of debentures' is a capital profit. It should be used to write off any amount of capital loss given in the question such as, discount on Issue, premium on redemption etc. The balance will be transferred to capital reserve. The entry will be: Profit on Redemption of Debenture A/c To Capital Loss (if any) To Capital Reserve A/c, Page 106

108 Note: When there is sinking fund, the Profit on Redemption of Debentures A/c should be credited to Sinking Fund (and not to Capital Reserve A/c). (c) When Debentures are purchased at a premium If the purchase price of the debentures Is more than the face value, there will be a loss on the purchase/redemption of such debentures and the loss will be debited to 'Loss on Redemption of Debentures A/c'. Suppose, debentures of the face value of f 50,000 are purchased in the market at? 52,000, the entry will be: Debentures A/c 50,000 Loss on Redemption of Debentures A/c. 2,000 To Bank A/c. 52,000 'Loss on Redemption of Debentures A/c' (or Loss on Purchase of Debentures A/c) is a capital loss. Therefore, it is written off against capital profits (debit Capital Reserve/ Security Premium and credit Loss on Redemption of Debentures A/c). In the absence of capital profits, it is written off from Statement of Profit or Loss. Note: When there Is sinking fund, the Loss on Redemption of Debentures A/c should be debited to Sinking Fund A/c. It should be noted that when own debentures are purchased for immediate cancellation, debentures account should be debited with nominal or face value (and debentures will be cancelled). \ When, there is no sinking fund, an amount equal to the nominal value of the debentures cancelled.(redeemed) should be transferred to Debenture Redemption Reserve A/c. The entry is: Profit or Loss. To Debenture Redemption Reserve A/c Example 14 (Purchase of debentures for cancellation) A Ltd. purchased for cancellation 1,000 of its own 10% debentures of Rs. 100 each at Rs. 97. The cost of purchase amounted to Rs.200 (ignore interest). Give journal entries. Note; When there is no sinking fund, a sum equal to the cost of debentures purchased and cancelled should be transferred from Statement of Profit or Loss to Debenture Redemption. Ex-Interest and Cum-Interest Quotations Generally interest on debentures is paid on fixed dates, I.e., half yearly or yearly. However, the company can buy its own debentures from the open market at any time during the year. If a company purchases its own debentures on the date of payment of interest, there will be no Page 107

109 problem with regard to interest. This is because the interest accrued upto the date of purchase (i.e., on the date of payment of interest) will be payable to debentureholder. If the debentures are purchased before the due date of the interest payment, then the problem arises as to whether the price paid includes interest for the expired period or not. Sometimes, the price paid for debenture the expired period. Sometimes, the price paid does not include the interest for the expired period. Expired period means the period from the date of previous payment of interest upto the date of purchase. The interest portion included in the purchase price constitutes revenue and the balance is capital (actual cost of debentures). The price paid for the debentures depends on the type of quotation. There are two types of quotations - cuminterest quotation and ex-interest quotation. Cum-interest Quotation If the purchase price includes interest for the period from previous date of interest to the date of purchase, it is called cum interest price(cnm is a Latin word which means 'with' i.e., cumulative or inclusive of interest). It means the price paid by the company for the debentures includes the interest for the expired period also. Journal Entries S At the time of recording the purchase of own debentures, only the price paid towards the cost of debentures must be debited to the own debentures account. The interest must be debited to Interest account. (a) When the debentures are purchased Debentures A/c Interest on Debentures A/c for immediate (Nominal value cancellation: of debentures) (Interest for the expired period) To Bank (Amount paid) Profit on Redemption of Debentures (Profit on redemption) (b) When the debentures are purchased for holding as investment: Own Debentures A/c (Cost of debentures) Interest on Debentures A/c (Interest for the expired period) To Bank A/c (Amount paid) In this case, Own Debentures A/c should be debited with cost of debentures (and not nominal value of debentures). Cost of Own Debentures = Price paid - Interest for the expired period, Page 108

110 Note: When own debentures are purchased as Investment, there will be no profit or loss on redemption of debentures. Profit or loss on redemption will occur at the time of cancellation of debentures. (c). When own debentures Debentures A/c To Own Debentures A/c purchased for investment are cancelled in future Dr (Nominal value) (Cost, i.e., price paid minus Interest) To Profit on Redemption of Debentures (Balance) Ex-interest Quotation If the purchase price excludes the interest for the expired period, it is called Exinterest price ('Ex'is also a Latin word which means 'without', i.e., exclusive of interest). This means that the purchase price of debentures does not include the interest for the expired period. This further means that the purchaser (company) has to pay, in addition, the interest for the expired period. Thus, Cost of Own Debentures = Price paid Journal Entries (a) When debentures are purchased for immediate cancellation Debentures A/c (Nominal value of debentures) Interest on Debentures A/c (Interest for the expired period) To Bank A/c To Profit on Redemption of Debentures (Total amount paid, i.e., cost of debentures + interest) (Balancing figure) (b) When debentures are purchased as investment Own Debentures A/c (Cost of debentures, i.e., Price paid) Interest on Debentures A/c (Interest for the expired period) To Bank A/c (Total) (c) When own debentures purchased for investment are cancelled in future Debentures A/c Dr (Nominal Value) To Own Debentures A/c (Cost, i.e., Price Paid) To Profit on Redemption of Debentures (Balance) Note: Interest should be calculated from the last date of payment up to the date of purchase. If the price is ex-interest, the buyer (company) has to pay higher amount than under cum-interest quotation. When own debentures are cancelled the profit on cancellation would be more in the case of cum - interest than ex-interest quotation. Page 109

111 3. In case of Govt. Securities and debentures the price quoted is Ex- interest unless/otherwise stated and in respect of non-govt. Securities and debentures, it is /Cum interest unless otherwise stated. On 1st July 2016, a company issued 1000, 6% debentures of? 100 each (interest payable on 30th June and 31st December). The company is allowed to purchase own debentures which may be cancelled or kept or reissued at the company's option. The company made following purchases in the open marked for immediate cancellation. On 31st May 2017,100 debentures at? 98 ex-interest On 30th September 2018, 50 Solution Journal 2016 July 1 Dec May 31 June 30 Dec 31 Bank A/c To 6% Debentures A/c (Issue of 1000 debentures of?100 each at par) Interest on Debentures A/c To Bank A/c (Payment of interest on debentures) 6% Debentures A/c (100 x 100) Dr Interest on Debentures A/c(10,000 x 5/12 x 6/100) To Bank A/c (price paid +interest) To Profit on Redemption of Deb. A/c (100 x2) (Purchase of 100 debentures ex-interest for cancellation) Interest on Debentures A/c To Bank A/c (Payment of interest on 900 debentures) Interest on debentures A/c To Bank A/c (Payment of interest on 900 debentures) Dec 31 Profit on Redemption of Debentures A/c To Capital Reserve A/c (Profit on redemption transferred to capital reserve) 2018 Interest on Debentures A/c Jun30 To Bank A/c (Payment on interest on 900 debentures) 1,00,000 1,00,000 3,000 3,000 10, , ,700 2,700 2,700 2, ,700 2,700 Page 110

112 PRACTICAL PROBLEM Illustration 1 On 1st January, 2017 X Ltd. issued 1,000 8% Debentures of f 100 each at a discount of 6%. The terns of issue provided; (a) That interest shall be payable on 30th June and 31st Dec. every year; and (b) That on the 31st December every year, one- fifth of the debentures shall be redeemed. Pass relevant journal entries in the books of the company including cash transactions for the years 2017 and Illustration 3 The following balances appeared in the books of X Ltd. on : Sinking Fund A/c? 50,000 Sinking Fund Investment A/c (10% Govt. Securities, Nominal value X 45,000) 12% Debentures 48,000 1,00,000 The company sold X 30,000 Govt. Securities at 110% and utilised the amount to redeem part of the Debentures at a premium of 10%. Show Debentures A/c, Sinking Fund A/c and Sinking Fund Investment A/c. QUESTIONS FOR PRACTICE A, Objective Type Questions Fill in the Blanks 1. Premium on redemption of debentures account is in the nature of... account Loss on issue of debentures account is...,... asset. After all the debentures are redeemed the balance in the sinking fund is transferred to Profit on sale of sinking fund investments is credited to account. Own debenture account will appear on the side of the B/S. When debentures are redeemed out of profits, an equal amount is transferred to account. From the same purchase price profit on cancellation of own debentures is more when purchased on basis If the purchase price of debentures includes interest for the expired period, the quotation is said to be... Debenture is a document which creates a... Page 111

113 Am: 1-personal, 2- fietiti0us,3- general reserve, 4- sinring fund, 5- ass ft, 6- debenture redemption reserve, 7- cum, 8-cum interest, 9-debt Choose the correct answer 1. Interest on debenture is (a) adjustment of profit, (b) appropriation of profit, (c) charge on profit, (d) none of these 2. After all the debentures are redeemed, the balance in the sinking fund is transferred to (a) general reserve, (b) capital reserve, (c) profit and loss account, (d) debentures account. 3. When own debentures are cancelled, any profit on cancellation is transferred to (a) general reserve, (b) capital reserve, (c) profit or loss (d) none of these. 4. When debentures are bought as own for the purpose of investment, the own debenture account is debited with (a) face value, (b) cum interest price, (c) ex-interest price, (d) face value with premium. 5. After realizing all the investments, the balance in the sinking fund account is transferred to (a) profit and loss account, (b) debenture account, (c) capital reserve, (d) sinking fund account. 6. Which of the following is not a source of redemption of debentures (a) redemption out of capital, (b) redemption out of borrowings from financial institution (c) redemption out of profit, (d) redemption by conversion Ans: 1-c, 2- a, 3-b, 4- c, 5- d, 6-b B Short Answer Type * 1. What do you mean by drawing by lot? 2. What is Debenture Redemption Reserve account? 3. What are own debentures? 4. What do you mean by sinking fund? C Short Essay Type l. What are the different methods of redeeming debentures? 2. Enumerate the various sources of redemption of debentures. 3. What is the significance of Sinking Fund method of redemption of debentures? 4. Distinguish between Sinking Fund for replacement of an asset and a Sinking Fund the redemption of a liability. 5. Distinguish between Sinking Fund method and Insurance Policy method. 6. How would you treat premium on redemption of debentures? 1. A company issued debentures of the face value of? 1,00,000 at a discount of 6%. The debentures were repayable by annual drawing of Rs. 20,000. How would you deal with the discount on debentures? Show the discount account in the company's ledger for the period of duration of debentures. (Amount written off in the 1st year Rs. 2000, IInd year Rs. 1600,IIIrd year Rs. 1200, IVth year Rs.800 and Vth year? 400) Page 112

114 2. A company has issued Rs.12,00,000, 6% debentures at a discount of 6% repayable over a period of 10 years at par by annual drawings of X 1,20,000. Write-up the Cash Book, Debentures Account and Discount on Debentures Account for the first three years. 3. XY Ltd. issued 2,000, 12% debentures of? 100 each at par on 1st January Debentures are repayable at 5% premium in 5 equal annual instalments by lottery, the 1st redemption occurring on 31st December Show Debentures Account, Premium on Redemption of Debentures Account, Loss on Issue of Debentures Account, Debenture holders Account for all the years assuming that: (i) the company's accounting year ending on 31st December, (ii) all the terms of Debenture issue are duly complied with; (iii) no sinking fund was created. BUY-BACK OF SHARES Some years back buy back of shares and securities was not allowed in many developed countries (including India), Over the years, the situation has changed. Companies in India now can buy-back their own shares. Section 88, 69 and 70 of the Companies Act, 2013 deal with buy-back shares, One of the first companies to offer the buyback of shares in India in. October 2000 was Philips India Pvt. Ltd, Later many MNCs, opted for this method to restructure capital, or avail other benefits. Meaning and Definition of Buy-Back of Shares Buy-back is the reverse of issue of shares, Buy-back simply means buying of own shares, It is a process of capital restructuring. It allows a company to buy-back its own shares, which were issued by it earlier. It is a method of cancellation of a company's share capital It leads to reduction in the share capital of a company Objectives of Buy-Back 1. To improve returns on capital 2. To return surplus cash to the investors. 3. To increase the market price of the share. 4. To change the capital structure (i.e., to restructure capital base). 5. To increase the EPS. 6. To prevent hostile takeover bids. 7. To improve the financial health after buy-back 8. To achieve optimum capital structure 9. To service the equity more efficiently. Reasons and Benefits of Buy-back 1. It helps to increase the EPS. 2. The market price of the share will go up. 3. It help to return surplus the cash to the investors Page 113

115 4. 5. It increases promoters' holding in the company. It helps to restructure the capital base of the company It helps to utilise the liquid assets to enhance the value of the company. 6. It is a reward for investors. 7. It will improve the company's image. Damage of Buy-Back 1. It may be used as a tool of insider trading. This gives an opportunity to insiders to make extra money 2. It may be used for manipulating the prices of shares. 3. It weakens the position of minority shareholders. Sources of Buy-back A company can purchase its own shares out of the following: 1. Free reserves (reserves that are free for distribution as dividend). 2. Security premium account 3. Proceeds of any shares or other securities. However, the proceeds of an earlier issu * of same kind of shares / securities should not be used for buy-back. Thus, for example, if equity shares are to be bought back, preference shares or debentures may be issued for the purpose. Methods (or Modes) of Buy-back According to SEBI guidelines, there are three methods of buyback of shares. They are: 1. Through the tender offer. 2. From open market. 3. From odd lots. 1. Buy-back through tender offer: A company can buy back its shares from its existing equity shareholders on a proportionate basis. Under this method the company fixes a price at which it wishes to buy back a specified number of shares from its shareholders. If the number of shares offered for buy back at the stated price is more than the number of shares to be bought back, then the shares are bought back from each shareholder proportionately. Escrow Account: A company has to open an Escrow Account if it wants to initiate the process of buy-back of shares. The word 'escrow7 literally means a contract or bond deposited with a third person (normally a bank) to perform its obligations under the scheme of buy-back. The company is required to deposit an amount equal to 25% of the consideration payable for shares to be bought upto Rs. 100 crores and 10% of the consideration in excess of Rs. 100 crores. After completion of all obligations this amount will be refunded to the company. 2. Buy-back from the open market: A company can buy back its shares from the open market also. This may be done in any one of the following methods: (a) through stock exchange, (b) book building process. Page 114

116 (a) Through stock exchange: Under this method, a company can buy back its shares at the prevailing quoted price in a stock exchange. The buy-back is made only on stock exchange with electronic trading facility. This method does not require Escrow Account. (b) Through book building process: Under book building process the shareholders offer their shares at a price at which they are willing to sell their shares within a price band (i.e., price range) specified by the company The company will receive the offers from the shareholders. The merchant banker and the company shall determine the buyback price based on the acceptances received. The final price of buy-back shall be the highest price accepted and this price shall be /paid to all shareholders whose specified securities have been accepted for buy / back, litis method, requires the opening of Escrow Account. 3. Buy-back of shares from odd lots : The companies may locate the odd lots of shares (i.e., the block of shares that is not held in multiples of 100) and purchase them back from the odd lot holders, Accounting Treatment Accounting treatment of buy-back of shares is more or less similar to redemption of preference shares. The following points may be noted: 1. Only fully paid up securities can be bought back, If the securities are partly paid, they must be made fully paid up by making final call 2. Sufficient balance must be standing to the credit of free reserves if buy back is to be made from free reserves. 3. If the shares are bought back out of free reserves or security premium, an amount equal to the face value of shares so bought back must be transferred from free reserves or security premium to Capital Redemption Reserve A/c (CRR). 4. The premium, if any paid on buy-back must be written off to security premium or free reserves. 5. Discount on payback, if any, must be transferred to Capital Reserve. 6. CRR can be utilized for the purpose of issuing fully paid bonus shares. It should be noted that for buy-back, security premium can be transferred to CRR. Note: If the fresh issue of shares (for the purpose of buy back) is less than the amount of shades to be bought back, capital redemption reserve is to be created for the balance. Jourrnal Entries 1. If the company issues fresh securities for the purpose of buy back, appropriate entries are passed. 2. If the company buys back shares from free reserves or security premium, an amount equal to the nominal value of shares so bought should be transferred to Capital Redemption Reserve A/c. The entry is: Page 115

117 Profit and Loss or Other Reserves or Security Premium A/c Dr To C.R.R. A/c (a) For buy back at par Share Capital A/c (with the face value of shares bought back) To Bank A/c (with amount paid) (b) For buy back at premium Share Capital A/c (with the face value). Security Premium/ Free Reserves (with the premium, i.e., excess of purchase price over face value) To Bank A/c (with the amount paid) (c) For buy back at discount Share Capital A/c (with the face value of shares) To Bank A/c (with the amount paid) To Capital Reserve A/c (with the discount, i.e., the excess of face value over purchase price) 3. Write Journal entry for buyback expenses incurred in respect of buyback: Buy-back Expense A/c To Bank A/c Buy back expenses account will be closed by transferring to Profit or Loss or other Reserves Accounts. The entry is: Profit or Loss (or Other Reserves) To Buy-back Expense A/c Note: Instead of one entry for buy-back, two entries can be written, i.e., for transferring the amount to shareholders account and the other for payment, SEBI has mentioned that the companies can buy-back there own shares with or without shareholders' resolution if the buy-back of share is upto the limit of 10% of the paid up capital and reserves. But if the buy-back of share is upto the extent of 25% of paid-up capital and reserves, then the sharesholders' resolution is compulsory.. J E example 1 (Buy back at par out of fresh issue of shares) A Ltd issued 2,00,000 equity shares of? 10 each. It wanted to buy back 30,000 equity shares at par. It issued 6% 3,000 preference shares of ^ 100 each, the proceeds being utilized for the purpose of buy back. Expenses relating to the buy back amounted to ^ 18,000. Give journal entries. Page 116

118 Solution Journal Bank A/c (3,000x100) 3,00,000 To 6% Preference Share Capital A/c 3,00,000 (Issue of preference shares at par) Equity Share Capital A/c (30,000 x 10) 3,00,000 To Bank A/c 3,00,000 (Buy back of 30,000 equity shares at par) Buy back Expenses A/c 18,000 To Bank A/c 18,000 (Buy back expenses paid) Profit or Loss 18,000 To Buy back Expenses A/c (Buy back expenses written off to P/L) 18,000 Example 2 (Buy-back at premium out of free reserves) A Ltd issued 4,00,000 shares of? 10 each. The balance in the security premium account and general reserve account were? 40,00,000 and? 50,00,000 respectively. The company bought back 1,00,000 shares at a price of? 30 each and issued cheques for this purpose from its bank account. Write journal entries. Page 117

119 Example 3 (Buy back of shares at premium out of fresh issue and free reserves) The following is the B/S of X Ltd as on : Liabilities Equity share capital (?10 each share) Assets Sundry Assets 14,50,000 10,00,000 General Reserve 1,00,000 Profit or Loss 70,000 Security Premium 2,20,000 Other Liabilities ,50,000 14,50,000 On , the company bought back 25,000 equity 20 each. The company issued 2,000 8% preference shares of? 100 each for the purpose. Give journal entries. QUESTIONS FOR PRACTICE A. Objective Type Fill in the blanks 1. A company can buy-back its own shares from free Buy-back of equity shares is a process of capital 3. Only paid up shares can be acquired under buy-back 4. A company can buy-back its own shares from the existing share holders on...basis 5. For buy-back through open market operations, price fixation is done through auction method. Ans: 1-reserves, 2-restructing, 3-fully, 4-proportionate, 5-dutch IJ/ Short Answer Type 1./ What is meant by buy-back of shares? 2 / What are free reserves? - 3/ What is escraw account? 4/.What do you mean by Page 118

120 tender offer method of buy-back? 5. Is it necessary for a company to buyback of shares? QS Short Essay Type. 1. What are the objects of buy-back of shares? 2. State the sources of buy-back of shares? 3.. State the conditions and limits of buy-back.? 4. What are the various methods of buy-back of shares? 5. The buy-back of shares is a convinent strategy for companies to avail many benefits". Comment. Problems 1. A Ltd. decides to buy back 50,000 equity shares of f 10 each at a premium of 20%, For this purpose, it decides to issue 10% preference shares of f 10 each at par. To meet the requirement of the law, the company has sufficient free reserves, i.e., General Reserves and Securities Premium Account. You are required to pass journal entries to record the above transactions. A Ltd. decides to buyback 10% of? 100 crores paid up equity capital. The face "value per equity share is f 10, but the market price per share is f 15.A Ltd. takes the following steps for buyback of its shares: 1. To issue 7% debentures of 100 each at par for face value of 10 crores. 2. To utilise general reserve, 3. To sell investments of 7 crores for 8 crores. 4. To buyback the shares at the market price. 5. To immediately cancel the shares boughtback. Journalise the above transactions. Following figures have been extracted from the books of X Ltd. as on : Authorised capital:' 50,00,000 Equity shares of f 10 each 5,00,00,000 Issued and subscribed capital: 50,00,000 equity shares of f 10 each, fully paid-up 5,00,00,000. Reserves & Surplus: General Reserve 80,00,000' Profit and Loss Following is 1 the Balance Sheet of X Ltd as on : B/S of the Company as on A, Assets Page 119

121 1. Non-current Assets Fixed Assets 2,700 Non Trade Investments Current Assets Stock Trade Receavables Cash and Cash Equivalents 160 Total Assets 4, Equity and Liabilities 1. Equity Share Capital (a) Equity Shares off 20 each 800 (b) Other Equity (Reserves and Surplus) General Reserve 780 Security Premium ' Surplus Account Non-current Liabilities 10% Debentures 3. ' 2,00,000 Current Liabilities Trade Payable. 320 Total Equity and Liabilities 4420 On the above date 16,000 shares are bought by the company at f 20 per share. For his purpose, the co. sold its all non-trade investments for? 3,20,000. Give journal entries. ALTERATION OF SHARE CAPITAL A company may alter the capital clause of its memorandum only if it is authorized by it s articles to do so. Meaning of alteration of share capital Increase or decrease in (or rearrangement of) the authorized share capital of a firm, as permitted in its articles of association. Any such change requires (1) passing of a resolution to the effect in the firm's general meeting, and (2) filing of the notice of alteration with the appropriate governmental office such as (in the UK) the Registrar Of Companies. Legal requirement for alteration of share capital The main legal requirements in connection with the alteration of share capital are summarized as under: Page 120

122 a. Authorized by articles: a company may alter the capital clause of its memorandum only if it is authorized by its articles of association to do so. b. Ordinary resolution: an ordinary resolution must be passed at a general meeting. c. Notice: a notice specifying alteration made must be given to the registrar within 30 days of alteration. Methods of alteration of share capital 1. Increase its share capital by making fresh issue If a company wants to increase its capital beyond the amount of its authorised capital, it must increase its authorised capital by the amount of new shares. Entries for the purpose will be the same as in the case of original issue of shares. 2. Consolidate and divide all or any of its share capital into shares of larger denomination: Alteration in the share capital can be done by consolidating the shares of smaller amounts into shares of larger amounts. This is possible when articles permit to do so. Journal entry, for this purpose, will be: (i) Share Capital (say Rs. 10) A/c To Share Capital (say, Rs. 100) A/c 3. Subdivide all or any of its share capital into shares of smaller denomination: Entry will be: Share Capital (say, Rs. 100) A/c To Share Capital (say, Rs. 10) A/c 4. Convert all or any of fully paid-up shares into stock or reconvert stock into fully paid-up shares of any denomination: Journal entry Share capital a/c dr Stock Example 1. A ltd having equity shares o f rs. 10 each decides to convert the share capital into equity stock. Write the journal entry. Solution Equity share capital a/c dr To equity stock a/c 5. By reconverting stock into shares: tock may be reconverted into shares. Journal entry Stock a/c dr Share capital a/c Example A ltd having equity stock of Rs decides to convert the equity stock into equity shares of Rs. 10 each. Write the journal entry Equity stock a/c dr Equity share capital a/c By decreasing the share capital Page 121

123 A company can decrease its share capital by cancelling unissued shares. The authorized share capital gets reduced by the amount of unissued shares now cancelled. This is the diminution of share capital. This should not be confused with the reduction of share capital. This means that decrease in the share capital is different from reduction of share capital. Journal entry No accounting entry is needed for cancellation of unissued shares. Only reduced authorized capital is to be shown in the next balance sheet. Example A ltd has an authorized share capital of Rs. 10,00,000 and issued capital of Rs It decides to alter its authorized share capital to rs. 8,00,000. Show the accounting treatment. No journal entry is required for cancellation of unissued shares. The reduced authorized share capital Rs. 8,00,000 is to be shown in the balance sheet. Example Page 122

124 MODULE-III PREPARATION OF SINGLE ENTITY FINANCIAL STATEMENT The objective of preparing general purpose financial statements of a single entity is to provide information about the entity s financial position, financial performance and cash flows to users for economic decision making. This chapter deals with the following accounting standards. 1. Accounting policies, change in accounting estimates and errors(as 8 and Ind AS 8) 2. Events after the reporting date (AS10 and Ind AS 10) 3. Presentation of financial statement (IAS 1 AND Ind AS 1) 4. Cash flow statement (IAS7 and IndAS 7) 1. International Accounting Standard 8 Accounting Policies, Changes in Accounting Estimates and Errors An entity may be required to change accounting policies and accounting estimates. Similarly, some errors might have committed in financial statements. Objective The objective of this Standard is to prescribe the criteria for selecting and changing accounting policies, together with the accounting treatment and disclosure of changes in accounting policies, changes in accounting estimates and corrections of errors. Scope 1. Selection and application of accounting policies 2. accounting for changes in accounting policies 3. changes in accounting estimates and 4. corrections of prior period errors. Definitions a. Accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements. b. A change in accounting estimate is an adjustment of the carrying amount of an asset or a liability, or the amount of the periodic consumption of an asset, that results from the assessment of the present status of, and expected future benefits and obligations associated with, assets and liabilities. Changes in accounting estimates result from new information or new developments and, accordingly, are not corrections of errors. c. Prior period errors are omissions from, and misstatements in, the entity s financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that: (a) was available when financial statements for those periods were authorised for issue; and (b) could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements. Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud. Page 123

125 d. Retrospective application is applying a new accounting policy to transactions, other events and conditions as if that policy had always been applied. e. Retrospective restatement is correcting the recognition, measurement and disclosure of amounts of elements of financial statements as if a prior period error had never occurred. Accounting policies Selection and application of accounting policies When a Standard or an Interpretation specifically applies to a transaction, other event or condition, the accounting policy or policies applied to that item must be determined by applying the Standard or Interpretation and considering any relevant Implementation Guidance issued by the IASB for the Standard or Interpretation. [IAS 8.7] In the absence of a Standard or an Interpretation that specifically applies to a transaction, other event or condition, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. [IAS 8.10]. In making that judgement, management must refer to, and consider the applicability of, the following sources in descending order: the requirements and guidance in IASB standards and interpretations dealing with similar and related issues; and the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework. [IAS 8.11] Consistency of accounting policies An entity shall select and apply its accounting policies consistently for similar transactions, other events and conditions, unless a Standard or an Interpretation specifically requires or permits categorization of items for which different policies may be appropriate. If a Standard or an Interpretation requires or permits such categorization, an appropriate accounting policy shall be selected and applied consistently to each category. Changes in accounting policies An entity is permitted to change an accounting policy only if the change: is required by a standard or interpretation; or results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the entity's financial position, financial performance, or cash flows. Applying changes in accounting policies The following rules may be followed for applying changes in accounting policies: a. an entity shall account for a changes in accounting policy resulting from the initial application of an Ind AS in accordance with the specific transitional provisions, if any, in that Ind AS, and b. if there are no specific transitional provisions applying to that change or an accounting policy is voluntarily changed, then the change should be applied retrospectively, unless it is impracticable to do so. Page 124

126 Retrospective application When a change in accounting policy is applied retrospectively, it requires the entity to adjust the opening balance of each affected components of equity for the earliest prior period presented and the other comparative amounts disclosed for each prior period presented as if the new accounting policy had always been applied. Limitations on retrospective application When it is impracticable to apply retrospective application, then the entity should apply the new accounting policy to the carrying amounts of assets and liabilities as at the beginning of the earliest period for which retrospective application is practicable, which may be the current period. Changes in accounting estimates As a result of the uncertainties inherent in business activities, many items in financial statements cannot be measured with precision but can only be estimated. Estimation involves judgement based on the latest available, reliable information. For example, estimates may be required of: (a) bad debts; (b) inventory obsolescence; (c) the fair value of financial assets or financial liabilities; (d) the useful lives of, or expected pattern of consumption of the future economic benefits embodied in, depreciable assets; and (e) warranty obligations. Change in measurement basis A change in the measurement basis applied is a change in an accounting policy, and is not a change in an accounting estimate. When it is difficult to distinguish a change in an accounting policy from a change in an accounting estimate, the change is treated as a change in an accounting estimate. Difficulty in distinguishing change in policy and changes in estimate When it is difficult to distinguish a change in an accounting policy from a change in an accounting estimate, then the change should be treated as a change in an accounting estimate. Change in accounting estimate (prospective application) The effect of change in an accounting estimate should be recognized prospectively by including it in profit or loss in : a. the period of the change, if the change effects that period only, for example, bad debts; b. the period of the change and future periods, if the change affects both, for example, estimated useful life depreciable assets. Errors Page 125

127 Errors discovered during a current period may have arisen on account of mathematical mistakes, incorrect application of accounting policies, misinterpretation of facts, oversights or fraud. Accounting treatment An entity should correct all prior period errors retrospectively in the first set of financial statements approved for issue after their discovery. This correction should be done by: a. restating the comparative amounts for the prior period(s) presented in which the error occurred; or b. if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented. Limitations on retrospective restatement In case it impracticable for the entity to determine the period specific effects of an error for one or more prior periods presented, it shall restate the opening balances of assets, liabilities and equity for the earliest period for which retrospective restatement is practicable. In case it is impracticable to determine the cumulative effect, at the beginning of the current period, of an error on all prior periods, the entity shall restate the comparative information to correct the error prospectively from the earliest date practicable. Example Example Page 126

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129 2. Events after the reporting period Events after the end of reporting period may be classified into two types: Adjusting Events - Those events that provide further evidence about conditions that existed at the end of reporting period. Non-Adjusting Events - Those events that reflect conditions that arose after the end of reporting period. Recognition and measurement Adjusting Events If any events occur after the end of the reporting period that provide further evidence of conditions that existed at the end of reporting period (i.e. Adjusting Events), then the financial statements must be adjusted accordingly. Example Page 128

130 Non adjusting events after the reporting period The following are the examples of non adjusting event after the balance sheet date: a. A major business combination after the balance sheet date, or disposing of a major subsidiary. b. Major purchases and disposals of assets, or expropriation of major assets by government. c. The destruction of a major production plant by a fire after the balance sheet date; d. Announcing, or commencing the implementation of a major restructuring. e. Major ordinary and potential share transactions, after the balance sheet date. f. Abnormally large changes, after the balance sheet date, in asset prices, or foreign exchange rates. g. Changes in tax rates, or tax law enacted, or announced after the balance sheet date. h. Commencing major litigation (law suit) arising solely out of events that occurred after the balance sheet date. i. Decline in the market value of investment between balance sheet date and the date of approval of financial statements. j. Declaration of an equity dividend. Dividends If dividends are declared to holders of equity instruments after the reporting period, the entity should not recognize it as liability at the end of the reporting period because no obligation exists at that time. Such dividends are disclosed in the notes under Ind AS 1. Going concern An entity should not prepare financial statements on a going concern basis if management determines after the reporting period that it intends to either liquidate the entity Page 129

131 or cease trading. For example, a fire destroyed inventory in the warehouse after the year end. This is non adjusting event. The loss of inventory means that the entity can no longer continue to trade. Then the going concern assumption is no longer valid. Presentation of Financial Statements Objective This Standard prescribes the basis for presentation of general purpose financial statements to ensure comparability both with the entity s financial statements of previous periods and with the financial statements of other entities. It sets out overall requirements for the presentation of financial statements, guidelines for their structure and minimum requirements for their content. Scope 1. An entity shall apply this Standard in preparing and presenting general purpose financial statements in accordance with Indian Accounting Standards (Ind ASs). 2. Other Ind ASs set out the recognition, measurement and disclosure requirements for specific transactions and other events. 3. This Standard does not apply to the structure and content of condense d interim financial statements prepared in accordance with Ind AS 34 Interim Financial Reporting. However, paragraphs apply to such financial statements. This Standard applies equally to all entities, including those that present consolidated financial statements and those that present separate financial statements as defined in Ind AS 27 Consolidated and Separate Financial Statements. 4. This Standard uses terminology that is suitable for profit -oriented entities, including public sector business enti ties. If entities with not-for-profit activities in the private sector or the public sector apply this Standard, they may need to amend the descriptions used for particular line items in the financial statements and for the financial statements themselves. 5. Similarly, entities whose share capital is not equity may need to adapt the financial statement presentation of members interests. Components of financial statement A complete set of financial statements comprises the following A balance sheet A statements of profit and loss Statement of changes in equity A statement of cash flows, Notes comprising significant accounting policies and other explanatory information Comparative information in respect of preceding period, and 7. A balance sheet as at the beginning of the preceding period when an entity applies an accounting policy retrospectively or makes a retrospective restatement or reclassifies items in its financial statements. Page 130

132 General Features of Financial Statements 1. Fair presentation and compliance with ASs 2. Going Concern 3. Accrual basis of Accounting 4. Materiality and Aggregation 5. Offsetting 6. Frequency of reporting 7. Comparative Information 8. Consistency of presentation. Statement of Financial Position [Balance Sheet] Statement of Financial Position, also known as the Balance Sheet, presents the financial position of an entity at a given date. It is comprised of three main components: Assets, liabilities and equity. Statement of Financial Position helps users of financial statements to assess the financial soundness of an entity in terms of liquidity risk, financial risk, credit risk and business risk. Form of balance sheet is given below Figures at Figures at the the end of end of current year previous year A. ASSETS Non current asset 1. Property, plant, and equipment 2. Capital work in progress 3. Investment property 4. Intangible assets 5. Other intangible assets 6. Financial assets a. Investment b. Trade receivable c. Loans d. Other to be specified 7. Biological assets 8. Deferred tax assets 9. Other non current assets Current assets 1. Inventories 2. Financial assets a. Investments Page 131

133 b. Trade receivables c. Cash and cash equivalents d. Bank balances other than (1) e. Loans f. Other to be specified 3. Current tax assets 4. Other current assets Total assets B. EQUITY AND LIABILITIES Equity a. Share capital b. Retained earnings(reserves and surplus) Non current liabilities a. Financial liabilities i. Borrowings ii. Trade payables iii. Other liabilities(to be specified) b. Provisions c. Deferred tax liabilities d. Other non current liabilities Current liabilities a. Financial liabilities i. Borrowings ii. Trade payable iii. Other financial liabilities(to be specified) b. Other current liabilities c. Provisions d. Current tax liabilities Total equity and liabilities GENERAL INSTRUCTIONS FOR PREPARATION OF BALANCE SHEET 1. An asset shall be classified as current when it satisfies any of the following criteria: (a) it is expected to be realised in, or is intended for sale or consumption in, the company s normal operating cycle; (b) it is held primarily for the purpose of being traded; (c) it is expected to be realised within twelve months after the reporting date; or Page 132

134 (d) it is cash or cash equivalent unless it is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting date. All other assets shall be classified as non-current. 2. An operating cycle is the time between the acquisition of assets for processing and their realisation in cash or cash equivalents. Where the normal operating cycle cannot be identified, it is assumed to have a duration of twelve months. 3. A liability shall be classified as current when it satisfies any of the following criteria: (a) it is expected to be settled in the company s normal operating cycle; (b) it is held primarily for the purpose of being traded; (c) it is due to be settled within twelve months after the reporting date; or (d) the company does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting date. Terms of a liability that could, at the option of the counterparty, result in its settlement by the issue of equity instruments do not affect its classification. All other liabilities shall be classified as non-current. 4. A receivable shall be classified as a trade receivable if it is in respect of the amount due on account of goods sold or services rendered in the normal course of business. 5. A payable shall be classified as a trade payable if it is in respect of the amount due on account of goods purchased or services received in the normal course of business. 6. A company shall disclose the following in the notes to accounts. A. Share Capital For each class of share capital (different classes of preference shares to be treated separately): (a) the number and amount of shares authorised; (b) the number of shares issued, subscribed and fully paid, and subscribed but not fully paid; (c) par value per share; (d) a reconciliation of the number of shares outstanding at the beginning and at the end of the reporting period; (e) the rights, preferences and restrictions attaching to each class of shares including restrictions on the distribution of dividends and the repayment of capital; (f) shares in respect of each class in the company held by its holding company or its ultimate holding company including shares held by or by subsidiaries or associates of the holding company or the ultimate holding company in aggregate; (g) shares in the company held by each shareholder holding more than 5 per cent. shares specifying the number of shares held; Page 133

135 (h) shares reserved for issue under options and contracts/commitments for the sale of shares/disinvestment, including the terms and amounts; (i) for the period of five years immediately preceding the date as at which the Balance Sheet is prepared: (A) Aggregate number and class of shares allotted as fully paid-up pursuant to contract(s) without payment being received in cash. (B) Aggregate number and class of shares allotted as fully paid-up by way of bonus shares. (C) Aggregate number and class of shares bought back. (j) terms of any securities convertible into equity/preference shares issued along with the earliest date of conversion in descending order starting from the farthest such date; (k) calls unpaid (showing aggregate value of calls unpaid by directors and officers); (l) forfeited shares (amount originally paid-up). B. Reserves and Surplus (i) Reserves and Surplus shall be classified as: (a) Capital Reserves; (b) Capital Redemption Reserve; (c) Securities Premium Reserve; (d) Debenture Redemption Reserve; (e) Revaluation Reserve; (f) Share Options Outstanding Account; (g) Other Reserves (specify the nature and purpose of each reserve and the amount in respect thereof); (h) Surplus i.e., balance in Statement of Profit and Loss disclosing allocations and appropriations such as dividend, bonus shares and transfer to/ from reserves, etc.; (Additions and deductions since last balance sheet to be shown under each of the specified heads); (ii) A reserve specifically represented by earmarked investments shall be termed as a fund. (iii) Debit balance of statement of profit and loss shall be shown as a negative figure under the head Surplus. Similarly, the balance of Reserves and Surplus, after adjusting negative balance of surplus, if any, shall be shown under the head Reserves and Surplus even if the resulting figure is in the negative. C. Long-Term Borrowings (i) Long-term borrowings shall be classified as: (a) Bonds/debentures; (b) Term loans: (A) from banks. Page 134

136 (B) from other parties. (c) Deferred payment liabilities; (d) Deposits; (e) Loans and advances from related parties; (f) Long term maturities of finance lease obligations; (g) Other loans and advances (specify nature). (ii) Borrowings shall further be sub-classified as secured and unsecured. Nature of security shall be specified separately in each case. (iii) Where loans have been guaranteed by directors or others, the aggregate amount of such loans under each head shall be disclosed. (iv) Bonds/debentures (along with the rate of interest and particulars of redemption or conversion, as the case may be) shall be stated in descending order of maturity or conversion, starting from farthest redemption or conversion date, as the case may be. Where bonds/debentures are redeemable by instalments, the date of maturity for this purpose must be reckoned as the date on which the first instalment becomes due. (v) Particulars of any redeemed bonds/debentures which the company has power to reissue shall be disclosed. (vi) Terms of repayment of term loans and other loans shall be stated. (vii) Period and amount of continuing default as on the balance sheet date in repayment of loans and interest, shall be specified separately in each case. D. Other Long-term Liabilities Other Long-term Liabilities shall be classified as: (a) Trade payables; (b) Others. E. Long-term provisions The amounts shall be classified as: (a) Provision for employee benefits; (b) Others (specify nature). F. Short-term borrowings (i) Short-term borrowings shall be classified as: (a) Loans repayable on demand; (A) from banks. (B) from other parties. (b) Loans and advances from related parties; (c) Deposits; (d) Other loans and advances (specify nature). Page 135

137 (ii) Borrowings shall further be sub-classified as secured and unsecured. Nature of security shall be specified separately in each case. (iii) Where loans have been guaranteed by directors or others, the aggregate amount of such loans under each head shall be disclosed. (iv) Period and amount of default as on the balance sheet date in repayment of loans and interest, shall be specified separately in each case. G. Other current liabilities The amounts shall be classified as: (a) Current maturities of long-term debt; (b) Current maturities of finance lease obligations; (c) Interest accrued but not due on borrowings; (d) Interest accrued and due on borrowings; (e) Income received in advance; (f) Unpaid dividends; (g) Application money received for allotment of securities and due for refund and interest accrued thereon. Share application money includes advances towards allotment of share capital. The terms and conditions including the number of shares proposed to be issued, the amount of premium, if any, and the period before which shares shall be allotted shall be disclosed. It shall also be disclosed whether the company has sufficient authorised capital to cover the share capital amount resulting from allotment of shares out of such share application money. Further, the period for which the share application money has been pending beyond the period for allotment as mentioned in the document inviting application for shares along with the reason for such share application money being pending shall be disclosed. Share application money not exceeding the issued capital and to the extent not refundable shall be shown under the head Equity and share application money to the extent refundable, i.e., the amount in excess of subscription or in case the requirements of minimum subscription are not met, shall be separately shown under Other current liabilities ; (h) Unpaid matured deposits and interest accrued thereon; (i) Unpaid matured debentures and interest accrued thereon; (j) Other payables (specify nature). H. Short-term provisions The amounts shall be classified as: (a) Provision for employee benefits. I. (b) Others (specify nature). Tangible assets (i) Classification shall be given as: Page 136

138 (a) Land; (b) Buildings; (c) Plant and Equipment; (d) Furniture and Fixtures; (e) Vehicles; (f) Office equipment; (g) Others (specify nature). (ii) Assets under lease shall be separately specified under each class of asset. (iii) A reconciliation of the gross and net carrying amounts of each class of assets at the beginning and end of the reporting period showing additions, disposals, acquisitions through business combinations and other adjustments and the related depreciation and impairment losses/reversals shall be disclosed separately. (iv) Where sums have been written-off on a reduction of capital or revaluation of assets or where sums have been added on revaluation of assets, every balance sheet subsequent to date of such write-off, or addition shall show the reduced or increased figures as applicable and shall by way of a note also show the amount of the reduction or increase as applicable together with the date thereof for the first five years subsequent to the date of such reduction or increase. J. Intangible assets (i) Classification shall be given as: (a) Goodwill; (b) Brands /trademarks; (c) Computer software; (d) Mastheads and publishing titles; (e) Mining rights; (f) Copyrights, and patents and other intellectual property rights, services and operating rights; (g) Recipes, formulae, models, designs and prototypes; (h) Licences and franchise; (i) Others (specify nature). (ii) A reconciliation of the gross and net carrying amounts of each class of assets at the beginning and end of the reporting period showing additions, disposals, acquisitions through business combinations and other adjustments and the related amortization and impairment losses/reversals shall be disclosed separately. (iii) Where sums have been written-off on a reduction of capital or revaluation of assets or where sums have been added on revaluation of assets, every balance sheet subsequent to date of such write-off, or addition shall show the reduced or increased figures as applicable and shall by way of a note also show the amount Page 137

139 of the reduction or increase as applicable together with the date thereof for the first five years subsequent to the date of such reduction or increase. K. Non-current investments (i) Non-current investments shall be classified as trade investments and other investments and further classified as: (a) Investment property; (b) Investments in Equity Instruments; (c) Investments in preference shares; (d) Investments in Government or trust securities; (e) Investments in debentures or bonds; (f) Investments in Mutual Funds; (g) Investments in partnership firms; (h) Other non-current investments (specify nature). Under each classification, details shall be given of names of the bodies corporate indicating separately whether such bodies are (i) subsidiaries, (ii) associates, (iii) joint ventures, or (iv) controlled special purpose entities in whom investments have been made and the nature and extent of the investment so made in each such body corporate (showing separately investments which are partly-paid). In regard to investments in the capital of partnership firms, the names of the firms (with the names of all their partners, total capital and the shares of each partner) shall be given. (ii) Investments carried at other than at cost should be separately stated specifying the basis for valuation thereof; (iii) The following shall also be disclosed: (a) Aggregate amount of quoted investments and market value thereof; (b) Aggregate amount of unquoted investments; (c) Aggregate provision for diminution in value of investments. L. Long-term loans and advances (i) Long-term loans and advances shall be classified as: (a) Capital Advances; (b) Security Deposits; (c) Loans and advances to related parties (giving details thereof); (d) Other loans and advances (specify nature). (ii) The above shall also be separately sub-classified as: (a) Secured, considered good; (b) Unsecured, considered good; (c) Doubtful. (iii) Allowance for bad and doubtful loans and advances shall be disclosed under the relevant heads separately. Page 138

140 (iv) Loans and advances due by directors or other officers of the company or any of them either severally or jointly with any other persons or amounts due by firms or private companies respectively in which any director is a partner or a director or a member should be separately stated. M. Other non-current assets Other non-current assets shall be classified as: (i) Long-term Trade Receivables (including trade receivables on deferred credit terms); (ii) Others (specify nature); (iii) Long term Trade Receivables, shall be sub-classified as: (a) (A) Secured, considered good; (B) Unsecured, considered good; (C) Doubtful. (b) Allowance for bad and doubtful debts shall be disclosed under the relevant heads separately. (c) Debts due by directors or other officers of the company or any of them either severally or jointly with any other person or debts due by firms or private companies respectively in which any director is a partner or a director or a member should be separately stated. N. Current Investments (i) Current investments shall be classified as: (a) Investments in Equity Instruments; (b) Investment in Preference Shares; (c) Investments in Government or trust securities; (d) Investments in debentures or bonds; (e) Investments in Mutual Funds; (f) Investments in partnership firms; (g) Other investments (specify nature). Under each classification, details shall be given of names of the bodies corporate [indicating separately whether such bodies are: (i) subsidiaries, (ii) associates, (iii) joint ventures, or (iv) controlled special purpose entities] in whom investments have been made and the nature and extent of the investment so made in each such body corporate (showing separately investments which are partly paid). In regard to investments in the capital of partnership firms, the names of the firms (with the names of all their partners, total capital and the shares of each partner) shall be given. (ii) The following shall also be disclosed: (a) The basis of valuation of individual investments; (b) Aggregate amount of quoted investments and market value thereof; (c) Aggregate amount of unquoted investments; Page 139

141 (d) Aggregate provision made for diminution in value of investments. O. Inventories (i) Inventories shall be classified as: (a) Raw materials; (b) Work-in-progress; (c) Finished goods; (d) Stock-in-trade (in respect of goods acquired for trading); (e) Stores and spares; (f) Loose tools; (g) Others (specify nature). (ii) Goods-in-transit shall be disclosed under the relevant sub-head of inventories. (iii) Mode of valuation shall be stated. P. Trade Receivables (i) Aggregate amount of Trade Receivables outstanding for a period exceeding six months from the date they are due for payment should be separately stated. (ii) Trade receivables shall be sub-classified as: (a) Secured, considered good; (b) Unsecured, considered good; (c) Doubtful. (iii) Allowance for bad and doubtful debts shall be disclosed under the relevant heads separately. (iv) Debts due by directors or other officers of the company or any of them either severally or jointly with any other person or debts due by firms or private companies respectively in which any director is a partner or a director or a member should be separately stated. Q. Cash and cash equivalents (i) Cash and cash equivalents shall be classified as: (a) Balances with banks; (b) Cheques, drafts on hand; (c) Cash on hand; (d) Others (specify nature). (ii) Earmarked balances with banks (for example, for unpaid dividend) shall be separately stated. (iii) Balances with banks to the extent held as margin money or security against the borrowings, guarantees, other commitments shall be disclosed separately. (iv) Repatriation restrictions, if any, in respect of cash and bank balances shall be separately stated. Page 140

142 (v) Bank deposits with more than twelve months maturity shall be disclosed separately. R. Short-term loans and advances (i) Short-term loans and advances shall be classified as: (a) Loans and advances to related parties (giving details thereof); (b) Others (specify nature). (ii) The above shall also be sub-classified as: (a) Secured, considered good; (b) Unsecured, considered good; (c) Doubtful. (iii) Allowance for bad and doubtful loans and advances shall be disclosed under the relevant heads separately. (iv) Loans and advances due by directors or other officers of the company or any of them either severally or jointly with any other person or amounts due by firms or private companies respectively in which any director is a partner or a director or a member shall be separately stated. S. Other current assets (specify nature) This is an all-inclusive heading, which incorporates current assets that do not fit into any other asset categories. T. Contingent liabilities and commitments (to the extent not provided for) (i) Contingent liabilities shall be classified as: (a) Claims against the company not acknowledged as debt; (b) Guarantees; (c) Other money for which the company is contingently liable. (ii) Commitments shall be classified as: (a) Estimated amount of contracts remaining to be executed on capital account and not provided for; (b) Uncalled liability on shares and other investments partly paid; (c) Other commitments (specify nature). U. The amount of dividends proposed to be distributed to equity and preference shareholders for the period and the related amount per share shall be disclosed separately. Arrears of fixed cumulative dividends on preference shares shall also be disclosed separately. V. Where in respect of an issue of securities made for a specific purpose, the whole or part of the amount has not been used for the specific purpose at the balance sheet date, there shall be indicated by way of note how such unutilised amounts have been used or invested. W. If, in the opinion of the Board, any of the assets other than fixed assets and noncurrent investments do not have a value on realisation in the ordinary course of business at least equal to the amount at which they are stated, the fact that the Board is of that opinion, shall be stated. Page 141

143 Statement of profit and loss or statement of comprehensive income (income statement) IAS 1 permit to present income and expenses either in a single statement called statement of profit or loss and other comprehensive income The following should be presented in the statement of p/l in addition to the prifit or loss and OCI sections: a. Profit or loss b. Total other comprehensive income (OCI) c. Comprehensive income for the period, beign the total of profit or loss and OCI Information to be presented in the profit or loss section of the statement of profit and loss The standard lists the following as the minimum to be disclosed on the face of the statement of profit or loss a. Revenue b. Finance cost c. Share of the profit or loss associates and joint ventures accounted for using equity method d. Tax expenses e. Tax gain (or loss) recorded on the disposal of assets or settlement of liabilities attributable to discontinuing operation f. Profit or loss The following items shall be disclosed on the face of the income statement (statement of profit or loss) s allocations of profit (or loss) for the period. i. Profit (loss) attributable to minority interest, and ii. Profit (loss) attributable to equity shareholders of the parent. An entity should present additional line item, heading and subtotals in the statement of profit and loss, when such presentation is relevant to an understanding of the entity s financial performance. Information to be presented in the OCI section The following shall be presented in the other comprehensive income section. i. Actuarial gains(or loss) on defined benefit plans ii. Share of associate s other comprehensive income iii. Exchange differences on translating foreign operations. iv. Increase or decrease in revaluation of property, plant, and equipment v. Cash flow hedges. Information to be presented in the statement of profit and loss or in the notes When items of income or expense are material, an entity should disclose their nature and amount separately. Page 142

144 Circumstances, that would give rise to the separate disclosure of items of income and expenses include; a. Write downs of inventories to net realizable value of property, plant and equipment to recoverable amount, as well as reversals of such write down. b. Restructuring of the activities of an entity and reversals of any provisions for the costs of restructuring. c. Disposals of items of property, plant and equipment d. Disposals of investments e. Discontinued operations, f. Litigations settlements, and g. Other reversals of provisions Classification of expense On the basis of nature of expense Revenue xxxx Other income xxxx Changes in inventories of finished goods and work in progress xxxx Raw materials and consumables used xxxx Employee benefits cost xxxx Depreciation and amortization expense xxx Other expenses xxxx Total expenses xxxx Profit xxxx Classification on the basis of function Revenue xxx Cost of sales (xxx) Gross profit xxx Other income xxx Total xxxx Distribution cost (xxx) Administrative expenses (xxx) Other expenses (xxx) Profit xxx Statement of comprehensive income a. Single statement approach Statement of comprehensive income of ABC ltd co. for the year ended 31st march 2018 Revenue Xxx Xxxx Page 143

145 Cost of sales Distribution costs Administrative expenses Financial cost Share of profit of associates Profit before tax Income tax expense Profit for the year from continuing operations Loss for the year from discontinued operations Profit for the year Other comprehensive income Exchange differences on translating foreign operations, net of tax Actuarial gains on defined benefit pension obligations, net of tax Share of associates other comprehensive income (Xxxx) (Xxxx) (Xxx) (Xxx) Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxx Xxxx Xxxx Xxxx Xxxx Other comprehensive income for the year, net of tax Total comprehensive income for the year Xxxx Xxxx Xxxx xxxx total comprehensive income is the change in equity during a period resulting from transactions, other than those changes resulting from transactions with owners in their capacity as owners. That is, total comprehensive income is the sum of profit or loss for the period and other comprehensive income. b. Two statement approach Statement of profit and loss of ABC ltd com for the year ended 31st march 2018 Revenue Cost of sales Distribution costs Administrative expenses Financial cost Share of profit of associates Profit before tax Income tax expense Profit for the year from continuing operations Loss for the year from discontinued operations Profit for the year Profit for the year is attributable to Owners of the parent company Non controlling interest Xxxx xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxxx Xxx Xxxx Xxxx Xxx Xxx Xxx Xxx Xxxx Xxxx Xxxx Xxxx Xxx Xxx xxx Xxx xxx Xxxx Xxxx Statement of other comprehensive income Profit for the year Page 144

146 Other comprehensive income Exchange differences on translating foreign operations, net of tax Actuarial gains on defined benefit pension obligations, net of tax Share of associates other comprehensive income Other comprehensive income for the year, net of tax Total comprehensive income for the year Total comprehensive income for the year attributable to: Owners of the parent Non controlling interest Xxxx Xxxx Xxx Xxxx Xxxx Xxxx Xxxx Xxx Xxxx Xxxx Xxx xxxx Xxx xxxx Note : under Ind AS, only one statement is prepared, but in two sections Statement of changes in equity The statement of changes in equity show information about the increase or decrease in net assets or wealth of an entity. IAS 1 requires preparation of a statement of changes in equity as a separate statement. Ind AS1 requires the statement of changes in equity to be shown as a part of the balance sheet. 1. The minimum information to be presented on the face of the statement of changes in equity includes. a. Total comprehensive income for the period showing separately the total amount attributable to owners of the parent and non controlling interest. b. The effects of retrospective applications or restatement recognized in accordance with IAS 8 on each of the components of equity. c. Reconciliation between the carrying amount at the beginning and end of the period for each components of equity. 2. Following details are also to be presented on the face of the statement of changes in equity or in the notes as other information. a. Capital transaction with owners and distribution to owners. b. The amount of dividend recognized as distribution to owners during the period and the related per share information. c. Reconciliation of the balance of accumulated profit or loss at the beginning and end of the year. d. Reconciliation of the carrying amount of each class of equity capital, share premium, and each reserve at the beginning and end of the period. Share Retaine capita d l earning Balance as Xxxx on 1/4/16 Correctio Equity instrumen ts Revaluatio n surplus Tota l Non controllin g interest Total equit y Xxxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Page 145

147 n of a prior period error Changes in accountin g policy xxxx Restated xxxx balances as on Ist april 2016 Changes in equity Dividends Total comprehensi ve income for the year Xxx xxxx xxxx Balance as xxxx on 31/3/17 Xxx Xxxx Changes in equity for the period xxx Issue of share capital Dividend Total comprehensi ve income for the year Transfer to ret. Earnings Balance 31/3/18 Xxxx Xxxx xxx xxx xxx Xxx Xxx Xxx Xxx Xxx xxxx xxxx Xxx Xxx Xxxx Xxx x Xxx Xxxx Xxx Xxx Xxxx Xxxx Xxx Xxxx Xxxx Xxx Xxxx Xxx x Xxx x on xxxx Page 146

148 Note: 1. where there is change of accounting policy, necessitating a retrospective restatement, the adjustment is disclosed for each period. Thus, rather than just showing an adjustment to balance on Ist april, 2017 the balance for is restated. 3. Gains and losses on cash flow hedges or on the translation of foreign operation would be shown in additional column. IV STATEMENT OF CASH FLOWS (IAS 7 & Ind AS 7) The Statement of Cash Flows (also referred to as the cash flow statement) is one of the three key financial statements that reports the cash generated and spent during a specific period of time (i.e., a month, quarter, or year). The statement of cash flows acts as a bridge between the income statement and balance sheet by showing how money moved in and out of the business. Three sections of the Statement of Cash Flows: 1. Operating Activities: The principal revenue-generating activities of an organization and other activities that are not investing or financing; any cash flows from current assets and current liabilities 2. Investing Activities: Any cash flows from the acquisition and disposal of long-term assets and other investments not included in cash equivalents 3. Financing Activities: Any cash flows that result in changes in the size and composition of the contributed equity or borrowings of the entity (i.e., bonds, stock, cash dividends) Cash flow definitions Cash flows: Inflows and outflows of cash and cash equivalents Cash: Cash on hand and demand deposits (cash balance on the balance sheet) Cash equivalents: Cash equivalents include cash held as bank deposits, short-term investments, and any very easily cash-convertible assets includes overdrafts and cash equivalents with short-term maturities (less than three months). Cash flow classification 1. Operating Cash Flow Operating activities are the principal revenue-producing activities of the entity. Operating cash flows typically include the cash flows associated with sales, purchases, and other expenses. The company s chief finance officer chooses between the direct and indirect presentation of operating cash flow: Direct presentation: Operating cash flows are presented as a list of cash flows; cash in from sales, cash out for purchases, etc. Simple but rarely used method, as the indirect presentation is more common. Page 147

149 Indirect presentation: Operating cash flows are presented as a reconciliation from profit to cash flow: Profit P Depreciation D Amortization A Impairment expense I Change in working capital ΔWC Change in provisions ΔP Interest Tax (I) Tax (T) Operating cash flow OCF The items in the cash flow statements are not cash flows but reasons why cash flow is different from profit. Depreciation expense reduces profit but does not impact cash flow. Hence, it is added back. Similarly, if the starting point profit is above interest and tax in the income statement, then interest and tax cash flows will need to be deducted if they are to be treated as operating cash flows. There is no specific guidance on which the profit amount should be used in the reconciliation. Different companies use operating profit, profit before tax, profit after tax, or net income. Clearly, the exact starting point for the reconciliation will determine the exact adjustments made to get down to an operating cash flow number. 2. Investing Cash Flow Investing activities are the acquisition and disposal of non-current assets and other investments not included in cash equivalents. Investing cash flows typically include the cash flows associated with buying or selling property, plant, and equipment (PP&E), other noncurrent assets, and other financial assets. Cash spent on purchasing PP&E is called capital expenditures (or CapEx for short). 3. Financing Cash Flow Financing activities are activities that result in changes in the size and composition of the equity capital or borrowings of the entity. Financing cash flows typically include cash flows associated with borrowing and repaying bank loans, and issuing and buying back shares. The payment of a dividend is also treated as a financing cash flow. Calculation of cash flow from operating activities Cash flow from operation means cash generated in the business as a result of producing goods and services. It can be ascertained either by direct or by indirect method. Direct method Page 148

150 Under the direct method, major classes of gross cash receipts and gross payments are disclosed. In this method, cash receipts from operating revenues and cash payments for operating expenses are calculated to arrive at cash flows from operating activities. The differences between the cash receipts and the payments in the net cash flow from operating activities. Cash flow from operating activities under direct method may be calculated in the following manner: Cash received from debtors xxx Cash paid to creditors (xxx) Cash paid to employees (xxx) Cash operating expenses paid (xxx) Interest paid (xxx) Income tax paid (xxx) Net cash flow from operating activities xxx Indirect method Indirect method is also known as net profit method or reconciliation method. This method starts with net profit or net loss as per the profit and loss account. The net cash flow from operation is determined by adjusting the net profit or loss for the effect of: a. Non cash items such as depreciation, provision, deferred taxes, unrealized foreign exchange gains/losses. b. Changes during the period in inventories and receivables and payables ie, changes in current assets and current liabilities. c. All other items which affect cash included in investing and financing activities such as loss/gain on sale of fixed assets and investments. Indirect method is widely used. This method is specially used when amount of sales is not given in the question. Cash flow from operating activities under indirect method may be calculated in the following manner. Cash flow from operating activities Net profit before tax xxxx Add: non cash and non operating items: Depreciation` xxx Preliminary expenses written off xxx Discount on issue of shares and debentures xxx Goodwill patents etc, written off xxx Loss on sale of fixed asset xxx Provision for doubtful debts etc xxx Dividend paid xxx Under writing commission written off xxx Page 149

151 Xxx Less: items to be deducted Rent received Interest received Dividend received Profit on sale of fixed asset, investment Operating profit before working capital changes Add: decrease in current assets(individually) Increase in current liability Less: increase in current assets (individually) Decrease in current liability Cash generated from operation Example xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx From the following summary of Cash Account of X Ltd., prepare Cash Flow Statement for the year ended 31st March 2007 in accordance with AS-3 using the direct method. The company does not have any cash equivalents. Page 150

152 1. Prepare Cash Flow Statement of Suryan Ltd. from the following: (a) During 2006, the business of a sole trader was purchased by issuing shares for Rs. 2, 00,000. The assets acquired from him were: Goodwill Rs. 20,000, Machinery Rs. 1, 00,000, Stock Rs. 50,000 and Debtors Rs. 30,000. (b) Provision for tax charged in 2006 was Rs. 35,000. (c) The debentures were issued at a premium of 5% which is included in the retained earnings. (d) Depreciation charged on machinery was Rs. 30,000. Page 151

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154 2. From the following Balance Sheets of Exe Ltd. make-out Cash Flow Statement: Additional Information: Page 153