GROUP - I PAPER - 1 ACCOUNTING V1 CHAPTER 1

1 ACCOUNTING STANDARDS Unit 1: Introduction to Accounting Standards Learning objectives After studying this unit you will be able to: ♦ Understand the concept of Accounting Standards. ♦ Grasp the objectives, benefits and limitations of Accounting Standards. ♦ Learn the standards setting process. ♦ Familiarize with the overview of Accounting Standards in India. ♦ Recognize the international accounting standard authorities. ♦ Appreciate the adoption of International Financial Reporting Standards as global standards. 1.1 Introduction Accounting Standards (ASs) are written policy documents issued by expert accounting body or by government or other regulatory body covering the aspects of recognition, measurement, presentation and disclosure of accounting transactions in the financial statements. The ostensible purpose of the standard setting bodies is to promote the dissemination of timely and useful financial information to investors and certain other parties having an interest in the company's economic performance. Accounting Standards reduce the accounting alternatives in the preparation of financial statements within the bounds of rationality, thereby ensuring comparability of financial statements of different enterprises. Accounting Standards deal with the issues of (i) recognition of events and transactions in the financial statements, (ii) measurement of these transactions and events, (iii) presentation of these transactions and events in the financial statements in a manner that is meaningful and understandable to the reader, and © The Institute of Chartered Accountants of India Accounting (iv) the disclosure requirements which should be there to enable the public at large and the stakeholders and the potential investors in particular, to get an insight into what these financial statements are trying to reflect and thereby facilitating them to take prudent and informed business decisions. Accounting Standards standardize diverse accounting policies with a view to eliminate, to the maximum possible extent, (i) the non-comparability of financial statements and thereby improving the reliability of financial statements, and (ii) to provide a set of standard accounting policies, valuation norms and disclosure requirements. Before moving on to further discussion, let us examine a very simple case of a trader to see how many rational figures of profit accountants can be derived: (i) On 01/04/05, a trader purchased 10 units of certain articles @ ` 50 per unit. (ii) On 02/04/05, the trader purchased further 10 units of same article @ ` 70 per unit. (iii) On 03/04/05, the trader sold 6 units of the article @ ` 65 per unit on credit (iv) On 04/04/05, the trader sold 9 units of the article @ ` 65 per unit for cash A few of the possible profit and stock figures are shown below: (a) Profit ` 125 (FIFO and accrual basis); Value of stock = ` 350 (5 units) (b) Profit ` 25 (LIFO and accrual basis); Value of stock = ` 250 (5 units) (c) Profit ` 75 (Weighted average and accrual basis); Value of stock = ` 300 (5 units) (d) Profit ` 135 (FIFO, and cash basis); Value of stock = ` 750 (11 units) (e) Loss ` 45 (LIFO and cash basis); Value of stock = ` 570 (5 units) (f) Profit ` 45 (Weighted average and cash basis); Value of stock = ` 660 (11 units) If as many as six alternatives are possible in this simple case, the readers can well imagine the number of possible alternatives that may exist in real life and the extent of confusion that will ensue. The users of financial statements are sure to lose all faith in accounting data and hardly any commerce will be possible. It is however worth noting that standardisation cannot reduce the number of possible alternatives to one, because more than one method must be permitted to suit the needs of particular trades and it is impractical to think of separate standardisation for each kind of trade. For example, when one stores liquid in single container, the use of FIFO is not rational. In the given case, standardisation (compliance with Accounting Standards) reduces the possible figures of profit and stock to two as explained below: (a) AS 2, Valuation of Inventory does not permit LIFO; (b) AS 9, Revenue Recognition, requires recognition of revenue for sale transactions when 1.2 © The Institute of Chartered Accountants of India Accounting Standards (i) the risks and rewards of ownership is transferred from the seller to buyer; and (ii) no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods. Thus, revenue should ordinarily be recognised on accrual basis. The two possible figures of profit and stock are as given below: ♦ Profit ` 125 (FIFO and accrual basis); Value of stock = ` 350 (5 units) ♦ Profit ` 75 (Weighted average and accrual basis); Value of stock = ` 300 (5 units) The standard policies are intended to reflect a consensus on accounting policies to be used in different identified area, e.g. inventory valuation, capitalisation of costs, depreciations and amortisations and so on. Since it is not possible to prescribe a single set of policies in any area to be appropriate for all enterprises for all time, it is not enough to comply with the standards and state that they have been followed; one must also disclose the accounting policies actually used in preparation of financial statements. (See AS 1, Disclosure of Accounting Policies). For example, an enterprise should disclose which of the permitted cost formula (FIFO, Weighted Average etc.) has actually been used for ascertaining inventory costs. In addition to improving credibility of accounting data, standardisation of accounting procedures improves comparability of financial statements, both intra-enterprise and inter- enterprise. Such comparisons are very effective and most widely used tools for assessment of enterprise performances by users of financial statements for taking economic decisions, e.g. whether or not to invest, whether or not to lend and so on. The intra-enterprise comparison involves comparison of financial statements of same enterprise over number of years. The intra-enterprise comparison is possible if the enterprise uses same accounting policies every year in drawing up its financial statements. For this reason, AS 1 requires disclosure of changes in accounting policies. The inter-enterprise comparison involves comparison of financial statements of different enterprises for same accounting period. This is possible only when comparable enterprises use same accounting policies in preparation of respective financial statements. The disclosure of accounting policies allows a user to make appropriate adjustments while comparing the financial statements. A third advantage of standardisation is reduction of scope for creative accounting. The creative accounting refers to twisting of accounting policies to produce financial statements favourable to a particular interest group. For example, it is possible to overstate profits and assets by capitalising revenue expenditure or to understate them by writing off a capital expenditure against revenue of current accounting period. Such practices can be curbed only by framing rules for capitalisation, particularly for the borderline cases where it is possible to have divergent views. The accounting standards do just that. (See AS 10, AS 16 and AS 26 for instances) 1.3 © The Institute of Chartered Accountants of India Accounting In brief, the accounting standards aim at improving the quality of financial reporting by promoting comparability, consistency and transparency, in the interests of users of financial statements. Good financial reporting not only promotes healthy financial markets, it also helps to reduce the cost of capital because investors can have faith in financial reports and consequently perceive lesser risks. 1.2 Standards Setting Process The Institute of Chartered Accountants of India (ICAI), being a premier accounting body in the country, took upon itself the leadership role by constituting the Accounting Standards Board (ASB) in 1977. The ICAI has taken significant initiatives in the setting and issuing procedure of Accounting Standards to ensure that the standard-setting process is fully consultative and transparent. The ASB considers the International Accounting Standards (IASs)/International Financial Reporting Standards (IFRSs) while framing Indian Accounting Standards (ASs) and try to integrate them, in the light of the applicable laws, customs, usages and business environment in the country. The composition of ASB includes, representatives of industries (namely, ASSOCHAM, CII, FICCI), regulators, academicians, government departments etc. Although ASB is a body constituted by the Council of the ICAI, it (ASB) is independent in the formulation of accounting standards and Council of the ICAI is not empowered to make any modifications in the draft accounting standards formulated by ASB without consulting with the ASB. The standard-setting procedure of Accounting Standards Board (ASB) can be briefly outlined as follows: ♦ Identification of broad areas by ASB for formulation of AS. ♦ Constitution of study groups by ASB to consider specific projects and to prepare preliminary drafts of the proposed accounting standards. The draft normally includes objective and scope of the standard, definitions of the terms used in the standard, recognition and measurement principles wherever applicable and presentation and disclosure requirements. ♦ Consideration of the preliminary draft prepared by the study group of ASB and revision, if any, of the draft on the basis of deliberations. ♦ Circulation of draft of accounting standard (after revision by ASB) to the Council members of the ICAI and specified outside bodies such as Department of Company Affairs (DCA), Securities and Exchange Board of India (SEBI), Comptroller and Auditor General of India (C&AG), Central Board of Direct Taxes (CBDT), Standing Conference of Public Enterprises (SCOPE), etc. for comments. ♦ Meeting with the representatives of the specified outside bodies to ascertain their views on the draft of the proposed accounting standard. ♦ Finalisation of the exposure draft of the proposed accounting standard and its issuance inviting public comments. 1.4 © The Institute of Chartered Accountants of India Accounting Standards ♦ Consideration of comments received on the exposure draft and finalisation of the draft accounting standard by the ASB for submission to the Council of the ICAI for its consideration and approval for issuance. ♦ Consideration of the final draft of the proposed standard and by the Council of the ICAI, and if found necessary, modification of the draft in consultation with the ASB is done. The accounting standard on the relevant subject is then issued by the ICAI. 1.3 Benefits and Limitations Accounting standards seek to describe the accounting principles, the valuation techniques and the methods of applying the accounting principles in the preparation and presentation of financial statements so that they may give a true and fair view. By setting the accounting standards the accountant has following benefits: (i) Standards reduce to a reasonable extent or eliminate altogether confusing variations in the accounting treatments used to prepare financial statements. (ii) There are certain areas where important information are not statutorily required to be disclosed. Standards may call for disclosure beyond that required by law. (iii) The application of accounting standards would, to a limited extent, facilitate comparison of financial statements of companies situated in different parts of the world and also of different companies situated in the same country. However, it should be noted in this respect that differences in the institutions, traditions and legal systems from one country to another give rise to differences in accounting standards adopted in different countries. However, there are some limitations of setting of accounting standards: (i) Alternative solutions to certain accounting problems may each have arguments to recommend them. Therefore, the choice between different alternative accounting treatments may become difficult. (ii) There may be a trend towards rigidity and away from flexibility in applying the accounting standards. (ii) Accounting standards cannot override the statute. The standards are required to be framed within the ambit of prevailing statutes. 1.4 How many Accounting Standards? The council of the Institute of Chartered Accountants of India has, so far, issued thirty two Accounting Standards. However, AS 8 on ‘Accounting for Research and Development’ has been withdrawn consequent to the issuance of AS 26 on ‘Intangible Assets’. Thus effectively, there are 31 Accounting Standards at present. The ‘Accounting Standards’ issued by the Accounting Standards Board establish standards which have to be complied by the business entities so that the financial statements are prepared in accordance with generally accepted accounting principles. 1.5 © The Institute of Chartered Accountants of India Accounting 1.5 Accounting Standard Interpretations The Accounting Standard Interpretations address questions that arise in course of application of a standard. These are therefore issued after issue of the relevant standard. Authority of an interpretation is same as that of the Accounting Standard to which it relates. So far, 30 interpretations have been issued. A brief summary of these interpretations is given below. The readers may refer appropriate chapters for details. Related No. Topic AS 1. 16 Interpretation of the term ‘substantial period’ 2. 10 Accounting for Machinery Spares Computation of deferred tax during tax holiday u/s 80-IA and 80-IB 3. 22 (Revised) Computation of deferred tax in respect of losses under the head 4. 22 Capital Gains 5. 22 Computation of deferred tax during tax holiday u/s 10A and 10B 6. 22 Computation of current and deferred tax subject to MAT u/s 115JB 7. 22 Disclosure of deferred tax assets/liabilities in balance sheet 8. 21, 23, 27 Interpretation of the term ‘near future’ 9. 22 Interpretation of the term ‘virtual certainty’ 10. 16 Computation of exchange difference to be treated as borrowing cost 11. 22 Accounting for Taxes on Income in case of an Amalgamation 12. 20 Applicability of AS 20 to unlisted companies 13. 18 Aggregation of related party disclosures 14. 9 Manner of disclosure of excise duty 15. 21 Notes to the Consolidated Financial Statements (CFS) 16. 23 Treatment in CFS: Dividend proposed by an associate 17. 23 Treatment in CFS: Changes in equity not included in P & L A/c Consideration of potential equity to ascertain whether the investee is 18. 23 an associate 19. 18 Interpretation of the term ‘intermediary’ 20. 17 Disclosure of segment information in certain cases (Revised) 21. 18 Non-executive directors; whether related parties 22. 17 Interest expenses; whether to treat as segment expenses Remuneration paid to key management personnel; whether related 23. 18 party transaction 24. 21 Subsidiaries having two parents 1.6 © The Institute of Chartered Accountants of India Accounting Standards 25. 21 Shares held as stock-in-trade 26. 21 Consolidation of current and deferred tax 27. 25 Applicability of AS 25 Disclosure of post-acquisition reserves in Consolidated Financial 28. 21, 27 Statements 29. 7 Turnover in case of contractors 30. 29 Applicability of AS 29 to onerous contracts In December, 2006, the Central Government notified the accounting standards issued by the ICAI in consultation with the NACAS. In the notified standards, the Central Government has included the consensus portion of certain Accounting Standard Interpretations (ASIs) as ‘Explanation’ to the relevant paragraphs as indicated below: ASI No. Title of the ASI Relevant Paragraph(s) of the Accounting Standards 1 Substantial Period of Time (Re. AS 16) Paragraph 3.2 of Accounting Standard (AS) 16, ‘Borrowing Costs’ 3 Accounting for Taxes on Income in the Paragraph 13 of Accounting Standard situations of Tax Holiday under Sections (AS) 22, ‘Accounting for Taxes on 80-IA and 80-IB of the Income-tax Act, Income’ 1961 (Re. AS 22) 4 Losses under the head Capital Gains Explanation 2 to paragraph 17 of (Re. AS 22) Accounting Standard (AS) 22, ‘Accounting for Taxes on Income’ 5 Accounting for Taxes on Income in the Paragraph 13 of Accounting Standard situations of Tax Holiday under Sections (AS) 22, ‘Accounting for Taxes on 10A and 10B of the Income-tax Act, Income’ 1961 (Re. AS 22) 6 Accounting for Taxes on Income in the Paragraph 21 of Accounting Standard context of Section 115JB of the Income- (AS) 22, ‘Accounting for Taxes on tax Act, 1961 (Re. AS 22) Income’ 7 Disclosure of deferred tax assets and Paragraph 30 of Accounting Standard deferred tax liabilities in the balance (AS) 22, ‘Accounting for Taxes on sheet of a company (Re. AS 22) Income’ 8 Interpretation of the term ‘Near Future’ Explanation (b) to paragraph 11 of (Re. AS 21, AS 23 and AS 27) Accounting Standard (AS) 21, ‘Consolidated Financial Statements’ Paragraph 7 of Accounting Standard (AS) 23, ‘Accounting for Investments in Associates in Consolidated Financial 1.7 © The Institute of Chartered Accountants of India Accounting Statements’ Paragraph 28 of Accounting Standard (AS) 27, ‘Financial Reporting of Interests in Joint Ventures’ 9 Virtual certainty supported by Explanation 1 to paragraph 17 of convincing evidence (Re. AS 22) Accounting Standard (AS) 22, ‘Accounting for Taxes on Income’ 10 Interpretation of paragraph 4(e) of AS Paragraph 4(e) of Accounting Standard 16 (Re. AS 16) (AS) 16, ‘Borrowing Costs’ 13 Interpretation of paragraphs 26 and 27 Paragraphs 26 and 27 of Accounting of AS 18 (Re. AS 18) Standard (AS) 18, ‘Related Party Disclosures’ 14 Disclosure of Revenue from Sales Paragraph 10 of Accounting Standard Transactions (Re. AS 9) (AS) 9, ‘Revenue Recognition’ 15 Notes to the Consolidated Financial Paragraph 6 of Accounting Standard Statements (Re. AS 21) (AS) 21, ‘Consolidated Financial Statements’ 16 Treatment of Proposed Dividend under Explanation (b) to paragraph 6 of AS 23 (Re. AS 23) Accounting Standard (AS) 23, ‘Accounting for Investments in Associates in Consolidated Financial Statements’ 17 Adjustments to the Carrying Amount of Explanation (a) to Paragraph 6 of Investment arising from Changes in Accounting Standard (AS) 23, Equity not Included in the Statement of ‘Accounting for Investments in Profit and Loss of the Associate (Re. AS Associates in Consolidated Financial 23) Statements’ 18 Consideration of Potential Equity Paragraph 4 of Accounting Standard Shares for Determining whether an (AS) 23, ‘Accounting for Investments in Investee is an Associate under AS 23 Associates in Consolidated Financial (Re. AS 23) Statements’ 19 Interpretation of the term Paragraph 13 of Accounting Standard ‘intermediaries’ (Re. AS 18) (AS) 18, ‘Related Party Disclosures’ 20 Disclosure of Segment Information (Re. Paragraph 38 of Accounting Standard AS 17) (AS) 17, ‘Segment Reporting’ 21 Non-Executive Directors on the Board- Paragraph 14 of Accounting Standard whether related parties (Re. AS 18) (AS) 18, ‘Related Party Disclosures’ 1.8 © The Institute of Chartered Accountants of India Accounting Standards 22 Treatment of Interest for determining Point (b) of the definition of ‘Segment Segment Expense (Re. AS 17) Expense’ under paragraph 5.6 of Accounting Standard (AS) 17, ‘Segment Reporting’ 24 Definition of ‘Control’ (Re. AS 21) Paragraph 10 of Accounting Standard (AS) 21, ‘Consolidated Financial Statements’ 25 Exclusion of a subsidiary from Explanation (a) to paragraph 11 of consolidation (Re. AS 21) Accounting Standard (AS) 21, ‘Consolidated Financial Statements’ 26 Accounting for taxes on income in the Explanation (a) to paragraph 13 of consolidated financial statements (Re. Accounting Standard (AS) 21, AS 21) ‘Consolidated Financial Statements’ 28 Disclosure of parent’s/venturer’s shares Explanation (b) to paragraph 13 of in post-acquisition reserves of a Accounting Standard (AS) 21, subsidiary/jointly controlled entity (Re. ‘Consolidated Financial Statements’ AS 21 and AS 27) Paragraph 32 of Accounting Standard (AS) 27, ‘Financial Reporting of Interests in Joint Ventures’ 30 Applicability of AS 29 to Onerous Paragraph 1(b) of Accounting Standard Contracts (Re. AS 29) (AS) 29, ‘Provisions, Contingent Liabilities and Contingent Assets’ On the basis of the above, the ASB of ICAI has also incorporated the consensus portion of the above mentioned ASIs as ‘Explanation’ to the relevant paragraphs of the Accounting Standards. Following ASIs have not been included in the notified Accounting Standards: (i) ASI 2 Accounting for Machinery Spares (Re. AS 2 and AS 10) (ii) ASI 11 Accounting for Taxes on Income in case of an Amalgamation (Re. AS 22) (iii) ASI 12 Applicability of AS 20 (Re. AS 20) (iv) ASI 23 Remuneration paid to key management personnel – whether a related party transaction (Re. AS 18) (v) ASI 27 Applicability of AS 25 to Interim Financial Results (Re. AS 25) (vi) ASI 29 Turnover in case of Contractors (Re. AS 7 (revised 2002)) The Council decided to withdraw the above ASIs and issue the same as Guidance Notes except ASI 2 and ASI 11. Guidance Notes are being separately issued. 1.9 © The Institute of Chartered Accountants of India Accounting 1.6 Need for Convergence towards Global Standards The last decade has witnessed a sea change in the global economic scenario. The emergence of trans-national corporations in search of money, not only for fuelling growth, but to sustain on going activities has necessitated raising of capital from all parts of the world, cutting across frontiers. Each country has its own set of rules and regulations for accounting and financial reporting. Therefore, when an enterprise decides to raise capital from the markets other than the country in which it is located, the rules and regulations of that other country will apply and this in turn will require that the enterprise is in a position to understand the differences between the rules governing financial reporting in the foreign country as compared to its own country of origin. Therefore translation and re-instatements are of utmost importance in a world that is rapidly globalising in all ways. In themselves also, the accounting standards and principle need to be robust so that the larger society develops degree of confidence in the financial statements, which are put forward by organizations. International analysts and investors would like to compare financial statements based on similar accounting standards, and this has led to the growing support for an internationally accepted set of accounting standards for cross-border filings. The harmonization of financial reporting around the world will help to raise confidence of investors generally in the information they are using to make their decisions and assess their risks. Also a strong need was felt by legislation to bring about uniformity, rationalization, comparability, transparency and adaptability in financial statements. Having a multiplicity of accounting standards around the world is against the public interest. If accounting for the same events and information produces different reported numbers, depending on the system of standards that are being used, then it is self-evident that accounting will be increasingly discredited in the eyes of those using the numbers. It creates confusion, encourages error and facilitates fraud. The cure for these ills is to have a single set of global standards, of the highest quality, set in the interest of public. Global Standards facilitate cross border flow of money, global listing in different bourses and comparability of financial statements. The convergence of financial reporting and accounting standards is a valuable process that contributes to the free flow of global investment and achieves substantial benefits for all capital market stakeholders. It improves the ability of investors to compare investments on a global basis and thus lowers their risk of errors of judgment. It facilitates accounting and reporting for companies with global operations and eliminates some costly requirements say reinstatement of financial statements. It has the potential to create a new standard of accountability and greater transparency, which are values of great significance to all market participants including regulators. It reduces operational challenges for accounting firms and focuses their value and expertise around an increasingly unified set of standards. It creates an unprecedented opportunity for standard setters and other stakeholders to improve the reporting model. For the companies with joint listings in both domestic and foreign country, the convergence is very much significant. 1.10 © The Institute of Chartered Accountants of India Accounting Standards 1.7 International Accounting Standard Board With a view of achieving these objectives, the London based group namely the International Accounting Standards Committee (IASC), responsible for developing International Accounting Standards, was established in June, 1973. It is presently known as International Accounting Standards Board (IASB), The IASC comprises the professional accountancy bodies of over 75 countries (including the Institute of Chartered Accountants of India). Primarily, the IASC was established, in the public interest, to formulate and publish, International Accounting Standards to be followed in the presentation of audited financial statements. International Accounting Standards were issued to promote acceptance and observance of International Accounting Standards worldwide. The members of IASC have undertaken a responsibility to support the standards promulgated by IASC and to propagate those standards in their respective countries. Between 1973 and 2001, the International Accounting Standards Committee (IASC) released International Accounting Standards. Between 1997 and 1999, the IASC restructured their organisation, which resulted in formation of International Accounting Standards Board (IASB). These changes came into effect on 1st April, 2001. Subsequently, IASB issued statements about current and future standards: IASB publishes its Standards in a series of pronouncements called International Financial, Reporting Standards (IFRS). However, IASB has not rejected the standards issued by the ISAC. Those pronouncements continue to be designated as “International Accounting Standards” (IAS). The IASB approved IASB Resolution on IASC Standards at their meeting in April, 2001, in which it confirmed the status of all IASC Standards and SIC Interpretations in effect as on 1st April, 2001. 1.8 International Financial Reporting Standards as Global Standards The term IFRS comprises IFRS issued by IASB; IAS issued by International Accounting Standards Committee (IASC); and Interpretations issued by the Standard Interpretations Committee (SIC) and the International Financial reporting Interpretations Committee (IFRIC) of the IASB. International Financial Reporting Standards (IFRSs) are considered a "principles-based" set of standards. In fact, they establish broad rules rather than dictating specific treatments. Every major nation is moving toward adopting them to some extent. Large number of authorities requires public companies to use IFRS for stock-exchange listing purposes, and in addition, banks, insurance companies and stock exchanges may use them for their statutorily required reports. So over the next few years, thousands of companies will adopt the international standards. This requirement will affect about 7,000 enterprises, including their subsidiaries, equity investors and joint venture partners. The increased use of IFRS is not limited to public- company listing requirements or statutory reporting. Many lenders and regulatory and government bodies are looking to IFRS to fulfil local financial reporting obligations related to financing or licensing. 1.11 © The Institute of Chartered Accountants of India Accounting 1.9 Adoption of IFRS in India Increasingly, Indian accountants and businessmen feel the need for convergence with IFRS. Capital markets provide an important explanation for this change. Some Indian companies are already listed on overseas stock exchanges and many more will list in the future. Internationally acceptable accounting standards are becoming the language of communication for Indian companies. Also, the recent stream of overseas acquisitions by Indian companies makes a compelling case for adoption of high quality standards to convince foreign enterprises about the financial standing as also the disclosure and governance standards of Indian acquirers. Convergence with IFRS would require several changes in Indian laws and decision processes. In India, the Institute of Chartered Accountants of India (ICAI) is on the way towards convergence of its Standards with Global Standards. Divergences have been minimized to the maximum possible extent in the areas wherein full convergence is difficult. Recognizing the growing need of full convergence of Indian Accounting Standards with IFRSs, ICAI constituted a Task Force to examine various issues involved. Full convergence involves adoption of IFRSs in the same form as that issued by the IASB. While formulating the Accounting Standards, ICAI recognizes the legal and other conditions prevailing in India and makes deviations from the corresponding IFRSs. To bring Indian standards at par with the IAS/IFRS, some of the earlier Accounting Standards and Guidance notes have been revised or are under the process of revision. However, at present the Acccounting Standard Board in consultation with the Core Group, constituted by the Ministry of Corporate Affairs (MCA) for convergence of Indian Accounting Standards with International Financial Reporting Standards (IFRS), has decided that there will be two separate sets of Accounting Standards viz. (i) Indian Accounting Standards converged with the IFRS (known as Ind AS) The MCA has issued 35 converged Indian Accounting Standards (Ind ‘AS’) without announcing the applicability date. These are the standards which are being converged by eliminating the differences of the Indian Accounting Standards vis-à-vis IFRS. These standards shall be applied for all companies falling under Phase I to Phase III as prescribed under the roadmap issued by the core group. (ii) Existing Accounting Standards The companies not falling within the threshold limits prescribed for IFRS compliance in the respective phases shall continue to use these standards in the preparation and presentation of financial statements. The Securities and Exchange Board of India (SEBI) has also set up a Standing Committee on Accounting Standards. It mandates the adherence to standards and enforces the same through the listing agreements between the companies and recognized Stock Exchanges. 1.12 © The Institute of Chartered Accountants of India Accounting Standards Unit 2: Overview of Accounting Standards Learning objectives After studying this unit you will be able to: ♦ Comprehend the status and applicability of accounting standards. ♦ Know the scope of various accounting standards. ♦ Understand the provisions of the given Accounting Standards. ♦ Relate relevant Accounting Standards at various situations and apply them accordingly. ♦ Solve the practical problems based on application of Accounting Standards. 2.1 Applicability of Accounting Standards It has already been mentioned in unit one of the chapter that the standards are developed by the Accounting Standards Board (ASB) of the institute and are issued under the authority of its Council. The institute not being a legislative body can enforce compliance with its standards only by its members. Also, the standards cannot override laws and local regulations. The accounting standards are nevertheless made mandatory from the dates specified in respective standards and are generally applicable to all enterprises, subject to certain exception as stated below. The implication of mandatory status of an accounting standard depends on whether the statute governing the enterprise concerned requires compliance with the standard. In assessing whether an accounting standard is applicable, one must find correct answer to the following three questions. (a) Does it apply to the enterprise concerned? If yes, the next question is: (b) Does it apply to the financial statement concerned? If yes, the next question is: (c) Does it apply to the financial item concerned? The preface to the statements of accounting standards answers the above questions. Enterprises to which the accounting standards apply Accounting Standards apply in respect of any enterprise (whether organised in corporate, co- operative or other forms) engaged in commercial, industrial or business activities, whether or not profit oriented and even if established for charitable or religious purposes. Accounting Standards however, do not apply to enterprises solely carrying on the activities, which are not of commercial, industrial or business nature, (e.g., an activity of collecting donations and giving them to flood affected people). Exclusion of an enterprise from the applicability of the Accounting Standards would be permissible only if no part of the activity of such enterprise is commercial, industrial or business in nature. Even if a very small proportion of the activities of an enterprise were considered to be commercial, industrial or business in nature, the 1.13 © The Institute of Chartered Accountants of India Accounting Accounting Standards would apply to all its activities including those, which are not commercial, industrial or business in nature. Implication of mandatory status Where the statute governing the enterprise does not require compliance with the accounting standards, e.g. a partnership firm, the mandatory status of an accounting standard implies that, in discharging their attest functions, the members of the Institute are required to examine whether the financial statements are prepared in compliance with the applicable accounting standards. (See Scheme of Applicability) In the event of any deviation from the accounting standards, they have the duty to make adequate disclosures in their reports so that the users of financial statements may be aware of such deviations. It should nevertheless be noted that responsibility for the preparation of financial statements and for making adequate disclosure is that of the management of the enterprise. The auditor’s responsibility is to form his opinion and report on such financial statements. Where the statute governing the enterprise requires compliance with the accounting standards, e.g. companies, mandatory status of an accounting standard implies that the duty of compliance is primarily on the enterprise presenting the financial statement. Section 211(3A) of the Companies Act requires companies to present their profit and loss accounts and balance sheets in compliance with the accounting standards. (See Note 1) Also, the auditor is required by section 227(3)(d) to report whether, in his opinion, the profit and loss account and balance sheet of the company audited, comply with the accounting standards referred to in section 211(3C). Where the profit and loss account and balance sheet of a company do not comply with the accounting standards, the company is required by section 211(3B) to disclose the deviations from the accounting standards together with reasons for the deviations and financial effect if any arising due to such deviations. In addition, listed companies are required to comply with the accounting standards issued by The Institute of Chartered Accountants of India, by clause 50 of listing agreement with the stock exchanges. The above discussion shows that unlike other enterprises, duty to comply with the standards is also on the company, which is presenting the financial statements. Note 1 As per section 211(3C), the expression ‘accounting standards’, for the purpose of section 211(3A), means standards of accounting recommended by the Institute of Chartered Accountants of India, as may be prescribed by the Central Government in consultation with the National Advisory Committee on Accounting Standards established under subsection (1) of section 210A. Till date, the Central Government has notified all the existing accounting standards except AS 30, 31 and 32 on Financial Instruments. Note 2 Enterprises in insurance business are required to comply with the accounting standards by the Insurance Regulatory and Development Authority (Preparation of Financial Statements and Auditor’s Report of Insurance Companies) Regulations, 2000. The standards to be complied by these enterprises are those, made applicable to them. 1.14 © The Institute of Chartered Accountants of India Accounting Standards Financial items to which the accounting standards apply The Accounting Standards are intended to apply only to items, which are material. An item is considered material, if its omission or misstatement is likely to affect economic decision of the user. Materiality is not necessarily a function of size; it is the information content if the financial item which is important. A penalty of ` 50,000 paid for breach of law by a company can seem to be a relatively small amount for a company incurring crores of rupees in a year, yet is a material item because of the information it conveys. The materiality should therefore be judged on case-to-case basis. If an item is material, it should be shown separately instead of clubbing it with other items. For example it is not appropriate to club the penalties paid with legal charges. Conflict between requirements of accounting standard and Court/Tribunal order On 17 November 2004, the Council of the ICAI has announced that if an item in the financial statement of an enterprise is treated differently pursuant to an Order made by the Court/Tribunal, as compared to the treatment required by an Accounting Standard, following disclosures should be made in the financial statements of the year in which different treatment has been given: A description of the accounting treatment made along with the reason that the same has been adopted because of the Court/Tribunal Order. (a) Description of the difference between the accounting treatment prescribed in the Accounting Standard and that followed by the enterprise. (b) The financial impact, if any, arising due to such a difference. Accounting Standard and Income Tax Act Accounting standards intend to reduce diversity in application of accounting principles. They improve comparability of financial statements and promote transparency and fairness in their presentation. Deductions and exemptions allowed in computation of taxable income on the other hand, is a matter of fiscal policy of the government. Thus, an expense required to be charged against revenue by an accounting standard does not imply that the same is always deductible for income tax purposes. For example, depreciation on assets taken on finance lease is charged in the books of lessee as per AS 19 but depreciation for tax purpose is allowed to lessor, being legal owner of the asset, rather than to lessee. Likewise, recognition of revenue in the financial statements cannot be avoided simply because it is exempted under section 10 of the Income Tax Act. As already explained, the Guidance Note on Audit Under Section 44AB of Income Tax Act, requires all financial statements prepared under mercantile system of accounting to comply with all applicable mandatory accounting standards issued by the Institute. The financial statements prepared under cash basis of accounting however, need not adhere to the accounting standards issued by the Institute. 1.15 © The Institute of Chartered Accountants of India Accounting It follows from above, that a member of the Institute reporting for tax audit purposes, is under an obligation to see whether the audited financial statements, if prepared under mercantile system of accounting, comply with all applicable mandatory standards issued by the Institute. In case of any deviation, the member should consider making qualification/appropriate disclosure in his reports. It should be noted that the Central Government has notified two accounting standards, viz. AS (IT) 1, Disclosure of Accounting Policies and AS (IT) 2, Disclosure of Prior Period and Extra Ordinary Items and Changes in Accounting Policies for the purpose of taxation. Section 145 of Income Tax Act requires all assesses keeping their books by the mercantile system of accounting to comply with these two standards. Also, requirements of AS (IT) 1 and AS (IT) 2 are practically same as the corresponding AS 1 and AS 5 issued by the institute. The mandatory compliance of AS (IT) 1 and AS (IT) 2 are nevertheless required for the limited purpose of income tax. Mandatory accounting standards issued by the ICAI apply to all financial statements prepared under mercantile system irrespective of the requirements of Income Tax Act. The differences between requirements of Income Tax Act and those of accounting standards cause taxable profit to differ from the accounting profit before tax. 2.2 List of Accounting Standards Following is the list of Accounting Standards: AS No. AS Title 1 Disclosure of Accounting Policies 2 Valuation of Inventories (Revised) 3 Cash Flow Statement (Revised) 4 Contingencies and Events Occurring after the Balance Sheet Date 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies (Revised) 6 Depreciation Accounting (Revised) 7 Construction Contracts (Revised) 8 Research & Development 9 Revenue Recognition 10 Accounting for Fixed Assets 11 The Effects of Changes in Foreign Exchange Rates (Revised) 12 Accounting for Government Grants 13 Accounting for Investments 1.16 © The Institute of Chartered Accountants of India Accounting Standards 14 Accounting for Amalgamations 15 Employee Benefits 16 Borrowing Costs 17 Segment Reporting 18 Related Party Disclosures 19 Leases 20 Earning Per Shares 21 Consolidated Financial Statement 22 Accounting for Taxes on Income 23 Accounting for Investment in Associates in Consolidated Financial Statement 24 Discontinuing Operations 25 Interim Financial Statement 26 Intangible Assets 27 Financial Reporting of Interests in Joint Ventures 28 Impairment of Assets 29 Provisions, Contingent Liabilities and Contingent Assets 30 Financial Instruments: Recognition and Measurement 31 Financial Instruments: Presentation 32 Financial Instruments: Disclosures Note: Accounting Standards 1, 2, 3, 6, 7, 9, 10, 13 and 14 are covered in the IPCC (Gr-I) syllabus and have been discussed in detail in the later paras. 2.3 Compliance of Accounting Standards For the purpose of compliance of the accounting Standards, ICAI issued an announcement ‘Applicability of Accounting Standards’. As per the announcement, there are three levels of entities. Level II entities and Level III entities as per the said Announcement are considered to be the Small and Medium Entities (SMEs). On the other hand, as per the Accounting Standards notified by the Government, there are two levels, namely, Small and Medium-sized Companies (SMCs) as defined in the Rules and companies other than SMCs. Non-SMCs are required to comply with all the Accounting Standards in their entirety, while certain exemptions/ relaxations have been given to SMCs. Certain differences in the criteria for classification of the levels were also noted. In this regard, the ASB of the ICAI decided to continue to have three levels as at present with certain modification, instead of two as per the Government notification. 1.17 © The Institute of Chartered Accountants of India Accounting 2.3.1 Criteria for classification of non-corporate entities as decided by the Institute of Chartered Accountants of India Level I Entities Non-corporate entities which fall in any one or more of the following categories, at the end of the relevant accounting period, are classified as Level I entities: (i) Entities whose equity or debt securities are listed or are in the process of listing on any stock exchange, whether in India or outside India. (ii) Banks (including co-operative banks), financial institutions or entities carrying on insurance business. (iii) All commercial, industrial and business reporting entities, whose turnover (excluding other income) exceeds rupees fifty crore in the immediately preceding accounting year. (iv) All commercial, industrial and business reporting entities having borrowings (including public deposits) in excess of rupees ten crore at any time during the immediately preceding accounting year. (v) Holding and subsidiary entities of any one of the above. Level II Entities (SMEs) Non-corporate entities which are not Level I entities but fall in any one or more of the following categories are classified as Level II entities: (i) All commercial, industrial and business reporting entities, whose turnover (excluding other income) exceeds rupees forty lakh but does not exceed rupees fifty crore in the immediately preceding accounting year. (ii) All commercial, industrial and business reporting entities having borrowings (including public deposits) in excess of rupees one crorebut not in excess of rupees ten crore at any time during the immediately preceding accounting year. (iii) Holding and subsidiary entities of any one of the above. Level III Entities (SMEs) Non-corporate entities which are not covered under Level I and Level II are considered as Level III entities. Additional requirements (1) An SME which does not disclose certain information pursuant to the exemptions or relaxations given to it should disclose (by way of a note to its financial statements) the fact that it is an SME and has complied with the Accounting Standards insofar as they are applicable to entities falling in Level II or Level III, as the case may be. (2) Where an entity, being covered in Level II or Level III, had qualified for any exemption or relaxation previously but no longer qualifies for the relevant exemption or relaxation in the 1.18 © The Institute of Chartered Accountants of India Accounting Standards current accounting period, the relevant standards or requirements become applicable from the current period and the figures for the corresponding period of the previous accounting period need not be revised merely by reason of its having ceased to be covered in Level II or Level III, as the case may be. The fact that the entity was covered in Level II or Level III, as the case may be, in the previous period and it had availed of the exemptions or relaxations available to that Level of entities should be disclosed in the notes to the financial statements. (3) Where an entity has been covered in Level I and subsequently, ceases to be so covered, the entity will not qualify for exemption/relaxation available to Level II entities, until the entity ceases to be covered in Level I for two consecutive years.Similar is the case in respect of an entity, which has been covered in Level I or Level II and subsequently, gets covered under Level III. (4) If an entity covered in Level II or Level III opts not to avail of the exemptions or relaxations available to that Level of entities in respect of any but not all of the Accounting Standards, it should disclose the Standard(s) in respect of which it has availed the exemption or relaxation. (5) If an entity covered in Level II or Level III desires to disclose the information not required to be disclosed pursuant to the exemptions or relaxations available to that Level of entities, it should disclose that information in compliance with the relevant Accounting Standard. (6) An entity covered in Level II or Level III may opt for availing certain exemptions or relaxations from compliance with the requirements prescribed in an Accounting Standard: Provided that such a partial exemption or relaxation and disclosure should not be permitted to mislead any person or public. (7) In respect of Accounting Standard (AS) 15, Employee Benefits, exemptions/ relaxations are available to Level II and Level III entities, under two subclassifications, viz., (i) entities whose average number of persons employed during the year is 50 or more, and (ii) entities whose average number of persons employed during the year is less than 50. The requirements stated in paragraphs (1) to (6) above, mutatis mutandis, apply to these sub- classifications. 2.3.2 Criteria for classification of Companies under the Companies (Accounting Standards) Rules, 2006 Small and Medium-Sized Company (SMC) as defined in Clause 2(f) of the Companies (Accounting Standards) Rules, 2006: “Small and Medium Sized Company” (SMC) means, a company- (i) whose equity or debt securities are not listed or are not in the process of listing on any stock exchange, whether in India or outside India; (ii) which is not a bank, financial institution or an insurance company; 1.19 © The Institute of Chartered Accountants of India Accounting (iii) whose turnover (excluding other income) does not exceed rupees fifty crore in the immediately preceding accounting year; (iv) which does not have borrowings (including public deposits) in excess of rupees ten crore at any time during the immediately preceding accounting year; and (v) which is not a holding or subsidiary company of a company which is not a small and medium-sized company. Explanation: For the purposes of clause (f), a company shall qualify as a Small and Medium Sized Company, if the conditions mentioned therein are satisfied as at the end of the relevant accounting period. Non-SMCs Companies not falling within the definition of SMC are considered as Non- SMCs. Instructions A. General Instructions 1. SMCs shall follow the following instructions while complying with Accounting Standards under these Rules:- 1.1 The SMC which does not disclose certain information pursuant to the exemptions or relaxations given to it shall disclose (by way of a note to its financial statements) the fact that it is an SMC and has complied with the Accounting Standards insofar as they are applicable to an SMC on the following lines: “The Company is a Small and Medium Sized Company (SMC) as defined in the General Instructions in respect of Accounting Standards notified under the Companies Act, 1956. Accordingly, the Company has complied with the Accounting Standards as applicable to a Small and Medium Sized Company.” 1.2 Where a company, being an SMC, has qualified for any exemption or relaxation previously but no longer qualifies for the relevant exemption or relaxation in the current accounting period, the relevant standards or requirements become applicable from the current period and the figures for the corresponding period of the previous accounting period need not be revised merely by reason of its having ceased to be an SMC. The fact that the company was an SMC in the previous period and it had availed of the exemptions or relaxations available to SMCs shall be disclosed in the notes to the financial statements. 1.3 If an SMC opts not to avail of the exemptions or relaxations available to an SMC in respect of any but not all of the Accounting Standards, it shall disclose the standard(s) in respect of which it has availed the exemption or relaxation. 1.20 © The Institute of Chartered Accountants of India Accounting Standards 1.4 If an SMC desires to disclose the information not required to be disclosed pursuant to the exemptions or relaxations available to the SMCs, it shall disclose that information in compliance with the relevant accounting standard. 1.5 The SMC may opt for availing certain exemptions or relaxations from compliance with the requirements prescribed in an Accounting Standard: Provided that such a partial exemption or relaxation and disclosure shall not be permitted to mislead any person or public. B. Other Instructions Rule 5 of the Companies (Accounting Standards) Rules, 2006, provides as below: “5. An existing company, which was previously not a Small and Medium Sized Company (SMC) and subsequently becomes an SMC, shall not be qualified for exemption or relaxation in respect of Accounting Standards available to an SMC until the company remains an SMC for two consecutive accounting periods.” 2.3.3 Applicability of Accounting Standards to Companies 2.3.3.1 Accounting Standards applicable to all companies in their entirety for accounting periods commencing on or after 7th December, 2006 AS 1 Disclosures of Accounting Policies AS 2 Valuation of Inventories AS 4 Contingencies and Events Occurring 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 Construction Contracts (revised 2002) AS 9 Revenue Recognition AS 10 Accounting for Fixed Assets AS 11 The Effects of Changes in Foreign Exchange Rates (revised 2003) AS 12 Accounting for Government Grants AS 13 Accounting for Investments AS 14 Accounting for Amalgamations AS 16 Borrowing Costs 1.21 © The Institute of Chartered Accountants of India Accounting AS 18 Related Party Disclosures AS 22 Accounting for Taxes on Income AS 24 Discontinuing Operations AS 26 Intangible Assets 2.3.3.2 Exemptions or Relaxations for SMCs as defined in the Notification (A) Accounting Standards not applicable to SMCs in their entirety: AS 3 Cash Flow Statements. AS 17 Segment Reporting (B) Accounting Standards not applicable to SMCs since the relevant Regulations require compliance with them only by certain Non-SMCs∗: (i) AS 21, Consolidated Financial Statements (ii) AS 23, Accounting for Investments in Associates in Consolidated Financial Statements (iii) AS 27, Financial Reporting of Interests in Joint Ventures (to the extent of requirements relating to Consolidated Financial Statements) (C) Accounting Standards∗∗ in respect of which relaxations from certain requirements have been given to SMCs: (i) Accounting Standard (AS) 15, Employee Benefits (revised 2005) (ii) AS 19, Leases (iii) AS 20, Earnings Per Share (iv) AS 28, Impairment of Assets (v) AS 29, Provisions, Contingent Liabilities and Contingent Assets (D) AS 25, Interim Financial Reporting, does not require a company to present interim financial report. It is applicable only if a company is required or elects to prepare and present an interim financial report. Only certain Non-SMCs are required by the concerned regulators to present interim financial results, e.g, quarterly financial results required by the SEBI. Therefore, the recognition and measurement requirements contained in this Standard are applicable to those Non-SMCs for preparation of interim financial results. ∗ AS 21, AS 23 and AS 27 (relating to consolidated financial statements) are required to be complied with by a company if the company, pursuant to the requirements of a statute/regulator or voluntarily, prepares and presents consolidated financial statements. ∗∗ The exemption provisions contained in these standards have not been detailed since these standards do not form part of syllabus of IPCC Paper-1 Accounting. 1.22 © The Institute of Chartered Accountants of India Accounting Standards 2.3.4 Applicability of Accounting Standards to Non-corporate Entities (As on 1.4.2008) 2.3.4.1 Accounting Standards applicable to all Non-corporate Entities in their entirety (Level I, Level II and Level III) AS 1 Disclosures of Accounting Policies AS 2 Valuation of Inventories AS 4 Contingencies and Events Occurring 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 Construction Contracts (revised 2002) AS 9 Revenue Recognition AS 10 Accounting for Fixed Assets AS 11 The Effects of Changes in Foreign Exchange Rates (revised 2003) AS 12 Accounting for Government Grants AS 13 Accounting for Investments AS 14 Accounting for Amalgamations AS 16 Borrowing Costs AS 22 Accounting for Taxes on Income AS 26 Intangible Assets 2.3.4.2 Exemptions or Relaxations for Non-corporate Entities falling in Level II and Level III (SMEs) (A) Accounting Standards not applicable to Non-corporate Entities falling in Level II in their entirety: AS 3 Cash Flow Statements AS 17 Segment Reporting (B) Accounting Standards not applicable to Non-corporate Entities falling in Level III in their entirety: AS 3 Cash Flow Statements AS 17 Segment Reporting AS 18 Related Party Disclosures AS 24 Discontinuing Operations 1.23 © The Institute of Chartered Accountants of India Accounting (C) Accounting Standards not applicable to all Non-corporate Entities since the relevant Regulators require compliance with them only by certain Level I entities∗: (i) AS 21, Consolidated Financial Statements (ii) AS 23, Accounting for Investments in Associates in Consolidated Financial Statements (iii) AS 27, Financial Reporting of Interests in Joint Ventures (to the extent of requirements relating to Consolidated Financial Statements) (D) Accounting Standards∗∗ in respect of which relaxations from certain requirements have been given to Non-corporate Entities falling in Level II and Level III (SMEs): (i) Accounting Standard (AS) 15, Employee Benefits (revised 2005) (ii) AS 19, Leases (iii) AS 20, Earnings Per Share (iv) AS 28, Impairment of Assets (v) AS 29, Provisions, Contingent Liabilities and Contingent Assets (E) AS 25, Interim Financial Reporting, does not require a non-corporate entity to present interim financial report. It is applicable only if a non corporate entity is required or elects to prepare and present an interim financial report. Only certain Level I non- corporate entities are required by the concerned regulators to present interim financial results e.g., quarterly financial results required by the SEBI. Therefore, the recognition and measurement requirements contained in this Standard are applicable to those Level I non-corporate entities for preparation of interim financial results. 2.4 Overview 2.4.1 Disclosure of Accounting Policies (AS 1) Irrespective of extent of standardisation, diversity in accounting policies is unavoidable for two reasons. First, accounting standards cannot and do not cover all possible areas of accounting and enterprises have the freedom of adopting any reasonable accounting policy in areas not covered by a standard. Second, since enterprises operate in diverse situations, it is impossible to develop a single set of policies applicable to all enterprises for all time. ∗ AS 21, AS 23 and AS 27 (to the extent these standards relate to preparation of consolidated financial statements) are required to be complied with by a non-corporate entity if the non-corporate entity, pursuant to the requirements of a statute/regulator or voluntarily, prepares and presents consolidated financial statements. ∗∗ The exemption provisions contained in these standards have not been detailed since these standards do not form part of syllabus of IPCC Paper-1 Accounting. 1.24 © The Institute of Chartered Accountants of India Accounting Standards The accounting standards therefore permit more than one policy even in areas covered by it. Differences in accounting policies lead to differences in reported information even if underlying transactions are same. The qualitative characteristic of comparability of financial statements therefore suffers due to diversity of accounting policies. Since uniformity is impossible, and accounting standards permit more than one alternative in many cases, it is not enough to say that all standards have been complied with. For these reasons, accounting standard 1 requires enterprises to disclose accounting policies actually adopted by them in preparation of their financial statements. Such disclosures allow the users of financial statements to take the differences in accounting policies into consideration and to make necessary adjustments in their analysis of such statements. The purpose of Accounting Standard 1, Disclosure of Accounting Policies, is to promote better understanding of financial statements by requiring disclosure of significant accounting policies in orderly manner. As explained in the preceding paragraph, such disclosures facilitate more meaningful comparison between financial statements of different enterprises for same accounting periods. The standard also requires disclosure of changes in accounting policies such that the users can compare financial statements of same enterprise for different accounting periods. Accounting Standard 1, Disclosure of Accounting Policies, was first issued November 1979. It came into effect in respect of accounting periods commencing on or after April 1, 1991. The standard applies to all enterprises. Fundamental Accounting Assumptions (Paragraph 10) The Accounting Standard 1 recognises three fundamental accounting assumptions. These are (a) Going Concern (b) Consistency and (c) Accrual. So long as these assumptions are followed in preparation of financial statements, no disclosure of such adherence is necessary. Any departure from any of these assumptions should however be disclosed. Going Concern: The financial statements are normally prepared on the assumption that an enterprise will continue in operation in the foreseeable future and neither there is intention, nor there is need to materially curtail the scale of operations. Going concern assumption is not likely to be compatible with the intention or necessity to enter into a scheme of arrangement with the enterprise’s creditors or to liquidate in near future. Financial statements prepared on going concern basis recognise among other things the need for sufficient retention of profit to replace assets consumed in operation and for making adequate provision for settlement of its liabilities. If any financial statement is prepared on a different basis, e.g. when assets of an enterprise are stated at net realisable values in its financial statements, the basis used should be disclosed. 1.25 © The Institute of Chartered Accountants of India Accounting Consistency: The principle of consistency refers to the practice of using same accounting policies for similar transactions in all accounting periods. The consistency improves comparability of financial statements through time. An accounting policy can be changed if the change is required (i) by a statute (ii) by an accounting standard (iii) for more appropriate presentation of financial statements. Accrual basis of accounting: Under this basis of accounting, transactions are recognised as soon as they occur, whether or not cash or cash equivalent is actually received or paid. Accrual basis ensures better matching between revenue and cost and profit/loss obtained on this basis reflects activities of the enterprise during an accounting period, rather than cash flows generated by it. While accrual basis is a more logical approach to profit determination than the cash basis of accounting, it exposes an enterprise to the risk of recognising an income before actual receipt. The accrual basis can therefore overstate the divisible profits and dividend decisions based on such overstated profit lead to erosion of capital. For this reason, accounting standards require that no revenue should be recognised unless the amount of consideration and actual realisation of the consideration is reasonably certain. Despite the possibility of distribution of profit not actually earned, accrual basis of accounting is generally followed because of its logical superiority over cash basis of accounting as illustrated below. Section 209(3)(b) of the Companies Act makes it mandatory for companies to maintain accounts on accrual basis only. It is not necessary to expressly state that accrual basis of accounting has been followed in preparation of a financial statement. In case, any income/expense is recognised on cash basis, the fact should be stated. Selection of Accounting Policy (Paragraph 17) Financial Statements are prepared to portray a true and fair view of the performance and state of affairs of an enterprise. In selecting a policy, alternative accounting policies should be evaluated in that light. In particular, major considerations that govern selection of a particular policy are: Prudence: In view of uncertainty associated with future events, profits are not anticipated, but losses are provided for as a matter of conservatism. Provision should be created for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information. The exercise of prudence in selection of accounting policies ensure that (i) profits are not overstated (ii) losses are not understated (iii) assets are not overstated and (iv) liabilities are not understated. The prudence however does not permit creation of hidden reserve by understating profits and assets or by overstating liabilities and losses. Example The most common example of exercise of prudence in selection of accounting policy is the policy of valuing inventory at lower of cost and net realisable value. 1.26 © The Institute of Chartered Accountants of India Accounting Standards Suppose a trader has purchased 500 units of certain article @ ` 10 per unit. He sold 400 articles @ ` 15 per unit. If the net realisable value per unit of the unsold article is ` 15, the trader shall value his stock at ` 10 per unit and thus ignoring the profit ` 500 that he may earn in next accounting period by selling 100 units of unsold articles. If the net realisable value per unit of the unsold article is ` 8, the trader shall value his stock at ` 8 per unit and thus recognising possible loss ` 200 that he may incur in next accounting period by selling 100 units of unsold articles. Profit of the trader if net realisable value of unsold article is ` 15 = Sale – Cost of goods sold = (400 x ` 15) – (500 x ` 10 – 100 x ` 10) = ` 2,000 Profit of the trader if net realisable value of unsold article is ` 8 = Sale – Cost of goods sold = (400 x ` 15) – (500 x ` 10 – 100 x ` 8) = ` 1,800 Example Exercise of prudence does not permit creation of hidden reserve by understating profits and assets or by overstating liabilities and losses. Suppose a company is facing a damage suit. No provision for damages should be recognised by a charge against profit, unless the probability of losing the suit is more than the probability of not losing it. Substance over form: Transactions and other events should be accounted for and presented in accordance with their substance and financial reality and not merely with their legal form. Materiality: Financial statements should disclose all ‘material items, i.e. the items the knowledge of which might influence the decisions of the user of the financial statement. Materiality is not always a matter of relative size. For example a small amount lost by fraudulent practices of certain employees can indicate a serious flaw in the enterprise’s internal control system requiring immediate attention to avoid greater losses in future. In certain cases quantitative limits of materiality is specified. A few of such cases are given below: (a) In giving break-up of purchases, stocks and turnover, items like spare parts and accessories, the list of which is too large to be included in the break-up, may be grouped under suitable headings without quantities, provided all those items, which in value individually account for 10% or more of the total value of purchases, stocks or turnover as the case may be, are shown as separate and distinct items with quantities thereof in the break-up. (Requirements as to Profit & Loss Account; Part II of Schedule VI of Companies Act). (b) Any item under which the expenses exceed 1 per cent of total revenue of the company or ` 5,000, whichever is higher, are shown as a separate and distinct item against appropriate account head in the Profit & Loss Account and are not combined with any other item shown under ‘Miscellaneous Expenses’. (Requirements as to Profit & Loss Account; Part II of Schedule VI of Companies Act). 1.27 © The Institute of Chartered Accountants of India Accounting Manner of disclosure: All significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed (Paragraph 24) The disclosure of the significant accounting policies as such should form part of the financial statements and the significant accounting policies should normally be disclosed in one place. (Paragraph 25) Note: Being a part of the financial statement, the opinion of auditors shall cover the disclosures of accounting policies. In view of paragraph 25, it is not appropriate to scatter the disclosures of accounting policies over the financial statement. For example, it is not correct to disclose depreciation policy as part of schedule of fixed assets and inventory policy as part of schedule of inventory. Disclosure of Changes in Accounting Policies (Paragraph 26) Any change in the accounting policies which has a material effect in the current period or which is reasonably expected to have a material effect in a later period should be disclosed. In the case of a change in accounting policies, which has a material effect in the current period, the amount by which any item in the financial statements is affected by such change should also be disclosed to the extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact should be indicated. Examples 1 A simple disclosure that an accounting policy has been changed is not of much use for a reader of a financial statement. The effect of change should therefore be disclosed wherever ascertainable. Suppose a company has switched over to weighted average formula for ascertaining cost of inventory, from the earlier practice of using FIFO. If the closing inventory by FIFO is ` 2 lakh and that by weighted average formula is ` 1.8 lakh, the change in accounting policy pulls down profit and value of inventory by ` 20,000. The company may disclose the change in accounting policy in the following manner: ‘The company values its inventory at lower of cost and net realisable value. Since net realisable value of all items of inventory in the current year was greater than respective costs, the company valued its inventory at cost. In the present year the company has changed to weighted average formula, which better reflects the consumption pattern of inventory, for ascertaining inventory costs from the earlier practice of using FIFO for the purpose. The change in policy has reduced profit and value of inventory by ` 20,000’. A change in accounting policy is to be disclosed if the change is reasonably expected to have material effect in future accounting periods, even if the change has no material effect in the current accounting period. The above requirement ensures that all important changes in accounting policies are actually disclosed. Suppose a company makes provision for warranty claims based on estimated costs of materials and labour. The company changed the policy in 2010-11 to include overheads in estimating costs for servicing warranty claims. If value of warranty sales in 2010-11 is not significant, the change in policy will not have any material effect on financial statements of 1.28 © The Institute of Chartered Accountants of India Accounting Standards 2010-11. Yet, the company must disclose the change in accounting policy in 2010-11 because the change can affect future accounting periods when value of warranty sales may rise to a significant level. If the disclosure is not made in 2010-11, then no disclosure in future years will be required. This is because an enterprise has to disclose changes in accounting policies in the year of change only. Disclosure of deviations from fundamental accounting assumptions (Paragraph 27) If the fundamental accounting assumptions, viz. Going concern, Consistency and Accrual are followed in financial statements, specific disclosure is not required. If a fundamental accounting assumption is not followed, the fact should be disclosed. The principle of consistency refers to the practice of using same accounting policies for similar transactions in all accounting periods. The deviation from the principle of consistency therefore means a change in accounting policy, the disclosure requirements for which are covered by paragraph 26. 2.4.2 Valuation of Inventory (AS 2) The cost of closing inventory, e.g. cost of closing stock of raw materials, closing work-in- progress and closing finished stock, is a part of costs incurred in the current accounting period that is carried over to next accounting period. Likewise, the cost of opening inventory is a part of costs incurred in the previous accounting period that is brought forward to current accounting period. Since inventories are assets, and assets are resources expected to cause flow of future economic benefits to the enterprise, the costs to be included in inventory costs, are costs that are expected to generate future economic benefits to the enterprise. Such costs must be costs of acquisition and costs that change either (i) the location of the inventory, e.g. freight incurred to carry the materials to factory or (ii) conditions of the inventory, e.g. costs incurred to convert the materials into finished stock. The costs incurred to maintain the inventory, e.g. storage costs, do not generate any extra economic benefits for the enterprise and therefore should not be included in inventory costs. The valuation of inventory is crucial because of its direct impact in measuring profit/loss for an accounting period. Higher the value of closing inventory lower is the cost of goods sold and hence larger is the profit. The principle of prudence demands that no profit should be anticipated while all foreseeable losses should be recognised. Thus, if net realisable value of inventory is less than inventory cost, inventory is valued at net realisable value to reduce the reported profit in anticipation of loss. On the other hand, if net realisable value of inventory is more than inventory cost, the anticipated profit is ignored and the inventory is valued at cost. In short, inventory is valued at lower of cost and net realisable value. The standard specifies (i) what the cost of inventory should consist of and (ii) how the net realisable value is determined. Failure of an item of inventory to recover its costs is unusual. If net realisable value of an item of inventory is less than its cost, the fall in profit in consequence of writing down of inventory 1.29 © The Institute of Chartered Accountants of India Accounting to net realisable is an unusual loss and should be shown as a separate line item in the Profit & Loss A/c to help the users of financial statements to make a more informed analysis of the enterprise performance. (See AS 5, for details) By their very nature, abnormal gains or losses are not expected to recur regularly. For a meaningful analysis of an enterprise’s performance, the users of financial statements need to know the amount of such gains/losses included in current profit/loss. For this reason, instead of taking abnormal gains and losses in inventory costs, these are shown in the Profit & Loss A/c in such way that their impact on current profit/loss can be perceived. (See AS 5 for details) Parts I and II of Schedule VI of Companies Act prescribes valuation and disclosure norms for inventory held by companies. The AS 2, Valuation of Inventories was first issued in June 1981 to supplement the legal requirements. It was revised and made mandatory for all enterprises in respect of accounting periods commencing on or after April 1, 1999. Paragraph 3 of the standard defines inventories as assets held (a) For sale in the ordinary course of business or (b) In the process of production for such sale or (c) In the form of materials or supplies to be consumed in the production process or in rendering of services. As per paragraph 1, the following are excluded from the scope of AS 2. Work in progress arising under construction contracts, i.e. cost of part construction, including directly related service contracts, being covered under AS 7, Accounting for Construction Contracts; Inventory held for use in construction, e.g. cement lying at the site shall however be covered by AS 2. (a) Work in progress arising in the ordinary course of business of service providers i.e. cost of providing a part of service. For example, for a shipping company, fuel and stores not consumed at the end of accounting period is inventory but not costs for voyage-in- progress. Work-in-progress may arise for different other services e.g. software development, consultancy, medical services, merchant banking and so on. (b) Shares, debentures and other financial instruments held as stock-in-trade. It should be noted that these are excluded from the scope of AS 13 as well. The current Indian practice is however to value them at lower of cost and fair value. (c) Producers’ inventories of livestock, agricultural and forest products, and mineral oils, ores and gases to the extent that they are measured at net realisable value in accordance with well established practices in those industries, e.g. where sale is assured under a forward contract or a government guarantee or where a homogenous market exists and there is negligible risk of failure to sell. Containers and Empties Containers and empties are not goods for sale in the ordinary course of business, nor are they goods in the production process nor they are materials or supplies for consumption in the 1.30 © The Institute of Chartered Accountants of India Accounting Standards production process or in rendering of services. The Expert Advisory Committee of ICAI has however expressed an opinion that containers and empties are items of inventory. It seems nevertheless that containers and empties having useful life more than one year should be regarded as depreciable assets, in accordance with AS 6. Measurement of Inventories (Paragraph 5) Inventories should be valued at lower of cost and net realisable value. As per paragraph 3, net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. The valuation of inventory at lower of cost and net realisable value is based on the view that no asset should be carried at a value which is in excess of the value realisable by its sale or use. Example 1 Cost of a partly finished unit at the end of 2009-10 is ` 800. The unit can be finished next year by a further expenditure of ` 100. The finished unit can be sold ` 250, subject to payment of 4% brokerage on selling price. The value of inventory is determined below: ` Net selling price 250 Less: Estimated cost of completion 100 150 Less: Brokerage (4% of 250) 10 Net Realisable Value 140 Cost of inventory 800 Value of inventory (Lower of cost and net realisable value) 140 Note: Incremental cost ` 100 (cost to complete) is less than incremental revenue ` 240 (` 250 – ` 10). The enterprise will therefore decide to finish the unit for sale at ` 250. Example 2 In example 1, suppose cost to complete the unit is ` 245 instead of ` 100. The enterprise will be better off by not finishing the unit as shown below: Incremental cost ` 245 (cost to complete) is more than incremental revenue ` 240 (` 250 – ` 10). The enterprise will therefore prefer not to finish the unit. Net Realisable Value = Nil Cost = ` 800 Value of inventory (Lower of cost and net realisable value) = Nil Costs of inventory (Paragraph 6) Costs of inventories comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. 1.31 © The Institute of Chartered Accountants of India Accounting Costs of purchase (Paragraph 7) The costs of purchase consist of the purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities, e.g. CENVAT credit, State level Value Added Tax etc, freight inwards and other expenditure directly attributable to the acquisition. Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase. Example 3 An enterprise ordered 13,000 Kg. of certain material at ` 90 per unit. The purchase price includes excise duty ` 5 per Kg., in respect of which full CENVAT credit is admissible. Freight incurred amounted to ` 80,600. Normal transit loss is 4%. The enterprise actually received 12,400 Kg and consumed 10,000 Kg. Cost of inventory and allocation of material cost is shown below : Normal cost per Kg. ` Purchase price (13,000 Kg. x ` 90) 11,70,000 Less: CENVAT Credit (13,000 Kg. x ` 5) 65,000 11,05,000 Add: Freight 80,600 A. Total material cost 11,85,600 B. Number units normally received = 96% of 13,000 Kg. Kg. 12,480 C. Normal cost per Kg. (A/B) 95 Allocation of material cost Kg. ` /Kg. ` Materials consumed 10,000 95 9,50,000 Cost of inventory 2,400 95 2,28,000 Abnormal loss 80 95 7,600 Total material cost 12,480 95 11,85,600 Note: Abnormal losses are recognised as separate expense Costs of Conversion The costs of conversion include costs directly related to production, e.g. direct labour. They also include overheads, both fixed and variable. (Paragraph 8) The fixed production overheads should be absorbed systematically to units of production over normal capacity. Normal capacity is the production the enterprise expects achieve on an average over a number of periods or seasons under normal circumstances, taking into 1.32 © The Institute of Chartered Accountants of India Accounting Standards account the loss of capacity resulting from planned maintenance. The actual level of production may be used if it approximates the normal capacity. (Paragraph 9) The amount of fixed production overheads allocated to each unit of production should not be increased as a consequence of low production or idle plant. Unallocated overheads (i.e. under recovery) is recognised as an expense in the period in which they are incurred. In periods of abnormally high production, the amount of fixed production overheads allocated to each unit of production is decreased so that inventories are not measured above cost. Variable production overheads are assigned to each unit of production on the basis of the actual use of the production facilities. (Paragraph 9) The above two points imply: Where actual production is less than or equal to normal capacity, fixed overheads are recovered on the basis of normal capacity. Where actual production is more than normal capacity, fixed overheads are recovered on the basis of actual production. Example 4 In example 3, suppose normal processing loss is 5% of input. During the accounting period, the enterprise has actually produced 9,600 units of finished product. 9,300 units were sold at ` 250 per unit. The labour and overhead costs amounted to ` 6,12,845 and ` 2,23,440 respectively. Overheads are recovered on the basis of output. Excise duty on final product is ` 28.50 per unit Profit & Loss A/c and costs of finished inventory assuming (i) normal capacity is 9,400 units (ii) normal capacity is 9,800 units are shown below. Case (i) (Actual production 9,600 units is more than normal capacity 9,400 units) Normal recovery rate = ` 2,23,440 / 9,400 units = ` 23.77 Actual Overhead per unit = ` 2,23,440 / 9,600 units = ` 23.275 Recovery rate is decreased to actual ` 23.275 per unit due to high production. Normal cost per unit of finished product ` Materials consumed 9,50,000 Wages 6,12,845 Overheads (9,600 x ` 23.275) 2,23,440 Excise Duty (9,600 x ` 28.50) 2,73,600 A. Total cost 20,59,885 B. Normal output (95% of 10,000) 9,500 units C. Normal cost per unit of finished product (A/B) 216.83 1.33 © The Institute of Chartered Accountants of India Accounting Allocation of total cost Units ` /Unit ` Cost of goods sold 9,300 216.83 20,16,519 Cost of finished inventory 300 216.83 65,049 9,600 216.83 20,81,568 Less: Abnormal gain 100 216.83 21,683 Total cost 9,500 216.83 20,59,885 Statement of Profit & Loss ` ` Sales 23,25,000 Less: Cost of goods sold 20,16,519 3,08,481 Abnormal Gain 21,683 Less: Abnormal loss 7,600 14,083 Net profit 3,22,564 Case (ii) (Actual production 9,600 units is less than normal capacity 9,800 units) Normal Overhead recovery rate = ` 2,23,440 / 9,800 units = ` 22.80 Actual overhead per unit = ` 2,23,440 / 9,600 units = ` 23.275 Recovery rate is not increased to actual ` 23.275 per unit due to low production. Overhead recovered = 9,600 x ` 22.80 = ` 2,18,880 Under-recovery = ` 2,23,440 – ` 2,18,880 = ` 4,560 Under recovery per unit of normal output = ` 4,560 / 9,500 = Re. 0.48 Normal cost per unit of finished product ` Materials consumed 9,50,000 Wages 6,12,845 Overheads (9,600 x ` 22.80) 2,18,880 Excise Duty (9,600 x ` 28.50) 2,73,600 A. Total cost 20,55,325 B. Normal output (95% of 10,000) 9,500 units C. Normal cost per unit of finished product (A/B) 216.35 1.34 © The Institute of Chartered Accountants of India Accounting Standards Allocation of total cost Units ` /Unit ` Cost of goods sold 9,300 216.35 20,12,055 Cost of finished inventory 300 216.35 64,905 9,600 216.35 20,76,960 Less: Abnormal gain 100 216.35 21,635 9,500 216.35 20,55,325 Add: Under-recovery 4,560 Total cost 20,59,885 Statement of Profit & Loss ` ` Sales 23,25,000 Less: Cost of goods sold 20,12,055 3,12,945 Less: Under recovery 4,560 3,08,385 Abnormal Gain 21,635 Less: Abnormal loss 7,600 14,035 Net profit 3,22,420 Note 1 Excise duty on output is product cost rather than period cost. Hence taken in production cost and consequently in cost of inventory. Note 2 Profit in case (ii) is reduced by ` 144 from that in case (i). This is because, the whole of under recovery is charged against profit for the year in case (ii) while a part of current year overhead ` 144 (300 units x Re. 0.48 per unit) gets carried over to next period as part of inventory cost in case (i). Joint or By-Products (Paragraph 10) In case of joint or by products, the costs incurred up to the stage of split off should be allocated on a rational and consistent basis. The basis of allocation may be sale value at split off point, for example. The value of by products, scrap and wastes are usually not material. Theses are therefore at net realisable value. The cost of main product is then joint cost minus net realisable value of by-products, scraps or wastes. Other Costs (a) These may be included in cost of inventory provided they are incurred to bring the inventory to their present location and condition. Cost of design, for example, for a custom made unit may be taken as part of inventory cost. (Paragraph 11) 1.35 © The Institute of Chartered Accountants of India Accounting (b) Interest and other borrowing costs are usually considered as not relating to bringing the inventories to their present location and condition. These costs are therefore not usually included in cost of inventory (Paragraph 12). Interests and other borrowing costs however are taken as part of inventory costs, where the inventory necessarily takes substantial period of time for getting ready for intended sale. Example of such inventory is wine. (See AS 16, Borrowing costs, for further details) (c) The standard is silent on treatment of amortisation of intangibles for ascertaining inventory costs. It nevertheless appears that amortisation of intangibles related to production, e.g. patents right of production or copyright for a publisher should be taken as part of inventory costs. (d) Exchange differences are not taken in inventory costs under Indian GAAP. Exclusions from the cost of inventories (Paragraph 13) In determining the cost of inventories, it is appropriate to exclude certain costs and recognise them as expenses in the period in which they are incurred. Examples of such costs are: (a) Abnormal amounts of wasted materials, labour, or other production costs; (b) Storage costs, unless the production process requires such storage; (c) Administrative overheads that do not contribute to bringing the inventories to their present location and condition; (d) Selling and distribution costs. Cost Formula (Paragraph 16) Mostly inventories are purchased / made in different lots and unit cost of each lot frequently differs. In all such circumstances, determination of closing inventory cost requires identification of units in stock to have come from a particular lot. This specific identification is best wherever possible (Para 14). In all other cases, the cost of inventory should be determined by the First-In First-Out (FIFO), or Weighted Average cost formula. The formula used should reflect the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition. Other techniques of cost measurement (a) Instead of actual, the standard costs may be taken as cost of inventory provided standards fairly approximate the actual. Such standards (for finished or partly finished units) should be set in the light of normal levels of material consumption, labour efficiency and capacity utilisation. The standards so set should be regularly reviewed and if necessary, be revised to reflect current conditions. (Paragraph 18) (b) In retail business, where a large number of rapidly changing items are traded, the actual costs of items may be difficult to determine. The units dealt by a retailer however, are usually sold for similar gross margins and a retail method to determine cost in such retail trades makes use of the fact. By this method, cost of inventory is determined by reducing sale value of unsold stock by appropriate average percentage of gross margin. (Paragraph 19) 1.36 © The Institute of Chartered Accountants of India Accounting Standards Example 5 A trader purchased certain articles for ` 85,000. He sold some these articles for ` 1,05,000. The average percentage of gross margin is 25% on cost. Opening stock of inventory at cost was ` 15,000. Cost closing inventory is shown below. ` Sale value of opening stock and purchase (` 85,000 + ` 15,000) x 1.25 1,25,000 Sales 1,05,000 Sale value of unsold stock 20,000 Less: Gross Margin (` 20,000 / 1.25) x 0.25 4,000 Cost of inventory 16,000 Estimates of Net Realisable Value Estimates of net realisable value are based on the most reliable evidence available at the time the estimates are made as to the amount the inventories are expected to realise. These estimates take into consideration fluctuations of price or cost directly relating to events occurring after the balance sheet date to the extent that such events confirm the conditions existing at the balance sheet date. (Paragraph 22) Comparison of Cost and Net Realisable Value (a) The comparison between cost and net realisable value should be made on item-by-item basis. In some cases nevertheless, it may be appropriate to group similar or related items. (Paragraph 21) Example 6 The cost, net realisable value and inventory value of two items that a company has in its inventory are given below: Cost Net Realisable Value Inventory Value ` ` ` Item 1 50,000 45,000 45,000 Item 2 20,000 24,000 20,000 Total 70,000 69,000 65,000 Estimates of NRV should be based on evidence available at the time of estimation As per paragraph 3, net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. Paragraph 22 provides that estimates of net realisable value are to be based on the most reliable evidence available at the time the estimates are made as to the amount the inventories are expected to realise. These estimates take into consideration fluctuations of 1.37 © The Institute of Chartered Accountants of India Accounting price or cost directly relating to events occurring after the balance sheet date to the extent that such events confirm the conditions existing at the balance sheet date. NRV of materials held for use or disposal As per paragraph 24, materials and other supplies held for use in the production of inventories are not written down below cost if the selling price of finished product containing the material exceeds the cost of the finished product. The reason is, as long as these conditions hold the material realises more than its cost as shown below. An enterprise may either (i) dispose off the material without incorporating it in finished product to realise its current price or (ii) Incorporate the material in finished product to realise the selling price less costs of making (Incremental Revenue) An enterprise prefers to incorporate the material in finished product when: Incremental Revenue by making > Current price of material Or when: (Selling price of finished product – Cost to make) > Current price of material Or when: (Selling price of finished product > (Current price of material + Cost to make) Or when: (Selling price of finished product > Relevant cost of finished product As long as selling price of finished product is more than relevant cost of finished product, the enterprise incorporates the material in finished product and realises incremental revenue rather than current price of material. Thus If selling price of finished product is more than relevant cost of finished product, the enterprise incorporates the material in finished product and NRV is incremental revenue. (a) If selling price of finished product is less than relevant cost of finished product, the enterprise disposes of the material and NRV is current price of material If current price of material is greater than material cost Observe that the NRV is either current price of material or higher, i.e. incremental revenue. Thus, if current price of material is greater than material cost, NRV always exceeds the material cost. The inventories in all such cases are therefore valued at cost. If current price of material is less than material cost As before, the NRV is either current price of material or higher, i.e. incremental revenue. If current price of material is less than material cost, and NRV is current price of material (i.e. when enterprise prefers to dispose of the material at current price) the NRV is less than material cost. The inventory is therefore written down to NRV, i.e. current price [See Example 12(a) below]. For the reason stated above, paragraph 24 further provides that when there has been a decline in the price of materials and it is estimated that the cost of finished products will exceed net realisable value (i.e. when enterprise prefers to dispose of the material at current price) the materials are written down to net realisable value. In such circumstances, the replacement cost (i.e. current price of material) may be the best available measure of net realisable value. 1.38 © The Institute of Chartered Accountants of India Accounting Standards If current price of material is less than material cost, and NRV is incremental revenue, (i.e. when enterprise prefers to make the product) the NRV is more than current price of material but may or may not exceed the material cost. If the incremental revenue exceeds material cost, the inventory is valued at cost [See Example 14(b) below]. If the incremental revenue is less than material cost, the inventory is valued at NRV, i.e. incremental revenue [See Example 12(c) below]. Example 7 Raw materials inventory of a company includes 1 Kg. of certain material purchased at ` 100 per Kg. The price of the material is on decline and replacement cost of the inventory at the year-end is ` 80 per Kg. It is possible to incorporate the material in a finished product. The conversion cost (wages and overheads) is ` 120. Inventory values for expected selling prices of the finished product (a) ` 195 (b) ` 230 and (c) ` 210. are shown below. In all cases, current price of material (` 80) is less than material cost ` 100 Case (a): Selling price = ` 195 Incremental revenue = ` 195 – ` 120 = ` 75 Current price of material = ` 80 It is better to not to make the product. Net realisable value = ` 80 Cost of material = ` 100 Value of inventory = ` 80 Case (b): Selling price = ` 230 Incremental revenue = ` 230 – ` 120 = ` 110 Current price of material = ` 80 It is better to make the product. Net realisable value = ` 110 Cost of material = ` 100 Value of inventory = ` 100 Case (c): Selling price = ` 210 Incremental revenue = ` 210 – ` 120 = ` 90 Current price of material = ` 80 It is better to make the product. Net realisable value = ` 90 Cost of material = ` 100 Value of inventory = ` 90 1.39 © The Institute of Chartered Accountants of India Accounting Review of net realisable value at each balance sheet date If an item of inventory remains at more than one balance sheet dates, paragraph 25 requires reassessment of net realisable value of the item at each balance sheet date. The AS 2 is silent whether an item of inventory carried at net realisable value, can be written up on subsequent increase of net realisable value. The IAS 2, Inventory permits such write-ups. Disclosures Paragraph 26 requires financial statements to disclose: The accounting policies adopted in measuring inventories, including the cost formula used; and The total carrying amount of inventories and its classification appropriate to the enterprise. Paragraph 27 requires disclosure of carrying amounts and changes in them during an accounting period for each class of inventory, e.g. raw materials, components, work-in- progress, finished stock, stores, spares and loose tools. 2.4.3 Cash Flow Statement (AS 3) Traditional financial statements comprised of a balance sheet portraying at the end of accounting period, resources controlled by the reporting enterprise together with sources of funds used for their acquisition and a statement of income, showing income, expenses and profit earned or loss incurred by the reporting enterprise during the accounting period. It was however noticed that due to use of accrual basis of accounting, recognition of financial elements, e.g. assets, liabilities, income, expenses and equity, coincide with the events to which they relate rather than with cash receipts or payments. For this reason, traditional financial statements fail to inform the users the way the reporting enterprise has generated cash and the way these were utilised during the accounting period. To a person, less accustomed with accounting practices, it may sometimes appear perplexing to observe that despite earning large profit, an enterprise is left with very little cash to pay dividends. The need for inclusion of a summary of cash receipts and payments in the financial statements of the reporting enterprise was therefore recognised. The summary of cash receipts and payments during an accounting period is called the Cash Flow Statement. A simple example is given below to illustrate the relation of cash flow with profitability of an enterprise. Status of AS 3 The standard is mandatory for Level 1 enterprises in respect of accounting periods commencing on or after April 1, 2001. The Level II and Level III enterprises are encouraged but not required to apply the standard. All listed companies in India are required by Clause 32 of the listing agreements with stock exchanges to prepare and present cash flow statements by indirect method in accordance with AS 3. 1.40 © The Institute of Chartered Accountants of India Accounting Standards Meaning of the term cash for cash flow statements (Paragraph 5) Cash for the purpose of cash flow statement consists of the following: (a) Cash in hand and deposits repayable on demand with any bank or other financial institutions and (b) Cash equivalents, which are short term, highly liquid investments that are readily convertible into known amounts of cash and are subject to insignificant risk or change in value. A short-term investment is one, which is due for maturity within three months from the date of acquisition. Investments in shares are not normally taken as cash equivalent, because of uncertainties associated with them as to realisable value. Note : For the purpose of cash flow statement, ‘cash’ consists of at least three balance sheet items, viz. cash in hand; demand deposits with banks etc. and investments regarded as cash equivalents. For this reason, the paragraph 42 of the standard requires enterprises to give a break-up of opening and closing cash shown in their cash flow statements. This is presented as a note to cash flow statement. Meaning of the term cash flow (Paragraph 5) Cash flows are inflows (i.e. receipts) and outflows (i.e. payments) of cash and cash equivalents. Any transaction, which does not result in cash flow, should not be reported in the cash flow statement. Movements within cash or cash equivalents are not cash flows because they do not change cash as defined by AS 3, which is sum of cash, bank and cash equivalents. For example, acquisitions of cash equivalent investments or cash deposited into bank are not cash flows. It is important to note that a change in cash does not necessarily imply cash flow. For example suppose an enterprise has a bank balance of USD 10,000, stated in books at ` 4,90,000 using the rate of exchange ` 49/USD prevailing on date of receipt of dollars. If the closing rate of exchange is ` 50/USD, the bank balance will be restated at ` 5,00,000 on the balance sheet date. The increase is however not a cash flow because neither there is any cash inflow nor there is any cash outflow. Types of cash flow Cash flows for an enterprise occur in various ways, e.g. through operating income or expenses, by borrowing or repayment of borrowing or by acquisition or disposal of fixed assets. The implication of each type of cash flow is clearly different. Cash received on disposal of a useful fixed asset is likely to have adverse effect on future performance of the enterprise and it is completely different from cash received through operating income or cash received through borrowing. It may also be noted that implications cash flow types are interrelated. For example, borrowed cash used for meeting operating expenses is not same as borrowed cash used for acquisition of useful fixed assets. 1.41 © The Institute of Chartered Accountants of India Accounting For the aforesaid reasons, the standard identifies three types of cash flows, i.e. investing cash flows, financing cash flows and operating cash flows. Separate presentation of each type of cash flow in the cash flow statement improves usefulness of cash flow information. The investing cash flows are cash flows generated by investing activities. The investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. The examples of investing cash flows include cash flow arising from investing activities include: (a) receipts from disposals of fixed assets; (b) loan given to / recovered from other entities (other than loans by financial enterprises) (c) payments to acquire fixed assets (d) Interests and dividends earned (other than interests and dividends earned by financial institutions). The financing cash flows are cash flows generated by financing activities. Financing activities are activities that result in changes in the size and composition of the owners’ capital (including preferences share capital in the case of company) and borrowings of the enterprise. Examples include issue of shares / debentures, redemption of debentures / preference shares, payment of dividends and payment of interests (other than interests paid by financial institutions). The operating cash flows are cash flows generated by operating activities or by other activities that are not investing or financing activities. Operating activities are the principal revenue- producing activities of the enterprise. Examples include, cash purchase and sale of goods, collections from customers for goods, payment to suppliers of goods, payment of salaries, wages etc. Identifying type of cash flows Cash flow type depends on the business of the enterprise and other factors. For example, since principal business of financial enterprises consists of borrowing, lending and investing, loans given and interests earned are operating cash flows for financial enterprises and investing cash flows for other enterprises. A few typical cases are discussed below. Loans/Advances given and Interests earned (See Paragraph 30) (a) Loans and advances given and interests earned on them in the ordinary course of business are operating cash flows for financial enterprises. (b) Loans and advances given and interests earned on them are investing cash flows for non-financial enterprises. (c) Loans and advances given to subsidiaries and interests earned on them are investing cash flows for all enterprises. (d) Loans and advances given to employees and interests earned on them are operating cash flows for all enterprises. (e) Advance payments to suppliers and interests earned on them are operating cash flows for all enterprises. 1.42 © The Institute of Chartered Accountants of India Accounting Standards (f) Interests earned from customers for late payments are operating cash flows for non- financial enterprises. Loans/Advances taken and interests paid (See Paragraph 30) (a) Loans and advances taken and interests paid on them in the ordinary course of business are operating cash flows for financial enterprises. (b) Loans and advances taken and interests paid on them are financing cash flows for non- financial enterprises. (c) Loans and advances taken from subsidiaries and interests paid on them are investing cash flows for all enterprises. (d) Advance taken from customers and interests paid on them are operating cash flows for non-financial enterprises. (e) Interests paid to suppliers for late payments are operating cash flows for all enterprises. (f) Interests taken as part of inventory costs in accordance with AS 16 are operating cash flows. Investments made and dividends earned (See Paragraph 30) (a) Investments made and dividends earned on them in the ordinary course of business are operating cash flows for financial enterprises. (b) Investments made and dividends earned on them are investing cash flows for non- financial enterprises. (c) Investments in subsidiaries and dividends earned on them are investing cash flows for all enterprises. Dividends Paid (See Paragraph 30) Dividends paid are financing cash outflows for all enterprises. Income Tax (See Paragraph 34) (a) Tax paid on operating income is operating cash outflows for all enterprises (b) Tax deducted at source against income are operating cash outflows if concerned incomes are operating incomes and investing cash outflows if the concerned incomes are investment incomes, e.g. interest earned. (c) Tax deducted at source against expenses are operating cash inflows if concerned expenses are operating expenses and financing cash inflows if the concerned expenses are financing expenses, e.g. interests paid. Insurance claims received (a) Insurance claims received against loss of stock or loss of profits are extraordinary operating cash inflows for all enterprises. 1.43 © The Institute of Chartered Accountants of India Accounting (b) Insurance claims received against loss of fixed assets are extraordinary investing cash inflows for all enterprises. Paragraph 28 of the standard requires separate disclosure of extraordinary cash flows, classifying them as cash flows from operating, investing or financing activities, as may be appropriate. Profit or loss on disposal of fixed assets Profit or loss on sale of fixed asset is not operating cash flow. The entire proceeds of such transactions should be taken as cash inflow from investing activity. Fundamental techniques of cash flow preparation A cash flow statement is a summary of cash receipts and payments of an enterprise during an accounting period. Any attempt to compile such a summary from cashbooks is impractical due to the large volume of transactions. Fortunately, it is possible to compile such a summary by comparing financial statements at the beginning and at the end of accounting period. There are two methods, by which operating cash flows can be presented. By direct approach, the operating cash flows are presented under broad headings, e.g. cash received from customers and cash paid to suppliers and employees. By the indirect approach, operating cash flows are obtained by adjusting profits for changes in working capital and for non-cash charges, e.g. depreciation. Reporting Cash Flows on Net Basis Paragraph 21 forbids netting of receipts and payments from investing and financing activities. Thus, cash paid on purchase of fixed assets should not be shown net of cash realised from sale of fixed assets. For example, if an enterprise pays ` 50,000 in acquisition of machinery and realises ` 10,000 on disposal of furniture, it is not right to show net cash outflow of ` 40,000. The exceptions to this rule are stated in paragraphs 22 and 24. As per paragraph 22, cash flows from the following operating, investing or financing activities may be reported on a net basis. (a) Cash receipts and payments on behalf of customers, e.g. cash received and paid by a bank against acceptances and repayment of demand deposits. (b) Cash receipts and payments for items in which the turnover is quick, the amounts are large and the maturities are short, e.g. purchase and sale of investments by an investment company. Paragraph 24 permits financial enterprises to report cash flows on a net basis in the following three circumstances. (a) Cash flows on acceptance and repayment of fixed deposits (b) Cash flows on placement and withdrawal deposits from other financial enterprises (c) Cash flows on advances/loans given to customers and repayments received therefrom. 1.44 © The Institute of Chartered Accountants of India Accounting Standards Non-Cash transactions (Paragraph 40) Investing and financing transactions that do not require the use of cash or cash equivalents, e.g. issue of bonus shares, should be excluded from a cash flow statement. Such transactions should be disclosed elsewhere in the financial statements in a way that provides all the relevant information about these investing and financing activities. Business Purchase The aggregate cash flows arising from acquisitions and disposals of business units should be presented separately and classified as cash flow from investing activities. (Paragraph 37) (a) The cash flows from disposal and acquisition should not be netted off. (Paragraph 39) (b) As per paragraph 38, an enterprise should disclose, in aggregate, in respect of both acquisition and disposal of subsidiaries or other business units during the period each of the following: (i) The total purchase or disposal consideration; and (ii) The portion of the purchase or disposal consideration discharged by means of cash and cash equivalents. Treatment of current assets and liabilities taken over on business purchase Business purchase is not operating activity. Thus, while taking the differences between closing and opening current assets and liabilities for computation of operating cash flows, the closing balances should be reduced by the values of current assets and liabilities taken over. This ensures that the differences reflect the increases/decreases in current assets and liabilities due to operating activities only. Exchange gains and losses The foreign currency monetary assets (e.g. balance with bank, debtors etc.) and liabilities (e.g. creditors) are initially recognised by translating them into reporting currency by the rate of exchange transaction date. On the balance sheet date, these are restated using the rate of exchange on the balance sheet date. The difference in values is exchange gain/loss. The exchange gains and losses are recognised in the statement of profit and loss (See AS 11 for details). The exchange gains/losses in respect of cash and cash equivalents in foreign currency (e.g. balance in foreign currency bank account) are recognised by the principle aforesaid, and these balances are restated in the balance sheet in reporting currency at rate of exchange on balance sheet date. The change in cash or cash equivalents due to exchange gains and losses are however not cash flows. This being so, the net increases/decreases in cash or cash equivalents in the cash flow statements are stated excusive of exchange gains and losses. The resultant difference between cash and cash equivalents as per the cash flow statement and that recognised in the balance sheet is reconciled in the note on cash flow statement. (Paragraph 25) 1.45 © The Institute of Chartered Accountants of India Accounting Disclosures Paragraph 45 requires an enterprise to disclose the amount of significant cash and cash equivalent balances held by it but not available for its use, together with a commentary by management. This may happen for example, in case of bank balances held in other countries subject to such exchange control or other regulations that the fund is practically of no use. Paragraph 47 encourages disclosure of additional information, relevant for understanding the financial position and liquidity of the enterprise. Such information may include: (a) The amount of undrawn borrowing facilities that may be available for future operating activities and to settle capital commitments, indicating any restrictions on the use of these facilities; and (b) The aggregate amount of cash flows required for maintaining operating capacity, e.g. purchase of machinery to replace the old, separately from cash flows that represent increase in operating capacity, e.g. additional machinery purchased to increase production. Note: For details regarding preparation of Cash Flow Statement and Problems based on practical application of AS 3, students are advised to refer unit 2 of Chapter 2. 2.4.4 Depreciation Accounting (AS 6) Where an asset, e.g. machinery, generates revenue over more than one accounting period, the matching principle demands that the cost of the asset be recognised over same number of accounting periods. Also, the allocation, as far as possible should be in the proportion of revenue generated by the asset. Depreciation for an accounting period is the cost of assets allocated to that accounting period. However, the allocated historical cost of an asset may not always reflect the appropriate charge against revenue. This can happen for example, when the asset has a terminal value or when the asset is revalued. For this reason, depreciation for an accounting period is regarded as amount of depreciable value allocated to an accounting period. The depreciable value is historical cost ± Change in historical cost due to revaluation or otherwise – terminal value expected on disposal of the asset. The depreciation is a non-cash charge, i.e. a charge of depreciation reduces profit available for distribution without reducing the available cash. The cash thus retained in the business is intended to be used for replacement of the depreciable asset. For this reason, section 205 of the Companies Act 1956, provides that companies can pay dividend only out of profit available after charging depreciation in accordance with subsection 2 of that section. For the purpose, Schedule XIV of the Companies Act prescribes certain rates of depreciation. These are minimum rates of depreciation a company must charge. Accounting standard 6, sets the broad principles for computation of depreciation without prescribing any specific rate or method of depreciation. Enterprises other than companies to which the standard applies, must compute and charge depreciation in accordance with the standard. In case of companies, the depreciation charged should be higher of (i) depreciation under Companies Act (ii) depreciation as per AS 6. 1.46 © The Institute of Chartered Accountants of India Accounting Standards AS 6 is mandatory in respect of accounting periods commencing on or after April 1, 1995. It applies to all enterprises. Land has indefinite life and hence does not permit allocation of value over finite number of accounting periods. Hence, the standard does not apply to land, unless it has a limited useful life. The standard applies to all depreciable assets except the following to which special considerations apply: (i) forests, plantations and similar regenerative natural resources (ii) wasting assets including expenditure on the exploration for and extraction of minerals, oils, natural gas and similar non-regenerative resources (iii) expenditure on research and development (iv) livestock Accounting Standard 6 defines depreciation as a measure of the wearing out, consumption or other loss of value of depreciable asset arising from use, efflux of time or obsolescence through technology and market changes. Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. Depreciation includes amortization of assets whose useful life is pre-determined. "Depreciable assets" are assets which: 1. are expected to be used during more than one accounting period; and 2. have a limited useful life; and 3. are held by an enterprise for use in the production or supply of goods and services, for rental to others, or for administrative purposes and not for the purpose of sale in the ordinary course of business. "Useful life" is either (a) the period over which a depreciable asset is expected be used by the enterprise; or (b) the number of production or similar units expected to be obtained from the use of the asset by the enterprise. "Depreciable amount" of a depreciable asset is its historical cost, or other amount substituted for historical cost in the financial statements, less estimated residual value. The depreciable amount of a depreciable asset should be allocated on a systematic basis to each accounting period during the useful life of the asset. (Paragraph 20) The useful life of a depreciable asset should be estimated after considering: expected physical wear and tear (i) obsolescence and (ii) legal or other limits on the use of the asset. (Paragraph 22) 1.47 © The Institute of Chartered Accountants of India Accounting The useful lives of major depreciable assets or classes of depreciable assets may be reviewed periodically. Where there is a revision of the estimated useful life of an asset, the unamortised depreciable amount should be charged over the revised remaining useful life. (Paragraph 23) Example 1 A machine of cost 1,20,000 is depreciated straight-line assuming 10 year working life and zero residual value for three years. The estimate of remaining useful life after third year was reassessed at 5 years. Depreciation per year charged for three years = ` 1,20,000 / 10 = ` 12,000 WDV of the machine at the end of third year = ` 1,20,000 – ` 12,000 × 3 = ` 84,000. Remaining useful life as per previous estimate = 7 years Remaining useful life as per revised estimate = 5 years Depreciation for the fourth year onwards = ` 84,000 / 5 = ` 16,800. Additions and Extensions (Paragraph 24) (a) Where an addition or extension retains a separate identity and is capable of being used after the existing asset is disposed off, depreciation should be provided independently on the basis of an estimate of its own useful life. (b) Where an addition or extension becomes an integral part of an existing asset, it should be depreciated over the asset's remaining useful life. The depreciation on such addition or extension may also be provided at the rate applied to the existing asset. Example 2 The estimated working life of a machine is 6 years. The machine is used with an attachment having a useful life of 10 years. The cost of the machine and that of the attachment are ` 60,000 and ` 6,000 respectively. The terminal value is zero for both. Straight-line depreciation is in use. Depreciation for the year: (a) if the attachment retains a separate identity and is capable of being used after the machine is disposed off = ` 60,000 / 6 + ` 6,000 / 10 = ` 10,600 (b) if the attachment becomes an integral part of the machine = ` 66,000 / 6 = ` 11,000 Change in depreciable amount (a) The historical cost of a depreciable asset may change due to increase or decrease in long-term liability on account of exchange fluctuations (See note), price adjustments, changes in duties or other similar factors. In these cases, depreciation on the revised unamortised depreciable amount should be provided prospectively over the residual life of the asset. (Paragraph 25) 1.48 © The Institute of Chartered Accountants of India Accounting Standards (b) Where the depreciable assets are revalued, the provision for depreciation should be based on the revalued amount and on the estimate of the remaining useful lives of such assets. In case the revaluation has a material effect on the amount of depreciation, the same should be disclosed separately in the year in which revaluation is carried out. (Para 26) The aforesaid two requirements ensure that no amortisation of depreciable amounts remain pending after the assets cease to be useful. Since an asset does not generate any revenue after its useful is over, any amortisation charged against revenue after such time, defeats the principle of matching revenue and costs. Example 3 A machine of cost 1,20,000 is depreciated straight-line assuming 10 year working life and zero residual value for three years. At the end of third year, the machine was revalued upwards by ` 6,000 the remaining useful life was reassessed at 9 years. Depreciation per year charged for three years = ` 1,20,000 / 10 = ` 12,000 WDV of the machine at the end of third year = ` 1,20,000 – ` 12,000 × 3 = ` 84,000. Depreciable amount after revaluation = ` 84,000 + ` 6,000 = ` 90,000 Remaining useful life as per previous estimate = 7 years Remaining useful life as per revised estimate = 9 years Depreciation for the fourth year onwards = ` 90,000 / 9 = ` 10,000. Change in method of charging depreciation (Paragraph 21) The depreciation method selected should be applied consistently from period to period. A change from one method of providing depreciation to another should be made only if the adoption of the new method is required by statute or for compliance with an accounting standard or if it considered that the change would result in a more appropriate preparation or presentation of the financial statements of the enterprise. 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 recomputation 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. Example 4 A company acquired a machine on 01/04/06 for ` 5,00,000. The company charged straight- line depreciation based on 10 year working life estimate and residual value ` 50,000 upto 1.49 © The Institute of Chartered Accountants of India Accounting 2008-09. From 2009-10, the company decided to change to 20% reducing balance method of depreciation. Show adjustment required in books of the company. Solution Annual depreciation charged by the company upto 2008-09 = (` 5,00,000 – ` 50,000)/10 = ` 45,000 WDV of machine at the end of 2008-09 = ` 5,00,000 – ` 45,000 × 3 = ` 3,65,000 WDV of machine at the end 2008-09 (by reducing balance method) = ` 5,00,000 (1 – 0.20) 3 = ` 2,56,000 Depreciation to be charged in 2009-10 = (` 3,65,000 – ` 2,56,000) + 20% of ` 2,56,000 = ` 1,60,200 Books of the company ` 000 ` 000 Depreciation 160.2 To Machine 160.2 Profit & Loss A/c 160.2 To Depreciation 160.2 Machine A/c ` 000 ` 000 To Balance b/d 365.0 By Depreciation 160.2 By Balance c/d 204.8 365.0 365.0 Disclosures (a) The following information should be disclosed in the financial statements: ♦ The historical cost or other amount substituted for historical cost of each class of depreciable assets; ♦ Total depreciation for the period for each class of assets and the related accumulated depreciation. (b) In addition to above, the following information should be disclosed in the financial statements along with the disclosure of other accounting policies: ♦ depreciation methods used; and ♦ depreciation rates or the useful lives of the assets, if they are different from the 1.50 © The Institute of Chartered Accountants of India