TWO WORDS FROM AUTHOR

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1 TWO WORDS FROM AUTHOR Accounting Standard is the foundation of accounts. We can t learn accounts without the use of accounting standards. Accounts without Accounting Standard are like breathing without oxygen! I know many of the students avoid learning accounting standards with the reason that these are very difficult. What I feel is that the Accounting standards seems to be difficult not because they are but because they are given in somewhat difficult language & exactly here the role of the teacher starts. It is the responsibility of the teacher to make the Accounting standards easy & create the interest of the students in it. Thus these notes are divided in 2 parts: 1. Conceptual questions to understand the basic concepts in particular Accounting Standard & their use, 2. Practical questions to apply these concepts & to get the mastery on it. So lets start the journey of knowledge in accounting standards and I am sure everyone will not only realize the importance of Accounting Standards but also will start enjoying them and applying them in their studies Accounting Standard well as practical life also. Remember The journey of miles starts with the first step only Good luck. CA Yogesh Panchakshari ,

2 INDEX AS No. Accounting Standard Page No. 1 Disclosure of Accounting Policies 3 2 Valuation of Inventories 9 3 Cash Flow Statement 18 4 Contingencies & Events Occurring after balance sheet date 22 5 Net Profit Or Loss For The Period, Prior Period Items And Changes In 28 Accounting Policies 6 Depreciation Accounting 33 7 Construction Contracts 37 8 Not in Existence 9 Revenue Recognition Accounting For Fixed Assets Effects of changes in foreign exchange rates Accounting for government grants Accounting for Investments Accounting for Amalgamation Accounting for employee benefits Borrowing Cost Segment Reporting Related party Disclosure Accounting for Leases Earnings Per Share Consolidated Financial Statement (Holding Company Accounts) Accounting for taxes on Income 23 Accounting For Investments In Associates In Consolidated Financial Statements Discontinuing Operations Interim Financial Reporting Intangible Assets Financial Reporting Of Interests In Joint Venture Impairment of Assets Provisions, Contingent Liabilities And Contingent Asset , 31 & 32 Accounting for financial instruments 171 2

3 AS-1 DISCLOSURE OF ACCOUNTING POLICIES OBJECTIVE: To give guidelines for basic accounting principles and the disclosures to be made by our client. Conceptual Questions: Q. 1 Our client Vijay is confused with accounting policy term comment. Ans Accounting policy is the policy used in day to day accounting by our client. It includes methods of depreciation, inventory valuation, cash vs. accrual system etc. AS 1 helps to choose proper accounting policy. Q. 2 Anil gave the comments below the Balance Sheet as an auditor. Directors refused to disclose it in the books of accounts. Comment. Ans Such footnote is called as Notes to Accounts. It has legal validity and thus it must be disclosed. Q. 3 Your client Akshay, changed his method of depreciation. Comment. Ans As per AS1, method of depreciation should be unchanged as per AS or any law. In this case, he must disclose impact of such change in current year and subsequent years also; if impact can t be calculated then it should be disclosed. Q. 4 Our client Ajay is confused about fundamental accounting assumptions. Comment. Ans Following three principles are assumed to be followed by every accountant. 1) Going Concern Long life of business. 2) Consistency No change in accounting policy 3) Accrual All outstanding expense and incomes are considered properly. If anyone of these principles is not followed then we should disclose it separately as per AS 1. Q. 5 Out client Akshay is implementing accounting system in his new business. Suggest three principles to be followed for choosing accounting policy. Ans Principles: 1) Prudence (Rationality) Accounting should be rationally acceptable. 2) Materiality All the material (important) factors must be disclosed separately. 3) Substance over form It means some disclosure should be made even if it is not given in format. For e.g. Managerial Remuneration. 3

4 Practical Questions: 1. Can same type of inventory at two different factories be valued by applying two different accounting policies? 2. The gross block of fixed assets are shown at the cost of acquisition, which includes tax, duties (net of MODVAT and set off availed) and other identified direct expenses. Interest on borrowing to finance the fixed assets is not capitalized. Comment. 3. Fixed assets are stated at cost of acquisition or construction including attributable interest and financial cost till such assets are put to use less specific grants received. Comments. 4. PPA Ltd. As consistently followed in the past the LIFO cost formula in inventory valuation, hence it continues to follow the same: 5. A Partnership firm was formed to secure the tenders floated by BSNL for publication of telephone directories in It bagged the tender for publishing directly for Pune circle for 5 years. It has made a profit in , , and It bid in tenders for publication of directories for other circles Nagpur, Nashik, Mumbai, Hyderabad but failed to bag any of these. You are auditing the accounts of Is the going concern assumption appropriate for preparation of accounts for ? 6. In Question if the situation continues during the year would your answer be different? 7. A & Co., a partnership firm has prepared its accounts on cash basis. 8. A Limited has sold its building for Rs. 50 lakhs. The purchaser has paid the full price. Company has given possession to the purchaser. The book value of the building is Rs. 35 lakhs. As at 31 st March 2003, documentation and legal formalities are pending. The company has not recorded the disposal. It has shown the amount received as advance. Do you agree with the treatment? 9. PPF Ltd. has taken a loan of Rs. 10 crores from ICICI Limited. Its bankers Canara Bank have given guarantee to ICICI on its behalf. PPF Ltd. has mortgaged its assets to Canara Bank. PPF Ltd. has disclosed this loan in its balance sheet as unsecured loan on the grounds that no security has been given to the lender ICICI Ltd. 10. Sanjay Ltd. follows the practice of disclosing accounting policies adopted in preparation of financial statements in the Directors report. Comment on this practice. 11. Shipuka Ltd. has disclosed accounting policies related to fixed assets in schedule E Fixed Assets, accounting policies relating to investments in schedule F Investment, and accounting policies relating to inventories in schedule G Current assets, loan and advances and so on. Comment on this practice. 12. Taxmann Ltd. has not accounted for income tax in accordance with AS-22. They tell you (their auditors) that no qualification in audit report is necessary since disclosures have been given in notes to the accounts. 13. Can different methods of depreciation be followed for the same class of assets used in different plants? 14. X Co. Ltd charged depreciation on its asset on SLM basis. For the year ended it changed to WDV basis. The impact of the change when computed from the date of the asset coming to use amounts to Rs. 20 lakhs being additional charge. 4

5 Decide how it must be disclosed in Profit and Loss Account. Also, discuss when such changes in method of depreciation can be adopted by an enterprise as per AS Vinayak Chemical Ltd., a Government Company, is engaged in production of fertilizers and various nitrogenous chemicals. As per the Company s accounting policy, expenses incurred upto Rs. 25,000 relating to a future periods are expensed in the current year. The Statutory Auditors of the Company, opine that the Company has not complied with AS-1 and Sec. 209 (3) (b) of the Companies Act, 1956, which prescribes accrual basis of accounting. Does the aforesaid accounting policy of the Company violate the provisions of AS-1 and Sec. 209 (3) (b) of the Companies Act, 1956? 16. Gajamukh Ltd has accounted for its liability towards retirement benefits of its employees on cash basis, and had disclosed the same in the Notes on Accounts. Since, it has not followed the fundamental accounting assumption of accrual, the Auditors want to quality the report. The Company feels that a Qualified Audit Report is not necessary, since AS -1 simply requires a disclosure if a fundamental accounting assumption has not been followed. Comment. 17. Is there any specific disclosure under AS 1 for a Company in Liquidation? 18. Vignesh Ltd. Has changed the method of inventory valuation in the current year from FIFO to Weighted Average. The change, however, has no material effect on the Financial Statements for the current period; through it is likely to have a material effect in the next financial year. Is a disclosure of change necessary in the current year? 19. Ekadanta Ltd. Had made a rights issue of shares in In the offer document to its members, it had projected a surplus of Rs.40 Crores during the accounting year to end on The draft results for the year, prepared on the hitherto followed accounting policies and presented for perusal of the Board of Directors showed a deficit of Rs. 10 Crores. The Board in consultation with the Managing Director, decided on the followinga) Value year-end inventory at Works (Rs. 50 Crores) instead of the hitherto method of valuation of inventory at Prime Cost (Rs. 30 Crores). b) Provide depreciation for the year on straight line basis on account of substantial additions in Gross Block during the year, instead of on reducing balance method, which was hitherto adopted. As a consequence, the charge for depreciation at Rs. 27 Crores is lower than the amount of Rs. 45 Crores, which would have been provided had the old method been followed, by Rs. 18 Crores. c) Not to provide for After Sales Expenses during the warranty period. Till the last year, provision at 2% of Sales used to be made under the concept of matching of costs against revenue and actual expenses used to be charged against the provision. The Board now decided to account for expenses as and when actually incurred. Sales during the year total to Rs. 600 Crores. d) Provide for permanent fall in the value of Investments which fall had taken place over the past five years the provision being Rs. 10 Crores. As Chief Accountants of the Company, you are asked by the Directors to draft the Notes on Accounts for inclusion in the Annual Report for Kapila Ltd., prior to receipt of their Management Consultants suggestions, had been valuing its stock consistently, by adding Factory Overheads to its Prime Cost. The Consultants had recommended a better procedure, which would ensure a fair allocation of Overheads. The Company intends to adopt 5

6 the new basis, but unwilling to accept the fact that this was a change in the basis of accounting as stated by their Consultants. Comments. 21. Write a short note on The concept of Materiality. Answers: Q. No. Answer Hints

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9 9 AS 2: VALUATION OF INVENTORIES OBJECTIVE: To give guidelines for valuation of inventory. Conceptual Questions: Q. 1 Arvind is confused about the stock valuation. Details are given below Material Market Price Cost Price P 50,000 60,000 Q 80,000 70,000 R 60,000 50,000 S 30,000 50,000 Ans As per AS 2, stock is valued at cost price or market price, whichever is lower. Thus stock should be valued as follows Material Market Price Cost Price Valued at P 50,000 60,000 50,000 Q 80,000 70,000 70,000 R 60,000 50,000 50,000 S 30,000 50,000 30,000 Total 2,00,000 Q. 2 Bhushan is requested to find out cost per unit as per information of two materials. Particulars A B Units purchased Purchase Price Sales Tax 10% 5% Excise Duty 20% 10% CENVAT Credit 60% 70% Octrio (for both) 20, Special Packing Units lost in transit Further expected loss 10% 5% Ans Rule as per AS2 Inventory must be valued after considering all the expense directly connected with bringing such inventory in today or existing conditions. Calculation is as follows: Particulars A B Purchasing Price 150, ,000 (Add) Sales Tax [on purchasing price] 15,000 6,000 (Add) Excise [on purchasing price 30,000 12,000 (Less) CENVAT [on excise] (18,000) (-8,400) (Add) Octrio [in the ratio units i.e. 3:2] 12,000 8,000 (Add) Special Packing - 6,000 Total Cost (I) 189, ,600 Effective Units Particulars A B Sent 3,000 2,000

10 (Less) Lost in transit (200) (400) 2,800 1,600 (Less) Further expected loss (280) (80) Effective units (II) 1,520 1,520 Cost per unit = I/II Rs. 75 Rs Q, 3 To which item AS2 is not applicable? Ans Following items to which AS2 is not applicable 1) Service contracts in process 2) Construction contracts in process 3) Livestock 4) Financial Instruments like shares, derivatives etc. Q. 4 Which methods are suggested for valuation of stock? Ans Methods suggested are Special Identification Method, Standard Cost Method, First in First Out (FIFO), Weighted Average Method (WAM). Practical Questions: 1. M Ltd values its finished goods at prime cost (FIFO) or net realizable value, whichever is less. Comments. 2. Paper Ltd., values its finished goods at lower of cost or net realizable value, and its by-products at net realizable value. Comment in the light of AS Asia Biscuit Ltd. has a normal capacity of 6,000 tonnes and the fixed annual overheads are Rs. 24,000. During the year, it manufactured only 5,500 tones at a variable cost consisting of material and Rs. 6 and Rs. 4 per tonne. At the end of the year, it had 1,800 tonnes of inventory. Find out the value of inventory as per AS Viptanu Ltd. produces 4 different types of capacitors. A, B, C and D. For the year their closing stock of finished goods have been valued as follows: A B C D Cost of production Rs. 5,00,000 Rs. 6,00,000 Rs. 4,00,000 Rs. 2,50,000 Net Realizable Value Rs. 4,80,000 Rs. 6,25,000 Rs, 4,10,000 Rs. 2,10,000 Find out the value of inventory. 5. How the following can be valued as per AS-2 for presentation in the financial statements. i) Inventories of live stocks ii) Agricultural and Forest products iii) Mineral Oils, and iv) Financial assets such as shares held as stock in trade. 6. An enterprise has in its stock, 10,000 bags of cement purchased at a cost of Rs. 180 per bag. The terms of trade are that the cement is delivered at the buyer s door, and the cost of delivery of Rs. 10 per bag is paid by the seller. The selling price of cement is Rs. 187 per bag. Find out the value of closing stock. 10

11 7. Blue Lagoon Ltd. produces a consumer durable whose cost of production consists of variable element of Rs. 240 per unit. The total annual production overheads are Rs. 25,00,000 out of which 40% are fixed. The company has an normal capacity of 10,00,000 per annum, but during the year , it produced 20,00,000 units, out of which 1,00,000 units are still unsold at the end of the year. Find out the value of the closing stock. 8. The cost of production (per unit) of a product is given below: Raw material Rs. 300 Direct Labour Rs. 90 Overheads Rs. 30 Rs. 420 At the end of the year, the firm has 1,500 units of raw material which are to be valued for financial statements. The current replacement cost of raw material is Rs. 280 per unit. Find out the value of raw material inventory if the selling price of the finished goods is (i) Rs. 450, or (ii) Rs During a year, Orpat Ltd. received an order for supply of 10 machines to be produced as per the specification given by ABC Ltd. 4 machines have already been completed and delivered to ABC Ltd. Work on the remaining 6 machines is at different stages of completion. Out of these, 4 units are virtually completed, but the finishing of which was suspended after receiving a request from the ABC Ltd. regarding withholding the delivery and production of remaining units. The accounting records show the valuation of inventory and debtors relating to this order as follow: Finished goods (3 units) Rs. 5,75,000 Work in Progress (3 units) Rs. 4,18,000 Debtors (ABC Ltd.) Rs. 6,50,000 At the end of the year, ABC Ltd. has already gone into the liquidation process. How Orpat Ltd. should show these items in the financial statements given that there is no market for these types of machines and are always manufactured as per the specification of the customer. 10. Cap Products Ltd. has an annual capacity of 40,000 units. The production overheads for the year are estimated at Rs. 3,20,000 whereas the total variable cost incurred is Rs. 6,90,000. The administrative costs and selling costs were Rs. 2,00,000 and Rs. 1,80,000 respectively. At the end of year, there were 6,000 units in stock. Find out the value of inventory given that the factory remained closed for one month for non receipt of orders which is a normal practice. Would your answer be different if the factory remained closed for any abnormal reason. 11. A business includes in its stock three major categories of goods : A, B and C. as 31 st March, 2002 the following information is available: Stock Category Historic Cost (Rs.) Replacement Cost Net Realisable Value A 25,000 26,500 18,500 B 32,500 30,000 32,000 C 25,000 28,000 36,000 Calculate the value of inventory to be shown in the balance sheet as on 31 st March, 2002 as per the requirement of AS Can interest on customs duty paid be included in the value of inventory? 13. In order to value the inventory of finished goods, HR Ltd. has adopted the standard cost or raw material, labour and overheads. Income tax officer wants to know the method, as per AS-2, for the valuation of raw material. 11

12 14. Mr. A, a wholesale trader in food grains claims that he is entitled to value his stocks at net realizable value since AS-2 does not apply to inventories of agricultural products. Is he justified? 15. Company purchases chemicals in drums. These are not returnable. Their cost cannot be ascertained since, the cost of these drums. Are these inventories within the meaning of AS-2 (revised)? 16. Can intangible assets be inventories within the meaning of AS-2 (Revised)? 17. As a Company Auditor how would you react to the following situations? Inventories of a Car manufacturing company includes the value of items, required for the manufacture of a model which was removed from the production line five years back, at cost price. 18. Can Materials issued on loan to other Companies / Contractors be classified along with Inventories or under the head Loans and Advances? 19. AS Ltd. Purchased goods at the cost of Rs. 40 lakhs in October. Till the end of the financial year, 75% of the stocks were sold. The Company wants to disclose Closing Stock at Rs. 10 Lakhs. The expected Sale Value is Rs. 11 lakhs and a commission at 10% on sale is payable to the agent. What is the correct value of Closing Stock? 20. AS Limited, manufacturing fancy terry towels has valued at the year-end, its Closing Stock of inventories of Finished Goods, (for which firm contracts have been received and goods are packed for export, but the ownership of which has been transferred to the foreign buyers) at the Realisable Value inclusive of profit and the export cash inventories. Give your views on the above. 21. State with reference to AS, how will you value the inventories in the following case. Per Kilogram of finished Goods consisted of Material Cost Rs. 100 per kg. Direct Labour cost Rs. 20 per kg and direct variable Production Overhead Rs. 10 per kg. Fixed Production charges for the year on normal capacity of 1,00,000 kg is Rs. 10 lakhs. 2,000 kg of Finished Goods are on stock at the year-end. 22. AS Ltd. s normal production volume is 50,000 units and the Fixed Overheads are estimated at Rs. 5,00,000. Give the treatment of Fixed Production OH under AS-2, if actual production during a period was a) 42,000 units, b) 50,000 units and 60,000 units ,000 units of Exe and 2,500 units of Wye arise jointly from a production process, involving a total cost of Rs. 2,60,000. If the Sales Value at split off point is Rs. 100 and Rs. 60 respectively for the products Exe and Wye, explain how the total Joint Cost of conversion will be allocated to the products. 24. AS Ltd. produces four Joint Products L, M, N and P from a joint process, incurring a cost of Rs. 5,71,200. Allocate the Joint Costs with the following information. Particulars L M N P Quantity Produced (in 000s) Sales Price per Kg Stock Quantity at end of year 10 kg Rs. 13 1,625 kg 12 Kg Rs kg 14 Kg Rs. 19 Nil Also determine the value of Closing Stock in respect of the above products. 16 Kg Rs. 22 1,550 kg 25. In a production process, normal waste is 5% of input. 5,000 MT of input were put in process resulting in a wastage of 300 MT. Cost per MT of input is Rs. 1,000. The entire quantity of waste is on stock at the year-end. State with reference to AS, how will you value the inventories in the above case. 12

13 26. The main object of a Company is to undertake plantation activities, raising of teak and other forestry operations. It takes about 10 to 12 years for a teak tree to grow. In order to carry out these plantation activities till the full growth of the tree is ready for sale, the Company will be incurring expenditure on maintaining them as also paying lease rent to the owners of the land. The Company has decided to treat all these costs of planting, its subsequent Maintenance, Lease Rent, etc. as a capital expenditure and treat as long term capital receipts, the sales proceeds realized when finally at the end of 10 to 12 years the trees would be felled and sold. Comment on the appropriateness of the accounting policy. 27. AS Ltd manufactures a commodity product at two different locations A and B. It values Closing stock consistently as follows: Stock Item Location A Location B Raw Materials At Cost, arrived at on FIFO basis. At Cost, arrived at on LIFO basis. Work Progress in Finished Goods At Raw Materials Cost plus a proportionate share of Variable Factory Overheads. At Raw Materials cost plus Variable Factory Overheads At Raw Materials Cost plus a proportionate share of Variable Factory Overheads. At Raw Materials cost plus Variable Factory Overheads The Overheads considered above are Direct Wages and benefits of Workers, Fuel Costs and Spares consumed. Comment on the Company s accounting policy. 28. Shri. Ganesh operates a retail business. For a financial year, the following data is given Particulars At Retail Price At Cost Value of Opening Inventory Value of Purchases Rs. 80,000 Rs. 1,40,000 Rs. 60,000 Rs. 1,20,000 Calculate the cost of Closing Stocks, if the Sales made during the period is Rs. 2,00, AS Ltd deals in 3 products A, B and C, which are neither similar nor interchangeable. At the end of a financial year, the Historical Cost and NRV of items of Closing Stock are given below. Determine the value of Closing Stock. Items Historical Cost (in Rs. Lakhs) Net Realisable Value (in Rs. Lakhs) A B C Included under Current Assets of AS Ltd. is inventory aggregating Rs. 20 crores. A part of the said inventory manufactured for export had to be sold earlier at a discounted price offshore due to moisture content present at the time of delivery. A part of similar inventory is included in Rs. 20 crores. As an Auditor, give your comments. 31. As Ltd purchased Raw material Z at Rs. 500 per kilolitre a few weeks back. Its current market price is on steep decline. The finished Goods in which Z is incorporated is expected to be sold below cost. The Company has 1000 kilolitres of Z in stock at the year-end. The current market price of Z is Rs. 330 per kilolitre. At what rate raw material inventories be valued for Balance Sheet purchases? 13

14 32. State with reference to AS-2, how will you value the inventories when a Raw Material was purchased at Rs. 100 per kilo and its price is on the decline. The Finished Goods in which the Raw Material is incorporated is expected to be sold at below cost. 10,000 kg of Raw Material is on stock at the yearend. 33. As an Auditor, state your views on the following: Notes No. 7 of published Accounts of AS Ltd reads thus The cost of Work-in-Process Materials estimated to remain in several posts of smelting plant Is not taken into accounts, both at the beginning and at the end of the year for the following three reasons- a) The cost of Work-in-process material put into the pots immediately before commissioning of the smelting plant stood capitalized. b) The quantity of work-in-process material is expected to be the same at any point of time. c) It is extremely difficult to measure exactly the amount of fill in the pots. The Management tells you that WIP is not valued since it is difficult to ascertain the same and view of multiple process involved and in any case, the value of Opening and Closing WIP would be more or less the same. Comments. Q. No. Answer Hints

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18 33 AS-3 CASH FLOW STATEMENT AS 3 is introduced for providing information relating to changes in cash and cash equivalents of an enterprise. So that it is useful tool for planning. Conceptual Questions: 1. What are the Contents of CFS? Cash Flow Include: 1) Cash in hand 2) Demand deposit with bank 3) Cash equivalents 2. What are three sub heads in CFS? Cash flow activities may be classified as in flow and out flow but as per AS 3 they classified as : 1) Operating Activities i.e. principal revenue generating activities. 2) Investing activities which are relate to acquisition and disposal of long-term assets and other investment. 3) Financing Activities which include the ones which results in changes in size and composition of the owner s capital (including preference share capital) and borrowings of the enterprise. 3. Which are two methods for preparing CFS? Methods to calculate cash flow operating activities include a) Direct Method The direct method, whereby major classes of gross cash payment are disclose. b) Indirect Method The indirect method, whereby Net Profit or loss in adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payment and items of income or expense associated with investing or financing cash flow. 18

19 Practical Questions: 1. Aastha ltd. Company s Comparative Balance Sheet for 2004 and the Company s Income Statement for the year follow : Aastha Ltd. Comparative Balance Sheet December 31, 2004 and 2003 (Rs. In crores) Sources of funds: Shareholder s funds Share Capital Retained earnings Loan funds Bonds Payable Application of funds Fixed Assets Plant and Equipment Less accumulated Depreciation. (218) 212 (194) 115 Investments Current Assets Inventory Accounts receivable Pre-paid expenses Cash Less current liabilities & Provisions Accounts payable Accrued liabilities Deferred income-tax Provision Aastha Ltd. Income Statement For the year ended December 31, 2004

20 (Rs. In crores) Sale Rs. 1,000 Less cost of goods sold 530 Gross margin 470 Less operating expenses 352 Net operating income 118 Non-operating items: Loss on sale of equipment (4) Income before taxes 114 Less income-taxes 48 Net income 66 Additional information: a. Dividends of Rs. 48 crores were paid in b. The loss on sale of equipment of Rs. 4 core reflects a transaction in which equipment with an original cost of Rs. 12 core and accumulated depreciation of Rs. 5 core were sold for Rs. 3 core in cash. Required: a. Using the indirect method, determine the net cash provided by operating activities for 2004 and construction a statement of cash flows. 2. The financial position of the Aastha Company Ltd. As on 31 st December, 2003 and 31 st December, 2004 and the profit and loss account for the year ended on 31 st December, 2004 are given below : Assets Rs. Rs. Land and buildings 1,50,000 1,00,000 Plant and machinery 2,20,000 2,00,000 Less : Accumulated depreciation (82,000) (80,000) Inventory 1,25,000 90,000 Debtors 40,000 45,000 Cash 70,000 50,000 5,23,000 4,05,000 Liabilities Share capital 1,75,000 75,000 Securities premium 12,500 7,500 Reserves and surplus 62,500 17,500 Institutional loan 23,000 15,000 Debentures 1,20,000 1,50,000 Creditors 25,000 30,000 Salaries payable 15,000 10,000 Provision for tax 50,000 60,000 Provision for dividend 40,000 40,000 5,23,000 4,05,000 Profit and Loss Account for the year ended 31 st December, 2004 Rs. Rs. Sales 5,00,000 Less: Cost of goods sold 2,10,000 Gross profit 2,90,000 Less: Operating expenses : Office and administrative 45,000 Selling and distribution 25,000 20

21 Interest 12,000 Depreciation 22,000 1,04,000 Operating profit 1,86,000 Add: Gain on sale of plant 6,000 Total profit 1,92,000 Less: Income-tax 87,000 Net profit 1,05,000 The additional information is given below: a. During the year, plant costing Rs. 50,000 (accumulated depreciation of Rs. 20,000) was sold. b. The debentures of the face value of Rs. 30,000 were converted into share capital at par. c. The company paid a dividend of Rs. 40,000 and issued bonus shares of Rs. 20,000 during the year. d. The company further issued 5,000 shares of Rs. 10 each at a premium of Re. 1 per share during the year. Prepare cash flow statements. 3. Arrange and redraft the following Cash Flow Statement in proper order keeping in mind the requirements of AS-3: Rs. (in lacs) Rs. (in lacs) Net Profit 60,000 Add: Sale of Investment 70,000 Depreciation in Assets 11,000 Issue of Preference Shares 9,000 Loan raised 4,500 Decrease in Stock 12,000 1,66,500 Less: Purchase of Fixed Assets 65,000 Decrease in Creditors 6,000 Increase in Debtors 8,000 Exchange gain 8,000 Profit on sale of investments 12,000 Redemption of Debenture 5,700 Dividend paid 1,400 Interest paid 945 1,07,045 59,455 Add: Opening cash and cash equivalent 12,341 Closing cash and cash equivalent 71, Classify the following under operating, financing and investing activity as per AS 3 (Revised) i. Interest and dividends received by financial institutions. ii. Redemption of preference share capital. iii. Receipt from trade debtors. iv. Payment for acquisition of long term assets. v. Payment to employees. vi. Dividend paid to shareholders. vii. Acquisition of equity or debt securities. 21

22 AS-4: CONTINGENCIES AND EVENTS OCCURING AFTER THE BALACNE SHEET DATE Objective It gives guidelines of accounting treatment for accounting, contingent assets, and event s occurring after Balance Sheet date. Conceptual Questions: Q.1 Mr. Aditya Birla purchased one lottery ticket for Rs. 5 lakhs. He wishes to sow the amount as income receivable in asset side. Comment. Ans As per AS 4, when outcome of event depends on another uncertain event then it is called as contingent event. In this case lottery income will be the contingent event. Thus, it can be recorded in the books [Conservatism Concept] Q. 2 There is case against A Ltd. and accountant is confused whether to record this or not. Comment. Ans As per AS4, Contingent Liabilities are divided into three parts 1) Remote liability Ignore 2) Probable liability Disclose below Balance Sheet 3) Possible Create Provision. An accountant will have to analyze the current provision of liability on the above basis and then he should decide the accounting treatment. Q.3 Book of accounts of P Ltd. were closed on and fire occurred on books accounts sanctioned by board of directors on An accountant wish to show fire loss in books of accounts of last year. Comment. Ans As per AS4, such event is called as Events occurring after Balance Sheet date. In this case the accounting treatment is suggested as followsi) If event was known on the Balance Sheet date but confirmed after Balance Sheet date, then adjust it in last year s book. ii) If the event was unknown on Balance Sheet date but confirmed afterwards, then, it can be adjusted in the books but it must be shown as a disclosure. In the above case, fire breakout after Balance Sheet date and it was unknown on Balance Sheet date. Thus we can give the disclosure below Balance Sheet. Q4 The accounting year for Q Ltd. ended on but dividend declared on can it be adjusted in the books? Ans As per AS 4, the dividend cannot be recorded because it was unknown on Balance Sheet but it is declared as an exception to AS 4 in AS4 itself. 22

23 Application In the above case, dividend must be adjusted in books of accounts i.e. at the debit side of P & L Appropriation A/c and provision in the liability side. Practical Questions: 1. XYZ Ltd. Had written off Rs lakhs of debts of PQ Ltd. Treating the same as bad and doubtful during the year ending on March 3,2005, as the amount was not recovered for last five years. Company is in the process of finalizing the Balance Sheet, XYZ Ltd. Is able to recover the entire amount from PQ Ltd. What treatment should been given to this information in preparation if Balance sheet as on During the year 2004, it has been found that there was a loss of goods by theft during the year 2003, valued at Rs. 2,70,000. How would you deal with the above in financial statements for the year 2003 and 2004? 3. ABC Ltd. Prepared its financial statements as on The following events took place in April, 2004: a. A fire broke out in the premises damaging goods costing Rs. 12,00,000 (salvage value Rs. 3,50,000). b. Dividend proposed by the Board, Rs. 7 per share. 4. Las Ltd. Has received a demand notice on for Rs. 78,00,000 from the Excise Department in respect of duty payable for several years. The financial statements for the year have been approved in August,2003. In July, 2003, the company has appealed against the demand of Rs. 62,00,000 and the balance has been deposited by it. The company has expected that the demand of Rs.62,00,000 should be reduced to Rs. 27,00,000 only. Show the above in the financial statements for the year In one of the plant of XYZ Ltd., there was a fire on in which the entire plant was damaged and the loss of Rs. 40,00,000 is estimated. The claim with the insurance company has been filed and a recovery of Rs. 27,00,000 is expected. The financial statement for the year ending were presented on Show how should it be shown? What would be the presentation if the financial year ended on ? 6. While preparing its final accounts for the year ended 31 st March, 2003 a company made a provision for bad 5% of its total debtors. In the last week of February, 2003 a debtor for Rs. 2 lakhs had suffered heavy loss due to an earthquake; the loss was not covered by any insurance policy. In April, 2003 the debtor became a bankrupt. Can the company provide for the full loss arising out of insolvency of the debtor in the final accounts for the year ended 31 st March, 2003? 7. A major fire has damaged the assets in a factory of AS Limited on 2 nd April, two days after the yearend closure of account. The loss is estimated at Rs. 20 Crores out of which Rs. 12 crores will be 23

24 recoverable from the insurers. Explain briefly how the loss should be treated in the final accounts for the previous year. 8. AS Ltd invested Rs. 100 lakhs in April, in the acquisition of another Company doing similar business, the negotiations for which had started during the Financial Year just ended on 31 st March. How will this be treated in the final accounts for the year just ended. 9. The company has not made provision for proposed Divided in its accounts but has carried forward the balance on the Profit & Loss Account and proposes to charge the dividend to the Profit & Loss Account when payment is made. Comment. 10. AS Ltd had taken a large-sized civil construction contract, for a public sector undertaking, valued at Rs. 2 crores. In the course of execution of the work on 29 th May, the company found while raising the work that it had met a rocky surface and cost of contract would go up by an extra Rs. 50 lakhs, which would not be recoverable from the Contractee. The Company s accounting year had ended on 31 st March and the accounts were considered and approved by the Board of Directors on 15 th May. How will you treat the above in the accounts for the year ended 31 st March. 11. AS Ltd entered into an agreement to sell its immovable property included in the Balance Sheet at Rs. 5 lakhs to another Company for Rs. 20 lakhs. The agreement to sell was concluded on 31 st January but the Sale Deed was registered only on 30 th April. The Company s accounting year ended on 31 st March and the accounts for that period were considered and approved by the Board of Directors on 15 th May. How will you treat the above in the accounts for the year ended 31 st March? 12. A Company deals in petroleum products. The sale price of petrol is fixed by the Government. After the Balance Sheet date, but before the finalization of the Company s accounts, the Government unexpectedly increased the price retrospectively. Can the Company account for additional revenue at the close of the year? Discuss. 13. You are the Auditor of a Manufacturing Company, whose year ends on 31 st March. An event occurred after the year ended, but before you complete the audit. The Audit Report issued by you is dated 20 th July. The Sales Ledger balance at 31 st March was Rs. 95,000. By 20 th July Rs. 65,000 only had been received against this amount as full and final payment. How will you deal with the above? 14. These was a Government Notification in June 20x1 increasing the limit for gratuity payment with effect from 24 th September 20x0. The accounts were approved by the Board of Directors in July 20x1. The Board of opines that since the change took place after the Balance Sheet Date, no effect should be given to it in the Financial Statements for the year ended 31 st March 20x1. Is the view correct? 15. AS Ltd wants to adjust the bank balance on the Balance Sheet Date by reversing the entry for a cheque issued in the normal course of business and cancelled after the year-end but before the finalization of accounts. The cheque was returned on the ground that the signature differs. Give your views on the above. 16. A Limited Company closes its accounts on 31 st March every year. It issued a cheque in favour of one of its customers towards the refund of advance in January. In July, the customer returned the cheque to the Company without presentation to the Bank while accounts of the Company for that year were being finalized. Since the cheque was cancelled, the reversal entry was passed in the books of accounts as on 31 st March with a view to disclose the correct balance as on that date, instead of showing the Bank Balance lower by treating the cheque as issued but not encashed as on 31 st 24

25 March. Whether the reversal entry passed in the books of accounts of the Company as on 31 st March was proper since the cheque was cancelled before closing of the accounts for the year? 17. You are an accountant preparing accounts of AS Ltd. As at 31 st March. After the end of the year, the following events took place in April. A fire broke out in the premises damaging, uninsured stock worth Rs. 10 lakhs (Salvage Value Rs. 2 lakhs) A suit against the Company s advertisement was filed by a party claiming damage of Rs. 20 lakhs. Dividend proposed at 20% on Share Capital of Rs. 100 lakhs. Describe, how the above will be dealt with in the accounts for the year ended 31 st March. 18. The Financial statement of Construction Limited for the year ended 31 st March, 2008 were considered and approved by the board of directors on 20 th May, The company was engaged in construction work involving Rs. 10 core. In the course of execution of work, a portion of factory shed under construction came crashing down on 30 th May, Fortunately, there was no loss of life, but the company will have to rebuild the structure at an additional at an additional cost of Rs. 2 crores which cannot be recovered from the contractee. How should this event be reported? Q. No. Answer Hints

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28 AS-5: NET PROFIT OR LOSS FOR THE PERIOD, PRIOR PERIOD ITEMS AND CHANGES IN ACCOUNTING POLICIES Conceptual Questions: Objective To give guidelines for i) Finding up appropriate profit of current year ii) Dealing with prior period items and iii) Dealing with changes in items. Q. 1 Mr. Ajay is finalizing his books of accounts and he found that there was loss by theft of Rs considering small amount, he added it in miscellaneous expenses, comment. Ans As per AS5, Net Profit of every fanatical year must be calculated by showing ordinary and extra ordinary items separately. Analysis In the above case, even if amount is small, loss by theft is an extra ordinary item and must be shown separately thus above accounting treatment is incorrect. Q. 2 Your client Mr. Ambani showed Bad Debts of Rs. 30 lakhs in but amount is recovered in he has credited this amount in general income of Comment. Ans As per AS 5, if any adjustment is done in current year due to adjustment of earlier year s mistake, then it is called as prior period items and it should be record in current year separately. Analysis In above case Mr. Ambani should credit P & L A/c of year and not the year It should be shown separately as prior period item. Q. 3 In year , Mr. Ratan Tata made provision for doubtful 10%. But after year end it is needed at 12% p.a. Comment. 28

29 Ans As per AS 5, such provision is called as estimate and such change is called as changes in estimates. It should be adjusted in Financial Year. Analysis In above case even if Mr. Tata realized change estimate after year end, still he must adjust it in Financial Year Practical Questions: 1. Show the presentation of following items in the financial statements : a. Last year, stock was overvalued by Rs. 5,30,000. b. Insurance claim lodged last year but received in current year, Rs. 1,20,000. c. Change of method of valuation of raw material inventory from FIFO to weighted average method. 2. Show the presentation of following items in the financial statements : a. Payment of expense of Rs. 1,10,000 for previous year. It was not recorded last year due to oversight. b. A debtor was considered bad and full provision for doubtful debt was created. In the current year, however, a part of the total amount has been recovered. c. An employee retired last year from the firm. He lodged a claim in the court of law for Rs. 7,20,000 in the current year. Court s verdict may come in current year or may be declared in future years. 3. X Ltd. Is a regular buyer of goods from Y Ltd. Under an agreement, 50% of the order amount is payable in advance and balance 50% is payable at the time of delivery. In case, the delivery is not taken within 15 days of intimation, the buyer has to pay Rs. 1,000 per day as storage charges to the seller, In the past, whenever such charges were paid, were included in the valuation of inventory. However, in the current year, X Ltd. Has decided not to include this expense as a part of inventory value, but as a general expense. Comment. 4. RST Ltd. Has a policy of providing 10% provision for doubtful debts on the gross value of debtors. In the current year also, it has applied the same policy. However, it has created an additional provision of Rs. 60,000 (over and above 10%) in respect of a debtor which is outstanding for more than one year and it is expected that he may be declared insolvent. It is a change in accounting policy? Comment. 5. Whether disclosure of advances / receivable written back / written off is necessary even if the amount involved does not exceed 1% of the revenue? 6. The company found in that stock sheet as on had included twice an item of Rs. 1,97,221/-. How will this be dealt with, in the books? 7. ABC Ltd. Was making provision for non-moving stocks based on no issues for the last 12 months upto The company wants to provide during the year ending based on technical evaluation: Total value of stock Rs. 100 lakhs Provision required based on 12 months issue Rs. 3.5 lakhs 29

30 Provision required based on technical evaluation Rs. 2.5 lakhs Does this amount to change in accounting policy? Can the company change the method of provision? 8. State, how you will deal with the following matters in the accounts of U Ltd. For the year ended 31 st March, 2003 with reference to Accounting Standard: a. The company finds that the stock sheets of did not include two pages containing details of inventory worth Rs lakhs. 9. State briefly the duty of an auditor with a regard to each of the following: a. A sum of Rs. 10,00,000 is received from an insurance company in respect of a claim for loss a goods in transit costing Rs. 8,00,000. The amount is credited to the Purchases Account. b. A loss of Rs. 2,00,000 on account of embezzlement of cash was suffered by the company and it was debited to Salary Account. 10. As a Company Auditor how would you react to the following situations? a. Sale value of scrap items adjusted miscellaneous expenditure. b. Insurance claim of Rs. 2 lakhs received stands included under miscellaneous income. 11. Sagar Limited belongs to the engineering industry. The Chief Accountant has prepared the draft accounts for the year ended You are required to advise the company on the following items from the viewpoint of finalization of accounts, taking not of the mandatory accounting standards. An audit stock verification during the year revealed that the opening stock of the year was understated by Rs. 3 lakhs due to wrong counting. 12. In preparing the financial statements of R Ltd. For the year ended 31 st March, 1998 you come across the following information. State with reasons, how you would deal with them in the financial statements- There was a major theft of stores valued at Rs. 10 lakhs in the preceding year, which was detected only during the current financial year ( ). 13. As an auditor state your views on the following situations : Y Ltd. Provided Rs. 25 lakhs for inventory obsolescence in In the subsequent year, it was determined that 50% of such stock was usable. The company wants to adjust the same through prior period adjustment account as the provision was made in the earlier year. 14. In the context of relevant Accounting Standards, give your comments on the following matters for the financial year ending on While preparing its final accounts for the year ended 31 st March, 200 Rainbow Limited created a provision for Bad and Doubtful debts at 2% on trade debtors. A few weeks later the company found that payments from some of the major debtors were not forthcoming. Consequently the company decided to increase the provision by 10% on the debtors on 31 st March, 2002 as the accounts were still open awaiting approval of the Board of Directors. Is this to be considered as an extraordinary items or prior period item? 15. What will be the treatment of the following in the final statement of account for the year ended 31 st March, 1995 of a limited company? Revision in the salary, effective 1 st April, 1994, would cost the company an additional liability of Rs. 3,00,000 per annum. 30

31 16. M/s. Dinesh & Company signed an agreement with workers for increase in wages with retrospective effect. The out-flow on account of arrears was for Rs lakhs, for Rs lakhs and for Rs lakhs. This amount is September, The accountant wants to charge Rs lakhs as prior period charges in financial statement for Discuss. Q. No. Answer Hints

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33 16 AS-6: DEPRECIATION ACCOUNTING Conceptual Questions: Objective It gives guidelines for recording depreciation. Q. 1 Which are the different methods of depreciation. Ans i] SLM, ii] WDV, iii] Production units method, iv] Machine hour rate method, v] Depreciation method [For mines] vi] Sum of years digit method, vii] Annuity Method. Q. 2 What if there is change in method? Ans Refer AS 1. Q. 3 What if there is change in useful life? Ajay purchased machine of Rs. 10 Lacks, life 10 years, after 3 rd year, machine was damaged and expected further life 2 year. Find out depreciation of last 2 years. Ans As per AS 6 and AS 10, if there is change in value of asset or its useful life, and then remaining value should be written off in remaining life. i.e. Purchasing Price = 1000,000 Value after 3 years = 700,000 i.e Remaining life = 2 years. Depreciate on = 350, Practical Questions:

34 1. Advise the firm in respect of the Following: a. The firm wants to change depreciation as per SL method for Plant I and as per WDV method for plant II b. In Plant III, a new machine is to be depreciation as per SL method whereas existing machines are being depreciated as per WDV. method. 2. ABC Ltd. Purchased on credit, an asset costing Rs.5,00,000 during the year It charges WDV on this types of asset. During the year, it has Rs.2,20,000 to the supplier, including the interest for the delayed payment. Rs.3,00,000 together with interest will be payable next year. The amount of depreciation provided for the year is Rs. 33,000 i.e. 15% of Rs. 2,20,000. Comment. 3. PQR Ltd. Charges depreciation on its Plant and 20% WDV. in the current year, a new machine has been acquired, which will work as a part of the existing plant. However, the life of this machine is expected to be only 4 years. So, the company wants to charges depreciation as per 4 years SL method on this machine. Is it allowed as per AS-6? 4. There could be instances where a company adopts accelerate depreciation rates in respect of certain class of assets i.e. depreciation rates are higher than rates prescribed under Schedule XIV of the companies Act. for the other assets, the company charges depreciation at the rates lower than schedule XIV of the companies Act. However, aggregate depreciation charges on all assets as per the company s policy is higher than aggregate depreciation had the company followed schedule XIV rate for all the assets. Whether such accounting policy is in conformity with the accounting standards and the companies Act? 5. Whether depreciation on machinery can be charged on the basic actual hours worked during the year? 6. What are the provisions of the Companies Act and AS-6 relating to depreciation on fixed asset items costing below Rs.5000? 7. Goats and Gains Ltd. Use houses to transport material from one place to another place on hilly area where construction activity is going on. It purchases horses worth Rs.43,20,000 for transporting material on useful life of horses was estimated 5 years, and at the end of the period, the company expects that the horse can be sold for a nominal value of Rs.3,20,000/-. Therefore company decided to write off depreciation on horses as per SLM over 5 years. Comment. 8. A Plant was depreciation under two different method as under: YEAR SLM (Rs. In Lakhs) W.D.V. (Rs. In Lakhs) What should be the amount of resultant surplus/deficiency, if the company decides to switch over from W.D.V. method for first four years? Also state, how will you treat the same in Accounts. 34