Department of Business Management, S P College of Engineering, Visnagar

Subject: Accounting for Managers Module II: Accounting Standards notes

AS-1: DISCLOSURE OF ACCOUNTING POLICIES This standard deals with disclosure of significant accounting policies followed in the preparation and presentation of the financial statements and is mandatory in nature. The accounting policies refer to the specific accounting principles adopted by the enterprise. Proper disclosure would ensure meaningful comparison both inter/intra enterprise and also enable the users to properly appreciate the financial statements. Financial statements are intended to present a fair reflection of the financial position financial performance and cash flows of an enterprise. Areas involving different accounting policies by different enterprises are Methods of depreciation, depletion and amortization Treatment of expenditure during construction Treatment of foreign currency conversion/translation, Valuation of inventories Treatment of intangible assets Valuation of investments Treatment of retirement benefits Recognition of profit on long-term contracts Valuation of fixed assets Treatment of contingent liabilities

Factors governing the selection and application of accounting policies are: Prudence: Prudence means making of estimates, which is required under conditions of uncertainty. Profits are not anticipated till certain for realization, while provisions are made for all known liabilities ascertainable or based on estimates (e.g. warranty expenses). Substance over form: It means that transaction should be accounted for in accordance with actual happening and economic reality of the transactions, i.e. events governed by substance and not merely by the legal form Materiality: a) As to the disclosure of all material items, individually or in aggregate in the context of fair presentation of financial statements as a whole if its omission or misstatement could influence the economic or financial decision of the user relying upon the financial statements b) Depends on the size of the items or errors judged in the particular circumstances of its omissions or misstatements. c) Is a cut off point rather than being a primary qualitative characteristic which information must have. d) This is a matter of judgment, varies from one entity to another and over one period to another. AS-1 requires that all significant (i.e. only accounting policy that is useful for an understanding by the user of the financial statements) accounting policies adopted in the preparation and presentation of financial statements, should be disclosed by way of Note in one place as the note No I (this is the basis of the preparation of financial statements.)
1 Prof. Darshan Ranpura, dbm-spce, Visnagar

Department of Business Management, S P College of Engineering, Visnagar

Subject: Accounting for Managers Module II: Accounting Standards notes

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 the later period should be disclosed. In the case of a change in accounting policies, having 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 as ascertainable, otherwise the fact that the effect is not (wholly or partially) ascertainable, should be disclosed. PROBLEMS 1. The gross block of fixed assets are shown at the cost of acquisition, which includes tax, duties (net of MODVAT and set off availed) and other identified direct expenses. Interest on borrowing to finance the fixed assets is considered as revenue. Answer: The policy appears to be correct. AS-2: VALUATION OF INVENTORIES At the outset AS -2 excludes the following though appears to be inventory in common parlance: a) Work-in-progress in construction contract and directly related service contract (ref: AS- 2), inventories not forming part of construction work-in-progress will attract AS-2 b) Work-in-progress arising in the ordinary course of business of service providers Shares, debentures and other financial instruments held as stock-in-trade (ref: AS-13 as Current Investments) c) Livestock, agricultural and forest product, mineral oil/gasses as measured at net realizable value as per trade practices at certain stage of production. AS-2 covers inventories as an item of assets which are A] Held for sale in the ordinary course of business B] In the process of production for such sale C] In the form of material or supplies for the process of production or rendering of service Inventories are valued at lower of cost or net realizable value (NRV) a) Cost to include purchase price, conversion and other costs incurred in bringing the inventories to their present location and condition. An enterprise should use the same cost formula for all inventories having similar nature and use - specific cost, FIFO, weighted average, standard cost, adjusted selling price b) Net realizable value is the estimated selling price in the ordinary course of business reduced by the estimated cost to bring the item in saleable condition, considered on each balance sheet date, usually on item by item basis or under suitable group of similar or related item. Disclosure under AS-2
2 Prof. Darshan Ranpura, dbm-spce, Visnagar

Department of Business Management, S P College of Engineering, Visnagar

Subject: Accounting for Managers Module II: Accounting Standards notes

a) The accounting policy adopted in measuring inventories b) The cost formula used c) Carrying amount (value) of inventory commonly classified under Raw Material and Components, Work in Progress, Finished goods and Stores, Spares and Loose tools. d) Schedule-VI and AS-2 disclosure are at par PROBLEMS 1. Raw materials purchased at Rs.10 per kg. price of materials is on the decline. The finished goods in which the raw material is incorporated are expected to be sold at below cost. 1,000 kgs of raw material is in stock at the year-end. Replacement cost is Rs.8 per kg. How will you value the inventory? Answer: As per para 24 of AS-2, on valuation of inventories, material 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 or above cost. However, when there is a decline in the price of materials and it is estimated that the cost of the finished products will exceed net realizable value, the materials are written down to net realizable value. AS -6 (REVISED) DEPRECIATION ACCOUNTING Deprecation is a measure of the wearing out consumption or other loss of value of a depreciable asset due to use efflux of time or obsolescence through technology and market changes and also includes amortization of assets having predetermined life. Different accounting policies are followed by different enterprises; hence disclosure is necessary to appreciate the view presented in the financial statements. Depreciation has a significant effect in determining and presenting financial position and operating results. A depreciable asset must fulfil the following criteria: a) Expected to be used for more than one accounting period b) Limited useful life c) Held for use in the production or supply of goods and services, for rental, for administrative purposes, and not for sale in the ordinary course of business. Specific exclusions from the scope of AS-6: 1. Forest, plantation and similar regenerative resource 2. Wasting asset, expenditure or a exploration for and extraction of minerals, oils natural gas and similar non-regenerative resources. 3. R&D expenditure 4. Goodwill 5. Livestock Depreciation charge for a period is usually recognized as an expense unless included in carrying amount (e.g. depreciation of manufacturing plant is included in the cost of conversion of inventories or depreciation of assets used for development activities may be treated as an intangible assets or capital reduced)
3 Prof. Darshan Ranpura, dbm-spce, Visnagar

Department of Business Management, S P College of Engineering, Visnagar

Subject: Accounting for Managers Module II: Accounting Standards notes

Useful life is either: (a) the period over which a depreciable asset is expected to be used by the enterprise or (b) on the basis of production or similar units obtainable from the use of assets. A change in depreciation method will arise in the following situation: a) Adoption is required by the statute, or b) For compliance with the relevant AS, or c) It is considered that the change would result in more appropriate presentation of the financial statements When the change is adopted, the depreciation is reworked with reference to the date of the asset put to use by the enterprise, the deficiency/surplus is adjusted in the P/L A/c in the year of change given effect with appropriate disclosure since as per AS 6. This is considered as a change in the Accounting Policy. Change in depreciation method always applies retrospectively. AS-9 REVENUE RECOGNITION The statement covers the recognition of revenue arising in the course of ordinary activities. Of the enterprise from Sale of goods Rendering of service Outsourcing of resources yielding interest, royalties and dividend Specific exclusion from the standard pertains to: a. Construction contracts b. lease/hire purchase agreement c. govt. grants/subsidies d. Insurance contract of insurance companies

Essential criterion for recognition for revenue from ordinary activities as aforesaid is that the consideration is reasonably determinable even though the payments are made by instalments. In the event of uncertainty, the recognition is postponed and considered as revenue of the period in which it is properly recognized. The standard requires, in addition to the AS- I, that an enterprise should also disclose the circumstances in which revenue recognition has been postponed pending resolution of significant uncertainties. AS-10: ACCOUNTING FOR FIXED ASSETS Fixed assets for the purpose of the statement are those held by an enterprise with the intention of being used for the purpose of producing or providing goods or services and not held for sale in the normal course of business and applies to financial statements prepared on historical cost/substituted cost basis.

Prof. Darshan Ranpura, dbm-spce, Visnagar

Department of Business Management, S P College of Engineering, Visnagar

Subject: Accounting for Managers Module II: Accounting Standards notes

The following items need special consideration and normally not covered under this statement. Unless the expenditure on individual items are separable and identified. forest plantation and regenerative natural resources wasting assets and non-generative resources (mineral rights. exploration of mineral, oil and natural gas) expenditure on real estate development livestock

Apart from direct cost, all directly attributable cost to bring the asset concerned to their working condition for intended use also forms the part of fixed asset. Subsequent expenditure after the initial capitalization that increases the future benefits from the existing assets beyond the previously assessed standard of performance (e.g. increase in quality of output, substantial reduction in operating cost) is capitalized to form the gross book value. Financial statements are normally prepared on the basis of historical cost but sometimes a part or all of fixed assets, are restated (revalued) and substituted for historical cost. The commonly accepted and preferred method of restating is by appraisal by a competent valuer. As per Schedule VI, every B/S subsequent to revaluation shall disclose the increased figure with the date of increase in place of the original cost for the first 5(five) years, but the fact of such revaluation will continue to be disclosed till such time such assets appear in the B/S. Revaluation is made for an entire class of assets or the selection of assets on a systematic basis (fact of which should be appropriately stated). An increase in net book value arising on revaluation of fixed assets should be credited to Owners Fund under Revaluation Reserve unless the decrease on any previously revaluation recorded as a change in P/L A/c or Revaluation Reserve if increase in previous occasion was credited thereto. All material items retired from active use and not disposed off should be stated at the lower of net book value or net realizable value as a separate item in the Schedule of Fixed Assets. Depreciation as per AS-6 should be charged on the total value of fixed assets including revalued portion. Disclosure in addition to AS-1 and AS-6, should be made under AS-l0 in the following lines: Gross and net book value of fixed assets at the beginning and end of an accounting Period with additions, disposals, acquisitions and other movements. Expenditures incurred on account of fixed assets in the course of constructional acquisition Revalued amounts substituted for historical cost, the basis of selection for revaluation, The method adopted, the year of appraisal, involvement of external valuer. The revalued amounts of each class of fixed assets are presented in the B/S separately Without netting off the result of revaluation of various classes of fixed assets.

Prof. Darshan Ranpura, dbm-spce, Visnagar

Department of Business Management, S P College of Engineering, Visnagar

Subject: Accounting for Managers Module II: Accounting Standards notes

AS-13: ACCOUNTING FOR INVESTMENTS The Standard deals with accounting for investments in the financial statements of an enterprise and relevant disclosure requirement. Investments are assets held for earning income, capital appreciation or for other benefits to the investing enterprise, obviously investments held as stock-in-trade are not Investments. The following are outside the purview of AS-13: a. b. c. d. Recognition of income on investment as dealt with under AS-9 (Revenue Recognition) Operating or Finance Lease. Investment of retirement benefits plans and Life Insurance Enterprise. Mutual fund, Asset Management Companies, Banks, Public Financial Institution, enacted under specific Act/Companies Act, 1956.

Reasons, type, purposes etc varies widely and for this the standard is set to harmonize the accounting. Cost of investment, means and includes, a. Acquisition charges e.g. brokerage, fees, duties etc. b. If acquired by issue of shares/securities, the acquisition cost is the fair market value, may be with reference to issue price determined by statutory authorities. Fair market value may be determined with reference to market value or net realizable value (net of expenses to be incurred) or net of recovery of cost (dividend or interest accrued and included in the price of investments). Current investment/Short term investment: a. Readily realizable and not intended to be held for more than a year from date of investment. b. The carrying amount on the reporting date is taken at lower of cost or fair value to prudently account for the unrealized losses but not the unrealized gains, considering individual or category of investments (not on overall basis). c. Any reduction to the fair value and any reversal to such reduction is included in the P/ L Account. Long-term investment: a. Investments held otherwise even if readily marketable are long term investments b. Intended to protect, facilitate and furtherance to existing operation, also known as Trade investments (not meant to provide additional cash resources) c. Long-term investments are normally carried at cost unless there is a permanent diminution in the value when the same is recognized in the carrying amount by charging or reversing through P/L Account. d. The carrying amount is determined on individual investment basis. On disposal, the difference between the carrying amount and the net proceed of disposal is recognized in the P/L Account. Investment in Property is in Land or Building, not intended for occupation substantially for use by or in the operation of the Investing Enterprise, should be treated as long-term investment.
6 Prof. Darshan Ranpura, dbm-spce, Visnagar

Department of Business Management, S P College of Engineering, Visnagar

Subject: Accounting for Managers Module II: Accounting Standards notes

Reclassification of Investments: 1. Long term to current: Take lower of cost and carrying amount 2. Current to Long term: Take lower of cost and fair value AS 26: INTANGIBLE ASSETS An intangible asset is an identifiable non-monetary asset, without physical substance held for production or supply of goods and services for rental to others or for administrative purposes. AS-26: I. II. III. Prescribes the accounting treatment for intangible assets that are not specifically covered in other accounting standard; Recognizes an intangible asset on fulfilment of certain criteria; Deals with deferment of expenses except in a few specific instances.

AS-26 applies, among other things, to expenditure on advertisement, training, startup, R&D activities, Rights under Licensing Agreement for motion picture video recording, plays, manuscript, patents and copyrights, the criteria is that expenditure should provide future economic benefits to an enterprise. Sometimes, an asset may incorporate both tangible and intangible component and it is practically inseparable. Judgment is required to determine the applicability of AS-10 (fixed asset) and AS-26 (intangible asset). Example: I. II. Computer software which is integral part and without that the computer-controlled machine cannot operate - treated as fixed asset. Computer software, not an integral part of related hardware - treated as. an intangible asset,

Essential criteria for recognition of an intangible asset: a. identifiable:- It must be separate from goodwill and the enterprise could rem. sell: exchange or distribute the future economic benefits attributable to the asset without disposing of future economic benefits that flow from other assets in the same revenue earning activity - but goodwill cannot be meaningfully transferred to a new owner without also selling the other assets or the operation of the business. e.g. patents, copyrights, license, brand name, import quota, computer software, lease hold right, marketing rights, technical know-how etc. control:- The enterprise has the power to obtain the future economic benefits, flowing from the underlying resources and also can restrict the access of others I to those benefits (not necessarily legal right and may be in some other way I market and technical knowledge may give rise to future economic benefit). future economic benefits:- An enterprise should asses the probability of future economic benefits using reasonable and supportable assumptions that represent best estimate of the set of economic

b.

c.

Prof. Darshan Ranpura, dbm-spce, Visnagar

Department of Business Management, S P College of Engineering, Visnagar

Subject: Accounting for Managers Module II: Accounting Standards notes

d.

conditions that will exist over the useful life of the asset on the basis of weight age to external evidence available at the time of initial recognition.. Cost can be measured reliably :

The cost of an internally generated intangible asset comprises all expenditure that can be directly attributed or allocated on a reasonable and consistent basis for creating, producing and making the asset ready for its intended use, but in no case once treated as an expense, cannot be reversed for capitalization even if the essential criteria for recognition are complied with a later date. Normally the following costs are not recognized for internally generated intangible asset: Selling, administrative and other general overhead unless directly attributable. Clearly identified inefficiencies and initial operating loses incurred before an asset achieves planned performance. Expenditure on training the staff to operate the asset. Subsequent expenditure on an internally generated intangible asset after its purchase or completion is normally treated as expense unless it is assessed to generate future economic benefits over and above the originally assessed standard of performance or it can be measured and reliably attributed to the concerned intangible asset.

Prof. Darshan Ranpura, dbm-spce, Visnagar