CA INTER

P1: ADVANCED ACCOUNTING (MODULE – 1)

INDEX
1. INTRODUCTION TO ACCOUNTING STANDARDS ............................................................................................................... 3
2. FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS................................................... 27

3. APPLICABILITY OF ACCOUNTING STANDARDS................................................................................................................ 58

4. PRESENTATION & DISCLOSURES BASED ACCOUNTING STANDARDS ............................................................................. 79

UNIT 1: ACCOUNTING STANDARD 1 DISCLOSURE OF ACCOUNTING POLICIES .................................................................. 79

UNIT 2: ACCOUNTING STANDARD 3: CASH FLOW STATEMENT .......................................................................................... 92

UNIT 3: ACCOUNTING STANDARD 17: SEGMENT REPORTING ......................................................................................... 111

UNIT 4: ACCOUNTING STANDARD 18: RELATED PARTY DISCLOSURES............................................................................. 133

UNIT 5: ACCOUNTING STANDARD 20: EARNINGS PER SHARE ......................................................................................... 151

UNIT 6: ACCOUNTING STANDARD 24: DISCONTINUING OPERATIONS ............................................................................ 174

5. ASSETS BASED ACCOUNTING STANDARDS ................................................................................................................... 185

UNIT 1: ACCOUNTING STANDARD 2 VALUATION OF INVENTORY .................................................................................... 185

UNIT 2: ACCOUNTING STANDARD 10: PROPERTY, PLANT AND EQUIPMENT .................................................................. 201
UNIT 3: ACCOUNTING STANDARD 13: ACCOUNTING FOR INVESTMENTS ....................................................................... 249

UNIT 4: ACCOUNTING STANDARD 16: BORROWING COSTS............................................................................................. 278

UNIT 5: ACCOUNTING STANDARD 19: LEASES .................................................................................................................. 296

UNIT 6: ACCOUNTING STANDARD 26: INTANGIBLE ASSETS ............................................................................................ 331

UNIT 7: ACCOUNTING STANDARD 28: IMPAIRMENT OF ASSETS ..................................................................................... 356

1
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 2
Page

CA CS KARTHIK MANIKONDA – 75501 37279

1. INTRODUCTION TO ACCOUNTING STANDARDS
LEARNING OUTCOMES
After studying this chapter, you will be able to:
 Understand the concept of Accounting Standards;
 Grasp the objectives and benefits of Accounting Standards;
 Learn the standards setting process;
 Familiarize with the status of Accounting Standards in India;
 Recognize the International Accounting Standard Authorities;
 Appreciate the emergence of International Financial Reporting Standards as global standards;
 Differentiate between convergence vs. adoption;
 Know the process of convergence of IFRS in India;
 Understand the concept of Ind AS;
 Understand the objectives and concepts of carve outs/ins.

1. INTRODUCTION
Generally Accepted Accounting Principles
Generally accepted accounting principles (GAAP) refer to a common set of accepted accounting
principles, standards, and procedures that business reporting entity must follow when it prepares
and presents its financial statements.
GAAP is a combination of authoritative standards (set by policy boards) and the commonly accepted
ways of recording and reporting accounting information. At international level, such authoritative
standards are known as International Financial Reporting Standards (IFRS) at many places and in
India we have authoritative standards named as Accounting Standards (ASs) and Indian Accounting
Standard (Ind AS).
Accounting Standards (ASs) are written policy documents issued by the Government with the
support of other regulatory bodies e.g., Ministry of Corporate Affairs (MCA) issuing Accounting
Standards for corporates in consultation with National Financial Reporting Authority (NFRA) covering
the following aspects of accounting transaction or events in the financial statements:
 Recognition;
 Measurement;
 Presentation; and
3

 Disclosure.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

The ostensible purpose of the standard setting bodies is to promote the dissemination of timely and
useful financial information to investors and certain other stakeholders, 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 following aspects:
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
iv. the disclosures relating to these transactions and events 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 deal with aspects of accounting events
Recognition of Measurement of Presentation of Disclosure
events and transactions and transactions and events requirements
transactions events
The following are the benefits of Accounting Standards:
i. Standardisation of alternative accounting treatments: Accounting Standards reduce or
eliminate, to a reasonable extent, any confusing variations in the accounting treatment and
presentation of economic events while preparing financial statements.

The standard policies are intended to reflect a consensus on accounting policies to be used in
different identified areas, e.g. inventory valuation, capitalisation of costs, depreciation and
amortisation, etc.

Since it is not possible to prescribe a single set of policies for any specific accounting area that
would be appropriate for all enterprises, it is not enough to comply with the standards and state
that they have been followed.

In other words, one must also disclose the accounting policies used in preparation of financial
4

statements. (Refer AS 1, Disclosure of Accounting Policies given in Accounting Pronouncements).

Page

CA CS KARTHIK MANIKONDA – 75501 37279

 For example, an enterprise should disclose which of the permitted cost formula (FIFO, Weighted
Average, etc.) has actually been used for ascertaining inventory costs.

ii. Requirements for additional disclosures: There are certain areas where information is not
statutorily required to be disclosed. However, accounting standards may call for appropriate
disclosures of accounting policies followed and other required information in the financial
statements which would be helpful for readers to understand the accounting treatment done for
various items in those financial statements.

iii. Comparability of financial statements: 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’s financial health and performance 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 a number of years. The intra-enterprise comparison is possible if the enterprise uses same
accounting policies every year in drawing up its financial statements.

The inter-enterprise comparison involves comparison of financial statements of different enterprises

for same accounting period. This is possible only when comparable enterprises use similar
accounting policies in preparation of respective financial statements (or in case the policies are
slightly different, the same are disclosed in the financial statements). The disclosure of accounting
policies allows a user to make appropriate adjustments while comparing the financial statements of
comparable enterprises.

standardisation
of alternative
accounting
treatments

Benefits of
comparability Accounting Requirements
of financial standards for additional
statements disclosures
5
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Since Accounting Standards are principle based, application of Accounting Standards becomes
judgemental in case of complex business transactions. Accounting Standards have to be read in line
with the legal requirements, i.e., in case of any conflict, Statute would prevail over Accounting
Standards.
Another 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 policies for capitalisation,
particularly for the borderline cases where it is possible to have divergent views. The accounting
standards provide adequate guidance in this regard.

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 for the issuance of Accounting Standards to ensure
that the standard setting process is fully consultative and transparent. The ASB considered the
International Accounting Standards (IASs)/International Financial Reporting Standards (IFRSs) while
framing Accounting Standards (ASs) in India and tried 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, associations 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. NFRA recommend these
standards to the MCA. MCA has to spell out the accounting standards applicable for companies in
India.
The standard-setting procedure of ASB can be briefly outlined as follows:
 Step I – Identification of area:
Identification of broad areas by ASB for formulation of AS.

 Step II – Constitution of study groups:

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
6

principles wherever applicable and presentation and disclosure requirements.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Consideration of the preliminary draft prepared by the study group of ASB and revision, if any, of
the draft on the basis of deliberations.

 Step III - Preparation of draft and its circulation:

Circulation of draft of accounting standard (after revision by ASB) to the Council members of the
ICAI and specified outside bodies such as MCA, 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.

 Step IV - Ascertainment of views of different bodies on draft:

Meeting with the representatives of the specified outside bodies to ascertain their views on the
draft of the proposed accounting standard.

 Step V - Finalisation of exposure draft (E.D.):

Finalisation of the exposure draft of the proposed accounting standard and its issuance inviting
public comments.

 Step VI – Comments received on exposure draft (E.D.):

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.
 Step VII – Modification of the draft:
Consideration of the final draft of the proposed standard by the Council of the ICAI and if found
necessary, modification of the draft in consultation with the ASB is done.

 Step VIII – Issue of AS:

The accounting standard on the relevant subject (for non-corporate entities) is then issued by
the ICAI. For corporate entities the accounting standards are issued by the Ministry of Corporate
Affairs in consultation with the NFRA.
7
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Standard – Setting Process

Identification of area

Constitution of study group

Preparation of draft and its circulation

Ascertainment of views of different bodies on draft

Finalisation of exposure draft (E.D.)

Comments received on exposure draft (E.D.)

Modification of the draft

Issue of AS

Earlier, ASB used to issue Accounting Standard Interpretations (ASIs) which address questions that
arise in course of application of standard. These were, therefore, issued after issuance of the
relevant standard. Authority of the ASIs was same as that of the AS to which it relates.
However, after notification of Accounting Standards by the Central Government for the companies,
where the consensus portion of ASI was merged as ‘Explanation’ to the relevant paragraph of the
Accounting Standard, the Council of ICAI also decided to merge the consensus portion of ASI as
‘Explanation’ to the relevant paragraph of the AS issued by them. This initiative was taken by the
Council of the ICAI to harmonise both the set of standards, i.e., ASs issued by the ICAI for non-
corporates and ASs notified by the MCA for corporates.
It may be noted that as per Section 133 of the Companies Act, 2013, the Central Government may
prescribe the standards of accounting or any addendum thereto, as recommended by the ICAI,
constituted under section 3 of the Chartered Accountants Act, 1949, in consultation with and after
examination of the recommendations made by NFRA.
3. HOW MANY ACCOUNTING STANDARDS?
The Institute of Chartered Accountants of India has, so far, issued 29 Accounting Standards.
However, AS 6 on ‘Depreciation Accounting’ has been withdrawn on revision of AS 10 ‘Property,
Plant and Equipment ’ and AS 8 on ‘Accounting for Research and Development’ has been
8
Page

withdrawn consequent to the issuance of AS 26 on ‘Intangible Assets’.

CA CS KARTHIK MANIKONDA – 75501 37279

Thus effectively, there are 27 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 GAAP.
In recent times there are various improvements/developments in the global accounting standards
which have taken place. In India, Ind AS have become mandatory for certain class of companies as
per the MCA roadmap. AS being the guidelines to prepare financial statements, have to keep pace
with these changes in global accounting scenarios. Number of fundamental changes have been
made in these AS so as to be globally aligned as far as possible.
MCA vide notification date 30th March 2016 announced Companies (Accounting Standards)
Amendment Rules, 2016. These rules were superseded by the Companies (Accounting Standards)
Rules, 2021 which were notified by the MCA on 23rd June, 2021. Various ASs i.e. AS 2, AS 4, AS 10,
AS 13, AS 14, AS 21, AS 29 have been revised to make them in line with corresponding Ind AS to the
extent possible.
The following is the list of Accounting Standards with their respective date of applicability:
AS No. AS Title Date of applicability
1 Disclosure of Accounting Policies 01/04/1993
2 Valuation of Inventories (Revised) 01/04/1999
3 Cash Flow Statement 01/04/2001
4 Contingencies and Events Occurring after the Balance Sheet
Date (Revised) 01/04/1998
5 Net Profit or Loss for the Period, Prior Period Items and
Changes in Accounting Policies 01/04/1996
7 Construction Contracts 01/04/2002
9 Revenue Recognition 01/04/1993
10 Property, Plant and Equipment (Revised) 01/04/2016
11 The Effects of Changes in Foreign Exchange Rates (Revised) 01/04/2004
12 Accounting for Government Grants 01/04/1994
13 Accounting for Investments (Revised) 01/04/1995
14 Accounting for Amalgamations (Revised) 01/04/1995
15 Employee Benefits 01/04/2006
16 Borrowing Costs 01/04/2000
17 Segment Reporting 01/04/2001
9

18 Related Party Disclosures 01/04/2001

Page

CA CS KARTHIK MANIKONDA – 75501 37279

 19 Leases 01/04/2001
20 Earnings Per Share 01/04/2001
21 Consolidated Financial Statements (Revised) 01/04/2001
22 Accounting for Taxes on Income 01/04/2006
23 Accounting for Investments in Associates in Consolidated
Financial Statements 01/04/2002
24 Discontinuing Operations 01/04/2004
25 Interim Financial Reporting 01/04/2002
26 Intangible Assets 01/04/2003
27 Financial Reporting of Interests in Joint Ventures 01/04/2002
28 Impairment of Assets 01/04/2008
29 Provisions, Contingent Liabilities and Contingent Assets
(Revised) 01/04/2004

NOTE:
In the study material, Accounting Standards have not been discussed sequentially; instead the
related Accounting Standards have been grouped and discussed in the ensuing chapters for ease of
understanding. For example, the ‘Presentation and Disclosure based Accounting Standards like AS 1,
AS 3, AS 17, AS 18, AS 20, AS 24 and AS 25 have been grouped in one chapter. The chapter-wise
grouping of Accounting Standards, has been discussed in the Study Material, as follows:
Chapter 4 Presentation & Disclosures based Accounting Standards
AS 1 : Disclosure of Accounting Policies
AS 3 : Cash Flow Statements
AS 17 : Segment Reporting
AS 18 : Related Party Disclosures
AS 20 : Earnings Per Share
AS 24 : Discontinuing Operations
AS 25 : Interim Financial Reporting
Chapter 5 Assets based Accounting Standards
AS 2 : Valuation of Inventories
AS 10 : Property, Plant and Equipment
AS 13 : Accounting for Investments
10

AS 16 : Borrowing Costs
Page

CA CS KARTHIK MANIKONDA – 75501 37279

AS 19 : Leases
AS 26 : Intangible Assets
AS 28 : Impairment of Assets
Chapter 6 Liabilities based Accounting Standards
AS 15 : Employee Benefits
AS 29 : Provisions, Contingent Liabilities and Contingent Assets
Chapter 7 Accounting Standards based on items impacting Financial Statements
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 11 : The Effects of Changes in Foreign Exchange Rates
AS 22 : Accounting for Taxes on Income
Chapter 8 Revenue based Accounting Standards
AS 7 : Construction Contracts
AS 9 : Revenue Recognition
Chapter 9 Other Accounting Standards
AS 12 : Accounting for Government Grants
AS 14 : Accounting for Amalgamations (excluding inter- company holdings)
Chapter 10 Accounting Standards for Consolidated Financial Statements
AS 21 : Consolidated Financial Statements of single subsidiaries (excluding problems involving
acquisition of Interest in Subsidiary at Different Dates, Cross holding, Disposal of a
Subsidiary and Foreign Subsidiaries).
AS 23 : Accounting for Investment in Associates in Consolidated Financial Statements
AS 27 : Financial Reporting of Interests in Joint Ventures

4. STATUS OF ACCOUNTING STANDARDS

It has already been mentioned that the ASs are developed by the ASB of the ICAI. 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 ASs are nevertheless made mandatory
from the dates specified in respective standards and are generally applicable to all enterprises,
subject to certain exceptions. The implication of mandatory status of an AS depends on whether the
statute governing the enterprise concerned requires compliance with the ASs. The Companies Act
had earlier notified 28 ASs and mandated the corporate entities to comply with the provisions stated
11

therein. However, in 2016 the MCA withdrew AS 6. Hence there are now only 27 notified ASs as per
Page

the Companies (Accounting Standards) Rules, 2021.

CA CS KARTHIK MANIKONDA – 75501 37279

5. 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.
Few key aspects which required the need for convergence are as under:
1. Raising funds from international markets:
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 reinstatements are of utmost importance in a world that is rapidly
globalising in all ways. Further, the ASs and principles need to be robust so that the larger society
develops degree of confidence in the financial statements, which are put forward by organisations.
2. Comparability of Financial Statements:
International analysts and investors would like to compare financial statements based on similar
ASs, and this has led to the growing need for an internationally accepted set of ASs 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.
3. Uniformity, Comparability Transparency etc.:
A strong need was felt by legislation to bring about uniformity, rationalisation, comparability,
transparency and adaptability in financial statements. Having a multiplicity of types of ASs
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 may facilitate 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 stock markets and comparability of financial statements.
4. Global Investment:
The convergence of financial reporting and ASs is a valuable process that contributes to the free
12

flow of global investment and achieves substantial benefits for all capital market stakeholders. It
Page

improves the ability of investors to compare investments on a global basis and, thus, lower their

CA CS KARTHIK MANIKONDA – 75501 37279

 risk of errors of judgment. It facilitates accounting and reporting for companies with global
operations and eliminates some costly requirements like reinstatement of financial statements. It
has the potential to create a new standard of accountability and greater transparency provides
value to all market participants including regulators. It reduces operational challenges for
accounting firms and focuses their values 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.
6. INTERNATIONAL ACCOUNTING STANDARD BOARD (IASB)
With a view of achieving the objective of setting global standards, the London based group namely
the International Accounting Standards Committee (IASC), responsible for developing International
Accounting Standards (IAS), 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 ICAI). Primarily, the IASC was established, in the public interest, to
formulate and publish, IASs to be followed in the preparation and presentation of financial
statements. IASs were issued to promote acceptance and observance of IASs worldwide. The
members of IASC undertook a responsibility to support the standards developed by IASC and to
propagate those standards in their respective countries.
Between 1973 and 2001, the IASC released IASs. Between 1997 and 1999, the IASC restructured
their organisation, which resulted in formation of 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 IASC. Those pronouncements continue
to be designated as “International Accounting Standards” (IAS).
The standards issued by IASC till 31.03.2001 are known as IASs and the standards issued by IASB
since 01.04.2001 are known as IFRSs.
13
Page

CA CS KARTHIK MANIKONDA – 75501 37279

7. INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) AS GLOBAL STANDARDS

IFRS issued
by IASB

Interpretations
IAS issued by
on IAS/IFRS
IASC and
IFRS issued by IFRS
adopted by
interpretation
IASB
Commitee

Interpretation
on IAS issued
by SIC

The term International Financial Reporting Standards (IFRS) comprises:

1. IFRS issued by IASB;
2. IAS issued by IASC;
3. Interpretations issued by the Standard Interpretations Committee (SIC); and
4. Interpretations issued by the IFRS Interpretations Committee of the IASB (called IFRIC –
International Financial Reporting Standards Interpretation Committee).
IFRSs are considered as 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 permits 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, number of companies will adopt the
international standards. This requirement will affect thousands of enterprises, including their
subsidiaries, equity investors and joint venture partners. The increased use of IFRS is not limited to
public-companies 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.
14
Page

CA CS KARTHIK MANIKONDA – 75501 37279

8. BECOMING IFRS COMPLIANT
Any country can become IFRS compliant either by adoption process or by convergence process.

Technique I - Adoption
IFRS
COMPLAINT Technique II- Convergence

Technique I – Adoption Process:

Adoption would mean that the country sets a specific timetable when specific entities would be
required to use IFRS as issued by the IASB.
Technique II – Convergence Process:
Convergence means that the country will develop high quality, compatible accounting standards and
there would be alignment of the standards of different standard setters with a certain rate of
compromise, by adopting the requirements of the standards either fully or partially.
Ind AS are almost similar to IFRS but with few carve outs so as to make them suitable for Indian
Environment.
Convergence with IFRS will result in following benefits:
 Improves investor confidence across the world with transparency and comparability
 Improves inter-unit/ inter-firm/inter-industry comparison
 Group consolidation will be easy with same standard by all companies in group irrespective of
their global location.
 Acceptability of financial statements by stock exchanges across the globe, which will facilitate
listing of Indian companies to international stock exchanges.

Cross border
flow of
money
Helps Listing of
investors in companies at
decision global stock
making exchange

Becoming IFRS
Complaint

Comparability
Low risk of
of financial
error
statements

Greater
15

transparency
Page

CA CS KARTHIK MANIKONDA – 75501 37279

9. WHAT ARE CARVE OUTS/INS IN IND AS?
The Government of India in consultation with the ICAI decided to converge and not to adopt IFRS
issued by the IASB. The decision of convergence rather than adoption was taken after the detailed
analysis of IFRS requirements and extensive discussion with various stakeholders.
Accordingly, while formulating Ind AS, efforts have been made to keep these Standards, as far as
possible, in line with the corresponding IAS/IFRS and departures have been made where considered
absolutely essential. These changes have been made considering various factors, such as:
 Terminology differences:
Various terminology related changes have been made to make it consistent with the terminology
used in law, e.g., ‘statement of profit and loss’ in place of ‘statement of comprehensive income’
(SOCI) and ‘balance sheet’ in place of ‘statement of financial position’ (SOFP).
 Removal of options in accounting principles and practices:
Removal of options in accounting principles and practices in Ind AS vis-a-vis IFRS, have been
made to maintain consistency and comparability of the financial statements to be prepared by
following Ind AS. However, these changes will not result into carve outs.
 Difference in economic environment:
Certain changes have been made considering the economic environment of the country, which is
different as compared to the economic environment presumed to be in existence by IFRS. These
differences are due to differences in economic conditions prevailing in India. These differences
which are in deviation to the accounting principles and practices stated in IFRS, are commonly
known as ‘Carve-outs’.
Additional guidance given in Ind AS over and above what is given in IFRS, is termed as ‘Carve in’.

Formulation of Ind AS

Departures

Resulting into Carve-outs not resulting into carve-outs

Removal of options in accounting

Deviation from the accounting
principles and practices in Ind AS vis -a-
principles stated in IFRS
16

vis IFRS
Page

CA CS KARTHIK MANIKONDA – 75501 37279

10. CONVERGENCE TO IFRS IN INDIA
In the scenario of globalisation, India cannot isolate itself from the accounting developments taking
place worldwide. In India, so far as the ICAI, NFRA and various regulators such as SEBI and Reserve
Bank of India (RBI) are concerned, the aim is to comply with the IFRS to the extent possible with the
objective to formulate sound financial reporting standards for the purpose of preparing globally
accepted financial statements. The ICAI, being a member of the International Federation of
Accountants (IFAC), considered the IFRS and tried to integrate them, to the extent possible, in the
light of the laws, customs, practices and business environment prevailing in India.
Due to the recent stream of overseas acquisitions by Indian companies, there is need for adoption of
high-quality standards to convince foreign enterprises about the financial standing as also the
disclosure and governance standards of Indian acquirers.
In India, the ICAI has worked towards convergence of global accounting standards by considering the
application of IFRS in Indian corporate environment.
Recognising the growing need of full convergence of Ind AS with IFRS, ICAI constituted a Task Force
to examine various issues involved.
Full convergence involves adoption of IFRS in the same form as that issued by the IASB.
For convergence of Ind AS with IFRS, the ASB in consultation with the MCA, decided that there will
be two separate sets of accounting standards viz. (i) Ind AS converged with the IFRS – standards
which are being converged by eliminating the differences of the Ind AS vis-à-vis IFRS and (ii) Existing
notified AS.

Deviation from
Application of corresponding
IFRS in india IFRS if required
Convergence to
considering legal
ICAI

IFRS; not Indian Accounting

and other
adoption Decision to have Standards (Ind AS)
conditions
prevailing in India two set of
Accounting Existing
standards Accounting
Standards (ASs)

11. WHAT ARE INDIAN ACCOUNTING STANDARDS (IND AS)?

Ind AS are IFRS converged standards issued by the Central Government of India under the
supervision and control of ASB of ICAI and in consultation with NFRA.
NFRA recommends these standards to the MCA. MCA has to spell out the accounting standards
17

applicable for companies in India.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

Ind AS are named and numbered in the same way as the corresponding IAS. However, for Ind AS
corresponding to IFRS, one need to add 100 to the IFRS number e g. for IFRS 1 corresponding Ind AS
number is 101.
Indian Accounting Standards
Globalization and Transparency of financial Comparability of Enhanced
Liberalization statements financial statements Disclosure
requirements

12. HISTORY OF IFRS-CONVERGED INDIAN ACCOUNTING STANDARDS (IND AS)

First Step towards IFRS
The ICAI being the accounting standards-setting body in India, way back in 2006, initiated the
process of moving towards the IFRS issued by the IASB with a view to enhance acceptability and
transparency of the financial information communicated by the Indian corporates through their
financial statements. This move towards IFRS was subsequently accepted by the Government of
India.
Government of India - Commitment to IFRS Converged Ind AS
As per the original roadmap for implementation of IFRS-converged Ind AS issued by the Government
of India, initially Ind AS were expected to be implemented from the year 2011. However, keeping in
view the fact that certain issues including tax issues were still to be addressed, the Ministry of
Corporate Affairs decided to postpone the date of implementation of Ind AS.
In July 2014, the Finance Minister of India at that time, Late Shri Arun Jaitley Ji, in his Budget Speech,
announced an urgency to converge the existing accounting standards with the IFRS through
adoption of the Ind AS by the Indian companies.
Pursuant to the above announcement, various steps have been taken to facilitate the
implementation of IFRS-converged Ind AS. Moving in this direction, the MCA issued the Companies
(Indian Accounting Standards) Rules, 2015 vide Notification dated February 16, 2015 covering the
revised roadmap of implementation of Ind AS for companies other than Banking companies,
Insurance Companies and NBFCs and Ind AS.
As per the Notification, Ind AS converged with IFRS were required to be implemented on voluntary
basis from 1st April, 2015 and mandatorily from 1st April, 2016.
Separate roadmaps were prescribed for implementation of Ind AS to Banking, Insurance companies
and NBFCs.
18
Page

CA CS KARTHIK MANIKONDA – 75501 37279

13. LIST OF IND AS
The following is the list of notified Ind AS vis-a-vis IFRS and AS:
Ind AS IAS/ Title of Ind AS / IFRS AS / GN AS / GN Title
IFRS
101 IFRS 1 First Time Adoption of Indian - -
Accounting Standards
102 IFRS 2 Share Based Payment GN Guidance Note on Accounting for
Share-based Payments
103 IFRS 3 Business Combinations AS 14 Accounting for Amalgamations
104 IFRS 4 Insurance Contracts - -
105 IFRS 5 Non-current Assets Held for Sale AS 24 Discontinuing Operations
and Discontinued Operations
106 IFRS 6 Exploration for and Evaluation GN 15 Guidance Note on Accounting for
of Mineral Resources Oil and Gas Producing Activities
107 IFRS 7 Financial Instruments: - -
Disclosures
108 IFRS 8 Operating Segments AS 17 Segment Reporting
109 IFRS 9 Financial Instruments - -
110 IFRS 10 Consolidated Financial AS 21 Consolidated Financial Statements
Statements
111 IFRS 11 Joint Arrangements AS 27 Financial Reporting of Interests in
Joint Ventures
112 IFRS 12 Disclosure of Interests in Other - -
Entities
113 IFRS 13 Fair Value Measurement - -
114 IFRS 14 Regulatory Deferral Accounts GN Accounting for Rate Regulated
Activities
115 IFRS 15 Revenue from contracts with AS 7 Construction Contract
customers AS 9 Revenue Recognition
116 IFRS 16 Leases AS 19 Leases
IFRS 17 Insurance Contracts - -
19

1 IAS 1 Presentation of Financial AS 1 Disclosure of Accounting Policies

Page

Statements

CA CS KARTHIK MANIKONDA – 75501 37279

 2 IAS 2 Inventories AS 2 Valuation of Inventories
7 IAS 7 Statement of Cash Flows AS 3 Cash Flow Statements
8 IAS 8 Accounting Policies, Changes in AS 5 Net Profit or Loss for the Period,
Accounting Estimates and Errors Prior period Items and Changes in
Accounting Policies
10 IAS 10 Events after the Reporting AS 4 Contingencies and Events Occurring
Period After the Balance Sheet date
12 IAS 12 Income Taxes AS 22 Accounting for Taxes on Income
16 IAS 16 Property, Plant and Equipment AS 10 Property, Plant and Equipment
19 IAS 19 Employee Benefits AS 15 Employee Benefits
20 IAS 20 Accounting for Government AS 12 Accounting for Government Grants
Grants and Disclosure of
Government Assistance
21 IAS 21 The Effects of Changes in AS 11 The Effects of Changes in Foreign
Foreign Exchange Rates Exchange Rates
23 IAS 23 Borrowing Costs AS 16 Borrowing Costs
24 IAS 24 Related Party Disclosures AS 18 Related Party Disclosures
27 IAS 27 Separate Financial Statements - -
28 IAS 28 Investment in Associates and AS 23 Accounting for Investment in
Joint Ventures Associates in Consolidated
Financial Statements
29 IAS 29 Financial Reporting in - -
Hyperinflationary Economies
32 IAS 32 Financial Instruments: - -
Presentation
33 IAS 33 Earnings per Share AS 20 Earnings per Share
34 IAS 34 Interim Financial Reporting AS 25 Interim Financial Reporting
36 IAS 36 Impairment of Assets AS 28 Impairment of Assets
37 IAS 37 Provisions, Contingent Liabilities AS 29 Provisions, Contingent Liabilities
and Contingent Assets and Contingent Assets
38 IAS 38 Intangible Assets AS 26 Intangible Assets
20

40 IAS 40 Investment Property AS 13 Accounting for Investments

Page

41 IAS 41 Agriculture - -

CA CS KARTHIK MANIKONDA – 75501 37279

14. ROADMAP FOR IMPLEMENTATION OF INDIAN ACCOUNTING STANDARDS (IND AS): A
SNAPSHOT
For Companies other than Banks, NBFCs and Insurance Companies
Phase I: 1st April 2015 or thereafter (with Comparatives): Voluntary Basis for any company (other
than Banks, NBFCs and Insurance companies) and its holding, subsidiary, Joint venture (JV) or
Associate Company.
1st April 2016: Mandatory Basis
a. Companies listed/in process of listing on Stock Exchanges in India or Outside India having net
worth of INR 500 crore or more;
b. Unlisted Companies having net worth of INR 500 crore or more;
c. Parent, Subsidiary, Associate and JV of above.
Phase II: 1st April 2017: Mandatory Basis
a. All companies which are listed/or in process of listing on Stock Exchanges in India or outside
India not covered in Phase I (other than companies listed on SME Exchanges);
b. Unlisted companies having net worth of INR 250 crore or more but less than INR 500 crore;
c. Parent, Subsidiary, Associate and JV of above.
Special Points to Consider:-

 Companies listed on SME exchange are not required to apply Ind AS. Such companies shall
continue to apply existing ASs unless they choose otherwise.
 Once Ind AS are applicable, an entity shall be required to follow the Ind AS for all the subsequent
financial statements i.e. there is no looking back once the Ind AS are adopted by companies.
 Companies not covered by the above roadmap shall continue to apply Accounting Standards
notified in Companies (Accounting Standards) Rules, 2006.
For Non-Banking Financial Companies (NBFCs), Scheduled Commercial Banks (Excluding RRBs) and
Insurers/Insurance Companies and
Non-Banking Financial Companies (NBFCs)
Phase I: From 1st April, 2018 (with comparatives)
 NBFCs (whether listed or unlisted) having net worth INR 500 crore or more
 Holding, Subsidiary, JV and Associate companies of above NBFC other than those
already covered under corporate roadmap shall also apply from said date.
Phase II: From 1st April, 2019 (with comparatives)
 NBFCs whose equity and/or debt securities are listed or are in the process of listing
21

on any stock exchange in India or outside India and having net worth less than INR
Page

500 crore

CA CS KARTHIK MANIKONDA – 75501 37279

  NBFCs that are unlisted having net worth INR 250 crore or more but less than INR
500 crore
 Holding, Subsidiary, JV and Associate companies of above companies other than
those already covered under corporate roadmap shall also apply Ind AS from the
said date.
 Applicable to both Consolidated and Individual Financial Statements
 NBFC having net worth below INR 250 crore and not covered under the above provisions shall
continue to apply ASs specified in Annexure to Companies (Accounting Standards) Rules, 2006.
 Adoption of Ind AS is allowed only when required as per the roadmap.
 Voluntary adoption of Ind AS is not allowed.
Scheduled Commercial banks (excluding RRBs)
 Scheduled Commercial Banks (SCBs) excluding Regional Rural Banks (RRBs) were initially required
to implement Ind AS from 1 April 2018. However, RBI (Reserve Bank of India) vide a press release
dated 5 April 2018, deferred the implementation of Ind AS by one year i.e. to be effective from 1
April 2019 instead of 1 April 2018.
 Further, the RBI through a notification dated 22 March 2019, deferred the Ind AS
implementation till further notice. Urban Cooperative banks (UCBs) and Regional Rural banks
(RRBs) are not required to apply Ind AS.
Insurers/Insurance companies
 MCA had outlined the road map for implementation of Ind AS by insurers/insurance companies
from 1 April 2018.
 IRDAI (Insurance Regulatory and Development Authority of India) deferred the implementation
of Ind AS in the insurance sector in India for a period of two years whereby the effective date
was deferred to 1st April 2020.
IRDAI, vide circular dated 21 January 2020, has deferred implementation of Ind AS in the insurance
sector till further notice.

SUMMARY
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. The
ICAI has, so far, issued 29 ASs. However, AS 6 on ‘Depreciation Accounting’ was withdrawn on
revision of AS 10 ‘Property, Plant and Equipment and AS 8 on ‘Accounting for Research and
Development’ has been withdrawn consequent to the issuance of AS 26 on ‘Intangible Assets’.
22

Thus, there are 27 ASs at present.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

In the scenario of globalisation, India cannot isolate itself from the developments taking place
worldwide. In India, so far as the ICAI and the Government authorities and various regulators such
as SEBI and RBI are concerned, the aim has always been to comply with the IFRS to the extent
possible with the objective of formulating sound financial reporting standards. Ind AS are IFRS
converged standards issued by the Central Government of India under the supervision and control
of ASB of ICAI and in consultation with NFRA.
As per the MCA Notification dated 16th February 2015, Ind AS converged with IFRS shall be
implemented on voluntary basis from 1st April, 2015 and mandatorily from 1st April, 2016.

Separate roadmaps have been prescribed for implementation of Ind AS in Banking companies,
Insurance companies and NBFCs.

23
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. Accounting Standards for non-corporate entities in India are issued by
a. Central Govt.
b. State Govt.
c. Institute of Chartered Accountants of India.
d. MCA

2. Accounting Standards
a. Harmonise accounting policies and eliminate the non-comparability of financial
statements.
b. Improve the reliability of financial statements.
c. Both (a) and (b).
d. Manipulate the data for the management.

3. It is essential to standardize the accounting principles and policies in order to ensure

a. Transparency.
b. Consistency.
c. Comparability.
d. All the above.

4. Which committee is responsible for approval of accounting standards and their modification
for the purpose of applicability to companies?
a. NFRA.
b. MCA.
c. Central Government Advisory Committee.
d. IASB

5. Global Standards facilitate

a. Cross border flow of money.

b. Comparability of financial statements.
c. Uniformity and Transparency of financial statements.
24
Page

d. All the three.

CA CS KARTHIK MANIKONDA – 75501 37279

ANSWERS/HINTS
MCQs
1. c. Institute of Chartered Accountants of India
2. c. Both (a) and (b).
3. d. All the above.
4. b. MCA.
5. d. All the three.

THEORETICAL QUESTIONS
Q.NO.1. Explain the objective of “Accounting Standards” in brief. State the advantages of setting
Accounting Standards.
ANSWER
Accounting Standards are the written policy documents issued by Government relating to various
aspects of measurement, treatment, presentation and disclosure of accounting transactions and events.
Following are the objectives of Accounting Standards:
a. Accounting Standards harmonize the diverse accounting policies and practices followed by
different companies in India.
b. Accounting Standards facilitates the preparation of financial statements and make them
comparable.
c. Accounting Standards give a sense of faith and reliability to the users.
The main advantage of setting accounting standards are as follows:
a. Accounting Standards makes the financial statements of different companies comparable which
helps investors in decision making.
b. Accounting Standards prevent any misleading accounting treatment.
c. Accounting Standards prevent manipulation of data by the management.

Q.NO.2. Briefly explain the process of issuance of Indian Accounting Standards.

ANSWER
Due to the recent stream of overseas acquisitions by Indian companies, there is need for adoption of
high-quality standards to convince foreign enterprises about the financial standing as also the
disclosure and governance standards of Indian acquirers.
The Government of India in consultation with the ICAI decided to converge and not to adopt IFRSs
25

issued by the IASB. The decision of convergence rather than adoption was taken after the detailed
Page

analysis of IFRSs requirements and extensive discussion with various stakeholders.

CA CS KARTHIK MANIKONDA – 75501 37279

The ICAI has worked towards convergence of global accounting standards by considering the
application of IFRS in Indian corporate environment. Recognising the growing need of full
convergence of Ind AS with IFRS, ICAI constituted a Task Force to examine various issues involved.
Ind AS are issued by the Central Government of India under the supervision and control of ASB of
ICAI and in consultation with NFRA. NFRA recommends these standards to the MCA and MCA has to
spell out the accounting standards applicable for companies in India.

Q.NO.3. Explain the significance of emergence of IFRS as Global Standards.

ANSWER
Global Standards facilitate cross border flow of money, global listing in different bourses and
comparability of financial statements. Global Standards improve 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.

Q.NO.4. What do you mean by Carve outs/ins in Ind AS? Explain.

ANSWER
Certain changes have been made in Ind AS considering the economic environment of the country,
which is different as compared to the economic environment presumed to be in existence by IFRS.
These differences are due to differences in economic conditions prevailing in India. These differences
which are in deviation to the accounting principles and practices stated in IFRS, are commonly
known as ‘Carve-outs’. Additional guidance given in Ind AS over and above what is given in IFRS, is
termed as ‘Carve in’.

26
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 2. FRAMEWORK FOR PREPARATION AND
PRESENTATION OF FINANCIAL STATEMENTS
LEARNING OUTCOMES
After studying this chapter, you will be able to:
 Understand the meaning and significance of Framework for the Preparation and Presentation of
Financial Statements;
 Learn objectives of Financial Statements
 Understand qualitative characteristics of Financial Statements;
 Comprehend recognition and measurement of elements of Financial Statements;
 Know concepts of capital, capital maintenance and determination of profit.

1. INTRODUCTION
The development of accounting standards or any other accounting guidelines need a foundation
of underlying principles. (ASB) of ICAI issued a framework in July, 2000 which provides the
fundamental basis for development of new standards as also for review of existing standards.
The principal areas covered by the framework are as follows:
a. Components of financial statements;
b. Objectives of financial statements;
c. Assumptions underlying financial statements;
d. Qualitative characteristics of financial statements;
e. Elements of financial statements;
f. Criteria for recognition of elements in financial statements;
g. Principles for measurement of financial elements;
h. Concepts of Capital and Capital Maintenance.

2. PURPOSE OF THE FRAMEWORK

The framework sets out the concepts underlying the preparation and presentation of general-
purpose financial statements prepared by enterprises for external users. The main purpose of
the framework is to assist:
a. Enterprises in preparation of their financial statements in compliance with Accounting
Standards and in dealing with the topics not yet covered by any Accounting Standard,
27

b. ASB in its task of development and review of Accounting Standards,

Page

CA CS KARTHIK MANIKONDA – 75501 37279

 c. ASB in promoting harmonisation of regulations, Accounting Standards and procedures
relating to the preparation and presentation of financial statements by providing a basis for
reducing the number of alternative accounting treatments permitted by Accounting
Standards,
d. Auditors in forming an opinion as to whether financial statements conform to the Accounting
Standards,
e. Users in interpretation of financial statements,
f. those who are interested in the work of ASB with information about its approach to the
formulation of Accounting Standards.
3. STATUS AND SCOPE OF THE FRAMEWORK
The framework applies to general-purpose financial statements (hereafter referred to as
‘financial statements’ usually prepared annually for external users, by all commercial, industrial
and business enterprises, whether in public or private sector. The special purpose financial
reports, for example computations prepared for tax purposes are outside the scope of the
framework. Nevertheless, the framework may be applied in preparation of such reports, to the
extent not inconsistent with their requirements.
Nothing in the framework overrides any specific Accounting Standard. In case of conflict
between an Accounting Standard and the framework, the requirements of the Accounting
Standard will prevail over those of the framework.
4. COMPONENTS OF FINANCIAL STATEMENTS
A complete set of financial statements normally consists of a Balance Sheet, a Statement of
Profit and Loss and a Cash Flow Statement together with notes, other statements and
explanatory materials that form an integral part of the financial statements.
All components of the financial statements are interrelated because they reflect different
aspects of same transactions or other events. Although each statement provides information
that is different from each other, none in isolation is likely to serve any single purpose nor can
anyone provide all information needed by a user.
The major information contents of different components of financial statements are explained as
below:
Balance Sheet portrays value of economic resources controlled by an enterprise. It also provides
information about liquidity and solvency of an enterprise which is useful in predicting the ability
of the enterprise to meet its financial commitments as they fall due.
28

Statement of Profit and Loss presents the result of operations of an enterprise for an accounting
Page

period, i.e., it depicts the performance of an enterprise, in particular its profitability.

CA CS KARTHIK MANIKONDA – 75501 37279

 Cash Flow Statement shows the way an enterprise has generated cash and the way they have
been used in an accounting period and helps in evaluating the investing, financing and operating
activities during the reporting period.
Notes and other statements present supplementary information explaining different items of
financial statements. For example, they may contain additional information that is relevant to the
needs of users about the items in the balance sheet and statement of profit and loss. They include
various other disclosures such as disclosure of accounting policies, segment reporting, related
party disclosures, earnings per share, etc.

5. OBJECTIVES AND USERS OF FINANCIAL STATEMENTS

The objective of financial statements is to provide information about the financial position,
performance and cash flows of an enterprise that is useful to a wide range of users in making
economic decisions.
The framework identifies seven broad groups of users of financial statements.

Users of Financial
Statements

Investors Employees Lenders Suppliers Customers Govt . Public

and
creditors

All users of financial statements expect the statements to provide useful information needed to
make economic decisions. The financial statements provide information to suit the common
needs of most users. However, they cannot and do not intend to provide all information that may
be needed, e.g. they do not provide non-financial data even if they may be relevant for making
decisions.
The aforesaid users use financial statements in order to satisfy some of their information needs.
These needs may include the following:
a. Investors - The providers of risk capital are concerned with the risk inherent in, and return
provided by, their investments. They are also interested in information which enables them
to assess the ability of the enterprise to pay dividends.
b. Employees - Employees and their representative groups are interested in information about
the stability and profitability of their employers. They are also interested in information
29

which enables them to assess the ability of the enterprise to provide remuneration,
Page

retirement benefits and employment opportunities.

CA CS KARTHIK MANIKONDA – 75501 37279

 c. Lenders - Lenders are interested in information which enables them to determine whether
their loans, and the interest attaching to them, will be paid when due.
d. Suppliers and other trade creditors - Suppliers and other creditors are interested in
information which enables them to determine whether amounts owing to them will be paid
when due. Trade creditors are likely to be interested in an enterprise over a shorter period
than lenders unless they are dependent upon the continuance of the enterprise as a major
customer.
e. Customers - Customers have an interest in information about the continuance of an
enterprise, especially when they have a long term involvement with, or are dependent on,
the enterprise for their goods and services.
f. Governments and their agencies - Governments and their agencies are interested in the
allocation of resources and, therefore, the activities of enterprises. They also require
information in order to regulate the activities of enterprises and determine taxation policies,
and to serve as the basis for determination of national income and similar statistics.
g. Public - Enterprises affect members of the public in a variety of ways. For example,
enterprises may make a substantial contribution to the local economy in many ways including
the number of people they employ and their patronage of local suppliers. Financial
statements may assist the public by providing information about the trends and recent
developments in the prosperity of the enterprise and the range of its activities.

6. FUNDAMENTAL ACCOUNTING ASSUMPTIONS

As per the framework, there are three fundamental accounting assumptions:

Fundamental Accounting Assumptions

Going concern Accrual Consistency

These are assumptions, i.e., the users of financial statements believe that the same has been
considered while preparing the financial statements. That is why, as long as financial statements
are prepared in accordance with these assumptions, no separate disclosure in financial
statements would be necessary.
If nothing has been written about the fundamental accounting assumption in the financial
30

statements, then it is assumed that they have already been followed in their preparation of
Page

financial statements.

CA CS KARTHIK MANIKONDA – 75501 37279

 However, if any of the above-mentioned fundamental accounting assumption is not followed
then this fact should be specifically disclosed.
Let us discuss these assumptions in detail.
a. Going Concern: Financial statements are normally prepared on the assumption that an
enterprise will continue in operation in the foreseeable future and neither there is an
intention, nor there is a need to materially curtail the scale of operations.

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.
(Refer Illustration 1)
b. Accrual Basis: According to AS 1, revenues and costs are accrued, that is, recognised as they
are earned or incurred (and not as money is received or paid) and recorded in the financial
statements of the periods to which they relate. Further Section 128(1) of the Companies Act,
2013 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.
Let’s understand the impact of both approaches of accounting by way of an example.
Example 1
a. A trader purchased article A on credit in period 1 for Rs.50,000.
b. He also purchased article B in period 1 for Rs.2,000 cash.
c. The trader sold article A in period 1 for Rs.60,000 in cash.
d. He also sold article B in period 1 for Rs.2,500 on credit.
Profit and Loss Account of the trader by two basis of accounting are shown below. A look at
the cash basis Profit and Loss Account will convince any reader of the irrationality of cash
basis of accounting.
31
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Cash basis of accounting
Cash purchase of article B and cash sale of article A is recognised in period 1 while purchase of
article A on payment and sale of article B on receipt is recognised in period 2.
Profit and Loss Account
Rs. Rs.
Period 1 To Purchase 2,000 Period 1 By Sale 60,000
To Net Profit 58,000

60,000 60,000
Period 2 To Purchase 50,000 Period 2 By Sale 2,500
By Net Loss 47,500
50,000 50,000
Accrual basis of accounting
Credit purchase of article A and cash purchase of article B and cash sale of article A and credit
sale of article B is recognised in period 1 only.
Rs. Rs.
Period 1 To Purchase 52,000 Period 1 By Sale 62,500
To Net Profit 10,500
62,500 62,500

c. Consistency: It is assumed that accounting policies are consistent from one period to another.
The consistency improves comparability of financial statements through time. According to
Accounting Standards, an accounting policy can be changed if the change is required
i. by a statute or
ii. by an Accounting Standard or
iii. for more appropriate presentation of financial statements.

7. QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS

The qualitative characteristics are attributes that improve the usefulness of information provided
in financial statements. The framework suggests that the financial statements should observe
and maintain the following four qualitative characteristics as far as possible within limits of
reasonable cost/ benefit.

Qualitative Characteristics of Financial Statements

32

Understandability Relevance Comparability Reliability

Page

CA CS KARTHIK MANIKONDA – 75501 37279

 These attributes can be explained as:
1. Understandability: The financial statements should present information in a manner as to be
readily understandable by the users with reasonable knowledge of business and economic
activities and accounting.
2. Relevance: It is not right to think that more information is always better. A mass of irrelevant
information creates confusion and can be even more harmful than non-disclosure.

The financial statements should contain relevant information only. Information, which is
likely to influence the economic decisions by the users, is said to be relevant. Such
information may help the users to evaluate past, present or future events or may help in
confirming or correcting past evaluations. The relevance of a piece of information should be
judged by its materiality. A piece of information is said to be material if its misstatement (i.e.,
omission or erroneous statement) can influence economic decisions of a user taken on the
basis of the financial information. Materiality depends on the size and nature of the item or
error, judged in the specific circumstances of its misstatement. Materiality provides a
threshold or cut-off point rather than being a primary qualitative characteristic which the
information must have if it is to be useful.

Further it is important to know the constraints also on Relevant and Reliable Information to
better understand the qualitative characteristics of financial statements. Following are some
of the constraints:
a. Timeliness
If there is undue delay in the reporting of information it may lose its relevance.
Management may need to balance the relative merits of timely reporting and the
provision of reliable information. To provide information on a timely basis it may often be
necessary to report before all aspects of a transaction or other event are known, thus
impairing reliability. Conversely, if reporting is delayed until all aspects are known, the
information may be highly reliable but of little use to users who have had to make
decisions in the interim. In achieving a balance between relevance and reliability, the
overriding consideration is how best to satisfy the information needs of users.
b. Balance between Benefit and Cost
The balance between benefit and cost is a pervasive constraint rather than a qualitative
characteristic. The benefits derived from information should exceed the cost of providing
it. The evaluation of benefits and costs is, however, substantially a judgmental process.
33

The preparers and users of financial statements should be aware of this constraint.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 3. Reliability: To be useful, the information must be reliable; that is to say, they must be free
from material error and bias. The information provided are not likely to be reliable unless:
a. Transactions and events reported are faithfully represented.
b. Transactions and events are reported on the principle of 'substance over form (discussed
later in AS-1)'.
c. The reporting of transactions and events are neutral, i.e. free from bias.
d. Prudence is exercised in reporting uncertain outcome of transactions or events.
e. The information in financial statements must be complete.
4. Comparability: Comparison of financial statements is one of the most frequently used and
most effective tools of financial analysis. The financial statements should permit both inter-
firm and intra-firm comparison. One essential requirement of comparability is disclosure of
financial effect of change in accounting policies. However, the need for comparability should
not be confused with mere uniformity and should not be allowed to become an impediment
to the introduction of improved accounting standards. It is not appropriate for an enterprise
to continue accounting in the same manner for a transaction or other event if the policy
adopted is not in keeping with the qualitative characteristics of relevance and reliability. It is
also inappropriate for an enterprise to leave its accounting policies unchanged when more
relevant and reliable alternatives exist.
8. TRUE AND FAIR VIEW
Financial statements are required to show a true and fair view of the performance, financial
position and cash flows of an enterprise. The framework does not deal directly with this concept
of true and fair view, yet application of the principal qualitative characteristics and appropriate
accounting standards normally results in financial statements portraying true and fair view of
information about an enterprise.
9. ELEMENTS OF FINANCIAL STATEMENTS
The framework classifies items of financial statements in five broad groups depending on their
economic characteristics.

Elements of Financial Statements

Asset Liability Equity Income Expenses

34
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Gains and losses differ from income and expenses in the sense that they may or may not arise in
the ordinary course of business. Except for the way they arise, economic characteristics of gains
are same as income and those of losses are same as expenses. For these reasons, gains and
losses are not recognised as separate elements of financial statements.
Let us discuss each element of financial statement in detail.
1. Asset: An asset is a resource controlled by the enterprise as a result of past events from
which future economic benefits are expected to flow to the enterprise. The following points
must be considered while recognising an asset:
a. The resource regarded as an asset, need not have a physical substance. The resource may
represent a right generating future economic benefit, e.g. patents, copyrights, trade
receivables. An asset without physical substance can be either intangible asset, e.g.
patents and copyrights or monetary assets, e.g. trade receivables. The monetary assets
are money held and assets to be received in fixed or determinable amounts of money.
b. An asset is a resource controlled by the enterprise. This means it is possible to recognise
a resource not owned but controlled by the enterprise as an asset, i.e., legal ownership
may or may not vest with the enterprise. Such is the case of financial lease, where lessee
recognises the asset taken on lease, even if ownership lies with the lessor. Likewise, the
lessor does not recognise the asset given on finance lease as asset in his books, because
despite of ownership, he does not control the asset.
c. A resource cannot be recognised as an asset if the control is not sufficient. For this reason
specific management or technical talent of an employee cannot be recognised because of
insufficient control. When the control over a resource is protected by a legal right, e.g.
copyright, the resource can be recognised as an asset.
d. To be considered as an asset, it must be probable that the resource generates future
economic benefits. If the economic benefits from a resource is expected to expire within
the current accounting period, it is not an asset. For example, economic benefits, i.e.
profit on sale, from machinery purchased by an enterprise who deals in such kind of
machinery is expected to expire within the current accounting period. Such purchase of
machinery is therefore booked as an expense rather than capitalised in the machinery
account. However, if the articles purchased by a dealer remain unsold at the end of
accounting period, the unsold items are recognised as assets, i.e. closing stock, because
the sale of the article and resultant economic benefit, i.e. profit is expected to be earned
35

in the next accounting period.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

 e. To be considered as an asset, the resource must have a cost or value that can be
measured reliably.
f. When flow of economic benefit to the enterprise beyond the current accounting period is
considered improbable, the expenditure incurred is recognised as an expense rather than
as an asset.
2. Liability: A liability is a present obligation of the enterprise arising from past events, the
settlement of which is expected to result in an outflow of a resource embodying economic
benefits. The following points may be noted:
a. A liability is a present obligation, i.e. an obligation the existence of which, based on the
evidence available on the balance sheet date is considered probable. For example, an
enterprise may have to pay compensation if it loses a damage suit filed against it. The
damage suit is pending on the balance sheet date. The enterprise should recognise a
liability for damages payable by a charge against profit if it is probable that the enterprise
will lose the suit and if the amount of damages payable can be ascertained with
reasonable accuracy. The enterprise should create a provision for damages payable by
charge against profit, if probability of losing the suit is more than not losing it and if the
amount of damages payable can be ascertained with reasonable accuracy. In other cases,
the company reports the damages payable as ‘contingent liability’, which does not meet
the definition of liability. Accounting standards define provision as a liability, which can be
measured only by using a substantial degree of estimation.
b. It may be noted that certain provisions, e.g. provisions for doubtful debts, depreciation
and impairment losses, represent diminution in value of assets rather than obligations.
These provisions should not be considered as liability.
c. A liability is recognised only when outflow of economic resources in settlement of a
present obligation can be anticipated and the value of outflow can be reliably measured.
Otherwise, the liability is not recognised. For example, liability cannot arise on account of
future commitment. A decision by the management of an enterprise to acquire assets in
the future does not, of itself, give rise to a present obligation. An obligation normally
arises only when the asset is delivered or the enterprise enters into an irrevocable
agreement to acquire the asset.
36
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Example 2
A Ltd. has entered into a binding agreement with P Ltd. to buy a custom-made machine for
Rs.40,000. At the end of 20X1-X2, before delivery of the machine, A Ltd. had to change its
method of production. The new method will not require the machine ordered and it will be
scrapped after delivery. The expected scrap value is nil.
A liability is recognised when outflow of economic resources in settlement of a present
obligation can be anticipated and the value of outflow can be reliably measured. In the given
case, A Ltd. should recognise a liability of Rs.40,000 to P Ltd.
When flow of economic benefit to the enterprise beyond the current accounting period is
considered improbable, the expenditure incurred is recognised as an expense rather than as an
asset. In the present case, flow of future economic benefit from the machine to the enterprise is
improbable. The entire amount of purchase price of the machine should be recognised as an
expense. The accounting entry is suggested below:
Particulars Rs. Rs.
Loss on change in production Method Rd. 40,000
To P Ltd. 40,000
(Loss due to change in production method)
Profit and loss A/c Rd. 40,000
To Loss on change in production method 40,000
(loss transferred to profit and loss account)

3. Equity: Equity is defined as residual interest in the assets of an enterprise after deducting all
its liabilities. It is important to avoid mixing up liabilities with equity. Equity is the excess of
aggregate assets of an enterprise over its aggregate liabilities. In other words, equity
represents owners’ claim consisting of items like capital and reserves, which are clearly
distinct from liabilities, i.e. claims of parties other than owners. The value of equity may
change either through contribution from / distribution to equity participants or due to
income earned /expenses incurred.

4. Income: Income is increase in economic benefits during the accounting period in the form of
inflows or enhancement of assets or decreases in liabilities that result in increase in equity
other than those relating to contributions from equity participants. The definition of income
encompasses revenue and gains. Revenue is an income that arises in the ordinary course of
37

activities of the enterprise, e.g. sales by a trader. Gains are income, which may or may not
Page

arise in the ordinary course of activity of the enterprise, e.g. profit on disposal of Property,

CA CS KARTHIK MANIKONDA – 75501 37279

 Plant and Equipment. Gains are showed separately in the statement of profit and loss
because this knowledge is useful in assessing performance of the enterprise.
Income earned is always associated with either increase of asset or reduction of liability. This
means, no income can be recognised unless the corresponding increase of asset or decrease of
liability can be recognised. For example, a bank does not recognise interest earned on non-
performing assets because the corresponding asset (increase in advances) cannot be recognised,
as flow of economic benefit to the bank beyond current accounting period is not probable.
Thus
Balance sheet of an enterprise can be written in form of:
A – L = E.
Where:
A = Aggregate value of asset
L = Aggregate value of liabilities
E = Aggregate value of equity

Example 3
Suppose at the beginning of an accounting period, aggregate values of assets, liabilities and
equity of a trader are Rs. 5 lakh, Rs. 2 lakh and Rs. 3 lakh respectively. Also suppose that the
trader had the following transactions during the accounting period.
a. Introduced capital Rs. 20,000.
b. Earned income from investment Rs. 8,000.
c. A liability of Rs. 31,000 was finally settled on payment of Rs. 30,000.
Balance sheets of the trader after each transaction are shown below:
Transactions Assets – Liabilities = Equity
Rs. lakh Rs. lakh Rs. lakh
Opening 5.00 – 2.00 = 3.00
a. Capital introduced 5.20 – 2.00 = 3.20
b. Income from investments 5.28 – 2.00 = 3.28
c. Settlement of liability 4.98 – 1.69 = 3.29

The example given above explains the definition of income. The equity increased by Rs.29,000
during the accounting period, due to (i) Capital introduction Rs.20,000 and (ii) Income earned
38

Rs.9,000 (Income from investment + Discount earned). Incomes therefore result in increase in
Page

equity without introduction of capital.

CA CS KARTHIK MANIKONDA – 75501 37279

 Also note that income earned is accompanied by either increase of asset (Cash received as
investment income) or by decrease of liability (Discount earned).
5. Expense: An expense is decrease in economic benefits during the accounting period in the
form of outflows or depletions of assets or incurrence of liabilities that result in decrease in
equity other than those relating to distributions to equity participants. The definition of
expenses encompasses expenses that arise in the ordinary course of activities of the
enterprise, e.g. wages paid. Losses may or may not arise in the ordinary course of activity of
the enterprise, e.g. loss on disposal of Property, Plant and Equipment. Losses are separately
shown in the statement of profit and loss because this knowledge is useful in assessing
performance of the enterprise.
Expenses are always incurred simultaneously with either reduction of asset or increase of
liability. Thus, expenses are recognised when the corresponding decrease of asset or increase
of liability are recognised by application of the recognition criteria stated above. Expenses
are recognised in Profit & Loss A/c by matching them with the revenue generated. However,
application of matching concept should not result in recognition of an item as asset (or
liability), which does not meet the definition of asset or liability as the case may be.
Where economic benefits are expected to arise over several accounting periods, expenses
are recognised in the profit and loss statement on the basis of systematic and rational
allocation procedures. The obvious example is that of depreciation.

An expense is recognised immediately in the profit and loss statement when it does not meet
or ceases to meet the definition of asset or when no future economic benefit is expected. An
expense is also recognised in the profit and loss statement when a liability is incurred
without recognition of an asset, as is the case when a liability under a product warranty
arises.
Example 4
Continuing with the example 3 given earlier, suppose the trader had the following further
transactions during the period:
a. Wages paid Rs. 2,000.
b. Rent outstanding Rs. 1,000.
c. Drawings Rs. 4,000.
39
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Balance sheets of the trader after each transaction are shown below:
Transactions Assets – Liabilities = Equity
Rs. lakh Rs. lakh Rs. Lakh
Opening 5.00 – 2.00 = 3.00
a. Capital introduced 5.20 – 2.00 = 3.20
b. Income from investments 5.28 – 2.00 = 3.28
c. Settlement of liability 4.98 – 1.69 = 3.29
d. Wages paid 4.96 – 1.69 = 3.27
e. Rent Outstanding 4.96 – 1.70 = 3.26
f. Drawings 4.92 – 1.70 = 3.22
The example given above explains the definition of expense. The equity decreased by Rs. 7,000
from Rs. 3.29 lakh to Rs. 3.22 lakh due to (i) Drawings Rs. 4,000 and (ii) Expenses incurred Rs.
3,000 (Wages paid + Rent).
Expenses therefore result in decrease of equity without drawings. Also note that expenses
incurred is accompanied by either decrease of asset (Cash paid for wages) or by increase in
liability (Rent outstanding).
Note: The points discussed above leads us to the following relationships:
Closing equity (CE) = Closing Assets (CA) – Closing Liabilities (CL)
Opening Equity (OE) = Opening Assets (OA) – Opening Liabilities (OL)
Capital Introduced = C
Drawings = D
Income = I
Expenses = E
CE= OE + C + (I – E) – D
Or CE = OE + C + Profit – D
Or Profit = CE – OE – C + D
Or Profit = (CA – CL) – (OA – OL) – C + D
From above, one can clearly see that profit depends on values of assets and liabilities. Since
historical costs are mostly used for valuation, the reported profits are mostly based on historical
cost conventions. The framework recognises other methods of valuation of assets and liabilities.
The point to note is that reported figures of profit change with the changes in the valuation
basis. Conceptually, this is the foundation of idea of Capital Maintenance.
40
Page

CA CS KARTHIK MANIKONDA – 75501 37279

10. MEASUREMENT OF ELEMENTS OF FINANCIAL STATEMENTS
Measurement is the process of determining money value at which an element can be recognised
in the balance sheet or statement of profit and loss. The framework recognises four alternative
measurement bases. These bases relate explicitly to the valuation of assets and liabilities. The
valuation of income or expenses, i.e. profit is implied, by the value of change in assets and
liabilities.

Historical
Cost

Present measurement Current

Value bases Cost

Reliasable
Value

In preparation of financial statements, all or any of the measurement basis can be used in
varying combinations to assign money values to items, subject to the requirements under the
Accounting Standards. However, it may be noted, that Accounting Standards largely uses the
‘historical cost’ for the purpose of preparation of financial statements though for some items,
use of other value is permitted, e.g., inventory is recorded at historical costs on its acquisition,
however, at year end, it is valued at lower of costs and net realisable value.
A brief explanation of each measurement basis is as follows:
1. Historical Cost: Historical cost means acquisition price. For example, the businessman paid
Rs.7,00,000 to purchase the machine, its acquisition price including installation charges is
Rs.8,00,000. The historical cost of machine would be Rs.8,00,000.

According to this, assets are recorded at an amount of cash or cash equivalent paid or the fair
value of the asset at the time of acquisition. Liabilities are recorded at the amount of
proceeds received in exchange for the obligation. In certain circumstances a liability is
recorded at the amount of cash or cash equivalent expected to be paid to satisfy the
obligation in the normal course of business.
41
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 When Mr. X, a businessman, takes Rs.5,00,000 loan from a bank @ 10% interest p.a., it is to
be recorded at the amount of proceeds received in exchange for the obligation. Here the
obligation is the repayment of loan as well as payment of interest at an agreed rate i.e. 10%.
Proceeds received are Rs.5,00,000 - it is the historical cost of the transaction. Take another
case regarding payment of income tax liability. You know that every individual has to pay
income tax on his income if it exceeds certain minimum limit. But the income tax liability is
not settled immediately when one earns his income. The income tax authority settles it
sometime later, which is technically called assessment year. Then how does he record this
liability? As per historical cost basis, it is to be recorded at an amount expected to be paid to
discharge the liability.

Example 5
Mr. X purchased a machine on 1st January, 20X1 at Rs. 7,00,000. As per historical cost basis, he
has to record it at Rs. 7,00,000 i.e., the acquisition price. As on 1.1.20X6, Mr. X found that it
would cost Rs. 25,00,000 to purchase that machine. Mr. X also took loan from a bank as on 20X1
for Rs. 5,00,000 @ 18% p.a. repayable at the end of 15th year together with interest.
As per historical cost, the liability is recorded at Rs. 5,00,000 at the amount of proceeds received
in exchange for obligation and asset is recorded at Rs. 7,00,000.
2. Current Cost: Current cost gives an alternative measurement basis. Assets are carried at the
amount of cash or cash equivalent that would have to be paid if the same or an equivalent
asset was acquired currently. Liabilities are carried at the undiscounted amount of cash or
cash equivalents that would be required to settle the obligation currently.

Example 6
A machine was acquired for $ 10,000 on deferred payment basis. The rate of exchange on the
date of acquisition was Rs. 49 per $. The payments are to be made in 5 equal annual instalments
together with 10% interest per year. The current market value of similar machine in India is Rs. 5
lakhs.
Current cost of the machine = Current market price = Rs. 5,00,000.
By historical cost convention, the machine would have been recorded at Rs. 4,90,000.
To settle the deferred payment on current date one must buy dollars at Rs. 49/$. The liability is
therefore recognised at Rs. 4,90,000 ($ 10,000 × Rs. 49). Note that the amount of liability
42

recognised is not the present value of future payments. This is because, in current cost
Page

convention, liabilities are recognised at undiscounted amount.

CA CS KARTHIK MANIKONDA – 75501 37279

 3. Realisable (Settlement) Value: For assets, this is the amount of cash or cash equivalents
currently realisable on sale of the asset in an orderly disposal. For liabilities, this is the
undiscounted amount of cash or cash equivalents expected to be paid on settlement of
liability in the normal course of business.
4. Present Value: Assets are carried at the present value of the future net cash inflows that the
item is expected to generate in the normal course of business. Liabilities are carried at the
present value of the future net cash outflows that are expected to be required to settle the
liabilities in the normal course of business.
Present value (P) is an amount, one has to invest on current date to have an amount (A) after
n years. If the rate of interest is R then,
A = P(1 + R)n
A 1
Or P (Present value of A after n years) = = A
(1  r)n
(1  r)n
The process of obtaining present value of future cash flow is called discounting. The rate of
interest used for discounting is called the discounting rate. The expression [1/(1+R)n ], called
discounting factor which depends on values of R and n.
Let us take a numerical example assuming interest 10%, A = Rs. 11,000 and n = 1 year 11,000 =
10,000(1 + 0.1)1
11,000 1
Or Present value of Rs. 11,000 after 1 year =  1
 11,000 
(1.10) (1.10)1
Or Present value of Rs. 11,000 after 1 year = 11,000 × 0.909 = Rs. 10,000
Note that a receipt of Rs. 10,000 (present value) now is equivalent of a receipt of Rs. 11,000
(future cash inflow) after 1 year, because if one gets Rs. 10,000 now he can invest to collect Rs.
11,000 after 1 year. Likewise, a payment of Rs. 10,000 (present value) now is equivalent of paying
of Rs. 11,000 (future cash outflow) after 1 year.
Thus if an asset generates Rs. 11,000 after 1 year, it is actually contributing Rs. 10,000 at the
current date if the rate of earning required is 10%. In other words, the value of the asset is Rs.
10, 000. which is the present value of net future cash inflow it generates.
If an asset generates Rs. 11,000 after 1 year, and Rs. 12,100 after two years, it is actually
contributing Rs. 20,000 (approx.) at the current date if the rate of earning required is 10% (Rs.
11,000 × 0.909 + Rs. 12,100 × 0.826). In other words the value of the asset is Rs. 20,000(approx.),
i.e. the present value of net future cash inflow it generates.
43

Under present value convention, assets are carried at present value of future net cash flows
Page

generated by the concerned assets in the normal course of business. Liabilities under this

CA CS KARTHIK MANIKONDA – 75501 37279

 convention are carried at present value of future net cash flows that are expected to be required
to settle the liability in the normal course of business.
Example 7
Carrying amount of a machine is Rs. 40,000 (Historical cost less depreciation). The machine is
expected to generate Rs. 10,000 net cash inflow. The net realisable value (or net selling price) of
the machine on current date is Rs. 35,000. The enterprise’s required earning rate is 10% per year.
The enterprise can either use the machine to earn Rs. 10,000 for 5 years. This is equivalent of
receiving present value of Rs. 10,000 for 5 years at discounting rate 10% on current date. The
value realised by use of the asset is called value in use. The value in use is the value of asset by
present value convention.
Value in use = Rs. 10,000 (0.909 + 0.826 + 0.751 + 0.683 + 0.621) = Rs. 37,900
Net selling price = Rs. 35,000
The present value of the asset is Rs. 37,900, which is called its recoverable value. It is obviously
not appropriate to carry any asset at a value higher than its recoverable value. Thus the asset is
currently overstated by Rs. 2,100 (Rs. 40,000 – Rs. 37,900).

11. CAPITAL MAINTENANCE

Capital refers to net assets of a business. Since a business uses its assets for its operations, a fall
in net assets will usually mean a fall in its activity level. It is therefore important for any business
to maintain its net assets in such a way, as to ensure continued operations at least at the same
level year after year. In other words, dividends should not exceed profit after appropriate
provisions for replacement of assets consumed in operations. For this reason, the Companies Act
does not permit distribution of dividend without providing for depreciation on Property, Plant
and Equipment. Unfortunately, this may not be enough in case of rising prices. The point is
explained below:
We have already observed: P = (CA – CL) – (OA – OL) – C + D
Where: Profit = P
Opening Assets = OA and Opening Liabilities = OL
Closing Assets = CA and Closing Liabilities = CL
Introduction of capital = C and Drawings / Dividends = D
Retained Profit = P – D = (CA – CL) – (OA – OL) – C
A business should ensure that Retained Profit (RP) is not negative, i.e. closing equity should not
44

be less than capital to be maintained, which is sum of opening equity and capital introduced.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 It should be clear from above that the value of retained profit depends on the valuation of assets
and liabilities. In order to check maintenance of capital, i.e. whether or not retained profit is
negative, we can use any of following three bases:
Financial capital maintenance at historical cost: Under this convention, opening and closing
assets are stated at respective historical costs to ascertain opening and closing equity. If retained
profit is greater than or equals to zero, the capital is said to be maintained at historical costs. This
means the business will have enough funds to replace its assets at historical costs. This is quite
right as long as prices do not rise.

Example 8
A trader commenced business on 01/01/20X1 with Rs. 12,000 represented by 6,000 units of a
certain product at Rs. 2 per unit. During the year 20X1 he sold these units at Rs. 3 per unit and
had withdrawn Rs. 6,000. Thus:
Opening Equity = Rs. 12,000 represented by 6,000 units at Rs. 2 per unit.
Closing Equity = Rs. 12,000 (Rs. 18,000 – Rs. 6,000) represented entirely by cash.
Retained Profit = Rs. 12,000 – Rs. 12,000 = Nil
The trader can start year 20X2 by purchasing 6,000 units at Rs. 2 per unit once again for selling
them at Rs. 3 per unit. The whole process can repeat endlessly if there is no change in purchase
price of the product.

Financial capital maintenance at current purchasing power: Under this convention, opening and
closing equity at historical costs are restated at closing prices using average price indices. (For
example, suppose opening equity at historical cost is Rs. 3,00,000 and opening price index is 100. The
opening equity at closing prices is Rs. 3,60,000 if closing price index is 120). A positive retained profit
by this method means the business has enough funds to replace its assets at average closing price.
This may not serve the purpose because prices of all assets do not change at average rate in real
situations. For example, price of a machine can increase by 30% while the average increase is 20%.
Example 9
In the previous example 8, suppose that the average price indices at the beginning and at the
end of year are 100 and 120 respectively.
Opening Equity = Rs. 12,000 represented by 6,000 units at Rs. 2 per unit.
Opening equity at closing price = (Rs. 12,000 / 100) x 120 = Rs. 14,400 (6,000 x Rs. 2.40)
Closing Equity at closing price
45

= Rs. 12,000 (Rs. 18,000 – Rs. 6,000) represented entirely by cash.

Page

Retained Profit = Rs. 12,000 – Rs. 14,400 = (–) Rs. 2,400

CA CS KARTHIK MANIKONDA – 75501 37279

 The negative retained profit indicates that the trader has failed to maintain his capital. The
available fund of Rs. 12,000 is not sufficient to buy 6,000 units again at increased price Rs. 2.40
per unit. In fact, he should have restricted his drawings to Rs. 3,600 (Rs. 6,000 – Rs. 2,400).
Had the trader withdrawn Rs. 3,600 instead of Rs. 6,000, he would have left with Rs. 14,400, the
fund required to buy 6,000 units at Rs. 2.40 per unit.
Physical capital maintenance at current costs: Under this convention, the historical costs of
opening and closing assets are restated at closing prices using specific price indices applicable to
each asset. The liabilities are also restated at a value of economic resources to be sacrificed to
settle the obligation at current date, i.e. closing date. The opening and closing equity at closing
current costs are obtained as an excess of aggregate of current cost values of assets over
aggregate of current cost values of liabilities. A positive retained profit by this method ensures
retention of funds for replacement of each asset at respective closing prices.
(Refer Illustration 2)
SUMMARY
 Components of Financial Statements
Balance sheet Portrays value of economics resources controlled by an
enterprise
Statement of Profit and loss Presents the results of operations of an enterprise
Cash flow statement Shows the way an enterprise generates cash and uses it
Notes, other statements and Presents supplementary information explaining different items
other explanatory materials
 Users of Financial Statements
Investors Analysis of performance, profitability, financial position of
company
Employees Knowledge of stability, continuity, growth
Suppliers, creditors Determination of credit worthiness
Customers Analysis of stability, profitability
Government Evaluation of entity’s performance and contribution to social
objectives
Lenders Determine whether their loans, and the interest attaching to
them, will be paid when due
Public Determine contribution to the local economy and public at
46

large
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Fundamental Accounting Assumptions
Accrual Transactions are recognised as and when they occur, without
considering receipt /payment of cash.
Going concern Enterprise will continue in operation in foreseeable future and
will not liquidate.
Consistency Using same accounting policies for similar transactions in all
accounting periods
 Qualitative Characteristics of Financial Statements
 Understandability  Information presented in financial statements should be
readily understandable by the users with reasonable
knowledge of business and economic activities.
 Relevance  Financial statements should contain relevant information
only. Information, which is likely to influence the economic
decisions of the users is called relevant.
 Reliability  Information must be reliable; that is to say, they must be
free from material error and bias.
 Comparability  Financial statements should provide both inter-firm and
intra-firm comparison.
 Elements of Financial Statements
Asset Resource controlled by the enterprise as a result of past events
from which future economic benefits are expected to flow to
the enterprise
Liability Present obligation of the enterprise arising from past events,
the settlement of which is expected to result in an outflow of a
resource embodying economic benefits.
Equity Residual interest in the assets of an enterprise after deducting
all its liabilities
Income/gain Increase in economic benefits during the accounting period in
the form of inflows or enhancement of assets or decreases in
liabilities that result in increase in equity other than those
relating to contributions from equity participants
Expense/loss Decrease in economic benefits during the accounting period in
the form of outflows or depletions of assets or incurrence of
liabilities that result in decrease in equity other than those
47

relating to distributions to equity participants

Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Measurement of Elements in Financial Statements
 Historical cost  Acquisition price
 Current Cost  Assets are carried at the amount of cash or cash equivalent
that would have to be paid if the same or an equivalent
asset is acquired currently. Liabilities are carried at the
undiscounted amount of cash or cash equivalents that
would be required to settle the obligation currently.
 Realisable (Settlement)  For assets, amount currently realisable on sale of the asset
Value in an orderly disposal. For liabilities, this is the undiscounted
amount expected to be paid on settlement of liability in the
normal course of business.
 Present Value  Assets are carried at present value of future net cash flows
generated by the concerned assets in the normal course of
business. Liabilities are carried at present value of future
net cash flows that are expected to be required to settle the
liability in the normal course of business.
 Financial Capital Maintenance
At historical cost Opening and closing assets are stated at historical costs
At current purchasing power Restatement at closing prices using average price indices
Physical capital maintenance Restatement at closing prices using specific price indices

48
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 ILLUSTRATIONS
Illustration 1
Balance sheet of a trader on 31st March, 20X1 is given below:
Liabilities Rs. Assets Rs.
Capital 60,000 Property, Plant and Equipment 65,000
Stock 30,000
Profit and Loss Account 10% 25,000 Trade receivables 20,000
Loan 35,000 Deferred expenditure 10,000
Trade payables 10,000 Bank 5,000
1,30,000 1,30,000

Additional information:
a. The remaining life of Property, Plant and Equipment is 5 years. The pattern of use of the asset
is even. The net realisable value of Property, Plant and Equipment on 31.03.X2 was Rs. 60,000.
b. The trader’s purchases and sales in 20X1-X2 amounted to Rs. 4 lakh and Rs. 4.5 lakh
respectively.
c. The cost and net realisable value of stock on 31.03.X2 were Rs. 32,000 and Rs. 40,000
respectively.
d. Expenses (including interest on 10% Loan of Rs. 3,500 for the year) amounted to Rs. 14,900.
e. Deferred expenditure is amortised equally over 4 years.
f. Trade receivables on 31.03.X2 is Rs. 25,000, of which Rs. 2,000 is doubtful. Collection of
another Rs. 4,000 depends on successful re-installation of certain product supplied to the
customer.
g. Closing trade payable is Rs. 12,000, which is likely to be settled at 5% discount.
h. Cash balance on 31.03.X2 is Rs. 37,100.
i. There is an early repayment penalty for the loan Rs. 2,500.
You are required to prepare Profit and Loss Accounts and Balance Sheets of the trader in both
cases
i. assuming going concern
ii. not assuming going concern.
49
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Solution
Profit and Loss Account for the year ended 31st March, 20X2
Case (i) Case (ii) Case (i) Case (ii)
Rs. Rs. Rs. Rs.
To Opening Stock 30,000 30,000 By Sales 4,50,000 4,50,000
To Purchases 4,00,000 4,00,000 By Closing Stock 32,000 40,000

To Expenses 14,900 14,900 By Trade payables − 600

To Depreciation 13,000 5,000
To Provision for
doubtful debts 2,000 6,000
To Deferred
expenditure 2,500 10,000
To Loan penalty − 2,500
To Net Profit
(b.f.) 19,600 22,200
4,82,000 4,90,600 4,82,000 4,90,600

Balance Sheet as at 31st March, 20X2

Liabilities Case (i) Case (ii) Assets Case (i) Case (ii)
Rs. Rs. Rs. Rs.
Capital 60,000 60,000 Property, Plant and 52,000 60,000
Equipment
Profit & Loss A/c 44,600 47,200 Stock 32,000 40,000
10% Loan 35,000 37,500 Trade Receivables (less 23,000 19,000
provision)
Deferred expenditure 7,500 Nil
Trade payables 12,000 11,400
Bank 37,100 37,100

1,51,600 1,56,100 1,51,600 1,56,100

50
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Illustration 2
A trader commenced business on 01/01/20X1 with Rs. 12,000 represented by 6,000 units of a
certain product at Rs. 2 per unit. During the year 20X1 he sold these units at Rs. 3 per unit and had
withdrawn Rs. 6,000. Let us assume that the price of the product at the end of year is Rs. 2.50 per
unit. In other words, the specific price index applicable to the product is 125.
Current cost of opening stock = (Rs. 12,000 / 100) x 125 = 6,000 x Rs. 2.50 = Rs. 15,000
Current cost of closing cash = Rs. 12,000 (Rs. 18,000 – Rs. 6,000)
Opening equity at closing current costs = Rs. 15,000 Closing equity at closing current costs = Rs.
12,000 Retained Profit = Rs. 12,000 – Rs. 15,000 = (-) Rs. 3,000
The negative retained profit indicates that the trader has failed to maintain his capital. The
available fund of Rs. 12,000 is not sufficient to buy 6,000 units again at increased price of Rs. 2.50
per unit. The drawings should have been restricted to Rs. 3,000 (Rs. 6,000 – Rs. 3,000). Had the
trader withdrawn Rs. 3,000 instead of Rs. 6,000, he would have left with Rs.15,000, the fund
required to buy 6,000 units at Rs. 2.50 per unit.
You are required to compute the Capital maintenance under all three bases ice.
i. Historical costs,
ii. Current purchasing power and
iii. Physical capital maintenance.
Solution
Financial Capital Maintenance at historical costs
Rs. Rs.
Closing capital (At historical cost) 12,000
Less: Capital to be maintained
Opening capital (At historical cost) 12,000
Introduction (At historical cost) Nil (12,000)
Retained profit Nil
Financial Capital Maintenance at current purchasing power
Rs. Rs.
Closing capital (At closing price) 12,000
Less: Capital to be maintained
Opening capital (At closing price) 14,400
Introduction (At closing price) Nil (14,400)
51

Retained profit/(loss) (2,400)

Page

CA CS KARTHIK MANIKONDA – 75501 37279

Physical Capital Maintenance
Rs. Rs.
Closing capital (At current cost) ( 4,800 units) 12,000
Less: Capital to be maintained
Opening capital (At current cost) (6,000 units) 15,000
Introduction (At current cost) Nil (15,000)
Loss resulting in non-maintenance of capital (3,000)

52
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. The 'going concern' concept assumes that
a. The business can continue in operational existence for the foreseeable future.
b. The business cannot continue in operational existence for the foreseeable future.
c. The business is continuing to be profitable.
d. The business cannot continue if it is not able to earn profits.

2. Two principal qualitative characteristics of financial statements are

a. Understandability and materiality
b. Relevance and reliability
c. Relevance and materiality
d. Comparability and materiality.

3. All of the following are components of financial statements except

a. Balance sheet
b. Statement of Profit and loss
c. Human responsibility report
d. Social responsibility report.

4. An accounting policy can be changed if the change is required

a. By statute or accounting standard
b. For more appropriate presentation of financial statements
c. Both (a) and (b)
d. By statute as well as accounting standards.

5. Value of equity may change due to

a. Contribution from or Distribution to equity participants
b. Income earned
c. expenses incurred
d. All the three.
53
Page

CA CS KARTHIK MANIKONDA – 75501 37279

ANSWERS/HINTS
MCQs
1. a. The business can continue in operational existence for the foreseeable future.
2. b. Relevance and reliability
3. c. Human responsibility report
4. c. Both (a) and (b)
5. d. All the three.

THEORETICAL QUESTIONS
Q.NO.1. What are the qualitative characteristics of the financial statements which improve the
usefulness of the information furnished therein?
ANSWER
The qualitative characteristics are attributes that improve the usefulness of information provided in
financial statements. Understandability; Relevance; Reliability; Comparability are the qualitative
characteristics of financial statements. For details, refer para 7 of the chapter.
Q.NO.2. “One of the characteristics of financial statements is neutrality”- Do you agree with this
statement?
ANSWER
Yes, one of the characteristics of financial statements is neutrality. To be reliable, the information
contained in financial statement must be neutral, that is free from bias. Financial Statements are not
neutral if by the selection or presentation of information, the focus of analysis could shift from one
area of business to another thereby arriving at a totally different conclusion on the business results.

54
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 PRACTICAL QUESTIONS
Q.NO.1. Mohan started a business on 1st April 20X1 with Rs. 12,00,000 represented by 60,000
units of Rs. 20 each. During the financial year ending on 31st March, 20X2, he sold the entire stock
for Rs. 30 each. In order to maintain the capital intact, calculate the maximum amount, which can
be withdrawn by Mohan in the year 20X1-X2 if Financial Capital is maintained at historical cost.
SOLUTION
Particulars Financial Capital Maintenance at Historical
Cost (Rs.)
Closing equity
(Rs. 30 x 60,000 units) 18,00,000 represented by cash
Opening equity 60,000 units x Rs. 20 = 12,00,000
Permissible drawings to keep Capital intact 6,00,000 (18,00,000 – 12,00,000)

Q.NO.2. Opening Balance Sheet of Mr. A is showing the aggregate value of assets, liabilities and
equity Rs. 8 lakh, Rs. 3 lakh and Rs. 5 lakh respectively. During accounting period, Mr. A has the
following transactions:
1. Earned 10% dividend on 2,000 equity shares held of Rs. 100 each
2. Paid Rs. 50,000 to creditors for settlement of Rs. 70,000
3. Rent of the premises is outstanding Rs. 10,000
4. Mr. A withdrew Rs. 9,000 for his personal use.
SOLUTION
Effects of each transaction on Balance sheet of the trader is shown below:
Transactions Assets – Liabilities = Equity
Rs. lakh Rs. lakh Rs. lakh
Opening 8.00 – 3.00 = 5.00
1. Dividend earned 8.20 – 3.00 = 5.20
2. Settlement of Creditors 7.70 – 2.30 = 5.40
3. Rent Outstanding 7.70 – 2.40 = 5.30
4. Drawings 7.61 – 2.40 = 5.21
55
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Q.NO.3. Balance Sheet of Anurag Trading Co. on 31st March, 20X1 is given below:
Liabilities Rs. Assets Rs.
Capital 50,000 Property, Plant and Equipment 69,000
Profit and Loss Account 22,000 Stock in Trade 36,000
10% Loan 43,000 Trade receivables 10,000
Trade payables 18,000 Deferred expenditure 15,000
Bank 3,000
1,33,000 1,33,000

Additional Information:
i. Remaining life of Property, Plant and Equipment is 5 years with even use. The net realisable
value of Property, Plant and Equipment as on 31st March, 20X2 was Rs. 64,000.
ii. Firm’s sales and purchases for the year 20X1-X2 amounted to Rs. 5 lakh and Rs. 4.50 lakh
respectively.
iii. The cost and net realisable value of the stock were Rs. 34,000 and Rs. 38,000 respectively.
iv. General Expenses for the year 20X1-X2 were Rs. 16,500.
v. Deferred Expenditure is normally amortised equally over 4 years starting from F.Y. 20X0-X1 i.e.
Rs. 5,000 per year.
vi. Out of trade receivables worth Rs.10,000, collection of Rs.4,000 depends on successful re -
design of certain product already supplied to the customer.
vii. Closing trade payable is Rs.10,000, which is likely to be settled at 95%.
viii. There is pre-payment penalty of Rs.2,000 for Bank loan outstanding.
Prepare Profit & loss Account for the year ended 31st March, 20X2 by assuming it is not a Going
Concern.
SOLUTION
Profit and Loss Account of Anurag Trading
Co. for the year ended 31st March, 20X2
(Assuming business is not a going concern)
Rs. Rs.
To Opening Stock 36,000 By Sales 5,00,000
To Purchases 4,50,000 By Trade payables 500
To Expenses 16,500 By Closing Stock 38,000
56

To Depreciation (69,000-64,000) 5,000

Page

To Provision for doubtful debts 4,000

CA CS KARTHIK MANIKONDA – 75501 37279

To Deferred expenditure 15,000
To Loan penalty 2,000
To Net Profit (b.f.) 10,000
5,38,500 5,38,500

57
Page

CA CS KARTHIK MANIKONDA – 75501 37279

3. APPLICABILITY OF ACCOUNTING STANDARDS
LEARNING OUTCOMES
After studying this chapter, you will be able to:
 Comprehend the status of Accounting Standards;
 Understand the applicability of Accounting Standards.
1. STATUS OF ACCOUNTING STANDARDS
It has already been mentioned in chapter 1 that the standards are developed by the Accounting
Standards Board (ASB) of the Institute of Chartered Accountants of India and are issued under
the authority of its Council which are approved by the MCA (Ministry of Corporate Affairs) for
corporate entities. The standards cannot override laws and local regulations. The Accounting
Standards are nevertheless made mandatory from the dates notified by the MCA and are
generally applicable to all enterprises, subject to certain exceptions 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, e.g., the Ministry of
Corporate Affairs have notified Accounting Standards for companies incorporated under the
Companies Act, 1956 (or the Companies Act, 2013).
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 Accounting
58

Standards would apply to all its activities including those, which are not commercial, industrial or
Page

business in nature.

CA CS KARTHIK MANIKONDA – 75501 37279

 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 accounti ng
standards. 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.
Section 129 (1) of the Companies Act, 2013 requires companies to present their financial
statements in accordance with the accounting standards notified under Section 133 of the
Companies Act, 2013 (refer Note below). Also, the auditor is required by Section 143(3)(e) to
report whether, in his opinion, the financial statements of the company audited, comply with the
accounting standards referred to in Section 133 of the Companies Act, 2013. Where the financial
statements of a company do not comply with the accounting standards, the company should
disclose in its financial statements, the deviation from the accounting standards, the reasons for
such deviation and the financial effects, if any, arising out of such deviations as per Section
129(5) of the Companies Act, 2013. Provided also that the financial statements should not be
treated as not disclosing a true and fair view of the state of affairs of the company, merely by
reason of the fact that they do not disclose—
a. in the case of an insurance company, any matters which are not required to be disclosed by
the Insurance Act, 1938, or the Insurance Regulatory and Development Authority Act, 1999;
b. in the case of a banking company, any matters which are not required to be disclosed by the
Banking Regulation Act, 1949;
c. in the case of a company engaged in the generation or supply of electricity, any matters
which are not required to be disclosed by the Electricity Act, 2003;
d. in the case of a company governed by any other law for the time being in force, any matters
which are not required to be disclosed by that law.
Note: As per the Companies Act, 2013, the Central Government may prescribe standards of
accounting or addendum thereto, as recommended by the Institute of Chartered Accountants of
59

India, in consultation with the National Financial Reporting Authority (NFRA).

Page

CA CS KARTHIK MANIKONDA – 75501 37279

 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 i.e. the
financial item which is important. A penalty of Rs.50,000 paid for breach of law by a company
can seem to be a relatively small amount for a company incurring crore of rupees in a year, yet is
a material item because of the information it conveys. The materiality should, therefore, be
judged on a 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.
Accounting Standards and Income Tax Act, 1961
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 taken to the Statement of profit and loss 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 purposes 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, 1961.
Income Computation and Disclosure Standards
Section 145(2) of the Income Tax Act, 1961, empowers the Central Government to notify in the
Official Gazette from time to time, Income Computation and Disclosure Standards to be followed
by any class of assesses or in respect of any class of income. Accordingly, the Central
Government has, in exercise of the powers conferred under Section 145(2) of the Income Tax
Act, 1961, notified ten Income Computation and Disclosure Standards (ICDSs) to be followed by
all assesses (other than an individual or a Hindu undivided family who is not required to get his
accounts of the previous year audited in accordance with the provisions of Section 44AB of the
Income Tax Act, 1961) following the mercantile system of accounting, for the purposes of
computation of income chargeable to income-tax under the head “Profit and gains of business or
profession” or “ Income from other sources”, from the Assessment Year (A.Y.) 2017-18. The ten
60

notified ICDSs are:

Page

ICDS I : Accounting Policies

CA CS KARTHIK MANIKONDA – 75501 37279

 ICDS II : Valuation of Inventories
ICDS III : Construction Contracts
ICDS IV : Revenue Recognition
ICDS V : Tangible Fixed Assets
ICDS VI : The Effects of Changes in Foreign Exchange Rates
ICDS VII : Government Grants
ICDS VIII : Securities
ICDS IX : Borrowing Costs
ICDS X : Provisions, Contingent Liabilities and Contingent Assets

2. APPLICABILITY OF ACCOUNTING STANDARDS

For the purpose of compliance of the accounting Standards, the ICAI has issued an announcement
on ‘Criteria for Classification of Entities and Applicability of Accounting Standards’. As per the
announcement, entities are classified into four levels. Level IV, Level III and Level II entities as per the
said Announcement were referred to as Micro, Small and Medium Entities (MSMEs).
However, when the accounting standards were notified by the Central Government in consultation
with the National Advisory Committee on Accounting Standards, the Central Government also
issued the ‘Criteria for Classification of Entities and Applicability of Accounting Standards’ for the
companies.
According to the ‘Criteria for Classification of Entities and Applicability of Accounting Standards’ as
issued by the Government, there are two levels, namely, Small and Medium-sized Companies (SMCs)
as defined in the Companies (Accounting Standards) Rules, 2021 and companies other than SMCs
(Non-SMCs). Non-SMCs are required to comply with all the Accounting Standards in their entirety,
while certain exemptions/ relaxations have been given to SMCs.
“Criteria for Classification of Entities and Applicability of Accounting Standards” for corporate
entities and non-corporate entities have been explained in the coming paragraphs.
2.1. Criteria for classification of Non-company entities for applicability of Accounting Standards
The Council of the ICAI, at its 400th meeting, held on March 18-19, 2021, considered the matter
relating to applicability of Accounting Standards issued by the ICAI, to Non-company entities
(Enterprises). The scheme for applicability of Accounting Standards to Non-company entities shall
come into effect in respect of accounting periods commencing on or after 1 April 2020.
1. For the purpose of applicability of Accounting Standards, Non-company entities are classified
into four categories, viz., Level I, Level II, Level III and Level IV.
61

Level I entities are large size entities, Level II entities are medium size entities, Level III entities
Page

are small size entities and Level IV entities are micro entities. Level IV, Level III and Level II

CA CS KARTHIK MANIKONDA – 75501 37279

 entities are referred to as Micro, Small and Medium size entities (MSMEs). The criteria for
classification of Non-company entities into different levels are given in Annexure 1.
The terms ‘Small and Medium Enterprise’ and ‘SME’ used in Accounting Standards shall be read
as ‘Micro, Small and Medium size entity’ and ‘MSME’ respectively.
2. Level I entities are required to comply in full with all the Accounting Standards.
3. Certain exemptions/relaxations have been provided to Level II, Level III and Level IV Non-
company entities. Applicability of Accounting Standards and exemptions/relaxations to such
entities are given in Annexure 2.
4. This Announcement supersedes the earlier Announcement of the ICAI on ‘Harmonisation of
various differences between the Accounting Standards issued by the ICAI and the Accounting
Standards notified by the Central Government’ issued in February 2008, to the extent it
prescribes the criteria for classification of Non-company entities (Non-corporate entities) and
applicability of Accounting Standards to non-company entities, and the Announcement ‘Revision
in the criteria for classifying Level II non-corporate entities’ issued in January 2013.
5. This Announcement is not relevant for Non-company entities who may be required to follow Ind
AS as per relevant regulatory requirements applicable to such entities. Recurrence
Annexure 1
Criteria for classification of Non-company Entities as decided by the Institute of Chartered
Accountants of India
Level I Entities
Non-company 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 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 entities engaged in commercial, industrial or business activities, whose turnover (excluding
other income) exceeds rupees two-fifty crore in the immediately preceding accounting year.
iv. All entities engaged in commercial, industrial or business activities having borrowings (including
public deposits) in excess of rupees fifty crore at any time during the immediately preceding
accounting year.
v. Holding and subsidiary entities of any one of the above.
62
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Level II Entities
Non-company 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 entities engaged in commercial, industrial or business activities, whose turnover (excluding
other income) exceeds rupees fifty crore but does not exceed rupees two-fifty crore in the
immediately preceding accounting year.
ii. All entities engaged in commercial, industrial or business activities having borrowings (including
public deposits) in excess of rupees ten crore but not in excess of rupees fifty crore at any time
during the immediately preceding accounting year.
iii. Holding and subsidiary entities of any one of the above.
Level III Entities
Non-company entities which are not covered under Level I and Level II but fall in any one or more of
the following categories are classified as Level III entities:
i. All entities engaged in commercial, industrial or business activities, whose turnover (excluding
other income) exceeds rupees ten crore but does not exceed rupees fifty crore in the
immediately preceding accounting year.
ii. All entities engaged in commercial, industrial or business activities having borrowings (including
public deposits) in excess of rupees two crore but does not exceed rupees ten crore at any time
during the immediately preceding accounting year.
iii. Holding and subsidiary entities of any one of the above.
Level IV Entities
Non-company entities which are not covered under Level I, Level II and Level III are considered as
Level IV entities.
Additional requirements
1. An MSME which avails the exemptions or relaxations given to it shall disclose (by way of a note
to its financial statements) the fact that it is an MSME, the Level of MSME and that it has
complied with the Accounting Standards insofar as they are applicable to entities falling in Level
II or Level III or Level IV, as the case may be.
2. Where an entity, being covered in Level II or Level III or Level IV, had 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
63

need not be revised merely by reason of its having ceased to be covered in Level II or Level III or
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Level IV, as the case may be. The fact that the entity was covered in Level II or Level III or Level IV,
as the case may be, in the previous period and it had availed of the exemptions or relaxations
available to that Level of entities shall be disclosed in the notes to the financial statements. The
fact that previous period figures have not been revised shall also 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 and gets
covered in Level II or Level III or Level IV, the entity will not qualify for exemption/relaxation
available to that Level, 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 II or Level III and
subsequently, gets covered under Level III or Level IV.
4. If an entity covered in Level II or Level III or Level IV 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 shall 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 or Level IV opts not to avail any one or more of the
exemptions or relaxations available to that Level of entities, it shall comply with the relevant
requirements of the Accounting Standard.
6. An entity covered in Level II or Level III or Level IV 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.
7. In respect of Accounting Standard (AS) 15, Employee Benefits, exemptions/ relaxations are
available to Level II and Level III entities, under two sub classifications, 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.
Annexure 2
Applicability of Accounting Standards to Non-company Entities
The Accounting Standards issued by the ICAI, as on April 1, 2020, and such standards as issued from
time-to-time are applicable to Non-company entities subject to the relaxations and exemptions in
the announcement. The Accounting Standards issued by ICAI as on April 1, 2020, are:
AS 1 Disclosure of Accounting Policies
64

AS 2 Valuation of Inventories
Page

CA CS KARTHIK MANIKONDA – 75501 37279

AS 3 Cash Flow Statements
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 7 Construction Contracts
AS 9 Revenue Recognition
AS 10 Property, Plant and Equipment
AS 11 The Effects of Changes in Foreign Exchange Rates
AS 12 Accounting for Government Grants
AS 13 Accounting for Investments
AS 14 Accounting for Amalgamations
AS 15 Employee Benefits
AS 16 Borrowing Costs
AS 17 Segment Reporting
AS 18 Related Party Disclosures
AS 19 Leases
AS 20 Earnings Per Share
AS 21 Consolidated Financial Statements
AS 22 Accounting for Taxes on Income
AS 23 Accounting for Investments in Associates in Consolidated Financial Statements
AS 24 Discontinuing Operations
AS 25 Interim Financial Reporting
AS 26 Intangible Assets
AS 27 Financial Reporting of Interests in Joint Ventures
AS 28 Impairment of Assets
AS 29 Provisions, Contingent Liabilities and Contingent Assets

1. Applicability of the Accounting Standards to Level 1 Non- company entities.

Level I entities are required to comply in full with all the Accounting Standards.
2. Applicability of the Accounting Standards and exemptions/relaxations for Level II, Level III and
Level IV Non-company entities
A. Accounting Standards applicable to Non-company entities
AS Level II Entities Level III Entities Level IV Entities
65

AS 1 Applicable Applicable Applicable

Page

CA CS KARTHIK MANIKONDA – 75501 37279

AS 2 Applicable Applicable Applicable
AS 3 Not Applicable Not Applicable Not Applicable
AS 4 Applicable Applicable Applicable
AS 5 Applicable Applicable Applicable
AS 7 Applicable Applicable Applicable
AS 9 Applicable Applicable Applicable
AS 10 Applicable Applicable with disclosures Applicable with disclosures
exemption exemption
AS 11 Applicable Applicable with disclosures Applicable with disclosures
exemption exemption
AS 12 Applicable Applicable Applicable
AS 13 Applicable Applicable Applicable with disclosures
exemption
AS 14 Applicable Applicable Not Applicable (Refer note
2(C))
AS 15 Applicable with exemptions Applicable with exemptions Applicable with exemptions
AS 16 Applicable Applicable Applicable
AS 17 Not Applicable Not Applicable Not Applicable
AS 18 Applicable Not Applicable Not Applicable
AS 19 Applicable with disclosures Applicable with disclosures Applicable with disclosures
exemption exemption exemption

AS 20 Not Applicable Not Applicable Not Applicable

AS 21 Not Applicable (Refer note Not Applicable (Refer note Not Applicable (Refer note
2(D)) 2(D)) 2(D))
AS 22 Applicable Applicable Applicable only for current
tax related provisions (Refer
note 2(B)(vi))
AS 23 Not Applicable (Refer note Not Applicable (Refer note Not Applicable (Refer note
2(D)) 2(D)) 2(D))
AS 24 Applicable Not Applicable Not Applicable
AS 25 Not Applicable (Refer note Not Applicable (Refer note Not Applicable (Refer note
66

2(D)) 2(D)) 2(D))

Page

CA CS KARTHIK MANIKONDA – 75501 37279

AS 26 Applicable Applicable Applicable with disclosures
exemption
AS 27 Not Applicable (Refer notes Not Applicable (Refer notes Not Applicable (Refer notes
2(C) and 2(D)) 2(C) and 2(D)) 2(C) and 2(D))
AS 28 Applicable with disclosures Applicable with disclosures Not Applicable
exemption exemption
AS 29 Applicable with disclosures Applicable with disclosures Applicable with disclosures
exemption exemption exemption

B. Accounting Standards in respect of which relaxations/exemptions from certain requirements

have been given to Level II, Level III and Level IV Non-company entities:
i. Accounting Standard (AS) 10, Property, Plant and Equipments
Paragraph 87 relating to encouraged disclosures is not applicable to Level III and Level IV
Non-company entities.

ii. AS 11, The Effects of Changes in Foreign Exchange Rates (revised 2018)
Paragraph 44 relating to encouraged disclosures is not applicable to Level III and Level IV
Non-company entities.

iii. AS 13, Accounting for Investments

Paragraph 35(f) relating to disclosures is not applicable to Level IV Non-company entities.

iv. Accounting Standard (AS) 15, Employee Benefits (revised 2005)

1. Level II and Level III Non-company entities whose average number of persons employed
during the year is 50 or more are exempted from the applicability of the following
paragraphs:
a. paragraphs 11 to 16 of the standard to the extent they deal with recognition and
measurement of short-term accumulating compensated absences which are non-
vesting (i.e., short-term accumulating compensated absences in respect of which
employees are not entitled to cash payment for unused entitlement on leaving);
b. paragraphs 46 and 139 of the Standard which deal with discounting of amounts that
fall due more than 12 months after the balance sheet date;
c. recognition and measurement principles laid down in paragraphs 50 to 116 and
67

presentation and disclosure requirements laid down in paragraphs 117 to 123 of the
Page

Standard in respect of accounting for defined benefit plans. However, such entities

CA CS KARTHIK MANIKONDA – 75501 37279

 should actuarially determine and provide for the accrued liability in respect of
defined benefit plans by using the Projected Unit Credit Method and the discount
rate used should be determined by reference to market yields at the balance sheet
date on government bonds as per paragraph 78 of the Standard. Such entities should
disclose actuarial assumptions as per paragraph 120(l) of the Standard; and
d. recognition and measurement principles laid down in paragraphs 129 to 131 of the
Standard in respect of accounting for other long-term employee benefits. However,
such entities should actuarially determine and provide for the accrued liability in
respect of other long-term employee benefits by using the Projected Unit Credit
Method and the discount rate used should be determined by reference to market
yields at the balance sheet date on government bonds as per paragraph 78 of the
Standard.
2. Level II and Level III Non-company entities whose average number of persons employed
during the year is less than 50 and Level IV Non-company entities irrespective of number
of employees are exempted from the applicability of the following paragraphs:
a. paragraphs 11 to 16 of the standard to the extent they deal with recognition and
measurement of short-term accumulating compensated absences which are non-
vesting (i.e., short-term accumulating compensated absences in respect of which
employees are not entitled to cash payment for unused entitlement on leaving);
b. paragraphs 46 and 139 of the Standard which deal with discounting of amounts that
fall due more than 12 months after the balance sheet date;
c. recognition and measurement principles laid down in paragraphs 50 to 116 and
presentation and disclosure requirements laid down in paragraphs 117 to 123 of the
Standard in respect of accounting for defined benefit plans. However, such entities
may calculate and account for the accrued liability under the defined benefit plans by
reference to some other rational method, e.g., a method based on the assumption
that such benefits are payable to all employees at the end of the accounting year; and
d. recognition and measurement principles laid down in paragraphs 129 to 131 of the
Standard in respect of accounting for other long-term employee benefits. Such
entities may calculate and account for the accrued liability under the other long-term
employee benefits by reference to some other rational method, e.g., a method based
on the assumption that such benefits are payable to all employees at the end of the
68

accounting year.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 v. AS 19, Leases
a. Paragraphs 22 (c),(e) and (f); 25 (a), (b) and (e); 37 (a) and (f); and 46 (b) and (d) relating
to disclosures are not applicable to Level II Non-company entities.
b. Paragraphs 22 (c),(e) and (f); 25 (a), (b) and (e); 37 (a), (f) and (g); and 46 (b), (d) and (e)
relating to disclosures are not applicable to Level III Non-company entities.
c. Paragraphs 22 (c),(e) and (f); 25 (a), (b) and (e); 37 (a), (f) and (g); 38; and 46 (b), (d) and
(e) relating to disclosures are not applicable to Level IV Non-company entities.
vi. AS 22, Accounting for Taxes on Income
a. Level IV Non-company entities shall apply the requirements of AS 22, Accounting for
Taxes on Income, for Current tax defined in paragraph 4.4 of AS 22, with recognition as
per paragraph 9, measurement as per paragraph 20 of AS 22, and presentation and
disclosure as per paragraphs 27-28 of AS 22.
b. Transitional requirements
On the first occasion when a Non-company entity gets classified as Level IV entity, the
accumulated deferred tax asset/liability appearing in the financial statements of
immediate previous accounting period, shall be adjusted against the opening revenue
reserves.
vii. AS 26, Intangible Assets
Paragraphs 90(d)(iii); 90(d)(iv) and 98 relating to disclosures are not applicable to Level I
Non-company entities.

viii. AS 28, Impairment of Assets

a. Level II and Level III Non-company entities are allowed to measure the ‘value in use’ on
the basis of reasonable estimate thereof instead of computing the value in use by
present value technique. Consequently, if Level II or Level III Non-company entity
chooses to measure the ‘value in use’ by not using the present value technique, the
relevant provisions of AS 28, such as discount rate etc., would not be applicable to such
an entity. Further, such an entity need not disclose the information required by
paragraph 121(g) of the Standard.
b. Also, paragraphs 121(c) (ii); 121(d) (i); 121(d) (ii) and 123 relating to disclosures are not
applicable to Level III Non-company entities.

ix. AS 29, Provisions, Contingent Liabilities and Contingent Assets (revised 2016)
69

Paragraphs 66 and 67 relating to disclosures are not applicable to Level II, Level III and Level
Page

IV Non-company entities.

CA CS KARTHIK MANIKONDA – 75501 37279

C. In case of Level IV Non-company entities, generally there are no such transactions that are
covered under AS 14, Accounting for Amalgamations, or jointly controlled operations or jointly
controlled assets covered under AS 27, Financial Reporting of Interests in Joint Ventures.
Therefore, these standards are not applicable to Level IV Non-company entities. However, if
there are any such transactions, these entities shall apply the requirements of the relevant
standard.
D. AS 21, Consolidated Financial Statements, AS 23, Accounting for Investments in Associates in
Consolidated Financial Statements, AS 27, Financial Reporting of Interests in Joint Ventures (to
the extent of requirements relating to Consolidated Financial Statements), and AS 25, Interim
Financial Reporting, do not require a Non-company entity to present consolidated financial
statements and interim financial report, respectively. Relevant AS is applicable only if a Non-
company entity is required or elects to prepare and present consolidated financial statements or
interim financial report.

Example 1
M/s Omega & Co. (a partnership firm), had a turnover of Rs.1.25 crore (excluding other income)
and borrowings of Rs.0.95 crore in the previous year. It wants to avail the exemptions available in
application of Accounting Standards to non-corporate entities for the year ended 31.3.20X1.
Advise the management of M/s Omega & Co in respect of the exemptions of provisions of ASs, as
per the directive issued by the ICAI.
Solution
The question deals with the issue of Applicability of Accounting Standards to a non-corporate entity.
For availment of the exemptions, first of all, it has to be seen that M/s Omega & Co. falls in which
level of the non-corporate entities. Its classification will be done on the basis of the classification of
non-corporate entities as prescribed by the ICAI. According to the ICAI, non-corporate entities can be
classified under 4 levels viz Level I, Level II, Level III and Level IV entities.
Non-corporate entities which meet following criteria are classified as Level IV entities:
i. All entities engaged in commercial, industrial or business activities, whose turnover (excluding
other income) does not exceed rupees ten crore in the immediately preceding accounting year.
ii. All entities engaged in commercial, industrial or business activities having borrowings (including
public deposits) does not exceed rupees two crore at any time during the immediately preceding
accounting year.
70

iii. Holding and subsidiary entities of any one of the above.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

As the turnover of M/s Omega & Co. is less than Rs.10 crore and borrowings less than Rs.2 crore, it
falls under Level IV non-corporate entities. In this case, AS 3, AS 14, AS 17, AS 18, AS 20, AS 21, AS
23, AS 24, AS 25, AS 27 and AS 28 will not be applicable to M/s Omega & Co. Relaxations from
certain requirements in respect of AS 10, AS 11, AS 13, AS 15, AS 19, AS 22, AS 26 and AS 29 are also
available to M/s Omega & Co.
2.2 Criteria for classification of Companies under the Companies (Accounting Standards) Rules,
2021
Small and Medium-Sized Company (SMC) as defined in Clause 2(e) of the Companies (Accounting
Standards) Rules, 2021:
“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;
iii. whose turnover (excluding other income) does not exceed rupees two-fifty crore in the
immediately preceding accounting year;
iv. which does not have borrowings (including public deposits) in excess of rupees fifty 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 2(e), a company should 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
 General Instructions
1. SMCs should 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 should 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
71

applicable to an SMC on the following lines:

Page

CA CS KARTHIK MANIKONDA – 75501 37279

 “The Company is a Small and Medium Sized Company (SMC) as defined in the Companies
(Accounting Standards) Rules, 2021 notified under the Companies Act, 2013. 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 should 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 should disclose the standard(s) in
respect of which it has availed the exemption or relaxation.
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 should 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 should not be
permitted to mislead any person or public.
Note:
An existing company which was previously not a SMC and subsequently becomes a SMC, shall not be
qualified for exemption or relaxation in respect of Accounting Standards available to a SMC until the
company remains a SMC for two consecutive accounting periods.
2.3 Applicability of Accounting Standards to Companies other than those following Indian
Accounting Standards (Ind AS)1
2.3.1 Accounting Standards applicable in their entirety to companies
AS 1 Disclosures of Accounting Policies
AS 2 Valuation of Inventories (revised 2016)
AS 3 Cash Flow Statements
AS 4 Contingencies and Events Occurring After the Balance Sheet Date (revised 2016)
72

AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies
Page

CA CS KARTHIK MANIKONDA – 75501 37279

AS 7 Construction Contracts (revised 2002)
AS 9 Revenue Recognition
AS 10 Property, Plant and Equipment
AS 11 The Effects of Changes in Foreign Exchange Rates (revised 2003)
AS 12 Accounting for Government Grants
AS 13 Accounting for Investments (revised 2016)
AS 14 Accounting for Amalgamations (revised 2016)
AS 16 Borrowing Costs
AS 18 Related Party Disclosures
AS 21 Consolidated Financial Statements (revised 2016)
AS 22 Accounting for Taxes on Income
AS 23 Accounting for Investments in Associates in Consolidated Financial Statements
AS 24 Discontinuing Operations
AS 26 Intangible Assets
AS 27 Financial Reporting of Interest in Joint Ventures

2.3.2 Exemptions or Relaxations for Small and Medium Sized Companies (SMCs) as defined in the
Notification dated June 23, 2021, issued by the Ministry of Corporate Affairs, Government of India
1. Accounting Standards not applicable to SMCs in their entirety:
AS 17 Segment Reporting
2. Accounting Standards in respect of which relaxations from certain requirements have been given
to SMCs:
i. Accounting Standard (AS) 15, Employee Benefits (revised 2005)
a. paragraphs 11 to 16 of the standard to the extent they deal with recognition and
measurement of short-term accumulating compensated absences which are non-vesting
(i.e., short-term accumulating compensated absences in respect of which employees are
not entitled to cash payment for unused entitlement on leaving);
b. paragraphs 46 and 139 of the Standard which deal with discounting of amounts that fall
due more than 12 months after the balance sheet date;
c. recognition and measurement principles laid down in paragraphs 50 to 116 and
presentation and disclosure requirements laid down in paragraphs 117 to 123 of the
Standard in respect of accounting for defined benefit plans. However, such companies
73

should actuarially determine and provide for the accrued liability in respect of defined
Page

benefit plans by using the Projected Unit Credit Method and the discount rate used

CA CS KARTHIK MANIKONDA – 75501 37279

 should be determined by reference to market yields at the balance sheet date on
government bonds as per paragraph 78 of the Standard. Such companies should disclose
actuarial assumptions as per paragraph 120(l) of the Standard; and
d. recognition and measurement principles laid down in paragraphs 129 to 131 of the
Standard in respect of accounting for other long-term employee benefits. However, such
companies should actuarially determine and provide for the accrued liability in respect of
other long-term employee benefits by using the Projected Unit Credit Method and the
discount rate used should be determined by reference to market yields at the balance
sheet date on government bonds as per paragraph 78 of the Standard.
ii. AS 19, Leases
Paragraphs 22 (c), (e) and (f); 25 (a), (b) and (e); 37 (a) and (f); and 46 (b) and (d) relating to
disclosures are not applicable to SMCs.
iii. AS 20, Earnings Per Share
Disclosure of diluted earnings per share (both including and excluding extraordinary items) is
exempted for SMCs.
iv. AS 28, Impairment of Assets
SMCs are allowed to measure the ‘value in use’ on the basis of reasonable estimate thereof
instead of computing the value in use by present value technique. Consequently, if an SMC
chooses to measure the ‘value in use’ by not using the present value technique, the relevant
provisions of AS 28, such as discount rate etc., would not be applicable to such an SMC.
Further, such an SMC need not disclose the information required by paragraph 121(g) of the
Standard.
v. AS 29, Provisions, Contingent Liabilities and Contingent Assets (revised)
Paragraphs 66 and 67 relating to disclosures are not applicable to SMCs.

3. 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.
74
Page

CA CS KARTHIK MANIKONDA – 75501 37279

SUMMARY
According to the Criteria for Classification of Entities and Applicability of Accounting Standards as
issued by the Government, there are two levels, namely, Small and Medium-sized Companies (SMCs)
as defined in the Companies (Accounting Standards) 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. Criteria for classification of entities for
applicability of accounting standards for corporate and non-corporate entities have been prescribed
as per the Govt. notification.

75
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. Non-corporate entities which are not Level I entities whose turnover (excluding other income)
exceeds rupees ___________ but does not exceed rupees two-fifty crore in the immediately
preceding accounting year are classified as Level II entities.
a. five crore.
b. two crore.
c. fifty crore.
d. ten crore.

2. The following Accounting Standard is not applicable to Non-corporate Entities falling in Level II
in its entirety
a. AS 10.
b. AS 17.
c. AS 2.
d. AS 13.

3. All non-corporate entities engaged in commercial, industrial and business reporting entities,
whose turnover (excluding other income) exceeds rupees 250 crore in the immediately
preceding accounting year, are classified as
a. Level II entities.
b. Level I entities.
c. Level III entities.
d. Level IV entities.

4. All non-corporate entities engaged in commercial, industrial or business activities having

borrowings (including public deposits) in excess of rupees two crore but does not exceed
rupees ten crore at any time during the immediately preceding accounting year.
a. Level II entities.
b. Level IV entities.
c. Level III entities.
d. Level I entities.
76
Page

CA CS KARTHIK MANIKONDA – 75501 37279

5. “Small and Medium Sized Company” (SMC) means, a company-
a. which may be a bank, financial institution or an insurance company.
b. whose turnover (excluding other income) does not exceed rupees two-fifty crores in the
immediately preceding accounting year;
c. whose turnover (excluding other income) does not exceed rupees fifty crores in the
immediately preceding accounting year;
d. whose turnover (excluding other income) does not exceed rupees five hundred crore in
the immediately preceding accounting year.
ANSWERS/HINTS
MCQs
1. c. fifty crores.
2. b. AS 17.
3. b. Level I entities.
4. c. Level III entities.
5. b. whose turnover (excluding other income) does not exceed rupees two-fifty crore in
the immediately preceding accounting year;

THEORY QUESTIONS
Q.NO.1. What are the issues, with which Accounting Standards deal?
ANSWER
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 (iv) Disclosure requirements.
Q.NO.2. List the criteria to be applied for rating a non-corporate entity as Level-I entity and
Level II entity for the purpose of compliance of Accounting Standards in India.
ANSWER
Refer para 1.2.1 for Criteria to be applied for rating a non-corporate entity as Level-I entity and Level
II entity for the purpose of compliance of Accounting Standards in India.
Q.NO.3. List the criteria to be applied for rating a non-corporate entity as Level IV entity for the
purpose of compliance of Accounting Standards in India.
ANSWER
77

Refer para 1.2.1 for Criteria to be applied for rating a non-corporate entity as Level IV entity for the
Page

purpose of compliance of Accounting Standards in India.

CA CS KARTHIK MANIKONDA – 75501 37279

 PRACTICAL QUESTIONS
Q.NO.1. XYZ Ltd., with a turnover of Rs.50 crore during previous year and borrowings of Rs.1
crore during any time in the previous year, wants to avail the exemptions available in adoption of
Accounting Standards applicable to companies for the year ended 31.3.20X1. Advise the
management on the exemptions that are available as per the Companies (Accounting Standards)
Rules, 2021.
ANSWER
The question deals with the issue of Applicability of Accounting Standards for corporate entities.
The companies can be classified under two categories viz SMCs and Non SMCs under the Companies
(Accounting Standards) Rules, 2021.
As per the Companies (Accounting Standards) Rules, 2021, criteria for above classification as SMCs,
are:
“Small and Medium Sized Company” (SMC) means, a company-
 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;
 which is not a bank, financial institution or an insurance company;
 whose turnover (excluding other income) does not exceed rupees two fifty crore in the
immediately preceding accounting year;
 which does not have borrowings (including public deposits) in excess of rupees fifty crore at any
time during the immediately preceding accounting year; and
 which is not a holding or subsidiary company of a company which is not a small and medium-
sized company.
Since, XYZ Ltd.’s turnover was Rs.50 crore which does not exceed Rs.250 crore and borrowings
of Rs.1 crore are less than Rs.50 crore, it is a small and medium sized company (SMC).
Q.NO.2. A company was classified as Non-SMC in 20X1-X2. In 20X2-X3, it has been classified as
SMC. The management desires to avail the exemptions or relaxations available for SMCs in 20X2-
X3. However, the accountant of the company does not agree with the same. Comment.
ANSWER
As per Companies (Accounting Standards) Rules, 2021, an existing company, which was previously
not a SMC and subsequently becomes a SMC, should not be qualified for exemption or relaxation in
respect of accounting standards available to a SMC until the company remains a SMC for two
consecutive accounting periods. Therefore, the management of the company cannot avail the
exemptions/ relaxations available to the SMCs for the FY 20X2-X3.
78
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 4. PRESENTATION & DISCLOSURES BASED
ACCOUNTING STANDARDS
UNIT 1: ACCOUNTING STANDARD 1 DISCLOSURE OF ACCOUNTING POLICIES
LEARNING OUTCOMES
After studying this chapter, you would be able to Comprehend the-
 Fundamental Accounting Assumptions
 Nature of Accounting Policies
 Areas in Which Different Accounting Policies are encountered.
 Considerations in the Selection of Accounting Policies.

1.1 INTRODUCTION
Irrespective of extent of standardization, 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.
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 significant 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
financial 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 an
orderly manner. As explained in the preceding paragraph, such disclosures facilitate more
79

meaningful comparison between financial statements of different enterprises for same accounting
Page

period.

CA CS KARTHIK MANIKONDA – 75501 37279

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.
This Accounting Standard applies to all enterprises.

1.2 FUNDAMENTAL ACCOUNTING ASSUMPTIONS

Fundamental Accounting
Assumptions

Going concern Consistency Accural

Fundamental Accounting Assumptions

If followed If not followed

Not required to be disclosed Disclosure required in financial

statements

Going Concern: The financial statements are normally prepared on the assumption that an
enterprise will continue its operations in the foreseeable future and neither there is intention, nor
there is need to materially curtail the scale of operations. 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.
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
80

better matching between revenue and cost and profit/loss obtained on this basis reflects activities of
Page

the enterprise during an accounting period, rather than cash flows generated by it.

CA CS KARTHIK MANIKONDA – 75501 37279

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. Section 128(1) of
the Companies Act, 2013 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.
1.3 ACCOUNTING POLICIES
The accounting policies refer to the specific accounting principles and the methods of applying those
principles adopted by the enterprise in the preparation and presentation of financial statements .
Accountant has to make decisions from various options for recording or disclosing items in the books
of accounts e.g.
Items to be disclosed Method of disclosure or valuation
Inventories FIFO, Weighted Average etc.
Cash Flow Statement Direct Method, Indirect Method

This list is not exhaustive i.e. endless. For every item right from valuation of assets and liabilities to
recognition of revenue, providing for expected losses, for each event, accountant need to form
principles and evolve a method to adopt those principles. This method of forming and applying
accounting principles is known as accounting policies.
As we say that accounts is both science and art, it’s a science because we have some tested
accounting principles, which are applicable universally, but simultaneously the application of these
principles depends on the personal ability of each accountant. Since different accountants may have
different approach, we generally find that in different enterprises under same industry, different
accounting policies are followed. Though ICAI along with Government is trying to reduce the number
of accounting policies followed in India but still it cannot be reduced to one. Accounting policy
adopted will have considerable effect on the financial results disclosed by the financial statements; it
81

makes it almost difficult to compare two financial statements.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

1.4 SELECTION OF ACCOUNTING POLICY
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.

Example 1
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.
Suppose a trader has purchased 500 units of certain article @ Rs. 10 per unit. He sold 400 articles @
Rs. 15 per unit. If the net realisable value per unit of the unsold article is Rs. 15, the trader should
value his stock at Rs. 10 per unit and thus ignoring the profit Rs. 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 Rs. 8, the trader should value his stock at Rs.8 per unit and thus recognising possible
loss Rs. 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 Rs. 15
= Sale – Cost of goods sold = (400 x Rs. 15) – (500 x Rs. 10 – 100 x Rs. 10) = Rs. 2,000
Profit of the trader if net realisable value of unsold article is Rs. 8
= Sale – Cost of goods sold = (400 x Rs. 15) – (500 x Rs.10 – 100 x Rs. 8) = Rs. 1,800
Example 2
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 by their legal form.
Materiality: Financial statements should disclose all ‘material items, i.e. the items the knowledge of
82

which might influence the decisions of the user of the financial statement. Materiality is not always a
Page

matter of relative size. For example a small amount lost by fraudulent practices of certain employees

CA CS KARTHIK MANIKONDA – 75501 37279

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. A company should disclose by way of notes additional information regarding any item of income
or expenditure which exceeds 1% of the revenue from operations or Rs.1,00,000 whichever is
higher (Refer general Instructions for preparation of Statement of Profit and Loss in Schedule III
to the Companies Act, 2013).
b. A company should disclose in Notes to Accounts, shares in the company held by each
shareholder holding more than 5 per cent shares specifying the number of shares held. (Refer
general Instructions for Balance Sheet in Schedule III to the Companies Act, 2013).
Manner of disclosure: All significant accounting policies adopted in the preparation and
presentation of financial statements should be disclosed
The disclosure of the significant accounting policies as such should form part of the financial
statements and the significant accounting policies should normally be disclosed in one place.
1.5 DISCLOSURE OF CHANGES IN ACCOUNTING POLICIES
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.

Change in Accounting Policy

Material in current period Not material in current period

but ascertainable in later
periods

Amount Amount not

ascertained ascertained Fact of such change in later
period to be disclosed in
current period.
Amount to be Fact to be
disclosed disclosed
83
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Example 3
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 using FIFO method is Rs.2
lakh and that by weighted average method is Rs.1.8 lakh, the change in accounting policy pulls down
profit and value of inventory by Rs.20,000. The company may disclose the change in accounting
policy in the following manner:
‘The company values its inventory at lower of cost or 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 method,
which better reflects the consumption pattern of inventory, for ascertaining inventory costs from the
earlier practice of using FIFO method for the purpose. The change in policy has reduced profit for
the year and value of inventory as at the year-end by Rs.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.
1.6 DISCLOSURE OF DEVIATIONS FROM FUNDAMENTAL ACCOUNTING ASSUMPTIONS
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.
84
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 ILLUSTRATIONS
Illustration 1
In the books of M/s Prashant Ltd., closing inventory as at 31.03.20X2 amounts to Rs. 1,63,000 (on
the basis of FIFO method).
The company decides to change from FIFO method to weighted average method for ascertaining
the cost of inventory from the year 20X1-X2. On the basis of weighted average method, closing
inventory as on 31.03.20X2 amounts to Rs. 1,47,000. Realisable value of the inventory as on
31.03.20X2 amounts to Rs. 1,95,000.
Discuss disclosure requirement of change in accounting policy as per AS-1.
Solution
As per AS 1“Disclosure of Accounting Policies”, any change in an accounting policy which has a
material effect should be disclosed in the financial statements. 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. Thus
Prashant Ltd. should disclose the change in valuation method of inventory and its effect on financial
statements. The company may disclose the change in accounting policy in the following manner:
‘The company values its inventory at lower of cost and net realizable value. Since net realizable 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 i.e. 20X1-X2, the company has changed to weighted average
method, 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 current
profit and value of inventory by Rs. 16,000.
Illustration 2
Jagannath Ltd. had made a rights issue of shares in 20X2. In the offer document to its members, it
had projected a surplus of Rs.40 crore during the accounting year to end on 31st March, 20X2. The
draft results for the year, prepared on the hitherto followed accounting policies and presented for
perusal of the board of directors showed a deficit of Rs.10 crore. The board in consultation with
the managing director, decided on the following:
i. Value year-end inventory at works cost (Rs. 50 crore) instead of the hitherto method of
valuation of inventory at prime cost (Rs. 30 crore).
ii. Provide for permanent diminution in the value of investments, which had taken place over the
85

past five years, the amount of provision being Rs.10 crore.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

As chief accountant of the company, you are asked by the managing director to draft the notes on
accounts for inclusion in the annual report for 20X1-20X2.
Solution
As per AS 1, any change in the accounting policies which has a material effect in the current period
or which is reasonably expected to have a material effect in later periods should be disclosed. In the
case of a change in accounting policies which has a material effect in the current period, the a mount
by which any item in the financial statements is affected by such change should also be disclosed to
the extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact should
be indicated. Accordingly, the notes on accounts should properly disclose the change and its effect.
Notes on Accounts:
i. During the year inventory has been valued at factory cost, against the practice of valuing it at
prime cost as was the practice till last year. This has been done to take cognizance of the more
capital intensive method of production on account of heavy capital expenditure during the year.
As a result of this change, the year-end inventory has been valued at Rs. 50 crore and the profit
for the year has increased by Rs. 20 crore.
ii. The company has decided to provide Rs.10 crore for the permanent diminution in the value of
investments which has taken place over the period of past five years. The provision so made has
reduced the profit disclosed in the accounts by Rs.10 crore.
Illustration 3
XYZ Company is engaged in the business of financial services and is undergoing tight liquidity
position, since most of the assets of the company are blocked in various claims/petitions in a
Special Court. XYZ has accepted Inter-Corporate Deposits (ICDs) and it is making its best efforts to
settle the dues. There were claims at varied rates of interest, from lenders, from the due date of
ICDs to the date of repayment. The company has provided interest, as per the terms of the
contract till the due date and a note for non-provision of interest on the due date to date of
repayment was affected in the financial statements. On account of uncertainties existing regarding
the determination of the amount and in the absence of any specific legal obligation at present as
per the terms of contracts, the company considers that these claims are in the nature of "claims
against the company not acknowledged as debt”, and the same has been disclosed by way of a
note in the accounts instead of making a provision in the statement of profit and loss. State
whether the treatment done by the Company is correct or not
86
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Solution
AS 1 ‘Disclosure of Accounting Policies’ recognises 'prudence' as one of the major considerations
governing the selection and application of accounting policies. In view of the uncertainty attached to
future events, profits are not anticipated but recognised only when realised though not necessarily
in cash. Provision is made for all known liabilities and losses even though the amount cannot be
determined with certainty and represents only a best estimate in the light of available information.
Also as per AS 1, ‘accrual’ is one of the fundamental accounting assumptions. Irrespective of the
terms of the contract, so long as the principal amount of a loan is not repaid, the lender cannot be
replaced in a disadvantageous position for non-payment of interest in respect of overdue amount.
From the aforesaid, it is apparent that the company has an obligation on account of the overdue
interest.
In this situation, the company should provide for the liability (since it is not waived by the lenders) at
an amount estimated or on reasonable basis based on facts and circumstances of each case.
However, in respect of the overdue interest amounts, which are settled, the liability should be
accrued to the extent of amounts settled. Non-provision of the overdue interest liability amounts to
violation of accrual basis of accounting. Therefore, the treatment, done by the company, of not
providing the interest amount from due date to the date of repayment is not correct.
Reference: The students are advised to refer the full text of AS 1 “Disclosure of Accounting
Policies”.

87
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. Which of the following is NOT a major consideration in selection and application of accounting
policies?
a. Prudence
b. Comparability
c. Materiality
d. Substance over form

2. Adoption of different accounting policies by different companies operating in the same

industry affects which of the qualitative characteristics the most?
a. Comparability
b. Relevance
c. Faithful representation
d. Reliability

3. Which of the following statement would not be correct in relation to disclosures to be made in
the financial statements after making any change in an accounting policy?
a. Any change in an accounting policy which has a material effect should be disclosed.
b. The amount by which any item in the financial statements is affected by such change
should be disclosed to the extent ascertainable. Where such amount is not ascertainable,
wholly or in part, the fact should be indicated.
c. If a change is made in the accounting policies which has no material effect on the financial
statements for the current period but which is reasonably expected to have a material
effect in later periods, the fact of such change should be appropriately disclosed in the
period in which the change is adopted.
d. If a change is made in an accounting policy which has material effect on the financial
statements for the current period and is reasonably expected to have a material effect in
later periods, the fact of such change should be appropriately disclosed only in the later
periods i.e. year(s) next to the year in which the change is adopted.
88
Page

CA CS KARTHIK MANIKONDA – 75501 37279

ANSWERS/HINTS
MCQs
1. b. Comparability
2. a. Comparability
3. d. If a change is made in an accounting policy which has material effect on the financial
statements for the current period and is reasonably expected to have a material effect
in later periods, the fact of such change should be appropriately disclosed only in the
later periods i.e. year(s) next to the year in which the change is adopted.

THEORETICAL QUESTIONS
Q.NO.1. What are the three fundamental accounting assumptions recognised by Accounting
Standard (AS) 1? Briefly describe each one of them.
ANSWER
Accounting Standard (AS) 1 recognises three fundamental accounting assumptions. These are:
(i) Going Concern; (ii) Consistency; and (iii) Accrual basis of accounting.

Q.NO.2. Has Accounting Standard 1 prescribed the manner in which the accounting policies
followed by the entity should be disclosed?
ANSWER
Paras 18-20 of Accounting Standard 1, Disclosure of Accounting Policies, lay down the manner in
which accounting policies have to be disclosed, which is stated as under:
 To ensure proper understanding of financial statements, it is necessary that all significant
accounting policies adopted in the preparation and presentation of financial statements should
be disclosed.
 Such disclosure should form part of the financial statements.
 All the disclosures should be made at one place instead of being scattered over several
statements, schedules and notes.
89
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 PRACTICAL QUESTIONS
Q.NO.1. State whether the following statements are 'True' or 'False'. Also give reason for your
answer.
i. Certain fundamental accounting assumptions underline the preparation and presentation of
financial statements. They are usually specifically stated because their acc eptance and use are
not assumed.
ii. If fundamental accounting assumptions are not followed in presentation and preparation of
financial statements, a specific disclosure is not required.
iii. All significant accounting policies adopted in the preparation and presentation of financial
statements should form part of the financial statements.
iv. Any change in an accounting policy, which has a material effect should be disclosed. Where the
amount by which any item in the financial statements is affected by such change is not
ascertainable, wholly or in part, the fact need not to be indicated.
SOLUTION
i. False: As per AS 1 “Disclosure of Accounting Policies”, certain fundamental accounting
assumptions underlie the preparation and presentation of financial statements. They are usually
not specifically stated because their acceptance and use are assumed. Disclosure is necessary if
they are not followed.
ii. False: As per AS 1, if the fundamental accounting assumptions, viz. Going Concern, Consistency
and Accrual are followed in financial statements, specific disclosure is not required. If a
fundamental accounting assumption is not followed, the fact should be disclosed.
iii. True: To ensure proper understanding of financial statements, it is necessary that all significant
accounting policies adopted in the preparation and presentation of financial statements should
be disclosed. The disclosure of the significant accounting policies as such should form part of the
financial statements and they should be disclosed in one place.
iv. False: Any change in the accounting policies which has a material effect in the current period or
which is reasonably expected to have a material effect in later periods should be disclosed.
Where such amount is not ascertainable, wholly or in part, the fact should be indicated.
Q.NO.2. Give examples of areas where accounting policies adopted could be different for
different enterprises. Would there be any adverse impact due to the adoption of different policies,
and if yes, how does Accounting Standard 1 seek to address such issue?
SOLUTION
There are various areas where different accounting policies could be adopted by different entities
90

within the same industry. An entity may choose to value its inventories using FIFO method, whereas
Page

another entity may choose to value the same using Weighted Average method.

CA CS KARTHIK MANIKONDA – 75501 37279

While an entity is free to choose its accounting policy as long as in the financial statements reflect a
true and fair view of the state of affairs of the enterprise as at the balance sheet date and of the
profit or loss for the period ended, the application of different accounting policies by different
entities affects the comparability of the financial statements of such different entities by
stakeholders, analysts, investors etc. To mitigate the loss of comparability, Accounting Standard 1,
Disclosure of Accounting Policies requires disclosure of significant accounting policies as a part of the
financial statements. This would help users of the financial statements to understand the policies
followed by different entities, particularly if they belong to the same industry, and make a correct
analysis of each entity resulting in more informed decision-making.

91
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 UNIT 2: ACCOUNTING STANDARD 3: CASH FLOW
STATEMENT
LEARNING OUTCOMES
After studying this unit, you will be able to comprehend –
 What are Cash and Cash Equivalents
 Presentation of a Cash Flow Statement
 Reporting Cash Flows from Operating Activities
 Reporting Cash Flows from Investing and Financing Activities
 Reporting Cash Flows on a Net Basis
 Foreign Currency Cash Flows
 Extraordinary Items
 Interest and Dividends
 Taxes on Income
 Non-Cash Transactions.

2.1 INTRODUCTION
This Standard is mandatory for Non-SMCs (Non Small & Medium Companies) and the enterprises
which fall in the category of Level I (for non-corporate entities), at the end of the relevant accounting
period. For all other enterprises though it is not compulsory but it is encouraged to prepare such
statements.
However, the Companies Act, 2013, mandates preparation of Cash flow statement by all companies
except one person company, small company and dormant company (refer note below).
Where an enterprise was not covered by this statement during the previous year but qualifies in the
current accounting year, they are not supposed to disclose the figures for the corresponding
previous years. Whereas, if an enterprises qualifies under this statement to prepare the cash flow
statements during the previous year but now disqualified, will continue to prepare cash flow
statements for another two consecutive years.
Note : Under Section 129 of the Companies Act, 2013, the financial statement, with respect to
One Person Company, small company and dormant company, may not include the cash flow
statement. As per the Amendment, under Chapter I, clause (40) of section 2, an exemption has
92

been provided vide Notification dated 13th June, 2017 under Section 462 of the Companies Act
Page

CA CS KARTHIK MANIKONDA – 75501 37279

2013 to a start-up private company besides one person company, small company and dormant
company. As per the amendment, a start-up private company is not required to include the cash
flow statement in the financial statements.
Thus the financial statements, with respect to one Person Company, small company, dormant
company and private company (if such a private company is a start-up), may not include the cash
flow statement.
2.2 OBJECTIVE
Cash flow Statement (CFS) is an additional information provided to the users of accounts in the form
of an statement, which reflects the various sources from where cash was generated (inflow of cash)
by an enterprise during the relevant accounting year and how these inflows were utilised (outflow of
cash) by the enterprise. This helps the users of accounts:
 To identify the historical changes in the flow of cash & cash equivalents.
 To determine the future requirement of cash & cash equivalents.
 To assess the ability to generate cash & cash equivalents.
 To estimate the further requirement of generating cash & cash equivalents.
 To compare the operational efficiency of different enterprises.
 To study the insolvency and liquidity position of an enterprise.
 As an indicator of amount, timing and certainty of future cash flows.
 To check the accuracy of past assessments of future cash flows
 In examining the relationship between profitability and net cash flow and the impact of changing
prices.
2.3 MEANING OF THE TERM CASH AND CASH EQUIVALENTS FOR CASH FLOW STATEMENTS
Cash and cash equivalents 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 of 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 and cash equivalent’ consists of at least three
balance sheet items, viz. cash in hand; demand deposits with banks and investments regarded as
cash equivalents. For this reason, the AS 3 requires enterprises to give a break-up of opening and
93

closing cash shown in their cash flow statements. This is presented as a note to cash flow statement.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

2.4 MEANING OF THE TERM CASH FLOW
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 Rs.4,90,000 using the
rate of exchange Rs.49/USD prevailing on date of receipt of dollars. If the closing rate of exchange is
Rs.50/USD, the bank balance will be restated at Rs.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.
2.5 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 of each 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.
For the aforesaid reasons, the standard identifies three types of cash flows, i.e.
i. operating cash flows;
ii. investing cash flows; and
iii. financing cash flows.
Separate presentation of each type of cash flow in the cash flow statement improves usefulness of
cash flow information.
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.
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
94

include: (a) receipts from disposals of fixed assets; (b) loan given to / recovered from other entities
Page

CA CS KARTHIK MANIKONDA – 75501 37279

(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).
2.6 IDENTIFYING TYPE OF CASH FLOWS
Classification of Cash Flows

Net Cash Flows

Operating Activities Investing Activities Financing Activities

Direct method In direct method Direct method Direct method

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.
2.6.1 Loans/Advances given and Interests earned
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.
f. Interests earned from customers for late payments are operating cash flows for non-financial
95

enterprises.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

2.6.2 Loans/Advances taken and interests paid
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 financing 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.
2.6.3 Investments made and dividends earned
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.
2.6.4 Dividends Paid
Dividends paid are financing cash outflows for all enterprises.
2.6.5 Income Tax
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.
2.6.6 Insurance claims received
a. Insurance claims received against loss of stock or loss of profits are extraordinary operating cash
inflows for all enterprises.
b. Insurance claims received against loss of fixed assets are extraordinary investing cash inflows for
96

all enterprises.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

AS 3 requires separate disclosure of extraordinary cash flows, classifying them as cash flows from
operating, investing or financing activities, as may be appropriate.
2.7 REPORTING CASH FLOWS FROM OPERATING ACTIVITIES
Net cash flow from operating activities can be reported either as direct method or as indirect
method.
In ‘Direct method’ we take the gross receipts from sales, trade receivables and other operating
inflows subtracted by gross payments for purchases, creditors and other expenses ignoring all non-
cash items like depreciation, provisions.
In ‘Indirect method’ we start from the net profit or loss figure, eliminate the effect of any non-cash
items, investing items and financing items from such profit figure i.e. all such expenses like
depreciation, provisions, interest paid, loss on sale of assets etc. are added and interest received etc.
are deducted. Adjustment for changes in working capital items are also made ignoring cash and cash
equivalent to reach to the figure of net cash flow.
Direct method is preferred over indirect because, direct method gives us the clear picture of various
sources of cash inflows and outflows which helps in estimating the future cash inflows and outflows.
Below is the format for Cash Flow Statement (Illustrative):
Cash Flow Statement of X Ltd. for the year ended March 31, 20X1
(Direct Method)
Particulars Rs. Rs.
Operating Activities:
Cash received from sale of goods xxx
Cash received from Trade receivables xxx
Cash received from sale of services xxx xxx
Less: Payment for Cash Purchases xxx
Payment to Trade payables xxx
Payment for Operating Expenses xxx
(e.g. power, rent, electricity)
Payment for wages & salaries xxx
Payment for Income Tax xxx xxx
xxx
Adjustment for Extraordinary Items xxx
Net Cash Flow from Operating Activities xxx
97
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Cash Flow Statement of X Ltd. for the year ended March 31, 20X1
(Indirect Method)
Particulars Rs. Rs.
Operating Activities:
Closing balance of Profit & Loss Account xxx
Less: Opening balance of Profit & Loss Account xxx
xxx
Reversal of the effects of Profit & Loss Appropriation Account xxx
Add: Provision for Income Tax xxx
Effects of Extraordinary Items xxx
Net Profit Before Tax and Extraordinary Items xxx
Reversal of the effects of non-cash and non-operating items xxx
Effects for changes in Working Capital except cash & cash equivalent xxx
xxx
Less : Payment of Income Tax xxx xxx
Adjustment for Extraordinary Items xxx
Net Cash Flow from Operating Activities xxx

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 end of accounting period.
2.8 REPORTING CASH FLOWS ON NET BASIS
AS 3 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 Rs.50,000 in acquisition of machinery and realises Rs.10,000 on disposal of
furniture, it is not right to show net cash outflow of Rs.40,000. The exceptions to this rule are stated
below.
98

Cash flows from the following operating, investing or financing activities may be reported on a net
Page

basis.

CA CS KARTHIK MANIKONDA – 75501 37279

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.
AS 3 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 with a fixed maturity date
b. Cash flows on placement and withdrawal deposits from other financial enterprises
c. Cash flows on advances/loans given to customers and repayments received there from.
Interest and Dividends
Cash flows from interest and dividends received and paid should each be disclosed separately. Cash
flows arising from interest paid and interest and dividends received in the case of a financial
enterprise should be classified as cash flows arising from operating activities. In the case of other
enterprises, cash flows arising from interest paid should be classified as cash flows from financing
activities while interest and dividends received should be classified as cash flows from investing
activities. Dividends paid should be classified as cash flows from financing activities.
Non-Cash transactions 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.
2.9 BUSINESS PURCHASE
The aggregate cash flows arising from acquisitions and disposals of subsidiaries or other business
units should be presented separately and classified as cash flow from investing activities.
a. The cash flows from disposal and acquisition should not be netted off.
b. 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
99

differences reflect the increases/decreases in current assets and liabilities due to operating activities
Page

only.

CA CS KARTHIK MANIKONDA – 75501 37279

2.10 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.
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 exclusive 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.
2.11 DISCLOSURES
AS 3 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.
AS 3 encourages disclosure of additional information, relevant for understanding the financial
position and liquidity of the enterprise together with a commentary by management. 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.
100
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 ILLUSTRATIONS
Illustration 1
Classify the following activities as (a) Operating Activities, (b) Investing Activities, (c) Financing
Activities (d) Cash Equivalents.
a. Purchase of Machinery.
b. Proceeds from issuance of equity share capital
c. Cash Sales.
d. Proceeds from long-term borrowings.
e. Cheques collected from Trade receivables.
f. Cash receipts from Trade receivables.
g. Trading Commission received.
h. Purchase of investment.
i. Redemption of Preference Shares.
j. Cash Purchases.
k. Proceeds from sale of investment
l. Purchase of goodwill.
m. Cash paid to suppliers.
n. Interim Dividend paid on equity shares.
o. Wages and salaries paid.
p. Proceed from sale of patents.
q. Interest received on debentures held as investment.
r. Interest paid on Long-term borrowings.
s. Office and Administration Expenses paid
t. Manufacturing Overheads paid.
u. Dividend received on shares held as investments.
v. Rent Received on property held as investment.
w. Selling and distribution expense paid.
x. Income tax paid
y. Dividend paid on Preference shares.
z. Underwritings Commission paid.
aa. Rent paid.
101

bb. Brokerage paid on purchase of investments.

Page

cc. Bank Overdraft

CA CS KARTHIK MANIKONDA – 75501 37279

dd. Cash Credit
ee. Short-term Deposits
ff. Highly liquid Marketable Securities (without risk of change in value)
gg. Refund of Income Tax received.
Solution
a. Operating Activities: c, e, f, g, j, m, o, s, t, w, x, aa & gg.
b. Investing Activities: a, h, k, l, p, q, u, v, bb & ee.
c. Financing Activities: b, d, i, n, r, y, z, cc & dd.
d. Cash Equivalent: ff.

Illustration 2
X Ltd. purchased debentures of Rs.10 lakh of Y Ltd., which are redeemable within three months.
How will you show this item as per AS 3 while preparing cash flow statement for the year ended
on 31st March, 20X1?
Solution
As per AS 3 on ‘Cash flow Statement’, cash and cash equivalents consists of cash in hand, balance
with banks and short-term, highly liquid investments . If investment, of Rs.10 lakh, made in
debentures is for short-term period then it is an item of ‘cash equivalents’.
However, if investment of Rs.10 lakh made in debentures is for long-term period then as per AS 3, it
should be shown as cash flow from investing activities.
Illustration 3
Classify the following activities as per AS 3 Cash Flow Statement:
i. Interest paid by financial enterprise
ii. Tax deducted at source on interest received from subsidiary company
iii. Deposit with Bank for a term of two years
iv. Insurance claim received towards loss of machinery by fire
v. Bad debts written off
Solution
i. Interest paid by financial enterprise
Cash flows from operating activities
ii. TDS on interest received from subsidiary company
102

Cash flows from investing activities

iii. Deposit with bank for a term of two years
Page

Cash flows from investing activities

CA CS KARTHIK MANIKONDA – 75501 37279

iv. Insurance claim received against loss of fixed asset by fire
Extraordinary item to be shown as a separate heading under ‘Cash flow from investing activities’
v. Bad debts written off
It is a non-cash item which is adjusted from net profit/loss under indirect method, to arrive at
net cash flow from operating activity.
Illustration 4
Following is the cash flow abstract of Alpha Ltd. for the year ended 31st March, 20X1:
Cash Flow (Abstract)
Inflows Rs. Outflows Rs.
Opening balance: Payment for Account
Cash 10,000 Payables 90,000
Bank 70,000 Salaries and wages 25,000
Share capital – shares issued 5,00,000 Payment of overheads 15,000
Collection on account of Trade Property, plant and
Receivables 3,50,000 equipment acquired 4,00,000
Sale of Property, plant and 70,000 Debentures redeemed 50,000
equipment Bank loan repaid 2,50,000
Taxation 55,000
Dividends 1,00,000
Closing balance:
Cash 5,000
bank 10,000
10,00,000 10,00,000
Prepare Cash Flow Statement for the year ended 31st March, 20X1 in accordance with Accounting
Standard 3.
Solution
Cash Flow Statement for the year ended 31.3.20X1
Rs. Rs.
Cash flow from operating activities
Cash received on account of trade receivables 3,50,000
Cash paid on account of trade payables (90,000)
103

Cash paid to employees (salaries and wages) (25,000)

Other cash payments (overheads) (15,000)
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Cash generated from operations 2,20,000
Income tax paid (55,000)
Net cash generated from operating activities 1,65,000
Cash flow from investing activities
Payment for purchase of Property, plant and equipment (4,00,000)
Proceeds from sale of Property, plant and equipment 70,000
Net cash used in investment activities (3,30,000)
Cash flow from financing activities
Proceeds from issue of share capital 5,00,000
Bank loan repaid (2,50,000)
Debentures redeemed (50,000)
Dividends paid (1,00,000)
Net cash used in financing activities 1,00,000
Net decrease in cash and cash equivalents (65,000)
Cash and cash equivalents at the beginning of the year 80,000
Cash and cash equivalents at the end of the year 15,000

Illustration 5
Prepare Cash Flow from Investing Activities of M/s. Creative Furnishings Limited for the year
ended 31-3-20X1.
Particulars Rs.
Plant acquired by the issue of 8% Debentures 1,56,000
Claim received for loss of plant in fire 49,600
Unsecured loans given to subsidiaries 4,85,000
Interest on loan received from subsidiary companies 82,500
Pre-acquisition dividend received on investment made 62,400
Debenture interest paid 1,16,000
Term loan repaid 4,25,000
Interest received on investment 68,000
(TDS of Rs. 8,200 was deducted on the above interest)
Book value of plant sold (loss incurred Rs. 9,600) 84,000
104
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Solution
Cash Flow Statement from Investing Activities of
M/s Creative Furnishings Limited for the year ended 31-03-20X1
Cash generated from investing activities Rs. Rs.
Interest on loan received 82,500
Pre-acquisition dividend received on investment made 62,400
Unsecured loans given to subsidiaries (4,85,000)
Interest received on investments (gross value) 76,200
TDS deducted on interest (8,200)
Sale of plant 74,400
Cash used in investing activities (before extra-ordinary item) (1,97,700)
Extraordinary claim received for loss of plant 49,600
Net cash used in investing activities (after extra-ordinary item) (1,48,100)
Note:
1. Debenture interest paid and Term Loan repaid are financing activities and, therefore, not
considered for preparing cash flow from investing activities.
2. Plant acquired by issue of 8% debentures does not amount to cash outflow, hence also not
considered in the above cash flow statement.
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 11.
Reference: The students are advised to refer the full text of AS 3 “Cash Flow Statement.

105
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. Crown Ltd. wants to prepare its cash flow statement. It sold equipment of book value of
Rs.60,000 at a gain of Rs. 8,000. The amount to be reported in its cash flow statement under
operating activities is
a. Nil
b. Rs. 8,000
c. Rs. 68,000
d. Rs. 60,000

2. While preparing cash flows statement, an entity (other than a financial institution) should
disclose the dividends received from its investment in shares as
a. operating cash inflow
b. investing cash inflow
c. financing cash inflow
d. cash & cash equivalent

3. XYZ Co. is a financial enterprise. In its cash flow statement, interest paid and dividends
received should be
a. Classified as operating cash flows.
b. Classified as financing cash flows.
c. Not shown in cash flow statement.
d. Classified as investing cash flows.

4. In the cash flow statement, ‘cash and cash equivalents’ do not include
a. Bank balances
b. Short-term investments readily convertible into Cash are subject to an insignificant risk of
changes in value.
c. Cash balances.
d. Loan from bank.

5. While preparing a Cash Flow Statement using the Indirect method as required under AS 3,
which of the following will not be deducted from/added to the Net Profit to arrive at the “Cash
106

flow from Operating activities”?

a. Interest income
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 b. Gain on sale of a fixed asset.
c. Depreciation.
d. Gain on sale of inventory
ANSWERS/HINTS
MCQs
1. a. Nil
2. b. investing cash inflow
3. a. Classified as operating cash flows.
4. d. Loan from bank.
5. d. Gain on sale of inventory

THEORETICAL QUESTIONS
Q.NO.1. What are the main features of the Cash Flow Statement?
ANSWER
According to AS 3 on “Cash Flow Statement”, cash flow statement deals with the provision of
information about the historical changes in cash and cash equivalents of an enterprise during the
given period from operating, investing and financing activities. Cash flows from operating activities
can be reported using either (a) the direct method, or (b) the indirect method. A cash flow
statement when used in conjunction with the other financial statements, provides information that
enables users to evaluate the changes in net assets of an enterprise, its financial structure (including
its liquidity and solvency), and its ability to affect the amount and timing of cash flows in order to
adapt to changing circumstances and opportunities.
Q.NO.2. Mayuri Ltd. acquired Plant and Machinery for Rs. 25 lakh. During the same year, it also
sold Furniture and Fixtures for Rs. 4 lakh. Can the company disclose, Net Cash Outflow towards
purchase of Fixed Assets Rs. 21 lakh (i.e., 25 lakh – 4 lakh) in the Cash Flow Statement?
ANSWER
As per AS 3, Cash Flow Statements, an enterprise should report separately major classes of gross
cash receipts and gross cash payments arising from investing and financing activities, except in the
case of:
 cash receipts and payments on behalf of customers when the cash flows reflect the activities of
the customer rather than those of the enterprise; and
107

 cash receipts and payments for items in which the turnover is quick, the amounts are large, and
the maturities are short.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

In the given case, since the purchase of Plant and Machinery and disposal of Furniture and Fixtures
do not fall in the criteria of exception mentioned above, the same should be presented on a gross
basis as an outflow of Rs. 25 lakh and an inflow of Rs. 4 lakh. Presentation of net cash outflow of
Rs.21 lakh is not permitted as per AS 3.
PRACTICAL QUESTIONS
Q.NO.1. How would the following cash flows be classified in accordance with AS 3?
 Corporate Income Tax paid amounting to Rs. 70 lakh during the reporting period.
 Payment of advance tax Rs. 8,75,000 out of which Rs. 75,000 was towards capital gains arising
on account of sale of assets during the reporting period.
 Fixed Deposits withdrawn by customers of State Bank of India Rs. 3 crore.
SOLUTION
As per AS 3, the given cash flows shall be recorded as under:
Corporate Income Tax paid amounting to Rs.70 lakh Rs.70 lakh: Operating Cash Flows
during the reporting period.
Payment of advance tax Rs.8,75,000 out of which Rs.8,00,000: Operating Cash Flows
Rs.75,000 was towards capital gains arising on Rs.75,000: Investing Cash Flows
account of sale of assets during the reporting period.
Fixed Deposits withdrawn by customers of State Bank Rs.3 crore: Operating Cash Flows for State
of India Rs.3 crore. Bank of India.

Q.NO.2. Money Ltd., a non-financial company has the following entries in its Bank Account. It
has sought your advice on the treatment of the same for preparing Cash Flow Statement.
i. Loans and Advances given to the following and interest earned on them:
1. to suppliers
2. to employees
3. to its subsidiaries companies
ii. Investment made in subsidiary Smart Ltd. and dividend received
iii. Dividend paid for the year Discuss in the context of AS 3 Cash Flow Statement.
SOLUTION
Treatment as per AS 3 ‘Cash Flow Statement’
i. Loans and advances given and interest earned
108

1. to suppliers - Cash flows from operating activities

2. to employees - Cash flows from operating activities
Page

3. to its subsidiary companies - Cash flows from investing activities

CA CS KARTHIK MANIKONDA – 75501 37279

ii. Investment made in subsidiary company and dividend received
Cash flows from investing activities
iii. Dividend paid for the year
Cash flows from financing activities

Q.NO.3. From the following information of XYZ Limited, calculate cash and cash equivalent as on
31-03-20X2 as per AS 3.
Particulars Amount
(Rs.)
Balance as per the Bank Statement 25,000
Cheque issued but not presented in the Bank 15,000
Short Term Investment in liquid equity shares of ABC Limited 50,000
Fixed Deposit created on 01-11-20X1 and maturing on 15- 04-20X2 75,000
Short Term Investment in highly liquid Sovereign Debt Mutual fund on 01-03-20X2
(having maturity period of less than 3 months) 1,00,000
Bank Balance in a Foreign Currency Account in India $ 1,000
(Conversion Rate: On the day of deposit Rs. 69/USD as on 31-03-20X2 Rs.70/USD)
SOLUTION
Computation of Cash and Cash Equivalents as on 31st March, 20X2
(Rs.)
Cash balance with bank (Rs. 25,000 less Rs. 15,000) 10,000
Short term investment in highly liquid sovereign debt mutual fund on 1.3.20X2 1,00,000
Bank balance in foreign currency account ($1,000 x Rs. 70) 70,000
1,80,000

Note: Short term investment in liquid equity shares and fixed deposit will not be considered as cash
and cash equivalents.

Q.NO.4. Z Ltd. has no Foreign Currency Cash Flow during the reporting period. It held a deposit
in a bank in France. The balances as at the beginning of the year and at the end of the year were €
100,000 and € 105,000 respectively. The exchange rate at the beginning of the year was € 1 =
Rs.82, and at the end of the year was € 1 = Rs. 85. The increase in the deposit balance of € 5,000
was on account of interest credited on the last day of the reporting period. The deposit was
109

reported at Rs. 82,00,000 in the opening balance sheet and at Rs. 89,25,000 in the closing balance
sheet. You are required to show+ how these transactions would be presented in the Cash Flow
Page

Statement as per AS 3.

CA CS KARTHIK MANIKONDA – 75501 37279

SOLUTION
The Statement of Profit and Loss was credited on account of:
Interest Income: € 5,000 x Rs.85 = Rs.4,25,000
Exchange difference = € 100,000 x (Rs.85 – Rs.82) = Rs.3,00,000
In preparing the Cash Flow Statement, the exchange difference of Rs.3,00,000 should be deducted
from the Net Profit before taxes, since it is a non-cash item. However, in order to reconcile the
opening balance of the Cash and Cash Equivalents with its closing balance, the Exchange Difference
of Rs.3,00,000 should be added to the opening balance in a Note to the Cash Flow Statement,
Cash Flows arising from transactions in a Foreign Currency shall be recorded in Z Ltd’s reporting
currency by applying to the foreign currency amount the exchange rate between the reporting
currency and the foreign currency at the date of the cash flow.

110
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 UNIT 3: ACCOUNTING STANDARD 17: SEGMENT
REPORTING
LEARNING OUTCOMES

After studying this unit, you will be able to comprehend the-

 Definition and Identification of Reportable Segments
 Primary and Secondary Segment Reporting Formats
 Business and Geographical Segments
 How to identify the Reportable Segments
 Disclosures.
3.1 INTRODUCTION
AS 17 is mandatory in respect of non-SMCs (and level I entities in case of non-corporate). Other
entities are encouraged to comply with AS 17.
This standard establishes principles for reporting financial information about different types of
products and services an enterprise produces and different geographical areas in which it operates.
The standard is more relevant for assessing risks and returns of a diversified or multi-locational
enterprise which may not be determinable from the aggregated data.
Before we start the standard, let us lay down the areas to be covered from the examination point of
view.

Identify the segments - Business or Geographical

Identify the Reportable Segments

Prepare a Segmental Report +Make appropriate Disclosures

3.2 OBJECTIVE
Many enterprises provide groups of products and services or operate in geographical areas that are
subject to differing rates of profitability, opportunities for growth, future prospects, and risks. The
objective of this Standard is to establish principles for reporting financial information, about the
111

different types of products and services an enterprise produces and the different geographical areas
in which it operates. Such information helps users of financial statements:
Page

CA CS KARTHIK MANIKONDA – 75501 37279

a. Better understand the performance of the enterprise;
b. Better assess the risks and returns of the enterprise; and
c. Make more informed judgements about the enterprise as a whole.
3.3 SCOPE
AS 17 should be applied in presenting general purpose financial statements.
An enterprise should comply with the requirements of this Standard fully and not selectively. If a single
financial report contains both consolidated financial statements and separate financial statements of the
parent, segment information need be presented only on the basis of the consolidated financial
statements.
3.4 DEFINITION OF THE TERMS USED IN THE ACCOUNTING STANDARD
A business segment is a distinguishable component of an enterprise that is engaged in providing an
individual product or service or a group of related products or services and that is subject to risks
and returns that are different from those of other business segments. Factors that should be
considered in determining whether products or services are related include:
a. The nature of the products or services
b. The nature of the production processes
c. The type or class of customers for the products or services
d. The methods used to distribute the products or provide the services
e. If applicable, the nature of the regulatory environment, for example, banking, insurance, or
public utilities
A single business segment does not include products and services with significantly differing risks
and returns. While there may be dissimilarities with respect to one or several of the factors listed in
the definition of business segment, the products and services included in a single business segment
are expected to be similar with respect to a majority of the factors.
A geographical segment is a distinguishable component of an enterprise that is engaged in providing
products or services within a particular economic environment and that is subject to risks and
returns that are different from those of components operating in other economic environments.
Factors that should be considered in identifying geographical segments include:
a. Similarity of economic and political conditions.
b. Relationships between operations in different geographical areas.
c. Proximity of operations.
112

d. Special risks associated with operations in a particular area.

e. Exchange control regulations and
Page

CA CS KARTHIK MANIKONDA – 75501 37279

f. The underlying currency risks.
A single geographical segment does not include operations in economic environments with
significantly differing risks and returns. A geographical segment may be a single country, a group of
two or more countries, or a region within a country.
The risks and returns of an enterprise are influenced both by the geographical location of its
operations (where its products are produced or where its service rendering activities are based) and
also by the location of its customers (where its products are sold or services are rendered). The
definition allows geographical segments to be based on either:
a. The location of production or service facilities and other assets of an enterprise; or
b. The location of its customers.
The predominant sources of risks affect how most enterprises are organised and managed.
Therefore, the organisational structure of an enterprise and its internal financial reporting system
are normally the basis for identifying its segments.
A reportable segment is a business segment or a geographical segment identified on the basis of
foregoing definitions for which segment information is required to be disclosed by AS 17.
Segment revenue is the aggregate of
i. The portion of enterprise revenue that is directly attributable to a segment;
ii. The relevant portion of enterprise revenue that can be allocated on a reasonable basis to a
segment; and
iii. Revenue from transactions with other segments of the enterprise.
Segment revenue does not include:
a. Extraordinary items as defined in AS 5;
b. Interest or dividend income, including interest earned on advances or loans to other segments
unless the operations of the segment are primarily of a financial nature; and
c. Gains on sales of investments or on extinguishment of debt unless the operations of the segment
are primarily of a financial nature.
Segment expense is the aggregate of
i. The expense resulting from the operating activities of a segment that is directly attributable to
the segment;
ii. The relevant portion of enterprise expense that can be allocated on a reasonable basis to the
segment; and
113

iii. Including expense relating to transactions with other segments of the enterprise.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Segment expense does not include:
a. Extraordinary items as defined in AS 5;
b. Interest expense, including interest incurred on advances or loans from other segments, unless
the operations of the segment are primarily of a financial nature;
c. Losses on sales of investments or losses on extinguishment of debt unless the operations of the
segment are primarily of a financial nature;
d. Income tax expense; and
e. General administrative expenses, head-office expenses, and other expenses that arise at the
enterprise level and relate to the enterprise as a whole. However, costs are sometimes incurred
at the enterprise level on behalf of a segment. Such costs are part of segment expense if they
relate to the operating activities of the segment and if they can be directly attributed or
allocated to the segment on a reasonable basis.
Segment result is segment revenue less segment expense.
Segment assets are those operating assets that are employed by a segment in its operating activities
and that either are directly attributable to the segment or can be allocated to the segment on a
reasonable basis.
If the segment result of a segment includes interest or dividend income, its segment assets include
the related receivables, loans, investments, or other interest or dividend generating assets.
Segment assets do not include:
 income tax assets; and
 assets used for general enterprise or head-office purposes.
Segment assets are determined after deducting related allowances/provisions that are reported as
direct offsets in the balance sheet of the enterprise.
Segment liabilities are those operating liabilities that result from the operating activities of a
segment and that either are directly attributable to the segment or can be allocated to the segment
on a reasonable basis.
If the segment result of a segment includes interest expense, its segment liabilities include the
related interest-bearing liabilities.
Examples of segment liabilities include trade and other payables, accrued liabilities, customer advances,
product warranty provisions, and other claims relating to the provision of goods and services.
Segment liabilities do not include:

114

income tax liabilities; and

 borrowings and other liabilities that are incurred for financing rather than operating purposes.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Assets and liabilities that relate jointly to two or more segment should be allocated to segments if,
and only if, their related revenues and expenses also are allocated to those segments.
3.5 TREATMENT OF INTEREST FOR DETERMINING SEGMENT EXPENSE
The interest expense relating to overdrafts and other operating liabilities identified to a particular
segment should not be included as a part of the segment expense unless the operations of the
segment are primarily of a financial nature or unless the interest is included as a part of the cost of
inventories.
In case interest is included as a part of the cost of inventories where it is so required as per AS 16,
read with AS 2 (Revised), and those inventories are part of segment assets of a particular segment,
such interest should be considered as a segment expense. In this case, the amount of such interest
and the fact that the segment result has been arrived at after considering such interest should be
disclosed by way of a note to the segment result.
3.6 ALLOCATION
An enterprise looks to its internal financial reporting system as the starting point for identifying
those items that can be directly attributed, or reasonably allocated, to segments. There is thus a
presumption that amounts that have been identified with segments for internal financial reporting
purposes are directly attributable or reasonably allocable to segments for the purpose of measuring
the segment revenue, segment expense, segment assets, and segment liabilities of reportable
segments.
In some cases, however, a revenue, expense, asset or liability may have been allocated to segments
for internal financial reporting purposes on a basis that is understood by enterprise management
but that could be deemed arbitrary in the perception of external users of financial statements.
Conversely, an enterprise may choose not to allocate some item of revenue, expense, asset or
liability for internal financial reporting purposes, even though a reasonable basis for doing so exists.
Such an item is allocated pursuant to the definitions of segment revenue, segment expense,
segment assets, and segment liabilities in AS 17.
Segment revenue, segment expense, segment assets and segment liabilities are determined before
intra-enterprise balances and intra-enterprise transactions are eliminated as part of the process of
preparation of enterprise financial statements, except to the extent that such intra-enterprise
balances and transactions are within a single segment.
While the accounting policies used in preparing and presenting the financial statements of the
115

enterprise as a whole are also the fundamental segment accounting policies, segment accounting
policies include, in addition, policies that relate specifically to segment reporting, such as
Page

CA CS KARTHIK MANIKONDA – 75501 37279

identification of segments, method of pricing inter-segment transfers, and basis for allocating
revenues and expenses to segments.
3.7 PRIMARY AND SECONDARY SEGMENT REPORTING FORMATS
The dominant source and nature of risks and returns of an enterprise should govern whether its
primary segment reporting format will be business segments or geographical segments.
If the risks and returns of an enterprise are affected predominantly by differences in the products
and services it produces, its primary format for reporting segment information should be business
segments, with secondary information reported geographically. Similarly, if the risks and returns of
the enterprise are affected by the fact that it operates in different countries or other geographical
areas, its primary format for reporting segment information should be geographical segments, with
secondary information reported for groups of related products and services.

3.8 BUSINESS AND GEOGRAPHICAL SEGMENTS

Generally, business and geographical segments are determined on the basis of internal financial
reporting to the board of directors and the Chief Executive Officer. But if such segment does not
satisfy the definitions given in AS, then following points should be considered:
a. If one or more of the segments reported internally to the directors and management is a
business segment or a geographical segment based on the factors in the definitions but others
are not, paragraph below should be applied only to those internal segments that do not meet
the definitions (that is, an internally reported segment that meets the definition should not be
further segmented).
b. For those segments reported internally to the directors and management that do not satisfy the
definitions, management of the enterprise should look to the next lower level of internal
segmentation that reports information along product and service lines or geographical lines, as
appropriate under the definitions and
c. If such an internally reported lower-level segment meets the definition of business segment or
geographical segment, the criteria for identifying reportable segments should be applied to that
segment.
3.9 IDENTIFYING REPORTABLE SEGMENTS (QUANTITATIVE THRESHOLDS)
A business segment or geographical segment should be identified as a reportable segment if:
a. Its revenue from sales to external customers and from transactions with other segments is 10%
116

or more of the total revenue, external and internal, of all segments; or

b. Its segment result, whether profit or loss, is 10% or more of –
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 i. The combined result of all segments in profit, or
ii. The combined result of all segments in loss,
Whichever is greater in absolute amount; or
c. Its segment assets are 10% or more of the total assets of all segments. A business segment or a
geographical segment which is not a reportable segment as per above paragraph, may be
designated as a reportable segment despite its size at the discretion of the management of the
enterprise. If that segment is not designated as a reportable segment, it should be included as an
unallocated reconciling item.
If total external revenue attributable to reportable segments constitutes less than 75% of the
total enterprise revenue, additional segments should be identified as reportable segments, even
if they do not meet the 10% thresholds, until at least 75% of total enterprise revenue is included
in reportable segments.
We can summarize the steps as under:
Step I – Apply 10% Test (Materiality Test):
Any 1 Test needs to be met – For Reportable Segment:
Revenue Test Revenue (External + Internal) of the segment is 10% or more of the Total Revenue
of all segments
Profit/Loss Test Case I – All segments have profits:
Profit of the segment is 10% or more of the total profit of all segments
Case II – Few segments have profit + Few segments have losses:
1. Add the profits of profitable segments only.
2. Add the losses of loss-making segments only.
3. Take the figure (from 1 and 2) whichever is greater (in absolute values).
4. The segment which has profit/loss equal to 10% or more of the absolute
figure computed in Point 3 becomes reportable.
Asset Test The segment assets are 10% or more of the total assets of all segments.
Note:
A business segment or a geographical segment which is not a reportable segment as per above
steps, may be designated as a reportable segment despite its size at the discretion of the
management of the enterprise.
Step II – Apply 75% Test (Overall Test):
117

Ensure that the total external revenue attributable to reportable segments constitutes at least 75%
of the total enterprise revenue.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

If not, additional segments should be identified as reportable segments, even if they do not meet
the 10% thresholds, until at least 75% of total enterprise revenue is included in reportable segments.
Notes:
1. A segment identified as a reportable segment in the immediately preceding period because it
satisfied the relevant 10% thresholds should continue to be a reportable segment for the current
period notwithstanding that its revenue, result, and assets all no longer meet the 10% thresholds.
2. If a segment is identified as a reportable segment in the current period because it satisfies the
relevant 10% thresholds, preceding-period segment data that is presented for comparative
purposes should, unless it is impracticable to do so, be restated to reflect the newly reportable
segment as a separate segment, even if that segment did not satisfy the 10% thresholds in the
preceding period.
3.10 SEGMENT ACCOUNTING POLICIES
Segment information should be prepared in conformity with the accounting policies adopted for
preparing and presenting the financial statements of the enterprise as a whole. AS 17 does not
prohibit the disclosure of additional segment information that is prepared on a basis other than the
accounting policies adopted for the enterprise financial statements provided that-
a. the information is reported internally to the board of directors and the chief executive officer for
purposes of making decisions about allocating resources to the segment and assessing its
performance; and
b. the basis of measurement for this additional information is clearly described.
3.11 PRIMARY REPORTING FORMAT
An enterprise should disclose the following for each reportable segment:
a. Segment revenue, classified into segment revenue from sales to external customers and segment
revenue from transactions with other segments;
b. Segment result;
c. Total carrying amount of segment assets;
d. Total amount of segment liabilities;
e. Total cost incurred during the period to acquire segment assets that are expected to be used
during more than one period (tangible and intangible fixed assets);
f. Total amount of expense included in the segment result for depreciation and amortisation in
respect of segment assets for the period; and
g. Total amount of significant non-cash expenses, other than depreciation and amortisation in
respect of segment assets that were included in segment expense and, therefore, deducted in
118

measuring segment result.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

An enterprise that reports the amount of cash flows arising from operating, investing and financing
activities of a segment need not disclose depreciation and amortisation expense and non-cash
expenses.
An enterprise should present a reconciliation between the information disclosed for reportable
segments and the aggregated information in the enterprise financial statements.
In presenting the reconciliation:
- segment revenue should be reconciled to enterprise revenue;
- segment result should be reconciled to enterprise net profit or loss;
- segment assets should be reconciled to enterprise assets; and
- segment liabilities should be reconciled to enterprise liabilities.
3.12 SECONDARY SEGMENT INFORMATION
If primary format of an enterprise for reporting segment information is business segments, it should
also report the following information:
a. Segment revenue from external customers by geographical area based on the geographical
location of its customers, for each geographical segment whose revenue from sales to external
customers is 10% or more of enterprise revenue;
b. The total carrying amount of segment assets by geographical location of assets, for each
geographical segment whose segment assets are 10% or more of the total assets of all
geographical segments; and
c. The total cost incurred during the period to acquire segment assets that are expected to be used
during more than one period (tangible and intangible fixed assets) by geographical location of
assets, for each geographical segment whose segment assets are 10% or more of the total assets
of all geographical segments.
If primary format of an enterprise for reporting segment information is geographical segments
(whether based on location of assets or location of customers), it should also report the following
segment information for each business segment whose revenue from sales to external customers is
10% or more of enterprise revenue or whose segment assets are 10% or more of the total assets of
all business segments:
a. Segment revenue from external customers;
b. The total carrying amount of segment assets; and
c. The total cost incurred during the period to acquire segment assets that are expected to be used
during more than one period (tangible and intangible fixed assets).
119

3.13 OTHER DISCLOSURES

Page

CA CS KARTHIK MANIKONDA – 75501 37279

In measuring and reporting segment revenue from transactions with other segments, inter-segment
transfers should be measured on the basis that the enterprise actually used to price those transfers.
The basis of pricing inter-segment transfers and any change therein should be disclosed in the
financial statements.
Changes in accounting policies adopted for segment reporting that have a material effect on
segment information should be disclosed. Such disclosure should include a description of the nature
of the change, and the financial effect of the change if it is reasonably determinable.
Some changes in accounting policies may relate specifically to segment reporting.
 Example could be: changes in identification of segments; and
 changes in the basis for allocating revenues and expenses to segments.
Such changes can have a significant impact on the segment information reported but will not change
aggregate financial information reported for the enterprise. To enable users to understand the
impact of such changes, this Standard requires the disclosure of the nature of the change and the
financial effects of the change, if reasonably determinable.
An enterprise should indicate the types of products and services included in each reported business
segment and indicate the composition of each reported geographical segment, both primary and
secondary, if not otherwise disclosed in the financial statements.

120
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 ILLUSTRATIONS
Illustration 1
The Chief Accountant of Sports Ltd. gives the following data regarding its six segments:
Rs. in lakh
Particulars M N O P Q R Total
Segment Assets 40 80 30 20 20 10 200
Segment Results 50 (190) 10 10 (10) 30 (100)
Segment Revenue 300 620 80 60 80 60 1,200
The Chief accountant is of the opinion that segments “M” and “N” alone should be reported. Is he
justified in his view? Discuss.
Solution
As per AS 17 ‘Segment Reporting’, a business segment or geographical segment should be identified
as a reportable segment if:
Its revenue from sales to external customers and from other transactions with other segments is
10% or more of the total revenue- external and internal of all segments; or
Its segment result whether profit or loss is 10% or more of:
 The combined result of all segments in profit; or
 The combined result of all segments in loss,
whichever is greater in absolute amount; or
Its segment assets are 10% or more of the total assets of all segments.
If the total external revenue attributable to reportable segments constitutes less than 75% of total
enterprise revenue, additional segments should be identified as reportable segments even if they do
not meet the 10% thresholds until atleast 75% of total enterprise revenue is included in reportable
segments. On the basis of turnover criteria segments M and N are reportable segments.
On the basis of the result criteria, segments M, N and R are reportable segments
(since their results in absolute amount is 10% or more of Rs. 200 lakh).
On the basis of asset criteria, all segments except R are reportable segments.
Since all the segments are covered in at least one of the above criteria, all segments have to be
reported in accordance with Accounting Standard (AS) 17. Hence the opinion of chief accountant is
wrong.
121

Illustration 2
A Company has an inter-segment transfer pricing policy of charging at cost less 10%. The market
Page

prices are generally 25% above cost. Is the policy adopted by the company correct?

CA CS KARTHIK MANIKONDA – 75501 37279

Solution
AS 17 ‘Segment Reporting’ requires that inter-segment transfers should be measured on the basis
that the enterprise actually used to price these transfers. The basis of pricing inter-segment transfers
and any change therein should be disclosed in the financial statements. Hence the enterprise can
have its own policy for pricing inter-segment transfers and hence inter-segment transfers may be
based on cost, below cost or market price. However, whichever policy is followed, the same should
be disclosed and applied consistently. Therefore, in the given case inter-segment transfer pricing
policy adopted by the company is correct if, followed consistently.
Illustration 3
M/s XYZ Ltd. has three segments namely X, Y, Z. The total Assets of the Company are Rs. 10.00
crores. Segment X has Rs. 2.00 crores, segment Y has Rs. 3.00 crores and segment Z has Rs. 5.00
crores. Deferred tax assets included in the assets of each segments are X- Rs. 0.50 crores, Y—Rs.
0.40 crores and Z—Rs. 0.30 crores. The accountant contends that all the three segments are
reportable segments. Comment.
Solution
According to AS 17 “Segment Reporting”, segment assets do not include income tax assets.
Therefore, the revised total assets are Rs. 8.8 crores [Rs. 10 crores – (Rs. 0.5 + Rs. 0.4 +Rs. 0.3)].
Segment X holds total assets of Rs. 1.5 crores (Rs. 2 crores –Rs. 0.5 crores);
Segment Y holds Rs. 2.6 crores (Rs. 3 crores –Rs. 0.4 crores); and
Segment Z holds Rs. 4.7 crores (Rs. 5 crores –Rs. 0.3 crores).
Thus all the three segments hold more than 10% of the total assets, all segments are reportable
segments.
Illustration 4
Prepare a segmental report for publication in Diversifiers Ltd. from the following details of the
company’s three divisions and the head office:
Rs. (‘000)
Forging Shop Division
Sales to Bright Bar Division 4,575
Other Domestic Sales 90
Export Sales 6,135
10,800
122

Bright Bar Division

Sales to Fitting Division 45
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Export Sales to Rwanda 300
345
Fitting Division
Export Sales to Maldives 270

Particulars Head Office Forging Shop Bright Bar Fitting

Rs. (‘000) Division Division Division
Rs. (‘000) Rs. (‘000) Rs. (‘000)
Pre-tax operating result 240 30 (12)
Head office cost reallocated 72 36 36
Interest costs 6 8 2
Fixed assets 75 300 60 180
Net current assets 72 180 60 135
Long-term liabilities 57 30 15 180
Solution
Diversifiers Ltd.
Segmental Report
(Rs. ’000)
Divisions Inter Consolidated
Particulars Forging Bright Bar Fitting Segment Total
shop Eliminations
Segment Revenue
Sales:
Domestic 90 − − − 90
Export 6,135 300 270 − 6,705
External Sales 6,225 300 270 − 6,795
Inter-Segment Sales 4,575 45 − 4,620 −
Total Revenue 10,800 345 270 4,620 6,795
Segment Result (Given) 240 30 (12) 258
Head Office Expenses (144)
Operating Profit 114
123

Interest Expense (16)

Profit Before Tax 98
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Information in Relation to Assets
and Liabilities:
Fixed Assets 300 60 180 − 540
Net Current Assets 180 60 135 − 375
Segment assets 480 120 315 − 915
Unallocated Corporate Assets (75
+ 72) − − − − 147
Total assets 1,062
Segment liabilities 30 15 180 − 225
Unallocated corporate liabilities 57
Total liabilities 282
Sales Revenue by Geographical Market
(Rs. ’000)
Home Export Sales Export to Export to Consolidated
Sales (by forging Rwanda Maldives Total
shop division)
External sales 90 6,135 300 270 6,795

Illustration 5
Microtech Ltd. produces batteries for scooters, cars, trucks, and specialised batteries for invertors
and UPS. How many segments should it have and why?
Solution
In case of Microtech Ltd., the basic product is the batteries, but the risks and returns of the batteries
for automobiles (scooters, cars and trucks) and batteries for invertors and UPS are affected by
different set of factors. In case of automobile batteries, the risks and returns are affected by the
Government policy, road conditions, quality of automobiles, etc. whereas in case of batteries for
invertors and UPS, the risks and returns are affected by power condition, standard of living, etc.
Therefore, it can be said that Microtech Ltd. has two business segments viz- ‘Automobile batteries’
and ‘batteries for Invertors and UPS’.
Reference: The students are advised to refer the full text of AS 17 “Segment Reporting”.
124
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. As per AS 17, reportable segments are those whose total revenue from external sales and
inter-segment sales is
a. 10% or more of the total revenue of all segments
b. 10% or more of the total revenue of all external segments
c. 12% or more of the total revenue of all segments
d. 12% or more of the total revenue of all external segments

2. Which of the following statements is correct?

a. Management has a discretion to include a segment as a reportable segment even if it
passes the 10% materiality test.
b. Management has a discretion to include any segment as a reportable segment if it fails the
12% materiality test.
c. It is mandatory for the management to include the segment as a reportable segment if it
passes the 10% materiality test.
d. It is not mandatory for the management to include the segment as a reportable segment if
it passes the 10% materiality test.

3. Which of the following statements is correct?

a. The overall test of 75% considers only external revenue to compute the threshold limit.
b. The overall test of 75% considers only internal revenue to compute the threshold limit.
c. The overall test of 75% considers both internal and external revenue to compute the
threshold limit.
d. It is management choice whether they want to include both external and internal revenue
for computing threshold limit.

4. Which of the following statements is correct?

a. The 10% test computed on the basis of revenue, considers both internal and external
revenue to compute the threshold limit.
b. The 10% test computed on the basis of revenue, considers only external revenue to
125

compute the threshold limit.

c. The 10% test computed on the basis of revenue, considers only internal revenue to
Page

compute the threshold limit.

CA CS KARTHIK MANIKONDA – 75501 37279

 d. It is management choice whether they want to include both external and internal revenue
for computing threshold limit.

5. Which of the following statements is correct?

a. In case of 10% test based on profit/loss, we need to consider that any segment whose
profit or loss is 10% or more than the net profit or net loss respectively of all segments
taken together becomes reportable segment.
b. In case of 10% test based on profit/loss, we need to consider that any segment whose
profit or loss is 10% or more than the net profit (after netting the losses) of all segments
taken together becomes reportable segment.
c. In case of 10% test based on profit/loss, we need to consider that any segment whose
profit or loss is 10% or more than the net profit or loss (whichever is higher in absolute
figures) of all segments taken together becomes reportable segment.
d. In case of 10% test based on profit/loss, we need to consider that any segment whose
profit or loss is 10% or more than the net profit or loss (whichever is lower in absolute
figures) of all segments taken together becomes reportable segment.

ANSWERS/ HINTS
MCQs
1. a. 10% or more of the total revenue of all segments
2. c. It is mandatory for the management to include the segment as a reportable segment if
it passes the 10% materiality test.
3. a. The overall test of 75% considers only external revenue to compute the threshold limit.
4. a. The 10% test computed on the basis of revenue, considers both internal and external
revenue to compute the threshold limit.
5. c. In case of 10% test based on profit/loss, we need to consider that any segment whose
profit or loss is 10% or more than the net profit or loss (whichever is higher in absolute
figures) of all segments taken together becomes reportable segment.
126
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 PRACTICAL QUESTIONS
Q.NO.1. Nathan Limited has three segments namely P, Q and R. The assets of the company are
Rs. 15 crores. Segment P has 4 crores, Segment Q has 6 crores and Segment R has 5 crores.
Deferred tax assets included in the assets of each segment are P - Rs. 1 crore, Q - Rs. 0.90 crores
and R - Rs. 0.80 crores. The accountant contends all these three segments are reportable
segments. Comment.
ANSWER
According to AS 17 "Segment Reporting", segment assets do not include income tax assets.
Therefore, the revised total assets are 12.3 crores [Rs. 15 - (Rs. 1 +0.9 + 0.8).
Details of Segment wise assets:
Segment P holds total assets of Rs. 3 crores (Rs. 4 crores - Rs. 1 crores);
Segment Q holds Rs. 5.1 crores (Rs. 6 crores - Rs. 0.9 crores);
Segment R holds Rs. 4.2 crores (Rs. 5 crores - Rs. 0.8 crores).
Thus, all the three segments hold more than 10% of the total assets, all segments are reportable
segments.
Hence, the contention of the Accountant that all three segments are reportable segments is correct.

Q.NO.2. Company A is engaged in the manufacture and sale of products, which constitute two
distinct business segments. The products of the Company are sold in the domestic market only.
The management information system of the Company is organized to reflect operating
information by two broad market segments, rural and urban.
ANSWER
AS 17 explains that, “a single geographical segment does not include operations in economic
environments with significantly differing risks and returns. A geographical segment may be a single
country, a group of two or more countries, or a region within a country”.
Accordingly, to identity geographical segments, Company A needs to evaluate whether the segments
reflected in the management information system function in environments that are subject to
significantly differing risks and returns irrespective of the fact whether they are within the same country.
The Standard recognizes that, “Determining the composition of a business or geographical segment
involves a certain amount of judgement…”. Accordingly, while the management information system
of the Company provides segment information for rural and urban geographical segments for the
purpose of internal reporting, judgement is required to determine whether these segments are
127

subject to significantly differing risks and returns based on the definition of geographical segment. In
Page

making such a judgement, aspect like different pricing and other policies, e.g., credit policies,

CA CS KARTHIK MANIKONDA – 75501 37279

deployment of resources between different regions etc., may be considered for the purpose
identifying ‘urban and ‘rural’ as separate geographical segment.
Company A, in making judgment for identifying geographical segments, should also consider the
relevance, reliability and comparability over time of segment information that will be reported. The
Standard, explains that, “In making that judgement, enterprise management takes into account the
objective of reporting financial information by segment as set forth in the standard and the
qualitative characteristics of financial statements. The qualitative characteristics include the
relevance, reliability and comparability over time of financial information that is reported about the
different groups of products and services of an enterprise and about its operations in particular
geographical areas, and the usefulness of that information for assessing the risks and returns of the
enterprise.”
Q.NO.3. PK Ltd. has identified business segment as its primary reporting format. It has identified
India, USA and UK as three geographical segments. It sells its products in the Indian market, which
constitutes 70 percent of the Company’s sales. 25 per cent is sold in USA and the balance is sold in
UK. Is PK Ltd. as part of its geographical secondary segment information, required to disclose
segment revenue from export sales, where such sales are not significant?
ANSWER
As per AS 17, if primary format of an enterprise for reporting segment information is business
segments, it should also report segment revenue from external customers by geographical area
based on the geographical location of its customers, for each geographical segment whose revenue
from sales to external customers is 10 per cent or more of enterprise revenue. Therefore, for the
purposes of disclosing secondary segment information, PK Ltd. is not required to disclose segment
revenue from export sales to UK, since that segment does not meet the 10 per cent or more of
enterprise revenue threshold. However, other secondary segment information as per AS 17 should
be disclosed in respect of this segment if the thresholds prescribed in the AS 17 are met.
Q.NO.4. XYZ Ltd. has 5 business segments. Profit / Loss of each of the segments for the year ended
31st March, 20X2 have been provided below. You are required to identify from the following whether
reportable segments or not reportable segments, on the basis of "profitability test" as per AS-17.
Segment Profit (Loss) Rs. in lakhs
A 225
B 25
C (175)
128

D (20)
E (105)
Page

CA CS KARTHIK MANIKONDA – 75501 37279

ANSWER
As per AS 17 ‘Segment Reporting’, a business segment or geographical segment should be identified
as a reportable segment if: Its segment results whether profit or loss is 10% or more of:
 The combined result of all segments in profit; i.e. Rs. 250 Lakhs or
 The combined result of all segments in loss; i.e. Rs. 300 Lakhs
Whichever is greater in absolute amount i.e. Rs. 300 Lakhs.
Operating Segment Absolute amount of Profit or Reportable Segment
Loss (Rs. In lakhs) Yes or No
A 225 Yes
B 25 No
C 175 Yes
D 20 No
E 105 Yes
On the basis of the profitability test (result criteria), segments A, C and E are reportable segments
(since their results in absolute amount is 10% or more of Rs. 300 lakhs i.e. 30 lakhs).

Q.NO.5. ABC Limited has 5 segments namely A, B, C, D and E. The profit/loss of each segment
for the year ended March 31st, 20X2 is as follows:
Segment Profit /(Loss)
(Rs. in crore)
A 780
B 1,500
C (2,300)
D (4,500)
E 6,000
Total 1,480
Identify the Reportable segments.
ANSWER
In compliance with AS 17, the segment profit/loss of respective segment will be compared with the
greater of the following:
i. All segments in profit, i.e., A, B and E - Total profit Rs. 8,280 crores.
129

ii. All segments in loss, i.e., C and D - Total loss Rs. 6,800 crores.
Greater of the above - Rs. 8,280 crores.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Based on the above, reportable segments will be determined as follows:
Segment Profit/(Loss) Absolute Profit/Loss as a Reportable
% of 8,280 Segment
A 780 9% No
B 1,500 18% Yes
C (2,300) 28% Yes
D (4,500) 54% Yes
E 6,000 72% Yes
Total 1,480

Q.NO.6. Heavy Goods Ltd. has 6 segments namely L-Q (below). The total revenues (internal and
external), profits or losses and assets are set out below: (In Rs.)
Segment Inter Segment Sales External Profit / loss Total assets
Sales
L 4,200 12,300 3,000 37,500
M 3,500 7,750 1,500 23,250
N 1,000 3,500 (1,500) 15,750
0 0 5,250 (750) 10,500
P 500 5,500 900 10,500
Q 1,200 1,050 600 5,250
10,400 35,350 3,750 1,02,750
Heavy Goods Ltd. needs to determine how many reportable segments it has. You are required to
advice Heavy Goods Ltd. as per the criteria defined in AS 17.
ANSWER
Quantitative Threshold Test:
Revenue Test:
Combined total sales of all the segment = Rs. 10,400 + Rs. 35,350 = Rs. 45,750.
10% thresholds = 45,750 x 10% = 4,575.
Profitability Test:
In the given situation, combined reported profit = Rs. 6,000 and combined reported loss (Rs. 2,250).
Hence, for 10% thresholds Rs. 6,000 will be considered.
130

10% thresholds = Rs. 6,000 x 10% = Rs. 600

Page

Asset Test: Combined total assets of all the segment = Rs. 1,02,750

CA CS KARTHIK MANIKONDA – 75501 37279

10% thresholds = Rs. 1,02,750 x 10% = 10,275
Accordingly, quantitative thresholds are calculated below:
Segments L M N O P Q Reportable
segments
% segment sales to 36.66% 24.59% 9.84% 11.48% 13.11% 4.92% L, M,O,P
total sales
% segment profit 50% 25% 25% 12.5% 15% 10% L,M,N,O,P,Q
to total profits
% segment assets 36.50% 22.63% 15.33% 10.22% 10.22% 5.11% L,M,N,O,P
to total assets
Conclusion:
Segments L, M, O and P clearly satisfy the revenue and assets tests and they are separate reportable
segments.
Segment N does not satisfy the revenue test, but it does satisfy the asset test and it is a reportable
segment.
Segment Q does not satisfy the revenue or the assets test but is does satisfy the profits test.
Therefore, Segment Q is also a reportable segment.
Hence all segments i.e. L, M, N, O, P and Q are reportable segments.

Q.NO.7. Calculate the segment results of a manufacturing organization from the following
information:
Segments A B C Total
Directly attributed revenue 5,00,000 3,00,000 1,00,000 9,00,000
Enterprise revenue 1,10,000
(allocated in 5 :4 : 2 basis)
Revenue from transactions
with other segments
Transaction from B 1,00,000 50,000 1,50,000
Transaction from C 10,000 50,000 60,000
Transaction from A 25,000 1,00,000 1,25,000
Operating expenses 3,00,000 1,50,000 75,000 5,25,000
Enterprise expenses 77,000
131

(allocated in 5 :4 :2 basis)
Page

Expenses on transactions

CA CS KARTHIK MANIKONDA – 75501 37279

with other segments
Transaction from B 75,000 30,000
Transaction from C 6,000 40,000
Transaction from A 18,000 82,000
ANSWER
Computation of segment result:
Segments A B C Total
Directly attributed revenue 5,00,000 3,00,000 1,00,000 9,00,000
Enterprise revenue 50,000 40,000 20,000 1,10,000
(allocated in 5 :4 : 2 basis)
Revenue from transactions with
other segments
Transaction from B 1,00,000 50,000 1,50,000
Transaction from C 10,000 50,000 60,000
Transaction from A 25,000 1,00,000 1,25,000
Total segment revenue (1) 6,60,000 4,15,000 2.70,000 13,45,000
Operating expenses 3,00,000 1,50,000 75,000 5,25,000
Enterprise expenses 35,000 28,000 14,000 77,000
(allocated in 5 :4 :2 basis)
Expenses on transactions with
other segments
Transaction from B 75,000 30,000 1,05,000
Transaction from C 6,000 40,000 46,000
Transaction from A 18,000 82,000 1,00,000
Total segment expenses (2) 4,16,000 2,36,000 2,01,000 8,53,000
Segment result (1-2) 2,44,000 1,79,000 69,000 4,92,000
132
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 UNIT 4: ACCOUNTING STANDARD 18: RELATED
PARTY DISCLOSURES
LEARNING OUTCOMES
After studying this unit, you will be able to comprehend the –
 Need for disclosure of related party relationship;
 How to identify the related party relationships;
 Which parties are not treated as related party;
 Exemption from Related Party Disclosure in certain situations;
 Disclosure requirements under AS-18.
4.1 INTRODUCTION
AS 18 prescribes the requirements for disclosure of related party relationship and transactions
between the reporting enterprise and its related parties. The requirements of the standard apply to
the financial statements of each reporting enterprise as also to consolidated financial statements
presented by a holding company.
4.2 RELATED PARTY ISSUE – WHY DISCLOSURE IS NEEDED?
Related party relationships are a normal feature of commerce and business.
There is a general presumption that transactions reflected in financial statements are consummated
on an arm’s-length basis between independent parties. However, that presumption may not be valid
when related party relationships exist because related parties may enter into transactions which
unrelated parties would not enter into.
Also, transactions between related parties may not be effected at the same terms and conditions as
between unrelated parties. Sometimes, no price is charged in related party transactions, for
example, free provision of management services and the extension of free credit on a debt.
Also, sometimes the operating results and financial position of an enterprise may be affected by a
related party relationship even if related party transactions do not occur. The mere existence of the
relationship may be sufficient to affect the transactions of the reporting enterprise with other
parties. For example, a subsidiary may terminate relations with a trading partner on acquisition by
the holding company of a fellow subsidiary engaged in the same trade as the former partner.
Alternatively, one party may refrain from acting because of the control or significant influence of
another - for example, a subsidiary may be instructed by its holding company not to engage in
133

research and development.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

Likewise, in certain cases transactions would not have taken place if the related party relationship
had not existed. For example, a company that sold a large proportion of its production to its holding
company at cost might not have found an alternative customer if the holding company had not
purchased the goods.
In view of the aforesaid, the resulting accounting measures may not represent what they usually
would be expected to represent. Thus, a related party relationship could have an effect on the
financial position and operating results of the reporting enterprise.
4.3 RELATED PARTY RELATIONSHIPS, AS CONTEMPLATED UNDER AS-18
Related Party - As per AS-18, parties are considered to be related if at any time during the reporting
period one party has the ability to control the other party or exercise significant influence over the
other party in making financial and/or operating decisions.
It is worthwhile to note that AS-18 provides a definitive list of related party relationships to which
AS-18 applies. Accordingly, AS 18 deals only with the following five types of related party
relationships described in (a) to (e) below:
a. Enterprises that directly, or indirectly through one or more intermediaries, control, or are
controlled by, or are under common control with, the reporting enterprise (this includes holding
companies, subsidiaries and fellow subsidiaries).
Note: This is the case when there is a parent-subsidiary relationship (including relationship
among fellow subsidiaries), as illustrated later in this chapter. For meaning of the term control,
refer to subsequent discussion under this chapter.
b. Associates and joint ventures of the reporting enterprise and the investing party or venturer in
respect of which the reporting enterprise is an associate or a joint venture.
c. Individuals owning, directly or indirectly, an interest in the voting power of the reporting
enterprise that gives them control or significant influence over the enterprise, and relatives of
any such individual.
d. Key management personnel and relatives of such personnel; and
e. Enterprises over which any person described in (c) or (d) is able to exercise significant influence. This
includes enterprises owned by directors or major shareholders of the reporting enterprise and
enterprises that have a member of key management in common with the reporting enterprise.
4.4 WHO ARE NOT DEEMED TO BE RELATED PARTIES UNDER AS-18?
In the context of AS 18, the following are deemed not to be related parties:
134

a. Two companies are not related parties simply because they have a director in common (unless
the director is able to affect the policies of both companies in their mutual dealings).
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Accordingly, if the common director is able to influence the policies of both the companies in
their mutual dealings – then related party relationship exists.
b. A single customer, supplier, franchiser, distributor, or general agent with whom an enterprise
transacts a significant volume of business merely by virtue of the resulting economic
dependence; and
c. The parties listed below, in the course of their normal dealings with an enterprise by virtue only
of those dealings (although they may circumscribe the freedom of action of the enterprise or
participate in its decision-making process):
i. Providers of finance
ii. Trade unions
iii. Public utilities
iv. Government departments and government agencies including government sponsored bodies
4.5 EXEMPTION FROM RELATED PARTY DISCLOSURE IN CERTAIN SITUATIONS
1. Conflict with the reporting enterprise’s duties of confidentiality: Related party disclosure
requirements as laid down in AS 18 do not apply in circumstances where providing such
disclosures would conflict with the reporting enterprise’s duties of confidentiality as specifically
required in terms of a statute or by any regulator or similar competent authority. Put differently,
in cases where a statute or a regulator or a similar competent authority governing an enterprise
prohibit the enterprise to disclose certain information which is required to be disclosed as per
this Standard, disclosure of such information is not warranted. For example, banks are obliged by
law to maintain confidentiality in respect of their customers’ transactions and this Standard
would not override the obligation to preserve the confidentiality of customers’ dealings.
2. Consolidated financial statements: No disclosure is required in consolidated financial
statements in respect of intra-group transactions - since disclosure of transactions between
members of a group is unnecessary in consolidated financial statements. This is mainly because
consolidated financial statements present information about the holding and its subsidiaries as a
single reporting enterprise.
3. State-controlled enterprises: No disclosure is required in the financial statements of state-
controlled enterprises as regards related party relationships with other state-controlled
enterprises and transactions with such enterprises.
4.6 DEFINITIONS OF OTHER TERMS USED IN AS 18
135

Related party transaction:AS-18 defines related party transaction as, “A transfer of resources or
obligations between related parties, regardless of whether or not a price is charged”.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Control: As per AS-18 Control means:
a. Ownership, directly or indirectly, of more than one half of the voting power of an enterprise, or
b. Control of the composition of the board of directors in the case of a company or of the
composition of the corresponding governing body in case of any other enterprise, or
c. A substantial interest in voting power and the power to direct, by statute or agreement, the
financial and/or operating policies of the enterprise.
Also, AS-18 clarifies that for the purpose of AS 18, an enterprise is considered to control the
composition of the board of directors of a company or governing body of an enterprise, if it has
the power, without the consent or concurrence of any other person, to appoint or remove all or
a majority of directors/members of the governing body of that company/enterprise. Put
differently, control to the composition of the Board of directors is determined with reference to
the authority of an enterprise to appoint or remove all or majority of directors of another
enterprise without concurrence of any other person.
Further, an enterprise is deemed to have the power to appoint a director/ member of the
governing body, if any of the following conditions is satisfied:
a. A person cannot be appointed as director/member of the governing body without the
exercise in his favour by that enterprise of such a power as aforesaid or
b. A person’s appointment as director/member of the governing body follows necessarily from
his appointment to a position held by him in that enterprise or
c. The director/member of the governing body is nominated by that enterprise; in case that
enterprise is a company, the director is nominated by that company/subsidiary thereof.
An enterprise is considered to have a substantial interest in another enterprise if that enterprise
owns, directly or indirectly, 20% or more interest in the voting power of the other enterprise.
Similarly, an individual is considered to have a substantial interest in an enterprise, if that
individual owns, directly or indirectly, 20 per cent or more interest in the voting power of the
enterprise.
Associate: AS-18 defines an Associate as an enterprise in which an investing reporting party has
significant influence and which is neither a subsidiary nor a joint venture of that party. Therefore,
an associate should not be a subsidiary neither a joint venture of that investing reporting
enterprise.
And, the term Significant influence is defined by AS-18 as “Participation in the financial and/or
operating policy decisions of an enterprise, but not control of those policies”.
136

Further,AS-18 clarifies that significant influence may be exercised in several ways, for example,
(1) by representation on the board of directors;, (2) participation in the policy making process;
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 (3) material inter-company transactions, (4) interchange of managerial personnel or (5)
dependence on technical information.
Significant influence may be gained by share ownership, statute or agreement. As regards share
ownership, if an investing party holds, directly or indirectly through intermediaries, 20 per cent
or more of the voting power of the enterprise, it is presumed that the investing party has
significant influence, unless it can be clearly demonstrated that this is not the case. Conversely, if
the investing party holds, directly or indirectly through intermediaries, less than 20% of the
voting power of the enterprise, it is presumed that the investing party does not have significant
influence, unless such influence can be clearly demonstrated. A substantial or majority
ownership by another investing party does not necessarily preclude an investing party from
having significant influence.
Key Management Personnel: As per AS-18, Key Management Personnel are those persons who
have the authority and responsibility for planning, directing and controlling the activities of the
reporting enterprise.
For example, in the case of a company, (1) the managing director(s), (2) whole time director(s), (3)
manager and (4) any person in accordance with whose directions or instructions the board of
directors of the company is accustomed to act, are usually considered key management personnel.
AS-18 further provides an explanation that a non-executive director of a company -is not
considered as a key management person under this Standard by virtue of merely his being a
director unless he has the authority and responsibility for planning, directing and controlling the
activities of the reporting enterprise.
The requirements of AS 18 should not be applied in respect of a non-executive director even if
he participates in the financial and/or operating policy decision of the enterprise, unless he falls
in any of the categories of ‘related party relationships’ discussed above.
Relative: As per AS-18, a Relative in relation to an individual, means the spouse, son, daughter,
brother, sister, father and mother who may be expected to influence, or be influenced by, that
individual in his/her dealings with the reporting enterprise.
Joint Venture - AS-18 defines a Joint Venture as a contractual arrangement whereby two or more
parties undertake an economic activity which is subject to joint control.
Joint Control–AS-18 defines a Joint Control as the contractually agreed sharing of power to
govern the financial and operating policies of an economic activity so as to obtain benefits from
it. Accordingly, when two or more parties contractually agree to share power to govern the
137

financial and operating policies of an economic activity, this contractual agreement is termed as
Page

joint control.

CA CS KARTHIK MANIKONDA – 75501 37279

 It is pertinent to note that joint venture does not depend upon voting power of the parties
involved. Rather, it is linked to the ability to exercise joint control over an economic activity.
Holding Company–AS-18 defines Holding Company as a company having one or more
subsidiaries
Subsidiary AS 18 defines a Subsidiary – as a company:
a. in which another company (the holding company) holds, either by itself and/or through one
or more subsidiaries, more than one-half, in nominal value of its equity share capital; or
b. of which another company (the holding company) controls, either by itself and/or through
one or more subsidiaries, the composition of its board of directors.
Fellow Subsidiary–AS-18 clarifies that a company is considered to be a fellow subsidiary of
another company if both are subsidiaries of the same holding company.
(Refer Illustration 8)
4.7 DISCLOSURE REQUIREMENTS UNDER AS-18
At the outset, it is to be noted that AS-18 prescribe related party disclosure requirements.
a. name of the related party and
b. nature of the related party relationship where control exists should be disclosed - irrespective of
whether or not there have been transactions between the related parties.
This is to enable users of financial statements to form a view about the effects of related party
relationships on the enterprise.
If there have been transactions between related parties, during the existence of a related party
relationship, the reporting enterprise should disclose the following:
i. The name of the transacting related party;
ii. A description of the relationship between the parties;
iii. A description of the nature of transactions;
iv. Volume of the transactions either as an amount or as an appropriate proportion;
v. Any other elements of the related party transactions necessary for an understanding of the
financial statements;
vi. The amounts or appropriate proportions of outstanding items pertaining to related parties
at the balance sheet date and provisions for doubtful debts due from such parties at that
date;
vii. Amounts written off or written back in the period in respect of debts due from or to related
138

parties.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Items of a similar nature may be disclosed in aggregate by type of related party except when
separate disclosure is necessary for an understanding of the effects of related party transactions on
the financial statements of the reporting enterprise.
Remuneration paid to key management personnel should be considered as a related party
transaction requiring disclosures. In case non-executive directors on the Board of Directors are not
related parties, remuneration paid to them should not be considered a related party transaction.
4.8 LIST OF RELATED PARTY TRANSACTIONS, TO BE DISCLOSED (WHAT NEEDS TO BE DISCLOSED?)
AS-18 gives following examples of related party transactions, in respect of which disclosures may be
made by a reporting enterprise:
1. Purchases or sales of goods (finished or unfinished)
2. Purchases or sales of fixed assets
3. Rendering or receiving of services
4. Agency arrangements
5. Leasing or hire purchase arrangements
6. Transfer of research and development
7. Licence agreements
8. Finance (including loans and equity contributions in cash or in kind)
9. Guarantees and collaterals
10. Management controls including for deputation of employees.

139
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 ILLUSTRATIONS
Illustration 1
Identify the related parties in the following case as per AS 18:
A Ltd. holds 51% of
B Ltd. B Ltd holds 51% of O Ltd.
Z Ltd holds 49% of O Ltd.
Solution
In relation to Reporting enterprise - A Ltd.
 B Ltd. (subsidiary) is a related party
 O Ltd. (subsidiary) is a related party In relation to Reporting enterprise - B Ltd.
 A Ltd. (holding company) is a related party
 O Ltd. (subsidiary) is a related party In relation to Reporting enterprise - O Ltd.
 A Ltd. (ultimate holding company) is a related party
 B Ltd. (holding company) is a related party
 Z Ltd. (investor/ investing party) is a related party (O Ltd being Associate of Z Ltd)
Reporting enterprise - Z Ltd.
 O Ltd. (Associate) is a related party

Illustration 2
Consider a scenario wherein:
 A Ltd. has 60% voting right in B Ltd.
 A Ltd. also has 22% voting right in C Ltd.; and
 B Ltd. has 30% voting right in C Ltd.
Whether C Ltd. is to be treated under AS-18 as a party related to A Ltd.?
Solution
Yes – in relation to A Ltd. (the reporting enterprise), C Ltd. is a related party under AS-18. This is
because A Ltd. indirectly controls C Ltd. In this case, A Ltd. (together with its subsidiary B Ltd.)
controls more than one half of the voting rights of C Ltd.
Illustration 3
Consider a scenario wherein:
140

 X Ltd. holds 28% voting right in Y Ltd. (and hence Y Ltd. is an associate of X Ltd.)
 Y Ltd. holds 32% voting right in Z Ltd. (and hence Z Ltd. is an associate of Y Ltd.)
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 X Ltd.

28 % Voting

Y Ltd.

32 % Voting

Z Ltd

In the above case, since Y Ltd. is an associate of X Ltd. – Y Ltd. is a related party to X Ltd.
Likewise, since Z Ltd. is an associate of Y Ltd. - Z Ltd. is a related party to Y Ltd.
The question is: Whether Z Ltd. is to be treated under AS-18 as a party related to X Ltd.?
Solution
No – in relation to X Ltd. (the reporting enterprise), Z Ltd. is a not a related party.
This is because as per the requirements of AS-18, ‘associate of an associate’ is not a related party.
Illustration 4
Consider the following organization structure related to P Ltd.

P Ltd.
80% Shares

Q Ltd.

60% Shares 80% Shares

R Ltd. S Ltd.

65% Shares 70% Shares

X Ltd. Y Ltd.

Given the above structure: Identify related party relationships, if R Ltd. is the reporting enterprise
Solution
The following table identifies the related party relationships for R Ltd. (being the reporting
enterprise):
Party Relationship under AS-18
141

Name
Page

P Ltd.  P Ltd. has indirect control on R Ltd. (through Q Ltd.)

CA CS KARTHIK MANIKONDA – 75501 37279

  Hence R Ltd. is related to P Ltd.
Q Ltd.  Q Ltd. has direct control of R Ltd.
 Hence R Ltd. is related to Q Ltd.
S Ltd.  R Ltd. and S Ltd. are under common control of Q Ltd.
 Hence R Ltd. is related to S Ltd.
X Ltd.  X Ltd. is controlled by R Ltd.
 Hence R Ltd. is related to X Ltd.
Y Ltd.  Y Ltd. is the sub-subsidiary of Q Ltd.
 Both R Ltd. and Y Ltd. are under common control of Q Ltd.
 Hence R Ltd. is related to Y Ltd.

Illustration 5
Consider the following organization structure related to UH Ltd. (the ultimate parent company of a
Group), wherein UH Ltd. has made the following investments:
 Investment in two of the wholly owned subsidiaries, viz. Sub 1 and Sub 2
 Investment in JC 1, in which UH Ltd. has a joint control
 20% investment in Ass 1 (and hence, Ass 1 is an associate of UH Ltd.)

UH Ltd
100% 100% Joint Control 28% Associate

Sub 1 Sub 2 JC 1 Ass 1

Given the above structure: Identify related party relationships for each of the above entities under
AS-18
Solution
The following table identifies the related party relationships for each of the entities in the Group:
Reporting enterprise Related Party as per AS-18
UH Ltd. All the four entities (viz. Sub 1, Sub 2, JC 1 and Ass 1)
Sub 1 Only two of the entities in the Group (viz. UH Ltd. and Sub 2)
Sub 2 Only two of the entities in the Group (viz. UH Ltd. and Sub 1)
142

JC 1 Only UH Ltd.
Page

Ass 1 Only UH Ltd.

CA CS KARTHIK MANIKONDA – 75501 37279

Illustration 6
Consider a scenario wherein:
 Mr. Robert holds 70% shares and voting rights in P Ltd

70% Shares
Mr. Robert P Ltd.

and, has control

Are they related?

Mrs. Andy

(Spouse of Mr. Robert)

Determine: Whether Andy (spouse of Mr. Robert) is a related party to P Ltd. under AS-18?
Solution
Yes – Andy is a related party to P Ltd., in view of the requirements of AS-18.
It may be recalled that under AS-18 ‘relatives of individuals owning an interest in the voting power of
the reporting enterprise that gives them control or significant influence over the enterprise’ are
considered as related parties.

Illustration 7
Consider a scenario wherein:
 Mr. Robert is a Managing Director of P Ltd.
 Andy (spouse of Robert) received a remuneration of Rs 5 lacs from P Ltd. – for the services she
rendered to P Ltd. for the period 1st April 20X1 through 30th June 20X1
 Andy left the services of P Ltd. on 1st July 20X1
 Consider 31st March 20X2 as the year-end date for P Ltd.

MD
Mr. Robert P Ltd.

Received remuneration
of Rs.5 lacs

Mrs. Andy
(Spouse of Mr. Robert)

Year - end 31st

1st April 20X1 30th June 20X1
March 20X2
143
Page

Mrs. Andy left on 1st July 20X1

CA CS KARTHIK MANIKONDA – 75501 37279

Whether Andy is to be identified as related party at the year-end date (31st March 20X2) for the
purposes of AS-18?
Solution
Yes – This is because as per AS-18, parties are considered to be related if at any time during the
reporting period one party has the ability to control the other party or exercise significant influence
over the other party in making financial and/or operating decisions.
Hence Andy (being the spouse and relative of the KMP of P Ltd.) needs to be reported as related
party at the year-end date (i.e. 31st March 20X2). This is because the remuneration Andy received
from P Ltd. (for the period April 20X1 to 30 June 20X1) falls within the reporting year April 20X1 to
March 20X2.
Illustration 8
Consider a scenario wherein:
 UK Bank holds 23% equity shares with voting rights in P Ltd.
 The bank has provided a loan of Rs. 20 million to P Ltd. at market interest rate
 As per the terms and conditions of the loan agreement, the bank has appointed one person as
its nominee to the board of directors of P Ltd. and any major transaction to be entered into by
P Ltd. will require the consent of the Bank

UK
Bank

Holds 23% Shares with voting rights P

BANK
Provided loan of Rs.20 Million @ market Ltd.
rates
Hence has power to nominate 1 member
to BoDs

Determine: Whether under AS-18 - UK Bank is a related party to P Ltd. (the reporting enterprise)?
Solution
In the instant case, the UK Bank holds 23% shares with voting rights in P Ltd. and hence is deemed to
exercise significant influence over P Ltd.
The bank is also a provider of finance to P Ltd. (the reporting enterprise) and as per AS-18, parties
like providers of finance are deemed not to be considered as a related party in the course of normal
dealings with an enterprise by virtue only of those dealings. However, this exemption will not be
144

available to UK Bank in this case – since it exercises significant influence over P Ltd. (by virtue of
Page

holding 23% shares with voting rights in P Ltd.)

CA CS KARTHIK MANIKONDA – 75501 37279

Accordingly, for P Ltd. (the reporting enterprise), the UK Bank is a related party and it will be
required to disclose the transactions with UK Bank in its financial statements.
Illustration 9
Consider a scenario wherein:
 P Ltd. hold 22% shares and voting rights in Q Ltd. (and hence Q Ltd. is an associate of P Ltd.)
 On 1st April 20X1, P Ltd. sold certain goods to Q Ltd. amounting to Rs. 5 lacs
 On 30th June 20X1, P Ltd. sold its entire 22% stake in Q Ltd. (and hence the related party
relationship ceased to exist after 30th June 20X1)
 However, P Ltd. continued supply goods to Q Ltd. subsequent to 30th June 20X1 (just like any
other customer) and sold goods worth Rs. 15 lacs during 9-month period ended 31st March
20X2
 Consider 31st March 20X2 as the year-end date for P Ltd.

P Ltd.

22% shares and Goods sold on 1st April 20X1

voting rights amounting to Rs.5 lacs

Q Ltd.

Yearend
1st April 20X1 30th June 20X1 31st March 20X2

Goods sold Rs.5 Goods worth Rs.15 lacs sold

lacs
Sold entire 22% shareholding

Determine whether the transaction for the entire year (ending on 31st March 20X2) is required to
be disclosed under AS-18 as related party transaction.
Solution
No – This is because as per AS-18, the disclosure requirements under the Standard relate only to the
period during related party relationship existed.
Accordingly, only transactions between P Ltd and Q Ltd till 30th June 20X1 (being sale of goods
145

worth Rs.5 lacs) are required to be reported / disclosed under AS-18.

Transactions entered into after 30th June 20X1 are NOT required to be disclosed under AS-18.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Illustration 10
Narmada Ltd. sold goods for Rs.90 lakhs to Ganga Ltd. during financial year ended 31-3-20X1. The
Managing Director of Narmada Ltd. owns 100% shares of Ganga Ltd. The sales were made to Ganga
Ltd. at normal selling prices by Narmada Ltd. The Chief accountant of Narmada Ltd contends that
these sales need not require a different treatment from the other sales made by the company and
hence no disclosure is necessary as per the accounting standard. Is the Chief Accountant correct?
Solution
As per AS 18 ‘Related Party Disclosures’, Enterprises over which a key management personnel is able
to exercise significant influence are related parties. This includes enterprises owned by directors or
major shareholders of the reporting enterprise and enterprise that have a member of key
management in common with the reporting enterprise.
In the given case, Narmada Ltd. and Ganga Ltd are related parties and hence disclosure of
transaction between them is required irrespective of whether the transaction was done at normal
selling price.
Hence the contention of Chief Accountant of Narmada Ltd is wrong.

146
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. According to AS-18 Related Party Disclosures, which ONE of the following is not a related party
of Skyline Limited?
a. A shareholder of Skyline Limited owning 30% of the ordinary share capital
b. An entity providing banking facilities to Skyline Limited in the normal course of business
c. An associate of Skyline Limited
d. Key management personnel of Skyline Limited

2. Are the following statements in relation to related parties true or false, according to AS-18
Related Party Disclosures?
A. A party is related to another entity that it is jointly controlled by.
B. A party is related to another entity that it controls.
Statement (A) Statement (B)
a. False False
b. False True
c. True False
d. True True

3. Which of the following is not a related party as envisaged by AS-18 Related Party Disclosures?
a. A director of the entity
b. The parent company of the entity
c. A shareholder of the entity that holds 1% stake in the entity
d. The spouse of the managing director of the entity

4. According to AS-18 Related Party Disclosures, related party transaction is a transfer of

resources or obligations between related parties – provided a price is charged for such transfer.
a. True
b. False

5. According to AS-18 Related Party Disclosures, parties are considered to be related, if and only
if at the end of the reporting period - one party has the ability to control the other party or
exercise significant influence over the other party in making financial and/or operating
147

decisions.
a. True
Page

b. False

CA CS KARTHIK MANIKONDA – 75501 37279

ANSWERS/HINTS
MCQs
1. b. An entity providing banking facilities to Skyline Limited in the normal course of
business
2. d. True
3. c. A shareholder of the entity that holds 1% stake in the entity
4. b. False
5. b. False

THEORETICAL QUESTIONS
Q.NO.1. Who are related parties under AS 18? What are the related party disclosure
requirements?
ANSWER
Parties are considered to be related if at any time during the reporting period one party has the
ability to control the other party or exercise significant influence over the other party in making
financial and/or operating decisions.
If there have been transactions between related parties, during the existence of a related party
relationship, the reporting enterprise should disclose the following:
i. The name of the transacting related party;
ii. A description of the relationship between the parties;
iii. A description of the nature of transactions;
iv. Volume of the transactions either as an amount or as an appropriate proportion;
v. Any other elements of the related party transactions necessary for an understanding of the
financial statements;
vi. The amounts or appropriate proportions of outstanding items pertaining to related parties at the
balance sheet date and provisions for doubtful debts due from such parties at that date;
vii. Amounts written off or written back in the period in respect of debts due from or to related
parties.

Q.NO.2. ABC Limited is in the business of manufacturing textiles. It has certain commercial
contracts with its customers and those customer contracts carry various clauses, imposing
148

restriction on ABC Limited for disclosure of certain information. Accordingly, the company doesn’t
intend to provide related party disclosure under AS-18 in its ensuing financial statements. Is this
Page

correct?

CA CS KARTHIK MANIKONDA – 75501 37279

ANSWER
As per AS-18 stipulate that related party disclosure requirements under AS-18 do not apply in
circumstances, where providing such disclosures would conflict with the reporting enterprise's
duties of confidentiality, as specifically required in terms of a statute or by any regulator or similar
competent authority.
In case, where (1) a statute or (2) a regulator or (3) a similar competent authority governing an
enterprise prohibit the enterprise to disclose certain information, which is required to be disclosed
as per AS 18, disclosure of such information is not warranted. For example, banks are obliged by law
to maintain confidentiality in respect of their customers' transactions and AS-18 would not override
the obligation to preserve the confidentiality of customers' dealings.
However, this exemption is not available in respect of confidentiality provisions in a commercial
contract between two enterprises - where confidentiality is not specifically required in terms of (1) a
statute or (2) by any regulator or (3) similar competent authority.
Therefore, in the given case AS-18 related party disclosures would have to be made by ABC Limited
in its ensuing financial statements.

Q.NO.3. Should the related parties be identified as at the reporting date (i.e. balance sheet
date) for the purposes of AS-18? In disclosing transactions with related parties, are the
transactions of the entire reporting period to be disclosed or only those for the period during
which related party relationship exists?
ANSWER
As per the definition of related parties in AS-18, the existence of a related party relationship should
be identified at all points during the year (and not only at the close of the financial year). However,
AS 18 requires disclosure of transactions with these parties only during the existence of the related
party relationship.
149
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 PRACTICAL QUESTIONS
Q.NO.1. Mr. Raj, a relative of key management personnel, received remuneration of
Rs.2,50,000 for his services in the company for the period from 1.4.20X1 to 30.6.20X1. On
1.7.20X1, he left the service of the company.
Should the relative be identified as at the closing date i.e. on 31.3.20X2 for the purposes of AS 18?
SOLUTION
According to AS 18 on ‘Related Party Disclosures’, parties are considered to be related if at any time
during the reporting period one party has the ability to control the other party or exercise significant
influence over the other party in making financial and/or operating decisions. Hence Mr. Raj, a
relative of key management personnel, should be identified as related party for disclosure in the
financial statements for the year ended 31.3.20X2.
Q.NO.2. X Ltd. sold goods to its associate company during the 1st quarter ended 30.6.20X1.
After that, the related party relationship ceased to exist. However, goods were supplied as were
supplied to any other ordinary customer. Decide whether transactions of the entire year have to
be disclosed as related party transaction .
SOLUTION
As per AS 18, transactions of X Ltd. with its associate company for the first quarter ending
30.06.20X1 only are required to be disclosed as related party transactions. The transactions for the
period in which related party relationship did not exist would not be reported.
Q.NO.3. You are required to identify the related parties in the following cases as per AS 18:
M Ltd. holds 61 % shares of S Ltd.
S Ltd. holds 51 % shares of F Ltd.
C Ltd. holds 49% shares of F Ltd.
(Give your answer - Reporting Entity wise for M Ltd., S Ltd., C Ltd. and F Ltd.)
SOLUTION
Reporting Entity Related Party
M Ltd. S Ltd. (subsidiary)
F Ltd.(subsidiary)
S Ltd. M Ltd. (holding company)
F Ltd. (subsidiary)
F Ltd. M Ltd. (ultimate holding company)
S Ltd. (holding company)
C Ltd. (investor/ investing party)
150

C Ltd. F Ltd. (associate)

Page

CA CS KARTHIK MANIKONDA – 75501 37279

 UNIT 5: ACCOUNTING STANDARD 20: EARNINGS
PER SHARE
LEARNING OUTCOMES
After studying this unit, you will be able to comprehend the following:
 Basic Earnings Per Share
 Issues related to Numerator – Earnings
 Issues related to Denominator – Weighted average number of shares
 Diluted Earnings Per Share
 Issues related to Numerator – Earnings
 Issues related to Denominator – Weighted average number of shares
 Dilutive Potential Equity Shares
 Restatement of Earnings per share
 Disclosures
5.1 INTRODUCTION
The objective of AS 20 is to describe principles for determination (i.e. computation) and presentation
(i.e. presentation in the Statement of Profit and Loss) of earnings per share which will improve
comparison of performance among different enterprises for the same period and among different
accounting periods for the same enterprise.

Computation Presentation Results in

Where -In the Inter firm

i.e Determination
Income statement comparison

Of - Basic & On the Face of Intra Firm

Diluted EPS the P&L A/C Comparision

Earnings per share (EPS) is a financial ratio indicating the amount of profit or loss for the period
attributable to each equity share and AS 20 gives computational methodology for determination and
151

presentation of basic and diluted earnings per share.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

This Accounting Standard is mandatory for all companies. However, disclosure of diluted earnings
per share (both including and excluding extraordinary items) is not mandatory for SMCs. Such
companies are however encouraged to make these disclosures.
In consolidated financial statements, the information required by AS 20 should be presented on the
basis of consolidated information.
5.2 DEFINITION OF THE TERMS USED IN AS 20
An equity share is a share other than a preference share.
A preference share is a share carrying preferential rights to dividends and repayment of capital.
A financial instrument is any contract that gives rise to both a financial asset of one enterprise and a
financial liability or equity shares of another enterprise.
A financial asset is any asset that is
a. Cash;
b. A contractual right to receive cash or another financial asset from another enterprise;
c. A contractual right to exchange financial instruments with another enterprise under conditions
that are potentially favourable; or
d. An equity share of another enterprise.
A financial liability is any liability that is a contractual obligation to deliver cash or another financial
asset to another enterprise or to exchange financial instruments with another enterprise under
conditions that are potentially unfavourable.
A potential equity share is a financial instrument or other contract that entitles, or may entitle, its
holder to equity shares.
Examples of potential equity shares are:
a. Debt instruments or preference shares, that are convertible into equity shares;
b. Share warrants;
c. Options including employee stock option plans under which employees of an enterprise are
entitled to receive equity shares as part of their remuneration and other similar plans; and
d. Shares which would be issued upon the satisfaction of certain conditions resulting from
contractual arrangements (contingently issuable shares), such as the acquisition of a business or
other assets, or shares issuable under a loan contract upon default of payment of principal or
interest, if the contract so provides.
Note:
152

A partly paid-up share where the holder is not entitled to dividends is treated as a potential equity
share for the purposes of computing Diluted EPS.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Share warrants or options are financial instruments that give the holder the right to acquire equity
shares.
Fair value is the amount for which an asset could be exchanged, or a liability settled, between
knowledgeable, willing parties in an arm’s length transaction.
Basic Earnings Per Share
Basic earnings per share is calculated as
Net profit (loss)attributab le to equity shareholde rs
Weighted average number of equity shares outstandin g during the period
5.3 EARNINGS-BASIC
All items of income and expense which are recognised in a period, including tax expense and
extraordinary items, are included in the determination of the net profit or loss for the period unless
AS 5 requires or permits otherwise.
The amount of preference dividends and any attributable tax thereto for the period is deducted from
the net profit for the period (or added to the net loss for the period) in order to calculate the net
profit or loss for the period attributable to equity shareholders.
The amount of preference dividends for the period that is deducted from the net profit for the
period is:
a. The amount of any preference dividends on non-cumulative preference shares provided for in
respect of the period; and
b. The full amount of the required preference dividends for cumulative preference shares for the
period, whether or not the dividends have been provided for. The amount of preference
dividends for the period does not include the amount of any preference dividends for cumulative
preference shares paid or declared during the current period in respect of previous periods.
Note:
If an enterprise has more than one class of equity shares, net profit or loss for the period is
apportioned over the different classes of shares in accordance with their dividend rights.
[In other words, there will be more than 1 Basic EPS for such a company; i.e. EPS for each class of
equity shares]
A quick recap of adjustments to be made to the numerator will be as under:
Particulars Adjusted in the numerator of Basic EPS
Tax expense (Current and Deferred Tax) Yes
153

Exceptional items as per AS 5 Yes

Extraordinary items as per AS 5 Yes
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Changes in Accounting estimates as per AS 5 Yes
Changes in Accounting Policy as per AS 5 Yes
Amount of preference dividends and any attributable
tax thereto
a. Non-cumulative preference Yes – only if it has been provided in the
books
b. Cumulative preference shares Yes – irrespective, whether or not the
dividends have been provided for in the
books

5.4 PER SHARE- BASIC

The number of shares used in the denominator for basic EPS should be the weighted average
number of equity shares outstanding during the period.
The weighted average number of equity shares outstanding during the period is the number of
shares outstanding at the beginning of the period, adjusted by the number of equity shares bought
back or issued during the period multiplied by a time-weighting factor.
The time-weighting factor is:
Numbers of days the shares are outstandin g
Number of days in the period
Although the Standard defines the time-weighting factor as being determined on a daily basis, it
acknowledges that a reasonable approximation of the weighted average is adequate in many
circumstances.
(Refer Illustration 1)
5.5 SHARES ISSUED IN A SCHEME OF AMALGAMATION
1. Equity shares issued as part of the consideration in an amalgamation in the nature of purchase
are included in the weighted average number of shares as of the date of the acquisition because
the transferee incorporates the results of the operations of the transferor into its statement of
profit and loss as from the date of acquisition.
2. Equity shares issued as part of the consideration in an amalgamation in the nature of merger
are included in the calculation of the weighted average number of shares from the beginning of
the reporting period because the financial statements of the combined enterprise for the
154

reporting period are prepared as if the combined entity had existed from the beginning of the
reporting period. Therefore, the number of equity shares used for the calculation of basic
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 earnings per share in an amalgamation in the nature of merger is the aggregate of the weighted
average number of shares of the combined enterprises, adjusted to equivalent shares of the
enterprise whose shares are outstanding after the amalgamation.
Partly paid equity shares are treated as a fraction of an equity share to the extent that they were
entitled to participate in dividends relative to a fully paid equity share during the reporting period.
(Refer Illustration 2)
Where an enterprise has equity shares of different nominal values but with the same dividend
rights, the number of equity shares is calculated by converting all such equity shares into equivalent
number of shares of the same nominal value.
Contingently Issuable Shares
Equity shares which are issuable upon the satisfaction of certain conditions resulting from
contractual arrangements (contingently issuable shares) are considered outstanding, and included in
the computation of basic earnings per share from the date when all necessary conditions under the
contract have been satisfied.
Bonus Issue, Share split and Right issue
Equity shares may be issued, or the number of shares outstanding may be reduced, without a
corresponding change in resources. Examples include:
a. A bonus issue;
b. A bonus element in any other issue, for example a bonus element in a rights issue to existing
shareholders;
c. A share split; and
d. A reverse share split (consolidation of shares).
In case of a bonus issue or a share split, equity shares are issued to existing shareholders for no
additional consideration. Therefore, the number of equity shares outstanding is increased without
an increase in resources. The number of equity shares outstanding before the event is adjusted for
the proportionate change in the number of equity shares outstanding as if the event had occurred at
the beginning of the earliest period reported means along with the impact to current year
adjustment, it will also impact the calculation of EPS of last year retrospectively.
For example, upon a two-for-one bonus issue, the number of shares outstanding prior to the issue is
multiplied by a factor of three to obtain the new total number of shares, or by a factor of two to
obtain the number of additional shares.
155

(Refer Illustration 3)
Page

CA CS KARTHIK MANIKONDA – 75501 37279

The issue of equity shares at the time of exercise or conversion of potential equity shares will not
usually give rise to a bonus element, since the potential equity shares will usually have been issued
for full value, resulting in a proportionate change in the resources available to the enterprise. In a
rights issue, on the other hand, the exercise price is often less than the fair value of the shares.
Therefore, a rights issue usually includes a bonus element. [Thus, it may be noted that if a company
makes a right issue at fair value itself, then there will be no bonus element in the right issue]. The
number of equity shares to be used in calculating basic earnings per share for all periods prior to the
rights issue is the number of equity shares outstanding prior to the issue, multiplied by the following
adjustment factor:
Fair value per share immediatel y prior to the exercise of rights
Theoretica l ex - rights fair value per share
The theoretical ex-rights fair value per share is calculated by adding the aggregate fair value of the
shares immediately prior to the exercise of the rights to the proceeds from the exercise of the rights,
and dividing by the number of shares outstanding after the exercise of the rights.
(Refer Illustration 4)
5.6 DILUTED EARNINGS PER SHARE
In calculating diluted earnings per share, effect is given to all dilutive potential equity shares that
were outstanding during the period, that is:
a. The net profit for the period attributable to equity shares is:
i. Increased by the amount of dividends recognised in the period in respect of the dilutive
potential equity shares as adjusted for any attributable change in tax expense for the period;
ii. Increased by the amount of interest recognised in the period in respect of the dilutive
potential equity shares as adjusted for any attributable change in tax expense for the period;
and
iii. Adjusted for the after-tax amount of any other changes in expenses or income that would
result from the conversion of the dilutive potential equity shares.
b. The weighted average number of equity shares outstanding during the period is increased by the
weighted average number of additional equity shares which would have been outstanding
assuming the conversion of all dilutive potential equity shares.
For the purpose of AS 20, share application money pending allotment or any advance share
application money as at the balance sheet date, which is not statutorily required to be kept
156

separately and is being utilised in the business of the enterprise, is treated in the same manner as
dilutive potential equity shares for the purpose of calculation of diluted earnings per share.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Note: As mentioned earlier, a partly paid-up share where the holder is not entitled to dividends is
treated as a potential equity share for the purposes of computing Diluted EPS.

5.7 EARNINGS-DILUTED
For the purpose of calculating diluted earnings per share, the amount of net profit or loss for the
period attributable to equity shareholders, should be adjusted by the following, after taking into
account any attributable change in tax expense for the period:
a. any dividends on dilutive potential equity shares which have been deducted in arriving at the net
profit attributable to equity shareholders;
b. interest recognised in the period for the dilutive potential equity shares; and
c. any other changes in expenses or income that would result from the conversion of the dilutive
potential equity shares.
After the potential equity shares are converted into equity shares, the dividends, interest and other
expenses or income associated with those potential equity shares will no longer be incurred (or
earned). Instead, the new equity shares will be entitled to participate in the net profit attributable to
equity shareholders. Therefore, the net profit for the period attributable to equity shareholders
calculated in Basic Earnings Per Share is increased by the amount of dividends, interest and other
expenses that will be saved, and reduced by the amount of income that will cease to accrue, on the
conversion of the dilutive potential equity shares into equity shares. The amounts of dividends,
interest and other expenses or income are adjusted for any attributable taxes.
(Refer Illustration 5)
5.8 PER SHARE- DILUTED
For the purpose of calculating diluted earnings per share, the number of equity shares should be the
aggregate of the weighted average number of equity shares, and the weighted average number of
equity shares which would be issued on the conversion of all the dilutive potential equity shares into
equity shares. Dilutive potential equity shares should be deemed to have been converted into equity
shares at the beginning of the period or, if issued later, the date of the issue of the potential equity
shares.
The number of equity shares which would be issued on the conversion of dilutive potential equity
shares is determined from the terms of the potential equity shares. The computation assumes the
most advantageous conversion rate or exercise price from the standpoint of the holder of the
157

potential equity shares.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

Equity shares which are issuable upon the satisfaction of certain conditions resulting from
contractual arrangements (contingently issuable shares) are considered outstanding and included in
the computation of both the basic earnings per share and diluted earnings per share from the date
when the conditions under a contract are met. If the conditions have not been met, for computing
the diluted earnings per share, contingently issuable shares are included as of the beginning of the
period (or as of the date of the contingent share agreement, if later). The number of contingently
issuable shares included in this case in computing the diluted earnings per share is based on the
number of shares that would be issuable if the end of the reporting period was the end of the
contingency period. Restatement is not permitted if the conditions are not met when the
contingency period actually expires subsequent to the end of the reporting period. The provisions of
this paragraph apply equally to potential equity shares that are issuable upon the satisfaction of
certain conditions (contingently issuable potential equity shares).
Potential equity shares are weighted for the period they were outstanding. Potential equity shares
that were cancelled or allowed to lapse during the reporting period are included in the computation
of diluted earnings per share only for the portion of the period during which they were outstanding.
Potential equity shares that have been converted into equity shares during the reporting period are
included in the calculation of diluted earnings per share from the beginning of the period to the date
of conversion; from the date of conversion, the resulting equity shares are included in computing
both basic and diluted earnings per share.
A quick recap of the timing factor when these potential equity shares will be considered as a part of
the denominator for weighted average computations.
Particulars From which date Till which date
Potential equity shares which were issued Beginning of the year End of the year
last year and not yet converted into equity
shares in current year
Potential equity shares which were issued Beginning of the year End of the year (Till date of
last year and have been converted into conversion as a potential
equity shares in current year equity share and after
conversion both as a part of
Basic and Diluted EPS)
Potential equity shares which were issued Date of issue End of the year
158

in the current year and not yet converted

into equity shares in current year
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Potential equity shares which were issued Beginning of the year Till the date of cancellation
last year and have been cancelled or have or when they lapse
lapsed in current year

Diluted EPS in case of share options

For the purpose of calculating diluted earnings per share, an enterprise should assume the exercise
of dilutive options and other dilutive potential equity shares of the enterprise. The assumed
proceeds from these issues should be considered to have been received from the issue of shares at
fair value. The difference between the number of shares issuable and the number of shares that
would have been issued at fair value should be treated as an issue of equity shares for no
consideration.
Options and other share purchase arrangements are dilutive when they would result in the issue of
equity shares for less than fair value. The amount of the dilution is fair value less the issue price.
Therefore, in order to calculate diluted earnings per share, each such arrangement is treated as
consisting of:
a. A contract to issue a certain number of equity shares at their average fair value during the
period. The shares to be so issued are fairly priced and are assumed to be neither dilutive nor
anti-dilutive. They are ignored in the computation of diluted earnings per share; and
b. A contract to issue the remaining equity shares for no consideration. Such equity shares generate
no proceeds and have no effect on the net profit attributable to equity shares outstanding.
Therefore, such shares are dilutive and are added to the number of equity shares outstanding in
the computation of diluted earnings per share.
(Refer Illustration 6)
Note: The earnings have not been increased as the total number of shares has been increased
only by the number of shares (25,000) deemed for the purpose of the computation to have been
issued for no consideration.

5.9 DILUTIVE POTENTIAL EQUITY SHARES

Potential equity shares are anti-dilutive when their conversion to equity shares would increase
earnings per share from continuing ordinary activities or decrease loss per share from continuing
ordinary activities. The effects of anti-dilutive potential equity shares are ignored in calculating
diluted earnings per share.
159

Thus, it is important to note that the ‘control factor’ is the profit from continuing ordinary activities.
Page

In simple words, we can conclude as under:

CA CS KARTHIK MANIKONDA – 75501 37279

 Particulars Remarks Is it to be taken as a part
of Diluted EPS or not?
Conversion to equity shares would decrease earnings Dilutive Yes
per share from continuing ordinary activities.
Conversion to equity shares would increase earnings Anti-dilutive No
per share from continuing ordinary activities.
Conversion to equity shares would increase loss per Dilutive Yes
share from continuing ordinary activities.
Conversion to equity shares would decrease loss per Anti-dilutive No
share from continuing ordinary activities.
(Refer Illustration 7)
In case there are more than 1 potential equity shares:
In considering whether potential equity shares are dilutive or anti-dilutive, each issue or series of
potential equity shares is considered separately rather than in aggregate. The sequence in which
potential equity shares are considered may affect whether or not they are dilutive. Therefore, in
order to maximise the dilution of basic earnings per share, each issue or series of potential equity
shares is considered in sequence from the most dilutive to the least dilutive. For the purpose of
determining the sequence from most dilutive to least dilutive potential equity shares, the earnings
per incremental potential equity share is calculated. Where the earnings per incremental share is the
least, the potential equity share is considered most dilutive and vice-versa.
5.10 RESTATEMENT
If the number of equity or potential equity shares outstanding increases as a result of a bonus issue
or share split or decreases as a result of a reverse share split (consolidation of shares), the
calculation of basic and diluted earnings per share should be adjusted for all the periods presented.
If these changes occur after the balance sheet date but before the date on which the financial
statements are approved by the board of directors, the per share calculations for those financial
statements and any prior period financial statements presented should be based on the new
number of shares. When per share calculations reflect such changes in the number of shares, that
fact should be disclosed.
5.11 PRESENTATION
An enterprise should present basic and diluted earnings per share on the face of the statement of
profit and loss for each class of equity shares that has a different right to share in the net profit for
160

the period. An enterprise should present basic and diluted earnings per share with equal
Page

prominence for all periods presented.

CA CS KARTHIK MANIKONDA – 75501 37279

AS 20 requires an enterprise to present basic and diluted earnings per share, even if the amounts
disclosed are negative (a loss per share).
5.12 DISCLOSURE
An enterprise should disclose the following:
a. Where the statement of profit and loss includes extraordinary items (as defined is AS 5), basic
and diluted EPS computed on the basis of earnings excluding extraordinary items (net of tax
expense);
b. The amounts used as the numerators in calculating basic and diluted earnings per share, and a
reconciliation of those amounts to the net profit or loss for the period;
c. The weighted average number of equity shares used as the denominator in calculating basic and
diluted earnings per share, and a reconciliation of these denominators to each other; and
d. The nominal value of shares along with the earnings per share figures.
If an enterprise discloses, in addition to basic and diluted earnings per share, per share amounts
using a reported component of net profit other than net profit or loss for the period attributable to
equity shareholders, such amounts should be calculated using the weighted average number of
equity shares determined in accordance with AS 20. If a component of net profit is used which is not
reported as a line item in the statement of profit and loss, a reconciliation should be provided
between the component used and a line item which is reported in the statement of profit and loss.
Basic and diluted per share amounts should be disclosed with equal prominence.

161
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 ILLUSTRATIONS
Illustration 1
Date Particulars Balance
1st January Balance at beginning of year 1,800 - 1,800
31st May Issue of shares for cash 600 - 2,400
1st November Buy Back of shares - 300 2,100
Calculate Weighted Number of Shares.
Solution
Computation of Weighted Average:
(1,800 x 5/12) + (2,400 x 5/12) + (2,100 x 2/12) = 2,100 shares.
The weighted average number of shares can alternatively be computed as follows:
(1,800 x12/12) + (600 x 7/12) - (300 x 2/12) = 2,100 shares
In most cases, shares are included in the weighted average number of shares from the date the
consideration is receivable, for example:
a. Equity shares issued in exchange for cash are included when cash is receivable;
b. Equity shares issued as a result of the conversion of a debt instrument to equity shares are
included as of the date of conversion;
c. Equity shares issued in lieu of interest or principal on other financial instruments are included as
of the date interest ceases to accrue;
d. Equity shares issued in exchange for the settlement of a liability of the enterprise are included as
of the date the settlement becomes effective;
e. Equity shares issued as consideration for the acquisition of an asset other than cash are included
as of the date on which the acquisition is recognised; and
f. Equity shares issued for the rendering of services to the enterprise are included as the services
are rendered.
In these and other cases, the timing of the inclusion of equity shares is determined by the specific
terms and conditions attaching to their issue. Due consideration should be given to the substance of
any contract associated with the issue.

Illustration 2
Date Particulars Balance
162

1st January Balance at beginning of year 1,800 Rs.10 Rs.10

Page

31st October Issue of shares 600 Rs.10 Rs.5

CA CS KARTHIK MANIKONDA – 75501 37279

Calculate Weighted Number of Shares.
Solution
Assuming that partly paid shares are entitled to participate in the dividend to the extent of amount
paid, number of partly paid equity shares would be taken as 300 for the purpose of calculation of
earnings per share.
Computation of weighted average would be as follows:
(1,800 x 12/12) + (300 x 2/12) = 1,850 shares.

Illustration 3
Net profit for the year 20X1 Rs.18,00,000
Net profit for the year 20X2 Rs.60,00,000
No. of equity shares outstanding until 30th September 20X2 20,00,000
Bonus issue 1st October 20X2 was 2 equity shares for each equity share outstanding at 30th
September, 20X2
Calculate Basic Earnings Per Share.
Solution
No. of Bonus Issue 20,00,000 x 2 = 40,00,000 shares
Rs.60,00,000
Earnings per share for the year 20X2 = Rs.1.00
(20,00,000  40,00,000)
Rs.18,00,000
Adjusted earnings per share for the year 20X1 = Rs.0.30
(20,00,000  40,00,000)
Since the bonus issue is an issue without consideration, the issue is treated as if it had occurred prior
to the beginning of the year 20X1, the earliest period reported.

Illustration 4
Net profit for the year 20X1 Rs.11,00,000
Net profit for the year 20X2 Rs.15,00,000
No. of shares outstanding prior to rights issue 5,00,000 shares
Rights issue price Rs.15.00
Last date to exercise rights 1st March 20X2

Rights issue is one new share for each five outstanding (i.e. 1,00,000 new shares) Fair value of one
163

equity share immediately prior to exercise of rights on 1st March 20X2 was Rs.21.00. Compute
Page

Basic Earnings Per Share

CA CS KARTHIK MANIKONDA – 75501 37279

Solution
Fair value of shares immediatel y prior to exercise of rights  Total amount received from exercise
Number of shares outstandin g prior to exercise  Number of shares issuedin the exercise
(Rs.21.00 5,00,000 shares)  (Rs.15.00 1,00,000 Shares)
5,00,000 Shares  1,00,000 Shares
Theoretical ex-rights fair value per share = Rs.20.00
Computation of adjustment factor:
Fair value per share prior to exercise of rights Rs.(21.00)
 1.05
Theoretica l ex - rights value per share Rs.(20.00)
Computation of earnings per share:
EPS for the year 20X1 as originally reported: Rs.11,00,000/5,00,000 shares = Rs.2.20
EPS for the year 20X1 restated for rights issue: Rs.11,00,000/ (5,00,000 shares x 1.05)
= Rs.2.10
EPS for the year 20X2 including effects of rights issue:
(5,00,000 x 1.05 x 2/12) + (6,00,000 x 10/12) = 5,87,500 shares
EPS = 15,00,000/5,87,500 = Rs.2.55

Illustration 5
Net profit for the current year Rs.1,00,00,000
No. of equity shares outstanding 50,00,000
Basic earnings per share Rs.2.00
No. of 12% convertible debentures of Rs.100 each 1,00,000
Each debenture is convertible into 10 equity shares
Interest expense for the current year Rs.12,00,000
Tax relating to interest expense (30%) Rs.3,60,000

Compute Diluted Earnings Per Share.

Solution
Adjusted net profit for the current year (1,00,00,000 + 12,00,000 – 3,60,000) = Rs.1,08,40,000
No. of equity shares resulting from conversion of debentures: 10,00,000 Shares
No. of equity shares used to compute diluted EPS: (50,00,000 + 10,00,000) = 60,00,000
164

Shares Diluted earnings per share: (1,08,40,000/60,00,000) = Rs.1.81

Page

CA CS KARTHIK MANIKONDA – 75501 37279

Illustration 6
Net profit for the year 20X1 Rs.12,00,000
Weighted average number of equity shares outstanding during the year 20X1 5,00,000 shares
Average fair value of one equity share during the year 20X1 Rs.20.00
Weighted average number of shares under option during the year 20X1 1,00,000 shares
Exercise price for shares under option during the year 20X1 Rs.15.00
Compute Basic and Diluted Earnings Per Share.
Solution
Computation of earnings per share
Earnings Shares Earnings/Share
Rs. Rs.
Net profit for the year 20X1 12,00,000
Weighted average no. of shares during year 20X1 5,00,000
Basic earnings per share 2.40
Number of shares under option 1,00,000
Number of shares that would have been issued at
fair value (100,000 x 15.00)/20.00 ________ (75,000)
Diluted earnings per share 12,00,000 5,25,000 2.29

Illustration 7
X Limited, during the year ended March 31, 20X1, has income from continuing ordinary operations
of Rs.2,40,000, a loss from discontinuing operations of Rs. 3,60,000 and accordingly a net loss of
Rs.1,20,000. The Company has 1,000 equity shares and 200 potential equity shares outstanding as
at March 31, 20X1.
You are required to compute Basic and Diluted EPS?
Solution
As per AS 20 “Potential equity shares should be treated as dilutive when, and only when, their
conversion to equity shares would decrease net profit per share from continuing ordinary
operations”.
As income from continuing ordinary operations, Rs. 2,40,000 would be considered and not
Rs.(1,20,000), for ascertaining whether 200 potential equity shares are dilutive or anti-dilutive.
165

Accordingly, 200 potential equity shares would be dilutive potential equity shares since their
inclusion would decrease the net profit per share from continuing ordinary operations from Rs. 240
Page

to Rs.200. Thus, the basic E.P.S would be Rs. (120) and diluted E.P.S. would be Rs. (100).

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. AB Company Ltd. had 1,00,000 shares of common stock outstanding on January 1. Additional
50,000 shares were issued on July 1, and 25,000 shares were reacquired on September 1. The
weighted average number of shares outstanding during the year on Dec. 31 is
a. 1,40,000 shares
b. 1,25,000 shares
c. 1,16,667 shares
d. 1,20,000 shares

2. As per AS 20, potential equity shares should be treated as dilutive when, and only when, their
conversion to equity shares would
a. Decrease net profit per share from continuing ordinary operations.
b. Increase net profit per share from continuing ordinary operations.
c. Make no change in net profit per share from continuing ordinary operations.
d. Decrease net loss per share from continuing ordinary operations.

3. As per AS 20, equity shares which are issuable upon the satisfaction of certain conditions
resulting from contractual arrangements are
a. Dilutive potential equity shares
b. Contingently issuable shares
c. Contractual issued shares
d. Potential equity shares

4. In case potential equity shares have been cancelled during the year, they should be:
a. Ignored for computation of Diluted EPS.
b. Considered from the beginning of the year till the date they are cancelled.
c. The company needs to make an accounting policy and can follow the treatment in (a) or (b)
as it decides.
d. Considered for computation of diluted EPS only if the impact of such potential equity
shares would be material.

5. Partly paid up equity shares are:

166

a. Always considered as a part of Basic EPS.

b. Always considered as a part of Diluted EPS.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 c. Depending upon the entitlement of dividend to the shareholder, it will be considered as a
part of Basic or Diluted EPS as the case may be.
d. Considered as part of Basic/ Diluted EPS depending on the accounting policy of the
company.

ANSWERS/HINTS
1. c. 1,16,667 shares
2. a. Decrease net profit per share from continuing ordinary operations.
3. b. Contingently issuable shares
4. b. Considered from the beginning of the year till the date they are cancelled.
5. c. Depending upon the entitlement of dividend to the shareholder, it will be considered
as a part of Basic or Diluted EPS as the case may be.

THEORETICAL QUESTIONS
Q.NO.1. In the following list of shares issued, for the purpose of calculation of weighted average
number of shares, from which date weight is to be considered:
i. Equity Shares issued in exchange of cash,
ii. Equity Shares issued as a result of conversion of a debt instrument,
iii. Equity Shares issued in exchange for the settlement of a liability of the enterprise,
iv. Equity Shares issued for rendering of services to the enterprise,
v. Equity Shares issued in lieu of interest and/or principal of an other financial instrument,
vi. Equity Shares issued as consideration for the acquisition of an asset other than in cash. Also
define Potential Equity Share.
Also define Potential Equity Share.
ANSWER
The following dates should be considered for consideration of weights for the purpose of calculation
of weighted average number of shares in the given cases:
i. Date of Cash receivable
ii. Date of conversion
iii. Date on which settlement becomes effective
iv. When the services are rendered
v. Date when interest ceases to accrue
167

vi. Date on which the acquisition is recognised.

A Potential Equity Share is a financial instrument or other contract that entitles or may entitle its
Page

holder to equity shares.

CA CS KARTHIK MANIKONDA – 75501 37279

Q.NO.2. Stock options have been granted by AB Limited to its employees and they vest equally
over 5 years, i.e., 20 per cent at the end of each year from the date of grant. The options will vest
only if the employee is still employed with the company at the end of the year. If the employee
leaves the company during the vesting period, the options that have vested can be exercised,
while the others would lapse. Currently, AB Limited includes only the vested options for
calculating Diluted EPS.
ANSWER
As per AS 20 “A potential equity share is a financial instrument or other contract that entitles, or
may entitle, its holder to equity shares”.
Options including employee stock option plans under which employees of an enterprise are entitled
to receive equity shares as part of their remuneration and other similar plans are examples of
potential equity shares. Further, for the purpose of calculating diluted earnings per share, the net
profit or loss for the period attributable to equity shareholders and the weighted average number of
shares outstanding during the period should be adjusted for the effects of all dilutive potential
equity shares.
The current method of calculating Diluted EPS adopted by AB limited is not in accordance with AS
20. The calculation of Diluted EPS should include all potential equity shares, i.e., all the stock options
granted at the balance sheet date, which are dilutive in nature, irrespective of the vesting pattern.
The options that have lapsed during the year should be included for the portion of the period the
same were outstanding, pursuant to the requirement of the standard.

Q.NO.3. Explain why the bonus issue of shares and the shares issue at full market price are
treated differently in the calculation of the basic earnings per share?
ANSWER
In case of a bonus issue, equity shares are issued to existing shareholders for no additional
consideration. Therefore, the number of equity shares outstanding is increased without an increase
in resources. Since the bonus issue is an issue without consideration, the issue is treated as if it had
occurred prior to the beginning of the earliest period reported.
However, the share issued at full market price does not carry any bonus element and usually results
in a proportionate change in the resources available to the enterprise. Therefore, it is taken into
consideration from the time it has been issued i.e. the time- weighting factor is considered based on
the specific shares outstanding as a proportion of the total number of days in the period.
168
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 PRACTICAL QUESTIONS
Q.NO.1. NAT, a listed entity, as on 1st April, 20X1 had the following capital structure:
Particulars Rs.
10,00,000 Equity Shares having face value of Rs.1 each 10,00,000
10,00,000 8% Preference Shares having face value of Rs.10 each 1,00,00,000
During the year 20X1-20X2, the company had profit after tax of Rs. 90,00,000.
On 1st January, 20X2, NAT made a bonus issue of one equity share for every 2 equity shares
outstanding as at 31st December, 20X1.
On 1st January, 20X2, NAT issued 2,00,000 equity shares of Rs. 1 each at their full market price of
Rs. 7.60 per share.
NAT's shares were trading at Rs. 8.05 per share on 31st March, 20X2.
Further it has been provided that the basic earnings per share for the year ended 31st March,
20X1 was previously reported at Rs. 62.30.
You are required to:
i. Calculate the basic earnings per share to be reported in the financial statements of NAT for the
year ended 31st March, 20X2 including the comparative figure, in accordance with AS-20
Earnings Per Share.
ii. Explain why the bonus issue of shares and the shares issue at full market price are treated
differently in the calculation of the basic earnings per share?
SOLUTION
i. Computation of Basic Earnings per share for the year ended 31st March, 20X2:
(Including the comparative figure)
Working Note – I:
Earnings for the year ended 31st March, 20X1:
= EPS x Number of shares outstanding during 20X0-20X1
= Rs.62.30 x 10,00,000 equity shares
= Rs.6,23,00,000
Adjusted/Restated Earnings per share for the year ended 31st March 20X1:
(after taking into consideration bonus issue)
Adjusted/Restated Basic EPS:
= Earnings for the year 20X0-20X1 / (Total outstanding shares +Bonus issue)
169

= Rs.6,23,00,000 / (10,00,000+ 5,00,000)

= Rs.6,23,00,000 / 15,00,000
Page

= Rs.41.53 per share

CA CS KARTHIK MANIKONDA – 75501 37279

 Computation of Basic EPS for the year 20X1-20X2:
Basic EPS = (Total Earnings – Preference Shares Dividend) / (Total shares outstanding at the
beginning + Bonus issue + weighted average of the shares issued in January, 20X2)
= (Rs.90,00,000 – Rs. (1,00,00,000 x 8%)) / (10,00,000 + 5,00,000 + (2,00,000 x 3/12))
= Rs.82,00,000 / 15,50,000 shares
= Rs.5.29 per share

ii. In case of a bonus issue, equity shares are issued to existing shareholders for no additional
consideration. Therefore, the number of equity shares outstanding is increased without an
increase in resources. Since the bonus issue is an issue without consideration, the issue is treated
as if it had occurred prior to the beginning of the year 20X1, the earliest period reported.
However, the share issued at full market price does not carry any bonus element and usually
results in a proportionate change in the resources available to the enterprise. Therefore, it is
taken into consideration from the time it has been issued i.e. the time- weighting factor is
considered based on the specific shares outstanding as a proportion of the total number of days
in the period.

Q.NO.2. X Ltd. supplied the following information. You are required to compute the basic
earnings per share:
(Accounting year 1.1.20X1– 31.12.20X1)
Net Profit : Year 20X1: Rs.20,00,000
Year 20X2: Rs.30,00,000
No. of shares outstanding prior to Right Issue : 10,00,000 shares
Right Issue : One new share for each four
outstanding i.e., 2,50,000 shares.
Right Issue price – Rs.20
Last date of exercise rights–
31.3.20X2.
Fair rate of one Equity share immediately prior to : Rs.25
exercise of rights on 31.3.20X2
170
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 SOLUTION
Computation of Basic Earnings per Share
(as per paragraphs 10 and 26 of AS 20 on Earnings Per Share)
Year 20X1 Year 20X2
Rs. Rs.
EPS for the year 20X1 as originally reported
Net profit of the year attributab le to equity share holders
weighted average number of equity shares outstandin g during the year
= (Rs.20,00,000 / 10,00,000 shares) 2.00
EPS for the year 20X1 restated for rights issue
= [Rs.20,00,000 / (10,00,000 shares  1.04 )] 1.91
(approx.)
EPS for the year 20X2 including effects of rights Issue
Rs.30,00,000
 3  9
 10,00,000 shares  1.04     12,50,000 shares  
 12   12 
2.51
Rs.30,00,000
11,97,500 shares (approx.)

Working Notes:
1. Computation of theoretical ex-rights fair value per share
Fair value of all outstandin g shares immediatel y prior to
exercise of rights  Total amount received from exercise
Number of shares outstandin g prior to exercise 
Number of shares issuedin the excercise
(Rs.25  10,00,000 shares)  (Rs.20  2,50,000 shares) Rs.3,00,00,000
   Rs.24
10,00,000 shares  2,50,000 shares 12,50,000 shares

2. Computation of adjustment factor

Fair value per share prior to exercise of rights

Theoretica l ex - rights value per share
Rs.25
 =1.04(approx.)
Rs.24 (Re fer Working Note 1)
171
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Q.NO.3. On 1 st April, 20X1 a company had 6,00,000 equity shares of Rs.10 each (Rs.5 paid up by
all shareholders). On 1st September, 20X1 the remaining Rs.5 was called up and paid by all
shareholders except one shareholder having 60,000 equity shares. The net profit for the year
ended 31st March, 20X2 was Rs.21,96,000 after considering dividend on preference shares of
Rs.3,40,000.
You are required to compute Basic EPS for the year ended 31st March, 20X2 as per Accounting
Standard 20 "Earnings Per Share".
SOLUTION
Basic Earnings per share (EPS) =
Net profit attributab le to equity shareholde rs

Weighted average number of equity shares outstandin g during the year
21,96,000
  Rs.4.80 pershare
4 ,57,500 shares (asper working note )

Working Note:
Calculation of weighted average number of equity shares
As per AS 20 ‘Earnings Per Share’, partly paid equity shares are treated as a fraction of equity share
to the extent that they were entitled to participate in dividend relative to a fully paid equity share
during the reporting period.
Assuming that the partly paid shares are entitled to participate in the dividend to the extent of
amount paid, weighted average number of shares will be calculated as follows:
Date No. of equity shares Amount paid Weighted average no. of equity
per share shares
Rs. Rs. Rs.
1.4.20X1 6,00,000 5 6,00,000 х 5/10 х 5/12 =
1,25,000
1.9.20X1 5,40,000 10 5,40,000 х 7/12 =
3,15,000
1.9.20X1 60,000 5 60,000 х 5/10 х 7/12 = 17,500
Total weighted average equity shares 4,57,500

Q.NO.4. In case of a bonus issue, equity shares are issued to existing shareholders for no
172

additional consideration. Therefore, the number of equity shares outstanding is increased without
an increase in resources. Since the bonus issue is an issue without consideration, the issue is
Page

treated as if it had occurred prior to the beginning of the earliest period reported.

CA CS KARTHIK MANIKONDA – 75501 37279

However, the share issued at full market price does not carry any bonus element and usually
results in a proportionate change in the resources available to the enterprise. Therefore, it is taken
into consideration from the time it has been issued i.e. the time- weighting factor is considered
based on the specific shares outstanding as a proportion of the total number of days in the period.
SOLUTION
Earnings for the year:
= No. of Shares x Basic EPS
= 30,00,000 shares x Rs.5 per share = Rs.1,50,00,000
Computation of Adjusted Net Profit:
= Earnings for the year + Interest on debentures net of tax
= 1,50,00,000 + (6,00,000 - 1,80,000) = Rs.1,54,20,000
Computation of Adjusted Denominator:
No. of equity shares resulting from conversion of debentures:
= 50,000 x 10 shares = 5,00,000 shares
No. of equity shares for diluted EPS = 30,00,000 + 5,00,000 = 35,00,000 shares
Computation of Diluted EPS:
= Rs.1,54,20,000/35,00,000 shares = Rs.4.4 per share.

173
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 UNIT 6: ACCOUNTING STANDARD 24:
DISCONTINUING OPERATIONS
LEARNING OUTCOMES
After studying this unit, you will be able to comprehend the following:
 Meaning of Discontinuing Operation;
 Definition of Initial Disclosure Event;
 Recognition and Measurement principles;
 Presentation and Disclosures as required under the standard.

6.1 INTRODUCTION
Imagine that a large company selling several products in the market decides to discontinue the sale
of one of its key product as it plans to sell that portion of its business to another entity.
Ideally, this information should be disclosed to primary stakeholders as they would take economic
decisions based on the performance of the remaining portion of the business that is expected to be
continued by the company in future. Therefore, the presentation requirements of such discontinuing
operations becomes relevant and the aspects of AS 24 need to be understood. AS 24 is applicable to
all discontinuing operations.
The objective of AS 24 is to establish principles for reporting information about discontinuing
operations, thereby enhancing the ability of users of financial statements to make projections of an
enterprise's cash flows, earnings-generating capacity, and financial position by segregating
information about discontinuing operations from information about continuing operations.
6.2 DISCONTINUING OPERATION
A discontinuing operation is a component of an enterprise:
a. That the enterprise, pursuant to a single plan, is:
i. Disposing of substantially in its entirety, such as by selling the component in a single
transaction or by demerger or spin-off of ownership of the component to the enterprise's
shareholders; or
ii. sposing of piecemeal, such as by selling off the component's assets and settling its liabilities
individually; or
iii. Terminating through abandonment; and
174

b. That represents a separate major line of business or geographical area of operations.

Page

c. That can be distinguished operationally and for financial reporting purposes.

CA CS KARTHIK MANIKONDA – 75501 37279

Example 1
Co XY runs a famous chain of restaurants. It decides to sell its stake in one of the restaurant. This
restaurant contributes around 5% of total revenue to the entire business. XY does not intend to sell
any other restaurant as part of its strategy.
In the above case, the sale of one restaurant out of the chain does not constitute disposal of
business under a single plan, or a portion that represents a major line of business or geographical
area of operations. Thus, it cannot be regarded as a discontinuing operation.
Example 2
Group MN operates in various industries including Hotels, Airlines and Software through its
subsidiaries. It has decided to sell its Airline business to be able to concentrate on other verticals. As
a result, it has started to sell its aircrafts and paying off the associated liabilities. During the year, it
has sold off 5 aircrafts out of the fleet of 50 aircrafts so far as part of the sale. The Airline business
constitutes 25% of total group revenue.
In the above case, Airline business may be considered as discontinuing operation. This is due to the fact
that the assets are sold off as part of a single plan, and that the business represents a separate major line
of business, and can be distinguished both operationally and for financial reporting purposes.
Separate major line of business or geographical area of operations:
 A reportable business segment or geographical segment as defined in AS 17 ‘Segment Reporting’,
would normally satisfy criteria and it would represent a separate major line of business or
geographical area of operations.
 A part of such a segment may also satisfy criteria and it would represent a separate major line of
business or geographical area of operations
 For an enterprise that operates in a single business or geographical segment which does not
report segment information, a major product or service line may also satisfy the criteria (see
example below)
Example 3 Entity RT operates in a single state and is trading in 3 products – X, Y and Z. Details with
respect to the performance of each of the products are as under:
Particulars X Y Z Total
Sales 1,00,000 14,00,000 20,00,000 35,00,000
Cost of Goods Sold (80,000) (10,80,000) (14,40,000) (26,00,000)
Gross Margin 20,000 3,20,000 5,60,000 9,00,000
175

Operational Expenses (15,000) (1,70,000) (3,60,000) (5,45,000)

Profit before Tax 5,000 1,50,000 2,00,000 3,55,000
Page

CA CS KARTHIK MANIKONDA – 75501 37279

RT has decided to sell the business relating to Product Y to another entity. Since Product Y
constitutes a major product, it may be considered as a discontinuing operations.
Instead of disposing of a component substantially in its entirety, an enterprise may discontinue and
dispose of the component by selling its assets and settling its liabilities piecemeal (individually or in
small groups). For piecemeal disposals, while the overall result may be a net gain or a net loss, the
sale of an individual asset or settlement of an individual liability may have the opposite effect.
Moreover, there is no specific date at which an overall binding sale agreement is entered into.
Rather, the sales of assets and settlements of liabilities may occur over a period of months or
perhaps even longer. Thus, disposal of a component may be in progress at the end of a financial
reporting period. To qualify as a discontinuing operation, the disposal must be pursuant to a single
coordinated plan.
An enterprise may terminate an operation by abandonment without substantial sales of assets. An
abandoned operation would be a discontinuing operation if it satisfies the criteria in the definition.
However, changing the scope of an operation or the manner in which it is conducted is not
abandonment because that operation, although changed, is continuing.
Example 4
GH, a large car manufacturing company, decides to discontinue its manufacturing operations relating
to the diesel cars production. It plans to restructure the business by revamping its existing
operations, and starting new manufacturing process for manufacture and sale of electric vehicles.
In the above example, it needs to be evaluated whether the restructuring is a result of continuing
operations, or termination of existing operations, and accordingly it can be concluded whether it is a
case of discontinuing operations or not.
Examples of activities that do not necessarily satisfy criterion (a) of the definition, but that might do
so in combination with other circumstances, include:
a. Gradual or evolutionary phasing out of a product line or class of service;
b. Discontinuing, even if relatively abruptly, several products within an ongoing line of business;
c. Shifting of some production or marketing activities for a particular line of business from one
location to another; and
d. Closing of a facility to achieve productivity improvements or other cost savings.
An example in relation to consolidated financial statements is selling a subsidiary whose activities
are similar to those of the parent or other subsidiaries.
176

A component can be distinguished operationally and for financial reporting purposes - criterion (c) of
the definition of a discontinuing operation - if all the following conditions are met:
Page

CA CS KARTHIK MANIKONDA – 75501 37279

a. The operating assets and liabilities of the component can be directly attributed to it.
b. Its revenue can be directly attributed to it.
c. At least a majority of its operating expenses can be directly attributed to it. Assets, liabilities,
revenue, and expenses are directly attributable to a component if they would be eliminated
when the component is sold, abandoned or otherwise disposed of. If debt is attributable to a
component, the related interest and other financing costs are similarly attributed to it.
Discontinuing operations are infrequent events, but this does not mean that all infrequent
events are discontinuing operations. The fact that a disposal of a component of an enterprise is
classified as a discontinuing operation under AS 24 does not, in itself, bring into question the
enterprise's ability to continue as a going concern.
6.3 INITIAL DISCLOSURE EVENT
With respect to a discontinuing operation, the initial disclosure event is the occurrence of one of the
following, whichever occurs earlier:
a. The enterprise has entered into a binding sale agreement for substantially all of the assets
attributable to the discontinuing operation; or
b. The enterprise's board of directors or similar governing body has both
i. approved a detailed, formal plan for the discontinuance and
ii. made an announcement of the plan.
A detailed, formal plan for the discontinuance normally includes:
 identification of the major assets to be disposed of;
 the expected method of disposal;
 the period expected to be required for completion of the disposal;
 the principal locations affected;
 the location, function, and approximate number or employees who will be compensated for
terminating their services; and
 the estimated proceeds or salvage to be realised by disposal.
An enterprise’s board of directors or similar governing body is considered to have made the
announcement of a detailed, formal plan for discontinuance, if it has announced the main
features of the plan to those affected by it, such as, lenders, stock exchanges, trade payables,
trade unions, etc. in a sufficiently specific manner so as to make the enterprise demonstrably
committed to the discontinuance.
6.4 RECOGNITION AND MEASUREMENT
177

For recognising and measuring the effect of discontinuing operations, this AS does not provide any
Page

guidelines, but for the purpose the relevant Accounting Standards should be referred.

CA CS KARTHIK MANIKONDA – 75501 37279

6.5 PRESENTATION AND DISCLOSURE
6.5.1 Initial Disclosure
An enterprise should include the following information relating to a discontinuing operation in its
financial statements beginning with the financial statements for the period in which the initial
disclosure event occurs:
a. A description of the discontinuing operation(s);
b. The business or geographical segment(s) in which it is reported as per AS 17;
c. The date and nature of the initial disclosure event;
d. The date or period in which the discontinuance is expected to be completed if known or
determinable;
e. The carrying amounts, as of the balance sheet date, of the total assets to be disposed of and the
total liabilities to be settled;
f. The amounts of revenue and expenses in respect of the ordinary activities attributable to the
discontinuing operation during the current financial reporting period;
g. The amount of pre-tax profit or loss from ordinary activities attributable to the discontinuing
operation during the current financial reporting period, and the income tax expense related
thereto;
h. The amounts of net cash flows attributable to the operating, investing, and financing activities of
the discontinuing operation during the current financial reporting period;
6.5.2 Disclosures Other Than Initial Disclosures Note
All the disclosures above should be presented in the notes to the financial statements except for
amounts pertaining to pre-tax profit/loss of the discontinuing operation and the income tax expense
thereon (second last bullet above) which should be shown on the face of the statement of profit and
loss.
6.5.3 Other disclosures
When an enterprise disposes of assets or settles liabilities attributable to a discontinuing operation
or enters into binding agreements for the sale of such assets or the settlement of such liabilities, it
should include, in its financial statements, the following information when the events occur:
a. For any gain or loss that is recognised on the disposal of assets or settlement of liabilities
attributable to the discontinuing operation, (i) the amount of the pre-tax gain or loss and (ii)
income tax expense relating to the gain or loss and
b. The net selling price or range of prices (which is after deducting expected disposal costs) of those
178

net assets for which the enterprise has entered into one or more binding sale agreements, the
expected timing of receipt of those cash flows and the carrying amount of those net assets on
Page

the balance sheet date.

CA CS KARTHIK MANIKONDA – 75501 37279

6.6 UPDATING THE DISCLOSURES
In addition to these disclosures, an enterprise should include, in its financial statements, for periods
subsequent to the one in which the initial disclosure event occurs, a description of any significant
changes in the amount or timing of cash flows relating to the assets to be disposed or liabilities to be
settled and the events causing those changes.
The disclosures should continue in financial statements for periods up to and including the period in
which the discontinuance is completed. Discontinuance is completed when the plan is substantially
completed or abandoned, though full payments from the buyer(s) may not yet have been received.
If an enterprise abandons or withdraws from a plan that was previously reported as a discontinuing
operation, that fact, reasons therefore and its effect should be disclosed.
6.7 SEPARATE DISCLOSURE FOR EACH DISCONTINUING OPERATION
Any disclosures required by AS 24 should be presented separately for each discontinuing operation.
6.8 PRESENTATION OF THE REQUIRED DISCLOSURES
The above disclosures should be presented in the notes to the financial statements except the
following which should be shown on the face of the statement of profit and loss:
a. The amount of pre-tax profit or loss from ordinary activities attributable to the discontinuing
operation during the current financial reporting period, and the income tax expense related
thereto; and
b. The amount of the pre-tax gain or loss recognised on the disposal of assets or settlement of
liabilities attributable to the discontinuing operation.
6.9 RESTATEMENT OF PRIOR PERIODS
Comparative information for prior periods that is presented in financial statements prepared after
the initial disclosure event should be restated to segregate assets, liabilities, revenue, expenses, and
cash flows of continuing and discontinuing operations in a manner similar to that mentioned above.
6.10 DISCLOSURE IN INTERIM FINANCIAL REPORTS
Disclosures in an interim financial report in respect of a discontinuing operation should be made in
accordance with AS 25, ‘Interim Financial Reporting’, including:
a. Any significant activities or events since the end of the most recent annual reporting period
relating to a discontinuing operation and
b. Any significant changes in the amount or timing of cash flows relating to the assets to be
disposed or liabilities to be settled.
179
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. AB decided to dispose of its Clothing division as part of its long-term strategy.
a. Date of Board approval - 1st March 20X1;
b. Date of formal announcement made to affected parties - 15th March 20X1.
c. Date of Binding Sale agreement – 1st July 20X1;
d. Reporting date – 31st March 20X1

2. The date of initial disclosure event would be:

a. 1st March 20X1
b. 15th March 20X1
c. 31st March 20X1
d. 31st July 20X1

3. To qualify as a component that can be distinguished operationally and for financial reporting
purposes, the condition(s) to be met is (are):
a. The operating assets and liabilities of the component can be directly attributed to it.
b. Its revenue can be directly attributed to it.
c. At least a majority of its operating expenses can be directly attributed to it.
d. All of the above

4. Identify which of the following statements is incorrect?

a. A discontinuing operation is a component of an enterprise that represents a separate
major line of business or geographical area of operations.
b. A discontinuing operation is a component of an enterprise that can be distinguished
operationally and for financial reporting purposes.
c. A discontinuing operation is a component of an enterprise that may or may not be
distinguished operationally and for financial reporting purposes.
d. A discontinuing operation may be disposed of in its entirety or piecemeal, but always
pursuant to an overall plan to discontinue the entire component.

5. Identify the incorrect statement.

180

a. Discontinuing operations are infrequent events, but this does not mean that all infrequent
Page

events are discontinuing operations.

CA CS KARTHIK MANIKONDA – 75501 37279

 b. The fact that a disposal of a component of an enterprise is classified as a discontinuing
operation under AS 24 would always raise a question regarding the enterprise's ability to
continue as a going concern.
c. For recognising and measuring the effect of discontinuing operations, AS 24 does not
provide any guidelines, but for the purpose the relevant Accounting Standards should be
referred.
d. An enterprise shall include a description of the discontinuing operation, in its financial
statements beginning with the financial statements for the period in which the initial
disclosure event occurs.
ANSWERS/HINTS
MCQs
1. b. Date of formal announcement made to affected parties - 15th March 20X1.
2. d. All of the above
3. c. A discontinuing operation is a component of an enterprise that may or may not be
distinguished operationally and for financial reporting purposes.
4. b. The fact that a disposal of a component of an enterprise is classified as a discontinuing
operation under AS 24 would always raise a question regarding the enterprise's ability
to continue as a going concern.

THEORETICAL QUESTIONS
Q.NO.1.
i. What are the disclosure and presentation requirements of AS 24 for discontinuing operations?
ii. Give four examples of activities that do not necessarily satisfy criterion (a) of paragraph 3 of AS
24, but that might do so in combination with other circumstances.
ANSWER
i. An enterprise should include prescribed information relating to a discontinuing operation in its
financial statements beginning with the financial statements for the period in which the initial
disclosure event (as defined in paragraph 15 of AS 24) occurs. For details, please refer Section
6.5 of this Chapter above.
ii. Examples of activities that do not necessarily satisfy criterion (a) of the definition, but that
might do so in combination with other circum-stances, include:
181

a. Gradual or evolutionary phasing out of a product line or class of service;

b. Discontinuing, even if relatively abruptly, several products within an ongoing line of
Page

business;

CA CS KARTHIK MANIKONDA – 75501 37279

 c. Shifting of some production or marketing activities for a particular line of business from
one location to another; and
d. Closing of a facility to achieve productivity improvements or other cost savings.
Q.NO.2. What are the initial disclosure requirements of AS 24 for discontinuing operations?
ANSWER
An enterprise should include the following information relating to a discontinuing operation in its
financial statements beginning with the financial statements for the period in which the initial
disclosure event occurs:
a. A description of the discontinuing operation(s)
b. The business or geographical segment(s) in which it is reported as per AS 17.
c. The date and nature of the initial disclosure event.
d. The date or period in which the discontinuance is expected to be completed if known or
determinable
e. The carrying amounts, as of the balance sheet date, of the total assets to be disposed of and the
total liabilities to be settled.
f. The amounts of revenue and expenses in respect of the ordinary activities attributable to the
discontinuing operation during the current financial reporting period.
g. The amount of pre-tax profit or loss from ordinary activities attributable to the discontinuing
operation during the current financial reporting period, and the income tax expense related
thereto.
h. The amounts of net cash flows attributable to the operating, investing, and financing activities of
the discontinuing operation during the current financial reporting period.

182
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 PRACTICAL QUESTIONS
Q.NO.1. Rohini Limited is in the business of manufacture of passenger cars and commercial
vehicles. The Company is working on a strategic plan to close the production of passenger cars and to
produce only commercial vehicles over the coming 5 years. However, no specific plans have been
drawn up for sale of neither the division nor its assets. As part of its prospective plan it will reduce the
production of passenger cars by 20% annually. It also plans to establish another new factory for the
manufacture of commercial vehicles and transfer surplus employees in a phased manner.
You are required to comment:
I. If mere gradual phasing out in itself can be considered as a 'discontinuing operation' within the
meaning of AS-24.
II. If the Company passes a resolution to sell some of the assets in the passenger car division and
also to transfer few other assets of the passenger car division to the new factory, does this
trigger the application of AS-24?
III. Would your answer to (ii) above be different if the Company resolves to sell the assets of the
passenger car division in a phased but time bound manner?
SOLUTION
I. A discontinuing operation is a component of an enterprise:
a. that the enterprise, pursuant to a single plan, is:
i. disposing of substantially in its entirety, such as by selling the component in a single
transaction or by demerger or spin-off of ownership of the component to the
enterprise's shareholders; or
ii. disposing of piecemeal, such as by selling off the component's assets and settling its
liabilities individually; or
iii. terminating through abandonment; and
b. that represents a separate major line of business or geographical area of operations; and
c. that can be distinguished operationally and for financial reporting purposes.
Mere gradual phasing out is not considered as discontinuing operation as defined under AS 24,
‘Discontinuing Operations’.
Examples of activities that do not necessarily satisfy criterion of the definition, but that might
do so in combination with other circumstances, include:
i. Gradual or evolutionary phasing out of a product line or class of service;
183

ii. Shifting of some production or marketing activities for a particular line of business from one
location to another; and
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 iii. Closing of a facility to achieve productivity improvements or other cost savings. In this case,
it cannot be considered as Discontinuing Operation as per AS-24 as the companies’ strategic
plan has no final approval from the board through a resolution and there is no specific time
bound activities like shifting of assets and employees. Moreover, the new segment i.e.
commercial vehicle production line in a new factory has not started.
II. No, the resolution is silent about stoppage of the Car segment in definite time period. Though,
sale of some assets and some transfer proposal were passed through a resolution to the new
factory, but the closure road map and new segment starting roadmap are missing. Hence AS 24
will not be applicable and it cannot be considered as Discontinuing operations.

III. Yes, phased and time bound program resolved in the board clearly indicates the closure of the
passenger car segment in a definite time frame and will constitute a clear roadmap.

Hence this action will attract compliance of AS 24 and it will be considered as Discontinuing
Operations as per AS-24.

184
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 5. ASSETS BASED ACCOUNTING STANDARDS
UNIT 1: ACCOUNTING STANDARD 2 VALUATION OF INVENTORY
LEARNING OUTCOMES
After studying this unit, you will be able to comprehend the
 Definition of Inventory;
 Measurement of Inventories;
 What is included in Cost of Inventories;
 Exclusions from the Cost of Inventories;
 Cost Formulas;
 Techniques for the Measurement of Cost.

1.1 INTRODUCTION
The accounting treatment for inventories is prescribed in AS 2 (Revised) ‘Valuation of Inventories’,
which provides guidance for determining the value at which inventories, are carried in the financial
statements until related revenues are recognised. It also provides guidance on the cost formulas that
are used to assign costs to inventories and any write-down thereof to net realisable value.

1.2 INVENTORIES
AS 2 (Revised) defines inventories as assets held
 for sale in the ordinary course of business, or
 in the process of production for such sale, or
 for consumption in the production of goods or services for sale, including maintenance supplies
and consumables other than machinery spares, servicing equipment and standby equipment
meeting the definition of Property, plant and equipment.
Inventories encompass goods purchased and held for resale, for example merchandise (goods)
purchased by a retailer and held for resale, or land and other property held for resale. Inventories
also include finished goods produced, or work in progress being produced, by the enterprise and
include materials, maintenance supplies, consumables and loose tools awaiting use in the
production process. Inventories do not include spare parts, servicing equipment and standby
equipment which meet the definition of property, plant and equipment as per AS 10 (Revised),
Property, Plant and Equipment. Such items are accounted for in accordance with Accounting
185

Standard (AS) (Revised) 10, Property, Plant and Equipment.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

Following are excluded from the scope of AS 2 (Revised).
a. 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 should however be
covered by AS 2 (Revised).
b. 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.
c. 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 (Revised) as well. The current Indian practice is
however to value them at lower of cost and fair value.
d. 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.
The types of inventories are related to the nature of business. The inventories of a trading concern
consist primarily of products purchased for resale in their existing form. It may also have an
inventory of supplies such as wrapping paper, cartons, and stationery. The inventories of
manufacturing concern consist of several types of inventories: raw material (which will become part
of the goods to be produced), parts and factory supplies, work-in-process (partially completed
products in the factory) and, of course, finished products.
At the year-end every business entity needs to ascertain the closing balance of Inventory which
comprise of Inventory of raw material, work-in-progress, finished goods and miscellaneous items.
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 generate future economic benefits
186

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
Page

CA CS KARTHIK MANIKONDA – 75501 37279

incurred in bringing the assets to their present (i) location of the inventory, e.g. freight incurred to
carry the materials to factory and (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 unless those costs are necessary in production process prior to a further production
stage.
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
higher 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.
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 and Loss statement in such way that their
impact on current profit/loss can be perceived.
Part I of Schedule III to the Companies Act, 2013 prescribes that valuation method should be
disclosed for inventory held by companies.
1.3 MEASUREMENT OF INVENTORIES
Inventories should be valued at lower of cost and net realisable value. 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.
187
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Inventories

Raw Finished Goods and

Materials Work in progress

At cost (if
Lower of the following
finished
goods are
sold at or
above cost), Cost Net Realisable
otherwise at Value
replacement
cost
Cost of Cost of Other Realisable Value
Purchase Conversion Costs Less Selling
Expenses less
estimated cost
of completion

Example 1
Cost of a partly finished unit at the end of 20X1-X2 is Rs.150. The unit can be finished next year by a
further expenditure of Rs.100. The finished unit can be sold at Rs.250, subject to payment of 4%
brokerage on selling price. Assume that the partly finished unit cannot be sold in semi-finished form
and its NRV is zero without processing it further. The value of inventory will be determined as below:
Rs.
Net selling price 250
Less: Estimated cost of completion (100)
150
Less: Brokerage (4% of 250) (10)
Net Realisable Value 140
Cost of inventory 150
Value of inventory (Lower of cost and net realisable value) 140

1.4 COSTS OF INVENTORY

Costs of inventories comprise all costs of purchase, costs of conversion and other costs incurred in
188

bringing the inventories to their present location and condition.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

1.5 COSTS OF PURCHASE
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, 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.

1.6 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 that are incurred in converting raw material to finished
goods.
The fixed production overheads should be absorbed systematically to units of production over
normal capacity. Normal capacity is the production the enterprise expects to achieve on an average
over a number of periods or seasons under normal circumstances, taking into account the loss of
capacity resulting from planned maintenance. The actual level of production may be used if it
approximates the normal capacity. 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) are 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.

Example 2
ABC Ltd. has a plant with the capacity to produce 1 lac unit of a product per annum and the
expected fixed overhead is Rs.18 lacs. Fixed overhead on the basis of normal capacity is Rs.18 (18
lacs/1 lac).
Case 1: Actual production is 1 lac units. Fixed overhead on the basis of normal capacity and actual
overhead will lead to same figure of Rs.18 lacs. Therefore, it is advisable to include this on normal
capacity.
Case 2: Actual production is 90,000 units. Fixed overhead is not going to change with the change in
output and will remain constant at Rs.18 lacs, therefore, overheads on actual basis is Rs.20 per unit
(18 lacs/ 90 thousands). Hence by valuing inventory at Rs.20 each for fixed overhead purpose, it will
189

be overvalued and the losses of Rs.1.8 lacs will also be included in closing inventory leading to a
Page

higher gross profit then actually earned. Therefore, it is advisable to include fixed overhead per unit

CA CS KARTHIK MANIKONDA – 75501 37279

on normal capacity to actual production (90,000 x 18)Rs.16.2 lacs and rest Rs.1.8 lacs should be
transferred to Profit & Loss Account.
Case 3: Actual production is 1.2 lacs units. Fixed overhead is not going to change with the change in
output and will remain constant at Rs.18 lacs, therefore, overheads on actual basis is Rs.15 (18 lacs/
1.2 lacs). Hence by valuing inventory at Rs.18 each for fixed overhead purpose, we will be adding the
element of cost to inventory which actually has not been incurred. At Rs.18 per unit, total fixed
overhead comes to Rs.21.6 lacs whereas, actual fixed overhead expense is only Rs.18 lacs. Therefore,
it is advisable to include fixed overhead on actual basis (1.2 lacs x 15) Rs.18 lacs.

1.7 JOINT OR BY-PRODUCTS

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,
value of by products, scraps and wastes are usually not material. These are therefore valued at net
realisable value. The cost of main product is then valued as joint cost minus net realisable value of
by-products, scraps or wastes.

1.8 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.
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. 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.
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.
190
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Conversion Cost

Factory Overheads Direct labour Joint Cost

Fixed Variable Main/Joint*** By Products

At actual Sale Value Sale Value Measured at

At Normal At actual
Production at at NRV. This NRV
Capacity* Production**
Separation completion is deducted
from cost of
main / joint
products

*When actual production is almost equal or lower than normal capacity.

** When actual production is higher than normal capacity.
*** Allocation at reasonable and consistent basis.

1.9 EXCLUSIONS FROM THE COST OF INVENTORIES

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.

1.10 COST FORMULA

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. 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.
191
Page

CA CS KARTHIK MANIKONDA – 75501 37279

1.11 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.
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.

Example 3
A trader purchased certain articles for Rs.85,000. He sold some of articles for Rs.1,05,000. The
average percentage of gross markup is 25% on cost. Opening stock of inventory at cost was
Rs.15,000.
Cost of closing inventory is shown below:
Rs.
Sale value of opening stock and purchase 1,25,000
(Rs.85,000 + Rs.15,000) x 1.25
Sales (1,05,000)
Sale value of unsold stock 20,000
Less: Gross Markup (Rs.20,000 / 1.25) x 0.25 (4,000)
Cost of inventory 16,000

Note: Margin is on sales and mark-up is on cost.

1.12 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
192

sheet date to the extent that such events confirm the conditions existing at the balance sheet date.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

1.13 COMPARISON OF COST AND NET REALISABLE VALUE
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.
Example 4
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
Rs. Rs. Rs.
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.

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. AS 2 (Revised)
also 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 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.

1.14 NRV OF MATERIALS HELD FOR USE OR DISPOSAL

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.
Review of net realisable value at each balance sheet date
An assessment is made of net realisable value as at each balance sheet date.

1.15 DISCLOSURES
The financial statements should disclose:
a. The accounting policies adopted in measuring inventories, including the cost formula used; and
193

b. The total carrying amount of inventories together with a classification appropriate to the
Page

enterprise.

CA CS KARTHIK MANIKONDA – 75501 37279

Information about the carrying amounts held in different classifications of inventories and the extent
of the changes in these assets is useful to financial statement users. Common classifications of
inventories are
1. Raw materials and components,
2. Work in progress,
3. Finished goods,
4. Stock-in-trade (in respect of goods acquired for trading),
5. Stores and spares,
6. Loose tools, and
7. Others (specify nature).

194
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 ILLUSTRATIONS
Illustration 1
The company deals in three products, A, B and C, which are neither similar nor interchangeable. At
the time of closing of its account for the year 20X1-X2, the Historical Cost and Net Realisable Value
of the items of closing stock are determined as follows:
Items Historical Cost (Rs.in lakhs) Net Realisable Value (Rs.in lakhs)
A 40 28
B 32 32
C 16 24

Solution
As per AS 2 (Revised) on ‘Valuation of Inventories’, inventories should be valued at the lower of cost
and net realisable value. Inventories should be written down to net realisable value on an item-by-
item basis in the given case.
Items Historical Cost Net Realisable Value Valuation of closing
(Rs.in lakhs) (Rs.in lakhs) stock (Rs.in lakhs)
A 40 28 28
B 32 32 32
C 16 24 16
88 84 76
Hence, closing stock will be valued at Rs.76 lakhs.

Illustration 2
X Co. Limited purchased goods at the cost of Rs.40 lakhs in October, 20X1. Till March, 20X2, 75% of
the stocks were sold. The company wants to disclose closing stock at 10 lakhs. The expected sale
value is Rs.11 lakhs and a commission at 10% on sale is payable to the agent. Advise, what is the
correct closing stock to be disclosed as at 31.3.20X2.
Solution
As per AS 2 (Revised) “Valuation of Inventories”, the inventories are to be valued at lower of cost or
net realisable value.
195

In this case, the cost of inventory is Rs.10 lakhs. The net realisable value is 11,00,000  90% =
Rs.9,90,000. So, the stock should be valued at Rs.9,90,000.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Illustration 3
In a production process, normal waste is 5% of input. 5,000 MT of input were put in process resulting
in wastage of 300 MT. Cost per MT of input is Rs.1,000. The entire quantity of waste is on stock at the
year end. State with reference to Accounting Standard, how will you value the inventories in this case?
Solution
As per AS 2 (Revised), abnormal amounts of wasted materials, labour and other production costs are
excluded from cost of inventories and such costs are recognised as expenses in the period in which
they are incurred.
In this case, normal waste is 250 MT and abnormal waste is 50 MT. The cost of 250 MT will be
included in determining the cost of inventories (finished goods) at the year end. The cost of
abnormal waste (50 MT x 1,052.6315 = Rs.52,632) will be charged to the profit and loss statement.
Cost per MT (Normal Quantity of 4,750 MT) = 50,00,000 / 4,750 = Rs.1,052.6315
Total value of inventory = 4,700 MT x Rs.1,052.6315 = Rs.49,47,368.

Illustration 4
You are required to value the inventory per kg of finished goods consisting of:
Rs. per kg.
Material cost 200
Direct labour 40
Direct variable overhead 20
Fixed production charges for the year on normal working capacity of 2 lakh kgs is Rs.20 lakhs.
4,000 kgs of finished goods are in stock at the year end.
Solution
In accordance with AS 2 (Revised), the cost of conversion include a systematic allocation of fixed and
variable overheads that are incurred in converting materials into finished goods. The allocation of
fixed overheads for the purpose of their inclusion in the cost of conversion is based on nor mal
capacity of the production facilities.
Cost per kg. of finished goods:
Rs.
Material Cost 200
Direct Labour 40
Direct Variable Production Overhead 20
 20,00,000 
Fixed Production Overhead  
196

 2,00,000  10 70
270
Page

Hence the value of 4,000 kgs. of finished goods = 4,000 kgs x Rs.270 = Rs.10,80,000

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. Which item of inventory is under the scope of AS 2 (Revised)?
a. WIP arising under construction contracts
b. Raw materials
c. Shares
d. Debentures held as stock in trade.

2. Materials and other supplies held for use in the production of inventories are not written
down below cost if the finished products in which they will be incorporated are expected to be
a. sold at or above cost.
b. sold above cost.
c. sold less than cost.
d. sold at market value (where market value is more than cost).

3. All of the following costs are excluded while computing value of inventories except?
a. Selling and Distribution costs
b. Allocated fixed production overheads based on normal capacity.
c. Abnormal wastage
d. Storage costs (which is necessary part of the production process)

4. Identify the statement(s) which is/are incorrect.

a. Storage costs which is a necessary part of the production process is included in inventory
valuation.
b. Administration overheads are never included in inventory valuation.
c. Full amount of variable production overheads incurred are included in inventory valuation.
d. Administration overheads are always included in inventory valuation.
ANSWERS/SOLUTION
MCQs
1. b. Raw materials
2. a. sold at or above cost.
197

3. b. Allocated fixed production overheads based on normal capacity.

4. b. Administration overheads are never included in inventory valuation.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 THEORY QUESTIONS
Q.NO.1. “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”. Provide examples of such
costs as per AS 2 (Revised) ‘Valuation of Inventories’.
ANSWER
As per AS 2 (Revised) ‘Valuation of Inventories’, certain costs are excluded from the cost of the
inventories and are recognised as expenses in the period in which incurred. Examples of such costs
are:
a. abnormal amount of wasted materials, labour, or other production costs;
b. storage costs, unless those costs are necessary in the production process prior to a further
production stage;
c. administrative overheads that do not contribute to bringing the inventories to their present
location and condition; and
d. selling and distribution costs.
PRACTICAL QUESTIONS
Q.NO.1. Capital Cables Ltd., has a normal wastage of 4% in the production process. During the
year 20X1-20X2 the Company used 12,000 MT of raw material costing Rs.150 per MT. At the end of
the year 630 MT of wastage was in stock. The accountant wants to know how this wastage is to be
treated in the books. Explain in the context of AS 2 (Revised) the treatment of normal loss and
abnormal loss and also find out the amount of abnormal loss, if any.
SOLUTION
As per AS 2 (Revised) ‘Valuation of Inventories’, abnormal amounts of wasted materials, labour and
other production costs are excluded from cost of inventories and such costs are recognised as
expenses in the period in which they are incurred. The normal loss will be included in determining
the cost of inventories (finished goods) at the year end.
Amount of Abnormal Loss:
Material used 12,000 MT @ Rs.150 = Rs.18,00,000
Normal Loss (4% of 12,000 MT) 480 MT
Net quantity of material 11,520 MT
Abnormal Loss in quantity 150 MT
Abnormal Loss Rs.23,437.50
198

[150 units @ Rs.156.25 (Rs.18,00,000/11,520)]

Amount Rs.23,437.50 will be charged to the Statement of Profit and Loss.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Q.NO.2. Mr. Mehul gives the following information relating to items forming part of inventory
as on 31-3-20X1. His factory produces Product X using Raw material A.
i. 600 units of Raw material A (purchased @ Rs.120). Replacement cost of raw material A as on
31-3-20X1 is Rs.90 per unit.
ii. 500 units of partly finished goods in the process of producing X and cost incurred till date
Rs.260 per unit. These units can be finished next year by incurring additional cost of Rs.60 per
unit.
iii. 1500 units of finished Product X and total cost incurred Rs.320 per unit.
Expected selling price of Product X is Rs.300 per unit.
Determine how each item of inventory will be valued as on 31-3-20X1. Also calculate the value
of total inventory as on 31-3-20X1.
SOLUTION
As per AS 2 (Revised) “Valuation of Inventories”, materials and other supplies held for use in the
production of inventories are not written down below cost if the finished products in which they will
be incorporated are expected to be sold at cost or above cost. However, when there has been a
decline in the price of materials and it is estimated that the cost of the finished products will exceed
net realisable value, the materials are written down to net realisable value. In such circumstances,
the replacement cost of the materials may be the best available measure of their net realisable
value. In the given case, selling price of product X is Rs.300 and total cost per unit for production is
Rs.320.
Hence the valuation will be done as under:
i. 600 units of raw material will be written down to replacement cost as market value of finished
product is less than its cost, hence valued at Rs.90 per unit.
ii. 500 units of partly finished goods will be valued at 240 per unit i.e. lower of cost (Rs.260) or Net
realisable value Rs.240 (Estimated selling price Rs.300 per unit less additional cost of Rs.60).
iii. 1,500 units of finished product X will be valued at NRV of Rs.300 per unit since it is lower than
cost Rs.320 of product X.
Valuation of Total Inventory as on 31.03.20X1:
Units Cost NRV / Value = units x
(Rs.) Replacement cost or NRV
cost whichever is less
(Rs.)
199

Raw material A 600 120 90 54,000

Partly finished goods 500 260 240 1,20,000
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Finished goods X 1,500 320 300 4,50,000
Value of Inventory 6,24,000

Q.NO.3. On 31st March 20X1, a business firm finds that cost of a partly finished unit on that
date is Rs.530. The unit can be finished in 20X1-X2 by an additional expenditure of Rs.310. The
finished unit can be sold for Rs.750 subject to payment of 4% brokerage on selling price. The firm
seeks your advice regarding the amount at which the unfinished unit should be valued as at 31st
March, 20X1 for preparation of final accounts. Assume that the partly finished unit cannot be sold
in semi-finished form and its NRV is zero without processing it further.
SOLUTION
Valuation of unfinished unit
Rs.
Net selling price 750
Less: Estimated cost of completion (310)
440
Less: Brokerage (4% of 750) (30)
Net Realisable Value 410
Cost of inventory 530
Value of inventory (Lower of cost and net realisable value) 410

200
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 UNIT 2: ACCOUNTING STANDARD 10: PROPERTY,
PLANT AND EQUIPMENT
LEARNING OUTCOMES
After studying this unit, you will be able to comprehend the
 Definition of PPE
 What is the Recognition Criteria for PPE
 Initial Costs
 Subsequent Costs
 Measurement at Recognition
 What is included in elements of Cost
 Measurement of Cost
 Measurement after Recognition
 Cost Model
 Revaluation Model
 Depreciation
 Depreciable Amount and Useful life
 Depreciation Method
 Retirement in case of PPE
 Derecognition aspects
 Disclosure requirements.

2.1 INTRODUCTION
The objective of this Standard is to prescribe accounting treatment for Property, Plant and
Equipment (PPE).

Help the Users Information about

of Investment in PPE
Prescribe
Objectives of AS *Accounting Financial
10 (Revised) Treatment for Statements
PPE" to Changes in such
201

understand Investment
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 The principal issues in Accounting for PPE are:

Determination of
their carrying Depreciation charge
amounts

Impairment losses to
Recognition of PPE be recognised in
relation to them
Principle
issues in
Accounting of
PPE

2.2 SCOPE OF THE STANDARD

As a general principle, AS 10 (Revised) should be applied in accounting for PPE.
Exception: When another Accounting Standard requires or permits a different accounting treatment.
Example:
AS 19 on Leases, requires an enterprise to evaluate its recognition of an item of leased PPE on the
basis of the transfer of risks and rewards. However, it may be noted that in such cases other aspects
of the accounting treatment for these assets, including depreciation, are prescribed by this Standard.

AS 10 (Revised)
Not Applicable to

Wasting Assets including Mineral rights ,

Biological Assets (other than bearer Expenditure on the exploration for and
plants) related to agricultural activity extraction of minerals ,oil,natural gas
and similar non - regenerative resources

Note: AS 10 (Revised) applies to Bearer Plants but it does not apply to the produce on Bearer
Plants.
202
Page

CA CS KARTHIK MANIKONDA – 75501 37279

2.3 DEFINITION OF PROPERTY, PLANT AND EQUIPMENT (PPE)
There are 2 conditions to be satisfied for a TANGIBLE item to be called PPE. PPE are tangible items
that:

use in production or supply of

goods or services ,or

Condition 1:
For Rental to others,or
Held for

PPE
For Administrative purposes
(Tangible items )

Condition 2 :
Used for more than 12 months
Expected to be

Note: Intangible items are covered under AS 26.

“Administrative purposes”: The term ‘Administrative purposes’ has been used in wider sense to
include all business purposes. Thus, PPE would include assets used for:
 Selling and distribution
 Finance and accounting
 Personnel and other functions of an Enterprise.
Items of PPE may also be acquired for safety or environmental reasons.
The acquisition of such PPE, although not directly increasing the future economic benefits of any
particular existing item of PPE, may be necessary for an enterprise to obtain the future economic
benefits from its other assets.
Such items of PPE qualify for recognition as assets because they enable an enterprise to derive
future economic benefits from related assets in excess of what could be derived had those items not
been acquired.
Example:
A chemical manufacturer may install new chemical handling processes to comply with
environmental requirements for the production and storage of dangerous chemicals; related plant
enhancements are recognised as an asset because without them the enterprise is unable to
203

manufacture and sell chemicals.

The resulting carrying amount of such an asset and related assets is reviewed for impairment in
Page

accordance with AS 28 ‘Impairment of Assets’.

CA CS KARTHIK MANIKONDA – 75501 37279

2.4 OTHER DEFINITIONS
1. Biological Asset: An Accounting Standard on “Agriculture” is under formulation, which will, inter
alia, cover accounting for livestock. Till the time, the Accounting Standard on “Agriculture” is
issued, accounting for livestock meeting the definition of PPE, will be covered as per AS 10
(Revised).

AS 10 (Revised) does not apply

Living Animal
if definition of PPE not met

Biological Asset

As 10 (Revised) applices to
Plant
Bearer plants

2. Bearer Plant: Is a plant that (satisfies all 3 conditions):

Is used in the production or supply • Of Agricultural procedure

• For more than a period of

Is expected to bear produce
12 months

Has a remote likelihood of being sold • Except for incidental scrap

as Agricultural produce sales

Note: When bearer plants are no longer used to bear produce they might be cut down and sold as
scrap. For example - use as firewood. Such incidental scrap sales would not prevent the plant from
satisfying the definition of a Bearer Plant.
204
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 What are not "Bearer plants"

Plants cultivated Plants cultivated to produce when

to be harvested there is more than a remote
likelihood that the entity will also Annual Crops
as Agricultural
produce harvest and sell the plant as
agricultural produce , other than
as incidental scrap sales

Trees grown for Maize and

use as lumber Trees which are Wheat
cultivated both for their
fruit and their lumber

Agricultural Produce is the harvested product of Biological Assets of the enterprise.

3. Agricultural Activity: Is the management by an Enterprise of:

o Biological transformation; and
o Harvest of Biological Assets
 For sale, Or
 For conversion into Agricultural Produce, Or
 Into additional Biological Assets

For sale

Biological
Agricultural transformation and For conversation into
Activity Management harvest of biological Agriculture produce
Assests
Into Additional
Biological Assets

2.5 RECOGNITION CRITERIA FOR PPE

The cost of an item of PPE should be recognised as an asset if, and only if:
 It is probable that future economic benefits associated with the item will flow to the enterprise,
and
205

 The cost of the item can be measured reliably.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

Notes:
1. It may be appropriate to aggregate individually insignificant items, such as moulds, tools and dies
and to apply the criteria to the aggregate value.
2. An enterprise may decide to expense an item which could otherwise have been included as PPE,
because the amount of the expenditure is not material.
(Refer Illustration 1)
Treatment of Spare Parts, Stand by Equipment and Servicing Equipment
Case I If they meet the definition of PPE as per AS 10 (Revised):
 Recognised as PPE as per AS 10 (Revised)
Case II If they do not meet the definition of PPE as per AS 10 (Revised):
 Such items are classified as Inventory as per AS 2 (Revised)
When do we apply the above criteria for Recognition?
An enterprise evaluates under this recognition principle all its costs on PPE at the time they are
incurred.
These costs include costs incurred:

Situation I To acquire or construct an

Initially item of PPE
Cost incurred
Situation II To add to,replace part of ,or
Subsequentlly service it

2.6 MEASUREMENT OF PPE

At Recognition Cost Model

Measurement
Cost Model

After Recognition

Revaluation Model
206
Page

CA CS KARTHIK MANIKONDA – 75501 37279

2.7 INITIAL RECOGNITION
An item of PPE that qualifies for recognition as an asset should be measured at its cost.
What are the elements of Cost?
Cost of an item of PPE comprises:

Cost of an Item of PPE

Includes Excludes

Any Directly Decommissioning, 1. Costs of opening a new

Purchase Price Attributable Restoration and facility or business (Such as,
Costs similar Liabilities Inauguration costs)
2. Costs of introducing a new
product or service (including
costs of advertising and
promotional activities)
3. Costs of conducting
business in a new location or
with a new class of customer
(including costs of staff
training)
4. Administration and other
general overhead costs

Let us understand the above in detail.

A. Purchase Price:
 It includes import duties and non –refundable purchase taxes.
 It requires deduction of Trade discounts and rebates
B. Directly Attributable Costs:
Any costs directly attributable to bringing the asset to the ‘location and condition’ necessary for
it to be capable of operating in the manner intended by management. Recognition of costs in the
carrying amount of an item of PPE ceases when the item is in the location and condition
necessary for it to be capable of operating in the manner intended by management.
The following costs are not included in the carrying amount of an item of PPE:
1. Costs incurred while an item capable of operating in the manner intended by management
207

has yet to be brought into use or is operated at less than full capacity.
2. Initial operating losses, such as those incurred while demand for the output of an item builds
Page

up. And

CA CS KARTHIK MANIKONDA – 75501 37279

 3. Costs of relocating or reorganising part or all of the operations of an enterprise.
Examples of directly attributable costs are:
1. Costs of employee benefits (as defined in AS 15) arising directly from the construction or
acquisition of the item of PPE
2. Costs of site preparation
3. Initial delivery and handling costs
4. Installation and assembly costs
5. Costs of testing whether the asset is functioning properly, after deducting the net proceeds
from selling any items produced while bringing the asset to that location and condition
(such as samples produced when testing equipment)
6. Professional fees
Examples of costs that are not costs of an item of property, plant and equipment are:
a. Costs of opening a new facility or business, such as, inauguration costs
b. Costs of introducing a new product or service (including costs of advertising and
promotional activities)
c. Costs of conducting business in a new location or with a new class of customer (including
costs of staff training)
d. Administration and other general overhead costs
Note: Some operations occur in connection with the construction or development of an item of
PPE but are not necessary to bring the item to the location and condition necessary for it to be
capable of operating in the manner intended by management. These incidental operations may
occur before or during the construction or development activities.

Example:
Income may be earned through using a building site as a car park until construction starts because
incidental operations are not necessary to bring an item to the location and condition necessary for
it to be capable of operating in the manner intended by management, the income and related
expenses of incidental operations are recognised in the Statement of Profit and Loss and included in
their respective classifications of income and expense.
208
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Income earned during development of PPE

Directly Attributable Incomes (e.g. sale of Not directly attriubtable to the asset
debris/ scrap material on demolition in case of (e.g. car parking rental income)
redevelopment

Recognize as income
Adjust from the cost of in the Statement of
PPE Profit and Loss

(Refer Illustration 2 - 5)
C. Decommissioning, Restoration and similar Liabilities:
Initial estimate of the costs of dismantling, removing the item and restoring the site on which it
is located, referred to as ‘Decommissioning, Restoration and similar Liabilities’, the obligation for
which an enterprise incurs either when the item is acquired or as a consequence of having used
the item during a particular period for purposes other than to produce inventories during that
period. Exception: An enterprise applies AS 2 (Revised) “Valuation of Inventories”, to the costs of
obligations for dismantling, removing and restoring the site on which an item is located that are
incurred during a particular period as a consequence of having used the item to produce
inventories during that period.
Note: The obligations for costs accounted for in accordance with AS 2 (Revised) or AS 10
(Revised) are recognised and measured in accordance with AS 29 (Revised) “Provisions,
Contingent Liabilities and Contingent Assets”.
2.8 COST OF A SELF-CONSTRUCTED ASSET
Cost of a self-constructed asset is determined using the same principles as for an acquired asset.
1. If an enterprise makes similar assets for sale in the normal course of business, the cost of the
asset is usually the same as the cost of constructing an asset for sale (Refer AS 2). Therefore, any
internal profits are eliminated in arriving at such costs.
2. Cost of abnormal amounts of wasted material, labour, or other resources incurred in self-
constructing an asset is not included in the cost of the asset.
209

3. AS 16 on Borrowing Costs, establishes criteria for the recognition of interest as a component of

the carrying amount of a self-constructed item of PPE.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

4. Bearer plants are accounted for in the same way as self-constructed items of PPE before they are
in the location and condition necessary to be capable of operating in the manner intended by
management.

Summary: Initial Recognition (COST)

Purchase Self-constructed

Purchase Price xxx Material xxx

+ non-creditable taxes xxx + Labour xxx
- Trade discount xxx + Fixed/Variable Prod. Overheads xxx
+ Directly attributabel Exp/Income xxx
+ Directly attributable Expense/Income xxx
+ Initial Estimate of Restoration etc. xxx
+ Initial Estimate of Restoration etc. xxx
+ Borrowing Cost (if qualifying asset) xxx
COST OF ASSET xxx
COST OF ASSET xxx

2.9 PPE ACQUIRED IN EXCHANGE FOR A NONMONETARY ASSET OR ASSETS OR A COMBINATION

OF MONETARY AND NON-MONETARY ASSETS:
Cost of such an item of PPE is measured at fair value unless:
a. Exchange transaction lacks commercial substance; or
b. Fair value of neither the asset(s) received nor the asset(s) given up is reliably measurable.
Note:
1. The acquired item(s) is/are measured in this manner even if an enterprise cannot immediately
derecognise the asset given up.
2. The fair value of an asset is reliably measurable if (a) the variability in the range of reasonable
fair value measurements is not significant for that asset or (b) the probabilities of the various
estimates within the range can be reasonably assessed and used when measuring fair value. If an
enterprise is able to measure reliably the fair value of either the asset received or the asset given
up, then the fair value of the asset given up is used to measure the cost of the asset received
210

unless the fair value of the asset received is more clearly evident.
3. If the acquired item(s) is/are not measured at fair value, its/their cost is measured at the carrying
Page

amount of the asset(s) given up.

CA CS KARTHIK MANIKONDA – 75501 37279

4. An enterprise determines whether an exchange transaction has commercial substance by
considering the extent to which its future cash flows are expected to change as a result of the
transaction. An exchange transaction has commercial substance if:
a. the configuration (risk, timing and amount) of the cash flows of the asset received differs
from the configuration of the cash flows of the asset transferred; or
b. the enterprise-specific value of the portion of the operations of the enterprise affected by
the transaction changes as a result of the exchange;
c. and the difference in (a) or (b) is significant relative to the fair value of the assets exchanged.
For the purpose of determining whether an exchange transaction has commercial substance, the
enterprise-specific value of the portion of operations of the enterprise affected by the
transaction should reflect post-tax cash flows. In certain cases, the result of these analyses may
be clear without an enterprise having to perform detailed calculations

Acquisition of Assets for non-cash/partly cash partly

non-cash consideration

Transaction has Transaction has no

Commercial Substance Commercial Substance

Cost of such PPE is measured at Fair A transaction lacks commercial

Value (FV) of the assets given up unless substance if the position of the
the FV of the asset received is more company (in terms of cash flows or
reliable. enterprise-specific values) before and
If information about reliability is not after the exchange transaction reamin
available, the following order of the same.
preference for recording PPE can be
followed:
1. Measure at FV of asset given up.
2. Measure at FV of assets received (if FV
of asset given up is not available). In such cases, the assets
acquired will be measured at
3. WDV of assets given up (ONLY if Points
the WDV of the assets given
1 and 2 are not available, which is a very
up.
remote possibility).
211

(Refer Illustration 6 & 7)

Page

CA CS KARTHIK MANIKONDA – 75501 37279

Determination of Cost in special cases:
Cost of an item of PPE is the cash price equivalent at the recognition date.
A. If payment is deferred beyond normal credit terms:
Total payment minus Cash price equivalent
 is recognised as an interest expense over the period of credit
 unless such interest is capitalised in accordance with AS 16
B. PPE purchased for a Consolidated Price:
Where several items of PPE are purchased for a consolidated price, the consideration is
apportioned to the various items on the basis of their respective fair values at the date of
acquisition.
Note: In case the fair values of the items acquired cannot be measured reliably, these values are
estimated on a fair basis as determined by competent valuers.
C. PPE held by a lessee under a Finance Lease:
The cost of an item of PPE held by a lessee under a finance lease is determined in accordance
with AS 19 (Leases).
D. Government Grant related to PPE:
The carrying amount of an item of PPE may be reduced by government grants in accordance with
AS 12 (Accounting for Government Grants).

2.10 TREATMENT OF SUBSEQUENT COSTS

Cost of day-to-day servicing
Meaning
Costs of day-to-day servicing are primarily the costs of labour and consumables and may include the
cost of small parts. The purpose of such expenditures is often described as for the ‘Repairs and
Maintenance’ of the item of PPE.
Accounting Treatment:
An enterprise does not recognise in the carrying amount of an item of PPE the costs of the day-to-
day servicing of the item. Rather, these costs are recognised in the Statement of Profit and Loss as
incurred.
Replacement of Parts of PPE
Parts of some items of PPE may require replacement at regular intervals.
Examples
1. A furnace may require relining after a specified number of hours of use.
212

2. Aircraft interiors such as seats and galleys may require replacement several times during the life
Page

of the airframe.

CA CS KARTHIK MANIKONDA – 75501 37279

3. Major parts of conveyor system, such as, conveyor belts, wire ropes, etc., may require
replacement several times during the life of the conveyor system.
4. Replacing the interior walls of a building, or to make a non-recurring replacement.

Accounting Treatment
An enterprise recognises in the carrying amount of an item of PPE the cost of replacing part of such
an item when that cost is incurred if the recognition criteria are met.
Note: The carrying amount of those parts that are replaced is derecognised in accordance with
the de-recognition provisions of this Standard.

Regular Major Inspections - Accounting Treatment

In certain cases, a condition of continuing to operate an item of property, plant and equipment (for
example, an aircraft) may be performing regular major inspections for faults regardless of whether
parts of the item are replaced. When each such major inspection is performed, its cost is recognised
in the carrying amount of the item of PPE as a replacement, if the recognition criteria are satisfied.
Any remaining carrying amount of the cost of the previous inspection (as distinct from physical
parts) is derecognised.

Subsequent
Expenditure

Expenses which Major replacements /

Regular / day-to-day increase life or major inspection / major
Repairs & Maintenance efficiency of the asset overhaul
beyond the originally
assessed life or
efficiency
Capitalized as under: WDV of
Asset xxx
Expensed to P/L
+ Cost of New Part xxx
Capitalized - WDV of Old Part xxx
Revised WDV xxx

The WDV of the old part / inspection (in case of major replacements / inspection) can be
determined through the following sources (in order of preference):
213

i. Breakup from suppliers’ invoice

Page

ii. Fair value of the part / inspection at the time of purchase

CA CS KARTHIK MANIKONDA – 75501 37279

If it is not practicable for an enterprise to determine the carrying amount of the replaced part/
inspection, it may use the cost of the replacement or the estimated cost of a future similar
inspection as an indication of what the cost of the replaced part/ existing inspection component was
when the item was acquired or constructed.
The WDV of the old part / inspection is computed after deducting the applicable depreciation.
(Refer Illustration 8 & 9)
MEASUREMENT AFTER RECOGNITION
An enterprise should choose
 Either Cost model,
 Or Revaluation model
as its accounting policy and should apply that policy to an entire class of PPE.
Class of PPE: A class of PPE is a grouping of assets of a similar nature and use in operations of an
enterprise.
Examples of separate classes:
a. Land
b. Land and Buildings
c. Machinery
d. Ships
e. Aircraft
f. Motor Vehicles
g. Furniture and Fixtures
h. Office Equipment
i. Bearer plants
Cost Model
After recognition as an asset, an item of PPE should be carried at:
Cost- Any Accumulated Depreciation- Any Accumulated Impairment losses
Revaluation Model
After recognition as an asset, an item of PPE whose fair value can be measured reliably should be
carried at a revalued amount.
Fair value at the date of the revaluation —
Less: Any subsequent accumulated depreciation (—)
214

Less: Any subsequent accumulated impairment losses (—)

Carrying value —
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Revaluation for entire class of PPE
If an item of PPE is revalued, the entire class of PPE to which that asset belongs should be revalued.
Reason
The items within a class of PPE are revalued simultaneously to avoid selective revaluation of assets
and the reporting of amounts in the Financial Statements that are a mixture of costs and values as at
different dates. It will ensure true and fair view of financial statements.
(Refer Illustration 10)

Frequency of Revaluations
Revaluations should be made with sufficient regularity to ensure that the carrying amount does not
differ materially from that which would be determined using Fair value at the Balance Sheet date.
The frequency of revaluations depends upon the changes in fair values of the items of PPE being
revalued.

Frequency of Revaluations (Sufficient Regularity)

Items of PPE experience significant and Items of PPE experience significant changes
volatile changes in Fair value in Fair value

Annual revaluation Revalue the item only every 3 or 5 years

Determination of Fair Value

Fair value of items of PPE is usually determined from market-based evidence by appraisal that is
normally undertaken by professionally qualified valuers.
If there is no market-based evidence of fair value because of the specialised nature of the item of
PPE and the item is rarely sold, except as part of a continuing business, an enterprise may need to
estimate fair value using an income approach Based on (Discounted cash flow projections) Ora
depreciated replacement cost approach which aims at making a realistic estimate of the current
cost of acquiring or constructing an item that has the same service potential as the existing item.
215

Accounting Treatment of Revaluations

When an item of PPE is revalued, the carrying amount of that asset is adjusted to the revalued
Page

amount.

CA CS KARTHIK MANIKONDA – 75501 37279

At the date of the revaluation, the asset is treated in one of the following ways:
A. Technique 1: Gross carrying amount is adjusted in a manner that is consistent with the
revaluation of the carrying amount of the asset.
Gross carrying amount
 May be restated by reference to observable market data, or
 May be restated proportionately to the change in the carrying amount.
Accumulated depreciation at the date of the revaluation is
 Adjusted to equal the difference between the gross carrying amount and the carrying
amount of the asset after taking into account accumulated impairment losses
Case Study on Technique I
PPE is revalued to Rs.1,500 consisting of Rs.2,500 Gross cost and Rs.1,000 Depreciation based on
observable market data.
Details of the PPE before and after revaluation are as follows:
Particulars Cost/ Revalued Accumulated Net book
Cost depreciation value
PPE before revaluation (assumed) 1,000 400 600
Fair Value 1,500
Revaluation Gain 900
Gain allocated proportionately to 1,500 600 900
cost and depreciation (900 x 1,000/600) (900 x 400/600)
PPE after revaluation 2,500 1,000 1,500
The increase on revaluation is Rs.900 (i.e., Rs.1,500 – Rs.600).
The following journal entry will be passed:
PPE Dr. 1,500
To Accumulated Depreciation 600
To Gain on Revaluation* 900
* Accounting treatment discussed later
B. Technique 2: Accumulated depreciation Is eliminated against the Gross Carrying amount of the
asset
Case Study on Technique II
(Taking the information given in the above Example)
216
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Details of the PPE before and after revaluation are as follows:
Particulars Cost / Revalued Accumulated Net book
Cost depreciation value
PPE before revaluation (assumed) 1,000 400 600
PPE after revaluation 1,500 1,500
Revaluation gain 500 400

The increase on revaluation is Rs.900 (i.e., Rs.500 + Rs.400).

The following journal entries will be passed:
Accumulated Depreciation Dr. 400
To PPE 400
(Accumulated depreciation eliminate against gross carrying amount of asset)
Therefore, carrying amount of asset is reduced to = 1,000 – 400 = 600
PPE Dr. 900
To Gain on Revaluation* 900
* Gain on Revaluation 1,500 – 600 = 900 recognized entirely in PPE, accounting treatment of this
gain to be discussed later.
Revaluation – Increase or Decrease

Revaluation

Increase Decrease

Credited directly to Exception: Charged to the Exception:

owners' interests When it is subsequently statement of When it is subsequently
under the heading of increased (intially profit and loss Decreased (initially
Revaluation surplus Decreased ) increased )

Decrease should be debited

Recognised in the statement of profit and directly to owners’ interests
loss to the extent that it reverses a under the heading of
revaluation decrease of the same asset Revaluation surplus to the
previously recognised in the statement of extent of any credit balance
profit and loss existing in the Revaluation
surplus in respect of that
217

asset
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Treatment of Revaluation Surplus
The revaluation surplus included in owners’ interests in respect of an item of PPE may be transferred
to the Revenue Reserves when the asset is derecognised.
Case I: When whole surplus is transferred:
When the asset is:
 Retired; Or
 Disposed of
Case II: Some of the surplus may be transferred as the asset is used by an enterprise:
In such a case, the amount of the surplus transferred would be:
Depreciation (based on Revalued Carrying amount) – Depreciation (based on Original Cost)
Transfers from Revaluation Surplus to the Revenue Reserves are not made through the Statement
of Profit and Loss.
Depreciation
Component Method of Depreciation:
Each part of an item of PPE with a cost that is significant in relation to the total cost of the item
should be depreciated separately. An enterprise allocates the amount initially recognised in respect
of an item of PPE to its significant parts and depreciates each such part separately.
Example:
It may be appropriate to depreciate separately the airframe and engines of an aircraft, whether
owned or subject to a finance lease.
Is Grouping of Components possible?
Yes. A significant part of an item of PPE may have a useful life and a depreciation method that are
the same as the useful life and the depreciation method of another significant part of that same
item. Such parts may be grouped in determining the depreciation charge.
Accounting Treatment
Depreciation charge for each period should be recognised in the Statement of Profit and Loss unless
it is included in the carrying amount of another asset.
Examples on Exception
AS 2 (Revised): Depreciation of manufacturing plant and equipment is included in the costs of
conversion of inventories as per AS 2 (Revised).
AS 26: Depreciation of PPE used for development activities may be included in the cost of an
218

intangible asset recognised in accordance with AS 26 on Intangible Assets.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

Depreciable Amount and Depreciation Period
Depreciable amount is:
Cost of an asset (or other amount substituted for cost i.e. revalued amount) less Residual value.
The depreciable amount of an asset should be allocated on a systematic basis over its useful life.
Useful life is:
a. the period over which an asset is expected to be available for use by an enterprise; or
b. the number of production or similar units expected to be obtained from the asset by an
enterprise.
The residual value of an asset is the estimated amount that an enterprise would currently obtain
from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already
of the age and in the condition expected at the end of its useful life.
All the following factors are considered in determining the useful life of an asset:
a. expected usage of the asset. Usage is assessed by reference to the expected capacity or physical
output of the asset.
b. expected physical wear and tear, which depends on operational factors such as the number of
shifts for which the asset is to be used and the repair and maintenance programme, and the care
and maintenance of the asset while idle.
c. technical or commercial obsolescence arising from changes or improvements in production, or
from a change in the market demand for the product or service output of the asset.
Expected future reductions in the selling price of an item that was produced using an asset could
indicate the expectation of technical or commercial obsolescence of the asset, which, in turn,
might reflect a reduction of the future economic benefits embodied in the asset.
d. legal or similar limits on the use of the asset, such as the expiry dates of related leases.
(Refer Illustration 11)
Review of Residual Value and Useful Life of an Asset
Residual value and the useful life of an asset should be reviewed at least at each financial year-end
and, if expectations differ from previous estimates, the change(s) should be accounted for as a
change in an accounting estimate in accordance with AS 5 ‘Net Profit or Loss for the Period, Prior
Period Items and Changes in Accounting Policies’.
Example:
As per accounting policy of NS Limited, engaged in shipping business, residual value of Steel
containers is 5%. Based on the external factors, steel prices have increased in recent past and based
219

on the recent data, company has observed that realized scrap value is approximately 10% of the cost
of the container. The company does not anticipate any material movement in the steel price in the
Page

foreseeable future.

CA CS KARTHIK MANIKONDA – 75501 37279

In the above case, based on the yearly review of residual value of Steel containers, company should
revise the residual value to 10%. The above change shall be treated as change in accounting estimate
as per AS 5 and should be applied prospectively.
(Refer Illustration 12)
Commencement of period for charging Depreciation
Depreciation of an asset begins when it is available for use, i.e., when it is in the location and
condition necessary for it to be capable of operating in the manner intended by the management.
(Refer Illustration 13)
Cessation of Depreciation
i. Depreciation ceases to be charged when asset’s residual value exceeds its carrying amount.
The residual value of an asset may increase to an amount equal to or greater than its carrying
amount. If it does, depreciation charge of the asset is zero unless and until its residual value
subsequently decreases to an amount below its carrying amount.
(Refer Illustration14)

ii. Depreciation of an asset ceases at the earlier of:

 The date that the asset is retired from active use and is held for disposal, and
 The date that the asset is derecognised.
Therefore, depreciation does not cease when the asset becomes idle or is retired from active use
(but not held for disposal) unless the asset is fully depreciated.
However, under usage methods of depreciation, the depreciation charge can be zero while there
is no production.
Land and Buildings
Land and buildings are separable assets and are accounted for separately, even when they are
acquired together.
A. Land: Land has an unlimited useful life and therefore is not depreciated.
Exceptions: Quarries and sites used for landfill.
Depreciation on Land:
i. If land itself has a limited useful life:
It is depreciated in a manner that reflects the benefits to be derived from it.
ii. If the cost of land includes the costs of site dismantlement, removal and restoration:
That portion of the land asset is depreciated over the period of benefits obtained by
220

incurring those costs.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

 B. Buildings:
Buildings have a limited useful life and therefore are depreciable assets.
An increase in the value of the land on which a building stands does not affect the
determination of the depreciable amount of the building.

Depreciation Method
The enterprise selects the method that most closely reflects the expected pattern of consumption of
the future economic benefits embodied in the asset. The depreciation method used should reflect
the pattern in which the future economic benefits of the asset are expected to be consumed by the
enterprise.
The method selected is applied consistently from period to period unless:
 There is a change in the expected pattern of consumption of those future economic benefits; Or
 That the method is changed in accordance with the statute to best reflect the way the asset is
consumed.

Methods of Depreciation

Diminishing Balance Units of production

Straight -line Method
method Method

Results in a constant charge

over the useful life if the Results in a decreasing Results in a charge
residual value of the asset charge over the useful based on the expected
does not change life use or output

Review of Depreciation Method

The depreciation method applied to an asset should be reviewed at least at each financial year-end
and, if there has been a significant change in the expected pattern of consumption of the future
economic benefits embodied in the asset, the method should be changed to reflect the changed
221

pattern.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Such a change should be accounted for as a change in an accounting estimate in accordance with AS 5.
Depreciation Method based on Revenue
A depreciation method that is based on revenue that is generated by an activity that includes the
use of an asset is not appropriate. Because the price component of revenue may be affected by
inflation, which has no bearing upon the way in which an asset is consumed.
(Refer Illustration 15)
Changes in Existing Decommissioning, Restoration and other Liabilities
The cost of PPE may undergo changes subsequent to its acquisition or construction on account of:
 Changes in Liabilities
 Price Adjustments
 Changes in Duties
 Changes in initial estimates of amounts provided for Dismantling, Removing, Restoration, and
 Similar factors
The above are included in the cost of the asset.
Accounting for the above changes:

Related Asset is measured using Cost

Model
Accounting
(Depends upon)
Related Asset is measured using
Revaluation Model

A. If the related asset is measured using the Cost model

Changes in the Liability should be added to, or deducted from, the cost of the related asset in the
current period
Note: Amount deducted from the cost of the asset should not exceed its carrying amount. If a
decrease in the liability exceeds the carrying amount of the asset, the excess should be
recognised immediately in the Statement of Profit and Loss.
If the adjustment results in an addition to the cost of an asset
 Enterprise should consider whether this is an indication that the new carrying amount of the
asset may not be fully recoverable.
Note: If it is such an indication, the enterprise should test the asset for impairment by
222

estimating its recoverable amount, and should account for any impairment loss, in accordance
Page

with applicable Accounting standards.

CA CS KARTHIK MANIKONDA – 75501 37279

B. If the related asset is measured using the Revaluation model:
Changes in the liability alter the revaluation surplus or deficit previously recognised on that
asset, so that:
i. Decrease in the liability credited directly to revaluation surplus in the owners’ interest
Exception
*It should be recognised in the Statement of Profit and Loss to the extent that it reverses a
revaluation deficit on the asset that was previously recognised in the Statement of Profit
and Loss.
Note: In the event that a decrease in the liability exceeds the carrying amount that would
have been recognised had the asset been carried under the cost model, the excess should
be recognised immediately in the Statement of Profit and Loss.

ii. Increase in the liability should be recognised in the Statement of Profit and Loss
Exception
*It should be debited directly to Revaluation surplus in the owners’ interest to the extent of
any credit balance existing in the Revaluation surplus in respect of that asset
Caution
A change in the liability is an indication that the asset may have to be revalued in order to
ensure that the carrying amount does not differ materially from that which would be
determined using fair value at the balance sheet date.

The adjusted depreciable amount of the asset is depreciated over its useful life.

What happens if the related asset has reached the end of its useful life?

All subsequent changes in the liability should be recognised in the Statement of Profit and
Loss as they occur.
Note: This applies under both the cost model and the revaluation model.
223
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Accounting for Compensation for Impairment:

Situations and Its

Accounting

De-recognition Cost of items of PPE

Compensation from
Implements of of items of PPE restored,
third parties for
items of PPE retired or purchased or
disposed of items of PPE that
constructed as
were impaired, lost
replacements
or given up
Determined in
Recognised in
accordance
accordance
with AS 10 Is included in Is determined in
with AS 28*
(Revised) determining profit or accordance with
loss when it becomes AS 10 (Revised)
receivable

(Refer Illustration 16)

Retirements
Items of PPE retired from active use and held for disposal should be stated at the lower of:
 Carrying Amount, and
 Net Realisable Value
Note: Any write-down in this regard should be recognised immediately in the Statement of Profit
and Loss.
De-recognition
The carrying amount of an item of PPE should be derecognised:
 On disposal
 By sale
 By entering into a finance lease, or
 By donation, Or
 When no future economic benefits are expected from its use or disposal
Accounting Treatment
Gain or loss arising from de-recognition of an item of PPE should be included in the Statement of
Profit and Loss when the item is derecognised unless AS 19 on Leases, requires otherwise on a sale
and leaseback (AS 19 on Leases, applies to disposal by a sale and leaseback.)
224

Where,
Gain or loss arising from de-recognition of an item of PPE
Page

= Net disposal proceeds (if any) - Carrying Amount of the item

CA CS KARTHIK MANIKONDA – 75501 37279

Note: Gains should not be classified as revenue, as defined in AS 9 ‘Revenue Recognition’. The
consideration receivable on disposal of an item of property, plant and equipment is recognised in
accordance with the principles enunciated in AS 9.
Exception
An enterprise that in the course of its ordinary activities, routinely sells items of PPE that it had held
for rental to others should transfer such assets to inventories at their carrying amount when they
cease to be rented and become held for sale.
The proceeds from the sale of such assets should be recognised in revenue in accordance with AS 9
on Revenue Recognition.
Determining the date of disposal of an item
An enterprise applies the criteria given in AS 9 for recognising revenue from the sale of goods.
Disclosure

Disclosures

Disclosures related to Voluntary

General Additional Revalued Assets disclosures

General Disclosures
The financial statements should disclose, for each class of PPE:
a. The measurement bases (i.e., cost model or revaluation model) used for determining the gross
carrying amount;
b. The depreciation methods used;
c. The useful lives or the depreciation rates used.
In case the useful lives or the depreciation rates used are different from those specified in the
statute governing the enterprise, it should make a specific mention of that fact;
d. The gross carrying amount and the accumulated depreciation (aggregated with accumulated
impairment losses) at the beginning and end of the period; and
e. A reconciliation of the carrying amount at the beginning and end of the period showing:
i. Additions
225

ii. assets retired from active use and held for disposal
iii. acquisitions through business combinations
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 iv. increases or decreases resulting from revaluations and from impairment losses recognised or
reversed directly in revaluation surplus in accordance with AS 2 28
v. impairment losses recognised in the statement of profit and loss in accordance with AS 28
vi. impairment losses reversed in the statement of profit and loss in accordance with AS 28
vii. depreciation
viii. net exchange differences arising on the translation of the financial statements of a non-
integral foreign operation in accordance with AS 11
ix. other changes
Additional Disclosures
The financial statements should also disclose:
a. The existence and amounts of restrictions on title, and property, plant and equipment pledged as
security for liabilities;
b. The amount of expenditure recognised in the carrying amount of an item of property, plant and
equipment in the course of its construction;
c. The amount of contractual commitments for the acquisition of property, plant and equipment;
d. If it is not disclosed separately on the face of the statement of profit and loss, the amount of
compensation from third parties for items of property, plant and equipment that were impaired,
lost or given up that is included in the statement of profit and loss; and
e. The amount of assets retired from active use and held for disposal.
Disclosures related to Revalued Assets
If items of property, plant and equipment are stated at revalued amounts, the following should be
disclosed:
a. The effective date of the revaluation;
b. Whether an independent valuer was involved;
c. The methods and significant assumptions applied in estimating fair values of the items;
d. The extent to which fair values of the items were determined directly by reference to observable
prices in an active market or recent market transactions on arm’s length terms or were
estimated using other valuation techniques; and
e. The revaluation surplus, indicating the change for the period and any restrictions on the
distribution of the balance to shareholders.
f. Disclosure of the methods adopted and the estimated useful lives or depreciation rates.
226

g. Disclosures as per AS 5, applicable if any.

h. Information on impaired PPE.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Voluntary disclosures:
An enterprise is encouraged to disclose the following:
a. the carrying amount of temporarily idle property, plant and equipment;
b. the gross carrying amount of any fully depreciated property, plant and equipment that is still in
use;
c. for each revalued class of property, plant and equipment, the carrying amount that would have
been recognised had the assets been carried under the cost model;
d. the carrying amount of property, plant and equipment retired from active use and not held for
disposal.
Reference: The students are advised to refer the full text of AS 10 (Revised) “Property, Plant and
Equipment” (2016).

227
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 ILLUSTRATIONS
Illustration 1 (Capitalising the cost of “Remodelling” a Supermarket)
Entity A, a supermarket chain, is renovating one of its major stores. The store will have more
available space for in store promotion outlets after the renovation and will include a restaurant.
Management is preparing the budgets for the year after the store reopens, which include the cost
of remodelling and the expectation of a 15% increase in sales resulting from the store renovations,
which will attract new customers. State whether the remodelling cost will be capitalised or not.
Solution
The expenditure in remodelling the store will create future economic benefits (in the form of 15% of
increase in sales) and the cost of remodelling can be measured reliably, therefore, it should be
capitalised.

Illustration 2
Entity A has an existing freehold factory property, which it intends to knock down and redevelop.
During the redevelopment period the company will move its production facilities to another
(temporary) site. The following incremental costs will be incurred:
1. Setup costs of Rs.5,00,000 to install machinery in the new location.
2. Rent of Rs.15,00,000
3. Removal costs of Rs.3,00,000 to transport the machinery from the old location to the
temporary location.
Can these costs be capitalised into the cost of the new building?
Solution
Constructing or acquiring a new asset may result in incremental costs that would have been avoided
if the asset had not been constructed or acquired. These costs are not to be included in the cost of
the asset if they are not directly attributable to bringing the asset to the location and condition
necessary for it to be capable of operating in the manner intended by management. The costs to be
incurred by the company are in the nature of costs of relocating or reorganising operations of the
company and do not meet the requirement of AS 10 (Revised) and therefore, cannot be capitalised.

Illustration 3
Omega Ltd. contracted with a supplier to purchase machinery which is to be installed in its one
228

department in three months' time. Special foundations were required for the machinery which
Page

were to be prepared within this supply lead time. The cost of the site preparation and laying

CA CS KARTHIK MANIKONDA – 75501 37279

foundations were Rs.1,40,000. These activities were supervised by a technician during the entire
period, who is employed for this purpose of Rs.45,000 per month. The machine was purchased at
Rs.1,58,00,000 and Rs.50,000 transportation charges were incurred to bring the machine to the
factory site. An Architect was appointed at a fee of Rs.30,000 to supervise machinery installation
at the factory site. You are required to ascertain the amount at which the Machinery should be
capitalized.
Solution
Particulars Rs.
Purchase Price Given 1,58,00,000
Add: Site Preparation Cost Given 1,40,000
Technician’s Salary Specific / Attributable overheads
for 3 months (45,000 x 3) 1,35,000
Initial Delivery Cost Transportation 50,000
Professional Fees for Installation Architect’s Fees 30,000
Total Cost of Machinery 1,61,55,000

Illustration 4 (Capitalisation of directly attributable costs)

Entity A, which operates a major chain of supermarkets, has acquired a new store location. The
new location requires significant renovation expenditure. Management expects that the
renovations will last for 3 months during which the supermarket will be closed.
Management has prepared the budget for this period including expenditure related to
construction and remodelling costs, salaries of staff who will be preparing the store before its
opening and related utilities costs. What will be the treatment of such expenditures?
Solution
Management should capitalise the costs of construction and remodelling the supermarket, because
they are necessary to bring the store to the condition necessary for it to be capable of operating in
the manner intended by management. The supermarket cannot be opened without incurring the
remodelling expenditure, and thus the expenditure should be considered part of the asset.
However, if the cost of salaries, utilities and storage of goods are in the nature of operating
expenditure that would be incurred if the supermarket was open, then these costs are not necessary
to bring the store to the condition necessary for it to be capable of operating in the manner
229

intended by management and should be expensed.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

Illustration 5 (Operating costs incurred in the start-up period)
An amusement park has a 'soft' opening to the public, to trial run its attractions. Tickets are sold
at a 50% discount during this period and the operating capacity is 80%. The official opening day of
the amusement park is three months later. Management claim that the soft opening is a trial run
necessary for the amusement park to be in the condition capable of operating in the intended
manner. Accordingly, the net operating costs incurred should be capitalised. Comment.
Solution
The net operating costs should not be capitalised but should be recognised in the Statement of Profit
and Loss. Even though it is running at less than full operating capacity (in this case 80% of operating
capacity), there is sufficient evidence that the amusement park is capable of operating in the
manner intended by management. Therefore, these costs are specific to the start-up and, therefore,
should be expensed as incurred.

Illustration 6 (Consideration received comprising a combination of non-monetary and monetary

assets)
Entity A exchanges land with a book value of Rs.10,00,000 for cash of Rs.20,00,000 and plant and
machinery valued at Rs.25,00,000. What will be the measurement cost of the assets received.
(Consider that the transaction has commercial substance)?
Solution
In the given case, Plant & Machinery is valued at Rs.25,00,000, which is assumed to be fair value in
absence of information. Further, since fair value of land (asset given up) is not given, the transaction
will be recorded at fair value of assets acquired of Rs.45,00,000 (Rs. Cash 20,00,000 + Rs. Plant &
Machinery 25,00,000). Since land of book value Rs.10,00,000 is transferred in exchange of assets
worth Rs.45,00,000, a gain of Rs.35,00,000 will be recognised in the books of Entity A.
The following journal entry will be passed in the books of Entity A:
Cash/ Bank A/c Dr. 20,00,000
Plant & Machinery A/c Dr. 25,00,000
To Land 10,00,000
To Profit on Sale of Land (balancing figure) 35,00,000

Illustration 7 (Exchange of assets that lack commercial substance)

Entity A exchanges car X with a book value of Rs.13,00,000 and a fair value of Rs.13,25,000 for
230

cash of Rs.15,000 and car Y which has a fair value of Rs.13,10,000. The transaction lacks
Page

commercial substance as the company’s cash flows are not expected to change as a result of the

CA CS KARTHIK MANIKONDA – 75501 37279

exchange. It is in the same position as it was before the transaction. What will be the
measurement cost of the assets received?
Solution
Since the transaction lacks commercial substance, the entity recognises the assets received at the
book value of car X. Therefore, it recognises cash of Rs.15,000 and car Y as PPE with a carrying value
of Rs.12,85,000.
The following journal entry will be passed in the books of Entity A:
Cash/ Bank A/c Dr. 15,000
Car Y A/c (balancing figure) Dr. 12,85,000
To Car X A/c 13,00,000

Illustration 8
What happens if the cost of the previous part / inspection was / was not identified in the
transaction in which the item was acquired or constructed?
Solution
De-recognition of the carrying amount occurs regardless of whether the cost of the previous
part/inspection was identified in the transaction in which the item was acquired or constructed.

Illustration 9
What will be your answer in the above question, if it is not practicable for an enterprise to
determine the carrying amount of the replaced part / inspection?
Solution
It may use the cost of the replacement or the estimated cost of a future similar inspection as an
indication of what the cost of the replaced part / existing inspection component was when the item
was acquired or constructed.

Illustration 10 (Revaluation on a class by class basis)

Entity A is a large manufacturing group. It owns a number of industrial buildings, such as factories
and warehouses and office buildings in several capital cities. The industrial buildings are located in
industrial zones, whereas the office buildings are in central business districts of the cities. Entity
A's management want to apply the revaluation model as per AS 10 (Revised) to the subsequent
measurement of the office buildings but continue to apply the historical cost model to the
231

industrial buildings.
Page

State whether this is acceptable under AS 10 (Revised) or not with reasons?

CA CS KARTHIK MANIKONDA – 75501 37279

Solution
Entity A's management can apply the revaluation model only to the office buildings. The office
buildings can be clearly distinguished from the industrial buildings in terms of their function, their
nature and their general location.AS 10 (Revised) permits assets to be revalued on a class by class
basis.
The different characteristics of the buildings enable them to be classified as different PPE classes.
The different measurement models can, therefore, be applied to these classes for subsequent
measurement.
However, all properties within the class of office buildings must be carried at revalued amount.

Illustration 11
Entity A has a policy of not providing for depreciation on PPE capitalised in the year until the
following year, but provides for a full year's depreciation in the year of disposal of an asset. Is this
acceptable?
Solution
The depreciable amount of a tangible fixed asset should be allocated on a systematic basis over its
useful life. The depreciation method should reflect the pattern in which the asset's future economic
benefits are expected to be consumed by the entity.
Useful life means the period over which the asset is expected to be available for use by the entity.
Depreciation should commence as soon as the asset is acquired and is available for use. Thus, the
policy of Entity A is not acceptable.

Illustration 12 (Change in estimate of useful life)

Entity A purchased an asset on 1st January 20X1 for Rs.1,00,000 and the asset had an estimated
useful life of 10 years and a residual value of nil.
On 1st January 20X5, the directors review the estimated life and decide that the asset will
probably be useful for a further 4 years.
Calculate the amount of depreciation for each year, if company charges depreciation on Straight
Line basis.
Solution
The entity has charged depreciation using the straight-line method at Rs.10,000 per annum i.e.
(1,00,000/10 years).
232

On 1st January 20X5, the asset's net book value is [1,00,000 – (10,000 x 4)] Rs.60,000.
Page

The remaining useful life is 4 years.

CA CS KARTHIK MANIKONDA – 75501 37279

The company should amend the annual provision for depreciation to charge the unamortised cost
over the revised remaining life of four years.
Consequently, it should charge depreciation for the next 4 years at Rs.15,000 per annum i.e. (60,000
/ 4 years).
Note: Depreciation is recognised even if the Fair value of the Asset exceeds its Carrying Amount.
Repair and maintenance of an asset do not negate the need to depreciate it.

Illustration 13
Entity B constructs a machine for its own use. Construction is completed on 1st November 20X1
but the company does not begin using the machine until 1st March 20X2. Comment.
Solution
The entity should begin charging depreciation from the date the machine is ready for use – that is,
1st November 20X1. The fact that the machine was not used for a period after it was ready to be
used is not relevant in considering when to begin charging depreciation.

Illustration 14 (Depreciation where residual value is the same as or close to Original cost)
A property costing Rs.10,00,000 is bought in 20X1. Its estimated total physical life is 50 years.
However, the company considers it likely that it will sell the property after 20 years.
The estimated residual value in 20 years' time, based on 20X1 prices, is:
Case (a) Rs.10,00,000
Case (b) Rs.9,00,000.
Calculate the amount of depreciation.
Solution
Case (a)
The company considers that the residual value, based on prices prevailing at the balance sheet date,
will equal the cost.
There is, therefore, no depreciable amount and depreciation is correctly zero.

Case (b)
The company considers that the residual value, based on prices prevailing at the balance sheet date,
will be Rs.9,00,000 and the depreciable amount is, therefore, Rs.1,00,000.
233

Annual depreciation (on a straight-line basis) will be Rs.5,000 [{10,00,000 – 9,00,000} ÷ 20].
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Illustration 15 (Determination of appropriate Depreciation Method)
Entity B manufactures industrial chemicals and uses blending machines in the production process.
The output of the blending machines is consistent from year to year and they can be used for
different products.
However, maintenance costs increase from year to year and a new generation of machines with
significant improvements over existing machines is available every 5 years. Suggest the depreciation
method to the management.
Solution
The straight-line depreciation method should be adopted, because the production output is
consistent from year to year.
Factors such as maintenance costs or technical obsolescence should be considered in determining
the blending machines’ useful life.

Illustration 16 (Gain on replacement of Insured Assets)

Entity A carried plant and machinery in its books at Rs.2,00,000. These were destroyed in a fire.
The assets were insured 'New for old' and were replaced by the insurance company with new
machines that cost Rs.20,00,000. The machines were acquired by the insurance company and the
company did not receive Rs.20,00,000 as cash compensation. State, how Entity A should acco unt
for the same?
Solution
Entity A should account for a loss in the Statement of Profit and Loss on de-recognition of the
carrying value of plant and machinery in accordance with AS 10 (Revised). Entity A should separately
recognise a receivable and a gain in the income statement resulting from the insurance proceeds
under AS 29 (Revised)* once receipt is virtually certain. The receivable should be measured at the
fair value of assets that will be provided by the insurer.
234
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. As per AS 10 (Revised) ‘Property, plant and equipment’, which of the following costs is not
included in the carrying amount of an item of PPE
a. Costs of site preparation
b. Costs of relocating
c. Installation and assembly costs.
d. initial delivery and handling costs

2. As per AS 10 (Revised) ‘Property, Plant and Equipment’, an enterprise holding investment

properties should value Investment property
a. as per fair value
b. under discounted cash flow model.
c. under cost model
d. under cash flow model

3. A plot of land with carrying amount of Rs.1,00,000 was revalued to Rs.1,50,000 at the end of
Year 2. Subsequently, due to drop in market values, the land was determined to have a fair
value of Rs.1,30,000 at the end of Year 4. Assuming that the entity adopts Revaluation Model,
what would be the accounting treatment of Revaluation?
a. Initial upward valuation of Rs.50,000 credited to Revaluation Reserve. Subsequent
downward revaluation of Rs.20,000 debited to P/L.
b. Initial upward valuation of Rs.50,000 credited to P/L. Subsequent downward revaluation of
Rs.20,000 debited to P/L.
c. Initial upward valuation of Rs.50,000 credited to Revaluation Reserve. Subsequent
downward revaluation of Rs.20,000 debited to Revaluation Reserve.
d. Initial upward valuation of Rs.50,000 debited to P/L. Subsequent downward revaluation of
Rs.20,000 credited to P/L.

4. A plot of land with carrying amount of Rs.1,00,000 was revalued to Rs.90,000 at the end of
Year 2. Subsequently, due to increase in market values, the land was determined to have a fair
235

value of Rs.1,05,000 at the end of Year 4. Assuming that the entity adopts Revaluation Model,
what would be the accounting treatment of Revaluation?
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 a. Initial downward valuation of Rs.10,000 debited to Revaluation Reserve. Subsequent
upward revaluation of Rs.15,000 credited to P/L.
b. Initial downward valuation of Rs.10,000 debited to P/L. Subsequent upward revaluation of
Rs.15,000 credited to P/L.
c. Initial downward valuation of Rs.10,000 debited to P/L. Subsequent upward revaluation of
Rs.10,000 credited to P/L and Rs.5,000 credited to Revaluation Reserve.
d. Initial downward valuation of Rs.10,000 credited to P/L. Subsequent upward revaluation of
Rs.10,000 debited to P/L and Rs.5,000 debited to Revaluation Reserve.

5. On sale of an asset which was revalued upwards, what would be the treatment of Revaluation
Reserve?
a. The Revaluation Reserve is credited to P/L since the profit on sale of such asset is now
realized.
b. The Revaluation Reserve is credited to Retained Earnings as a movement in reserves
without impacting the P/L.
c. No change in Revaluation Reserve since profit on sale of such asset is already impacting the
P/L.
d. The Revaluation Reserve is reduced from the asset value to compute profit or loss.

6. A machinery was purchased having an invoice price Rs.1,18,000 (including GST Rs.18,000) on 1
April 20X1. The GST amount is available as input tax credit. The rate of depreciation is 10% on
SLM basis. The depreciation for 20X2-X3 would be
a. Rs.10,000.
b. Rs.11,800.
c. Rs.9,000.
d. Rs.10,500.

ANSWERS/SOLUTIONS
MCQs
1. b. Costs of relocating
2. c. under cost model
236

3. c. Initial upward valuation of Rs.50,000 credited to Revaluation Reserve. Subsequent

downward revaluation of Rs.20,000 debited to Revaluation Reserve.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 4. c. Initial downward valuation of Rs.10,000 debited to P/L. Subsequent upward
revaluation of Rs.10,000 credited to P/L and Rs.5,000 credited to Revaluation
Reserve.
5. b. The Revaluation Reserve is credited to Retained Earnings as a movement in reserves
without impacting the P/L.
6. a. Rs.10,000.

THEORY QUESTIONS
Q.NO.1. A company changed its method of depreciation from SLM to WDV. How should the
change be recognised?
ANSWER
As per AS 10, Property, Plant and Equipment, the depreciation method applied to an asset should be
reviewed at least at each financial year-end and, if there has been a significant change in the
expected pattern of consumption of the future economic benefits embodied in the asset, the
method should be changed to reflect the changed pattern. Such a change should be accounted for
as a change in an accounting estimate in accordance with AS 5.
Accordingly, the change in method of depreciation should be accounting for as a change in
accounting estimate, prospectively.

Q.NO.2. A company has debited the Building Account with the Cost of the Land on which the
building stands and has provided depreciation on such total cost. Comment on the accounting
treatment.
ANSWER
As per AS 10, Property, Plant and Equipment, each part of an item of property, plant and equipment
with a cost that is significant in relation to the total cost of the item should be depreciated
separately. Further, Land and buildings are separable assets and are accounted for separately, even
when they are acquired together. With some exceptions, such as quarries and sites used for landfill,
land has an unlimited useful life and therefore is not depreciated. Buildings have a limited useful life
and therefore are depreciable assets.
In the given case, land should not be depreciated unless it has a limited useful life. Accordingly, it is
incorrect to debit the cost of land to the Building Account and provide depreciation on the aggregate
237

cost.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Q.NO.3. An entity is setting up a manufacturing plant. Construction of the plant is completed in
August and the plant is ready for commercial production in November. However, the entity
commences production in March. When should be company start charging depreciation.
ANSWER
As per AS 10, Property, Plant and Equipment, depreciation of an asset begins when it is available for
use, i.e., when it is in the location and condition necessary for it to be capable of operating in the
manner intended by management.
In the given case, since the plant is ready for commercial production in November, depreciation shall
commence from November. The date of commencement of commercial production is irrelevant for
charging depreciation.

Q.NO.4. Which factors should be considered by a company while determining useful life?
ANSWER
All the following factors are considered in determining the useful life of an asset:
a. expected usage of the asset. Usage is assessed by reference to the expected capacity or physical
output of the asset.
b. expected physical wear and tear, which depends on operational factors such as the number of
shifts for which the asset is to be used and the repair and maintenance programme, and the care
and maintenance of the asset while idle.
c. technical or commercial obsolescence arising from changes or improvements in production, or
from a change in the market demand for the product or service output of the asset. Expected
future reductions in the selling price of an item that was produced using an asset could indicate
the expectation of technical or commercial obsolescence of the asset, which, in turn, might
reflect a reduction of the future economic benefits embodied in the asset.
d. legal or similar limits on the use of the asset, such as the expiry dates of related leases.

Q.NO.5. An entity gave the following Note in its Financial Statements: ‘The company chooses
not to charge depreciation on Property, Plant and Equipment on account of:
a. Annual Maintenance Contracts being expensed thereby ensuring timely repairs of Plant and
Machinery.
b. Depreciation being a non-cash expense has no impact on cash flows. Accordingly, it is not
238

necessary to depreciate an asset when repairs and maintenance charges are expensed in the
Statement of Profit and Loss.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

c. The values of certain assets like Property increase with passage of time, and hence charging
depreciation does not make sense.
d. At the end of the useful life, the asset is ultimately sold, and since the asset is at cost due to no
depreciation, exact profit or loss on sale of the asset is stated.’
You are required to state the appropriateness of the above accounting policy in line with the
relevant Accounting Standards.
ANSWER
Depreciation refers to writing off the value of the asset over its useful life. Such write-off is
necessitated on account of normal wear-and-tear, usage, or obsolescence. Since items of Property,
Plant and Equipment are generally used in generating revenue, the pro-rated write-off in value of
such item should be recorded in the books against the income earned by such an asset.
Providing depreciation is mandatory, in spite of the fact that repairs are expensed in the Statement of
Profit and Loss, or the value of the Property is appreciating. Depreciation is a systematic allocation of cost
of the asset against the income generated from the continued use of the asset. Further, the Companies
Act, 2013 mandates depreciation to be charged in order to determine the correct profits. Thus, not
charging depreciation would result in non-compliance with the Companies Act provisions as well.
The argument laid down by the company and the reasons for the same being invalid are discussed
below.
a. Annual Maintenance Contracts being expensed thereby ensuring timely repairs of Plant and
Machinery:
The fact that the company enters into Annual Maintenance Contracts for timely repairs can be
regarded as a running cost. Such expense is incurred in order to ensure that the machine
continues to run as intended. Thus, it implies that because the machine is being utilized, it will
need regular repairs. In other words, continuous use is resulting in normal wear-and-tear which
is the reason why depreciation should be charged by the company. By stating that the company
incurs Annual Maintenance Expenses, the company is recording only the ’maintenance
expenses’, but not the wear-and-tear requiring the maintenance in the first place. Hence, this
argument put forth by the company is not valid.
b. Depreciation being a non-cash expense has no impact on cash flows. Accordingly, it is not
necessary to depreciate an asset when repairs and maintenance charges are expensed in the
Statement of Profit and Loss.
239

When viewed from the prism of depreciation alone, it appears that the fact that depreciation is a
non-cash item is correct. However, it must be noted that at the time of procurement of the asset,
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 the company would have paid cash. Depreciation is after all writing off this amount over the life
of the asset. Hence the argument that depreciation is a non-cash item is not valid. Depreciation
is writing off the cost of the asset (which was already paid for) over the useful life of the asset,
and hence is mandatory.
c. The values of certain assets like Property increase with passage of time, and hence charging
depreciation does not make sense.
Certain assets like immovable property do increase in value with the passage of time. However,
such assets are ‘used for the purposes of business’ and are not ‘held for sale’ or held as
investment property. Accordingly, since the asset is being used for carrying on business, v v 5.70
providing depreciation will give a true and fair view of the results of the company, and hence the
argument that the value of the property appreciates is not valid.
If the company wants to show the fair market value of the PPE, then it has the option to apply
Revaluation model. However, depreciation is mandatory to be charged in Revaluation model
also.

d. At the end of the useful life, the asset is ultimately sold, and since the asset is at cost due to no
depreciation, exact profit or loss on sale of the asset is stated.’

The value of any asset, after usage, will reduce. Accordingly, the argument that the ‘exact profit
or loss on sale of the asset’ will be obtained is incorrect. Due to usage of the asset, the value of
the asset would be lower than the cost. Charging depreciation would seek to bring the book
value approximating to such reduced value. Thereafter, on sale of the asset, the true profit or
loss would be available. Accordingly, this argument is also invalid.
It may be pertinent to note that Accounting Standard 1, Disclosure of Accounting Policies states
that Disclosure of accounting policies or of changes therein cannot remedy a wrong or
inappropriate treatment of the item in the accounts. In other words, the company cannot be
absolved of the fact that it has not complied with the relevant accounting standards merely by
giving a disclosure of incorrect policies or practices being followed.
Thus, the company’s stand of disclosing the incorrect policy as a remedy is not correct. The
company is suggested to charge depreciation on a systematic basis over the useful life of the
asset thereby complying with the Accounting Standards.
240
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 PRACTICAL QUESTIONS
Q.NO.1. With reference to AS-10 Revised, classify the items under the following heads:
HEADS
i. Purchase Price of Property, plant and Equipment (PPE)
ii. Directly attributable cost of PPE or
iii. Cost not included in determining the carrying amount of an item of PPE.
ITEMS
1. Import duties and non-refundable purchase taxes.
2. Initial delivery and handling costs.
3. Initial operating losses, such as those incurred while demand for the output of an item builds
up.
4. Costs incurred while an item capable of operating in the manner intended by management has
yet to be brought into use or is operated at less than full capacity.
5. Trade discounts and rebates.
6. Costs of relocating or reorganizing part or all of the operations of an enterprise.
7. Installation and assembly costs.
8. Administration and other general overhead costs.
SOLUTION
Heads
i. Purchase price of PPE
ii. Directly attributable cost of PPE
iii. Cost not included in determining the carrying amount of an item of PPE
Items Classified
under Head
1. Import duties and non-refundable purchase taxes (i)
2. Import duties and non-refundable purchase taxes (ii)
3. Initial delivery and handling costs 3 Initial operating losses, such as those (iii)
incurred while demand for the output of an item builds up
4. Costs incurred while an item capable of operating in the manner intended by (iii)
management has yet to be brought into use or is operated at less than full
capacity.
241

5. Trade discounts and rebates (deducted for computing purchase price) (i)
6. Costs of relocating or reorganizing part or all of the operations of an (iii)
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 enterprise.
7. Installation and assembly costs (ii)
8. Administration and other general overhead costs (iii)

Q.NO.2. ABC Ltd. is installing a new plant at its production facility. It has incurred these costs:
1. Cost of the plant (cost per supplier’s invoice plus taxes) Rs.25,00,000
2. Initial delivery and handling costs Rs.2,00,000
3. Cost of site preparation Rs.6,00,000
4. Consultants used for advice on the acquisition of the plant Rs.7,00,000
5. Interest charges paid to supplier of plant for deferred credit Rs.2,00,000
6. Estimated dismantling costs to be incurred after 7 years Rs.3,00,000
7. Operating losses before commercial production Rs.4,00,000

Please advise ABC Ltd. on the costs that can be capitalised in accordance with AS 10 (Revised).

SOLUTION
According to AS 10 (Revised), these costs can be capitalised:
1. Cost of the plant Rs.25,00,000
2. Initial delivery and handling costs Rs.2,00,000
3. Cost of site preparation Rs.6,00,000
4. Consultants’ fees Rs.7,00,000
5. Estimated dismantling costs to be incurred after 7 years Rs.3,00,000
Rs.43,00,000

Note: Interest charges paid on “Deferred credit terms” to the supplier of the plant (not a
qualifying asset) of Rs.2,00,000 and operating losses before commercial production amounting to
Rs.4,00,000 are not regarded as directly attributable costs and thus cannot be capitalised. They
should be written off to the Statement of Profit and Loss in the period they are incurred.

Q.NO.3. Arka Ltd. purchased machinery for Rs.3,000 lakhs. Depreciation was charged at 10% on
SLM basis for a useful life of 10 years. At the end of Year 4, the machinery was revalued to
Rs.2,700 lakhs and the same was adopted. What will be the carrying amount of the asset at the
242

end of Year 5 and Year 6? Assume no change in the useful life.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

SOLUTION
Particulars Rs.in lakhs
Original Cost of the Asset 3,000.00
Less: Depreciation for 4 years (Rs.3,000 lakhs x 10% x 4 years) (1,200.00)
Book Value at the end of Year 4 1,800.00
Add: Revaluation Surplus (balancing figure) 900.00
Revalued Amount as given (= revised depreciable value) 2,700.00
Less: Depreciation for Year 5 (Rs.2,700 lakhs ÷ 6 years) 450.00
Carrying Amount at the end of Year 5 2,250.00
Less: Depreciation for Year 6 (Rs.2,700 lakhs ÷ 6 years) 450.00
Carrying Amount at the end of Year 6 1,800.00

Q.NO.4. Skanda Ltd. acquired a machinery for Rs.2,50,00,000 five years ago. Depreciation was
charged at 10% p.a. on SLM basis, useful life being 10 years. At the beginning of Year 3, the
machinery was revalued to Rs.3,00,00,000 with the surplus on revaluation being credited to
Revaluation Reserve. Depreciation was provided on the revalued amount over the balance useful
life of 8 years. The machinery was sold in the current year for Rs.1,12,50,000. Give the accounting
treatment for the above in the Company’s accounts. What will be the treatment if the machinery
fetched only Rs.42,50,000 now?
SOLUTION
Particulars Rs.
Original Cost of the Asset 2,50,00,000

Less: Depreciation for 2 years (Rs.2,50,00,000 x 10% x 2years) (50,00,000)

Book Value at the end of Year 3 2,00,00,000

Add: Revaluation Surplus (balancing figure) 1,00,00,000

Revalued Amount as given (= revised depreciable value) 3,00,00,000

243

Less: Depreciation for Year 5 (Rs.3,00,00,000÷ 8 years x 3 yrs ) 1,12,50,000

Carrying Amount at the end of Year 5 1,87,50,000
Page

CA CS KARTHIK MANIKONDA – 75501 37279

The treatment of Gain / Loss on Disposal / Revaluation is as below:
Particulars Disposal Proceeds = Disposal Proceeds =
Rs.1,12,50,000 Rs.42,50,000
Book Value Less Disposal Proceeds = (Rs.1,87,50,000 – (Rs.1,87,50,000 –
Loss recognized in Profit or Loss Rs.1,12,50,000) Rs.42,50,000)
= Rs.75,00,000 (Loss) = Rs.1,45,00,000 (Loss)
Revaluation Surplus directly
transferred to Retained Earnings Rs.1,00,00,000 Rs.1,00,00,000

Q.NO.5. Akshar Ltd. installed a new Plant (not a qualifying asset), at its production facility, and
incurred the following costs:
 Cost of the Plant (as per supplier’s invoice): Rs.30,00,000
 Initial delivery and handling costs: Rs.1,00,000
 Cost of site preparation: Rs.2,00,000

 Consultant fee for advice on acquisition of Plant: Rs.50,000

 Interest charges paid to supplier against deferred credit: Rs.1,00,000
 Estimate of Dismantling and Site Restoration costs: Rs.50,000 after 10 years (Present Value is
Rs.30,000)
 Operating losses before commercial production: Rs.40,000
The company identified motors installed in the Plant as a separate component and a cost of
Rs.5,00,000 (Purchase Price) and other costs were allocated to them proportionately. The
company estimates the useful life of the Plant and those of the Motors as 10 years and 6 years
respectively and SLM method of Depreciation is used.

At the end of Year 4, the company replaces the Motors installed in the Plant at a cost of
Rs.6,00,000 and estimated the useful life of new motors to be 5 years. Also, the company revalued
its entire class of Fixed Assets at the end of Year 4. The revalued amount of Plant as a whole is
Rs.25,00,000. At the end of Year 8, the company decides to retire the Plant from active use and
also disposed the Plant as a whole for Rs.6,00,000.
There is no change in the Dismantling and Site Restoration liability during the period of use. You
are required to explain how the above transaction would be accounted in accordance with AS 10.
244
Page

CA CS KARTHIK MANIKONDA – 75501 37279

SOLUTION
1. Cost at Initial Recognition:
Particulars Rs.
Cost of the Plant (as per Invoice) 30,00,000
Initial Delivery and Handling Costs 1,00,000
Cost of Site Preparation 2,00,000
Consultants’ Fees 50,000
Estimated Dismantling and Site Restoration Costs 30,000
Total Cost of Plant including Motors 33,80,000
Less: Cost of Motors identified as a separate component (1/6)* 5,63,333
Cost of the Plant (excluding Motors – balance 5/6) 28,16,667

* Purchase price of Motors = Rs.5,00,000 out of Rs.30,00,000 i.e., 1/6 of value of Plant
Note: Since the asset is not a qualifying asset, payment of interest to the supplier is not
capitalized. Further, operating losses of Rs.40,000 incurred before commercial production is not a
directly attributable cost, and hence excluded from cost of asset. These costs are expensed to the
P/L as and when they are incurred.

2. Recognition of Motors Replacement

Particulars Rs.
Cost of Motors determined above 5,63,333
Less: Depreciation for 4 years (as per SLM) 3,75,555
5,63,333 ÷ 6 years x 4 years
Carrying Amount of Motors at the end of Year 4 1,87,778
Accounting: The company should derecognize the existing Carrying Amount of Motors replaced
of Rs.1,87,778. Further, the acquisition cost of new motors of Rs.6,00,000 would be capitalized as
a separate component. This amount will be depreciated over the next 5 years at Rs.6,00,000 ÷ 5
years = Rs.1,20,000 p.a.
3. Revaluation
Particulars Rs.
Cost of the Plant at initial recognition [from (1) above] 28,16,667
Less: SLM Depreciation for 4 years: Rs.28,16,667 ÷ 10 years x 4 years 11,26,667
245

Carrying Amount of Plant at the end of Year 4 16,90,000

Page

Revalued Amount of Plant (Excluding Motors, since the same is treated as

CA CS KARTHIK MANIKONDA – 75501 37279

 a separate component: Rs.25,00,000 – Rs.6,00,000) 19,00,000

Therefore, Gain on Revaluation credited to Revaluation Reserve 2,10,000

Revised Depreciation Charge p.a.: 19,00,000 ÷ 6 years 3,16,667

4. Derecognition
Particulars Motors Plant (excluding Motors)
Cost / Revalued Amount at end of Year 4 6,00,000 19,00,000
Less: Depreciation for Years 5-8 1,20,000 x 4 = 4,80,000 3,16,667 x 4 =12,66,668

Carrying Amount before Disposal / 1,20,000 6,33,332

De-recognition
Less: Disposal Proceeds Rs.6,00,000 95,575 5,04,425
allocated in ratio of carrying amount
Loss to be written off to P/L 24,425 1,28,907

Notes:
a. The Revaluation Surplus of Rs.2,10,000 would be transferred directly to Retained Earnings.
b. The allocation of disposal proceeds of Rs.6,00,000 for the plant as whole is apportioned
based on carrying amount of motors and plant (excluding motors)
Alternatively, it may be apportioned as 1/6 towards motors and 5/6 plant (excluding motors)
based on the reasoning that the initially, motors amounted to 1/6 of the entire plant. This
approach may not be preferable because there has been a revaluation of the plant (excluding
motors) and a disposal and subsequent acquisition of the Motor, which is not in the initial
proportion of 5/6 and 1/6 respectively

Q.NO.6. Bharat Infrastructure Ltd. acquired a heavy machinery at a cost of Rs.1,000 lakhs, the
breakdown of its components is not provided. The estimated useful life of the machinery is 10
years. At the end of Year 6, the turbine, which is a major component of the machinery, needed
replacement, as further usage and maintenance was uneconomical. The remainder of the machine
is in good condition and is expected to last for the remaining 4 years. The cost of the new turbine
is Rs.450 lakhs. Give the accounting treatment for the new turbine, assuming SLM Depreciation
and a discount rate of 8%.
246
Page

CA CS KARTHIK MANIKONDA – 75501 37279

SOLUTION
As per AS 10, Property, Plant and Equipment, the derecognition of the carrying amount of
components of an item of Property, Plant and Equipment occurs regardless of whether the cost of
the previous part / inspection was identified in the transaction in which the item was acquired or
constructed. If it is not practicable for an enterprise to determine the carrying amount of the
replaced part/ inspection, it may use the cost of the replacement or the estimated cost of a future
similar inspection as an indication of what the cost of the replaced part/ existing inspection
component was when the item was acquired or constructed.
In the given case, the new turbine will produce economic benefits to Bharat Infrastructure Ltd. and
the cost is measurable. Since the recognition criteria is fulfilled, the same should be recognised as a
separate item of Property, Plant and Equipment. However, since the initial breakup of the
components is not available, the cost of the replacement of Rs.450 lakhs can be used as an
indication based on the guidance given above, discounted at 8% for the 6-year period lapsed.
Thus, estimate of cost 6 years back = Rs.450 lakhs ÷ 1.086 = Rs.283.58 lakhs
Current carrying amount of turbine (to be de-recognised) = Estimated cost Rs.283.58 lakhs (–) SLM
depreciation at 10% (useful life 10 years) for 6 years Rs.170.15 lakhs= Rs.113.43 lakhs.
Hence revised carrying amount of the machinery will be as under :
Particulars Rs.
Historical Cost [Rs.1,000 lakhs (–) SLM Depreciation at 10% (10 year life) for 6 400.00
years]
Add: Cost of new turbine 450.00
Less: Derecognition of current carrying amount of old turbine (113.43)
New Carrying Amount of Machinery 736.57

Q.NO.7. Preet Ltd. intends to set up a steel plant, for which it has acquired a dilapidated factor
having an area of 5,000 acres at a cost of Rs.60,000 per acre. Preet Ltd. has incurred Rs.1.10 crores
on demolishing the old Factory Building thereon. A sum of Rs.63,00,000 (including 5% GST
thereon) was realized from the sale of material salvaged from the site. Preet Ltd. incurred Stamp
Duty and Registration Charges of 7% of land value, paid legal and consultancy charges Rs.8,00,000
for land acquisition and incurred Rs.1,25,000 on title guarantee insurance. Compute the value of
the land acquired.
247
Page

CA CS KARTHIK MANIKONDA – 75501 37279

SOLUTION
Particulars Rs.
Purchase Price: 5,000 acres x Rs.60,000 per acre 3,000.00
Stamp Duty and Registration Charges at 7% 210.00
Legal and Consultancy Fees 8.00
Title Guarantee Insurance 1.25
Demolition Expenses (Net of Salvage Income) 50.00
[Rs.110 lakhs (–) Rs.60 lakhs (Rs.63 lakhs x 100/105)]
Cost of Land 3,269.25

248
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 UNIT 3: ACCOUNTING STANDARD 13:
ACCOUNTING FOR INVESTMENTS
LEARNING OUTCOMES
After studying this unit, you will be able to comprehend–
 What are the various Forms of Investments
 Classification of Investments
 How to compute the Cost of Investments
 Current Investments
 Long-term Investments
 Investment Properties
 Disposal of Investments
 Reclassification of Investments
 Disclosure Requirements as per the standard.

3.1 INTRODUCTION
The standard deals with accounting for investments in the financial statements of enterprises and
related disclosure requirements.
Shares, debentures and other securities held as stock-in-trade (i.e., for sale in the ordinary course of
business) are not ‘investments’ as defined in this Standard. However, the manner in which they are
accounted for and disclosed in the financial statements is quite similar to that applicable in respect
of current investments. Accordingly, the provisions of this Standard, to the extent that they relate to
current investments, are also applicable to shares, debentures and other securities held as stock-in-
trade, with suitable modifications as specified in this Standard.

This Standard does not deal with:

a. The basis for recognition of interest, dividends and rentals earned on investments which are
covered by AS 9
b. Operating or finance leases
c. Investments on retirement benefit plans and life insurance enterprises
d. Mutual funds, venture capital funds and/ or the related asset management companies, banks
249

and public financial institutions formed under a Central or State Government Act or so declared
under the Companies Act, 2013.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

3.2 DEFINITION OF THE TERMS USED IN THE STANDARD
Investments are assets held by an enterprise for earning income by way of dividends, interest, and
rentals, for capital appreciation, or for other benefits to the investing enterprise. Assets held as
stock-in-trade (inventory) are not ‘investments’
Fair value is the amount for which an asset could be exchanged between a knowledgeable, willing
buyer and a knowledgeable, willing seller in an arm’s length transaction. Under appropriate
circumstances, market value or net realisable value provides an evidence of fair value.
Market value is the amount obtainable from the sale of an investment in an open market, net of
expenses necessarily to be incurred on or before disposal.

3.3 FORMS OF INVESTMENTS

Enterprises hold investments for diverse reasons. For some enterprises, investment activity is a
significant element of operations, and assessment of the performance of the enterprise may largely,
or solely, depend on the reported results of this activity.
Some investments have no physical existence and are represented merely by certificates or similar
documents (e.g., shares) while others exist in a physical form (e.g., buildings). For some investments,
an active market exists from which a market value (fair value) can be established. For other
investments, an active market does not exist and other means are used to determine fair value.
3.4 CLASSIFICATION OF INVESTMENTS

Classification of Investments

Current Investments Long Term Investments

A current investment is an investment that is by its nature readily realisable and is intended to be
held for not more than one year from the date on which such investment is made. The intention to
hold for not more than one year is to be judged at the time of purchase of investment.
A long term investment is an investment other than a current investment.
Further classification of current and long-term investments should be as specified in the statute
250

governing the enterprise. In the absence of a statutory requirement, such further classification
should disclose, where applicable, investments in:
Page

CA CS KARTHIK MANIKONDA – 75501 37279

a. Government or Trust securities
b. Shares, debentures or bonds
c. Investment properties
d. Others—specifying nature
3.5 COST OF INVESTMENTS
The cost of an investment includes acquisition charges such as brokerage, fees and duties etc.
Example
X Ltd invests in long-term deposit worth Rs. 200 lakhs on 1st April 2022. It incurs brokerage cost of
Rs.1 lakh to be able to make the investment. The value of the investment on 1st April 2022 is Rs.201
lakhs.
If an investment is acquired, or partly acquired, by the issue of shares or other securities, the
acquisition cost is the fair value of the securities issued. The fair value may not necessarily be equal
to the nominal or par value of the securities issued.
If an investment is acquired in exchange, or part exchange, for another asset, the acquisition cost of
the investment is determined by reference to the fair value of the asset given up or the fair value of
the investment acquired, whichever is more clearly evident.
Interest, dividends and rentals receivables in connection with an investment are generally regarded
as income, being the return on the investment. However, in some circumstances, such inflows
represent a recovery of cost and do not form part of income.
For example, when unpaid interest has accrued before the acquisition of an interest-bearing
investment and is therefore included in the price paid for the investment, the subsequent receipt of
interest is allocated between pre-acquisition and post-acquisition periods; the pre-acquisition
portion is deducted from cost. When dividends on equity are declared from pre-acquisition profits, a
similar treatment may apply. If it is difficult to make such an allocation except on an arbitrary basis,
the cost of investment is normally reduced by dividends receivable only if they clearly represent a
recovery of a part of the cost.
When right shares offered are subscribed for, the cost of the right shares is added to the carrying
amount of the original holding. If rights are not subscribed for but are sold in the market, the sale
proceeds are taken to the profit and loss statement.
However, where the investments are acquired on cum-right basis and the market value of
investments immediately after their becoming ex-right is lower than the cost for which they were
251

acquired, it may be appropriate to apply the sale proceeds of rights to reduce the carrying amount
of such investments to the market value.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Acquisition charges

Fair value of the

securities issued

Added fair value of the asset given up or

the fair vale of the investment
acquired ,whichever is more clearly
evident .

Cost of Right shares

subscribed

Cost of investment Interest received for pre-

acquisition period

Dividend received for pre-

acquisition period only if
they clearly represent a
recovery of cost .

Reduced
If investments acquired on cum-
right basis and the market value of
investments immediatly after their
becoming ex-rights is lower than the
cost for which they were
acquried,then sale proceeds till
carrying amount becomes equal to
market value.

3.6 CARRYING AMOUNT OF INVESTMENTS

The carrying amount for current investments is the lower of cost and fair value.
Valuation of current investments on overall (or global) basis is not considered appropriate.
Sometimes, the concern of an enterprise may be with the value of a category of related current
investments and not with each individual investment, and accordingly the investments may be
carried at the lower of cost and fair value computed category-wise (i.e. equity shares, preference
shares, convertible debentures, etc.). However, the more prudent and appropriate method is to
carry investments individually at the lower of cost and fair value.
252

Any reduction to fair value is debited to profit and loss account, however, if fair value of investment
is increased subsequently, the increase in value of current investment up to the cost of investment is
Page

credited to the profit and loss account (and excess portion, if any, is ignored).

CA CS KARTHIK MANIKONDA – 75501 37279

Long term investments are usually carried at cost. The carrying amount of long-term investments is
therefore determined on an individual investment basis. Where there is a decline, other than
temporary, in the carrying amounts of long term valued investments, the resultant reduction in the
carrying amount is charged to the profit and loss statement. The reduction in carrying amount is
reversed when there is a rise in the value of the investment, or if the reasons for the reduction no
longer exist. Example of Decline other than temporary:
A. Company in which investment is made is making cash operating losses which has resulted in
reduction of its net worth,
B. New regulation which has negative impact in the working of the investee,
C. Significant reduction of quoted price of the investment, etc.

Carrying Amount

Current Long term

investments investments

Lower of cost
and fair value. Valuation Carried Valuation

Any reduction to on overall (or

global) basis is at cost. Determined on
fair value is an individual
debited to profit not
considered investment
and loss account, basis.
however, if fair appropriate;
value of prudent Where there is a decline,
investment is method is to other than temporary,in the
increased carry carrying amounts of long term
subsequently, the investment valued investments, the
increase in value individually. resultant reduction in the
of current carrying amount is charged to
investment up to the profit and loss statement.
the cost of The reduction in carrying
investment is amount is reversed when
credited to the there is a rise in the value of
profit and loss the investment, or if the
account (and reasons for the reduction no
excess portion, if longer exist.
any, is ignored).

(Refer Illustration 1 & 2)

3.7 INVESTMENT PROPERTIES
253

An investment property is an investment in land or buildings that are not intended to be occupied
Page

substantially for use by, or in the operations of, the investing enterprise.

CA CS KARTHIK MANIKONDA – 75501 37279

An investment property is accounted for in accordance with cost model as prescribed in AS 10
(Revised), ‘Property, Plant and Equipment’. The cost of any shares in a co-operative society or a
company, the holding of which is directly related to the right to hold the investment property, is
added to the carrying amount of the investment property.
3.8 DISPOSAL OF INVESTMENTS
On disposal of an investment, the difference between the carrying amount and the disposal
proceeds, net of expenses, is recognised in the profit and loss statement.
When disposing of a part of the holding of an individual investment, the car rying amount to be
allocated to that part is to be determined on the basis of the average carrying amount of the total
holding of the investment1.
3.9 RECLASSIFICATION OF INVESTMENTS
Where long-term investments are reclassified as current investments, transfers are made at the
lower of cost and carrying amount at the date of transfer.
Where investments are reclassified from current to long-term, transfers are made at the lower of
cost and fair value at the date of transfer.
(Refer Illustration 3)
3.10 DISCLOSURE
The following disclosures in financial statements in relation to investments are appropriate: -
a. The accounting policies followed for the determination of carrying amount of investments’.
b. The amounts included in profit and loss statement for:
i. Interest, dividends (showing separately dividends from subsidiary companies), and rentals
on investments showing separately such income from long term and current investments.
Gross income should be stated, the amount of income tax deducted at source being
included under Advance Taxes Paid.
ii. Profits and losses on disposal of current investments and changes in carrying amount of
such investments.
iii. Profits and losses on disposal of long term investments and changes in the carrying amount
of such investments.
c. Significant restrictions on the right of ownership, realisability of investments or the remittance of
income and proceeds of disposal.
d. The aggregate amount of quoted and unquoted investments, giving the aggregate market value
of quoted investments.
254

e. Other disclosures as specifically required by the relevant statute governing the enterprise.
f. Classification of investments.
Page

(Refer Illustration 4 - 9)

CA CS KARTHIK MANIKONDA – 75501 37279

 ILLUSTRATIONS
Illustration 1
An unquoted long term investment is carried in the books at a cost of Rs. 2 lakhs. The published
accounts of the unlisted company received in May, 20X1 showed that the company was incurring
cash losses with declining market share and the long term investment may not fetch more than
Rs.20,000. How will you deal with this in preparing the financial statements of R Ltd. for the year
ended 31st March, 20X1?
Solution
As stated in the question that financial statements for the year ended 31st March, 20X1 are still
under preparation – The answer has been given on the assumption that the financial statements are
yet to be completed and approved by the Board of Directors.
Also, the fall in value of investments has been considered on account of conditions existing on the
balance sheet date.
Investments classified as long term investments should be carried in the financial statements at cost.
However, provision for diminution should be made to recognise a decline, other than temporary, in
the value of the investments, such reduction being determined and made for each investment
individually. AS 13 (Revised) ‘Accounting for Investments’ states that indicators of the value of an
investment are obtained by reference to its market value, the investee's assets and results and the
expected cash flows from the investment. On the above basis, the facts of the given case clearly
suggest that the provision for diminution should be made to reduce the carrying amount of long
term investment to Rs. 20,000 in the financial statements for the year ended 31st March, 20X1.
Illustration 2
X Ltd. on 1-1-20X1 had made an investment of Rs. 600 lakhs in the equity shares of Y Ltd. of which 50%
is made in the long term category and the rest as temporary investment. The realisable value of all
such investment on 31-3-20X1 became Rs. 200 lakhs as Y Ltd. lost a case of copyright. From the given
market conditions, it is apparent that the reduction in the value is not temporary in nature. How will
you recognise the reduction in financial statements for the year ended on 31-3-20X1?
Solution
X Ltd. invested Rs. 600 lakhs in the equity shares of Y Ltd. Out of the same, the company intends to
hold 50% shares for long term period i.e. Rs. 300 lakhs and remaining as temporary (current)
investment i.e. Rs. 300 lakhs. Irrespective of the fact that investment has been held by X Ltd. only for
255

3 months (from 1.1.20X1 to 31.3.20X1), AS 13 (Revised) lays emphasis on intention of the investor to
classify the investment as current or long term even though the long term investment may be readily
Page

marketable.

CA CS KARTHIK MANIKONDA – 75501 37279

In the given situation, the realisable value of all such investments on 31.3.20X1 became Rs. 200 lakhs
i.e. Rs. 100 lakhs in respect of current investment and Rs. 100 lakhs in respect of long term
investment.
As per AS 13 (Revised), ‘Accounting for Investment’, the carrying amount for current investments is
the lower of cost and fair value. In respect of current investments for which an active market exists,
market value generally provides the best evidence of fair value.
Accordingly, the carrying value of investment held as temporary investment should be shown at
realisable value i.e. at Rs. 100 lakhs. The reduction of Rs. 200 lakhs in the carrying value of current
investment will be charged to the profit and loss account.
The Standard further states that long-term investments are usually carried at cost. However, when
there is a decline, other than temporary, in the value of long term investment, the carrying amount
is reduced to recognise the decline.
Here, Y Ltd. lost a case of copyright which drastically reduced the realisable value of its shares to one
third which is quiet a substantial figure. Losing the case of copyright may affect the business and the
performance of the company in the long run. Accordingly, it will be appropriate to reduce the
carrying amount of long term investment by Rs. 200 lakhs and show the investments at Rs. 100
lakhs, since the downfall in the value of shares is other than temporary. The reduction of Rs. 200
lakhs in the carrying value of long term investment will also be charged to the Statement of profit
and loss.

Illustration 3
ABC Ltd. wants to re-classify its investments in accordance with AS 13 (Revised). Decide and state
on the amount of transfer, based on the following information:
1. A portion of current investments purchased for Rs. 20 lakhs, to be reclassified as long term
investment, as the company has decided to retain them. The market value as on the date of
Balance Sheet was Rs. 25 lakhs.
2. Another portion of current investments purchased for Rs. 15 lakhs, to be reclassified as long
term investments. The market value of these investments as on the date of balance sheet was
Rs. 6.5 lakhs.
3. Certain long term investments no longer considered for holding purposes, to be reclassified as
current investments. The original cost of these was Rs. 18 lakhs but had been written down to
Rs. 12 lakhs to recognise other than temporary decline as per AS 13 (Revised).
256
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Reclassification of investment

Long term to current Current to long term

lower of cost and carrying amount lower of cost fair value at the date
at the date of transfer of transfer

Solution
As per AS 13 (Revised), where investments are reclassified from current to long term, transfers are
made at the lower of cost and fair value at the date of transfer.
1. In the first case, the market value of the investment is Rs. 25 lakhs, which is higher than its cost
i.e. Rs. 20 lakhs. Therefore, the transfer to long term investments should be carried at cost i.e. Rs.
20 lakhs.
2. In the second case, the market value of the investment is Rs. 6.5 lakhs, which is lower than its
cost i.e. Rs. 15 lakhs. Therefore, the transfer to long term investments should be carried in the
books at the market value i.e. Rs. 6.5 lakhs. The loss of Rs. 8.5 lakhs should be charged to profit
and loss account.
As per AS 13 (Revised), where long-term investments are re-classified as current investments,
transfers are made at the lower of cost and carrying amount at the date of transfer.
3. In the third case, the book value of the investment is Rs. 12 lakhs, which is lower than its cost i.e.
Rs. 18 lakhs. Here, the transfer should be at carrying amount and hence this re-classified current
investment should be carried at Rs. 12 lakhs.

Illustration 4
M/s Innovative Garments Manufacturing Company Limited invested in the shares of another
company on 1st October, 20X3 at a cost of Rs. 2,50,000. It also earlier purchased Gold of Rs.
257

4,00,000 and Silver of Rs. 2,00,000 on 1st March, 20X1. Market value as on 31st March, 20X4 of
above investments are as follows:
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Particulars Rs.

Shares 2,25,000
Gold 6,00,000
Silver 3,50,000
How above investments will be shown in the books of accounts of M/s Innovative Garments
Manufacturing Company Limited for the year ending 31st March, 20X4 as per the provisions of
Accounting Standard 13 "Accounting for Investments"?
Solution
As per AS 13 (Revised) ‘Accounting for Investments’, for investment in shares if the investment is
purchased with an intention to hold for short-term period (less than one year), then it will be
classified as current investment and to be carried at lower of cost and fair value, i.e., in case of
shares, at lower of cost (Rs. 2,50,000) and market value (Rs. 2,25,000) as on 31 March 20X4, i.e., Rs.
2,25,000.
If equity shares are acquired with an intention to hold for long term period (more than one year),
then should be considered as long-term investment to be shown at cost in the Balance Sheet of the
company. However, provision for diminution should be made to recognise a decline, if other than
temporary, in the value of the investments.
Gold and silver are generally purchased with an intention to hold it for long term period (more than
one year) until and unless given otherwise. Hence, the investment in Gold and Silver (purchased on
1st March, 20X1) should continue to be shown at cost (since there is no ‘other than temporary’
diminution) as on 31st March, 20X4, i.e., Rs. 4,00,000 and Rs. 2,00,000 respectively, though their
market values have been increased.

Illustration 5
In 20X1, M/s. Wye Ltd. issued 12% fully paid debentures of Rs. 100 each, interest being payable
half yearly on 30th September and 31st March of every accounting year.
On 1st December, 20X2, M/s. Bull & Bear purchased 10,000 of these debentures at Rs. 101 ex-
interest price, also paying brokerage @ 1% of ex-interest amount of the purchase. On 1st March,
20X3 the firm sold all these debentures at Rs. 103 ex-interest price, again paying brokerage @ 1 %
of ex-interest amount. Prepare Investment Account in the books of M/s. Bull & Bear for the period
1st December, 20X2 to 1st March, 20X3.
258
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Solution
In the books of M/s Bull & Bear
Investment Account
for the period from 1st December 20X2 to 1st March, 20X3
(Scrip: 12% Debentures of M/s. Wye Ltd.)
Date Particulars Nominal Interest Cost Date Particulars Nominal Interest Cost
Value (Rs. ) Value (Rs.)
(Rs. ) (Rs. )
1.12.20X2 To Bank 10,00,000 20,000 10,20,100 1.03.20X3 By Bank 10,00,000 50,000 10,19,700
A/c A/c
(W.N.1) (W.N.2)
1.3.20X3 To Profit & 1.3.20X3 By Profit &
loss A/c* loss A/c
(b.f.) - 30,000 (b.f.) 400
10,00,000 50,000 10,20,100 10,00,000 50,000 10,20,100

* This represents income for M/s. Bull & Bear for the period 1st December, 20X2 to 1 st March, 20X3,
i.e., interest for three months- 1 st December, 20X2 to 28 February, 20X3).
Working Notes:
1. Cost of 12% debentures purchased on 1.12.20X2 Rs.

Cost Value (10,000  Rs. 101) = 10,10,000

Add: Brokerage (1% of Rs. 10,10,000) = 10,100

Total = 10,20,100

2. Sale proceeds of 12% debentures sold Rs.

Sales Price (10,000  Rs. 103) = 10,30,000
Less: Brokerage (1% of Rs. 10,30,000) = (10,300)
Total = 10,19,700

Illustration 6
On 1.4.20X1, Mr. Krishna Murty purchased 1,000 equity shares of Rs. 100 each in TELCO Ltd. @ Rs. 120
each from a Broker, who charged 2% brokerage. He incurred 50 paise per Rs. 100 as cost of shares
transfer stamps. On 31.1.20X2, Bonus was declared in the ratio of 1: 2. Before and after the record
date of bonus shares, the shares were quoted at Rs. 175 per share and Rs. 90 per share respectively.
On 31.3.20X2, Mr. Krishna Murty sold bonus shares to a Broker, who charged 2% brokerage.
259

Show the Investment Account in the books of Mr. Krishna Murty, who held the shares as Current
Page

assets and closing value of investments shall be made at Cost or Market value whichever is lower.

CA CS KARTHIK MANIKONDA – 75501 37279

Solution
In the books of Mr. Krishna Murty
Investment Account for the year ended 31st March, 20X2
(Scrip: Equity Shares of TELCO Ltd.)
Date Particulars Nominal Cost (Rs.) Date Particulars Nominal Cost (Rs.)
Value (Rs.) Value (Rs.)
1.4.20X1 To Bank A/c 1,00,000 1,23,000 31.3.20X2 By Bank A/c 50,000 44,100
(W.N.1) (W.N.2)
31.1.20X2 To Bonus shares 50,000 − 31.3.20X2 By Balance 1,00,000 82,000
(W.N.5) c/d (W.N.4)
31.3.20X2 To Profit & loss
A/c (W.N.3) − 3,100
1,50,000 1,26,100 1,50,000 1,26,100

Working Notes:
1. Cost of equity shares purchased on 1.4.20X1 = (1,000 Rs. 120) + (2% of Rs. 1,20,000) + (½% of
Rs. 1,20,000) = Rs. 1,23,000
2. Sale proceeds of equity shares (bonus) sold on 31st March, 20X2= (500 Rs. 90) – (2% of Rs.
45,000) = Rs. 44,100.
3. Profit on sale of bonus shares on 31st March, 20X2
= Sale proceeds – Average cost
Sale proceeds = Rs. 44,100
Average cost = Rs. (1,23,000 /1,50,000) x 50,000 = Rs. 41,000
Profit = Rs. 44,100 – Rs. 41,000 = Rs. 3,100.
4. Valuation of equity shares on 31st March, 20X2
Cost = (Rs. 1,23,000/1,50,000) x 1,00,000 = Rs. 82,000
Market Value = 1,000 shares × Rs. 90 = Rs. 90,000
Closing balance has been valued at Rs. 82,000 being lower than the market value.
5. Bonus shares do not have any cost.
Illustration 7
Mr. X purchased 500 equity shares of Rs. 100 each in Omega Co. Ltd. for Rs. 62,500 inclusive of
brokerage and stamp duty. Some years later the company resolved to capitalise its profits and to
issue to the holders of equity shares, one equity bonus share for every share held by them. Prior
to capitalisation, the shares of Omega Co. Ltd. were quoted at Rs. 175 per share. After the
260

capitalisation, the shares were quoted at Rs. 92.50 per share. Mr. X. sold the bonus shares and
received at Rs. 90 per share.
Page

Prepare the Investment Account in X’s books on average cost basis.

CA CS KARTHIK MANIKONDA – 75501 37279

Solution
In the books of X
Investment Account
[Scrip: Equity shares in Omega Co. Ltd.]
Particulars Nominal Cost Particulars Nominal Cost
Value Rs. Rs. Value Rs. Rs.
To Cash 50,000 62,500 By Cash - Sale (500 x 90) 50,000 45,000
To Bonus shares (W.N.1) 50,000 - By Balance c/d (W.N. 3) 50,000 31,250
To P & L A/c (W.N. 2) - 13,750
1,00,000 76,250 1,00,000 76,250
To Balance b/d 50,000 31,250
Working Notes:
1. Bonus shares do not have any cost.
2. Profit on sale of bonus shares = Sales proceeds – Average cost
Sales proceeds = Rs. 45,000
500
Average cost =  62,500 = Rs.31,250
1000
Profit = Rs. 45,000 – Rs.31,250 = Rs. 13,750.
3. Valuation of Closing Balance of Shares at the end of year
The total cost of 1,000 share including bonus is Rs.62,500
500
Therefore, cost of 500 shares (carried forward) is  62,500 = Rs. 31,250
1000
Market price of 500 shares = 92.50 x 500 = Rs. 46,250
Cost being lower than the market price, therefore shares are carried forward at cost.
Illustration 8
On 1st April, 20X1, Rajat has 50,000 equity shares of P Ltd. at a book value of Rs. 15 per share
(nominal value Rs. 10 each). He provides you the further information:
1. On 20th June, 20X1 he purchased another 10,000 shares of P Ltd. at Rs. 16 per share.
2. On 1st August, 20X1, P Ltd. issued one equity bonus share for every six shares held by the
shareholders.
3. On 31st October, 20X1, the directors of P Ltd. announced a right issue which entitles the
holders to subscribe three shares for every seven shares at Rs. 15 per share. Shareholders can
transfer their rights in full or in part.
261

Rajat sold 1/3rd of entitlement to Umang for a consideration of Rs. 2 per share and subscribed the
Page

rest on 5th November, 20X1.

CA CS KARTHIK MANIKONDA – 75501 37279

You are required to prepare Investment A/c in the books of Rajat for the year ending 31st March,
20X2.
Solution
In the books of Rajat
Investment Account
(Equity shares in P Ltd.)
Date Particulars No. of Amount Date Particulars No. of Amount
shares (Rs.) shares (Rs.)
1.4.X1 To Balance b/d 50,000 10,000 31.3.X2 By Balance c/d 90,000 12,10,000
(Bal. fig.)
20.6.X1 To Bank A/c 10,000 1,60,000
1.8.X1 To Bonus issue
(W.N.1) 10,000 -
5.11.X1 To Bank A/c
(right shares)
(W.N.4) 20,000 3,00,000
90,000 12,10,000 90,000 12,10,000

Working Notes:
50,000  10,000
1. Bonus shares = =10,000 shares
6
50,000  10,000  10,000
2. Right shares =  3  30,000 shares
7
1
3. Sale of rights = 30,000 shares×   Rs.2  Rs.20,000 to be credited to statement of profit
3
and loss
2
4. Rights subscribed = 30,000 shares × × Rs.15 = Rs.3,00,000
3

Illustration 9
On 1.4.20X1, Sundar had 25,000 equity shares of ‘X’ Ltd. at a book value of Rs. 15 per share
(Nominal value Rs. 10). On 20.6.20X1, he purchased another 5,000 shares of the company at Rs.16
per share. The directors of ‘X’ Ltd. announced a bonus and rights issue.
262

No dividend was payable on these issues. The terms of the issue are as follows:
Page

Bonus basis 1:6 (Date 16.8.20X1).

CA CS KARTHIK MANIKONDA – 75501 37279

 Rights basis 3:7 (Date 31.8.20X1) Price Rs. 15 per share.
Due date for payment 30.9.20X1.
Shareholders were entitled to transfer their rights in full or in part. Accordingly, Sundar sold
33.33% of his entitlement to Sekhar for a consideration of Rs. 2 per share.
Dividends: Dividends for the year ended 31.3.20X1 at the rate of 20% were declared by X Ltd. and
received by Sundar on 31.10.20X1. Dividends for shares acquired by him on 20.6.20X1 are to be
adjusted against the cost of purchase.
On 15.11.20X1, Sundar sold 25,000 equity shares at a premium of Rs. 5 per share.
You are required to prepare in the books of Sundar.
1. Investment Account
2. Profit & Loss Account. For your exercise, assume that the books are closed on 31.12.20X1and
shares are valued at average cost.
Solution
Books of Sundar
Investment Account (Scrip: Equity Shares in X Ltd.)
No. Amount No. Amount
Rs. Rs.
1.4.20X1 To Bal b/d 25,000 3,75,000 31.10.20X1 By Bank — 10,000
20.6.20X1 To Bank 5,000 80,000 (dividend
16.8.20X1 To Bonus 5,000 — on shares
(W.N.1) acquired on
30.9.20X1 To Bank 10,000 1,50,000 20/6/20X1)
(Rights (W.N.4)
Shares) 15.11.20X1 By Bank 25,000 3,75,000
(W.N.3) (Sale of
15.11.20X1 To Profit 44,444 shares)
(on sale of By Bal. c/d 20,000 2,64,444
shares) 31.12.20X1 (W.N.6)

45,000 6,49,444 45,000 6,49,444

Profit and Loss Account (An extract)

To Balance c/d 1,04,444 By Profit transferred 44,444
1,04,444 By Sale of rights (W.N.3) 10,000
263

By Dividend (W.N.4) 50,000

Page

1,04,444 1,04,444

CA CS KARTHIK MANIKONDA – 75501 37279

Working Notes:

 25,000  5,000 
1. Bonus Shares =   = 5,000 shares
 6 

 25,000  5,000  5,000 

2. Right Shares =    3 = 15,000 shares
 7 
3. Right shares renounced = 15,000×1/3 = 5,000 shares
Sale of right shares = 5,000 x 2 = Rs. 10,000
Right shares subscribed = 15,000 – 5,000 = 10,000 shares
Amount paid for subscription of right shares = 10,000 x 15 = Rs.1,50,000
4. Dividend received = 25,000 (shares as on 1st April 20X1) × 10 × 20% = Rs.50,000
Dividend on shares purchased on 20.6.20X1 = 5,000 × 10 × 20% = Rs.10,000 is adjusted to
Investment A/c
5. Profit on sale of 25,000 shares
= Sales proceeds – Average cost
Sales proceeds = Rs. 3,75,000

 3,75,000  80,000  1,50,000  10,000 

Average cost =   25,000  Rs.3,30,556
 45,000 
Profit = Rs.3,75,000– Rs.3,30,556= Rs.44,444.
6. Cost of shares on 31.12.20X1

 3,75,000  80,000  1,50,000  10,000 

   20,000  Rs.2,64,444
 45,000 
Reference: The students are also advised to refer the full bare text of AS 13 (Revised) “Accounting
for Investments”.

264
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. The cost of Right shares is
a. added to the cost of investments.
b. subtracted from the cost of investments.
c. no treatment is required.
d. added to cost of investments at market value.

2. Long term investments are carried at

a. fair value.
b. cost less ‘other than temporary’ decline.
c. Cost and market value whichever is less.
d. Cost and market value whichever is higher.

3. Current investments are carried at

a. Fair value.
b. cost.
c. Cost and fair value, whichever is less.
d. Cost and fair value, whichever is higher.

4. A Ltd. acquired 2,000 equity shares of Omega Ltd. on cum-right basis at Rs. 75 per share.
Subsequently, omega Ltd. made a right issue of 1:1 at Rs. 60 per share, which was subscribed
for by A. Total cost of investments at the year - end will be Rs.
a. 2,70,000.
b. 1,50,000.
c. 1,20,000.
d. 1,70,000.

5. Cost of investment includes

a. Purchase costs.
b. Brokerage and Stamp duty paid.
265

c. Both (a) and (b).

d. none of the above.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

ANSWERS/SOLUTIONS
MCQs
1. a. added to the cost of investments.
2. b. cost less ‘other than temporary’ decline.
3. c. Cost and fair value, whichever is less.
4. a. 2,70,000.
5. c. Both (a) and (b).

THEORY QUESTIONS
Q.NO.1. Briefly explain disclosure requirements for Investments as per AS-13.
ANSWER
The disclosure requirements as per AS 13 (Revised) are as follows:
i. Accounting policies followed for the determination of carrying amount of investments.
ii. Classification of investment into current and long term.
iii. The amount included in profit and loss statements for
a. Interest, dividends and rentals for long term and current investments, disclosing therein
gross income and tax deducted at source thereon;
b. Profits and losses on disposal of current investment and changes in carrying amount of such
investments;
c. Profits and losses and disposal of long term investments and changes in carrying amount of
investments.
iv. Aggregate amount of quoted and unquoted investments, giving the aggregate market value of
quoted investments;
v. Any significant restrictions on investments like minimum holding period for sale/disposal,
utilisation of sale proceeds or non-remittance of sale proceeds of investment held outside India.
vi. Other disclosures required by the relevant statute governing the enterprises

Q.NO.2. How will you classify the investments as per AS 13? Explain in Brief.
ANSWER
The investments are classified into two categories as per AS 13, viz., Current Investments and Long-
term Investments. A current Investment is an investment that is by its nature readily realisable and is
intended to be held for not more than one year from the date on which such investment is made.
266

The carrying amount for current investments is the lower of cost and fair value. Any reduction to fair
Page

value and any reversals of such reductions are included in the statement of profit and loss.

CA CS KARTHIK MANIKONDA – 75501 37279

A long-term investment is an investment other than a current investment. Long term investments
are usually carried at cost. However, when there is a decline, other than temporary, in the value of a
long term investment, the carrying amount is reduced to recognise the decline. The reduction in
carrying amount is charged to the statement of profit and loss.

Q.NO.3. Whether the accounting treatment 'at cost' under the head ‘Long Term Investments’
without providing for any diminution in value is correct and in accordance with the provisions of
AS 13. If not, what should have been the accounting treatment in such a situation? Explain in brief.
ANSWER
The accounting treatment 'at cost' under the head 'Long Term Investment’ in the financial
statements of the company without providing for any diminution in value is correct and is in
accordance with the provisions of AS 13 provided that there is no decline, other than temporary, in
the value of investment. If the decline in the value of investment is, other than temporary, compared
to the time when the shares were purchased, provision is required to be made.

267
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 PRACTICAL QUESTIONS
Q.NO.1. Mr. X acquires 200 shares of a company on cum-right basis for Rs. 70,000. He
subsequently receives an offer of right to acquire fresh shares in the company in the proportion of
1:1 at Rs. 107 each. He does not subscribe but sells all the rights for Rs. 12,000. The market value
of the shares after their becoming ex-rights has also gone down to Rs. 60,000. What should be the
accounting treatment in this case?
SOLUTION
As per AS 13, where the investments are acquired on cum-right basis and the market value of
investments immediately after their becoming ex-right is lower than the cost for which they were
acquired, it may be appropriate to apply the sale proceeds of rights to reduce the carrying amount
of such investments to the market value. In this case, the amount of the ex-right market value of 200
shares bought by X immediately after the declaration of rights falls to Rs. 60,000. In this case, out of
sale proceeds of Rs. 12,000, Rs. 10,000 may be applied to reduce the carrying amount to bring it to
the market value and Rs. 2,000 would be credited to the profit and loss account.

Q.NO.2. On 1st April, 20X1, XY Ltd. has 15,000 equity shares of ABC Ltd. at a book value of Rs. 15
per share (nominal value Rs. 10 per share). On 1st June, 20X1, XY Ltd. acquired 5,000 equity shares
of ABC Ltd. for Rs. 1,00,000. ABC Ltd. announced a bonus and right issue.
1. Bonus was declared, at the rate of one equity share for every five shares held, on 1st July 20X1.
2. Right shares are to be issued to the existing shareholders on 1st September 20X1. The
company will issue one right share for every 6 shares at 20% premium. No dividend was
payable on these shares.
3. Dividend for the year ended 31.3.20X1 were declared by ABC Ltd. @ 20%, which was received
by XY Ltd. on 31st October 20X1.
XY Ltd.
i. Took up half the right issue.
ii. Sold the remaining rights for Rs. 8 per share.
iii. Sold half of its shareholdings on 1st January 20X2 at Rs. 16.50 per share. Brokerage being
1%.
You are required to prepare Investment account of XY Ltd. for the year ended 31st March 20X2
assuming the shares are being valued at average cost.
268
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 SOLUTION
In the books of XY Ltd.
Investment in equity shares of ABC Ltd.
for the year ended 31st March, 20X2
Date Particulars No. Dividend Amount Date Particulars No. Dividend Amount
Rs. Rs. Rs. Rs.
20X1 April To Balance b/d 15,000 - 2,25,000 20X1 By Bank A/c - 30,000 10,000
1 Oct. 31 (W.N. 5)
June 1 To Bank A/c 5,000 - 1,00,000
20X2 By Bank A/c 13,000 - 2,12,355
Jan. 1 (W.N.4)
July 1 To Bonus Issue 4,000 - -
(W.N. 1) March By Balance c/d 13,000 - 1,69,500
31 (W.N. 6)

Sept.1 To Bank A/c 2,000 - 24,000

(W.N. 2)

20X2 To P & L A/c - - 42,855

Jan 1 (W.N. 4)

“20X2 To P & L A/c - 30,000 -

March 31
26,000 30,000 3,91,855 26,000 30,000 3,91,855

Working Notes:
1. Calculation of no. of bonus shares issued
15,000 shares  5,000 shares
Bonus Shares =  1  4 ,000 shares
5
2. Calculation of right shares subscribed
15,000 shares  5,000 shares  4 ,000 shares
Right Shares =  4 ,000 shares
6
4 ,000
Shares subscribed by XY Ltd. =  2,000 shares
2
Value of right shares subscribed = 2,000 shares @ Rs. 12 per share = Rs. 24,000
269

3. Calculation of sale of right entitlement

2,000 shares x Rs. 8 per share = Rs. 16,000
Page

Amount received from sale of rights will be credited to statement of profit and loss.

CA CS KARTHIK MANIKONDA – 75501 37279

4. Calculation of profit on sale of shares
Total holding = 15,000 shares original
5,000 shares purchased
4,000 shares bonus
2,000 shares right shares
26,000 shares
50% of the holdings were sold
i.e. 13,000 shares (26,000 x1/2) were sold.
Cost of total holdings of 26,000 shares (on average basis)
= Rs. 2,25,000 + Rs. 1,00,000 + Rs. 24,000– Rs. 10,000 = Rs. 3,39,000
Average cost of 13,000 shares would be
3,39,000
  13,000  Rs.1,69,500
26,000
Rs.
Sale proceeds of 13,000 shares (13,000 x Rs.16.50) 2,14,500
Less: 1% Brokerage (2,145)
2,12,355
Less: Cost of 13,000 shares (1,69,500)
Profit on sale 42,855

5. Dividend received on investment held as on 1st April, 20X1

= 15,000 shares x Rs. 10 x 20%
= Rs. 30,000 will be transferred to Profit and Loss A/c
Dividend received on shares purchased on 1st June, 20X1
= 5,000 shares x Rs. 10 x 20% = Rs.10,000 will be adjusted to Investment A/c
Note: It is presumed that no dividend is received on bonus shares as bonus shares are declared
on 1st July, 20X1 and dividend pertains to the year ended 31.3.20X1.
6. Calculation of closing value of shares (on average basis) as on 31st March, 20X2
3,39,000
13,000   Rs.1,69,500
26,000
Q.NO.3. The following information is presented by Mr. Z (a stock broker), relating to his holding
in 9% Central Government Bonds.
270

Opening balance (nominal value) Rs.1,20,000, Cost Rs.1,18,000 (Nominal value of each unit is Rs.
Page

100).

CA CS KARTHIK MANIKONDA – 75501 37279

 1.3.20X1 Purchased 200 units, ex-interest at Rs. 98.
1.7.20X1 Sold 500 units, ex-interest out of original holding at Rs. 100.
1.10.20X1 Purchased 150 units at Rs. 98, cum interest.
1.11.20X1 Sold 300 units, ex-interest at Rs. 99 out of original holdings.
Interest dates are 30th September and 31st March. Mr. Z closes his books every 31st December.
Show the investment account as it would appear in his books. Mr. Z follows FIFO method.
SOLUTION
In the Books of Mr. Z
9% Central Government Bonds (Investment) Account
Particulars Nominal Interest Principal Particulars Nominal Interest Principal
Value Value
20X1 Rs. Rs. Rs. 20X1 Rs. Rs. Rs.
Jan.1 To Balance b/d Mar. By Bank A/c
(W.N.1) 1,20,000 2,700 1,18,000 31 (W.N.3) - 6,300 -

March To Bank July 1 By Bank A/c 50,000 1,125 50,000

1 A/c 20,000 750 19,600 (W.N.4)
(W.N.2)
July 1 To P&L A/c - - 833 Sept. By Bank A/c - 4,050 -
(W.N.5) 30 (W.N.6)

Oct. 1 To Bank 15,000 - 14,700 Nov. By Bank A/c 30,000 225 29,700
A/c 1 (W.N.7)
(150 x 98)

Nov. 1 To P&L A/c - - 200 Dec. By Balance c/d 75,000 1,688 73,633
(W.N.8) 31 (W.N. 9 &
W.N.10)
Dec.31 To P & L A/c
(b.f.) (Transfer) 9,938

1,55,000 13,388 1,53,333 1,55,000 13,388 1,53,333

Working Note:
1. Interest element in opening balance of bonds = 1,20,000 x 9% x 3/12 = Rs.2,700
271

2. Purchase of bonds on 1. 3.20X1

Interest element in purchase of bonds = 200 x 100 x 9% x 5/12 = Rs.750
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Investment element in purchase of bonds = 200 x 98 = Rs.19,600
3. Interest for half-year ended 31 March = 1,400 x 100 x 9% x 6/12 = Rs.6,300
4. Sale of bonds on 1.7.20X1
Interest element = 500 x 100 x 9% x 3/12 = Rs.1,125
Investment element = 500 x 100 = Rs.50,000
5. Profit on sale of bonds on 1.7.20X1
Cost of bonds = (1,18,000/ 1,200) x 500 = Rs.49,167
Sale proceeds = Rs.50,000
Profit element = Rs.833
6. Interest for half-year ended 30 September
= 900 x 100 x 9% x 6/12 = Rs.4,050
7. Sale of bonds on 1.11.20X1
Interest element = 300 x 100 x 9% x 1/12 = Rs. 225
Investment element = 300 x 99 = Rs.29,700
8. Profit on sale of bonds on 1.11.20X1
Cost of bonds = (1,18,000/ 1,200) x 300 = Rs.29,500
Sale proceeds = Rs.29,700
Profit element = Rs.200
9. Closing value of investment
Calculation of closing balance: Nominal Rs.
value
Bonds in hand remained in hand at 31 st
December 20X1
From original holding 40,000 1,18,000 39,333
 40,000
(1,20,000 – 50,000 – 30,000) = 1,20,000

Purchased on 1st March 20,000 19,600

Purchased on 1st October 15,000 14,700
75,000 73,633
10. Interest element in closing balance of bonds = 750 x 100 x 9% x 3/12 = Rs.1,688

Q.NO.4. Mr. Purohit furnishes the following details relating to his holding in 8% Debentures
(Rs.100 each) of P Ltd., held as Current assets:
272

1.4.20X1 Opening balance – Nominal value Rs. 1,20,000, Cost Rs. 1,18,000
Page

1.7.20X1 100 Debentures purchased ex-interest at Rs. 98

CA CS KARTHIK MANIKONDA – 75501 37279

1.10.20X1 Sold 200 Debentures ex-interest at Rs. 100
1.1.20X2 Purchased 50 Debentures at Rs. 98 ex-interest
1.2.20X2 Sold 200 Debentures ex-interest at Rs.99
Due dates of interest are 30th September and 31st March.
Mr. Purohit closes his books on 31.3.20X2. Brokerage at 1% is to be paid for each transaction (at
ex-interest price). Show Investment account as it would appear in his books. Assume FIFO method.
Market value of 8% Debentures of P Limited on 31.3.20X2 is Rs. 99.
SOLUTION
Investment A/c of Mr. Purohit
for the year ending on 31-3-20X2
(Scrip: 8% Debentures of P Limited)
(Interest Payable on 30th September and 31st March)
Date Particulars Nominal Interest Cost Date Particulars Nominal Interest Cost
Value Value

Rs. Rs. Rs. Rs.

1.4.20X1 To Balance 30.9.20X1 By Bank
b/d 1,20,000 - 1,18,000 (1,300 x 100
x 8% x 6/12) - 5,200 -
1.7.20X1 To Bank
(ex- 1.10.20X1 By Bank 20,000 - 19,800
Interest) 10,000 200 9,898 (W.N.4)
(W.N.1)
1.10.20X1 To Profit & 1.2.20X2 By Bank (ex-
Loss A/c Interest)
(W.N.4) 133 (W.N.5) 20,000 533 19,602
1.1.20X2 To Bank 1.2.20X2 By Profit &
(ex- Loss A/c
Interest) (W.N.5) 64
(W.N.2) 5,000 100 4,949 31.3.20X2 By Bank
31.3.20X2 To Profit & (950 x 100 x
(W.N.3) Loss A/c 8% x 6/12) - 3,800 -
(Bal. fig.) - 9,233 31.3.20X2 By Balance
c/d (W.N.3) 95,000 - 93,514

1,35,000 9,533 1,32,980 1,35,000 9,533 1,32,980

273
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Working Notes:
1. Purchase of debentures on 1.7.20X1
Interest element = 100 x 100 x 8% x 3/12 = Rs. 200
Investment element = (100 x 98) + [1% (100 x 98)] = Rs. 9,898
2. Purchase of debentures on 1.1.20X2
Interest element = 50 x 100 x 8% x 3/12 = Rs. 100
Investment element = {(50 x 98) + [1% (50 x 98)]} = Rs. 4,949
3. Valuation of closing balance as on 31.3.20X2:
Market value of 950 Debentures at Rs. 99 = Rs. 94,050
Cost of

 1,18,000 
800 Debentures cost =   80,000  = 78,667
 1,20,000 
100 Debentures cost = 9,898
50 Debentures cost = 4,949
93,514
Value at the end = Rs. 93,514, i.e., whichever is less
4. Profit on sale of debentures as on 1.10.20X1
Rs.
Sales price of debentures (200 x Rs. 100) 20,000
Less: Brokerage @ 1% (200)
19,800
 1,18,000 
Less: Cost of Debentures =   20,000 
 1,20,000  (19,667)
Profit on sale 133
5. Loss on sale of debentures as on 1.2.20X2
Rs.
Sales price of debentures (200 x Rs. 99) 19,800
Less: Brokerage @ 1% (198)
19,602
 1,18,000 
Less: Cost of Debentures =   20,000 
 1,20,000  (19,666)
274

Loss on sale 64
Interest element in sale of investment = 200 x 100 x 8% x 4/12 Rs. 533
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Q.NO.5. On 1st April, 20X1, Mr. Vijay had 30,000 Equity shares in X Ltd. at a book value of
Rs.4,50,000 (Face Value Rs. 10 per share). On 22nd June, 20X1, he purchased another 5000 shares
of the same company for Rs. 80,000.
The Directors of X Ltd. announced a bonus of equity shares in the ratio of one share for seven
shares held on 10th August, 20X1.
On 31st August, 20X1 the Company made a right issue in the ratio of three shares for every eight
shares held, on payment of Rs. 15 per share. Due date for the payment was 30th September, 20X1,
Mr. Vijay subscribed to 2/3rd of the right shares and sold the remaining of his entitlement to Viru
for a consideration of Rs. 2 per share.
On 31st October, 20X1, Vijay received dividends from X Ltd. @ 20% for the year ended 31st March,
20X1. Dividend for the shares acquired by him on 22nd June, 20X1 to be adjusted against the cost
of purchase.
On 15th November, 20X1 Vijay sold 20,000 Equity shares at a premium of Rs. 5 per share.
You are required to prepare Investment Account in the books of Mr. Vijay for the year ended 31st
March, 20X2 assuming the shares are being valued at average cost.
SOLUTION
Investment Account in Books of Vijay
(Scrip: Equity Shares in X Ltd.)
No. Amount No. Amount

Rs. Rs.

1.4.20X1 To Bal b/d 30,000 4,50,000 31.10.20X1 By Bank — 10,000

22.6.20X1 To Bank 5,000 80,000 (dividend on
shares acquired
10.8.20X1 To Bonus 5,000 _ on 22.6.20X1)
30.9.20X1 To Bank 10,000 1,50,000
(Rights
Shares)
15.11.20X1 To P&L A/c 32,000
(Profit on
sale of 15.11.20X1 By Bank 20,000 3,00,000
shares) (Sale of shares)
31.3.20X2 By Bal. c/d 30,000 4,02,000
50,000 7,12,000 50,000 7,12,000
275

Working Notes:
1. Bonus Shares = (30,000 + 5,000) / 7 = 5,000 shares
Page

CA CS KARTHIK MANIKONDA – 75501 37279

  30,000  5,000  5,000 
2. Right Shares =   3  = 15,000
 8 
3. Rights shares sold = 15,000 × 1/3 = 5,000 shares
4. Dividend received = 30,000 × 10 × 20% = Rs. 60,000 will be taken to P&L statement
5. Dividend on shares purchased on 22.6.20X1
= 5,000×10×20%
= Rs. 10,000 is adjusted to Investment A/c
6. Profit on sale of 20,000 shares
= Sales proceeds – Average cost
Sales proceeds = Rs. 3,00,000
(4,50,000  80,000  1,50,000  10,000)
Average cost =  20,000
50,000
= Rs. 2,68,000
Profit = Rs.3,00,000– Rs.2,68,000= Rs.32,000.
7. Cost of shares on 31.3.20X2
(4,50,000  80,000  1,50,000  10,000)
 30,000  Rs.4,02,000
50,000
8. Sale of rights amounting Rs.10,000 (Rs.2 x 5,000 shares) will not be shown in investment A/c but
will directly be taken to P & L statement.

Q.NO.6. Blue-chip Equity Investments Ltd., wants to re-classify its investments in accordance
with AS 13 (Revised). State the values, at which the investments have to be reclassified in the
following cases:
i. Long term investments in Company A, costing Rs.8.5 lakhs are to be reclassified as current.
The company had reduced the value of these investments to Rs.6.5 lakhs to recognise ‘other
than temporary’ decline in value. The fair value on date of transfer is Rs.6.8 lakhs.
ii. Long term investments in Company B, costing Rs.7 lakhs are to be re-classified as current. The
fair value on date of transfer is Rs.8 lakhs and book value is Rs.7 lakhs.
iii. Current investment in Company C, costing Rs.10 lakhs are to be reclassified as long term as
the company wants to retain them. The market value on date of transfer is Rs.12 lakhs.
SOLUTION
As per AS 13 (Revised) ‘Accounting for Investments’, where long-term investments are reclassified as
current investments, transfers are made at the lower of cost and carrying amount at the date of
276

transfer. And where investments are reclassified from current to long term, transfers are made at
Page

lower of cost and fair value on the date of transfer.

CA CS KARTHIK MANIKONDA – 75501 37279

Accordingly, the re-classification will be done on the following basis:
i. In this case, carrying amount of investment on the date of transfer is less than the cost; hence
this re-classified current investment should be carried at Rs.6.5 lakhs in the books.
ii. The carrying / book value of the long term investment is same as cost i.e. Rs.7 lakhs. Hence this
long term investment will be reclassified as current investment at book value of Rs.7 lakhs only.
iii. In this case, reclassification of current investment into long-term investments will be made at
Rs.10 lakhs as cost is less than its market value of Rs.12 lakhs.

277
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 UNIT 4: ACCOUNTING STANDARD 16:
BORROWING COSTS
LEARNING OUTCOMES

After studying this unit, you will be able to recognize–

 Meaning of Borrowing costs;
 Definition of Qualifying Asset;
 Accounting treatment for borrowings – Specific and general borrowings;
 Time when does Commencement of Capitalisation takes place;
 Time when does Suspension and cessation of Capitalisation takes place;
 Disclosure requirements for this standard.
4.1 INTRODUCTION
The objective of AS 16 is to prescribe the accounting treatment for borrowing costs. It does not deal
with the actual or imputed cost of owners’ equity, including preference share capital not classified as
a liability.
Clarification Chart:
Particulars Remarks – Is the fund covered by AS
16?
Equity share capital No
Retained earnings No
Preference Share Capital classified as a liability Preference Yes
Share Capital classified as equity No

4.2 DEFINITIONS
Borrowing costs are interest and other costs incurred by an enterprise in connection with the
borrowing of funds.

Borrowing Cost

Finance
Amortisation
Interest & Amortisation charges for
of ancillary Exchange
Commitment of Discount/ assets
costs relating Differences*
charges on Premium on acquired on
to
Borrowings Borrowings Finance
278

Borrowings
Lease
Page

*To the extent they are regarded as an adjustment to interest cost

CA CS KARTHIK MANIKONDA – 75501 37279

A qualifying asset is an asset (Tangible or intangible) that necessarily takes a substantial period of
time to get ready for its intended use or sale.
Examples of qualifying assets are manufacturing plants, power generation facilities, inventories that
require a substantial period of time to bring them to a saleable condition, and inv estment
properties. Other investments and those inventories that are routinely manufactured or otherwise
produced in large quantities on a repetitive basis over a short period of time, are not qualifying
assets. Assets that are ready for their intended use or sale when acquired also are not qualifying
assets.
Clarification Chart:
Particulars Remarks – Is the fund covered
by AS 16?
PPE (Property, plant and equipment) Yes
Intangible assets Yes
Investment Properties Yes
(Building meant for capital appreciation and earning rental
income)
Inventory Yes – If they require a substantial
period of time to bring them to a
saleable condition.
Investments (Financial assets) No

Accounting standard further clarifies the meaning of the expression ‘substantial period of time’.
According to it, substantial period of time primarily depends on the facts and circumstances of each
case. It further states that, ordinarily, a period of twelve months is considered as substantial period
of time unless a shorter or longer period can be justified on the basis of the facts and circumstances
of the case. Therefore, a rebuttable presumption of a period of twelve months is considered
“substantial” period of time. In estimating the period, time which an asset takes technologically and
commercially to get it ready for its intended use or sale should be considered.
4.3 EXCHANGE DIFFERENCES ON FOREIGN CURRENCY BORROWINGS
Exchange differences arising from foreign currency borrowing and considered as borrowing costs are
those exchange differences which arise on the amount of principal of the foreign currency
279

borrowings to the extent of the difference between interest on local currency borrowings and
Page

interest on foreign currency borrowings. Thus, the amount of exchange difference not exceeding the

CA CS KARTHIK MANIKONDA – 75501 37279

difference between interest on local currency borrowings and interest on foreign currency
borrowings is considered as borrowings cost to be accounted for under this Standard and the
remaining exchange difference, if any, is accounted for under AS 11, ‘The Effect of Changes in Foreign
Exchange Rates’. For this purpose, the interest rate for the local currency borrowings is considered as
that rate at which the enterprise would have raised the borrowings locally had the enterprise not
decided to raise the foreign currency borrowings.

Clarification Chart:
Particulars Accounting Treatment
Exchange Gain Credited to P&L
Exchange Loss Lower of the following is treated as a part of borrowing costs:
1. Actual exchange loss;
2. Difference between interest on local currency borrowings and interest on
foreign currency borrowings.
Note: The excess exchange difference if any will be charged to P&L A/c.

If the difference between the interest on local currency borrowings and the interest on foreign
currency borrowings is equal to or more than the exchange difference on the amount of principal of
the foreign currency borrowings, the entire amount of exchange difference is covered under
paragraph 4 (e) of AS 16.
If there is exchange gain in the next year, then it will reduce the borrowing cost in that year to the
extent exchange loss was earlier treated as borrowing cost for that borrowing.
Example
XYZ Ltd. has taken a loan of USD 10,000 on April 1, 20X1, for a specific project at an interest rate of
5% p.a., payable annually. On April 1, 20X1, the exchange rate between the currencies was Rs. 45 per
USD. The exchange rate, as at March 31, 20X2, is Rs. 48 per USD. The corresponding amount could
have been borrowed by XYZ Ltd. in local currency at an interest rate of 11 per cent per annum as on
April 1, 20X1. The following computation would be made to determine the amount of borrowing
costs for the purposes of paragraph 4(e) of AS 16:
i. Interest for the period = USD 10,000 x 5% x Rs. 48/USD = Rs. 24,000
ii. Increase in the liability towards the principal amount = USD 10,000 x (48-45) = Rs. 30,000
iii. Interest that would have resulted if the loan was taken in Indian currency = USD 10,000 x 45 x
11% = Rs. 49,500
280

iv. Difference between interest on local currency borrowing and foreign currency borrowing =
Page

Rs.49,500 – Rs. 24,000 = Rs. 25,500

CA CS KARTHIK MANIKONDA – 75501 37279

Therefore, out of Rs. 30,000 increase in the liability towards principal amount, only Rs. 25,500 will be
considered as the borrowing cost. Thus, total borrowing cost would be Rs. 49,500 being the
aggregate of interest of Rs. 24,000 on foreign currency borrowings (covered by paragraph 4(a) of AS
16) plus the exchange difference to the extent of difference between interest on local currency
borrowing and interest on foreign currency borrowing of Rs. 25,500.
Thus, Rs. 49,500 would be considered as the borrowing cost to be accounted for as per AS 16 and
the remaining Rs. 4,500 would be considered as the exchange difference to be accounted for as per
Accounting Standard (AS) 11, The Effects of Changes in Foreign Exchange Rates.
In the above example, if the interest rate on local currency borrowings is assumed to be 13% instead
of 11%, the entire exchange difference of Rs. 30,000 would be considered as borrowing costs, since
in that case the difference between the interest on local currency borrowings and foreign currency
borrowings [i.e., Rs. 34,500 (Rs. 58,500 – Rs. 24,000)] is more than the exchange difference of
Rs.30,000. Therefore, in such a case, the total borrowing cost would be Rs. 54,000 (Rs. 24,000 +
Rs.30,000) which would be accounted for under AS 16 and there would be no exchange difference to
be accounted for under AS 11 ‘The Effects of Changes in Foreign Exchange Rates’.

4.4 BORROWING COSTS ELIGIBLE FOR CAPITALISATION

Treatment of Borrowing Costs

Borrowing costs

Directly related*for
*acquisition
*construction
*production of

Qualifying Assets Assets other than Qualifying assests

Capitalized Revenue Expenditure

281

*or that could have been avoided if the expenditure on qualifying assets had not been made.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

The borrowing costs (including exchange loss treated as borrowing cost as per para 4(e)) that are
directly attributable to the acquisition, construction or production of a qualifying asset are those
borrowing costs that would have been avoided if the expenditure on the qualifying asset had not
been made. Other borrowing costs are recognised as an expense in the period in which they are
incurred.
4.5 RECOGNITION CRITERIA
Borrowing costs are capitalised as part of the cost of a qualifying asset when:
a. it is probable that they will result in future economic benefits to the enterprise; and
b. the costs can be measured reliably.

Borrowing costs

Specific borrowings General borrowings

(Refer Illustration 1)
4.6 SPECIFIC BORROWINGS
When an enterprise borrows funds specifically for the purpose of obtaining a particular qualifying
asset, the borrowing costs that directly relate to that qualifying asset can be readily identified.
To the extent that funds are borrowed specifically for the purpose of obtaining a qualifying asset, the
amount of borrowing costs eligible for capitalisation on that asset should be determined as the
actual borrowing costs incurred on that borrowing during the period less any income on the
temporary investment of those borrowings.

Amount eligible for capitalisation:

= Actual borrowing costs incurred (-) Any income on the temporary investment of those
borrowings

The financing arrangements for a qualifying asset may result in an enterprise obtaining borrowed
funds and incurring associated borrowing costs before some or all of the funds are used for
expenditure on the qualifying asset. In such circumstances, the funds are often temporarily invested
pending their expenditure on the qualifying asset. In determining the amount of borrowing costs
282

eligible for capitalisation during a period, any income earned on the temporary investment of those
Page

borrowings is deducted from the borrowing costs incurred.

CA CS KARTHIK MANIKONDA – 75501 37279

4.7 GENERAL BORROWINGS
It may be difficult to identify a direct relationship between particular borrowings and a qualifying
asset and to determine the borrowings that could otherwise have been avoided. To the extent that
funds are borrowed generally and used for the purpose of obtaining a qualifying asset, the amount
of borrowing costs eligible for capitalisation should be determined by applying a capitalisation rate
to the expenditure on that asset. The capitalisation rate should be the weighted average of the
borrowing costs applicable to the borrowings of the enterprise that are outstanding during the
period, other than borrowings made specifically for the purpose of obtaining a qualifying asset. The
amount of borrowing costs capitalised during a period should not exceed the amount of borrowing
costs incurred during that period.
Step 1 - Compute the capitalisation rate:
Where,
Borrowing cost on general borrowings
Capitalisation Rate =  100
Weighted average of generalbor rowings
outstandin g during the period

Step 2 - Amount eligible for capitalisation:

= Expenditure incurred on Qualifying asset x Capitalisation rate
Step 3 – Cross check:
The amount of borrowing costs capitalised during a period should not exceed the amount of
borrowing costs incurred during that period.

4.8 EXCESS OF THE CARRYING AMOUNT OF THE QUALIFYING ASSET OVER RECOVERABLE AMOUNT
When the carrying amount or the expected ultimate cost of the qualifying asset exceeds its
recoverable amount or net realisable value, the carrying amount is written down or written off in
accordance with the requirements of other Accounting Standards. In certain circumstances, the
amount of the write-down or write-off is written back in accordance with those other Accounting
Standards.
(Refer Illustration 2)
4.9 COMMENCEMENT OF CAPITALISATION
The capitalisation of borrowing costs as part of the cost of a qualifying asset should commence when
all the following conditions are satisfied:
a. Expenditure for the acquisition, construction or production of a qualifying asset is being
283

incurred: Expenditure on a qualifying asset includes only such expenditure that has resulted in
Page

payments of cash, transfers of other assets or the assumption of interest-bearing liabilities.

CA CS KARTHIK MANIKONDA – 75501 37279

 Expenditure is reduced by any progress payments received and grants received in connection
with the asset. The average carrying amount of the asset during a period, including borrowing
costs previously capitalised, is normally a reasonable approximation of the expenditure to which
the capitalisation rate is applied in that period.

b. Borrowing costs are being incurred.

c. Activities that are necessary to prepare the asset for its intended use or sale are in progress:
The activities necessary to prepare the asset for its intended use or sale encompass more than
the physical construction of the asset. They include technical and administrative work prior to
the commencement of physical construction. However, such activities exclude the holding of an
asset when no production or development that changes the asset’s condition is taking place. For
example, borrowing costs incurred while land is under development are capitalised during the
period in which activities related to the development are being undertaken. However, borrowing
costs incurred while land acquired for building purposes is held without any associated
development activity do not qualify for capitalisation.

4.10 SUSPENSION OF CAPITALISATION

Capitalisation of borrowing costs should be suspended during extended periods in which active
development is interrupted.
Borrowing costs may be incurred during an extended period in which the activities necessary to
prepare an asset for its intended use or sale are interrupted. Such costs are costs of holding partially
completed assets and do not qualify for capitalisation. However, capitalisation of borrowing costs is
not normally suspended during a period when substantial technical and administrative work is being
carried out.
Capitalisation of borrowing costs is also not suspended when a temporary delay is a necessary part
of the process of getting an asset ready for its intended use or sale. For example: capitalisation
continues during the extended period needed for inventories to mature or the extended period
during which high water levels delay construction of a bridge, if such high water levels are common
during the construction period in the geographic region involved.

4.11 CESSATION OF CAPITALISATION

284

Capitalisation of borrowing costs should cease when substantially all the activities necessary to
prepare the qualifying asset for its intended use or sale are complete.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

An asset is normally ready for its intended use or sale when its physical construction or production is
complete even though routine administrative work might still continue. If minor modifications, such
as the decoration of a property to the user’s specification, are all that are outstanding, this indicates
that substantially all the activities are complete.
When the construction of a qualifying asset is completed in parts and a completed part is capable of
being used while construction continues for the other parts, capitalisation of borrowing costs in
relation to a part should cease when substantially all the activities necessary to prepare that part for
its intended use or sale are complete. A business park comprising several buildings, each of which
can be used individually, is an example of a qualifying asset for which each part is capable of being
used while construction continues for the other parts. An example of a qualifying asset that needs to
be complete before any part can be used is an industrial plant involving several processes which are
carried out in sequence at different parts of the plant within the same site, such as a steel mill.

Capitalization of Borrowing Cost

Commencement Suspension Cessation

Borrowing
Expenditure costs are Activities to during extended when
for qualifying being prepare the periods in which substantially
asset is being incurred qualifying asset active all the
incurred. is in progress. development is activities are
interrupted. complete ͘

4.12 DISCLOSURE
The financial statements should disclose:
a. The accounting policy adopted for borrowing costs; and
b. The amount of borrowing costs capitalised during the period.
(Refer Illustration 3 & 4)
285
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 ILLUSTRATIONS
Illustration 1
PRM Ltd. obtained a loan from a bank for Rs. 120 lakhs on 30-04-20X1. It was utilised as follows:
Particulars Amount (Rs. in lakhs)
Construction of a shed 50
Purchase of a machinery 40
Working Capital 20
Advance for purchase of Truck 10
Construction of shed was completed in March 20X2. The machinery was installed on the date of
acquisition. Delivery of truck was not received. Total interest charged by the bank for the year
ending 31-03-20X2 was Rs. 18 lakhs. Show the treatment of interest.
Solution
Qualifying Asset as per AS 16 = Rs. 50 lakhs (construction of a shed)
Borrowing cost to be capitalised = 18 x 50/120 = Rs. 7.5 lakhs
Interest to be debited to Profit or Loss account = Rs. (18 – 7.5) lakhs = Rs. 10.5 lakhs

Illustration 2
X Ltd. began construction of a new building on 1st January, 20X1. It obtained Rs. 1 lakh special
loan to finance the construction of the building on 1st January, 20X1 at an interest rate of 10%.
The company’s other outstanding two non-specific loans were:
Amount Rate of Interest
Rs. 5,00,000 11%
Rs. 9,00,000 13%
The expenditures that were made on the building project were as follows:
Rs.
January 20X1 2,00,000
April 20X1 2,50,000
July 20X1 4,50,000
December 20X1 1,20,000

Building was completed by 31st December 20X1. Following the principles prescribed in AS 16
286

‘Borrowing Cost,’ calculate the amount of interest to be capitalised and pass one Journal Entry for
Page

capitalising the cost and borrowing cost in respect of the building.

CA CS KARTHIK MANIKONDA – 75501 37279

Solution
i. Computation of weighted average accumulated expenses
Rs.
Rs. 2,00,000 x 12 / 12 = 2,00,000
Rs. 2,50,000 x 9 / 12 = 1,87,500
Rs. 4,50,000 x 6 / 12 = 2,25,000
Rs. 1,20,000 x 1 / 12 = 10,000
6,22,500

ii. Calculation of weighted average interest rate other than for specific borrowings
Amount of loan (Rs.) Rate of Amount of interest
interest (Rs.)
5,00,000 11% = 55,000
9,00,000 13% = 1,17,000
14,00,000 1,72,000
Weighted average rate of interest
 1,72,000 
 100 
 14,00,000  = 12.285% (approx.)

iii. Interest on weighted average accumulated expenses

Rs.
Specific borrowings (Rs.1,00,000 x 10%) = 10,000
Non-specific borrowings (Rs.5,22,500 x 12.285%) = 64,189
Amount of interest to be capitalised = 74,189

iv. Total expenses to be capitalized for building

Rs.
Cost of building Rs. (2,00,000 + 2,50,000 + 4,50,000 + 1,20,000) 10,20,000
Add: Amount of interest to be capitalised 74,189
10,94,189

v. Journal Entry
Date Particulars Dr. (Rs.) Cr. (Rs.)
31.12. 20X1 Building account Dr. 10,94,189
To Bank account 10,94,189
287

(Being amount of cost of building and

Page

borrowing cost thereon capitalised)

CA CS KARTHIK MANIKONDA – 75501 37279

 Illustration 3
The company has obtained Institutional Term Loan of Rs. 580 lakhs for modernisation and
renovation of its Plant & Machinery. Plant & Machinery acquired under the modernisation scheme
and installation completed on 31st March, 20X2 amounted to Rs. 406 lakhs, Rs. 58 lakhs has been
advanced to suppliers for additional assets and the balance loan of Rs. 116 lakhs has been utilised
for working capital purpose. The Accountant is on a dilemma as to how to account for the total
interest of Rs. 52.20 lakhs incurred during 20X1-20X2 on the entire Institutional Term Loan of
Rs.580 lakhs.
Solution
As per para 6 of AS 16 ‘Borrowing Costs’, borrowing costs that are directly attributable to the
acquisition, construction or production of a qualifying asset should be capitalised as part of the cost
of that asset. Other borrowing costs should be recognised as an expense in the period in which they
are incurred.
A qualifying asset is an asset that necessary takes a substantial period of time* to get ready for its
intended use or sale.
The treatment for total interest amount of Rs. 52.20 lakhs can be given as:
Purpose Nature Interest to be capitalised Interest to be charged
to profit and loss
account
Rs. in lakhs Rs.in lakhs
Modernisation and Qualifying asset 406
* *52.20   36.54
renovation of plant and 580
58
machinery * *52.20   5.22
580

Advance to supplies for Qualifying asset

additional assets 116
* *52.20   10.44
580

Working Capital Not a qualifying asset

41.76 10.44

* A substantial period of time primarily depends on the facts and circumstances of each case.
288

However, ordinarily, a period of twelve months is considered as substantial period of time unless a
shorter or longer period can be justified on the basis of the facts and circumstances of the case.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

** It is assumed in the above solution that the modernisation and renovation of plant and
machinery will take substantial period of time (i.e. more than twelve months). Regarding purchase of
additional assets, the nature of additional assets has also been considered as qualifying assets.
Alternatively, the plant and machinery and additional assets may be assumed to be non-qualifying
assets on the basis that the renovation and installation of additional assets will not take substantial
period of time. In that case, the entire amount of interest, Rs. 52.20 lakhs will be recognised as
expense in the profit and loss account for year ended 31st March, 20X2.

Illustration 4
Take Ltd. has borrowed Rs. 30 lakhs from State Bank of India during the financial year 20X1-20X2.
The borrowings are used to invest in shares of Give Ltd., a subsidiary company of Take Ltd., which
is implementing a new project, estimated to cost Rs. 50 lakhs. As on 31st March, 20X2, since the
said project was not complete, the directors of Take Ltd. resolved to capitalise the interest
accruing on borrowings amounting to Rs. 4 lakhs and add it to the cost of investments. Comment.
Solution
As per AS 13 (Revised) "Accounting for Investments", the cost of investment includes acquisition
charges such as brokerage, fees and duties. In the present case, Take Ltd. has used borrowed funds
for purchasing shares of its subsidiary company Give Ltd. Rs. 4 lakhs interest payable by Take Ltd. to
State Bank of India cannot be called as acquisition charges, therefore, cannot be constituted as cost
of investment.
Further, as per para 3 of AS 16 "Borrowing Costs", a qualifying asset is an asset that necessarily takes
a substantial period of time to get ready for its intended use or sale. Since, shares are ready for its
intended use at the time of sale, it cannot be considered as qualifying asset that can enable a
company to add the borrowing cost to investments. Therefore, the directors of Take Ltd. cannot
capitalise the borrowing cost as part of cost of investment. Rather, it has to be charged to the
Statement of Profit and Loss for the year ended 31st March, 20X2.
Reference: The students are advised to refer the full text of AS 16 “Borrowing Costs” (issued 2000).
289
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. As per AS 16, all the following are qualifying assets except
a. Manufacturing plants and Power generation facilities
b. Inventories that require substantial period of time
c. Assets those are ready for sale.
d. None of the above

2. Which of the following statement is correct:

a. Entire exchange gain is reduced from the cost of the Qualifying asset.
b. Entire exchange loss is added to the cost of a Qualifying asset.
c. No adjustment is done for the exchange loss while computing cost of Qualifying asset.
d. None of the above

3. Capitalisation rate considers:

a. Borrowing costs on general borrowings only.
b. Borrowing costs on general and specific borrowings both.
c. Borrowing costs on specific borrowings only
d. None of the above

4. If the amount eligible for capitalisation in case of inventory as per AS 16 is Rs. 12,000 and cost
of inventory is Rs. 40,000 and its net realizable value is Rs. 45,000; What amount can be
capitalised as a part of inventory cost.
a. Rs. 12,000.
b. Rs. 5,000.
c. Rs. 7,000.
d. Rs. 10,000.

5. X Ltd is commencing a new construction project, which is to be financed by borrowing. The

key dates are as follows:
i. 15th May, 20X1: Loan interest relating to the project starts to be incurred
ii. 2nd June, 20X1: Technical site planning commences
iii. 19th June, 20X1: Expenditure on the project started to be incurred
290

iv. 18th July, 20X1: Construction work commences

Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Identify the commencement date for capitalisation under AS 16.
a. 15th May, 20X1.
b. 19th June, 20X1.
c. 18th July, 20X1.
d. 2nd June, 20X1.

ANSWERS/SOLUTIONS
MCQs
1. c. Assets those are ready for sale.
2. c. No adjustment is done for the exchange loss while computing cost of Qualifying asset.
3. a. Borrowing costs on general borrowings only.
4. b. Rs.5,000.
5. b. 19th June, 20X1.

THEORY QUESTIONS
Q.NO.1. When capitalization of borrowing cost should cease as per Accounting Standard 16?
Explain the provision.
ANSWER
Capitalization of borrowing costs should cease when substantially all the activities necessary to
prepare the qualifying asset for its intended use or sale are complete. An asset is normally ready for
its intended use or sale when its physical construction or production is complete even though
routine administrative work might still continue. If minor modifications such as the decoration of a
property to the user’s specification, are all that are outstanding, this indicates that substantially all
the activities are complete. When the construction of a qualifying asset is completed in parts and a
completed part is capable of being used while construction continues for the other parts,
capitalisation of borrowing costs in relation to a part should cease when substantially all the
activities necessary to prepare that part for its intended use or sale are complete.

Q.NO.2. H Ltd. incurs borrowing costs for the purpose of construction of a qualifying asset for its
own use. The construction gets completed on May 31, 20X1. However, decoration work is under
process which is expected to be completed by November 20X1 after which H Ltd. will be able to
291

start using the said asset for its own use. H Ltd. wants to capitalize the eligible borrowing costs
incurred up to November 20X1.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

ANSWER
The capitalization of borrowing costs shall cease when substantially all the activities necessary to
prepare the qualifying assets for its intended use or sale is completed.
In the given case, H Ltd. should capitalize borrowing costs only up to May 31, 20X1. The borrowing
cost incurred thereafter cannot be capitalized as the asset was ready for its intended use on May 31,
20X1. The fact that decoration work was being carried out should not be considered as the asset was
ready for its intended use on May 31, 20X1.

Q.NO.3. ABC Ltd. is in the process of getting an entertainment park constructed. For this
purpose, it has taken loan from a bank. The said park consists of several rides and facilities, each
of which can be used individually. Three fourth part of the park has been constructed and can be
opened up for public, while construction on the remaining part is continuing. Whether the
capitalization of borrowing cost should continue for the whole park until construction continues?
ANSWER
ABC Ltd. is in process of constructing an entertainment park which consists of several rides and
facilities that can operate independently for their intended use. Even though the park as whole is not
complete, the individual facilities are ready for their intended use.
The cessation of capitalization depends upon the nature of the qualifying assets, particularly where
the qualifying assets consists of various parts. There are qualifying assets where each part is capable
of being used while the construction continues on other parts. There are qualifying assets where all
parts have to be completed before any earlier completed part can be put to use.
Since in the given scenario, the individual facilities are capable of operating independently and are
ready for their intended use, therefore the borrowing costs shall cease to be capitalized for the
three-fourth part of the project.
292
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 PRACTICAL QUESTIONS
Q.NO.1. On 1st April, 20X1, Amazing Construction Ltd. obtained a loan of Rs. 32 crores to be
utilised as under:
i. Construction of sea link across two cities:
(work was held up totally for a month during the year due to high water : Rs. 25 crores
levels)
ii. Purchase of equipments and machineries : Rs. 3 crores
iii. Working capital : Rs. 2 crores
iv. Purchase of vehicles : Rs. 50,00,000
v. Advance for tools/cranes etc. : Rs. 50,00,000
vi. Purchase of technical know-how : Rs. 1 crores
vii. Total interest charged by the bank for the year ending 31st March, 20X2 : Rs. 80,00,000
Show the treatment of interest by Amazing Construction Ltd.
SOLUTION
According to AS 16 ‘Borrowing costs’, qualifying asset is an asset that necessarily takes substantial
period of time to get ready for its intended use.
Borrowing costs that are directly attributable to the acquisition, construction or production of a
qualifying asset should be capitalised as part of the cost of that asset. Other borrowing costs should
be recognised as an expense in the period in which they are incurred.
The treatment of interest by Amazing Construction Ltd. can be shown as:
Qualifying Interest to be Interest to be
Asset capitalised charged to
Rs. Profit & Loss A/c
Rs.
Construction of sea-link Yes 62,50,000 [80,00,000x (25/32)]
Purchase of equipment No 7,50,000 [80,00,000x (3/32)]
and machineries
Working capital No 5,00,000 [80,00,000x (2/32)]
Purchase of vehicles No 1,25,000 [80,00,000x(0.5/32)]
Advance for tools, cranes
etc. No 1,25,000 [80,00,000x(0.5/32)]
Purchase of technical
293

know-how No 2,50,000 [80,00,000x(1/32)]

Total 62,50,000 17,50,000
Page

CA CS KARTHIK MANIKONDA – 75501 37279

*It is assumed that work held up for a month due to high water level is normal during the
construction of sea link and capitalization of borrowing cost should not be suspended for necessary
temporary delay.

Q.NO.2. Rainbow Limited borrowed an amount of Rs.150 crores on 1.4.20X1 for construction of
boiler plant @ 11% p.a. The plant is expected to be completed in 4 years. Since the weighted
average cost of capital is 13% p.a., the accountant of Rainbow Ltd. capitalized Rs.19.50 crores for
the accounting period ending on 31.3.20X2. Due to surplus fund out of Rs.150 crores, income of
Rs.3.50 crores were earned and credited to profit and loss account. Comment on the above
treatment of accountant with reference to relevant accounting standard.
SOLUTION
Para 10 of AS 16 'Borrowing Costs' states "To the extent that funds are borrowed specifically for the
purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for capitalization on
that asset should be determined as the actual borrowing costs incurred on that borrowing during
the period less any income on the temporary investment of those borrowings."
The capitalization rate should be the weighted average of the borrowing costs applicable to the
borrowings of the enterprise that are outstanding during the period, other than borrowings made
specifically for the purpose of obtaining a qualifying asset.
Thus, the treatment of accountant of Rainbow Ltd. is incorrect.
Amount of borrowing costs capitalized should be calculated as follows:
Particulars Rs. in crores
Actual interest for 20X1-20X2 (11% of Rs.150 crores) 16.50
Less: Income on temporary investment from specific borrowings (3.50)
Borrowing costs to be capitalized during year 20X1-20X2 13.00

Q.NO.3. Harish Construction Company is constructing a huge building project consisting of four
phases. It is expected that the full building will be constructed over several years but Phase I and
Phase II of the building will be started as soon as they are completed.
Following is the detail of the work done on different phases of the building during the current
year: (Rs. in lakhs)
Phase I Phase II Phase III Phase IV
Rs. Rs. Rs. Rs.
294

Cash expenditure 10 30 25 30
Page

Building purchased 24 34 30 38

CA CS KARTHIK MANIKONDA – 75501 37279

Total expenditure 34 64 55 68
Total expenditure of all phases 221
Loan taken @ 15% at the
beginning of the year 200

During mid of the current year, Phase I and Phase II have become operational. Find out the total
amount to be capitalized and to be expensed during the year.
SOLUTION
Computation of amount to be capitalized
No. Particulars Rs.
1. Interest expense on loan Rs.2,00,00,000 at 15% 30,00,000
2. Total cost of Phases I and II (Rs.34,00,000 +64,00,000) 98,00,000
3. Total cost of Phases III and IV (Rs.55,00,000 + Rs.68,00,000) 1,23,00,000
4. Total cost of all 4 phases 2,21,00,000
5. Total loan 2,00,00,000
6. Interest on loan used for Phases I & II, based on proportionate 3,30,317
(approx.)
30,00,000
Loan amount =   98,00,000
2,21,00,000

7. Interest on loan used for Phases III & IV, based on 16,69,683
30,00,000 (approx.)
proportionate Loan amount =   1,23,00,000
2,21,00,000

Accounting treatment
For Phase I and Phase II
Since Phase I and Phase II have become operational at the mid of the year, half of the interest
amount of Rs. 6,65,158.50 (i.e. Rs.13,30,317/2) relating to Phase I and Phase II should be capitalized
(in the ratio of asset costs 34:64) and added to respective assets in Phase I and Phase II and
remaining half of the interest amount of Rs.6,65,158.50 (i.e. Rs.13,30,317/2) relating to Phase I and
Phase II should be expensed during the year.
For Phase III and Phase IV
Interest of Rs.16,69,683 relating to Phase III and Phase IV should be held in Capital Work-in-Progress
295

till assets construction work is completed, and thereafter capitalized in the ratio of cost of assets. No
part of this interest amount should be charged/expensed off during the year since the work on these
Page

phases has not been completed yet.

CA CS KARTHIK MANIKONDA – 75501 37279

 UNIT 5: ACCOUNTING STANDARD 19: LEASES
LEARNING OUTCOMES
After studying this unit, you will be able to comprehend–
 What is a lease
 What are the parameters for Classification of Leases
 Accounting for leases in the Financial Statements of Lessees
 Finance Leases
 Operating Leases
 Accounting for Leases in the Financial Statements of Lessors
 Finance Leases
 Operating Leases
 Sale And Leaseback Transactions
 Disclosures required as per the standard
5.1 INTRODUCTION
Before, we start with the standard, let us lay down the coverage of AS 19 from the examination point
of view as under:
Areas covered by AS 19:

What is a lease and how do we classify a lease (Finance or operating)?

Lessee's point of view Lessee's point of view

Accounting of a Lease (Finance and operating )

Books of LEESE Books of LEESE

Special issue - Related to Lease Accounting

Sale and Lease back Transaction

296

The objective of AS 19 is to prescribe, for lessees and lessors, the appropriate accounting policies
and disclosures in relation to finance leases and operating leases.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

What is a Lease?
A Lease is an agreement whereby the Lessor (legal owner of an asset) conveys to the Lessee
(another party) in return for a payment or series of periodic payments (Lease rents), the right to use
an asset for an agreed period of time.
5.2 APPLICABILITY OF AS 19 [SCOPE]
The standard applies to all leases other than:
a. Lease agreements to explore for or use of natural resources, such as oil, gas, timber metals and
other mineral rights; and
b. Licensing agreements for items such as motion picture films, video recordings, plays,
manuscripts, patents and copyrights; and
c. Lease agreements to use lands
5.3 DEFINITIONS
A non-cancellable lease is a lease that is cancellable only:
a. upon the occurrence of some remote contingency; or
b. with the permission of the lessor; or
c. if the lessee enters into a new lease for the same or an equivalent asset with the same lessor; or
d. upon payment by the lessee of an additional amount such that, at inception, continuation of the
lease is reasonably certain.
The lease term is the non-cancellable period for which the lessee has agreed to take on lease the
asset together with any further periods for which the lessee has the option to continue the lease of
the asset, with or without further payment, which option at the inception of the lease it is
reasonably certain that the lessee will exercise.
The inception of the lease is the earlier of the date of the lease agreement and the date of a
commitment by the parties to the principal provisions of the lease.
Minimum lease payments are the payments over the lease term that the lessee is, or can be
required, to make excluding contingent rent, costs for services and taxes to be paid by and
reimbursed to the lessor, together with:
a. In the case of the lessee, any residual value guaranteed by or on behalf of the lessee; or
b. In the case of the lessor, any residual value guaranteed to the lessor:
i. by or on behalf of the lessee; or
ii. by an independent third party financially capable of meeting this guarantee.
297

However, if the lessee has an option to purchase the asset at a price which is expected to be sufficiently
lower than the fair value at the date the option becomes exercisable that, at the inception of the lease, is
Page

CA CS KARTHIK MANIKONDA – 75501 37279

reasonably certain to be exercised, the minimum lease payments comprise minimum payments payable
over the lease term and the payment required to exercise this purchase option.
The above definition can be summarized as under:
Note: The definition can be seen separately from the point of view of Lessee and Lessor.
From the point of view of Lessee
Case I – Lessee will return the asset at the end Case II – Lessee will retain the asset at the end
of the lease term of the lease term (as he has option to buy the
asset and it is reasonably certain that he will
exercise the option)
Payments over the lease term that the lessee is, Payments over the lease term that the lessee is,
or can be required, to make excluding: or can be required, to make excluding:
a. contingent rent. a. contingent rent.
b. costs for services and taxes to be paid by b. costs for services and taxes to be paid by
and reimbursed to the lessor. and reimbursed to the lessor.
+ +
Any residual value guaranteed by or on behalf Payment required to exercise the purchase
of the lessee. option.

From the point of view of Lessee

Case I – Lessee will return the asset at the end Case II – Lessee will retain the asset at the end
of the lease term of the lease term (as he has option to buy the
Payments over the lease term that the lessee is, asset and it is reasonably certain that he will
or can be required, to make excluding: exercise the option)
a. contingent rent. Payments over the lease term that the lessee is,
b. costs for services and taxes to be paid by or can be required, to make excluding:
and reimbursed to the lessor. a. contingent rent.
+ b. costs for services and taxes to be paid by
Any residual value guaranteed: and reimbursed to the lessor.
a. by or on behalf of the lessee; or +
b. by an independent third party financially Payment required to exercise the purchase
capable of meeting this guarantee. option.
298

Fair value is the amount for which an asset could be exchanged or a liability settled between
Page

knowledgeable, willing parties in an arm’s length transaction.

CA CS KARTHIK MANIKONDA – 75501 37279

Economic life is either:
a. the period over which an asset is expected to be economically usable by one or more users; or
b. the number of production or similar units expected to be obtained from the asset by one or
more users.
Useful life of a leased asset is either:
a. the period over which the leased asset is expected to be used by the lessee; or
b. the number of production or similar units expected to be obtained from the use of the asset by
the lessee.
Note: The economic life is always greater than the useful life of the asset. Useful life represents
the depreciable life of an asset whereas, economic life represents the total life during which an
asset is capable of generating economic benefits.
Residual value of a leased asset is the estimated fair value of the asset at the end of the lease term.

Guaranteed residual value is:

a. in the case of the lessee, that part of the residual value which is guaranteed by the lessee or by a
party on behalf of the lessee (the amount of the guarantee being the maximum amount that
could, in any event, become payable); and
b. in the case of the lessor, that part of the residual value which is guaranteed by or on behalf of
the lessee, or by an independent third party who is financially capable of discharging the
obligations under the guarantee.
Unguaranteed residual value of a leased asset is the amount by which the residual value of the
asset exceeds its guaranteed residual value.
Note: Residual value = Guaranteed Residual value (GRV) + Unguaranteed Residual value (UGRV)
Gross investment in the lease is the aggregate of the minimum lease payments under a finance lease
from the standpoint of the lessor and any unguaranteed residual value accruing to the lessor.
In simple words,
Gross Undiscounted total cash inflows from the point of view of the lessor
Investment Undiscounted total of:
(GI) a. Minimum Lease Payments (MLP); and
b. Unguaranteed Residual Value (UGRV).
Undiscounted total of:
a. Lease Payments;
299

b. Guaranteed residual value (GRV); and

Page

CA CS KARTHIK MANIKONDA – 75501 37279

 c. Unguaranteed Residual value (UGRV).
Undiscounted total of:
a. Lease Payments; and
b. Residual value (GRV and UGRV);

Unearned finance income is the difference between:

a. the gross investment in the lease; and
b. the present value of
i. the minimum lease payments under a finance lease from the standpoint of the lessor; and
ii. any unguaranteed residual value accruing to the lessor,
at the interest rate implicit in the lease.
Unearned Gross Investment (GI) – Net Investment (NI)
Finance Gross Investment (GI) – Present value of
Income (UFI) Gross Investment Gross Investment – Fair Value
Simply speaking = Total Interest

Net investment in the lease is the gross investment in the lease less unearned finance income.
In simple words,
Net Discounted total cash inflows from the point of view of the lessor
Investment Discounted total of:
(NI) a. Minimum Lease Payments (MLP); and
b. Unguaranteed Residual Value (UGRV).
Discounted total of:
a. Lease Payments;
b. Guaranteed residual value (GRV); and
c. Unguaranteed Residual value (UGRV).
Discounted total of:
a. Lease Payments; and
b. Residual value (GRV and UGRV);
Discounted Gross Investment (GI) i.e. Present value of GI
Simply speaking = Fair value
The interest rate implicit in the lease is the discount rate that, at the inception of the lease, causes
300

the aggregate present value of

Page

a. the minimum lease payments under a finance lease from the standpoint of the lessor; and

CA CS KARTHIK MANIKONDA – 75501 37279

b. any unguaranteed residual value accruing to the lessor, to be equal to the fair value of the leased
asset.
Interest rate Discount rate at which:
implicit in the lease Cash Outflows = Present value of Cash Inflows
Where,
Cash Outflow = Fair value of the asset;
Cash Inflow = Lease Payments + Residual Value (GRV and UGRV)
Simply speaking = Lessor’s IRR

The lessee’s incremental borrowing rate of interest is the rate of interest the lessee would have to
pay on a similar lease or, if that is not determinable, the rate that, at the inception of the lease, the
lessee would incur to borrow over a similar term, and with a similar security, the funds necessary t o
purchase the asset.
Contingent rent is that portion of the lease payments that is not fixed in amount but is based on a
factor other than just the passage of time (e.g., percentage of sales, amount of usage, price indices,
market rates of interest).
The definition of a lease includes agreements for the hire of an asset which contain a provision
giving the hirer an option to acquire title to the asset upon the fulfilment of agreed conditions.
These agreements are commonly known as hire purchase agreements. Hire purchase agreements
include agreements under which the property in the asset is to pass to the hirer on the payment of
the last instalment and the hirer has a right to terminate the agreement at any time before the
property so passes.

5.4 TYPES OF LEASES

For accounting purposes, leases are classified as:
i. Finance leases; and
ii. Operating leases.
Finance lease - A lease classified as Finance Lease if it transfers substantially all the risks and rewards
incident to ownership of an asset. Title may or may not be eventually transferred.
Operating Lease -A lease is classified as an Operating Lease if it does not transfer substantially all the
risk and rewards incident to ownership.
301

Whether a lease is a finance lease or an operating lease depends on the substance of the transaction
rather than its form.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Risks include the possibilities of losses from idle capacity or technological obsolescence and of
variations in return due to changing economic conditions.
Rewards may be represented by the expectation of profitable operation over the economic life of
the asset and of gain from appreciation in value or realisation of residual value.
We can summarize the types of lease conceptually as under:

Transfers the risk and reward

Finance
Typically, a loan arrangement
Type of Lease
Does not transfer the risk and reward
Operating
Typically, a rental arrangement

5.5 INDICATORS OF FINANCE LEASE

AS 19 has given a total of 8 parameters to decide whether it is a finance lease or not. (These
parameters have been discussed in para 5.6 and 5.7.
These 8 conditions can be divided into following categories:

5 Parameters -
Any 1 condition is met – It will be
Deterministic in
classified as finance lease.
nature
8 Parameters
Even if all the conditions are met –
3 Parameters -
It does not necessarily imply that it
Suggestive in nature
is a finance lease.

Let us take up these conditions one by one;

5.6 DETERMINISTIC CONDITIONS

Situations, which would normally lead to a lease being classified as a finance lease are:
a. The lease transfers ownership of the asset to the lessee by the end of the lease term;
b. The lessee has the option to purchase the asset at a price which is expected to be sufficiently
302

lower than the fair value at the date the option becomes exercisable such that, at the inception
Page

of the lease, it is reasonably certain that the option will be exercised;

CA CS KARTHIK MANIKONDA – 75501 37279

 Example
Mr. A has taken a car on lease for 5 years from XYZ. After 5 years of lease term Mr. A has the
option to purchase this car for Rs.20,000, whereas it is assumed the car market value at the end
of 5th year would be Rs.2,00,000. Considering the option to buy it at bargain price, it is
reasonably certain that Mr. A would exercise that option.
c. The lease term is for the major part of the economic life of the asset even if title is not
transferred;
Example
XYZ has taken a property on lease for 32 years from ABC, expected economic life of the property
is 40 years. Since XYZ is going to use the asset over major part of its economic life (80% in this
case), it will meet the condition to be treated as finance lease.
d. At the inception of the lease, present value of the minimum lease payments amounts to at least
substantially all of the fair value of the leased asset; and
e. The leased asset is of a specialized nature such that only the lessee can use it without major
modifications being made.
Example
PQR, a hospital ordered 10 ambulances, specially designed as per the requirement of PQR. These
ambulances are taken on lease and it cannot be used by anyone else without major
modifications. This would meet the condition of finance lease.

5.7 SUGGESTIVE CONDITIONS

Additional Indicators of situations which individually or in combination could also lead to a lease
being classified as a finance lease are:
a. If the lessee can cancel the lease and the lessor’s losses associated with the cancellation are
borne by the lessee;
b. If gains or losses from the fluctuations in the residual value accrue to the lessee (for example if
the lessor agrees to allow rent rebate equalling most of the disposal value of leased asset at the
end of the lease); and
c. If the lessee can continue the lease for a secondary period at a rent, which is substantially lower
than market rent.
Lease classification is made at the inception of the lease. If at any time the lessee and the lessor agree to
change the provisions of the lease, other than by renewing the lease, in a manner that would have
303

resulted in a different classification of the lease had the changed terms been in effect at the inception of
the lease, the revised agreement is considered as a new agreement over its revised term.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Changes in estimates (for example, changes in estimates of the economic life or of the residual value
of the leased asset) or changes in circumstances (for example, default by the lessee), however, do
not give rise to a new classification of a lease for accounting purposes.

5.8 ACCOUNTING FOR FINANCE LEASES (BOOKS OF LESSEE)

Following is the accounting treatment of Finance Leases in the books of Lessee:
i. On the date of inception of Lease, Lessee should show it as an asset and corresponding liability
at lower of:

 Fair value of leased asset at the inception of the lease

 Present value of minimum lease payments from the standpoint of the lessee
(Present value to be calculated with discount rate equal to interest rate implicit in the lease, if
this is practicable to determine; if not, the lessee’s incremental borrowing rate should be used).
Thus, the journal entry at inception will be as under:
Particulars Debit Credit
Asset Refer Note
To Lessor (Lease Liability) Refer Note
It is not appropriate to present the liability for a leased asset as a deduction from the leased
asset in the financial statements. The liability for a leased asset should be presented separately
in the balance sheet as a current liability or a long-term liability as the case may be.
Note:
The amount will be lower of the two:
a. Fair value.
b. Present value of MLP (Minimum Lease payments) from the point of view of lessee.
ii. Lease payments to be apportioned between the finance charge and the reduction of the
outstanding liability.
iii. Finance charges to be allocated to periods during the lease term so as to produce a constant rate
of interest on the remaining balance of liability for each period.
iv. A finance lease gives rise to a depreciation expense for the asset as well as a finance expense for
each accounting period. The depreciation policy for a leased asset should be consistent with that
for depreciable assets which are owned, and the depreciation recognised should be calculated
on the basis set out in AS 10 (Revised), Property, Plant and Equipment.
304

v. If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease
term, the asset should be fully depreciated over the lease term or its useful life, whichever is
Page

shorter.

CA CS KARTHIK MANIKONDA – 75501 37279

 Note:
Cases Useful life for Depreciation
Case I – Asset will be retained by the lessee Useful life
Case II – Asset will be returned to the lessor Useful life or lease term whichever is shorter
vi. Initial direct costs are often incurred in connection with specific leasing activities, as in
negotiating and securing leasing arrangements. The costs identified as directly attributable to
activities performed by the lessee for a finance lease are included as part of the amount
recognised as an asset under the lease.

5.8.1 Computation of interest rate implicit on lease

The interest rate implicit in the lease is the discount rate that, at the inception of the lease, causes
the aggregate present value of:
a. the minimum lease payments under a finance lease from the standpoint of the lessor; and
b. any unguaranteed residual value accruing to the lessor, to be equal to the fair value of the leased
asset.
Discounting rate = R% p.a;
Lease Rents = L1, L2 ……… Ln (Payable annually, at the end of each year)
Lease period = n years;
Guaranteed residual value = GR;
Unguaranteed residual value = UGR
Fair Value at the inception (beginning) of lease = FV
L1 L2 L3 GR
PV of MLP =   
(1  R)1 (1  R)2 (1  R)n (1  R)n
UGR
Present value of unguaranteed residual value =
(1  R)n
If interest rate implicit on lease is used as discounting rate:
Fair Value = PV of Minimum Lease Payments + PV of unguaranteed residual value ….. (1)
The interest rate implicit on lease can be computed by trial and error, provided the information
required, e.g. the unguaranteed residual value can be reasonably ascertained.

Example 1
Annual lease rents = Rs.50,000 at the end of each year.
305

Lease period = 5 years;

Page

Guaranteed residual value = Rs.25,000

CA CS KARTHIK MANIKONDA – 75501 37279

Unguaranteed residual value (UGR) = Rs.15,000
Fair Value at the inception (beginning) of lease = Rs.2,00,000
Interest rate implicit on lease is computed below:
Interest rate implicit on lease is a discounting rate at which present value of minimum lease
payments and unguaranteed residual value is Rs.2 lakhs.
PV of minimum lease payments and unguaranteed residual value at guessed rate 10%
Year MLP + UGR DF (10%) PV
Rs. Rs.
1 50,000 0.909 45,450
2 50,000 0.826 41,300
3 50,000 0.751 37,550
4 50,000 0.683 34,150
5 50,000 0.621 31,050
5 25,000 0.621 15,525
5 15,000 0.621 9,315
2,14,340

PV of minimum lease payments and unguaranteed residual value at guessed rate 14%
Year MLP + UGR DF (10%) PV
Rs. Rs.
1 50,000 0.877 43,850
2 50,000 0.769 38,450
3 50,000 0.675 33,750
4 50,000 0.592 29,600
5 50,000 0.519 25,950
5 25,000 0.519 12,975
5 15,000 0.519 7,785
1,92,360

Interest rate implicit on lease is computed below by interpolation:

14%  10%
Interest rate implicit on lease = 10%   (2,14,340  2,00,000)  12.6%
306

2,14,340  1,92,360
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Example 2
Annual lease rents = Rs.50,000 at the end of each year.
Lease period = 5 years;
Guaranteed residual value = Rs.25,000
Unguaranteed residual value (UGR) = Rs.15,000
Fair Value at the inception (beginning) of lease = Rs.2,00,000
Interest rate implicit on lease is = 12.6%
Present value of minimum lease payment is computed below:
Year MLP DF (12.6%) PV
Rs. Rs.
1 50,000 0.890 44,500
2 50,000 0.790 39,500
3 50,000 0.700 35,000
4 50,000 0.622 31,100
5 50,000 0.552 27,600
5 25,000 0.552 13,800
1,91,500
Present value of minimum lease payment = Rs.1,91,500
Fair value of leased asset = Rs.2,00,000
The accounting entry at the inception of lease to record the asset taken on finance lease in books of
lessee is suggested below:
Rs. Rs.
Asset A/c Dr. 1,91,500
To Lessor (Lease Liability) A/c 1,91,500
(Being recognition of finance lease as asset and liability)

Rs. Rs.
Asset A/c Dr. 1,91,500
To Lessor (Lease Liability) A/c 1,91,500
(Being recognition of finance lease as asset and liability)
307
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Example 3
Using data for example 2 and assuming zero residual value, allocation of finance charge over lease
period is shown below:
Year Minimum Lease Finance Charge Principal Principal due
Payments Rs. (12.6%) Rs. Rs. Rs.
0 -- -- -- 1,91,500
1 50,000 24,129 25,871 1,65,629
2 50,000 20,869 29,131 1,36,498
3 50,000 17,199 32,801 1,03,697
4 50,000 13,066 36,934 66,763
5 75,000 8,237 66,763
2,75,000 83,500 1,91,500
Accounting entries in year 1 to recognise the finance charge in books of lessee are suggested below:
Rs. Rs.
Finance Charge A/c Dr. 24,129
To Lessor 24,129
(Being finance charge due for the year)
Lessor Dr. 50,000
To Bank A/c 50,000
(Being payment of lease rent for the year)
P & L A/c Dr. 24,129
To Finance Charge A/c 24,129
(Being recognition of finance charge as expense for the year)

Example 4
In example 2, suppose unguaranteed residual value is not determinable and lessee’s incremental
borrowing rate is 10%.
Since interest rate implicit on lease is discounting rate at which present value of minimum lease
payment and present value of unguaranteed residual value equals the fair value, interest rate
implicit on lease cannot be determined unless unguaranteed residual value is known. If interest rate
implicit on lease is not determinable, the present value of minimum lease payments should be
308

determined using lessee’s incremental borrowing rate. Present value of minimum lease payment
Page

using lessee’s incremental borrowing rate 10% is computed below:

CA CS KARTHIK MANIKONDA – 75501 37279

 Year MLP DF (10%) PV
Rs. Rs.
1 50,000 0.909 45,450
2 50,000 0.826 41,300
3 50,000 0.751 37,550
4 50,000 0.683 34,150
5 50,000 0.621 31,050
5 25,000 0.621 15,525
2,05,025
Present value of minimum lease payment = Rs.2,05,025
Fair value of leased asset = Rs.2,00,000
The accounting entry at the inception of lease to record the asset taken on finance lease in books of lessee is
suggested below:
Rs. Rs.
Asset A/c Dr. 2,00,000
To Lessor (Lease Liability) 2,00,000
(Being recognition of finance lease as asset and liability)

Since the liability is recognised at fair value Rs.2 lakh (total principal), we need to ascertain a
discounting rate at which present value minimum lease payments equals Rs.2 lakh. The discounting
rate can then be used for allocation of finance charge over lease period.
PV of minimum lease payments at guessed rate 12%.
Year Minimum Lease Payments DF (12.6%) PV
Rs. Rs.
1 50,000 0.893 44,650
2 50,000 0.797 39,850
3 50,000 0.712 35,600
4 50,000 0.636 31,800
5 50,000 0.567 28,350
5 25,000 0.567 14,175
1,94,425
309

12%  10%
Required discounting rate = 10%   (2,05,025  2,00,000)  10.95%
Page

2,05,025  1,94 ,425

CA CS KARTHIK MANIKONDA – 75501 37279

Allocation of finance charge over lease period is shown below:
Year Minimum Lease Finance Charge Principal Principal due
Payments (12.6%) Rs. Rs.
Rs. Rs.
0 -- -- -- 2,00,000
1 50,000 21,900 28,100 1,71,900
2 50,000 18,823 31,177 1,40,723
3 50,000 15,409 34,591 1,06,132
4 50,000 13,066 36,934 66,763
5 75,000 7,247 67,753
2,75,000 75,000 2,00,000
Accounting entries in year 1 to recognise the finance charge in books of lessee are suggested below:
Rs. Rs.
Finance Charge A/c Dr. 21,900
To Lessor 21,900
(Being finance charge due for the year)
Lessor Dr. 50,000
To Bank A/c 50,000
(Being payment of lease rent for the year)
P & L A/c Dr. 21,900
To Finance Charge 21,900
(Being recognition of finance charge as expense for the year)
(Refer Illustration 1)
5.8.2 Disclosures made by the Lessee
The lessee should, in addition to the requirements of AS 10 (Revised), Property, Plant and
Equipment, and the governing statute, make the following disclosures for finance leases:
a. assets acquired under finance lease as segregated from the assets owned;
b. for each class of assets, the net carrying amount at the balance sheet date;
c. a reconciliation between the total of minimum lease payments at the balance sheet date and
their present value. In addition, an enterprise should disclose the total of minimum lease
payments at the balance sheet date, and their present value, for each of the following periods:
310

i. not later than one year;

Page

ii. later than one year and not later than five years;

CA CS KARTHIK MANIKONDA – 75501 37279

 iii. later than five years;
d. contingent rents recognised as expense in the statement of profit and loss for the period;
e. the total of future minimum sublease payments expected to be received under non-cancelable
subleases at the balance sheet date; and
f. a general description of the lessee's significant leasing arrangements including, but not limited
to, the following:
i. the basis on which contingent rent payments are determined;
ii. the existence and terms of renewal or purchase options and escalation clauses; and
iii. restrictions imposed by lease arrangements, such as those concerning dividends, additional
debt, and further leasing.
5.8.3 Accounting for finance leases (Books of lessor)
The lessor should recognise assets given under a finance lease in its balance sheet as a receivable at
an amount equal to the net investment in the lease.
In a finance lease, the lessor recognises the net investment in lease (which is usually equal to fair
value, i.e. usual market price of the asset, as shown below) as receivable by debiting the Lessee A/c.
Journal entries at inception:
Particulars Debit Credit
Asset Fair value
To Bank Fair value
(Being purchase of asset by lessor at FV)
Lease Receivable Fair value = NI
To Asset Fair value = NI
(Being asset by lessor given at lease)

Where,
Gross investment in Lease (GI)
= Minimum Lease Payments (MLP) + Unguaranteed Residual value (UGRV)
Net investment in Lease (NI)
= Gross investment in Lease (GI) – Unearned Finance Income (UFI).
Unearned finance income (UFI) = GI – (PV of MLP + PV of UGRV)
The discounting rate for the above purpose is the rate of interest implicit in the lease.
From the definition of interest rate implicit on lease:
311

(PV of MLP + PV of UGRV) = Fair Value.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

The above definitions imply that:
a. Unearned Finance Income (UFI) = GI – Fair Value
b. Net Investment in Lease = GI – UFI = GI – (GI – Fair Value) = Fair Value
Since the sale and receivables are recognised at net investment in lease, which is equal to fair value:
Profit recognised at the inception of lease = Fair Value – Cost
Total earning of lessor = GI – Cost
= (GI – Fair Value) + (Fair Value – Cost)
= Unearned Finance Income + (Fair Value – Cost)
The above analysis does not hold where the discounting rate is not equal to interest rate implicit on
lease. Such is the case, where the interest rate implicit on lease is artificially low. The discounting
rate in such situations should be the commercial rate of interest (refer discussion on ‘manufacturer
or dealer lessor’ below).

5.8.4 Recognition of Finance Income

The unearned finance income is recognised over the lease term on a systematic and rational basis.
This income allocation is based on a pattern reflecting a constant periodic return on the net
investment in lease outstanding.
The constant periodic return is the rate used for discounting, i.e. either the interest rate implicit on
lease or the commercial rate of interest.

5.8.4 Initial Direct Costs

Initial direct costs, such as commissions and legal fees, are often incurred by lessors in negotiating
and arranging a lease. For finance leases, these initial direct costs are incurred to produce finance
income and are either recognised immediately in the statement of profit and loss or allocated
against the finance income over the lease term.

5.8.6 Review of unguaranteed residual value by lessor

AS 19 requires a lessor to review unguaranteed residual value used in computing the gross
investment in lease regularly.
In case any reduction in the estimated unguaranteed residual value is identified, the income
allocation over the remaining lease term is to be revised. Also, any reduction in respect of income
already accrued is to be recognised immediately.
An upward adjustment of the estimated residual value is not made.
312

(Refer Illustration 2)
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Manufacturer or dealer lessor
The manufacturer or dealer lessor should recognise the transaction of sale in the statement of profit
and loss for the period, in accordance with the policy followed by the enterprise for outright sales. If
artificially low rates of interest are quoted, profit on sale should be restricted to that which would
apply if a commercial rate of interest were charged. Initial direct costs should be recognised as an
expense in the statement of profit and loss at the inception of the lease.

Disclosures
The lessor should make the following disclosures for finance leases:
a. a reconciliation between the total gross investment in the lease at the balance sheet date, and
the present value of minimum lease payments receivable at the balance sheet date. In addition,
an enterprise should disclose the total gross investment in the lease and the present value of
minimum lease payments receivable at the balance sheet date, for each of the following periods:
i. not later than one year;
ii. later than one year and not later than five years;
iii. later than five years;
b. unearned finance income;
c. the unguaranteed residual values accruing to the benefit of the lessor;
d. the accumulated provision for uncollectible minimum lease payments receivable;
e. contingent rents recognised in the statement of profit and loss for the period;
f. a general description of the significant leasing arrangements of the lessor; and
g. accounting policy adopted in respect of initial direct costs.
As an indicator of growth, it is often useful to also disclose the gross investment less unearned
income in new business added during the accounting period, after deducting the relevant amounts
for cancelled leases.

5.9 ACCOUNTING FOR OPERATING LEASES

5.9.1 Accounting treatment in the Books of lessee
Lease payments under an operating lease should be recognised as an expense in the statement of
profit and loss of a lessee on a straight line basis over the lease term unless another systematic basis
is more representative of the time pattern of the user’s benefit.
Lease payments may be tailor made to suit the payment capacity of the lessee. For example, a lease
term may provide for low initial rents and high terminal rent. Such payment patterns do not reflect
the pattern of benefit derived by the lessee from the use of leased asset. To have better matching
313

between revenue and costs, AS 19 requires lessees to recognise operating lease payments as
expense in the statement of profit and loss on a straight line basis over the lease term unless
Page

another systematic basis is more representative of the time pattern of the user's benefit.

CA CS KARTHIK MANIKONDA – 75501 37279

Example
Suppose outputs from a machine taken on a 3 year operating lease are estimated as 10,000 units
in year 1; 20,000 units in year 2 and 50,000 units in year 3. The agreed annual lease payments are
Rs.25,000, Rs.45,000 and Rs.50,000 respectively.
The total lease payment Rs.1,20,000 in this example should be recognised in proportion of output
as Rs.15,000 in year 1, Rs.30,000 in year 2 and Rs.75,000 in year 3. The difference between lease
rent due and lease rent recognised can be debited / credited to Lease Equalisation A/c.
The accounting entries for year 1 in books of lessee are suggested below:
Rs. Rs.
Lease Rent A/c Dr. 15,000
Lease Equalization A/c Dr. 10,000
To Lessor 25,000
(Being lease rent for the year due)
Lessor Dr. 25,000
To Bank A/c 25,000
(Being payment of lease rent for the year)
P & L A/c Dr. 15,000
To Lease Rent A/c 15,000
(Being recognition of lease rent as expense for the year)
Since total lease rent due and recognised must be same, the Lease Equalisation A/c will close in the
terminal year. Till then, the balance of Lease Equalisation A/c can be shown in the balance sheet
under "Current Assets" or Current Liabilities" depending on the nature of balance.

5.9.2 Disclosures by lessees

The paragraph 25 requires lessees to make following disclosures for operating leases:
a. the total of future minimum lease payments under non-cancellable operating leases for each of
the following periods:
i. not later than one year;
ii. later than one year and not later than five years;
iii. later than five years;
b. the total of future minimum sublease payments expected to be received under non-cancellable
subleases at the balance sheet date;
314

c. lease payments recognised in the statement of profit and loss for the period, with separate
Page

amounts for minimum lease payments and contingent rents;

CA CS KARTHIK MANIKONDA – 75501 37279

d. sub-lease payments received (or receivable) recognised in the statement of profit and loss for
the period;
e. a general description of the lessee's significant leasing arrangements including, but not limited
to, the following:
i. the basis on which contingent rent payments are determined;
ii. the existence and terms of renewal or purchase options and escalation clauses; and
iii. restrictions imposed by lease arrangements, such as those concerning dividends, additional
debt, and further leasing.
5.9.3 Accounting treatment in the books of lessor
i. The lessor should present an asset given under operating lease as PPE in its balance sheets.
ii. Lease income from operating leases should be recognised in the statement of profit and loss on
a straight line basis over the lease term, unless another systematic basis is more representative
of the time pattern in which benefit derived from the use of the leased asset is diminished.
iii. Depreciation should be recognised in the books of lessor. The depreciation of leased assets
should be on a basis consistent with the normal depreciation policy of the lessor for similar
assets, and the depreciation charge should be calculated on the basis set out in AS 10.
iv. The impairment losses on assets given on operating leases are determined and treated as per
AS 28
We can summarize the accounting treatment for the lessor and lessee for an operating lease as
under:
Particulars Books of lessor Books of Lessee
Asset Continues to appear in his books Asset does not appear in his books
Depreciation Yes – charged Not applicable
Impairment Yes – applicable Not applicable
Lease rent Income recognized on SLM Expense recognized on SLM

Initial direct costs incurred specifically to earn revenues from an operating lease are either deferred
and allocated to income over the lease term in proportion to the recognition of rent income, or are
recognised as an expense in the statement of profit and loss in the period in which they are incurred.
A manufacturer or dealer lessor should recognise the asset given on operating lease as PPE in their
books by debiting concerned PPE A/c and crediting Cost of Production / Purchase at cost. No selling
315

profit should be recognised on entering into operating lease, because such leases are not
equivalents of sales.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Suppose outputs from a machine of economic life of 6 years are estimated as 10,000 units in year 1,
20,000 units in year 2 and 30,000 units in year 3, 40,000 units in year 4, 20,000 units in year 5 and
5,000 units in year 6. The machine was given on 3-year operating lease by a dealer of the machine
for equal annual lease rentals to yield 20% profit margin on cost Rs.5,00,000. Straight-line
depreciation in proportion of output is considered appropriate.
Output during leaseperiod
Total lease rent = 120% of Rs.5lakhs 
Total output

60,000 units
 Rs.6 lakhs   Rs.2.88 lakhs
1,25,000 units

Annual lease rent = Rs.2,88,000 / 3 = Rs.96,000

Total lease rent should be recognised as income in proportion of output during lease period, i.e. in
the proportion of 10 : 20 : 30. Hence income recognised in years 1, 2 and 3 are Rs.48,000, Rs.96,000
and Rs.1,44,000 respectively.
Since depreciation in proportion of output is considered appropriate, the depreciable amount Rs.5
lakh should be allocated over useful life 6 years in proportion of output, i.e. in proportion of 10 : 20 :
30 : 40 : 20 : 5. Depreciation for year 1 is Rs.40,000.
The accounting entries for year 1 in books of lessor are suggested below:
Rs. Rs.
Machine given on Operating Lease Dr. 5,00,000
To Purchase 5,00,000
(Being machine given on operating lease brought into books)
Lessee Dr. 96,000
To Lease Equalization A/c 48,000
To Lease Rent (Being lease rent for the year due) 48,000
Bank Dr. 96,000
To Lessee 96,000
(Being receipt of lease rent for the year)
Lease Rent Dr. 48,000
To P & L A/c 48,000
(Being recognition of lease rent as income for the year)
Depreciation Dr. 40,000
316

To Machine given on Operating Lease 40,000

(Being depreciation for the year)
Page

CA CS KARTHIK MANIKONDA – 75501 37279

P & L A/c Dr. 40,000
To Depreciation 40,000
(Being depreciation for the year transferred to P & L A/c)

Since total lease rent due and recognised must be same, the Lease Equalisation A/c will close in the
terminal year. Till then, the balance of Lease Equalisation A/c can be shown in the balance sheet
under "Current Assets" or Current Liabilities" depending on the nature of balance.

5.9.4 Disclosures by lessors

As per AS 19, the lessor should, in addition to the requirements of AS 10 (Revised) and the governing
statute, make the following disclosures for operating leases:
a. for each class of assets, the gross carrying amount, the accumulated depreciation and
accumulated impairment losses at the balance sheet date; and
i. the depreciation recognized in the statement of profit and loss for the period;
ii. impairment losses recognized in the statement of profit and loss for the period;
iii. impairment losses reversed in the statement of profit and loss for the period;
b. the future minimum lease payments under non-cancellable operating leases in the aggregate
and for each of the following periods:
i. not later than one year;
ii. later than one year and not later than five years;
iii. later than five years;
c. total contingent ren recognized as income in the statement of profit and loss for the period;
d. a general description of the lessor ’s significant leasing arrangements; and
e. accounting policy adopted in respect of initial direct costs.

5.10 SALE AND LEASEBACK

The basis of a sale and leaseback agreement is simply that one sells an asset for cash and then leases
it back from the buyer. The asset subject to such sale and leaseback agreement is generally property.
Under such an agreement the property owner agrees to sell the property at an agreed valuation and
lease it back from the buyer. The lessee or seller receives cash immediately and makes periodic
payment in form of lease rents for right to use the property. The lease payments and the sale price
are generally interdependent as they are negotiated as a package. The accounting treatment of a
sale and lease back depends upon the type of lease involved. Accounting treatment of profits /
317

losses on sale of asset, as required by the standard in respect of sale and lease-back transactions,
Page

are summarised below.

CA CS KARTHIK MANIKONDA – 75501 37279

The accounting treatment depends upon the classification of the lease in the books of the seller-
lessee.

Situation I
 Where sale and leaseback results in finance lease
The excess or deficiency of sales proceeds over the carrying amount should be deferred and
amortised over the lease term in proportion to the depreciation of the leased asset.

Situation II
 Where sale and leaseback results in operating lease

Case 1: Sale price = Fair Value

Profit or loss should be recognised immediately.

Case 2: Sale Price < Fair Value

Profit and loss should be recognised immediately. However if the loss is compensated by future
lease payments at below market price, it should be deferred and amortised in proportion to the
lease payments over the period for which the asset is expected to be used.
Case 3: Sale Price > Fair Value
The excess over fair value should be deferred and amortised over the period for which the asset is
expected to be used.
For operating leases, if the fair value at the time of a sale and leaseback transaction is l ess than the
carrying amount of the asset, a loss equal to the amount of the difference between the carrying
amount and fair value should be recognised immediately.
For finance leases, no such adjustment is necessary unless there has been an impairment in value, in
which case the carrying amount is reduced to recoverable amount in accordance with AS 28.
Thus it can be summarised as:
Sale price at fair value Carrying Carrying amount less Carrying amount above
amount equal to than fair value fair value
fair value
Profit No Profit Recognise profit Not Applicable
immediately
318

Loss No Loss Not Applicable Recognise loss

immediately
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Sale price at fair value Carrying Carrying amount less Carrying amount above
amount equal to than fair value fair value
fair value
Profit No Profit Recognise profit No Profit.
immediately (Carrying amount of an
asset to be written down
to fair value)
Loss not compensated Recognise loss Recognise loss Carrying amount of an
by future lease immediately immediately asset to be written down
payments at below to fair value
market price
Loss compensated by Defer and Defer and amortise loss. Carrying amount of an
future lease payments amortise loss. asset to be written down
at below market price to fair value

Sale price at fair value Carrying amount Carrying amount less Carrying amount above
equal to fair than fair value fair value
value
Profit Defer and 1. Difference between Defer and amortise profit.
amortise profit. carrying amount and (The profit would be the
fair value to be difference between fair
immediately value and sale price as the
recognised. carrying amount would
2. Excess over fair value have been written down
to be Deferred and to fair value)
amortised.
Loss No Loss No Loss 1. Carrying amount of an
asset to be written
down to fair value.
2. Defer and amortise
the difference of sale
319

price and fair value.

(Refer Illustration 3)
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 ILLUSTRATIONS
Illustration 1
S. Square Private Limited has taken machinery on finance lease from S.K. Ltd. The information is as
under:
Lease term = 4 years
Fair value at inception of lease = Rs.20,00,000
Lease rent = Rs.6,25,000 p.a. at the end of year
Guaranteed residual value = Rs.1,25,000
Expected residual value = Rs.3,75,000
Implicit interest rate = 15%
Discounted rates for 1st year, 2nd year, 3rd year and 4th year are 0.8696, 0.7561, 0.6575 and
0.5718 respectively.
Calculate the value of the lease liability as per AS-19 and disclose impact of this on Balance sheet
and Profit & loss account at the end of year 1
Solution
According to para 11 of AS 19 “Leases”, the lessee should recognise the lease as an asset and a
liability at an amount equal to the lower of the fair value of the leased asset at the inception of the
finance lease and the present value of the minimum lease payments from the standpoint of the
lessee.
In calculating the present value of the minimum lease payments the discount rate is the interest rate
implicit in the lease. Present value of minimum lease payments will be calculated as follows:
Year Minimum Lease Payment Implicit interest rate Present value Rs.
Rs. (Discount rate @15%)
1 6,25,000 0.8696 5,43,500
2 6,25,000 0.7561 4,72,563
3 6,25,000 0.6575 4,10,937
4 7,50,000 0.5718 4,28,850
Total 26,25,000 18,55,850
Present value of minimum lease payments Rs.18,55,850 is less than fair value at the inception of
lease i.e. Rs.20,00,000, therefore, the asset and corresponding lease liability should be recognised at
320

Rs.18,55,850 as per AS 19.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

Illustration 2
Prakash Limited leased a machine to Badal Limited on the following terms:
(Rs. In lakhs)
i. Fair value of the machine 28.3
ii. Lease term 5 years
iii. Lease rental per annum 8.00
iv. Guaranteed residual value 1.60
v. Expected residual value 3.00
vi. Internal rate of return 15%
Discounted rates for 1st year to 5th year are 0.8696, 0.7561, 0.6575, 0.5718, and 0.4972
respectively. Ascertain Unearned Finance Income.
Solution
As per AS 19 on Leases, unearned finance income is the difference between (a) the gross
investment in the lease and (b) the present value of minimum lease payments under a finance lease
from the standpoint of the lessor; and any unguaranteed residual value accruing to the lessor, at the
interest rate implicit in the lease.
Where:

a. Gross investment in the lease is the aggregate of (i) minimum lease payments from the stand
point of the lessor and (ii) any unguaranteed residual value accruing to the l essor.
Gross investment
= Minimum lease payments + Unguaranteed residual value
= [Total lease rent + Guaranteed residual value (GRV)] + Unguaranteed residual value (URV)
= [(Rs.8,00,000  5 years) + Rs.1,60,000] + Rs.1,40,000
= Rs.43,00,000 (a)

b. Table showing present value of (i) Minimum lease payments (MLP) and (ii) Unguaranteed
residual value (URV).
Year MLP inclusive of URV Rs. Implicit interest rate Present value
(Discount rate @15%) Rs.
1 8,00,000 0.8696 6,95,680
2 8,00,000 0.7561 6,04,880
321

3 8,00,000 0.6575 5,26,000

4 8,00,000 0.5718 4,57,440
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 5 8,00,000 0.4972 3,97,760
1,60,000 (GRV) 0.4972 79,552
41,60,000 27,61,312 (i)
1,40,000 (URV) 0.4972 69,608 (ii)
43,00,000 (i)+ (ii) 28,30,920 (b)
Unearned Finance Income (a) - (b) = Rs.43,00,000 – Rs.28,30,920= Rs.14,69,080.

Illustration 3
A Ltd. sold machinery having WDV of Rs.40 lakhs to B Ltd. for Rs.50 lakhs and the same machinery
was leased back by B Ltd. to A Ltd. The lease back is operating lease. Comment if –
a. Sale price of Rs.50 lakhs is equal to fair value.
b. Fair value is Rs.60 lakhs.
c. Fair value is Rs.45 lakhs and sale price is Rs.38 lakhs.
d. Fair value is Rs.40 lakhs and sale price is Rs.50 lakhs.
e. Fair value is Rs.46 lakhs and sale price is Rs.50 lakhs
f. Fair value is Rs.35 lakhs and sale price is Rs.39 lakhs.
Solution
Following will be the treatment in the given cases:
a. When sales price of Rs.50 lakhs is equal to fair value, A Ltd. should immediately recognise the
profit of Rs.10 lakhs (i.e. 50 – 40) in its books.
b. When fair value is Rs.60 lakhs then also profit of Rs.10 lakhs should be immediately recognised
by A Ltd.
c. When fair value of leased machinery is Rs.45 lakhs & sales price is Rs.38 lakhs, then loss of Rs.2
lakhs (40 – 38) to be immediately recognised by A Ltd. in its books provided loss is not
compensated by future lease payment, otherwise defer and amortise the loss.
d. When fair value is Rs.40 lakhs & sales price is Rs.50 lakhs then, profit of Rs.10 lakhs is to be
deferred and amortised over the lease period.
e. When fair value is Rs.46 lakhs & sales price is Rs.50 lakhs, profit of Rs.6 lakhs (46 - 40) to be
immediately recognised in its books and balance profit of Rs.4 lakhs (50-46) is to be amortised /
deferred over lease period.
f. When fair value is Rs.35 lakhs & sales price is Rs.39 lakhs, then the loss of Rs.5 lakhs (40-35) to
322

be immediately recognised by A Ltd. in its books and profit of Rs.4 lakhs (39-35) should be
amortised / deferred over lease period.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. A Ltd. sold machinery having WDV of Rs.40 lakhs to B Ltd. for Rs.50 lakhs (Fair value Rs.50
lakhs) and same machinery was leased back by B Ltd. to A Ltd. The lease back is in nature of
operating lease. The treatment will be
a. A Ltd. should amortise the profit of Rs.10 lakhs over lease term.
b. A Ltd. should recognise the profit of Rs.10 lakhs immediately.
c. A Ltd. should defer the profit of Rs.10 lakhs.
d. B Ltd. should recognise the profit of Rs.10 lakhs immediately.

2. In case of an operating lease – identify which statement is correct:

a. The lessor continues to show the leased asset in its books of accounts.
b. The lessor de-recognises the asset from its Balance Sheet.
c. The lessor discontinues to claim depreciation in its books.
d. The lessee recognises the asset in its Balance Sheet.

3. In case of finance lease, if the asset is returned back to the lessor at the end of the lease term -
the lessee always claims depreciation based on which of the following:

a. Useful life.
b. Lease term.
c. Useful life or lease term whichever is less.
d. Useful life or lease term whichever is higher.

4. AS 19 lays down 5 deterministic conditions to classify the lease as a finance lease. To classify
the lease as an operating lease – which statement is correct?
a. Any 1 condition fails.
b. Majority of the 5 conditions fail.
c. All 5 conditions fail.
d. Any 2 conditions fails.

5. The basis of classification of a lease is:

a. Control Test.
b. Risk and reward Test.
323

c. Both control test and risk and reward test.

Page

d. Only reward Test

CA CS KARTHIK MANIKONDA – 75501 37279

ANSWERS/SOLUTIONS
MCQs
1. b. A Ltd. should recognise the profit of Rs.10 lakhs immediately.
2. a. The lessor continues to show the leased asset in its books of accounts.
3. c. Useful life or lease term whichever is less.
4. c. All 5 conditions fail.
5. b. Risk and reward Test.

THEORETICAL QUESTIONS
Q.NO.1. Explain the types of lease as per AS 19.
ANSWER
For the purpose of accounting AS 19, classifies leases into two categories as follows:
1. Finance Lease
2. Operating Lease
Finance Lease:
It is a lease, which transfers substantially all the risks and rewards incidental to ownership of an asset
to the lessee by the lessor but not the legal ownership.
As per para 8 of the standard, in following situations, the lease transactions are called Finance lease:
1. The lessee will get the ownership of leased asset at the end of the lease term.
2. The lessee has an option to buy the leased asset at the end of the lease term at price, which is
lower than its expected fair value at the date on which option will be exercised.
3. The lease term covers the major part of the life of asset even if title is not transferred.
4. At the beginning of lease term, present value of minimum lease rental covers the initial fair
value.
5. The asset given on lease to lessee is of specialized nature and can only be used by the lessee
without major modification.
Operating Lease:
It is lease, which does not transfer all the risks and rewards incidental to ownership.

Q.NO.2. Explain the accounting treatment for a sale and leaseback transaction under Operating
lease.
324

ANSWER
As per AS 19, where sale and leaseback results in operating lease, then the accounting treatment in
Page

different situations is as follows:

CA CS KARTHIK MANIKONDA – 75501 37279

Situation 1: Sale price = Fair Value
Profit or loss should be recognized immediately.
Situation 2: Sale Price < Fair Value
Profit should be recognized immediately. The loss should also be recognized immediately except
that, if the loss is compensated by future lease payments at below market price, it should be
deferred and amortized in proportion to the lease payments over the period for which the asset is
expected to be used.
Situation 3: Sale Price > Fair Value
The excess over fair value should be deferred and amortized over the period for which the asset is
expected to be used.

Q.NO.3. What do you understand by the term “Interest rate implicit on lease”?
ANSWER
As per para 3 of AS 19 'Leases' the interest rate implicit in the lease is the discount rate that, at the
inception of the lease, causes the aggregate present value of:
a. the minimum lease payments under a finance lease from the standpoint of the lessor; and
b. any unguaranteed residual value accruing to the lessor, to be equal to the fair value of the leased
asset.

Q.NO.4. What are the disclosures requirements for operating leases by the lessee as per AS-19?
ANSWER
As per AS 19, lessees are required to make following disclosures for operating leases:
a. the total of future minimum lease payments under non-cancellable operating leases for each of
the following periods:
i. not later than one year;
ii. later than one year and not later than five years;
iii. later than five years;
b. the total of future minimum sublease payments expected to be received under non- cancellable
subleases at the balance sheet date;
c. lease payments recognized in the statement of profit and loss for the period, with separate
amounts for minimum lease payments and contingent rents;
325

d. sub-lease payments received (or receivable) recognized in the statement of profit and loss for
the period;
Page

CA CS KARTHIK MANIKONDA – 75501 37279

e. a general description of the lessee's significant leasing arrangements including, but not limited
to, the following:
i. the basis on which contingent rent payments are determined;
ii. the existence and terms of renewal or purchase options and escalation clauses; and
iii. restrictions imposed by lease arrangements, such as those concerning dividends, additional
debt, and further leasing .
PRACTICAL QUESTIONS
Q.NO.1. Classify the following into either operating or finance lease:
i. Lessee has option to purchase the asset at lower than fair value, at the end of lease term;
ii. Economic life of the asset is 7 years, lease term is 6 years, but asset is not acquired at the end
of the lease term;
iii. Economic life of the asset is 6 years, lease term is 2 years, but the asset is of special nature and
has been procured only for use of the lessee;
iv. Present value (PV) of Minimum lease payment (MLP) = “X”. Fair value of the asset is “Y”.
SOLUTION
i. If it becomes certain at the inception of lease itself that the option will be exercised by the
lessee, it is a Finance Lease.
ii. The lease will be classified as a finance lease, since a substantial portion of the life of the asset is
covered by the lease term.
iii. Since the asset is procured only for the use of lessee, it is a finance lease.
iv. The lease is a finance lease if X = Y, or where X substantially equals Y.

Q.NO.2. A machine was given on 3 years operating lease by a dealer of the machine for equal
annual lease rentals to yield 30% profit margin on cost Rs.1,50,000. Economic life of the machine is
5 years and output from the machine are estimated as 40,000 units, 50,000 units, 60,000 units,
80,000 units and 70,000 units consecutively for 5 years. Straight line depreciation in proportion of
output is considered appropriate. Compute the following:
i. Annual Lease Rent
ii. Lease Rent income to be recognized in each operating year and
iii. Depreciation for 3 years of lease.
SOLUTION
i. Annual lease rent
Total lease rent
326

Output during leaseperiod

= 130% of Rs.1,50,000 x
Page

Total output

CA CS KARTHIK MANIKONDA – 75501 37279

 =130% of Rs.1,50,000 x (40,000 +50,000+ 60,000)/(40,000 + 50,000 + 60,000 + 80,000 + 70,000)
= 1,95,000 x 1,50,000 units/3,00,000 units = Rs.97,500
Annual lease rent = Rs.97,500 / 3 = Rs.32,500
ii. Lease rent Income to be recognized in each operating year
Total lease rent should be recognised as income in proportion of output during lease period, i.e.
in the proportion of 40 : 50 : 60.
Hence income recognised in years 1, 2 and 3 will be as:
Year 1 Rs.26,000,
Year 2 Rs.32,500 and
Year 3 Rs.39,000.
iii. Depreciation for three years of lease
Since depreciation in proportion of output is considered appropriate, the depreciable amount
Rs.1,50,000 should be allocated over useful life 5 years in proportion of output, i.e. in proportion
of 40 : 50 : 60 : 80 : 70 .
Depreciation for year 1 is Rs.20,000, year 2 = 25,000 and year 3 = 30,000.

Q.NO.3. Lessee Ltd. took a machine on lease from Lessor Ltd., the fair value being Rs.7,00,000.
The economic life of machine as well as the lease term is 3 years. At the end of each year Lessee
Ltd. pays Rs.3,00,000. The Lessee has guaranteed a residual value of Rs.22,000 on expiry of the
lease to the Lessor. However, Lessor Ltd., estimates that the residual value of the machinery will
be only Rs.15,000. The implicit rate of return is 15% p.a. and present value factors at 15% are
0.869, 0.756 and 0.657 at the end of first, second and third years respectively.
Calculate the value of machinery to be considered by Lessee Ltd. and the finance charges in each
year.
SOLUTION
As per para 11 of AS 19 "Leases", the lessee should recognize the lease as an asset and a liability at
the inception of a finance lease. Such recognition should be at an amount equal to the fair value of
the leased asset at the inception of lease. However, if the fair value of the leased asset exceeds the
present value of minimum lease payment from the standpoint of the lessee, the amount recorded as
an asset and liability should be the present value of minimum lease payments from the standpoint
of the lessee.
Computation of Value of machinery:
327

Present value of minimum lease payment = Rs.6,99,054

Page

(See working note below)

CA CS KARTHIK MANIKONDA – 75501 37279

Fair value of leased asset = Rs.7,00,000
Therefore, the recognition will be at the lower of the two i.e. 6,99,054
Working Note - Present value of minimum lease payments:
Annual lease rental × PVIF+ Present value of guaranteed residual value
= Rs.3,00,000 × (0.869 + 0.756 + 0.657) + Rs.22,000 × 0.657
= Rs.6,84,600 + Rs.14,454 = 6,99,054
Computation of finance charges:
Year Finance Payment Reduction in Outstanding
charge outstanding liability liability
1st Year beginning – – – 6,99,054
End of 1st year 1,04,858 3,00,000 1,95,142 5,03,912
End of 2nd year 75,587 3,00,000 2,24,413 2,79,499
End of 3rd year 41,925 3,00,000 2,58,075 21,424

Q.NO.4. B&P Ltd. availed a lease from N&L Ltd. The conditions of the lease terms are as under:
i. Lease period is 3 years, in the beginning of the year 2009, for equipment costing Rs.10,00,000
and has an expected useful life of 5 years.
ii. The Fair market value is also Rs.10,00,000
iii. The property reverts back to the lessor on termination of the lease.
iv. The unguaranteed residual value is estimated at Rs.1,00,000 at the end of the year 2011.
v. 3 equal annual payments are made at the end of each year.
vi. Consider IRR = 10%.
The present value off Rs.1 due at the end of 3rd year at 10% rate of interest is Rs.0.7513. The
present value of annuity of Rs.1 due at the end of 3rd year at 10% IRR is Rs.2.4868.
State whether the lease constitute finance lease and also calculate unearned finance income.
SOLUTION
Computation of annual lease payment:
Particulars Rs.
Cost of equipment 10,00,000
Unguaranteed residual value 1,00,000
Present value of unguaranteed residual value
328

(Rs. 1,00,000 x 0.7513) 75,130

Present value of lease payments
Page

CA CS KARTHIK MANIKONDA – 75501 37279

(Rs. 10,00,000 - Rs. 75,130) 9,24,870
Present value of annuity for three years is 2.4868
Annual lease payment [9,24,870/2.4868] 3,71,911.70
Classification of lease:
Parameter 1:
The present value of lease payment i.e., Rs. 9,24,870 which equals 92.48% of the fair market value
i.e., Rs. 10,00,000.
The present value of minimum lease payments substantially covers the fair value of the leased asset
Parameter 2:
The lease term (i.e. 3 years) covers the major part of the life of asset (i.e. 5 years).
Therefore, it constitutes a finance lease.
Computation of Unearned Finance Income:
Particulars Rs.
Total lease payments (Rs. 3,71,911.70 x 3) 11,15,735
Add: Unguaranteed residual value 1,00,000
Gross investment in the lease 1,215,735
Less: Present value of lease payments and residual value i.e.
Net Investment (Rs. 75,130 + Rs. 9,24,870) (10,00,000)
Unearned finance income 2,15,735

Q.NO.5. X Ltd. sold machinery having WDV of Rs. 300 lakhs to Y Ltd. for Rs. 400 lakhs and the
same machinery was leased back by Y Ltd. to X Ltd. The lease back arrangement is operating lease.
Give your comments in the following situations:
i. Sale price of Rs. 400 lakhs is equal to fair value.
ii. Fair value is Rs. 450 lakhs.
iii. Fair value is Rs. 350 lakhs and the sale price is Rs. 250 lakhs.
iv. Fair value is Rs. 300 lakhs and sale price is Rs. 400 lakhs.
v. Fair value is Rs. 250 lakhs and sale price is Rs. 290 lakhs.
SOLUTION
Accounting Treatment:
S. No. Particulars Accounting Treatment
i. When sale price of Rs. 400 lakhs is equal to X Ltd. should immediately recognize the
329

fair value profit of Rs. 100 lakhs (i.e. 400 – 300) in its
Page

books.

CA CS KARTHIK MANIKONDA – 75501 37279

 ii. When fair value is Rs. 450 lakhs Profit of Rs.100 lakhs should be immediately
recognized by X Ltd.
iii. When fair value of leased machinery is Rs. Then loss of Rs. 50 lakhs (300 – 250) to be
350 lakhs & sales price is Rs. 250 lakhs immediately recognized by X Ltd. in its books
provided loss is not compensated by future
lease payment.
iv. When fair value is Rs. 300 lakhs & sales price Then, profit of Rs. 100 lakhs is to be deferred
is Rs. 400 lakhs and amortized over the lease period.
v. When fair value is Rs. 250 lakhs & sales price Then the loss of Rs. 50 lakhs (300-250) to be
is Rs. 290 lakhs immediately recognized by X Ltd. in its books
and profit of Rs. 40 lakhs (290-250) should
be amortized/ deferred over lease period.

330
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 UNIT 6: ACCOUNTING STANDARD 26:
INTANGIBLE ASSETS
LEARNING OUTCOMES
After studying this unit, you will be able to comprehend–
 Definition of Intangible Assets
 Parameters for Recognition and Initial Measurement of an Intangible Asset
 Separate Acquisition
 Acquisition as part of an Amalgamation
 Acquisition by way of a Government Grant
 Exchanges of Assets
 Internally Generated Goodwill and other Intangible Assets
 Measurement Subsequent to Initial Recognition
 Principles for
 Amortisation Period
 Amortisation Method
 Residual Value
 Review of Amortisation Period and Amortisation Method
 Retirements and Disposals
 Disclosures as per the standard.

6.1 INTRODUCTION
The objective of AS 26 is to prescribe the accounting treatment for intangible assets that are not
dealt with specifically in another Accounting Standard. AS 26 requires an enterprise to recognise an
intangible asset if, and only if, certain criteria are met. AS 26 also specifies how to measure the
carrying amount of intangible assets and requires certain disclosures about intangible assets.
6.2 SCOPE AS 26 should be applied by all enterprises in accounting for intangible assets, except:
i. Intangible assets that are covered by another Accounting Standard, such as:
a. Intangible assets held by an enterprise for sale in the ordinary course of business (AS 2,
Valuation of Inventories and AS 7, Construction Contracts)
b. Deferred tax assets (AS 22, Accounting for Taxes on Income)
331

c. Leases that fall within the scope of AS 19, Leases; and

d. Goodwill arising on an amalgamation (AS 14 (Revised), Accounting for Amalgamations) and
Page

goodwill arising on consolidation (AS 21 (Revised), Consolidated Financial Statements)

CA CS KARTHIK MANIKONDA – 75501 37279

ii. Financial assets.
iii. Mineral rights and expenditure on the exploration for, or development and extraction of,
minerals, oil, natural gas and similar non-regenerative resources and
iv. Intangible assets arising in insurance enterprises from contracts with policyholders.
v. expenditure in respect of termination benefits.
However, AS 26 applies to other intangible assets used (such as computer software), and other
expenditure (such as start-up costs), in extractive industries or by insurance enterprises.
AS 26 also applies to:
i. Expenditure on advertising, training, start - up cost
ii. Research and development activities
iii. Right under licensing agreements for items such as motion picture films, video recordings, plays,
manuscripts, patents and copyrights. These items are excluded from the scope of AS 19.
iv. The underlying intangible asset in finance lease after its initial recognition.
6.3 DEFINITIONS
An asset is a resource:
a. Controlled by an enterprise as a result of past events and
b. From which future economic benefits are expected to flow to the enterprise.
Monetary assets are money held and assets to be received in fixed or determinable amounts of
money.
Non-monetary assets are assets other than monetary assets.
Amortisation is the systematic allocation of the depreciable amount of an intangible asset over its
useful life.
Depreciable amount is the cost of an asset less its residual value.
Useful life is either:
a. the period of time over which an asset is expected to be used by the enterprise; or
b. the number of production or similar units expected to be obtained from the asset by the
enterprise.
Fair value of an asset is the amount for which that asset could be exchanged between
knowledgeable, willing parties in an arm's length transaction.
An active market is a market where all the following conditions exist:
a. The items traded within the market are homogeneous.
332

b. Willing buyers and sellers can normally be found at any time and
c. Prices are available to the public.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable
amount.
Carrying amount is the amount at which an asset is recognised in the balance sheet, net of any
accumulated amortisation and accumulated impairment losses thereon.
A financial asset is any asset that is:
a. Cash.
b. A contractual right to receive cash or another financial asset from another enterprise.
c. A contractual right to exchange financial instruments with another enterprise under conditions
that are potentially favourable. or
d. An ownership interest in another enterprise.
Termination benefits are employee benefits payable as a result of either:
a. an enterprise’s decision to terminate an employee’s employment before the normal retirement
date. or
b. an employee’s decision to accept voluntary redundancy in exchange for those benefits (voluntary
retirement).
Intangible Asset is
 an identifiable
 non-monetary asset
 without physical substance
 held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes.
Enterprises frequently expend resources, or incur liabilities, on the acquisition, development,
maintenance or enhancement of intangible resources such as scientific or technical knowledge,
design and implementation of new processes or systems, licences, intellectual property, market
knowledge and trademarks (including brand names and publishing titles). Common examples are
computer software, patents, copyrights, motion picture films, customer lists, mortgage servicing
rights, fishing licences, import quotas, franchises, customer or supplier relationships, customer
loyalty, market share and marketing rights. Goodwill is another example of an item of intangible
nature which either arises on acquisition or is internally generated.
Not all the items described above will meet the definition of an intangible asset, that is,
identifiability, control over a resource and expectation of future economic benefits flowing to the
333

enterprise. If an item covered by AS 26 does not meet the definition of an intangible asset,
expenditure to acquire it or generate it internally is recognised as an expense when it is incurred.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Some intangible assets may be contained in or on a physical substance such as a compact disk (in the
case of computer software), legal documentation (in the case of a licence or patent) or film (in the
case of motion pictures). The cost of the physical substance containing the intangible assets is
usually not significant. Accordingly, the physical substance containing an intangible asset, though
tangible in nature, is commonly treated as a part of the intangible asset contained in or on it.
In some cases, an asset may incorporate both intangible and tangible elements that are, in practice,
inseparable. Judgement is required to assess as to which element is predominant. For example,
computer software for a computer controlled machine tool that cannot operate without that specific
software is an integral part of the related hardware and it is treated as a fixed asset. The same
applies to the operating system of a computer. Where the software is not an integral part of the
related hardware, computer software is treated as an intangible asset.
6.4 IDENTIFIABILITY
 The definition of an intangible asset requires that an intangible asset be identifiable. To be
identifiable, it is necessary that the intangible asset is clearly distinguished from goodwill.
 An intangible asset can be clearly distinguished from goodwill if the asset is separable which
means that enterprise could rent, sell, exchange or distribute the specific future economic
benefits attributable to the asset without also disposing of future economic benefits that flow
from other assets used in the same revenue earning activity.
 Separability is not a necessary condition for identifiability since an enterprise may be able to
identify an asset in some other way. For example, if an intangible asset is acquired with a group
of assets, the transaction may involve the transfer of legal rights that enable an enterprise to
identify the intangible asset. Also, even If an asset generates future economic benefits only in
combination with other assets, the asset is identifiable if the enterprise can identify the future
economic benefits that will flow from the asset.
6.5 CONTROL
An enterprise controls an asset if the enterprise has the power to obtain the future economic
benefits flowing from the underlying resource and also can restrict the access of others to those
benefits. The capacity of an enterprise to control the future economic benefits from an intangible
asset would normally stem from legal rights that are enforceable in a court of law. However, legal
enforceability of a right is not a necessary condition for control since an enterprise may be able to
control the future economic benefits in some other way.
334

Market and technical knowledge may give rise to future economic benefits. An enterprise controls
those benefits if, for example, the knowledge is protected by legal rights such as copyrights, a
Page

restraint of trade agreement or by a legal duty on employees to maintain confidentiality.

CA CS KARTHIK MANIKONDA – 75501 37279

Future economic benefit is also flown from the skill of labour and customer loyalty but usually this
flow of benefits cannot be controlled by the enterprise as employees may leave the enterprise
anytime or even loyal customers may decide to purchase goods and services from other suppliers.
Hence, these items don’t even qualify as intangible asset as per the definition given in AS 26.
Example 1:
Moon Limited has provided training to its staff on various new topics like GST, AS, Ind AS etc. to
ensure the compliance as per the required law. Can the company recognise such cost of staff
training as intangible asset?
In this case, it is clear that the company will obtain the economic benefits from the work performed
by the staff as it increases their efficiency. But it does not have control over them because staff could
choose to resign the company at any time. Hence the company lacks the ability to restrict the access
of others to those benefits. Therefore, the staff training cost does not meet the definition of an
intangible asset.
6.6 FUTURE ECONOMIC BENEFITS
The future economic benefits flowing from an intangible asset may include revenue from the sale of
products or services, cost savings, or other benefits resulting from the use of the asset by the
enterprise. For example, the use of intellectual property in a production process may reduce future
production costs rather than increase future revenues.
6.7 RECOGNITION AND INITIAL MEASUREMENT OF AN INTANGIBLE ASSET
The recognition of an item as an intangible asset requires an enterprise to demonstrate that the
item meets the definition of an intangible asset and recognition criteria set out as below:
An intangible asset should be recognised if, and only if:
a. It is probable that the future economic benefits that are attributable to the asset will flow to the
enterprise; and
b. The cost of the asset can be measured reliably.
An enterprise should assess the probability of future economic benefits using reasonable and
supportable assumptions that represent best estimate of the set of economic conditions that will
exist over the useful life of the asset.
An intangible asset should be measured initially at cost.
6.8 SEPARATE ACQUISITION
If an intangible asset is acquired separately, the cost of the intangible asset can usually be measured
335

reliably. This is particularly so when the purchase consideration is in the form of cash or other
monetary assets.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

The cost of an intangible asset comprises:
 its purchase price,
 any import duties and other taxes (other than those subsequently recoverable by the enterprise
from the taxing authorities), and
 any directly attributable expenditure on making the asset ready for its intended use. Directly
attributable expenditure includes, for example, professional fees for legal services.
 Any trade discounts and rebates are deducted in arriving at the cost.
If an intangible asset is acquired in exchange for shares or other securities of the reporting
enterprise, the asset is recorded at its fair value, or the fair value of the securities issued, whichever
is more clearly evident.
6.9 ACQUISITION AS PART OF AN AMALGAMATION
An intangible asset acquired in an amalgamation in the nature of purchase is accounted for in
accordance with AS 14 (Revised). In accordance with AS 26:
a. A transferee recognises an intangible asset that meets the recognition criteria, even if that
intangible asset had not been recognised in the financial statements of the transferor and
b. If the cost (i.e. fair value) of an intangible asset acquired as part of an amalgamation in the
nature of purchase cannot be measured reliably, that asset is not recognised as a separate
intangible asset but is included in goodwill.
Where in preparing the financial statements of the transferee company, the consideration is
allocated to individual identifiable assets and liabilities on the basis of their fair values at the date of
amalgamation.
Hence, judgement is required to determine whether the cost (i.e. fair value) of an intangible asset
acquired in an amalgamation can be measured with sufficient reliability for the purpose of separate
recognition. Quoted market prices in an active market provide the most reliable measurement of fair
value. The appropriate market price is usually the current bid price. If current bid prices are
unavailable, the price of the most recent similar transaction may provide a basis from which to
estimate fair value, provided that there has not been a significant change in economic circumstances
between the transaction date and the date at which the asset's fair value is estimated.
If no active market exists for an asset, its cost reflects the amount that the enterprise would have
paid, at the date of the acquisition, for the asset in an arm's length transaction between
knowledgeable and willing parties, based on the best information available. The cost initially
336

recognised for the intangible asset in this case is restricted to an amount that does not create or
increase any capital reserve arising at the date of the amalgamation.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Quoted market price

Determination of Fair Value Current bid price

If active market exists

Price of the mt recently similar

transaction

If active market does Amount that the enterprise would

not exist have paid

6.10 ACQUISITION BY WAY OF A GOVERNMENT GRANT

In some cases, an intangible asset may be acquired free of charge, or for nominal consideration, by
way of a government grant. This may occur when a government transfers or allocates to an
enterprise intangible assets such as airport landing rights, licences to operate radio or television
stations, import licences or quotas or rights to access other restricted resources.
AS 12, requires that government grants in the form of non-monetary assets, given at a concessional
rate should be accounted for on the basis of their acquisition cost.
Accordingly, intangible asset acquired free of charge, or for nominal consideration, by way of
government grant is recognised at a nominal value or at the acquisition cost, as appropriate; any
expenditure that is directly attributable to making the asset ready for its intended use is also
included in the cost of the asset.
6.11 EXCHANGE OF ASSETS
An intangible asset may be acquired in exchange or part exchange for another asset. In such a case,
the cost of the asset acquired is determined in accordance with the principles laid down in this
regard in AS 10.
The cost of such an item is measured at fair value unless:
a. the exchange transaction lacks commercial substance or
b. the fair value of neither the asset(s) received nor the asset(s) given up is reliably measurable.
The acquired item is measured in this manner even if an enterprise cannot immediately derecognize
the asset given up. If the acquired item is not measured at fair value, its/their cost is measured at
337

the carrying amount of the asset(s) given up.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

6.12 INTERNALLY GENERATED GOODWILL
Internally generated goodwill is not recognised as an asset because it is not an identifiable resource
controlled by the enterprise that can be measured reliably at cost.
Differences between the market value of an enterprise and the carrying amount of its identifiable
net assets at any point in time may be due to a range of factors that affect the value of the
enterprise. However, such differences cannot be considered to represent the cost of intangible
assets controlled by the enterprise.
6.13 INTERNALLY GENERATED INTANGIBLE ASSETS
It is sometimes difficult to assess whether an internally generated intangible asset qualifies for
recognition. It is often difficult to:
a. identify whether, and the point of time when, there is an identifiable asset that will generate
probable future economic benefits; and
b. determine the cost of the asset reliably. In some cases, the cost of generating an intangible asset
internally cannot be distinguished from the cost of maintaining or enhancing the enterprise’s
internally generated goodwill or of running day-to- day operations.
To assess whether an internally generated intangible asset meets the criteria for recognition, an
enterprise classifies the generation of the asset into
 Research Phase &
 Development Phase
If an enterprise cannot distinguish the research phase from the development phase of an internal
project to create an intangible asset, the enterprise treats the expenditure on that project as if it
were incurred in the research phase only.
6.14 RESEARCH PHASE
Research is original and planned investigation undertaken with the prospect of gaining new scientific
or technical knowledge and understanding.
No intangible asset arising from research or from the research phase should be recognised.
Expenditure on research or on the research phase should be recognised as an expense when it is
incurred.
Examples of research activities are:
a. Activities aimed at obtaining new knowledge.
b. The search for, evaluation and final selection of, applications of research findings or other
338

knowledge.
c. The search for alternatives for materials, devices, products, processes, systems or services;
Page

CA CS KARTHIK MANIKONDA – 75501 37279

d. The formulation, design, evaluation and final selection of possible alternatives for new or
improved materials, devices, products, processes, systems or services.
6.15 DEVELOPMENT PHASE
Development is the application of research findings or other knowledge to a plan or design for the
production of new or substantially improved materials, devices, products, processes, systems or
services prior to the commencement of commercial production or use.
An intangible asset arising from development (or from the development phase of an internal
project) should be recognised if, and only if, an enterprise can demonstrate all of the following:
a. The technical feasibility of completing the intangible asset so that it will be available for use or sale.
b. Its intention to complete the intangible asset and use or sell it.
c. Its ability to use or sell the intangible asset.
d. How the intangible asset will generate probable future economic benefits. Among other things, the
enterprise should demonstrate the existence of a market for the output of the intangible asset or the
intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.
e. The availability of adequate technical, financial and other resources to complete the
development and to use or sell the intangible asset and
f. Its ability to measure the expenditure attributable to the intangible asset during its development
reliably.
Examples of development activities are:
a. The design, construction and testing of pre-production or pre-use prototypes and models.
b. The design of tools, jigs, moulds and dies involving new technology.
c. The design, construction and operation of a pilot plant that is not of a scale economically feasible
for commercial production and
d. The design, construction and testing of a chosen alternative for new or improved materials,
devices, products, processes, systems or services.
AS 26 takes the view that expenditure on internally generated brands, mastheads, publishing titles,
customer lists and items similar in substance cannot be distinguished from the cost of developing
the business as a whole. Therefore, such items are not recognised as intangible assets.
To demonstrate how an intangible asset will generate probable future economic benefits, an
enterprise assesses the future economic benefits to be received from the asset using the principles
in Accounting Standard on Impairment of Assets. If the asset will generate economic benefits only in
339

combination with other assets, the enterprise applies the concept of cash generating units as set out
in Accounting Standard on Impairment of Assets.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

6.16 COST OF AN INTERNALLY GENERATED INTANGIBLE ASSET
The cost of an internally generated intangible asset is the sum of expenditure incurred from the time
when the intangible asset first meets the recognition criteria. Reinstatement of expenditure
recognised as an expense in previous annual financial statements or interim financial reports is
prohibited.
The cost of an internally generated intangible asset comprises all expenditure that can be directly
attributed, or allocated on a reasonable and consistent basis, to creating, producing and making the
asset ready for its intended use from the time when the intangible asset first meets the recognition
criteria. The cost includes, if applicable:
a. Expenditure on materials and services used or consumed in generating the intangible asset.
b. The salaries, wages and other employment related costs of personnel directly engaged in
generating the asset.
c. Any expenditure that is directly attributable to generating the asset, such as fees to register a
legal right and the amortisation of patents and licenses that are used to generate the asset (E.g.,
borrowing cost as per para 4(e) of AS 16, etc.) and
d. Overheads that are necessary to generate the asset and that can be allocated on a reasonable
and consistent basis to the asset. Allocations of overheads are made on bases similar to those
discussed in AS 2 & AS 16.
The following are not components of the cost of an internally generated intangible asset, these
should be expensed off in profit and loss account:
a. Selling, administrative and other general overhead expenditure unless this expenditure can be
directly attributed to making the asset ready for use.
b. Clearly identified inefficiencies and initial operating losses incurred before an asset achieves
planned performance and
c. Expenditure on training the staff to operate the asset
Example
An enterprise is developing a new production process. During the year 20X1, expenditure incurred
was Rs.10 lacs, of which Rs.9 lacs was incurred before 1 December 20X1 and 1 lac was incurred
between 1 December 20X1 and 31 December 20X1. The enterprise is able to demonstrate that, at 1
December 20X1, the production process met the criteria for recognition as an intangible asset. The
recoverable amount of the know-how embodied in the process (including future cash outflows to
340

complete the process before it is available for use) is estimated to be Rs.5 lacs.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

At the end of 20X1, the production process is recognised as an intangible asset at a cost of Rs.1 lac
(expenditure incurred since the date when the recognition criteria were met, that is, 1 December
20X1). The Rs.9 lacs expenditure incurred before 1 December 20X1 is recognised as an expense
because the recognition criteria were not met until 1 December 20X1. This expenditure will never
form part of the cost of the production process recognised in the balance sheet.
During the year 20X2, expenditure incurred is Rs.20 lacs. At the end of 20X2, the recoverable
amount of the know-how embodied in the process (including future cash outflows to complete the
process before it is available for use) is estimated to be Rs.19 lacs.
At the end of the year 20X2, the cost of the production process is Rs.21 lacs (Rs.1 lac expenditure
recognised at the end of 20X1 plus Rs.20 lacs expenditure recognised in 20X2). The enterprise
recognises an impairment loss of Rs.2 lacs to adjust the carrying amount of the process before
impairment loss (Rs.21 lacs) to its recoverable amount (Rs.19 lacs). This impairment loss will be
reversed in a subsequent period if the requirements for the reversal of an impairment loss in AS 28,
are met.

6.17 RECOGNITION OF AN EXPENSE

Expenditure on an intangible item should be recognised as an expense when it is incurred unless:
a. It forms part of the cost of an intangible asset that meets the recognition criteria or
b. The item is acquired in an amalgamation in the nature of purchase and cannot be recognised as
an intangible asset. It forms part of the amount attributed to goodwill (capital reserve) at the
date of acquisition.
In some cases, expenditure is incurred to provide future economic benefits to an enterprise, but no
intangible asset or other asset is acquired or created that can be recognised. In these cases, the
expenditure is recognised as an expense when it is incurred. For example, expenditure on research is
always recognised as an expense when it is incurred.
Examples of other expenditure that is recognised as an expense when it is incurred include:
a. expenditure on start-up activities (start-up costs), unless this expenditure is included in the cost
of an item of fixed asset under AS 10. Start-up costs may consist of preliminary expenses
incurred in establishing a legal entity such as legal and secretarial costs, expenditure to open a
new facility or business (pre-opening costs) or expenditures for commencing new operations or
launching new products or processes (pre-operating costs);
b. expenditure on training activities;
341

c. expenditure on advertising and promotional activities; and

Page

d. expenditure on relocating or re-organising part or all of an enterprise.

CA CS KARTHIK MANIKONDA – 75501 37279

The above guidance does not apply to payments for the delivery of goods or services made in
advance of the delivery of goods or the rendering of services. Such prepayments are recognised as
assets.
Past Expenses not to be recognised as an Asset
Expenditure on an intangible item that was initially recognised as an expense in previous annual
financial statements or interim financial reports should not be recognised as part of the cost of an
intangible asset at a later date.
6.18 SUBSEQUENT EXPENDITURE
Subsequent expenditure on an intangible asset after its purchase or its completion should be
recognised as an expense when it is incurred unless:
a. It is probable that the expenditure will enable the asset to generate future economic benefits in
excess of its originally assessed standard of performance and
b. The expenditure can be measured and attributed to the asset reliably.
If these conditions are met, the subsequent expenditure should be added to the cost of the
intangible asset.
Subsequent expenditure on brands, mastheads, publishing titles, customer lists and items similar in
substance is always recognised as an expense to avoid the recognition of internally generated goodwill.
The nature of intangible assets is such that, in many cases, it is not possible to determine whether
subsequent expenditure is likely to enhance or maintain the economic benefits that will flow to the
enterprise from those assets. Therefore, only rarely will expenditure incurred after the initial
recognition of a purchased intangible asset or after completion of an internally generated intangible
asset result in additions to the cost of the intangible asset.
6.19 MEASUREMENT SUBSEQUENT TO INITIAL RECOGNITION
After initial recognition, an intangible asset should be carried at its cost less any accumulated
amortisation and any accumulated impairment losses.
6.20 AMORTISATION PERIOD
The depreciable amount of an intangible asset should be allocated on a systematic basis over the
best estimate of its useful life. Amortisation should commence when the asset is available for use.
Estimates of the useful life of an intangible asset generally become less reliable as the length of the
useful life increases. AS 26 adopts a rebuttable presumption that the useful life of an intangible asset
will not exceed ten years from the date when the asset is available for use. Amortisation is
342

recognised whether or not there has been an increase in, for example, the asset's fair value or
recoverable amount.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Many factors need to be considered in determining the useful life of an intangible asset including:
a. the expected usage of the asset by the enterprise and whether the asset could be efficiently
managed by another management team;
b. typical product life cycles for the asset and public information on estimates of useful lives of
similar types of assets that are used in a similar way;
c. technical, technological or other types of obsolescence;
d. the stability of the industry in which the asset operates and changes in the market demand for
the products or services output from the asset;
e. expected actions by competitors or potential competitors;
f. the level of maintenance expenditure required to obtain the expected future economic benefits
from the asset and the company's ability and intent to reach such a level;
g. the period of control over the asset and legal or similar limits on the use of the asset, such as the
expiry dates of related leases; and
h. whether the useful life of the asset is dependent on the useful life of other assets of the
enterprise.
Given the history of rapid changes in technology, computer software and many other intangible
assets are susceptible to technological obsolescence. Therefore, it is likely that their useful life will
be short.
In some cases, there may be persuasive evidence that the useful life of an intangible asset will be a
specific period longer than ten years. In these cases, the presumption that the useful life generally
does not exceed ten years is rebutted and the enterprise:
a. Amortises the intangible asset over the best estimate of its useful life.
b. Estimates the recoverable amount of the intangible asset at least annually in order to identify
any impairment loss and
c. Discloses the reasons why the presumption is rebutted and the factors that played a significant
role in determining the useful life of the asset.
Example:
A. An enterprise has purchased an exclusive right to generate hydroelectric power for 60 years. The
costs of generating hydro-electric power are much lower than the costs of obtaining power from
alternative sources. It is expected that the geographical area surrounding the power station will
demand a significant amount of power from the power station for at least 60 years.
The enterprise amortises the right to generate power over 60 years, unless there is evidence that its
useful life is shorter.
343

B. An enterprise has purchased an exclusive right to operate a toll motorway for 30 years. There is
no plan to construct alternative routes in the area served by the motorway. It is expected that
Page

this motorway will be in use for at least 30 years.

CA CS KARTHIK MANIKONDA – 75501 37279

The enterprise amortises the right to operate the motorway over 30 years, unless there is evidence
that its useful life is shorter.
If control over the future economic benefits from an intangible asset is achieved through legal rights
that have been granted for a finite period, the useful life of the intangible asset should not exceed
the period of the legal rights unless the legal rights are renewable and renewal is virtually certain.
The useful life of an intangible asset may be very long but it is always finite.
There may be both economic and legal factors influencing the useful life of an intangible asset:
economic factors determine the period over which future economic benefits will be generated; legal
factors may restrict the period over which the enterprise controls access to these benefits. The
useful life is the shorter of the periods determined by these factors.
Example:
Company X has purchased a copyright to produce a safety equipment for sale in the market. The
rights have been obtained for 10 years. Hence, company is amortizing the intangible asset in 10
years. After 7 years, due to change in the environmental law, safety equipments produced out of
new technology are only considered valid.
In above scenario, the company need to write off the balance amount in the year of implementation
of the law.
6.21 AMORTISATION METHOD
The amortisation method used should reflect the pattern in which the asset's economic benefits are
consumed by the enterprise. If that pattern cannot be determined reliably, the straight-line method
should be used. A variety of amortisation methods can be used to allocate the depreciable amount
of an asset on a systematic basis over its useful life. These methods include
 the straight-line method,
 the diminishing balance method and
 the unit of production method.
The method used for an asset is selected based on the expected pattern of consumption of
economic benefits and is consistently applied from period to period, unless there is a change in the
expected pattern of consumption of economic benefits to be derived from that asset.
The amortisation charge for each period should be recognised as an expense unless another
Accounting Standard permits or requires it to be included in the carrying amount of another asset.
For example, the amortisation of intangible assets used in a production process is included in the
carrying amount of inventories.
344
Page

CA CS KARTHIK MANIKONDA – 75501 37279

6.22 RESIDUAL VALUE
Residual value is the amount, which an enterprise expects to obtain for an asset at the end of its
useful life after deducting the expected costs of disposal.
The residual value of an intangible asset should be assumed to be zero unless:
a. There is a commitment by a third party to purchase the asset at the end of its useful life or
b. There is an active market for the asset and:
i. Residual value can be determined by reference to that market and
ii. It is probable that such a market will exist at the end of the asset's useful life.
A residual value other than zero implies that an enterprise expects to dispose of the intangible asset
before the end of its economic life.
6.23 REVIEW OF AMORTISATION PERIOD AND AMORTISATION METHOD
The amortisation period and the amortisation method should be reviewed at least at each financial
year end. If the expected useful life of the asset is significantly different from previous estimates, the
amortisation period should be changed accordingly. If there has been a significant change in the
expected pattern of economic benefits from the asset, the amortisation method should be changed
to reflect the changed pattern. Such changes should be accounted for in accordance with AS 5.
6.24 RECOVERABILITY OF THE CARRYING AMOUNT-IMPAIRMENT LOSSES
Impairment losses of intangible assets are calculated on the basis of AS 28. AS 28 “Impairment of
Assets” is covered in next unit of this chapter.
In addition to the requirements of Accounting Standard on Impairment of Assets, an enterprise
should estimate the recoverable amount of the following intangible assets at least at each financial
year end even if there is no indication that the asset is impaired:
a. an intangible asset that is not yet available for use; and
b. an intangible asset that is amortised over a period exceeding ten years from the date when the
asset is available for use.
AS 26 requires an enterprise to test for impairment, at least annually, the carrying amount of an
intangible asset that is not yet available for use.
Example:
X limited is developing a customized software for Rs.10 Cr. It will take 3 years to complete
development. Present value of future economic benefit is considered to be Rs.15 Cr. After 2 years,
345

70% work is completed. However, due to change in market conditions, present value of future
economic benefits are estimated to be Rs.6 Cr only.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Company should recognize Rs.1 Cr as impairment loss on "Intangible asset under development” as
per AS 28. Only Rs.6 Cr can be shown as "Intangible asset under development”. Company cannot
capitalize any further amount till the time recoverable amount increases even if work of Rs.10 Cr is
completed.
6.25 RETIREMENTS AND DISPOSALS
An intangible asset should be derecognised (eliminated from the balance sheet) if
 disposed or
 when no future economic benefits are expected from its use and subsequent disposal.
Gains or losses arising from the retirement or disposal of an intangible asset should be determined
as the difference between the net disposal proceeds and the carrying amount of the asset and
should be recognised as income or expense in the statement of profit and loss.
An intangible asset that is retired from active use and held for disposal is carried at its carrying
amount at the date when the asset is retired from active use.
6.26 DISCLOSURE
The financial statements should disclose the following for each class of intangible assets,
distinguishing between internally generated intangible assets and other intangible assets:
1. The useful lives or the amortisation rates used.
2. The amortisation methods used.
3. The gross carrying amount and the accumulated amortisation (aggregated with accumulated
impairment losses) at the beginning and end of the period.
4. A reconciliation of the carrying amount at the beginning and end of the period showing:
i. Additions, indicating separately those from internal development and through
amalgamation.
ii. Retirements and disposals.
iii. Impairment losses recognised in the statement of profit and loss during the period.
iv. Impairment losses reversed in the statement of profit and loss during the period.
v. Amortisation recognised during the period and
vi. Other changes in the carrying amount during the period.
A class of intangible assets is a grouping of assets of a similar nature and use in an enterprise's
operations. Examples of separate classes may include:
a. brand names;
b. mastheads and publishing titles;
346

c. computer software;
d. licences and franchises;
Page

e. copyrights, and patents and other industrial property rights, service and operating rights;

CA CS KARTHIK MANIKONDA – 75501 37279

f. recipes, formulae, models, designs and prototypes; and
g. intangible assets under development.
6.27 OTHER DISCLOSURES
The financial statements should also disclose:
a. If an intangible asset is amortised over more than ten years, the reasons why it is presumed that
the useful life of an intangible asset will exceed ten years from the date when the asset is
available for use. In giving these reasons, the enterprise should describe the factor(s) that played
a significant role in determining the useful life of the asset.
b. A description, the carrying amount and remaining amortisation period of any individual
intangible asset that is material to the financial statements of the enterprise as a whole.
c. The existence and carrying amounts of intangible assets whose title is restricted and the carrying
amounts of intangible assets pledged as security for liabilities and
d. The amount of commitments for the acquisition of intangible assets.
The financial statements should disclose the aggregate amount of research and development
expenditure recognised as an expense during the period.
An enterprise is encouraged, but not required, to give a description of any fully amortised intangible
asset that is still in use.

347
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 ILLUSTRATIONS
Illustration 1
ABC Ltd. developed know-how by incurring expenditure of Rs.20 lakhs, The know-how was used
by the company from 1.4.20X1. The useful life of the asset is 10 years from the year of
commencement of its use. The company has not amortised the asset till 31.3.20X8. Pass Journal
entry to give effect to the value of know-how as per Accounting Standard-26 for the year ended
31.3.20X8.
Solution
Journal Entry
Rs. Rs.
Profit and Loss A/c (Prior period item) Dr. 12,00,000
Amortization A/c Dr. 2,00,000
To Know-how A/c [Being amortization of 7 years (out of which 14,00,000
amortization of 6 years charged as prior period item)]

Illustration 2
The company had spent Rs.45 lakhs for publicity and research expenses on one of its new
consumer product, which was marketed in the accounting year 20X1-20X2, but proved to be a
failure. State, how you will deal with the following matters in the accounts of U Ltd. for the year
ended 31st March, 20X2.
Solution
In the given case, the company spent Rs.45 lakhs for publicity and research of a new product which
was marketed but proved to be a failure. It is clear that in future there will be no related further
revenue/benefit because of the failure of the product. Thus, according to AS 26 ‘Intangible Assets’,
the company should charge the total amount of Rs.45 lakhs as an expense in the profit and loss
account.
Illustration 3
A company with a turnover of Rs.250 crores and an annual advertising budget of Rs.2 crores had
taken up the marketing of a new product. It was estimated that the company would have a
turnover of Rs.25 crores from the new product. The company had debited to its Profit and Lo ss
348

account the total expenditure of Rs.2 crore incurred on extensive special initial advertisement
campaign for the new product.
Page

Is the procedure adopted by the company correct?

CA CS KARTHIK MANIKONDA – 75501 37279

Solution
According to AS 26 ‘Intangible Assets’, “expenditure on an intangible item should be recognised as
an expense when it is incurred unless it forms part of the cost of an intangible asset”.
AS 26 mentions that expenditure on advertising and promotional activities should be recognised as
an expense when incurred.
In the given case, advertisement expenditure of Rs.2 crores had been taken up for the marketing of a
new product which may provide future economic benefits to an enterprise by having a turnover of
Rs.25 crores. Here, no intangible asset or other asset is acquired or created that can be recognised.
Therefore, the accounting treatment by the company of debiting the entire advertising expenditure
of Rs.2 crores to the Profit and Loss account of the year is correct.
Reference: The students are advised to refer the full text of AS 28 “Intangible Assets” (issued
2002).

349
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. Which of the following is not covered within the scope of AS 26?
a. Intangible assets held-for-sale in the ordinary course of business
b. Assets arising from employee benefits
c. (a) & (b) both
d. Research and development activities

2. Intangible asset is recognised if it:

a. meets the definition of an intangible asset
b. is probable that future economic benefits will flow
c. the cost can be measured reliably
d. meets all of the above parameters

3. Sun Limited has purchased a computer with various additional software. These are integral
part of the computer. Which of the following are true in the context of AS 26:
a. Recognise Computer and software as tangible asset
b. Recognise tangible and intangible separately
c. Recognise computer and software as intangible asset
d. Does not recognize the software as an asset.

4. Hexa Ltd developed a technology to enhance the battery life of mobile devices. Hexa has
capitalised development expenditure of Rs.5,00,000. Hexa estimates the life of the technology
developed to be 3 years but the company has forecasted that 50% of sales will be in year 1,
35% in year 2 and 15% in year 3. What should be the amortisation charge in the second year of
the product’s life?
a. Rs.2,50,000
b. Rs.1,75,000
c. Rs.1,66,667
d. Rs.1,85,000
350
Page

CA CS KARTHIK MANIKONDA – 75501 37279

ANSWERS/SOLUTIONS
MCQs
1. c. (a) & (b) both
2. d. meets all of the above parameters
3. a. Recognise Computer and software as tangible asset
4. b. Rs.1,75,000

THEORETICAL QUESTIONS
Q.NO.1. What is meant by Intangible Assets and what are the important factors to consider the
recognition of item as an Intangible asset? What is the recognition criteria in accordance with the
provisions of AS 26?
ANSWER
An intangible asset is an identifiable non-monetary asset, without physical substance, held for use in
the production or supply of goods or services, for rental to others, or for administrative purposes.
Below are the 3 key ingredients to be satisfied to cover an item as an intangible asset under this
standard:
 identifiability,
 control over a resource and
 expectation (i.e. probable – 50% plus) of future economic benefits flowing to the enterprise.
The recognition of an item as an intangible asset requires an enterprise to demonstrate that the
item meets the definition of an intangible asset and recognition criteria set out as below:
a. It is probable that the future economic benefits that are attributable to the asset will flow to the
enterprise; and
b. The cost of the asset can be measured reliably.

Q.NO.2. What is the measurement criteria at the time of initial recognition of Intangible assets
acquired through separate acquisition?
ANSWER
If an intangible asset is acquired separately, the cost of the intangible asset can usually be measured
reliably. This is particularly so when the purchase consideration is in the form of cash or other
monetary assets.
351

The cost of an intangible asset comprises:


Page

its purchase price,

CA CS KARTHIK MANIKONDA – 75501 37279

 any import duties and other taxes (other than those subsequently recoverable by the enterprise
from the taxing authorities), and
 any directly attributable expenditure on making the asset ready for its intended use. Directly
attributable expenditure includes, for example, professional fees for legal services.
 Any trade discounts and rebates are deducted in arriving at the cost.

Q.NO.3. What is the criteria for recognition and measurement of Internally generated intangible
assets. Describe which kind of cost is considered for capitalisation with respect to provisions of AS
26. Whether the same applies for internally generated goodwill also?
ANSWER
To assess whether an internally generated intangible asset meets the criteria for recognition, an
enterprise classifies the generation of the asset into 2 phases:
 Research Phase &
 Development Phase
Research Phase - The expenses related to Research phase is expensed off in statement of Profit and
loss.
Development Phase - Development is the application of research findings or other knowledge to a
plan or design for the production of new or substantially improved materials, devices, products,
processes, systems or services prior to the commencement of commercial production or use.
An intangible asset arising from development (or from the development phase of an internal
project) should be recognised if, and only if, an enterprise can demonstrate all of the conditions
given in para 6.15.
Cost of an Internally Generated Intangible Asset
The cost of an internally generated intangible asset is the sum of expenditure incurred from the time
when the intangible asset first meets the recognition criteria. Reinstatement of expenditure
recognised as an expense in previous annual financial statements or interim financial reports is
prohibited.
The cost of an internally generated intangible asset comprises all expenditure that can be directly
attributed, or allocated on a reasonable and consistent basis, to creating, producing and making the
asset ready for its intended use from the time when the intangible asset first meets the recognition
criteria. For details, refer para 6.16.
352

Internally generated goodwill is not recognised as an asset because it is not an identifiable resource
controlled by the enterprise that can be measured reliably at cost.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Q.NO.4. Advise the complete accounting treatment for Research and development phase as per
AS 26.
ANSWER
Research phase means acquisition of knowledge and Development phase means application of
knowledge.
The expenditure related to Research phase is expensed off in statement of Profit and loss. However,
the expenditure incurred in Development phase is capitalised as a cost of the internally generated
intangible asset.
If an enterprise cannot distinguish the research phase from the development phase of an internal
project to create an intangible asset, the enterprise treats the expenditure on that project as if it
were incurred in the research phase only.

Q.NO.5. What is meant by Amortisation of an Intangible asset. What are the different methods
for amortisation as per AS 26?
ANSWER
Amortisation is the systematic allocation of the depreciable amount of an intangible asset over its
useful life.
The amortisation method used should reflect the pattern in which the asset's economic benefits are
consumed by the enterprise. If that pattern cannot be determined reliably, the straight-line method
should be used. A variety of amortisation methods can be used to allocate the depreciable amount
of an asset on a systematic basis over its useful life. These methods include
 the straight-line method,
 the diminishing balance method and
 the unit of production method.
The method used for an asset is selected based on the expected pattern of consumption of
economic benefits and is consistently applied from period to period, unless there is a change in the
expected pattern of consumption of economic benefits to be derived from that asset.
353
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 PRACTICAL QUESTIONS
Q.NO.1. Swift Ltd. acquired a patent at a cost of Rs.80,00,000 for a period of 5 years and the
product life-cycle is also 5 years. The company capitalized the cost and started amortizing the
asset at Rs.10,00,000 per annum. The company had amortized the patent at 10,00,000 per annum
in first two years on the basis of economic benefits derived from the product manufactured under
the patent. After two years it was found that the product life-cycle may continue for another 5
years from then. The patent was renewable and Swift Ltd. got it renewed after expiry of five years.
The net cash flows from the product during these 5 years were expected to be Rs.36,00,000,
Rs.46,00,000, Rs.44,00,000, Rs.40,00,000 and Rs.34,00,000. Find out the amortization cost of the
patent for each of the years.
SOLUTION
Swift Limited amortised Rs.10,00,000 per annum for the first two years i.e. Rs.20,00,000. The
remaining carrying cost can be amortised during next 5 years on the basis of net cash flows arising
from the sale of the product. The amortisation may be found as follows:
S. No. Net cash flows Rs. Amortisation Ratio Amortisation Amount Rs.
I - 0.125 10,00,000
II - 0.125 10,00,000
III 36,00,000 0.180 10,80,000
IV 46,00,000 0.230 13,80,000
V 44,00,000 0.220 13,20,000
VI 40,00,000 0.200 12,00,000
VII 34,00,000 0.170 10,20,000
Total 2,00,00,000 1.000 80,00,000
It may be seen from above that from third year onwards, the balance of carrying amount i.e.,
Rs.60,00,000 has been amortised in the ratio of net cash flows arising from the product of Swift Ltd.

Q.NO.2. AB Ltd. launched a project for producing product X in October, 20X1. The Company
incurred Rs.20 lakhs towards Research. Due to prevailing market conditions, the Management
came to conclusion that the product cannot be manufactured and sold in the market for the next
10 years. The Management hence wants to defer the expenditure write off to future years.
Advise the Company as per the applicable Accounting Standard.
SOLUTION
As per para 41 of AS 26 “Intangible Assets”, expenditure on research should be recognised as an
354

expense when it is incurred. Hence, the expenses amounting Rs.20 lakhs incurred on the research
Page

has to be charged to the statement of profit and loss in the current year ending 31st March, 20X2.

CA CS KARTHIK MANIKONDA – 75501 37279

Q.NO.3. During 20X1-X2, an enterprise incurred costs to develop and produce a routine low risk
computer software product, as follows:
Particular Rs.
Completion of detailed program and design (Phase 1) 50,000
Coding and Testing (Phase 2) 40,000
Other coding costs (Phase 3 & 4) 63,000
Testing costs (Phase 3 & 4) 18,000
Product masters for training materials (Phase 5) 19,500
Packing the products (1,500 units) (Phase 6) 16,500
After completion of phase 2, it was established that the product is technically feasible for the
market. You are required to state how the above referred cost to be recognized in the books of
accounts.
SOLUTION
As per AS 26, costs incurred in creating a computer software product should be charged to research
and development expense when incurred until technological feasibility/asset recognition criteria has
been established for the product. Technological feasibility/asset recognition criteria have been
established upon completion of detailed program design, coding and testing. In this case, Rs.90,000
would be recorded as an expense (Rs.50,000 for completion of detailed program design and
Rs.40,000 for coding and testing to establish technological feasibility/asset recognition criteria). Cost
incurred from the point of technological feasibility/asset recognition criteria until the time when
products costs are incurred are capitalized as software cost (63,000+ 18,000+ 19,500) = Rs.1,00,500.
Packing cost Rs.16,500 should be recognized as expenses and charged to P & L A/c.

355
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 UNIT 7: ACCOUNTING STANDARD 28:
IMPAIRMENT OF ASSETS
LEARNING OUTCOMES
After studying this unit, you will be able to:
 Define the terms ‘recoverable amount’, ‘value in use’, ‘net selling price’, ‘cost of disposal’,
‘impairment loss’ and other related terms.
 Identify an asset that may be Impaired.
 Measure the recoverable amount after computing net selling price and value in use
 Recognise and measure the impairment loss
 Identify the cash generating units
 Compute the recoverable amount and carrying amount of a cash generating unit
 Identify goodwill that whether it relates to the cash-generating unit
 Impair the cash generating unit
 Set out the requirements for reversing an impairment loss
 Apply impairment provisions in case of discontinuing operations
7.1 INTRODUCTION
AS 28 came into effect in respect of accounting period commenced on or after 1-4-2004 and is
mandatory in nature from that date for the following:
i. Enterprises whose equity or debt securities are listed on a recognised stock exchange in India, and
enterprises that are in the process of issuing equity or debt securities that will be listed on a
recognised stock exchange in India as evidenced by the board of directors’ resolution in this regard.
ii. All other commercial, industrial and business reporting enterprises, whose turnover for the
accounting period exceeds Rs. 50 crores.
In respect of all other enterprises, the Accounting Standard came into effect in respect of
accounting periods commenced on or after 1-4-2005 and is mandatory in nature from that date.
This standard prescribes the procedures to be applied to ensure that the assets of an enterprise
are carried at an amount not exceeding their recoverable amount (amount to be recovered
through use or sale of the asset). The standard also lays down principles for reversal of
impairment losses and prescribes certain disclosures in respect of impaired assets. An enterprise
is required to assess at each balance sheet date whether there is an indication that an
enterprise’s assets may be impaired. If such an indication exists, the enterprise is required to
356

estimate the recoverable amount and the impairment loss, if any, should be recognised in the
profit and loss account.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

7.2 SCOPE
The standard should be applied in accounting for impairment of all assets except
1. inventories (AS 2),
2. assets arising under construction contracts (AS 7),
3. financial assets including investments covered under AS 13, and
4. deferred tax assets (AS 22).
There are chances that the provision on account of impairment losses may increase sickness of
companies and potentially sick companies may actually become sick.
7.3 ASSESSMENT
An enterprise should assess at each balance sheet date whether there is any indication that an
asset may be impaired. If any such indication exists, the enterprise should estimate the
recoverable amount of the asset. An asset is impaired when the carrying amount of the asset
exceeds its recoverable amount. The requirements use the term ‘an asset’ but apply equally to
an individual asset or a cash-generating unit. In assessing whether there is any indication that an
asset may be impaired, an enterprise should consider, as a minimum, the following indications:

External sources
Indicators of Impairment
[List is NOT exhaustive]
Internal sources

External sources of information

a. During the period, an asset’s market value has declined significantly more than would be
expected as a result of the passage of time or normal use.
b. Significant changes with an adverse effect on the enterprise have taken place during the period,
or will take place in the near future, in the technological, market, economic or legal environment
in which the enterprise operates or in the market to which an asset is dedicated.
c. Market interest rates or other market rates of return on investments have increased during the
period, and those increases are likely to affect the discount rate used in calculating an asset’s
value in use and decrease the asset’s recoverable amount materially.
d. The carrying amount of the net assets of the reporting enterprise is more than its market
357

capitalization.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Internal sources of information
a. Evidence is available of obsolescence or physical damage of an asset.
b. Significant changes with an adverse effect on the enterprise have taken place during the period,
or are expected to take place in the near future, in the extent to which, or manner in which, an
asset is used or is expected to be used. These changes include plans to discontinue or restructure
the operation to which an asset belongs or to dispose of an asset before the previously expected
date and
c. Evidence is available from internal reporting that indicates that the economic performance of an
asset is, or will be, worse than expected.
An enterprise may identify other indications that an asset may be impaired and these would also
require the enterprise to determine the asset’s recoverable amount.
Example that indicates that an asset may be impaired because of the following:
a. cash flows for acquiring the asset, or subsequent cash needs for operating or maintaining it, that
are significantly higher than those originally budgeted
b. actual net cash flows or operating profit or loss flowing from the asset that are significantly
worse than those budgeted;
c. a significant decline in budgeted net cash flows or operating profit, or a significant increase in
budgeted loss, flowing from the asset; or
d. operating losses or net cash outflows for the asset, when current period figures are aggregated
with budgeted figures for the future.
The concept of materiality applies in identifying whether the recoverable amount of an asset needs
to be estimated.
Note: If there is an indication that an asset may be impaired, this may indicate that the remaining
useful life, the depreciation method or the residual value for the asset need to be reviewed and
adjusted under the Accounting Standard 10, even if no impairment loss is recognised for the asset.

7.4 MEASUREMENT OF RECOVERABLE AMOUNT

An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable
amount.
Recoverable amount is the higher of an asset’s net selling price and it’s value in use.
Net selling price is the amount obtainable from the sale of an asset in an arm’s length transaction
358

between knowledgeable, willing parties, less the costs of disposal.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

Costs of disposal are incremental costs directly attributable to the disposal of an asset, excluding
finance costs and income tax expense. The best evidence for net selling price is a price in the bidding
sales agreement for the disposal of the assets or similar assets. In the absence of this, net selling
price is estimated from the transactions for the assets in active market, if the asset has the active
market. If there is no binding sale agreement or active market for an asset, net selling price is based
on the best information available to reflect the amount that an enterprise could obtain, at the
balance sheet date, for the disposal of the asset in an arm’s length transaction between
knowledgeable, willing parties, after deducting the costs of disposal.
Value in Use is the present value of estimated future cash flows expected to arise from the
continuing use of an asset and from its disposal at the end of its useful life.
Estimating the value in use of an asset involves the following steps:
a. Estimating the future cash inflows and outflows arising from continuing use of the asset and
from its ultimate disposal; and
b. Applying the appropriate discount rate to these future cash flows.
Carrying amount is the amount at which an asset is recognised in the balance sheet after deducting
any accumulated depreciation (amortisation) and accumulated impairment losses thereon.
Depreciation (Amortisation) is a systematic allocation of the depreciable amount of an asset over its
useful life.
Depreciable amount is the cost of an asset, or other amount substituted for cost in the financial
statements, less its residual value.
Useful life is either:
 The period of time over which an asset is expected to be used by the enterprise; or
 The number of production or similar units expected to be obtained from the asset by the
enterprise.
Note 1: If there is no reason to believe that an asset’s value in use materially exceeds its net
selling price, the asset’s recoverable amount may be taken to be its net selling price. This will
often be the case for an asset that is held for disposal. Otherwise, if it is not possible to determine
the selling price we take value in use of assets as it’s recoverable amount.

It is not always necessary to determine both an asset’s net selling price and its value in use. For
example, if either of these amounts exceeds the asset’s carrying amount, the asset is not
359

impaired, and it is not necessary to estimate the other amount.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

It may be possible to determine net selling price, even if an asset is not traded in an active market.
However, sometimes it will not be possible to determine net selling price because there is no basis
for making a reliable estimate of the amount obtainable from the sale of the asset in an arm’s
length transaction between knowledgeable and willing parties. In this case, the recoverable
amount of the asset may be taken to be its value in use.

Note 2: Recoverable amount is determined for an individual asset, unless the asset does not
generate cash inflows from continuing use that are largely independent of those from other assets
or groups of assets. If this is the case, recoverable amount is determined for the cash-generating
unit to which the asset belongs, unless either:
a. The asset’s net selling price is higher than its carrying amount; or
b. The asset’s value in use can be estimated to be close to its net selling price and net selling
price can be determined.

7.5 BASIS FOR ESTIMATES OF FUTURE CASH FLOWS

Cash flow projections should be based on the most recent approved budgets/forecasts for a
maximum of five years. Financial budgets/forecasts over a period longer than five years may be used
if management is confident that these projections are reliable and it can demonstrate its ability,
based on past experience, to forecast cash flows accurately over that longer period.
Cash flow projections until the end of an asset’s useful life are estimated by extrapolating the cash
flow projections based on the financial budgets/forecasts using a growth rate for subsequent years.
This rate is steady or declining. This growth rate should not exceed the long -term average growth
rate for the products, industries, or country or countries in which the enterprise operates, or for the
market in which the asset is used, unless a higher rate can be justified.
Cash flow projections should be based on reasonable and supportable assumptions that represent
management’s best estimate of the set of economic conditions that will exist over the remaining
useful life of the asset. Greater weight should be given to external evidence.

7.6 COMPOSITION OF ESTIMATES OF FUTURE CASH FLOWS

Estimates of future cash flows should include
i. Projections of net cash inflows from the continuing use of the asset
ii. projections of cash outflows that are necessarily incurred to generate the cash inflows from
360

continuing use of the asset and that can be directly attributed, or allocated on a reasonable and
Page

consistent basis, to the asset; and

CA CS KARTHIK MANIKONDA – 75501 37279

iii. Net cash flows, if any, to be received (or paid) for the disposal of the asset at the end of its useful
life.
Care should be taken for the following points:
a. When the carrying amount of an asset does not yet include all the cash outflows to be incurred
before it is ready for use or sale, estimate of any further cash outflow that is expected to be
incurred before the asset is ready for use or sale should be included.
b. Cash inflows from assets that generate cash inflows from continuing use that are largely
independent of the cash inflows from the asset under review should not be included.
c. Cash outflows that relate to obligations that have already been recognised as liabilities to be
excluded.
d. Future cash outflows or inflows expected to arise because of restructuring of the organization
should be not considered.
e. Any future capital expenditure enhancing the capacity of the assets and its related
savings/outflow should be excluded.
f. Any increase in expected cash inflow from the above expenditure should also be excluded.
g. Estimates of future cash flows should not include cash inflows or outflows from financing
activities and also income tax receipts or payments.
h. The estimate of net cashflow upon disposal of the asset should be the amount that an enterprise
expects to obtain from the disposal of the asset in an arm’s length transaction between
knowledgeable, willing parties prevailing at the date of the estimates, after deducting the
estimated costs of disposal.
When an enterprise becomes committed to a restructuring, some assets are likely to be affected by
this restructuring. Once the enterprise is committee to the restructuring, in determining value in
use, estimates of future cash inflows and cash outflows reflect the cost savings and other benefits
from the restructuring (based on the most recent financial budgets/forecasts that have been
approved by management).
Foreign Currency Future Cash Flows are estimated in the currency in which it will be generated and
then they are discounted for the time value of money using a discount rate appropriate for that
currency. we convert cashflow in the reporting currency on the basis of AS 11.
Discount Rate
The discount rate(s) should be a pre-tax rate(s) that reflect(s) current market assessments of the
361

time value of money and the risks specific to the asset. The discount rate(s) should not reflect risks
for which future cash flow estimates have been adjusted.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 A rate that reflects current market assessments of the time value of money and the risks specific to
the asset is the return that investors would require if they were to choose an investment that would
generate cash flows of amounts, timing and risk profile equivalent to those that the enterprise
expects to derive from the asset.
When an asset-specific rate is not directly available from the market, an enterprise uses other bases
to estimate the discount rate such as incremental borrowing rate, rate using capital asset pricing
model, etc.
These rates are adjusted:
a. to reflect the way that the market would assess the specific risks associated with the projected
cash flows; (Consideration is given to risks such as country risk, currency risk, price risk and cash
flow risk) and
b. to exclude risks that are not relevant to the projected cash flows.
An enterprise normally uses a single discount rate for the estimate of an asset’s value in use.
However, an enterprise uses separate discount rates for different future periods where value in use
is sensitive to a difference in risks for different periods or to the term structure of interest rates.
7.7 RECOGNITION AND MEASUREMENT OF AN IMPAIRMENT LOSS
Case I:
If recoverable amount of assets more than carrying amount, we ignore the difference and asset is
carried on at the same book value.
Note: As mentioned above, if there is an indication that an asset may be impaired, this may
indicate that the remaining useful life, the depreciation method or the residual value for the asset
need to be reviewed and adjusted under the Accounting Standard 10, even if no impairment loss
is recognised for the asset.
Case II:
When this recoverable amount is less than the carrying amount, this difference termed as
Impairment Loss.
Accounting implications:
Particulars Remarks
Treatment of Impairment loss It should be written off immediately as expenses to Profit & Loss
Account.
If assets are carried out at revalued figures then the impairment
362

loss equivalent to revalued surplus is adjusted with it and the

balance (if any) is charged to Profit & Loss Account.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Depreciation Depreciation for the coming years on the assets are recalculated
on the basis of the new carrying amount, residual value and
remaining useful life of the asset, according to AS 10.

Case III:
When the amount estimated for an impairment loss is greater than the carrying amount of the asset
to which it relates, an enterprise should recognise a liability if, and only if, that is required by another
Accounting Standard.
7.8 IDENTIFICATION OF THE CASHGENERATING UNIT TO WHICH AN ASSET BELONGS
A cash generating unit is the smallest identifiable group of assets that generates cash inflows from
continuing use that are largely independent of the cash inflows from other assets or groups of
assets.
If there is any indication that an asset may be impaired, the recoverable amount should be
estimated for the individual asset, if it is not possible to estimate the recoverable amount of the
individual asset because the value in use of the asset cannot be determined and it is probably
different from scrap value. Therefore, the enterprise estimates the recoverable amount of the cash-
generating unit to which the asset belongs.
If recoverable amount cannot be determined for an individual asset, an enterprise identifies the
lowest aggregation of assets that generate largely independent cash inflows from continuing use.
Even if part or all of the output produced by an asset or a group of assets is used by other units of
the reporting enterprise, this asset or group of assets forms a separate cash-generating unit if the
enterprise could sell this output in an active market. This is because this asset or group of assets
could generate cash inflows from continuing use that would be largely independent of the cash
inflows from other assets or groups of assets. In using information based on financial
budgets/forecasts that relates to such a cash generating unit, an enterprise adjusts this information
if internal transfer prices do not reflect management’s best estimate of future market prices for the
cash generating unit’s output.
Cash-generating units should be identified consistently from period to period for the same asset or
types of assets, unless a change is justified.
Example 1
A mining enterprise owns a private railway to support its mining activities. The private railway could
363

be sold only for scrap value and the private railway does not generate cash inflows from continuing
use that are largely independent of the cash inflows from the other assets of the mine.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

It is not possible to estimate the recoverable amount of the private railway because the value in use
of the private railway cannot be determined and it is probably different from scrap value. Therefore,
the enterprise estimates the recoverable amount of the cash-generating unit to which the private
railway belongs, that is, the mine as a whole.
Example 2
A bus company provides services under contract with a municipality that requires minimum service
on each of five separate routes. Assets devoted to each route and the cash flows from each route
can be identified separately. One of the routes operates at a significant loss.
Since the enterprise does not have the option to curtail any one bus route, the lowest level of
identifiable cash inflows from continuing use that are largely independent of the cash inflows from
other assets or groups of assets is the cash inflows generated by the five routes together. The cash-
generating unit for each route is the bus company as a whole.
If an active market exists for the output produced by an asset or a group of assets, this asset or
group of assets should be identified as a separate cash generating unit, even if some or all of the
output is used internally.

7.9 RECOVERABLE AMOUNT AND CARRYING AMOUNT OF A CASH-GENERATING UNIT

The carrying amount of a cash-generating unit should be determined consistently with the way the
recoverable amount of the cash-generating unit is determined i.e., carrying amount is the
summation of the carrying amount of all the assets grouped under one cash-generating unit. This
also includes the liability only if that liability is necessary to be considered to determine the recovery
amount. This may occur if the disposal of a cash-generating unit would require the buyer to take
over a liability. In this case, the net selling price of the cash-generating unit is the estimated selling
price for the assets of the cash-generating unit and the liability together, less the costs of disposal. In
order to perform a meaningful comparison between the carrying amount of the cash-generating unit
and its recoverable amount, the carrying amount of the liability is deducted in determining both the
cash-generating unit’s value in use and its carrying amount.
For practical reasons, the recoverable amount of a cash-generating unit is sometimes determined
after consideration of assets that are not part of the cash generating unit or liabilities that have
already been recognised in the financial statements. In such cases, the carrying amount of the cash-
generating unit is increased by the carrying amount of those assets and decreased by the carrying
364

amount of those liabilities.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

Example 3
A company operates a mine in a country where legislation requires that the owner must restore the
site on completion of its mining operations. The cost of restoration includes the replacement of the
overburden, which must be removed before mining operations commence. A provision for the costs
to replace the overburden was recognised as soon as the overburden was removed. The amount
provided was recognised as part of the cost of the mine and is being depreciated over the mine’s
useful life. The carrying amount of the provision for restoration costs is Rs. 50,00,000, which is equal
to the present value of the restoration costs.
The enterprise is testing the mine for impairment. The cash-generating unit for the mine is the mine
as a whole. The enterprise has received various offers to buy the mine at a price of around
Rs.80,00,000; this price encompasses the fact that the buyer will take over the obligation to restore
the overburden. Disposal costs for the mine are negligible. The value in use of the mine is
approximately Rs. 1,20,00,000 excluding restoration costs. The carrying amount of the mine is
Rs.1,00,00,000.
The net selling price for the cash-generating unit is Rs.80,00,000. This amount considers restoration
costs that have already been provided for. As a consequence, the value in use for the cash-
generating unit is determined after consideration of the restoration costs and is estimated to be
Rs.70,00,000 (Rs. 1,20,00,000 less Rs. 50,00,000). The carrying amount of the cash-generating unit is
Rs.50,00,000, which is the carrying amount of the mine (Rs. 1,00,00,000) less the carrying amount of
the provision for restoration costs (Rs. 50,00,000).

7.10 GOODWILL
Goodwill does not generate cash flows independently from other assets or groups of assets and,
therefore, the recoverable amount of goodwill as an individual asset cannot be determined. As a
consequence, if there is an indication that goodwill may be impaired, recoverable amount is
determined for the cash generating unit to which goodwill belongs. This amount is then compared to
the carrying amount of this cash-generating unit and any impairment loss is recognized.
If goodwill can be allocated on a reasonable and consistent basis, an enterprise applies the ‘bottom-
up’ test only. If it is not possible to allocate goodwill on a reasonable and consistent basis, an
enterprise applies both the ‘bottom-up’ test and ‘top-down’ test.

Can be allocated on a
Perform Bottom up Test
reasonable and
ONLY
consistent basis
Goodwill
365

Cannot be allocated on a
Perform Bottom up and
reasonable and
Top Down Test BOTH
consistent basis
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 Example:
At the end of 20X0, enterprise M acquired 100% of enterprise Z for Rs. 3,000 lakhs. Z has 3 cash-
generating units A, B and C with net fair values of Rs. 1,200 lakhs, Rs. 800 lakhs and Rs. 400 lakhs
respectively. M recognises goodwill of Rs. 600 lakhs (Rs. 3,000 lakhs less Rs. 2,400 lakhs) that relates
to Z.
At the end of 20X4, A makes significant losses. Its recoverable amount is estimated to be Rs. 1,350
lakhs. Carrying amounts are detailed below (Rs. In Lakh).
End of 20X4 A B C Goodwill Total
Net carrying amount 1300 1200 800 120 3420
Scenario A - Goodwill Can be Allocated on a Reasonable and Consistent Basis
On the date of acquisition of Z, the net fair values of A, B and C are considered a reasonable basis for
a pro-rata allocation of the goodwill to A, B and C.
Allocation of goodwill at the end of 20X4:
A B C Goodwill
End of 20X0
Net fair values 1200 800 400 2400
Pro-Rata 50% 33% 17% 100%
End of 20X4
Net carrying amount 1300 1200 800 3300
Allocation of goodwill 60 40 20 120
(Using pro rate above)
Net carrying amount (After goodwill) 1360 1240 820 3420

In accordance with the ‘bottom-up’ test in paragraph 78(a) of AS 28, M compares A’s recoverable
amount to its carrying amount after the allocation of the carrying amount of goodwill:
End of 20X4 A (Rs. In Lakh)
Carrying amount after allocation of goodwill 1360
Recoverable amount 1350
Impairment loss 10

M recognises an impairment loss of Rs. 10 lakhs for A. The impairment loss is fully allocated to the
366

goodwill in accordance with paragraph 87 of AS 28.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

Scenario B - Goodwill Cannot be Allocated on a Reasonable and Consistent Basis
There is no reasonable way to allocate the goodwill that arose on the acquisition of Z to A, B and C.
At the end of 20X4, Z’s recoverable amount is estimated to be Rs.3,400 lakhs.
At the end of 20X4, M first applies the ‘bottom-up’ test in accordance with paragraph 78(a) of this
Statement. It compares A’s recoverable amount to its carrying amount excluding the goodwill.
End of 20X4 A (Rs. In Lakh)
Carrying amount 1300
Recoverable amount 1350
Impairment loss 0

Therefore, no impairment loss is recognised for A as a result of the ‘bottom-up’ test.

Since the goodwill could not be allocated on a reasonable and consistent basis to A, M also performs
a ‘top-down’ test in accordance with paragraph 78(b) of AS 28. It compares the carrying amount of Z
as a whole to its recoverable amount (Z as a whole is the smallest cash-generating unit that includes
A and to which goodwill can be allocated on a reasonable and consistent basis).
Application of the ‘top-down’ test (Amount in Rs. lakhs)
End of 20X4 A B C Goodwill Total
Carrying amount 1300 1200 800 120 3420
Impairment loss arising from the
‘bottom-up’ test 0 - - - 0
Carrying amount after the ‘bottom-up’
test 1300 1200 800 120 3420
Recoverable amount - - - - 3400
Impairment loss arising from ‘top-down’
test - - - - 20
Therefore, M recognises an impairment loss of Rs. 20 lakhs that it allocates fully to goodwill in
accordance with paragraph 87 of AS 28.

7.11 CORPORATE ASSETS

Key characteristics of corporate assets are that they do not generate cash inflows independently
from other assets or groups of assets and their carrying amount cannot be fully attributed to the
367

cash-generating unit under review.

Page

CA CS KARTHIK MANIKONDA – 75501 37279

Examples
Building of a headquarter or a division of the enterprise, EDP equipment or a research Centre.
In testing a cash-generating unit for impairment, an enterprise should identify all the corporate
assets that relate to the cash-generating unit under review. For each identified corporate asset:
a. If the carrying amount of the corporate asset can be allocated on a reasonable and consistent
basis to the cash-generating unit under review, an enterprise should apply the ‘bottom-up’ test
only; and
b. If the carrying amount of the corporate asset cannot be allocated on a reasonable and consistent
basis to the cash-generating unit under review, an enterprise should apply both the ‘bottom-up’
and ‘top-down’ tests.

Can be allocated on a
Perform Bottom up Test
reasonable and
ONLY
consistent basis

Corporate Assets

Cannot be allocated on a
Perform Bottom up and
reasonable and
Top Down Test BOTH
consistent basis

7.12 IMPAIRMENT LOSS FOR A CASH GENERATING UNIT

The impairment loss should be allocated to reduce the carrying amount of the assets of the unit in
the following order:
a. First, to goodwill allocated to the cash-generating unit (if any); and
b. Then, to the other assets of the unit on a pro-rata basis based on the carrying amount of each
asset in the unit.
These reductions in carrying amounts should be treated as impairment losses on individual assets
The carrying amount of an asset should not be reduced below the highest of:
a. Its net selling price (if determinable);
b. Its value in use (if determinable); and
c. Zero.
The amount of the impairment loss that would otherwise have been allocated to the asset should be
allocated to the other assets of the unit on a pro-rata basis.
After the requirements of impairment loss have been applied, a liability should be recognised for any
368

remaining amount of an impairment loss for a cash-generating unit if that is required by another
Accounting Standard.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Example 4
A machine has suffered physical damage but is still working, although not as well as it used to. The
net selling price of the machine is less than its carrying amount. The machine does not generate
independent cash inflows from continuing use. The smallest identifiable group of assets that
includes the machine and generates cash inflows from continuing use that are largely independent
of the cash inflows from other assets is the production line to which the machine belongs. There
coverable amount of the production line shows that the production line taken as a whole is not
impaired.
Assumption 1: Budgets/forecasts approved by management reflect no commitment of management
to replace the machine.
a. The recoverable amount of the machine alone cannot be estimated since the machine’s value in
use: may differ from its net selling price; and
b. can be determined only for the cash-generating unit to which the machine belongs (the
production line).
The production line is not impaired, therefore, no impairment loss is recognised for the machine.
Nevertheless, the enterprise may need to reassess the depreciation period or the depreciation
method for the machine. Perhaps, a shorter depreciation period or a faster depreciation method is
required to reflect the expected remaining useful life of the machine or the pattern in which
economic benefits are consumed by the enterprise.
Assumption 2: Budgets/forecasts approved by management reflect a commitment of management
to replace the machine and sell it in the near future. Cash flows from continuing use of the machine
until its disposal are estimated to be negligible.
The machine’s value in use can be estimated to be close to its net selling price. Therefore, the
recoverable amount of the machine can be determined and no consideration is given to the cash-
generating unit to which the machine belongs (the production line). Since the machine’s net selling
price is less than its carrying amount, an impairment loss is recognised for the machine.

7.13 REVERSAL OF AN IMPAIRMENT LOSS

An enterprise should assess at each balance sheet date whether there is any indication that an
impairment loss recognised for an asset in prior accounting periods may no longer exist or may have
decreased. If any such indication exists, the enterprise should estimate the recoverable amount of
that asset. An impairment loss recognised for an asset in prior accounting periods should be
369

reversed if there has been a change in the estimates of cash inflows, cash outflows or discount rates
Page

used to determine the asset’s recoverable amount since the last impairment loss was recognised. If

CA CS KARTHIK MANIKONDA – 75501 37279

this is the case, the carrying amount of the asset should be increased to its recoverable amount.
That increase is a reversal of an impairment loss. Indications of a potential decrease in an
impairment loss are mainly mirror the indications of a potential impairment loss discussed above as
external and internal indicators. The concept of materiality applies in identifying whether an
impairment loss recognised for an asset in prior accounting periods may need to be reversed and the
recoverable amount of the asset determined.

7.14 REVERSAL OF AN IMPAIRMENT LOSS FOR AN INDIVIDUAL ASSET

Case I: If impairment loss was written off to profit and loss account, then the reversal of impairment
loss should be recognized as income in the financial statement immediately.
Case II: If impairment loss was adjusted with the Revaluation Reserve; then reversal of impairment
loss will be written back to the reserve account to the extent it was adjusted, any surplus will be
recognised as revenue. But in any case the increased carrying amount of an asset due to a reversal of
an impairment loss should not exceed the carrying amount that would have been determined (net of
amortisation or depreciation) had no impairment loss been recognised for the asset in prior
accounting periods. This is mainly because any further increase in value of asset is revaluation, which
is governed by AS 10.
Depreciation impact post reversal of impairment loss:
After a reversal of an impairment loss is recognised, the depreciation (amortisation) charge for the
asset should be adjusted in future periods to allocate the asset’s revised carrying amount, less its
residual value (if any), on a systematic basis over its remaining useful life.

7.15 REVERSAL OF AN IMPAIRMENT LOSS FOR A CASH-GENERATING UNIT

A reversal of an impairment loss for a cash-generating unit should be allocated to increase the
carrying amount of the assets of the unit in the following order:
a. First, assets other than goodwill on a pro-rata basis based on the carrying amount of each asset
in the unit; and
b. Then, to goodwill allocated to the cash-generating unit (if any),
In allocating a reversal of an impairment loss for a cash generating unit under paragraph 106, the
carrying amount of an asset should not be increased above the lower of:
a. its recoverable amount (if determinable); and
370

b. the carrying amount that would have been determined (net of amortisation or depreciation) had
no impairment loss been recognised for the asset in prior accounting periods.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

The amount of the reversal of the impairment loss that would otherwise have been allocated to the
asset should be allocated to the other assets of the unit on a pro-rata basis.
7.16 REVERSAL OF AN IMPAIRMENT LOSS FOR GOODWILL
This Statement does not permit an impairment loss to be reversed for goodwill because of a change
in estimates (for example, a change in the discount rate or in the amount and timing of future cash
flows of the cash generating unit to which goodwill relates), an impairment loss recognised for
goodwill should not be reversed in a subsequent period unless:
a. The impairment loss was caused by a specific external event of an exceptional nature that is not
expected to recur; and
b. Subsequent external events have occurred that reverse the effect of that event.

7.17 IMPAIRMENT IN CASE OF DISCONTINUING OPERATIONS

The approval and announcement of a plan for discontinuance is an indication that the assets
attributable to the discontinuing operation may be impaired or that an impairment loss previously
recognised for those assets should be increased or reversed.
In applying this Statement to a discontinuing operation, an enterprise determines whether the
recoverable amount of an asset of a discontinuing operation is assessed for the individual asset or
for the asset’s cash-generating unit. For example:
a. If the enterprise sells the discontinuing operation substantially in its entirety, none of the assets
of the discontinuing operation generate cash inflows independently from other assets within the
discontinuing operation. Therefore, recoverable amount is determined for the discontinuing
operation as a whole and an impairment loss, if any, is allocated among the assets of the
discontinuing operation in accordance with this Statement;
b. If the enterprise disposes of the discontinuing operation in other ways such as piecemeal sales,
the recoverable amount is determined for individual assets, unless the assets are sold in groups;
and
c. If the enterprise abandons the discontinuing operation, the recoverable amount is determined
for individual assets as set out in this Statement.
After announcement of a plan, negotiations with potential purchasers of the discontinuing operation
or actual binding sale agreements may indicate that the assets of the discontinuing operation may
be further impaired or that impairment losses recognised for these assets in prior periods may have
371

decreased.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

7.18 DISCLOSURE
For each class of assets, the financial statements should disclose:
a. The amount of impairment losses recognised in the statement of profit and loss during the
period and the line item(s) of the statement of profit and loss in which those impairment losses
are included;
b. The amount of reversals of impairment losses recognised in the statement of profit and loss
during the period and the line item(s) of the statement of profit and loss in which those
impairment losses are reversed;
c. The amount of impairment losses recognised directly against revaluation surplus during the
period; and
d. The amount of reversals of impairment losses recognised directly in revaluation surplus during
the period.
This information may be included in a reconciliation of the carrying amount of fixed assets, at the
beginning and end of the period, as required under AS 10.
An enterprise that applies AS 17, Segment Reporting, should disclose the following for each
reportable segment based on an enterprise’s primary format (as defined in AS 17):
a. The amount of impairment losses recognised in the statement of profit and loss and directly
against revaluation surplus during the period; and
b. The amount of reversals of impairment losses recognised in the statement of profit and loss and
directly in revaluation surplus during the period.
If an impairment loss for an individual asset or a cash-generating unit is recognised or reversed
during the period and is material to the financial statements of the reporting enterprise as a whole,
an enterprise should disclose:
a. The events and circumstances that led to the recognition or reversal of the impairment loss;
b. The amount of the impairment loss recognised or reversed;
c. For an individual asset:
i. The nature of the asset; and
ii. The reportable segment to which the asset belongs, based on the enterprise’s primary
format (as defined in AS 17, Segment Reporting);
d. For a cash-generating unit:
i. A description of the cash-generating unit (such as whether it is a product line, a plant, a
business operation, a geographical area, a reportable segment as defined in AS 17 or other);
372

ii. The amount of the impairment loss recognised or reversed by class of assets and by
reportable segment based on the enterprise’s primary format (as defined in AS 17); and
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 iii. If the aggregation of assets for identifying the cash-generating unit has changed since the
previous estimate of the cash-generating unit’s recoverable amount (if any), the enterprise
should describe the current and former way of aggregating assets and the reasons for
changing the way the cash-generating unit is identified;
e. Whether the recoverable amount of the asset (cash-generating unit) is its net selling price or its
value in use;
f. If recoverable amount is net selling price, the basis used to determine net selling price (such as
whether selling price was determined by reference to an active market or in some other way);
and
g. If recoverable amount is value in use, the discount rate(s) used in the current estimate and
previous estimate (if any) of value in use.
If impairment losses recognised (reversed) during the period are material in aggregate to the
financial statements of the reporting enterprise as a whole, an enterprise should disclose a brief
description of the following:
a. The main classes of assets affected by impairment losses (reversals of impairment losses);
b. The main events and circumstances that led to the recognition (reversal) of these impairment
losses.
An enterprise is encouraged to disclose key assumptions used to determine the recoverable amount
of assets (cash-generating units) during the period.

373
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 ILLUSTRATIONS
Illustration 1
Ergo Industries Ltd. gives the following estimates of cash flows relating to Property, Plant and
Equipment on 31-12-20X1. The discount rate is 15%.
Year Cash Flow (Rs. in lakhs)
20X2 4000
20X3 6000
20X4 6000
20X5 8000
20X6 4000
Residual value at the end of 20X6 = Rs. 1000 lakhs
Property, Plant and Equipment purchased on 1-1-20XX = Rs. 40,000 lakhs
Useful life = 8 years
Net selling price on 31-12-20X1 = Rs. 20,000 lakhs
Calculate on 31-12-20X1:
a. Carrying amount at the end of 20X1
b. Value in use on 31-12-20X1
c. Recoverable amount on 31-12-20X1
d. Impairment loss to be recognized for the year ended 31-12-20X1
e. Revised carrying amount
f. Depreciation charge for 20X2.
Note: The year 20XX is the immediate preceding year before the year 20X0.
Solution
Calculation of value in use
Year Cash Flow Discount as per 15% Discounted cash flow
20X2 4,000 0.870 3,480
20X3 6,000 0.756 4,536
20X4 6,000 0.658 3,948
20X5 8,000 0.572 4,576
20X6 4,000 0.497 1,988
374

20X6 (residual) 1,000 0.497 497

19,025
Page

CA CS KARTHIK MANIKONDA – 75501 37279

a. Calculation of carrying amount:
Original cost = Rs. 40,000 lakhs
Depreciation for 3 years = [(40,000-1000)3/8] = Rs. 14,625 lakhs
Carrying amount on 31-12-20X1 = [40,000-14,625] = Rs. 25,375 lakhs
b. Value in use = Rs. 19,025 lakhs
c. Recoverable amount = higher of value in use and net selling price i.e. Rs. 20,000 lakhs.
Recoverable amount = Rs. 20,000 lakhs
d. Impairment Loss = Rs. (25,375-20,000) = Rs. 5,375 lakhs
e. Revised carrying amount = Rs. (25,375-5,375) = Rs. 20,000 lakhs
f. Depreciation charge for 20X2 = (20,000-1000)/5 = Rs. 3,800 lakhs

Illustration 2
X Ltd. is having a plant (asset) carrying amount of which is Rs. 100 lakhs on 31.3.20X1. Its balance
useful life is 5 years and residual value at the end of 5 years is Rs. 5 lakhs. Estimated future cash
flow from using the plant in next 5 years are:
For the year ended on Estimated cash flow (Rs. in lakhs)
31.3.20X2 50
31.3.20X3 30
31.3.20X4 30
31.3.20X5 20
31.3.20X6 20
Calculate “value in use” for plant if the discount rate is 10% and also calculate the recoverable
amount if net selling price of plant on 31.3.20X1 is Rs. 60 lakhs.
Solution
Present value of future cash flow
Year ended Future Cash Flow Discount @ 10% Rate Discounted cash
Flow
31.3.20X2 50 0.909 45.45
31.3.20X3 30 0.826 24.78
31.3.20X4 30 0.751 22.53
31.3.20X5 20 0.683 13.66
375

31.3.20X6 20 0.620 12.40

Page

118.82

CA CS KARTHIK MANIKONDA – 75501 37279

Present value of residual price on 31.3.20X6 = 5  0.620 3.10
Present value of estimated cash flow by use of an asset and residual value,
which is called “value in use”. 121.92
If net selling price of plant on 31.3.20X1 is Rs. 60 lakhs, the recoverable amount will be higher of
Rs.121.92 lakhs (value in use) and Rs. 60 lakhs (net selling price), hence recoverable amount is
Rs.121.92 lakhs.

Illustration 3
G Ltd., acquired a machine on 1st April, 20X0 for Rs. 7 crore that had an estimated useful life of 7
years. The machine is depreciated on straight line basis and does not carry any residual value. On
1st April, 20X4, the carrying value of the machine was reassessed at Rs. 5.10 crore and the surplus
arising out of the revaluation being credited to revaluation reserve. For the year ended March,
20X6, conditions indicating an impairment of the machine existed and the amount recoverable
ascertained to be only Rs. 79 lakhs. You are required to calculate the loss on impairment of the
machine and show how this loss is to be treated in the books of G Ltd. G Ltd., had followed the
policy of writing down the revaluation surplus by the increased charge of depreciation resulting
from the revaluation.
Solution
Statement Showing Impairment Loss
(Rs. in crores)
Carrying amount of the machine as on 1st April, 20X0 7.00
Depreciation for 4 years i.e. 20X0-20X1 to 20X3-20X

 7 crores 
  4 years 
 7 years  (4.00)

Carrying amount as on 31.03.20X4 3.00

Add: Upward Revaluation (credited to Revaluation Reserve account) 2.10
Carrying amount of the machine as on 1st April, 20X4 (revalued) 5.10

Less: Depreciation for 2 years i.e. 20X4-20X5& 20X5-20X6

 5.10 crores 
  2 years 
 3 years  (3.40)

Carrying amount as on 31.03.20X6 1.70

376

Less: Recoverable amount (0.79)

0.91
Page

Impairment loss

CA CS KARTHIK MANIKONDA – 75501 37279

Less: Balance in revaluation reserve as on 31.03.20X6:
Balance in revaluation reserve as on 31.03.20X4 2.10
Less: Enhanced depreciation met from revaluation reserve
20X4-20X5 & 20X5-20X6=[(1.70 – 1.00) x 2 years] (1.40)
Impairment loss set off against revaluation reserve balance as per para 58 of AS 28
“Impairment of Assets” (0.70)
Impairment Loss to be debited to profit and loss account 0.21

Illustration 4
X Ltd. purchased a Property, Plant and Equipment four years ago for Rs. 150 lakhs and depreciates
it at 10% p.a. on straight line method. At the end of the fourth year, it has revalued the asset at Rs.
75 lakhs and has written off the loss on revaluation to the profit and loss account. However, on
the date of revaluation, the market price is Rs. 67.50 lakhs and expected disposal costs are Rs. 3
lakhs. What will be the treatment in respect of impairment loss on the basis that fair value for
revaluation purpose is determined by market value and the value in use is estimated at Rs. 60
lakhs?
Solution
Treatment of Impairment Loss
As per para 57 of AS 28 “Impairment of assets”, if the recoverable amount (higher of net selling price
and its value in use) of an asset is less than its carrying amount, the carrying amount of the asset
should be reduced to its recoverable amount. In the given case, net selling price is Rs.64.50 lakhs
(Rs.67.50 lakhs – Rs. 3 lakhs) and value in use is Rs.60 lakhs. Therefore, recoverable amount will be
Rs.64.50 lakhs. Impairment loss will be calculated as Rs.10.50 lakhs [Rs.75 lakhs (Carrying Amount
after revaluation - Refer Working Note) less Rs.64.50 lakhs (Recoverable Amount)].
Thus impairment loss of Rs. 10.50 lakhs should be recognised as an expense in the Statement of
Profit and Loss immediately since there was downward revaluation of asset which was already
charged to Statement of Profit and Loss.
Working Note:
Calculation of carrying amount of the Property, Plant and Equipment at the end of the fourth year
on revaluation
(Rs. in lakhs)
377

Purchase price of a Property, Plant and Equipment 150.00

Less: Depreciation for four years [(150 lakhs / 10 years) x 4 years] (60.00)
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Carrying value at the end of fourth year 90.00
Less: Downward revaluation charged to profit and loss account (15.00)
Revalued carrying amount 75.00

Reference: The students are advised to refer the full text of AS 28 “Impairment of Assets”
(issued 2002).

378
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 TEST YOUR KNOWLEDGE
MCQs
1. If there is indication that an asset may be impaired but the recoverable amount of the asset is
more than the carrying amount of the asset, the following are true:
a. No further action is required and the company can continue the asset in the books at the
book value itself.
b. The entity should review the remaining useful life, scrap value and method of depreciation
and amortization for the purposes of AS 10.
c. The entity can follow either (a) or (b).
d. The entity should review the scrap value and method of depreciation and amortization for
the purposes of AS 10.

2. In case Goodwill appears in the Balance Sheet of an entity, the following is true:
a. Apply Bottom up test if goodwill cannot be allocated to CGU (cash generating unit) under
review.
b. Apply Top down test if goodwill cannot be allocated to CGU (cash generating unit) under
review.
c. Apply both Bottom up test and Top down test if goodwill cannot be allocated to CGU (cash
generating unit) under review.
d. Apply either Bottom up test or Top down test if goodwill cannot be allocated to CGU (cash
generating unit) under review.

3. In case of Corporate assets in the Balance Sheet of an entity, the following is true:
a. Apply Bottom up test if corporate assets cannot be allocated to CGU (cash generating unit)
under review.
b. Apply Top down test if corporate assets cannot be allocated to CGU (cash generating unit)
under review.
c. Apply both Bottom up test and Top down test if corporate assets cannot be allocated to
CGU (cash generating unit) under review.
d. Apply either Bottom up test or Top down test if corporate assets cannot be allocated to
CGU (cash generating unit) under review.

4. In case of reversal of impairment loss, which statement is true:

379

a. Goodwill written off can never be reversed.

Page

b. Goodwill written off can be reversed without any conditions to be met.

CA CS KARTHIK MANIKONDA – 75501 37279

 c. Goodwill written off can be reversed only if certain conditions are met.
d. Goodwill written off can be reversed.

ANSWERS/HINTS
MCQs
1. b. The entity should review the remaining useful life, scrap value and method of depreciation
and amortization for the purposes of AS 10.
2. c. Apply both Bottom up test and Top down test if goodwill cannot be allocated to CGU (cash
generating unit) under review.
3. c. Apply both Bottom up test and Top down test if corporate assets cannot be allocated to CGU
(cash generating unit) under review.
4. c. Goodwill written off can be reversed only if certain conditions are met.

THEORY QUESTIONS
Q.NO.1. Write short note on impairment of asset and its application to inventory.
ANSWER
The objective of AS 28 ‘Impairment of Assets’ is to prescribe the procedures that an enterprise
applies to ensure that its assets are carried at no more than their recoverable amount. An asset is
carried at more than its recoverable amount if its carrying amount exceeds the amount to be
recovered through use or sale of the asset. If this is the case, the asset is described as impaired and
this Standard requires the enterprise to recognize an impairment loss.
 If carrying amount < = Recoverable amount : Asset is not impaired
 If carrying amount > Recoverable amount : Asset is impaired
Impairment Loss = Carrying Amount – Recoverable Amount
Recoverable amount is the higher of net selling price and its value in use
This standard should be applied in accounting for the impairment of all assets, other than (i)
inventories (AS 2, Valuation of Inventories); (ii) assets arising from construction contracts (AS 7,
Accounting for Construction Contracts); (iii) financial assets, including investments that are included
in the scope of AS 13, Accounting for Investments; and (iv) deferred tax assets (AS 22, Accounting for
Taxes on Income). AS 28 does not apply to inventories, assets arising from construction contracts,
deferred tax assets or investments because other accounting standards applicable to these assets
380

already contain specific requirements for recognizing and measuring the impairment related to
these assets.
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 PRACTICAL QUESTIONS
Q.NO.1. A publisher owns 150 magazine titles of which 70 were purchased and 80 were self-
created. The price paid for a purchased magazine title is recognized as an intangible asset. The
costs of creating magazine titles and maintaining the existing titles are recognized as an expense
when incurred. Cash inflows from direct sales and advertising are identifiable for each magazine
title. Titles are managed by customer segments. The level of advertising income for a magazine
title depends on the range of titles in the customer segment to which the magazine title relates.
Management has a policy to abandon old titles before the end of their economic lives and replace
them immediately with new titles for the same customer segment. What is the cash-generating
unit for an individual magazine title?
SOLUTION
It is likely that the recoverable amount of an individual magazine title can be assessed. Even though
the level of advertising income for a title is influenced, to a certain extent, by the other titles in the
customer segment, cash inflows from direct sales and advertising are identifiable for each title. In
addition, although titles are managed by customer segments, decisions to abandon titles are made
on an individual title basis. Therefore, it is likely that individual magazine titles generate cash inflows
that are largely independent of each other and that each magazine title is a separate cash-
generating unit.

Q.NO.2. An asset does not meet the requirements of environment laws which have been
recently enacted. The asset has to be destroyed as per the law. The asset is carried in the Balance
Sheet at the year end at Rs. 6,00,000. The estimated cost of destroying the asset is Rs. 70,000.
How is the asset to be accounted for?
SOLUTION
As per AS 28 “Impairment of Assets”, impairment loss is the amount by which the carrying amount
of an asset exceeds its recoverable amount, where recoverable amount is the higher of an asset’s
net selling price and its value in use. In the given case, recoverable amount will be nil [higher of
value in use (nil) and net selling price (negative Rs. 70,000)]. Thus impairment loss will be calculated
as Rs. 6,00,000 [carrying amount (Rs. 6,00,000) – recoverable amount (nil)]. Therefore, asset is to be
fully impaired and impairment loss of Rs. 6,00,000 has to be recognized as an expense immediately
in the statement of Profit and Loss as per para 58 of AS 28.
Further, as per para 60 of AS 28, When the amount estimated for an impairment loss is greater than
381

the carrying amount of the asset to which it relates, an enterprise should recognise a liability if, and
only if, that is required by another Accounting Standard. Hence, the entity should recognize liability
Page

for cost of disposal of Rs. 70,000 as per AS 10 & 29.

CA CS KARTHIK MANIKONDA – 75501 37279

Q.NO.3. Venus Ltd. has a fixed asset, which is carried in the Balance Sheet on 31.3.20X1 at Rs.
500 lakhs. As at that date the value in use is Rs. 400 lakhs and the net selling price is Rs. 375 lakhs.
From the above data:
i. Calculate impairment loss.
ii. Prepare journal entries for adjustment of impairment loss.
iii. Show, how impairment loss will be shown in the Balance Sheet.
SOLUTION
i. Recoverable amount is higher of value in use Rs. 400 lakhs and net selling price Rs. 375 lakhs.
Recoverable amount = Rs. 400 lakhs
Impairment loss = Carried Amount – Recoverable amount
= Rs. 500 lakhs – Rs. 400 lakhs = Rs. 100 lakhs.
ii. Journal Entries
Particulars Dr. Amount Cr. Amount
( Rs. in lakhs) ( Rs. in lakhs)
i. Impairment loss account Dr. 100
To Provision for Accumulated 100
Impairment Loss Account 100
(Being the entry for accounting impairment loss)
ii. Profit and loss account Dr. 100
To Impairment loss 100 100
(Being the entry to transfer impairment loss to profit
and loss account)

iii. Balance Sheet of Venus Ltd. as on 31.3.20X1

(Rs. in lakhs)
Fixed Asset
Asset less depreciation 500
Less: Impairment loss (100)
400
382
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Q.NO.4. Good Drugs and Pharmaceuticals Ltd. acquired a sachet filling machine on 1st April,
20X1 for Rs.60 lakhs. The machine was expected to have a productive life of 6 years. At the end of
financial year 20X1-20X2 the carrying amount was Rs.41 lakhs. A short circuit occurred in this
financial year but luckily the machine did not get badly damaged and was still in working order at
the close of the financial year. The machine was expected to fetch Rs.36 lakhs, if sold in the
market. The machine by itself is not capable of generating cash flows. However, the smallest group
of assets comprising of this machine also, is capable of generating cash flows of Rs.54 crore per
annum and has a carrying amount of Rs.3.46 crore. All such machines put together could fetch a
sum of Rs.4.44 crore if disposed. Discuss the applicability of Impairment loss.
SOLUTION
As per provisions of AS 28 “Impairment of Assets”, impairment loss is not to be recognized for a
given asset if its cash generating unit (CGU) is not impaired. In the given question, the related cash
generating unit which is group of asset to which the damaged machine belongs is not impaired; and
the recoverable amount is more than the carrying amount of group of assets. Hence there is no need
to provide for impairment loss on the damaged sachet filling machine.

Q.NO.5. From the following details of an asset (i) Find out impairment loss (ii) Treatment of
impairment loss (iii) Current year depreciation Particulars of asset:
Cost of asset Rs. 56 lakhs
Useful life period 10 years
Salvage value Nil
Current carrying value Rs. 27.30 lakhs
Useful life remaining 3 years
Recoverable amount Rs. 12 lakhs
Upward revaluation done in last year Rs. 14 lakhs

SOLUTION
According to AS 28 “Impairment of Assets”, an impairment loss on a revalued asset is recognised as
an expense in the statement of profit and loss. However, an impairment loss on a revalued asset is
recognised directly against any revaluation surplus for the asset to the extent that the impairment
loss does not exceed the amount held in the revaluation surplus for that same asset.
383

Impairment Loss and its treatment Rs.

Current carrying amount (including revaluation amount of Rs.14 lakhs) 27,30,000
Page

CA CS KARTHIK MANIKONDA – 75501 37279

Less: Current recoverable amount (12,00,000)
Impairment Loss 15,30,000
Impairment loss charged to revaluation reserve 14,00,000
Impairment loss charged to profit and loss account 1,30,000
After the recognition of an impairment loss, the depreciation (amortization) charge for the asset
should be adjusted in future periods to allocate the asset’s revised carrying amount, less its residual
value (if any), on a systematic basis over its remaining useful life.
In the given case, the carrying amount of the asset will be reduced to Rs. 12,00,000 after
impairment. This amount is required to be depreciated over remaining useful life of 3 years
(including current year). Therefore, the depreciation for the current year will be Rs. 4,00,000.

Q.NO.6. A plant was acquired 15 years ago at a cost of Rs. 5 crores. Its accumulated depreciation
as at 31st March, 20X1 was Rs. 4.15 crores. Depreciation estimated for the financial year 20X1 -
20X2 is Rs. 25 lakhs. Estimated Net Selling Price as on 31st March, 20X1 was Rs. 30 lakhs, which is
expected to decline by 20 percent by the end of the next financial year. Its value in use has been
computed at Rs. 35 lakhs as on 1st April, 20X1, which is expected to decrease by 30 per cent by the
end of the financial year.
i. Assuming that other conditions for applicability of the impairment Accounting Standard are
satisfied, what should be the carrying amount of this plant as at 31st March, 20X2?
ii. How much will be the amount of write off for the financial year ended 31st March, 20X2?
iii. If the plant had been revalued ten years ago and the current revaluation reserves against this
plant were to be Rs. 12 lakhs, how would you answer to questions (i) and (ii) above?
iv. If the value in use was zero and the enterprise were required to incur a cost of Rs. 2 lakhs to
dispose of the plant, what would be your response to questions (i) and (ii) above?
SOLUTION
As per AS 28 “Impairment of Assets”, if the recoverable amount of an asset is less than its carrying
amount, the carrying amount of the asset should be reduced to its recoverable amount and that
reduction is an impairment loss. An impairment loss on a revalued asset is recognized as an expense
in the statement of profit and loss. However, an impairment loss on a revalued asset is recognised
directly against any revaluation surplus for the asset to the extent that the impairment loss does not
exceed the amount held in the revaluation surplus for that same asset.
384

In the given case, recoverable amount (higher of asset’s net selling price and value in use) will be
Rs.24.5 lakhs on 31.3.20X2 according to the provisions of AS 28 [Refer working note].
Page

CA CS KARTHIK MANIKONDA – 75501 37279

 (Rs. in lakhs)
i. Carrying amount of plant (after impairment) as on 31st March, 20X2 24.50
ii. Amount of write off (impairment loss) for the financial year ended 31st March,
20X2 [Rs. 60 lakhs – Rs. 24.5 lakhs] 35.50
iii. If the plant had been revalued ten years ago
Debit to revaluation reserve 12.00
Amount charged to profit and loss account 23.50
(Rs. 35.50 lakhs – Rs. 12 lakhs)
iv. If Value in use is zero
Value in use (a) Nil
Nil Net selling price (b) (-)2.00
Recoverable amount [higher of (a) and (b)] Nil
Carrying amount (closing book value) Nil
Amount of write off (impairment loss) (Rs. 60 lakhs – Nil) 60.00
Entire book value of plant will be written off and charged to profit and loss
account.
Working Note:
Calculation of Closing Book Value, Estimated Net Selling Value and Estimated Value in Use of Plant
at 31st March, 20X2
(Rs. in lakhs)
Opening book value as on 1.4.20X1 (Rs.500 lakhs – Rs.415 lakhs) 85
Less: Depreciation for financial year 20X1–20X2 (25)
Closing book value as on 31.3.20X2 60
Estimated net selling price as on 1.4.20X1 30
Less: Estimated decrease during the year (20% of Rs.30 lakhs) (6)
Estimated net selling price as on 31.3.20X2 24
Estimated value in use as on 1.4.20X1 35.0
Less: Estimated decrease during the year (30% of Rs.35 lakhs) (10.5)
Estimated value in use as on 31.3.20X2 24.5
385

THE END
Page

CA CS KARTHIK MANIKONDA – 75501 37279