Accounting Standards | CMA Inter Syllabus
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Accountancy is often referred to as an art of recording, classifying and summarizing financial information, which involves the use of accountant’s creative skills. However, if full independence is provided to the accountants regarding the accounting system and practices to be followed, it is bound to result in lack of uniformity, and in some cases may end up in manipulation of accounts. Thus, there arises a need for an accounting framework on the basis of which the financial transactions should be recorded in the books of accounts and ultimately make the resulting financial statements comparable. This need led to the framing of the Generally Accepted Accounting Principles (GAAP).
The main objective of accounting is to provide financial information to the stakeholders, thus helping them in taking informed decisions. This financial information is normally communicated via the financial statements, which happen to be the interface between an organisation and its stakeholders. The financial statements are prepared from the information contained in the books of accounts, which are based on certain Generally Accepted Accounting Principles (GAAP).
In simple terms, Generally Accepted Accounting Principles (GAAP) is a collection of commonly followed accounting rules and standards meant for accounting of transactions and ultimately their reporting. It is an embodiment of rules and standards which are accepted and practiced by the accountants. GAAP contains a set of accounting standards, principles, and procedures that accountants must follow. These are basic accounting principles and guidelines which provide the framework for more detailed and comprehensive accounting rules, standards and other industry-specific accounting practices.
Accounting Standards are written policy documents which discuss the aspects of recognition, measurement and treatment of specific accounting transactions, along with the presentation and disclosure thereof in the financial statements of an entity. These are usually issued by specified professional accounting bodies, or by the government, or other regulatory bodies. In India, accounting standards are governed by The Institute of Chartered Accountants of India (ICAI). In the US, the American Institute of Certified Public Accountants (AICPA) is responsible to lay down the standards. The Financial Accounting Standards Board (FASB) is the body that sets up the International Accounting Standards. These standards basically deal with accounting treatment of business transactions and disclosing the same in financial statements.
In India, the Accounting Standards for non-corporate entities including Small and Medium sized Enterprises, are issued by the Accounting Standards Board (ASB) of Institute of Chartered Accountants of India (ICAI), to establish uniform standards for preparation of financial statements, in accordance with the Indian GAAP (Generally Accepted Accounting Practices), for better understanding of the users. However, in the case of corporate entities, the Accounting Standards notified by the MCA are applicable. These standards are mandatory on and from the dates specified either in the respective document or as may be notified by the ICAI/ MCA.
It may be noted that MCA also issues the Accounting Standards for companies, based on recommendations made by the ICAI. Accordingly MCA notifies such Accounting Standards vide Companies (Accounting Standards) Rules and amendments thereto, applicable for companies including Small and Medium Sized Companies to whom Indian Accounting Standards (Ind AS) are not applicable.
In the context of financial accounting and reporting, convergence refers to the process of harmonising the accounting standards issued by various regulatory bodies of different countries of the world. It refers to the goal of establishing a single set of high quality accounting standard that will be used internationally , and in particular the effort to reduce differences between the local generally accepted accounting practice and International Financial Reporting Standards (IFRS). IFRS are a set of accounting standards developed by the International Accounting Standards Board (IASB). These are the global standards for the preparation of public company financial statements The objective of the convergence exercise is to produce a common set of high quality accounting standards to enhance the consistency, comparability and efficiency of financial statements.
There are two aspects to the concept of convergence of accounting standards:
In the Indian context, convergence means that the Indian Accounting Standards and the International Financial Reporting Standards would, over time, continue working together to develop high quality, compatible accounting standards. It would be worth noting here that conceptually ‘convergence of accounting standards’ is different from that of ‘adoption of accounting standards’ which means full-fledged use of IFRS as issued by the IASB by the Indian public companies.
The Indian Accounting Standards (Ind AS), as notified under section 133 of the Companies Act 2013, have been formulated keeping the Indian economic & legal environment in view and with a view to converge with IFRS Standards as issued by the IFRS Foundation.
Applicability and Scope of Ind AS
Ind AS are the Indian version of IFRS which are global standards governing the accounting aspects. These are basically standards that have been harmonised with the IFRS to make reporting by Indian companies more globally accessible. The Ministry of Corporate Affairs (MCA), in 2015, had notified the Companies (Indian Accounting Standards) Rules 2015, which stipulated the adoption and applicability of IND AS in a phased manner beginning from the Accounting period 2016-17. The MCA has since issued seven Amendment Rules, one each in year 2016, 2017, 2018, 2019, 2020, 2021 and 2022 to amend the original 2015 rules.
Following is the timeline of applicability of Ind AS:
A. For Companies other than the Banks, Non-banking Financial Companies, and Insurance Companies Phase-I
1. 1st April 2015 and onwards: Application on a voluntary basis for all the companies along with comparatives.
2. 1st April 2016: Mandatory for the following companies:
Phase-II: From 1st April 2017
● All the companies that are listed or in the process of listing in India or outside India that are not covered in Phase-I
● Unlisted companies with a net worth of ₹ 250 crores or above but less than ₹ 500 crores
● Holding, subsidiary, joint venture, and associate of the above companies
In this respect, the following points are to be noted:
● Companies that are listed on the SME exchange are not required to apply Ind AS on a mandatory basis
● Once the company starts to follow Ind AS, whether voluntarily or mandatorily, then it shall follow Ind AS for all the subsequent financial statements even though any of the criteria does not subsequently apply to it.
● The companies who satisfy the above criteria in an accounting year shall immediately apply the Ind AS in subsequent accounting year with comparatives. The Ind AS shall be applicable on both standalone and consolidated financial statements.
● The remaining companies not covered above shall continue to apply the existing Accounting Standards as notified in the Companies (Accounting Standards) Rules, 2006.
B. For Scheduled Commercial Banks (excluding Regional Rural Banks), Non-Banking Financial Companies, Insurers, and Insurance Companies
(1) Non-Banking Financial Companies (NBFCs)
Phase-I: From 1st April 2018:
Phase-II: From 1st April 2019
In this respect, the following points are to be noted:
The Ind AS shall be applied on both standalone and consolidated financial statements. Also, NBFCs with a net worth of less than ₹ 250 crores shall not apply Ind AS on a voluntary basis.
(2) Scheduled Commercial Banks (Excluding Regional Rural Banks)
Ind AS were required to be implemented by Scheduled Commercial Banks (excluding RRBs) from 1st April 2018. However, presently it stands deferred till further notice.
(3) Insurance Companies/Insurers
The insurance companies were required to prepare Ind AS based stand-alone and consolidated financial statements for FY 2018-19 with comparatives of FY 2017-18. The IRDA issued a circular under Section 34 of the Insurance Act, 1938, which mandates insurers to comply with Ind AS and its implementation Roadmap issued by the MCA.
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:
Fundamental Accounting Assumptions
Certain basic assumptions, in the preparation of financial statements are accepted and their use are assumed, no separate disclosure is required except for noncompliance in respect of —
Factors governing the selection and application of accounting policies are:
Prudence : Generally maker of financial statement has to face uncertainties at the time of preparation of financial statement. These uncertainties may be regarding collectability of receivables, number of warranty claims that may occur. Prudence means making of estimates, which is required under conditions of uncertainty.
Substance over form : It means that transaction should be accounted for in accordance with actual happening and economic relity of the transactions not by its legal form. Like in hire purchaser if the assets are purchased on hire purchase by the hire purchaser the assets are shown in the books of hire purchaser in spite of the fact that the hire purchaser is not the legal owner of the assets purchased. Under the purchase the purchaser, becomes the owner only on the payment of last instalment. Therefore the legal form of the transaction is ignored and the transaction is accounted as per as substance.
Materiality : Financial Statement should disclose all the items and facts which are sufficient enough to influence the decisions of reader or /user of financial statement.
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.)
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.
The following are not considered as changes in accounting policies :
Illustration 1
Jivandeep Ltd. had made a right issue in 2020. In the offer document to its members, it had projected a surplus of ₹ 40 crores during the accounting year to be ended on 31st March 2022. 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 ₹ 10 crores. The Board, in consultation with the Managing Director, decided on the following:
Solution:
According to AS 1: “in the case of a change in accounting policies which has a material effect in the current period should be disclosd, 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.” Naturally, the Notes on Accounts must disclose the change.
Notes on Accounts
Illustration 2
Which one is the correct one? Fundamental accounting assumptions as per AS 1 are:
(a) Going Concern, Matching and Consistency;
(b) Money Measurement, Going Concern and Prudence;
(c) Accounting Period, Going Concern and Entity Concept; and
(d) Going Concern, Consistency and Accruals.
Solution:
As per As 1, the fundamental accounting assumptions are: Going Concern, Consistency and Accruals.
Illustration 3
Explain, in short, the relevant Disclosures of Accounting Policies as per AS 1.
Solution:
As per AS 1, the Disclosures of Accounting Policies are: 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.
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 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.
If the fundamental accounting assumptions, viz, Going Concern, Consistency and Accruals, are followed in financial statements, specific disclosure is not required. If a fundamental accounting assumption is not followed, the fact should be disclosed.
Illustration 4
Explain the methods/criteria for the selection and application of Accounting Policies.
Solution:
The major considerations governing the selection and application of accounting policies are:
Prudence – Generally maker of financial statement has to face uncertainties at the time of preparation of financial statement. These uncertainties may be regarding collectability of recoverable, number of warranty claims that may occur. Prudence means making of estimates that are required under conditions of uncertainty.
Substance over form – It means that transaction should be accounted for in accordance with actual happening and economic reality of the transactions not by its legal form.
Materiality – Financial Statement should disclose all the items and facts which are sufficient enough to influence the decisions of reader or/ user of financial statement.
Objective
The objective of AS 10 is to prescribe the accounting treatment for property, plant and equipment so that users of the financial statements can discern information about investment made by an enterprise in its property, plant and equipment and the changes in such investment.
Scope
This Standard shall be applied in accounting for property, plant, and equipment except when another Standard requires or permits a different accounting treatment.
This Standard does not apply to:
However, this Standard applies to property, plant and equipment used to develop or maintain the assets described in (a) and (b) above.
Definitions
The following terms are used in this Standard with the meanings specified:
Agricultural Activity is the management by an enterprise of the biological transformation and harvest of biological assets for sale or for conversion into agricultural produce or into additional biological assets.
Agricultural Produce is the harvested product of biological assets of the enterprise.
Bearer plant is a plant that (a) is used in the production or supply of agricultural produce; (b) is expected to bear produce for more than a period of twelve months; and (c) has a remote likelihood of being sold as agricultural produce, except for incidental scrap sales.
Biological Asset is a living animal1 or plant.
Carrying amount is the amount at which an asset is recognised after deducting any accumulated depreciation and accumulated impairment losses.
Cost is the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction or, where applicable, the amount attributed to that asset when initially recognised in accordance with the specific requirements of other Accounting Standards.
Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value.
Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.
Enterprise-specific value is the present value of the cash flows an enterprise expects to arise from the continuing use of an asset and from its disposal at the end of its useful life or expects to incur when settling a liability.
Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction.
Gross carrying amount of an asset is its cost or other amount substituted for the cost in the books of account, without making any deduction for accumulated depreciation and accumulated impairment losses.
An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.
Property, plant and equipment are tangible items that:
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.
Useful life is:
Recognition
The cost of an item of property, plant and equipment should be recognised as an asset if, and only if:
An enterprise evaluates under this recognition principle all its costs on property, plant and equipment at the time they are incurred. These costs include costs incurred: (i) initially to acquire or construct an item of property, plant and equipment; and (ii) subsequently to add to, replace part of, or service it.
Measurement at Recognition
An item of property, plant and equipment that qualifies for recognition as an asset should be measured at its cost.
The cost of an item of property, plant and equipment comprises:
Examples of directly attributable costs are:
Examples of costs that are not costs of an item of property, plant and equipment are:
The cost of a self-constructed asset is determined using the same principles as for an acquired asset.
Bearer plants are accounted for in the same way as self-constructed items of property, plant and equipment before they are in the location and condition necessary to be capable of operating in the manner intended by management.
Measurement after Recognition
An enterprise should choose either the cost model or the revaluation model as its accounting policy and should apply that policy to an entire class of property, plant and equipment.
Cost Model : After recognition as an asset, an item of property, plant and equipment should be carried at its cost less any accumulated depreciation and any accumulated impairment losses.
Revaluation Model: After recognition as an asset, an item of property, plant and equipment whose fair value can be measured reliably should be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. 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. If an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs should be revalued.
An increase in the carrying amount of an asset arising on revaluation should be credited directly to owners’ interests under the heading of Revaluation Surplus. However, the increase should be recognised in the Statement of Profit and Loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in the Statement of Profit and Loss.
A decrease in the carrying amount of an asset arising on revaluation should be charged to the Statement of Profit and Loss. However, the decrease should be debited directly to owners’ interests under the heading of revaluation surplus to the extent of any credit balance existing in the Revaluation Surplus in respect of that asset.
Depreciation
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.
The 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.
Depreciable Amount and Depreciation Period
Depreciable amount of an asset should be allocated on a systematic basis over its useful life. The 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.
Depreciation Method
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 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, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies.
Changes in Existing Decommissioning, Restoration and Other Liabilities
The cost of property, plant and equipment 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 and included in the cost of the asset. Such changes in cost should be accounted for as under:
If the related asset is measured using the cost model:
If the related asset is measured using the revaluation model:
The adjusted depreciable amount of the asset is depreciated over its useful life. Therefore, once 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. This applies under both the cost model and the revaluation model.
Compensation for Impairment
Compensation from third parties for items of property, plant and equipment that were impaired, lost or given up should be included in the Statement of Profit and Loss when the compensation becomes receivable.
Retirements
Items of property, plant and equipment retired from active use and held for disposal should be stated at the lower of their carrying amount and net realisable value. Any write-down in this regard should be recognised immediately in the Statement of Profit and Loss.
Derecognition
The carrying amount of an item of property, plant and equipment should be derecognized:
Gain or loss arising from the derecognition: The gain or loss arising from the derecognition of an item of property, plant and equipment should be determined as the difference between the net disposal proceeds, if any, and the carrying amount of the item. Such gain or loss should be included in the Statement of Profit and Loss when the item is derecognised (unless AS 19, Leases, requires otherwise on a sale and leaseback). It is to be noted that such gains should not be classified as revenue as per AS 9, Revenue Recognition. However, an enterprise that in the course of its ordinary activities, routinely sells items of property, plant and equipment 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, Revenue Recognition.
Disclosure
The financial statements should disclose, for each class of property, plant and equipment:
the financial statements should also disclose:
If items of property, plant and equipment are stated at revalued amounts, the following should be disclosed:
Further, 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.
Transitional Provisions
Where an entity has in past recognized an expenditure in the Statement of Profit and Loss which is eligible to be included as a part of the cost of a project for construction of property, plant and equipment, it may do so retrospectively for such a project. The effect of such retrospective application of this requirement, should be recognised net-of-tax in revenue reserves.
The requirements regarding the initial measurement of an item of property, plant and equipment acquired in an exchange of assets transaction should be applied prospectively only to transactions entered into after this Standard becomes mandatory.
The requirements of this Standard concerning separate depreciation of parts of an item of property, plant and equipment and concerning capitalisation of cost of replacing such parts are applicable in respect of items of property, plant and equipment on the date this standard becomes mandatory. The effect of application of this requirement insofar as change in useful life of various parts is concerned, should be accounted for in accordance with the standard except that where a part does not have any remaining useful life, the carrying amount of the part, if any, should be recognised net-of-tax in the opening balance of revenue reserves.
On the date of this Standard becoming mandatory, the spare parts, which hitherto were being treated as inventory under AS 2, Valuation of Inventories, and are now required to be capitalised in accordance with the requirements of this Standard, should be capitalised at their respective carrying amounts. The spare parts so capitalised should be depreciated over their remaining useful lives prospectively as per the requirements of this Standard.
The requirements regarding the revaluation model should be applied prospectively. In case, on the date of this Standard becoming mandatory, an enterprise does not adopt the revaluation model as its accounting policy but the carrying amount of item(s) of property, plant and equipment reflects any previous revaluation it should adjust the amount outstanding in the revaluation reserve against the carrying amount of that item. However, the carrying amount of that item should never be less than residual value. Any excess of the amount outstanding as revaluation reserve over the carrying amount of that item should be adjusted in revenue reserves.
Comparative Provisions under Ind AS 16 and AS 10
Presently, in India, Indian Accounting Standard (Ind AS) 16 Property, Plant, and Equipment deal with this issue. Ind AS 16 differs from AS 10, with respect to the following points:
| Ind AS 16 | AS 10 |
| Does not exclude accounting for real estate developers | Excludes the accounting for real estate developers |
| Specific recognition criteria for recognition of fixed assets are laid out. | No recognition criteria for fixed assets are laid out. |
| Components approach is followed. | Does not require adoption of components approach. |
| Requires organisation to choose Cost model or Revaluation model | Recognises the revaluation of fixed assets |
| Change in method of depreciation is considered as a change in accounting estimate. | No specific guidance provided. |
| Does not deal with jointly owned assets. | Deals with fixed assets that are owned jointly with others. |
| Doesn’t deal with assets held for sale. | Deals with fixed assets that have been put up for sale and that have been retired from active use. |
| Additional costs incurred in construction of self-generated asset should not be considered. | No specific guidance provided. |
| Revaluation Surplus may be transferred to retained earnings on derecognition of asset. | Guidance note provides recycling to income statement in the ratio of additional depreciation. |
| Gain on derecognition should be considered as Revenue. | No specific guidance provided. |
| PPE acquired in exchange of non-monetary asset is recognised at fair value. | PPE acquired in exchange is to be recorded at net book value of asset given up. |
Illustration 5
Machineries which appeared in the books of Dee Ltd. at ₹ 86,00,000 has been revalued at ₹ 90,00,000. The accumulated depreciation associated was ₹ 28,00,000. The accountant suggested that revaluation should be accounted for by adjusting accumulated depreciation account. You are required to discuss the treatment as per AS 10
Solution:
The suggestion of the accountant of Dee Ltd. is incorrect. As per AS 10, when fixed assets are revalued upwards, the increase on account of revaluation should be credited to Revaluation Surplus Account.
Illustration 6
Jay Ltd., a chemical producing company changed a semi-automatic component in an existing machine with a fully-automatic component incurring ₹ 85,000. This new component would result in increasing the output by 150%. The component changing exercise required the company to dismantle a part of the machine and also re-erect the same for which the company incurred ₹ 38,000. How should the costs be treated as per AS 10?
Solution:
Cost of new component: As the new component results in increased output, it would result in increasing the future benefits from the machine. So, the cost incurred ₹ 85,000 should be capitalised.
Cost of dismantling and re-erection: ₹ 38,000 incurred towards dismantling and re-erection should be charged to the Statement of Profit and Loss.
This accounting standard deals with the reporting of foreign exchange transactions in the financial statements of an organisation.
Objective
An enterprise may carry on activities involving foreign exchange in two ways. Firstly, it may have transactions in foreign currencies, and secondly, it may have foreign operations. For these purposes, transactions must be expressed in the enterprise’s reporting currency and the financial statements of foreign operations must be translated into the enterprise’s reporting currency.
The principal issues in accounting for foreign currency transactions and foreign operations are to decide which exchange rate to use and how to recognise in the financial statements the financial effect of changes in exchange rates.
Scope
AS 11 deals with:
The standard however does not cover the following issues:
Definitions
The following terms are used in this Standard with the meanings specified:
Average rate is the mean of the exchange rates in force during a period.
Closing rate is the exchange rate at the balance sheet date.
Exchange difference is the difference resulting from reporting the same number of units of a foreign currency in the reporting currency at different exchange rates.
Exchange rate is the ratio for exchange of two currencies.
Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.
Foreign currency is a currency other than the reporting currency of an enterprise.
Foreign operation is a subsidiary , associate, joint venture or branch of the reporting enterprise, the activities of which are based or conducted in a country other than the country of the reporting enterprise.
Forward exchange contract means an agreement to exchange different currencies at a forward rate.
Forward rate is the specified exchange rate for exchange of two currencies at a specified future date.
Integral foreign operation is a foreign operation, the activities of which are an integral part of those of the reporting enterprise.
Monetary items are money held and assets and liabilities to be received or paid in fixed or determinable amounts of money. Cash, receivables, and payables are examples of monetary items.
Net investment in a non-integral foreign operation is the reporting enterprise’s share in the net assets of that operation.
Non-integral foreign operation is a foreign operation that is not an integral foreign operation.
Non-monetary items are assets and liabilities other than monetary items. Fixed assets, inventories, and investments in equity shares are examples of non-monetary items.
Reporting currency is the currency used in presenting the financial statements.
Foreign Currency Transactions
Meaning:
A foreign currency transaction is a transaction which is denominated in or requires settlement in a foreign currency, including transactions arising when an enterprise either:
Initial Recognition:
A foreign currency transaction should be recorded, on initial recognition in the reporting currency, by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction. For practical reasons, a rate that approximates the actual rate at the date of the transaction is often used. Eg: An average rate for a week or a month might be used for all transactions in each foreign currency occurring during that period.
Reporting at Subsequent Balance Sheet Dates:
At each balance sheet date:
Recognition of Exchange Differences
An exchange difference results when there is a change in the exchange rate between the transaction date and the date of settlement of any monetary items arising from a foreign currency transaction.
Exchange differences arising on the settlement of monetary items or on reporting an enterprise’s monetary items at rates different from those at which they were initially recorded during the period, or reported in previous financial statements, should be recognised as income or as expenses in the period in which they arise. However, exchange differences arising on a monetary item that, in substance, forms part of an enterprise’s net investment in a non-integral foreign operation should be accumulated in a Foreign Currency Translation Reserve in the enterprise’s financial statements until the disposal of the net investment, at which time they should be recognised as income or as expenses. Such monetary items may include long-term receivables or loans but do not include trade receivables or trade payables.
When the transaction is settled within the same accounting period as that in which it occurred, all the exchange difference is recognised in that period. However, when the transaction is settled in a subsequent accounting period, the exchange difference recognised in each intervening period up to the period of settlement is determined by the change in exchange rates during that period.
Translation of Financial Statements of Foreign Operations
Classification of Foreign Operations: Foreign operations are classified as either “integral foreign operations” or “non-integral foreign operations”. The method used to translate the financial statements of a foreign operation depends on the way in which it is financed and operates in relation to the reporting enterprise.
Integral foreign operations: A foreign operation that is integral to the operations of the reporting enterprise carries on its business as if it were an extension of the reporting enterprise’s operations. For example, such a foreign operation might only sell goods imported from the reporting enterprise and remit the proceeds to the reporting enterprise. In such cases, a change in the exchange rate between the reporting currency and the currency in the country of foreign operation has an almost immediate effect on the reporting enterprise’s cash flow from operations. Therefore, the change in the exchange rate affects the individual monetary items held by the foreign operation rather than the reporting enterprise’s net investment in that operation.
Non-integral foreign operations: A non-integral foreign operation accumulates cash and other monetary items, incurs expenses, generates income and arranges borrowings, all substantially in its local currency. It may also enter into transactions in foreign currencies, including transactions in the reporting currency. When there is a change in the exchange rate between the reporting currency and the local currency, there is little or no direct effect on the present and future cash flows from operations of either the non-integral foreign operation or the reporting enterprise. The change in the exchange rate affects the reporting enterprise’s net investment in the nonintegral foreign operation rather than the individual monetary and non-monetary items held by the non-integral foreign operation.
Factors indicating that a foreign operation is a non-integral foreign operation: The following are indications that a foreign operation is a non-integral foreign operation rather than an integral foreign operation:
Translation of financial statements of an integral foreign operation: As Integral foreign operation is an extension to the reporting entity’s business, there is a need to convert all the items of financial statements as if they are of the reporting entity. For converting financial statements of integral foreign operations, the rate should be taken as follows:
Translation of Financial Statements of Non-integral Foreign Operations
In translating the financial statements of a non-integral foreign operation for incorporation in its financial statements, the reporting enterprise should use the following procedures:
Disposal of a Non-integral Foreign Operation
An enterprise may dispose of its interest in a non-integral foreign operation through sale, liquidation, repayment of share capital, or abandonment of all, or part of, that operation. On the disposal of a non-integral foreign operation, the cumulative amount of the exchange differences which have been deferred and which relate to that operation should be recognised as income or as expenses.
Change in the Classification of a Foreign Operation
When there is a change in the classification of a foreign operation, the translation procedures applicable to the revised classification should be applied from the date of the change in the classification.
Forward Exchange Contracts
An enterprise may enter into a forward exchange contract or another financial instrument that is in substance a forward exchange contract, which is not intended for trading or speculation purposes, to establish the amount of the reporting currency required or available at the settlement date of a transaction. The premium or discount arising at the inception of such a forward exchange contract should be amortised as expense or income over the life of the contract. Exchange differences on such a contract should be recognised in the statement of profit and loss in the reporting period in which the exchange rates change. Any profit or loss arising on cancellation or renewal of such a forward exchange contract should be recognised as income or as expense for the period.
A gain or loss on a forward exchange contract to which paragraph 36 does not apply should be computed by multiplying the foreign currency amount of the forward exchange contract by the difference between the forward rate available at the reporting date for the remaining maturity of the contract and the contracted forward rate (or the forward rate last used to measure a gain or loss on that contract for an earlier period). The gain or loss so computed should be recognised in the statement of profit and loss for the period. The premium or discount on the forward exchange contract is not recognised separately.
Disclosure
An enterprise should disclose:
When the reporting currency is different from the currency of the country in which the enterprise is domiciled, the reason for using a different currency should be disclosed. The reason for any change in the reporting currency should also be disclosed.
When there is a change in the classification of a significant foreign operation, an enterprise should disclose:
Transitional Provisions
On the first time application of this Standard, if a foreign branch is classified as a non-integral foreign operation in accordance with the requirements of this Standard, the accounting treatment as prescribed in respect of change in the classification of a foreign operation should be applied.
Comparative Provisions between AS 11 and Ind AS 21
Presently, in India, Indian Accounting Standard (Ind AS) 21 The effect of changes in foreign exchange rates deal with the same issue. Ind AS 11 differs from AS 21, with respect to the following points:
| Ind AS 21 | AS 11 |
| Forward exchange contracts are not covered. | Forward exchange contracts are included within its scope. |
| Accounting of foreign operations is based on functional currency approach. | Accounting of foreign operations is based on integral and non-integral approach |
| No specific guidance provided | Option to recognise exchange difference arising on translation of certain long-term monetary items over the period is available. |
| Presentation currency could be different from the local currency. | No such specification provided. |
Illustration 7
During the financial year 2021-22, Zeds Ltd., an e-commerce firm entered into a foreign currency transaction relating to fees for technical services paid to a Lucas Ltd., an Atlanta based organisation in the USA. The transaction was for $24,000, which was entered into on 07.12.2021. The payment for the same was made on 20.05.2022. Given that the exchange rates are: on 07.12.2021: $1 = ₹ 68.80; on 01.01.2021: $1 = ₹ 68.95; on 31.03.2022: $1 = ₹ 70.45; on 20.05.2022: $1 = ₹ 71.50.
You are required to:
(a) ascertain the amount at which the transaction would get recognised in the books; and
(b) calculate amount of foreign exchange gain/ loss to be recorded in the financial statement for the years 2021-22 and 2022-23.
Solution:
(a) As per AS 11, a foreign currency transaction should be recorded, on initial recognition in the reporting currency, by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction.
⸫ Fees for technical services $24,000 would be recorded on 07.12.2021 applying the exchange rate existing on that date = 24,000 × ₹ 68.80 = ₹ 16,51,200.
(b) For 2021-22:
On 31.03.2022, Outstanding fess for technical services should be reflected in the balance sheet using the closing rate ($1 = ₹ 70.45) i.e. 24,000 × ₹ 70.45 = ₹ 16,90,800.
⸫ Exchange loss to be charged to the Statement of Profit and Loss = ₹ (16,90,800 – 16,51,200) = ₹ 39,600.
For 2022-23:
On 20.05.2022, Outstanding fess for technical services paid should be recognised using the existing rate ($1
= ₹ 71.50) i.e. 24,000 × ₹ 71.50 = ₹ 17,16,000.
⸫ Exchange loss on settlement to be charged to the Statement of Profit and Loss = ₹ (17,16,000 – 16,90,800)
= ₹ 25,200.
Illustration 8
Subhash Ltd. purchased a machine costing ₹ 216 lakhs on 1.4.2021 and the same was fully financed by foreign currency loan (US $) payable in three annual equal instalments. Exchange rates were $1 = ₹ 67.50 and ₹70.45 as on 1.4.2021 and 31.03.2022 respectively. First instalment was paid on 31.03.2022. The entire difference in foreign exchange has been capitalized. Advice how the exchange gain/ loss should be accounted for by the company.
Solution:
Cost of machine (in US$) = ₹ 216,00,000/ 67.50 = $3,20,000.
⸫ Exchange loss on payment of first instalment = 3,20,000 × ₹ (70.45 – 67.50) = ₹ 9,44,000.
This entire loss due to exchange differences amounting ₹ 9,44,000 should be charged to the Statement of Profit and Loss.
Governments across the world provide different forms of incentives and grants to various organisations which undertake activities that are of importance to the country. The grants received from the government are in various forms such as subsidy, incentives, duty drawbacks among others. Accounting Standard 12 deals with accounting for government grants.
However, this Standard does not deal with:
Definitions
The following terms are used in this Standard with the meanings specified:
Government refers to government, government agencies and similar bodies whether local, national or international.
Government grants are assistance by government in cash or kind to an enterprise for past or future compliance with certain conditions. They exclude those forms of government assistance which cannot reasonably have a value placed upon them and transactions with government which cannot be distinguished from the normal trading transactions of the enterprise.
Recognition
Government grants should not be recognised until there is reasonable assurance that:
Mere receipt of a grant is not necessarily a conclusive evidence that conditions attaching to the grant have been or will be fulfilled.
Methods of accounting for Government Grants
There are two broad approaches which can be adopted for the accounting treatment of government grants. They are:
1. Capital approach; and
2. Income approach.
It is generally considered appropriate that accounting for government grant should be based on the nature of the relevant grant. Grants which have the characteristics similar to those of promoters’ contribution should be treated under Capital approach, whereas Income approach is considered more appropriate in the case of other grants.
Capital approach: Under this approach, a grant is treated as part of shareholders’ funds. This approach is followed because many government grants are in the nature of promoters’ contribution, i.e., they are given with reference to the total investment in an undertaking or by way of contribution towards its total capital outlay and no repayment is ordinarily expected in the case of such grants. These are credited directly to shareholders’ funds.
Income approach: Under this approach, a grant is considered to be an item of income over one or more periods. This approach is followed when the government grants are not gratuitous in nature. The enterprise earns them through compliance with their conditions and meeting the envisaged obligations. They should therefore be taken to income and matched with the associated costs which the grant is intended to compensate.
Non-monetary Government Grants
Government grants may take the form of non-monetary assets, such as land or other resources, given at concessional rates. In these circumstances, it is usual to account for such assets at their acquisition cost. Nonmonetary assets given free of cost are to be recorded at a nominal value.
Presentation of Government Grants in Financial Statements
Presentation of Grants Related to Specific Fixed Assets:
The primary condition of government grants related to specific fixed assets is that an enterprise qualifying for them should purchase, construct or otherwise acquire such assets. Other conditions may also be attached restricting the type or location of the assets or the periods during which they are to be acquired or held.
Two methods of presentation of grants (or the appropriate portions of grants) related to specific fixed assets are regarded as acceptable alternatives:
First method: The grant is shown as a deduction from the gross value of the asset concerned in arriving at its book value. The grant is thus recognised in the profit and loss statement over the useful life of a depreciable asset by way of a reduced depreciation. Where the whole, or virtually the whole, of the cost of the asset, the asset is shown in the balance sheet at a nominal value.
Second method: Grants related to depreciable assets are treated as deferred income which is recognised in the profit and loss statement on a systematic and rational basis over the useful life of the asset. Such allocation to income is usually made over the periods and in the proportions in which depreciation on related assets is charged.
Grants related to non-depreciable assets are credited to capital reserve as there is usually no charge to income in respect of such assets. However, if a grant related to a non-depreciable asset requires the fulfillment of certain obligations, the grant is credited to income over the same period over which the cost of meeting such obligations is charged to income. The deferred income is suitably disclosed in the balance sheet pending its apportionment to profit and loss account. For example, in the case of a company, it is shown after ‘Reserves and Surplus’ but before ‘Secured Loans’.
Presentation of Grants Related to Revenue: Grants related to revenue are sometimes presented as a credit in the profit and loss statement, either separately or under a general heading such as ‘Other Income’. Alternatively, they are deducted in reporting the related expense.
Presentation of Grants of the nature of Promoters’ contribution: Where the government grants are of the nature of promoters’ contribution, and no repayment is ordinarily expected in respect thereof, the grants are treated as capital reserve which can be neither distributed as dividend nor considered as deferred income.
Refund of Government Grants Government grants sometimes become refundable because certain conditions do not get fulfilled. A government grant that becomes refundable is treated as an extraordinary item (and treated accordingly as per AS 5).
Treatment of refund of government grant depends on the nature of grant recvd. These are discussed hereunder:
Refund of government grant is in the nature of promoters’ contribution: The amount refundable, in part or in full, to the government on non-fulfillment of some specified conditions, the relevant amount recoverable by the government is reduced from the capital reserve.
Refund of government grant is related to revenue: The amount refundable is applied first against any unamortised deferred credit remaining in respect of the grant. To the extent that the amount refundable exceeds any such deferred credit, or where no deferred credit exists, the amount is charged immediately to profit and loss statement.
Refund of government grant is related to specific fixed asset: The amount refundable is recorded by increasing the book value of the asset or by reducing the capital reserve or the deferred income balance, as appropriate, by the amount refundable. In case the book value of the asset is increased, depreciation is provided on the revised book value.
Disclosure
The following should be disclosed:
Comparative Provisions under Ind AS 20 and AS 12
Presently, in India, Indian Accounting Standard (Ind AS) 20 Accounting for Government Grants and Disclosure of Government Assistance deal with the issue of government grants. Ind AS 20 differs from AS 12, with respect to the following points:
| Ind AS 20 | AS 12 |
| Disclosure required in financial statements with indication on other forms of government assistance received | No specific guidance as does not deal with other forms of government assistance |
| Government grants in the nature of capital contribution are not recognized | Government grants as capital contribution are specifically recognize |
| Prohibition of recognition of grants directly to the shareholder’s fund | Grants for non-depreciable assets are required to be shown as a capital reserve under shareholder’s funds |
| Recognition of non-monetary grants at fair value | Recognition of non-monetary grants at acquisition cost or nominal value |
| No option to deduct the amount of grant from the book value of the asset | Optional to deduct the amount of grant from the book value of the asset. |
Illustration 9
Dee Ltd. received ₹ 80,00,000 from the Central Government as subsidy for setting up a factory in a backward area. How would you treat the transaction in the financial statement of the company?
Solution:
When government grants are in the nature of promoters’ contribution, i.e., they are given with reference to the total investment in an undertaking or by way of contribution towards its total capital outlay and no repayment is ordinarily expected in the case of such grants. These are credited directly to shareholders’ funds. So, Dee Ltd. should credit the amount of ₹ 80,00,000 to capital reserve and the same would get reflected in the Balance Sheet.
Illustration 10
Big Box Ltd., a start-up purchased on April 1, 2020, a machine worth ₹ 44,85,000 in relation to which it received ₹ 7,35,000 as grant from Government of India. The company decided to treat this grant as a capital receipt. It is estimated that the realizable value of the machine at the end of its useful life of 4 years will be ₹ 15,36,000. During the financial year 2022-23, the grant became refundable as the start-up company failed to comply with the necessary terms and conditions of the grant.
You are required to calculate the amount of depreciation that is to be charged to the statement of profit and loss for the years 2022-23 and 2023-24 given that the company follows straight line method of charging depreciation.
Solution:
As per AS 12, the amount refundable in respect of government grant is related to specific fixed asset is recorded by increasing the book value of the asset or by reducing the capital reserve or the deferred income balance, as appropriate, by the amount refundable. In case the book value of the asset is increased, depreciation is provided on the revised book value.
Calculation of Depreciation for the years 2022-23 and 2023-24
₹ ’000
| Cost of machine on 01.01.2020 | 4,485 |
| Less: Grant from Government of India | 735 |
| Net cost of machine | 3,750 |
| Estimated useful life | 4 years |
| Depreciation p.a. under straight line method [(3,750 - 1,536) / 4] | 553.5 |
| Depreciation charged during 2020-21 and 2021-22 [553.5 × 2] | 1,107 |
| Book value of machine on 01.04.2022 [3,750 – 1,107] | 2,643 |
| Add: Refund of government grant during 2022-23 | 735 |
| Revised Book value of machine | 3,378 |
| Remaining useful life of machine | 2 years |
| Revised depreciation p.a. [(3,378 - 1,536) / 2] | 921 |
An entity shall apply this Standard in accounting for borrowing costs. The Standard does not deal with the actual or imputed cost of equity, including preferred capital not classified as a liability. Further, an entity is not required to apply the Standard to borrowing costs directly attributable to the acquisition, construction or production of:
Definitions
This Standard uses the following terms with the meanings specified:
Borrowing costs are interest and other costs that an entity incurs in connection with the borrowing of funds.
A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.
‘Substantial Period of time’ w.r.t Qualifying Asset
What constitutes a substantial period of time primarily depends on the facts and circumstances of each case. 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 facts and circumstances of the case. In estimating the period, time which an asset takes, technologically and commercially, to get it ready for its intended use or sale is considered.
Examples of Qualifying Assets
Qualifying assets include manufacturing plants, power generation facilities, inventories that require a substantial period of time to bring them to a saleable condition, and investment 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.
Inclusions in Borrowing Costs
Borrowing costs may include:
Borrowing Cost and Exchange differences arising from Foreign Currency Borrowings
Exchange differences arising from foreign currency borrowings and considered as borrowing costs are those exchange differences which arise on the amount of principal of the foreign currency borrowings to the extent of the difference between interest on local currency borrowings and interest on foreign currency borrowings. Thus, the amount of exchange difference not exceeding the difference between interest on local currency borrowings and interest on foreign currency borrowings is considered as borrowings costs to be accounted for under this Standard and the remaining exchange difference, if any, is accounted for under AS 11, The Effects 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.
Recognition of Borrowing Costs
The borrowing costs 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. Such borrowing costs should be capitalised as part of the cost of that asset. The amount of borrowing costs eligible for capitalisation should be determined in accordance with this Standard.
Other borrowing costs should be recognised as an expense in the period in which they are incurred.
Capitalisation of Borrowing Costs
Borrowing costs are capitalised as part of the cost of a qualifying asset when it is probable that they will result in future economic benefits to the enterprise and the costs can be measured reliably. For the purpose of capitalisation, borrowings can be considered to be of two broad types:
Commencement, Suspension and Cessation of capitalisation of Borrowing Costs
As per AS – 16, there are three situations arise in relation to capitalization of borrowing costs – Commencement of Capitalisation of Borrowing Costs, Suspension of Capitalisation of Borrowing Costs, and Cessation of Capitalisation of Borrowing Costs. These are discussed hereunder:
Commencement of capitalisation of Borrowing Costs
The capitalisation of borrowing costs as part of the cost of a qualifying asset should commence when all the following conditions are satisfied:
Suspension of capitalisation of Borrowing Costs
Capitalisation of borrowing costs should be suspended during extended periods in which active development is interrupted. However, 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. Borrowing cost which are related to the suspension period should be treated as an expense and transferred to P/L A/c.
Cessation of capitalisation of Borrowing Costs
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. 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.
Disclosure
The financial statements should disclose:
Comparative Provisions under Ind AS 23 and AS 16
Presently, in India, Indian Accounting Standard (Ind AS) 23 Borrowing Costs deal with this issue. Ind AS 23 differs from AS 16, with respect to the following points:
| Ind AS 23 | AS 16 |
| Qualifying Assets will never Include Biological Assets. | Qualifying Assets may Include Biological Assets. |
| No specific definition and explanation on the understanding of substantial period of time has been provided; rather, it is a matter of judgement. | Specific definition and explanation on the understanding of substantial period of time is provided. |
| Inventories which are produced in large quantities should not be considered as Qualifying Assets. It implies that Inventories which are produced in lower quantity only can be considered as Qualifying assets. | Inventories may be considered as Qualifying assets if condition of substantial period is satisfied. |
| interest expense which is capitalized or not capitalized during the period should be disclosed separately. | Disclosure is required to be made only if capitalization of borrowing cost has been made during the period. |
| Borrowing costs in hyper-inflationary situation is addressed. If interest cost increase due to hyper inflationary situation then the increase in Interest cost should be written off in income statement. | Inflation in interest rate is not addressed. |
| Weighted Average capitalisation rate on borrowings should be disclosed in Notes to accounts. | No specific guidance provided. |
| In consolidated financial statements, weighted average capitalisation rate on total borrowing of Holding & subsidiaries is to be considered. | No specific guidance provided. |
Illustration 11
T&L Ltd. is a large construction company which is presently involved in the construction of a railway bridge over the Ganga river at Patna. The project cost is ₹ 125 crores, 40% of which is financed by borrowing from Asian Development Bank at an interest of 3%. There has been a delay in the completion of the project, and the project manager of the railway bridge construction site has identified that delay construction of the railway bridge has happened due to high water levels during the monsoon months of July to September. Ms. Sonali Mathur, the accountant of T&L Co. has not suspended the capitalisation of the borrowing cost and reflected the same in the cost of the qualifying asset.
You are required to comment on the treatment
Solution:
In this case, the work got suspended due to temporary delay which is a necessary part of the construction process. Capitalisation of borrowing cost would continue during the extended period during which high water levels delay construction of the railway bridge, as such high water levels are common during the monsoon period in the geographic region involved.
So, the treatment done by Ms. Mathur, the company accountant is correct.
Illustration 12
On 14.08.2021, Pushkar Ltd. obtained a loan from RBC Bank of ₹ 65 lakhs to be utilised as under:
Purchase of equipment: ₹ 19,50,000;
Construction of factory shed: ₹ 26,00,000;
Advance for purchase of delivery vehicle: ₹ 6,50,000;
Working capital: ₹ 13,00,000.
In March, 2022 installation of the machinery was completed and also construction of factory shed was completed and the machinery installed. However, the truck was not delivered within 31.03.2022. Total interest charged by the bank for the year ending 31.3.2004 was ₹ 11.70 lakhs. Discuss how the interest amount would be treated in the financial statements of the company as per AS 16.
Solution:
In this case, only the factory shed is a Qualifying Asset (QA) as per AS 16. The amount of interest on borrowings and its treatment is presented below:
| Particulars | Nature of asset |
Interest capitalised |
Interest charged to Income Statement |
| Purchase of equipment | Not a QA | 3,51,000 [11.7 × 19.5/65] |
|
| Construction of factory shed | QA | 4,68,000 [11.7 × 26/65] |
|
| Advance for purchase of delivery vehicle | Not a QA | 1,17,000 [11.7 × 6.5/65] |
|
| Working capital | Not a QA | 2,34,000 [11.7 × 13/65] |
|
| Total | 4,68,000 | 7,02,000 |
The operating results ascertained by drafting financial statements seldom match with the taxable profits. It would not be prudent to ignore this difference between the two profits. AS 22 Accounting for Taxes on Income governs the accounting for such differences. The objective of this Standard is to prescribe accounting treatment for matching the differences between accounting income and taxable income.
Scope
This Standard should be applied in accounting for taxes on income. This includes the determination of the amount of the expense or saving related to taxes on income in respect of an accounting period and the disclosure of such an amount in the financial statements. For the purposes of this Standard, income taxes include all domestic and foreign taxes which are based on taxable profits. Income taxes also include taxes, such as withholding taxes, which are payable by a subsidiary, associate or joint arrangement on distributions to the reporting entity. However, AS 22 does not specify when, or how, an enterprise should account for taxes that are payable on distribution of dividends and other distributions made by the enterprise.
Definitions
The following terms are used in this Standard with the meanings specified:
Accounting income (loss) is the net profit or loss for a period, as reported in the statement of profit and loss, before deducting income tax expense or adding income tax saving.
Taxable income (tax loss) is the amount of the income (loss) for a period, determined in accordance with the tax laws, based upon which income tax payable (recoverable) is determined.
Tax expense (tax saving) is the aggregate of current tax and deferred tax charged or credited to the statement of profit and loss for the period.
Current tax is the amount of income tax determined to be payable (recoverable) in respect of the taxable income (tax loss) for a period.
Deferred tax is the tax effect of timing differences.
Timing differences are the differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods.
Permanent differences are the differences between taxable income and accounting income for a period that originate in one period and do not reverse subsequently.
Timing differences
Timing differences arise because the period in which some items of revenue and expenses are included in taxable income do not coincide with the period in which such items of revenue and expenses are included or considered in arriving at accounting income.
Example 1: A machinery purchased for scientific research related to business is fully allowed as deduction in the first year for tax purposes whereas the same would be charged to the statement of profit and loss as depreciation over its useful life. The total depreciation charged on the machinery for accounting purposes and the amount allowed as deduction for tax purposes will ultimately be the same, but periods over which the depreciation is charged and the deduction is allowed will differ.
Example 2: For the purpose of computing taxable income, tax laws allow depreciation on the basis of the written down value method, whereas for accounting purposes, straight line method is used.
Example 3: Unabsorbed depreciation and carry forward of losses which can be set-off against future taxable income are also considered as timing differences.
Recognition
Tax expense for the period, comprising current tax and deferred tax, should be included in the determination of the net profit or loss for the period. Taxes on income are considered to be an expense incurred by the enterprise in earning income and are accrued in the same period as the revenue and expenses to which they relate. Such matching may result into timing differences.
The tax effects of timing differences are included in the tax expense in the statement of profit and loss and as deferred tax assets (subject to the consideration of prudence) or as deferred tax liabilities, in the balance sheet. Permanent differences do not result in deferred tax assets or deferred tax liabilities. Deferred tax should be recognised for all the timing differences, subject to the consideration of prudence in respect of deferred tax assets.
The deferred tax in respect of timing differences which reverse during the tax holiday period is not recognised to the extent the enterprise’s gross total income is subject to the deduction during the tax holiday period. Deferred tax in respect of timing differences which reverse after the tax holiday period is recognised in the year in which the timing differences originate. For the above purposes, the timing differences which originate first are considered to reverse first.
Recognition of Deferred Tax Assets
This Standard requires recognition of deferred tax for all the timing differences. This is based on the principle that the financial statements for a period should recognise the tax effect, whether current or deferred, of all the transactions occurring in that period. Deferred tax assets should be recognised and carried forward only to the extent that there is a reasonable certainty that sufficient future taxable income will be available against which such deferred tax assets can be realised. Where an enterprise has unabsorbed depreciation or carry forward of losses under tax laws, deferred tax assets should be recognised only to the extent that there is virtual certainty supported by convincing evidence that sufficient future taxable income will be available against which such deferred tax assets can be realised. Determination of virtual certainty that sufficient future taxable income will be available is a matter of judgement based on convincing evidence and will have to be evaluated on a case to case basis. Virtual certainty refers to the extent of certainty, which, for all practical purposes, can be considered certain. Virtual certainty cannot be based merely on forecasts of performance such as business plans. Virtual certainty is not a matter of perception and is to be supported by convincing evidence. Evidence is a matter of fact. To be convincing, the evidence should be available at the reporting date in a concrete form, for example, a profitable binding export order, cancellation of which will result in payment of heavy damages by the defaulting party. On the other hand, a projection of the future profits made by an enterprise based on the future capital expenditures or future restructuring etc., submitted even to an outside agency, e.g., to a credit agency for obtaining loans and accepted by that agency cannot, in isolation, be considered as convincing evidence.
Where an enterprise’s statement of profit and loss includes an item of ‘loss’which can be set-off in future for taxation purposes, only against the income arising under the head ‘Capital gains’ as per the requirements of the Act, that item is a timing difference to the extent it is not set-off in the current year and is allowed to be set-off against the income arising under the head ‘Capital gains’ in subsequent years subject to the provisions of the Act. In respect of such ‘loss’, deferred tax asset is recognised and carried forward subject to the consideration of prudence. Accordingly, in respect of such ‘loss’, deferred tax asset is recognised and carried forward only to the extent that there is a virtual certainty, supported by convincing evidence, that sufficient future taxable income will be available under the head ‘Capital gains’ against which the loss can be set-off as per the provisions of the Act. Whether the test of virtual certainty is fulfilled or not would depend on the facts and circumstances of each case. The examples of situations in which the test of virtual certainty, supported by convincing evidence, for the purposes of the recognition of deferred tax asset in respect of loss arising under the head ‘Capital gains’ is normally fulfilled, are sale of an asset giving rise to capital gain (eligible to set-off the capital loss as per the provisions of the Act) after the balance sheet date but before the financial statements are approved, and binding sale agreement which will give rise to capital gain (eligible to set-off the capital loss as per the provisions of the Act).
Re-assessment of Unrecognised Deferred Tax Assets
At each balance sheet date, an enterprise should re-assess the unrecognised deferred tax assets. The enterprise should recognise previously unrecognised deferred tax assets to the extent that it has become reasonably certain or virtually certain that sufficient future taxable income will be available against which such deferred tax assets can be realised.
Measurement
Current tax should be measured at the amount expected to be paid to (recovered from) the taxation authorities, using the applicable tax rates and tax laws. Deferred tax assets and liabilities should be measured using the tax rates and tax laws that have been enacted or substantively enacted by the balance sheet date. When different tax rates apply to different levels of taxable income, deferred tax assets and liabilities are measured using average rates. Deferred tax assets and liabilities should not be discounted to their present value.
Review of Deferred Tax Assets
The carrying amount of deferred tax assets should be reviewed at each balance sheet date. An enterprise should write-down the carrying amount of a deferred tax asset to the extent that it is no longer reasonably certain or virtually certain that sufficient future taxable income will be available against which deferred tax asset can be realised. Any such write-down may be reversed to the extent that it becomes reasonably certain or virtually certain that sufficient future taxable income will be available.
Presentation and Disclosure
Offsetting Current Tax: An enterprise should offset assets and liabilities representing current tax if the enterprise:
Offsetting Deferred Tax: An enterprise should offset deferred tax assets and deferred tax liabilities if:
Deferred tax assets and liabilities should be distinguished from assets and liabilities representing current tax for the period.
Deferred tax assets and liabilities should be disclosed under a separate heading in the balance sheet of the enterprise, separately from current assets and current liabilities. Deferred tax assets (net of the deferred tax liabilities, if any) is disclosed on the face of the balance sheet separately after the head ‘Investments’, while deferred tax liabilities (net of the deferred tax assets, if any) is disclosed on the face of the balance sheet separately after the head ‘Unsecured Loans’. The break-up of deferred tax assets and deferred tax liabilities into major components of the respective balances should be disclosed in the notes to accounts. Further, the nature of the evidence supporting the recognition of deferred tax assets should be disclosed, if an enterprise has unabsorbed depreciation or carry forward of losses under tax laws.
Transitional Provisions Accounting for Taxes on Income
On the first occasion that the taxes on income are accounted for in accordance with this Standard, the enterprise should recognise, in the financial statements, the deferred tax balance that has accumulated prior to the adoption of this Standard as deferred tax asset/liability with a corresponding credit/charge to the revenue reserves, subject to the consideration of prudence in case of deferred tax assets (see paragraphs 15-18). The amount so credited/ charged to the revenue reserves should be the same as that which would have resulted if this Standard had been in effect from the beginning.
Comparative Provisions between AS 22 and Ind AS 12
Presently, in India, Indian Accounting Standard (Ind AS) 12 Income Taxes deal with the same issue. Ind AS 12 differs from AS 22, with respect to the following points:
| Ind AS 12 | AS 22 |
| Based on Balance Sheet approach. | Based on Income Statement approach |
| Recognition is done based on difference between carrying amounts of assets and liabilities and their tax base | Recognises the difference between taxable income and accounting income. |
| Applies to two types of differences - Timing Differences and Permanent Differences. | Applies to two types of differences - Taxable Temporary Differences and Deductible Temporary Differences. This standard does not address Permanent ifferences. |
| Deductible temporary differences are recognised to the extent that future periods are likely to provide taxable earnings. | Deferred taxes are recognised only when and to the degree that there is a reasonable certainty of its realisation |
| No concept of virtual certainty | When a corporation has unabsorbed depreciation or losses carried forward, the deferred tax asset should be to the degree that there is a virtual certainty backed up by convincing evidence. |
| Current and deferred tax is recognised on income statement, except for tax that arises from transactions done in Other Comprehensive Income or directly in equity. | No specific guidance provided. |
| The disparity between carrying the amount of a revalued asset and its tax base is dealt with. | The disparity between carrying the amount of a revalued asset and its tax base is not covered. |
| No specific guidance provided regarding Minimum Alternate Tax u/s 115JB. | Specific guidance provided regarding tax rates for deferred tax assets/ liabilities Minimum Alternate Tax u/s 115JB. |
| No specific guidance provided on deferred tax for tax holiday situations and capital gain cases | Specific guidance provided on deferred tax for tax holiday situations and capital gain cases. |
Illustration 13
Classify the following as Timing Difference and Permanent Difference and also state whether they would result in Deferred Tax Asset or Deferred Tax Liability:
(a) Unabsorbed depreciation
(b) Income tax penalty
(c) Interest on loan taken from scheduled bank accounted in the books, but not paid till the date of filing Return of Income.
Solution:
| Particulars | Nature of difference | DTA/DTL |
| Unabsorbed depreciation | Timing Difference | DTA |
| Income tax penalty | Permanent Difference | Neither DTA nor DTL to be created |
| Interest on loan taken from scheduled bank accounted in the books, but not paid till the date of filing Return of Income. | Permanent Difference | Neither DTA nor DTL to be created |
Illustration 14
Parshuram Ltd., which commenced its operations in 2018-19, provides the following details:
| Financial year | Profit before tax (Rs.) | Timing Difference (Rs.) | Permanent Difference (Rs.) | Corporate tax rate | Remarks |
| 2018-19 | 28,00,000 | + 3,15,000 | + 3,50,000 | 40% | Reversible in 2021-22 |
| 2019-20 | 31,50,000 | + 2,10,000 | + 2,80,000 | 38% | Reversible in 2020-21 |
| 2020-21 | 35,00,000 | - 70,000 | + 3,15,000 | 35% | Reversible in 2021-22 |
| 2021-22 | 24,50,000 | Nil | + 4,20,000 | 30% |
You are required to calculate the amount of Current Tax for the four financial years.
Solution:
Calculation of Current Tax (in ₹ Lakhs)
| Particulars | 2018-19 | 2019-20 | 2020-21 | 2021-22 |
| Profit before tax | 28.00 | 31.5 | 35.00 | 24.50 |
| Timing Differences | 3.15 | 2.10 | (0.70) | Nil |
| Permanent Differences | 3.50 | 2.80 | 3.15 | 4.20 |
| Taxable Income | 34.65 | 36.40 | 37.45 | 28.70 |
| Corporate tax rate | 40% | 38% | 35% | 30% |
| Current Tax (Taxable Income Tax rate) | 13.86 | 13.832 | 13.1075 | 8.61 |
Illustration 15
The following information is available from the records of Vishnu Ltd.:
Depreciation charged to income statement ₹ 8,00,000; Depreciation u/s 32 of Income Tax Act ₹ 20,00,000;
Unamortised preliminary expenditure as per income tax records ₹ 1,50,000.
It is communicated that there is adequate evidence of future profit sufficiency. Given that the corporate tax rate is 40%, you are required to ascertain the amount of deferred tax asset/ deferred tax liability to be created in this situation.
Solution:
Timing Difference = Additional depreciation as per Income Tax Act (-) Preliminary expenditure to be allowed = ₹ (20,00,000 – 8,00,000) - 1,50,000 = ₹ 10,50,000.
Deferred Tax Liability = ₹ 10,50,000 40% = ₹ 4,20,000
A. Theoretical Questions
Multiple Choice Questions
Answers:
| 1 | d | 2 | a | 3 | a | 4 | b | 5 | b |
B. Numerical Questions
CMA book unsolved questions solution
1. Alpha Ltd. contracted with a supplier to purchase machinery which is to be installed in its one department in three months' time. Special foundations were required for the machinery which were to be prepared within this supply lead time. The cost of the site preparation and laying foundations were ₹ 1,40,000. These activities were supervised by a technician during the entire period, who is employed for this purpose of ₹ 45,000 per month.
The machine was purchased at ₹ 1,58,00,000 and ₹ 50,000 transportation charges were incurred to bring the machine to the factory site. An Architect was appointed at a fee of ₹ 30,000 to supervise machinery installation at the factory site.
You are required to ascertain the amount at which the Machinery should be capitalized under AS 10.
Solution:
Calculation of Cost of Fixed Asset (i.e. Machinery)
| Particulars | ₹ | |
| 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 x3) | 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 |
2. Mr. A bought a forward contract for three months of US$ 1,00,000 on 1st December at 1 US$ = ₹ 47.10 when exchange rate was US$ 1 = ₹ 47.02. On 31st December when he closed his books exchange rate was US$ 1 = ₹ 47.15. On 31st January, he decided to sell the contract at ₹ 47.18 per dollar. Show how the profits from contract will be recognised in the books.
Solution
Since the forward contract was for speculation purpose the premium on contract i.e. the difference between the spot rate and contract rate will not be recorded in the books. Only when the contract is sold the difference between the contract rate and sale rate will be recorded in the Profit & Loss Account.
| Sale Rate | ₹ 47.18 |
| Less: Contract Rate | (₹ 47.10) |
| Premium on Contract | ₹ 0.08 |
| Contract Amount | US$ 1,00,000 |
| Total Profit (1,00,000 x 0.08) | ₹ 8,000 |
3.
| Particulars | Exchange Rate per $ |
| Goods purchased on 1.1.2020 for US $15,000 | ₹ 75 |
| Exchange rate on 31.3.2020 | ₹ 74 |
| Date of actual payment 7.7.2020 | ₹ 73 |
You are required to ascertain the loss/gain to be recognized for financial years ended 31st March, 2020 and 31st March, 2021 as per AS 11.
Solution:
As per AS 11 on ‘The Effects of Changes in Foreign Exchange Rates’, all foreign currency transactions should be recorded by applying the exchange rate on the date of transactions. Thus, goods purchased on 1.1.2020 and corresponding creditors would be recorded at ₹ 11,25,000 (i.e. $15,000 × ₹ 75)
According to the standard, at the balance sheet date all monetary transactions should be reported using the closing rate. Thus, creditors of US $15,000 on 31.3.2020 will be reported at ₹ 11,10,000 (i.e. $15,000 × ₹ 74) and exchange profit of ₹ 15,000 (i.e. 11,25,000 – 11,10,000) should be credited to Profit and Loss account in the year ended 31st March, 2020.
On 7.7.2020, creditors of $15,000 is paid at the rate of ₹ 73. As per AS 11, exchange difference on settlement of the account should also be transferred to Profit and Loss account. Therefore, ₹ 15,000 (i.e. 11,10,000 – 10,95,000) will be credited to Profit and Loss account in the year ended 31st March, 2021.
4. On 1.4.2021, AS Ltd. received Government grant of ₹ 300 lakhs for acquisition of machinery costing ₹ 1,500 lakhs. The grant was credited to the cost of the asset. The life of the machinery is 5 years. The machinery is depreciated at 20% on WDV basis. The Company had to refund the grant in May 2024 due to non-fulfillment of certain conditions.
How you would deal with the refund of grant in the books of AS Ltd. assuming that the company did not charge any depreciation for year 2024?
Solution:
According to para 21 of AS 12 on Accounting for Government Grants, the amount refundable in respect of a grant related to a specific fixed asset should be recorded by increasing the book value of the asset or by reducing deferred income balance, as appropriate, by the amount refundable. Where the book value is increased, depreciation on the revised book value should be provided prospectively over the residual useful life of the asset.
| ₹ in Lakhs | ||
| 1st April, 2021 | Acquisition cost of machinery (₹1,500 - ₹300) | 1,200.00 |
| 31st March, 2022 | Less: Depreciation @ 20% | (240.00) |
| 31st March, 2023 | Book Value | 960.00 |
| 31st March, 2024 | Less: Depreciation @ 20% | 192.00 |
| 1st April, 2024 | Book value | 768.00 |
| May, 2024 | Less: Depreciation @ 20% | (153.60) |
| Book value | 614.40 | |
| Add: Refund of grant | 300.00 | |
| Revised book value | 914.40 |
Depreciation @ 20% on the revised book value amounting ₹ 914.40 lakhs is to be provided prospectively over the residual useful life of the asset.
5. The company has obtained Institutional Term Loan of ₹ 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 ₹ 406 lakhs, ₹ 58 lakhs has been advanced to suppliers for additional assets and the balance loan of ₹ 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 ₹ 52.20 lakhs incurred during 20X1-20X2 on the entire Institutional Term Loan of ₹ 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 ₹ 52.20 lakhs can be given as:
| Purpose | Nature | Interest to be capitalised | Interest to be charged to profit and loss Account |
| ₹ in Lakhs | ₹ in Lakhs | ||
| Modernisation and renovation of plant and machinery | Qualifying asset | **52.20 x 406/580 = 36.54 | |
| Advance to supplies for additional assets | Qualifying asset | **52.20 x 58/580 = 5.22 | |
| 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. 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.
** 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, ₹ 52.20 lakhs will be recognised as expense in the profit and loss account for year ended 31st March, 20X2.
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