Chapter 3 Various Accounting Standards issued by ASB

Transcription

1 Chapter 3 Various Accounting Standards issued by ASB 3.1 Introduction Accounting is as old as money itself Chanakya in his Arthashastra emphasized on the existence and the need of proper accounting and auditing. However, modern system of accounting owes its origin to Pacioli who lived in Italy in the 18th century. In those early days, business transactions were not so complex due to the existence of small and easily manageable organizations, which were managed by the proprietor himself. Accounting to be useful on an integral basis for economic development must be convenient and practiced in a broad context. It must encompass the private and public enterprises (financial and management) and government and national accounting, these branches of accounting refers to accounting information system. Accounting standards have been and are being formulated at different levels. At the international level, the accounting standards are set up by the International Accounting Standards Board. For different countries, the accounting standards are formulated by duly recognized and constituted authority keeping in mind: the objective of harmonizing the national accounting standards, and the legal provisions of accounting practices and other factors relating to that particular country. According to AICPA-1 (1973), Accounting standards may be regarded as a principal which has been logically derived from the objective of accounting, which has been awarded the stamp of authority with the intention of producing guidelines for formulation of accounting practices comparable with the objective The accounting standard setting, by its very nature, involves reaching an optimum balance of the requirements of financial information for various interest-groups having a stake in financial reporting. With a view to reach consensus, to the extent possible, as to the requirements of the relevant interestgroups and thereby bringing about general acceptance of the Accounting

2 Standards among such groups, considerable research, consultations and discussions with the representatives of the relevant interest-groups at different stages of standard formulation is being done. 3.2 Various Accounting Standards issued by ASB Taking into account, the need of the hour, Accounting Standards Board (ASB) also tries to adopt International Accounting Standards/International Financial Reporting Standards. So far the Accounting Standards Board has issued 32 Accounting Standards. They are:- AS-1 Disclosure of Accounting Policies AS-2 Valuation of Inventories AS-3 Cash Flow Statements AS-4 Contingencies and Events Occuring after the Balance Sheet Date AS-5 Net Profit or Loss for the period, Prior Period Items and Changes in Accounting Policies AS-6 Depreciation Accounting AS-7 Accounting for Construction Contracts AS-8 Accounting for Research and Development AS-9 Revenue Recognition AS-10 Accounting for Fixed Assets AS-11 Accounting for the Effects of Changes in Foreign Exchange Rates AS-12 Accounting for Government Grants AS-13 Accounting for Investments AS-14 Accounting for Amalgamations AS-15 Accounting for Retirement Benefits in the Financial Statement of Employers AS-16 Borrowing Costs AS-17 Segment Reporting AS-18 Related Party Disclosures AS-19 Leases AS-20 Earnings Per Share 31

3 AS-21 Consolidated Financial Statements As-22 Accounting for Taxes on income AS-23 Accounting for investments in Associates in Consolidated Financial Statements AS-24 Discontinuing Operations AS-25 Interim Financial Reporting AS-26 Intangible Assets AS-27Financial Reporting of Interests in Joint Ventures AS-28 Impairment of Assets AS-29 Provisions, Contingent Liabilities and Contingent Assets AS-30 Financial Instruments: Recognition and Meausrement AS-31 Financial Instruments: Presentation AS-32 Financial Instruments: Disclosures 3.3 Accounting Standards in brief AS-1 DISCLOSURE OF ACCOUNTING POLICIES -Accounting Policies- refer to specific accounting principles adopted by the enterprise in the preparation and presentation of financial statement. The choice of the appropriate accounting principles and the methods of applying those principles in the specific circumstances of each enterprise call for considerable judgement by the management of the enterprise. -The view presented in the financial statements of an enterprise of its state of affairs and of the profit or loss can be significantly affected by the accounting policies followed in the preparation and presentation of the financial statements. - All significant accounting policies adopted in the preparation and presentation of the financial statements should be disclosed. Such disclosure should form part of the financial statements and should normally disclosed in one place. 32

4 Areas in Which Differing Accounting Policies are Encountered- The following are examples of the areas in which different accounting policies may be adopted by different enterprises- Methods of depreciation, depletion and amortization Treatment of expenditure during construction Conversion or translation of foreign currency items Valuation of inventories Treatment of goodwill Valuation of investments Treatment of retirement benefits Recognition of profit on long-term contracts Valuation of fixed assets Treatment of contingent liabilities. The above list of examples is not intended to be exhaustive Considerations in the Selection of Accounting Policies Basic objective of selection of accounting policies is that financial statements should be prepared on the basis of such accounting policies, which exhibit true and fair view of state of affairs of balance sheet and the profit and loss account. -For this purpose, the major considerations governing the selection and application of accounting policies are: a. Prudence b. Substance over form c. Materiality -If the fundamental accounting assumptions viz. Going concern, Consistency and Accrual are followed in the financial statements specific disclosure is not required. If a fundamental accounting assumption is not followed, the fact should be disclosed. 33

5 Disclosure of Accounting Policies -To ensure proper understanding of financial statements, it is necessary that all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. -Such disclosure should form a part of the financial statements. It would be helpful to the reader of financial statements if they are all disclosed as such in one place instead of being scattered over several statements, schedules and notes. -Any change in the accounting policies which has a material effect in the current period or which is reasonably expected to a have a material effect in later periods should be disclosed. In the case of a change in the accounting policies which has a material effect in the current period, the amount by which any item in the financial statement is affected by such change should also be disclosed to extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact should be disclosed. -Disclosure of accounting policies or of changes therein cannot remedy a wrong or inappropriate treatment of the item in the accounts. 34

6 AS-2 VALUATION OF INVENTORIES Objective A primary issue in accounting for inventories is the determination of the value at which inventories are carried in the financial statements until the related revenues are recognized. This AS is Applied in accounting for inventories other than -Work-in-progress arising under construction contracts, including directly related service contracts. -WIP arising in the ordinary course of business of service providers. -Shares, debentures arising in the ordinary course of business of service providers. -Producer s inventories of livestock, agriculture and forest products and mineral oils, ores and gases to the extent that they are measured at net realizable value in accordance with well established practices in those industries. Inventories are assetsa. held for sale in the ordinary course of business b. in the process of production for such sale; or c. in the form of materials of supplies to be consumed in production process or rendering of services. d. NRV is the estimated selling price in the ordinary course of business less the estimated costs for completion and the estimated costs necessary to make the sale. e. inventories should be valued at the lower of cost and NRV. Cost of inventories- the cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. 35

7 Exclusions from inventories- - abnormal amounts of wasted materials, labour and other production costs. - Storage costs, unless those costs are necessary in the production prior to further production stage. - administration O/H that do not contribute to bringing the inventories to their present location and condition and - selling and distribution costs. Cost formula- - specific identification method means directly linking the cost with specific item of inventories. This method is applicable in the following conditions- in case of purchase of item specifically segregated for specific project and is not ordinarily inter-changeable. in case of goods or services produced and segregated for specific project. - where specific identification method is not applicable, the cost of inventories is valued by the following method- FIFO Weighted Average Cost - cost of inventories in certain conditions- when it is impracticable to calculate the cost, the following methods may be followed to ascertain cost. Standard Cost Retail Method NRV- NRV is estimated on the basis of most reliable evidence at the time of valuation. Estimation of NRV is made as at each Balance Sheet date. 36

8 Estimation of NRV- the NRV of the materials and other supplies used in the production of finished goods is estimated under- -if finished product in which raw material and supplies used is sold at cost or above cost, then the estimated realizable value of raw material and supplies is considered more than its cost. -if finished product in which raw material and supplies used is sold below cost, then the estimated realizable value of raw material or supplies is equal to replacement price of raw material or supplies. Disclosure in the financial statements- - Accounting policy adopted in measuring inventories. - Cost formula used. - Classification of inventories- like finished goods, raw material, spare parts and its carrying amount. 37

9 AS-3 CASH FLOW STATEMENTS Applicability This standard applies to the following enterprises- -Which has turnover more than Rs. 50 crores in financial year. -listed companies-cash flow statement of listed companies shall be presented only under indirect method as prescribed in AS-3. Benefits of Cash Flow Information A cash flow statement, when used in conjunction with the other financial statements, provides information that enables users to evaluate the changes in net assets of an enterprise, its financial structure (including its liquidity and solvency) and its ability to affect the amounts and timing of cash flows in order to adapt to changing circumstances and opportunities. Presentation of Cash Flow Statement The cash flow statement should report each flows during the period classified by operating, investing and financial activities. -Operating Activities-They are principal revenue producing activities of the enterprises other than investing and financing activities -Investment Activities-The activities of acquisition and disposal of long term assets and other investment not included in cash equivalents and disposal of debt and equity instruments, properly and fixed assets etc. -Financing Activities- Are those activities which result in change in size and composition of owners capital and borrowing of the organization. Reporting Cash Flows from operating activities- a) The Direct Method, whereby major classes of gross cash receipts and payments are disclosed. 38

10 b) The Indirect Method, whereby net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future. Operating cash receipt or payments and items of income or expense associated with investing or financing cash flows. Reporting Cash Flows from investing and financing activities An enterprise should report separately major classes of gross cash receipts and gross payments arising from investing and financing activities, except to the extent that cash flows reported on a net basis. Reporting cash flows on Net Basis- Cash flows arising from the following operating, investing and financing activities may be reported on a net basis- -cash receipts and payments on behalf of customers when the cash flows reflect the activities of the customer rather than those of the enterprise, and -each receipts and payments for the items in which the turnover is quick, the amount are large, and the maturities are short. Foreign Currency cash flows- The effect of change in exchange rate in cash and cash equivalents held in foreign currently should be reported as separate part the reconciliation of cash and cash equivalents. Unrealized gain and losses arising from changes in foreign exchange rates are not cash flows- Extraordinary items- The cash flows associated with extraordinary items should be classified as arising from operating, investing or financing activities as appropriate and separately disclosed. 39

11 Interest- Interest Received- - from investment-investment activities - from short term investment-as cash equivalents should be considered as cash inflows from operating activities. - on trade advances and operating receivables should be in operating activities Interest paid- - on loans debt in financing activities - on working capital loan and any other than taken to finance operating activities in operating activities. Dividend Received- -For financial enterprises- in operating activities. -For other than financial enterprises-in Investing activities. Dividend Paid- Always as financing activities. Treatment of Tax- -Cash flow for tax payments/refund- Operating activities. -If cash flow can be specifically identified as cash flow from investment, financing activities, appropriate classification should be made. Investment in associates, subsidiaries and joint Ventures - Report in cash flow statement only cash flow between it and investee. Cash flow relating to acquisition or disposal of subsidiaries -Presented separately and classified as investing activities. 40

12 Non-cash transactions- -Investing and financing transactions that do not involve the use of cash and cash equivalents should be excluded from cash flow statement. Disclosure of cash and cash equivalents An enterprise should disclose the components of cash and cash equivalents and should present a reconciliation of the amount in the cash flow statement with equivalent items reported in the balance sheet.

13 AS-4 CONTINGENCIES AND EVENTS OCCURRING AFTER BALANCE SHEET DATE Contingencies refers to- -Existing conditions or situations -Result of which (contingencies) would be known only on happening or nonhappening of certain events in future. -Results may be either a gain or loss. Contingencies- -the amount of a contingent loss should be provided for by a charge in the statement of profit and loss if; -It is probable that future events will confirm that, after taking into account any related probable recovery, on asset has been impaired or a liability has been incurred as at the balance sheet date and -A reasonable estimate of the amount of the resulting loss can be made. -the existence of a contingent loss should be disclosed in the financial statement if either of the above conditions is not met, unless the possibility of a loss is remote. -contingent gain should not be recognized in the financial statements. Events Occurring After Balance Sheet Date- -assets and liabilities should be adjusted for events occurring after the balance sheet date that provide additional information to assist the estimation of amounts relating to conditions existing at the balance sheet date or that indicate the fundamental accounting assumption of going concern is not appropriate. -dividends stated in respect of the period covered by the financial statements, which are proposed or declared by the enterprise after the balance sheet date but before approval of the financial statement, should be adjusted. 42

14 -disclosure should be made in the report of the approving authority of those events occurring after the balance sheet date that represent material change and commitments affecting the financial position of the enterprise. Disclosure- - if the disclosure of contingencies is required, the following should be provided- -the nature of contingency. -the uncertainties which may affect the future outcome. -as estimate of the financial effect, or a statement that estimate cannot be made. -if disclosure of events occurring after the balance sheet date in the report of the approving authority is required, the following information should be provided- -the nature of the event -an estimate of the financial effect, or a statement that such an estimate cannot be made. 43

15 AS-5 NET PROFIT OR LOSS FOR THE PERIOD, PRIOR PERIOD AND CHANGES IN ACCOUNTING POLICIES Net profit or loss for the period- all items of income and expenses which are recognized in a period should be included in the determination of net profit or loss for the unless an accounting standard required or permits otherwise. The net profit or loss for the period comprises the following components- i) profit or loss from ordinary activities and ii) extraordinary activities. i) profit or loss from ordinary activities- when items of income and expenses within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately. ii) extraordinary activities- extraordinary items should be disclosed in the statement of profit and loss as a part of net profit or loss for the period. The nature and the amount of each extraordinary item should be separately disclosed in the statement of profit or loss in such a manner that its impact on current profit or loss can be perceived. Prior period items- The nature and amount of prior period items should be separately disclosed in the statement of profit and loss in a manner that their impact on the current or loss can be perceived. Changes in Accounting Estimates - The effect of a change in an accounting estimate should be included in the determination of net profit or loss in- the period of the change; if the change affects the period only; or 44

16 the period of the change and future periods, if the change affects both. - The effect of a change in an accounting estimate should be classified using the same classification in the statement of profit and loss as was used previously for the estimate. - The nature and amount of a change in an accounting estimate which has a material effect in the current period, or which is expected to have a material effect in subsequent periods, should be disclosed. If it is impracticable to quantify the amount this fact should be disclosed. Changes in Accounting Policies A change in an accounting policy should be made only if the adoption of a different accounting policy is required by statute or for compliance of an accounting standard or, if it is considered that the change would result in a more appropriate presentation of the financial statements of the enterprise. Disclosure of change in Accounting Policies Material effect should be shown in financial statement to reflect the effect of such change. This effect should be disclosed in the year of change. If the effect of change is not ascertainable, the fact should be disclosed. If the effect of change is not material for current period, but it is material effect for the latter period, then fact should be disclosed in the period of change. 45

17 AS-6 DEPRECIATION ACCOUNTING - The depreciable amount of a depreciable asset should be allocated on systematic basis to each accounting period during the useful life of the asset. - The depreciation method selected should be applied consistently from period to period. Change in depreciation method is done in following conditions- For compliance of statute For compliance of accounting standards For more appropriate presentation of the financial statements. - When such a change in the method of depreciation is made, depreciation should be recalculated in accordance with the new method from the date of the asset coming into use. The deficiency or surplus arising from retrospective re-computation of depreciation in accordance with the new method should be adjusted in the accounts in the year in which the method of depreciation is changed. In case the change in the method results in deficiency in depreciation in respect of past years, the deficiency should be charged in the statement of profit and loss. In case the change in the method results in surplus, the surplus should be credited to the statement of profit and loss. Such a change should be treated as a change in accounting policy and its effect should be quantified and disclosed. Disclosure- The total cost of each class of assets historical cost or revalued cost. Total depreciation for the period of each of assets. Accumulated depreciation of each class of assets. Depreciation method. Depreciation rates or the useful life of the assets, if they are different than the rates specified in governing status. 46

18 AS-7 CONSTRUCTION CONTRACTS Types of construction contracts Fixed price contracts. Cost plus contracts. Combining and Segmenting Contracts For accounting purpose usually requirement of this accounting standard is applied separately to each contract to calculate profit or loss from the contract but under some circumstances the profit/loss may be calculated in combination of two or more contracts or group of combined contracts, basically group of contract may be combined for accounting purpose because in substance these contracts are part of single project with an overall profit margin Contract Revenue the initial amount of revenue agreed in the contract and variations in contract work, claims and incentive payments, -to the event that is probable that they will result in revenue; and -they are capable of being reliably measured. Contract Costs costs that relate directly to the specific contract; costs that are attributable to contract activity in general and can be allocated to the contract and Such other costs as are specifically chargeable to the customer under the terms of the contracts. Contract revenue and expenses Revenue recognized in the period in which work is performed. 47

19 Expenses recognized in the period in which the work to which expenses relate is performed. Conditions for recognizing the contract revenue- Total contract revenue can be measured reliably. It is probable that economic benefits associated with contract will flow to the contractor. Total contract cost and cost up to stage completion is measured reliably. Contract cost attributable to contract can be clearly identified. Uncertainty in collection amounts to expenses When some uncertainty arises about the collectability of an amount already included in contract revenue and already recognized in profit and loss statement amounts to expense. This uncollectible amount of which recovery has ceased to be probable is recognized as an expense rather than as adjustments to contract revenue. Disclosure -An enterprise should disclose- -the amount of contract revenue recognized as revenue in the period; -the methods used to determine the contract revenue recognized in the period and -the methods used to determine the stage of completion of contracts in process. -Disclose the following for contracts in process at the reporting -the aggregate amount of costs incurred and recognized profits up to reporting date. -the amount of advances received; and -the amount of retentions. -An enterprise should present- -the gross amount due from customers for contract work as an asset and -the gross due to customers for contract work as liability. 48

20 AS-9 REVENUE REGONISITION Objective The standard explains when the revenue should be recognized in profit and loss account and also state the circumstances in which revenue recognition can be postponed. Applicability Not applicable to following revenue or gain - Construction Contracts (Covered under AS-7) - Hire Purchase Agreements (Cover under AS-19) - Governments Grants or other similar subsidies (Cover under AS-12) - Insurance Contracts of Insurance Companies (Covered by a separate Statute) Revenue defined Revenue means the gross inflow of cash, receivable or other consideration arising in the course of ordinary activities of an enterprise from sale of goods, from rendering of services and from the use by others of the resources of the enterprise yielding interest, royalties and dividends. Timing of Revenue Recognition Revenue from sale of rendering services should be recognized at the time of sale or rendering of services. However, if at the time of rendering of services or sale there is significant uncertainty in the ultimate collection of revenue, then the revenue recognition is postponed and in such cases revenue should be recognized only when it become reasonably certain that ultimate collection will be made. It also applies to the revenue arising out of escalation of price; export incentive, interest etc. Revenue from sale of goods It is recognized when all the following conditions are fulfilled- 49

21 i. Seller has transferred the ownership of goods to buyer for a price or All significant risks and rewards of ownership have been transferred to buyer. ii. Seller does not retain any effective control of ownership of the transferred goods. iii. There is no significant uncertainty in collection of the amount of consideration (i.e. cash, receivable, etc.) Revenue from rendering of the services It is recognized as the service is performed. The performance of service is measured by two methods as under- -Completed service contract method- Revenue recognized when service is about to be completed and no significant uncertainties exist about the collection of service charges. -Proportionate Completion method- Revenue is recognized by reference to the performance of each act. The revenue recognized under this method would be determined on the basis of contract value, associated cost, number of acts or other suitable basis. Further, no significant uncertainty exists about the collection of amount of service charges of performed acts. Revenue from interest should be recognized on time proportion basis. Revenue from Royalties should be recognized on accrual basis as per terms of agreement. Revenue from Dividend should be recognized when the owner s right to receive payment is established. Disclosure When revenue recognition is postponed, the disclosure of the circumstances necessitating the postponement should be made. 50

22 AS-10 ACCOUNTING FOR FIXED ASSETS Scope AS 10 deals with recognition of fixed assets, elements that constitute cost of Fixed Assets items, as also the areas requiring specific accounting treatment. AS 10 is made applicable to financial statements prepared on historical cost basis. This accounting standard is not applicable to the following items- - Forests, plantations and similar regenerative natural resource. - Wasting assets like minerals, oil, and natural gas. - Expenditure on real estate development. - Live Stock. Fixed Assets It is an asset, which is- -Held with intention of being used for the purpose of producing or providing goods and service. -Not held for sale in the normal course of business. -Expected to be used for more than one accounting period. Composition of Cost-General Following principles apply in determining the historical cost of fixed assets- Purchase Price and any other costs directly attributing to bringing the asset to its working condition for its intended use. Like- -Import duties and other non-refundable taxes, -site preparation cost, -delivery and handling cost, -installation cost, -expenditure incurred on start up and commissioning of the project including the expenditure on test runs less income by sale of products, -administrative and other general overheads attributable for fixed assets, -loss/gain on deferred payment on foreign currency liability, 51

23 -subject to limitations prescribed under AS-16, finance and borrowing costs. Components of Cost- Some distinct areas- (I) Self constructed fixed assets- Cost of self constructed fixed assets; include the following- -All costs which are directly related to the specific assets. -All costs that are attributable to the construction activity should be allocated to the specific assets. -Any internal profit included in the cost should be eliminated. (II) Acquired in exchange for another- The cost of acquisition of fixed assets is determined under the different situations differently as under- Fixed Assets exchanged not similar- Assets acquired should be recorded either at fair market value of asset given up or fair market value of asset acquired, if this is more clearly evident. Fixed Assets exchanged are similar- Fixed Assets acquired is recorded at fair market value of assets given up or Fair Market Value of asset acquired, if this is more clearly evident or Net Book Value of the assets given up. Fixed Assets acquired in exchange of share or other securities- (When payment of fixed assets is made in shares or securities) Assets should be recorded at either fair market value of assets purchased of Fair Market Value of share or securities, whichever is more clearly available. Revaluation The following principles have a bearing on the method of accounting for revaluation of fixed assets- 1. An entire class of assets should be revalued or the selection of assets for revaluation should be made on systematic basis. This should be disclosed. 2. Revaluation of class of assets should not result in the net book value of the class being greater than the recoverable amount of assets of that class. 52

24 3. When a fixed asset is revalued upwards, accumulated depreciation existing at the date of revaluation should not be credited to profit and loss statement. 4. An increase in net book value arising on revaluation of fixed assets is normally credited to owner s interest under heading of revaluation reserves and it is not available for distribution. 5. A decrease in net book arising on revaluation of fixed assets is required to be charged to profit and loss statement with one exception. To the extent that such a decrease is considered to be related to a previous increase on revaluation included in revaluation reserve, the attributable amount is charged against that reserve. 6. An increase to be recorded is a reversal of previous decrease arising on revaluation which has been charged to profit and loss statement in which case the increase is credited to profit and loss statement to the extent that it offsets the previously recorded decrease. 7. A revalued fixed asset may be disposed. If this happens, difference between net disposal proceeds and the net book value should be charged or credited to P and L A/c with one exception. That such a loss is related to an increase which was previously recorded as a credit to revaluation reserve and which has not been subsequently reversed or utilized, may be charged directly to that reserve. Disclosure Requirements -Gross and net book values of fixed assets at the beginning and end of accounting period. -Additions, disposals, acquisitions and other movements in fixed assets. -Expenditure incurred for fixed assets that are in the process of construction or acquisition. -Amount substituted, if any, for historical cost of FA. 53

25 -Method adopted to compute the revalued amounts, the nature of indices used, the year of any appraisal made, and whether an external valuer was involved, in case fixed assets are stated at revalued amounts. 54

26 AS-11 EFFECTS OF CHANGES IN FOREIGN EXCHNAGE RATES Objective The principal issues in accounting for foreign currency transactions and foreign operations are to decide which exchange rate to use and how to recognize in the financial statements the financial effect of changes in exchange rates. Scope The Accounting Standards applies to -In accounting for transactions in foreign currencies. -In translating the financial statement of foreign operation-integral as well non-integral. -The accounting standard also prescribes the accounting for forward exchange contracts. Non-applicability- -Re-statement of an enterprise s financial statements from its reporting currency into another currency for the conveniences of users accustomed to that currency. -The presentation in a cash flow statement of cash flows arising from transactions in a foreign currency and the transactions of cash flows of foreign operations. -Exchange differences arising from foreign currency borrowing to the extent that they are regarded as an adjustment to interest cost. Definition -Closing rate is the exchange rate at the balance sheet date. -Exchange difference is the difference resulting from reporting the same number of units of a foreign currency in the reporting currency at different exchange rates. 55

27 -Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm s length transaction. -Foreign operation is a subsidiary, associate5, joint venture or branch of the reporting enterprise, the activities of which are based or conducted in a country other than the country of the reporting enterprise. -Forward exchange contract means an agreement to exchange different currencies at a forward rate. -Integral foreign operation is a foreign operation, the activities of which are an integral part of those of the reporting enterprise. -Monetary items are money held and assets and liabilities to be received or paid in fixed or determinable amounts of money. -Reporting currency is the currency used in presenting the financial statements. Classification for Accounting Treatment For the purposes of accounting treatment of the effect of change in foreign exchange rates, the transaction can be classified into following categories- -Category-I Foreign Currency transactions- - Buying or Selling the goods or services - Lending and borrowing in foreign currency - Acquisition and disposition of assets denominated in foreign currency. - Category-II Foreign Operations- - Foreign Branch -An Associate - Joint Venture -Foreign Subsidiary Further these are classified in two types- 56

28 -Integral operation -Non-Integral operation - Category-III Forwards Exchange Contracts- These may be of two types- -For managing risk/hedging -For trading and speculation Foreign Currency Transactions -Initial Recognition- A foreign currency transaction should be recorded, on initial recognition in the reporting currency, by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction. -Reporting at Subsequent Balance Sheet Dates- - Foreign currency monetary items should be reported using the closing rate. However, in certain circumstances, the closing rate may not reflect with reasonable accuracy the amount in reporting currency that is likely to be realized from, or required to disburse, a foreign currency monetary item at the balance sheet date. - Foreign currency non- monetary items- -Carried at historic cost- should be reported using the exchange rate at the date of the transaction; and -Carried at fair value- should be reported using the exchange rate that existed when the values were determined. -Recognition of Exchange Difference- All types of exchange differences will be charged to profit and loss account for the period. Translation of financial statement of foreign operation (Category-II) -INTEGRAL FOREIGN OPERATION-The individual items in the financial statements of the foreign operation are translated as if all these transactions had been entered into by the reporting enterprises. Therefore the financial statements 57

29 should be translated by using the principles as prescribed for foreign currency transactions of the reporting entity (as explained above). - NON INTEGRAL FOREIGN OPERATION- Accounts of non-integral foreign operation are translated using the following principles- (a) The assets and liabilities, both monetary and non-monetary, of the nonintegral foreign operation should be translated at the closing rate; (b) Income and expense items of the non-integral foreign operation should be translated at exchange rates at the dates of the transactions; and (c) All resulting exchange differences should be accumulated in a foreign currency translation reserve until the disposal of the net investment. Change in the Classification of a Foreign Operation When there is a change in the classification of a foreign operation; the translation procedures applicable to the revised classification should be applied from the date of the change in the classification. Accounting treatment of forward exchange contracts(category-iii) For the purpose of accounting treatment forward exchange contracts have been classified in two types- (i) entered for managing risk (hedging)- The premium or discount arising at the inception of such a forward exchange contract should be amortized as expense or income over the life of the contract. Exchange differences on such a contract should be recognized in the statement of profit and loss in the reporting period in which the exchange rates change. Any profit or loss arising on cancellation or renewal of such a forward exchange contract should be recognized as income or as expense for the period. (ii) entered for trading or speculation- When forward exchange contract is entered to earn profit by trading or speculation in foreign exchange, the accounting treatment shall be different as the object is not to reduce the risk but to gain. 58

30 As per the accounting standard premium or discount on such forward contract is not to be recognized. At each balance sheet date the value of contract is marked so its current market value, gains or loss on the contract is recognized. Disclosure An enterprise should disclose- - Amount of exchange difference included in the net profit or loss. - Amount accumulated in foreign exchange translation reserve. - Reconciliation of opening and closing balance of foreign exchange translation reserve. - If the reporting currency is different from the currency of the country in which entity is domiciled, the reason for such difference. - A change in classification of significant foreign operation needs following disclosures- - Nature of change in classification - The reason for the change. - Effect of such change on shareholders fund - Impact of change on net profit or loss for each prior period presented - The disclosure is also encouraged of an enterprise s foreign currency risk management policy. 59

31 AS-12 ACCOUNTING FOR GOVERNMENT GRANTS Scope Deals with important topic of grants or assistance in the form of both capital and revenue, from various government agencies. These grants are also referred to as subsidies, cash incentives, duty drawbacks etc. These can also be non-monetary. The standard provides accounting methods that can be followed, to suit specific situations. Government Grants Governments grants are assistants by the Govt. in the form of cash or kind to an enterprise in return for past or future compliance with certain conditions. Recognition of Govt. Grants The Govt. grants should be recognized when there is reasonable assurance that- -comply with the conditions attached to them and -the grants will be received. Kinds of Govt. Grants Govt. grants are of following types- -Non-monetary Govt. grants (Grants in form of assets such as land, plant and mach. etc) -Grants are given at concessional rate, and then such assets are accounted for at their acquisition cost. -Grants are given free of cost, then such assets are recorded at nominal value. -Monetary Grants- Grants related to depreciable fixed assets- There are two accounting treatments- -shown as deduction from the gross value of asset in arriving its book value. 60

32 -treated as deferred income. The deferred income is recognized in profit and loss account on systematic and rational basis over useful life of assets. -Grants related to non-depreciable fixed assets- -shown as deduction from the gross value of asset in arriving its book value. -if the conditions attached to grants are fulfilled, grants are credited to Capital Reserve A/c or -If condition attached to grants is yet to be fulfilled -credited to income over the same period over which the cost of meeting such conditions is charged to income. -unapportioned deferred income is disclosed in the balance sheet as Deferred Govt. Grants Grants related to Revenue Govt. grants related to revenue should be recognized on a systematic basis in the profit and loss statement. Such recognition should be spread over the periods necessary to match them with the related costs, which the grant is intended to compensate. Grants related to Promoter s Contribution should be credited to Capital Reserve and it should form part of the shareholder s funds. Refund of Govt. Grants -Refund of grants related to revenue- -should be adjusted against any unamortized deferred govt. grants, if any -remaining balance amount of refund should be charged to Profit and Loss A/c -Refund of grants related to specific assets- The amount refundable and relating to a specific fixed asset should be accounted for by increasing the book value of the assets, or by reducing the capital reserve, or the deferred income balance, as appropriate. 61

33 Disclosure The following disclosures are appropriate 1. The accounting policy adopted for Govt. grants including the methods of presentation in the financial statement. 2. The nature and extent of Govt grants recognized in the financial statements including grants of non-monetary assets given at a concessional rate or free of cost. 62

34 AS-13 ACCOUNTING FOR INVESTMENTS Scope Deals with the vital accounting aspects concerning investments. These include classification, determination of cost for initial recognition, disposal and re-classification of investments. Also prescribes appropriate procedures of valuation of investments in the financial statements. Applicability Does not deal with the following- -Bases for recognition of interest, dividend and rental earned on investment. -Operating or finance lease. -Investment of retirement benefit plans and life insurance enterprises. -Mutual Funds, Venture Capital Fund and/or the related Asset Mgt. Co.s, banks and public financial institutions. Investment Investments are assets held by an enterprise for earning income by way of dividends, interest and rentals, for capital appreciation, or other benefits to the investing enterprise. Classification of Investments Investments is classified into current and long term investment- -Current investments are those, which are readily realizable, and are intended to be held for not more than twelve months from the date of investment. -Long term investments are falling outside the ambit of current investments. Cost of Investments Cost of investment comprises of purchase price and acquisition charges such as brokerage, fees and duties etc. 63

35 -Acquired by issue of shares or other securities- purchase price of investment is the fair value of the securities issued. -Acquired in exchange for another asset-fair value of the asset given up or fair value of the investment received if it is more clearly evident. -Pre-acquisition interest- Interest has accrued in the preacquisition period and was included in cost of investment at the time of acquisition, then subsequent receipt of interest is deducted from the cost of investments. -Dividend- When dividend is declared from pre-acquisition profits and later on received, then such amount of dividend is deducted from the cost of investment. -Right Shares- -If right shares offered are subscribed, then cost of right shares is added to the carrying amount of the investment. -If right shares offered are not subscribed but right is sold in the market, then sale proceeds are taken to Profit and Loss A/c provided original shares on which right is not acquired cum-right. -Acquired Cum-right- If investments are acquired cum-right and after that it becomes ex-right then the cost of investments is to be reduced by the amount received on sale of rights. Carrying amount of Investment (Valuation) -Current Investment- Carrying amount of each current investment is the lower of cost and realizable value. Any reduction in realizable value is debited to profit and loss account; however if realizable value of investment is increased subsequently, the increase in value of current investment to the level of the cost is credited to profit and loss account. 64

36 -Long term investment- -It is usually carried/valued at cost. - Long-term investments are usually of individual importance to the investing enterprise. The carrying amount of long-term investments is therefore determined on an individual investment basis. -Where there is a decline, other than temporary, in the carrying amounts of long term investments, the resultant reduction in the carrying amount is charged to the profit and loss statement. The reduction in carrying amount is reversed when there is a rise in the value of the investment, or if the reasons for the reduction no longer exist. Investment Properties The cost of any shares in a co-operative society or a company, the holding of which is directly related to the right to hold the investment property, is added to the carrying amount of the investment property. Disposal of Investments On disposal of an investment, the difference between the carrying amount and the disposal proceeds, net of expenses, is recognized in the profit and loss statement. When disposing of a part of the holding of an individual investment, the carrying amount to be allocated to that part is to be determined on the basis of the average carrying amount of the total holding of the investment. Reclassification of Investments Where long-term investments are reclassified as current investments, transfers are made at the lower of cost and carrying amount at the date of transfer. 65

37 Where investments are reclassified from current to long-term, transfers are made at the lower of cost and fair value at the date of transfer Disclosures -Accounting policies followed for valuation of investment. -Classification of investment into current and long term in addition to classification as per Schedule VI of Companies Act in case of company. -Agreement amount of quoted and unquoted securities separately. -Any significant restriction on investment like minimum holding period for sale/disposal, utilization of sale proceeds, or non-remittance of sale proceeds of investment held outside India. 66

38 AS-14 ACCOUNTING FOR AMALGAMATION Definitions -Amalgamation means an amalgamation pursuant to the provisions of the Companies Act, 1956 or any other statute which may be applicable to companies. -Consideration for the amalgamation means the aggregate of the shares and other securities issued and the payment made in the form of cash or other assets by the transferee company to the shareholders of the transferor company. Accounting Standard in case of amalgamation This accounting standard deals with accounting to be made in the books of Transferee Company in case of amalgamation. This Accounting Standard is not applicable to cases of acquisition of shares when one company acquired/purchases the share of another company and the acquired company is not dissolved and its separate entity continues to exist. Types of Amalgamation As per this standard, there are two types of amalgamations- -Amalgamation in the nature of merger. -Amalgamation in the nature of purchase Amalgamation in the nature of merger An amalgamation is in the nature of merger if following conditions are satisfied- -All assets and liabilities of Transferor Company are taken over by the transferee company. -The shareholders holding at least 90% or more of the equity share of the transferor company become the equity shareholder of the transferee company. 67

39 -Consideration for the amalgamation is paid in equity shares (except fractional shares can be paid in cash). -Business of the transferor company is intended to be carried on by the transferee company. -No adjustment made in the book value of the assets and liabilities except the adjustments to ensure uniformity of accounting policies. Amalgamation in the nature of purchase An amalgamation will be considered in the nature of purchase if any of the conditions regarding amalgamation in the nature of merger is not satisfied Accounting Method There are two main methods of accounting for amalgamations: (a) the pooling of interests method; and (b) the purchase method Pooling Of Interests Method Under the pooling of interests method, the assets, liabilities and reserves of the transferor company are recorded by the transferee company at their existing carrying amounts. If, at the time of the amalgamation, the transferor and the transferee companies have conflicting accounting policies, a uniform set of accounting policies is adopted following the amalgamation. The effects on the financial statements of any changes in accounting policies are reported in accordance with Accounting Standard (AS) 5, Prior Period and Extraordinary Items and Changes in Accounting Policies. The Purchase Method Under the purchase method, the transferee company accounts for the amalgamation either by incorporating the assets and liabilities at their existing carrying amounts or by allocating the consideration to individual identifiable 68