Accounting Standards

Hetal Pandya

Accounting Standards
Accounting Standards are written documents, policy documents issued by expert accounting body or Government or other regulatory body covering the aspects of recognition, measurement, treatment, presentation and disclosure of accounting transactions in the financial statements. Accounting Standards in India are issued by the Institute of Charted Accountants of India.( ICAI)

Disclosure in Financial Statements (AS 1)

Gross Book Value (cost) and Net Book Value of Fixed assets at the beginning and end of an accounting period showing additions, disposals, acquisitions and other movements. Expenditure incurred towards fixed assets in the course of acquisition or construction. Additional disclosures where fixed assets are stated at revalue amounts: Revalue amount substituted for historical costs. The method adopted to compute the revalued amounts The year of any appraisal made. Whether an external valuer was involved. The nature & extent of Gove. Grants recognized in the financial statements. The amount of borrowing cost capitalized during the period.

Inventory Valuation
AS- 2

Valuation of Inventories
Definition : Inventories consist of following
Held for sale in the ordinary course of business In the process of production of such sale In the form of materials or supplies to be consumed in production process or in the rendering of services
Not applicable to : (WIP means work in progress) WIP arising under construction contract including directly related service contract WIP arising in ordinary course of business( Consultancy service, Incomplete merchant bank activities etc) Financial instrument held as stock- in- trade Producers inventories like livestock, agricultural and forest products, mineral oil, ores & gas. Such inventories are valued at net realizable value.

Measurement of Inventories
Inventories should be valued at lower of cost and net realizable value. Major points for valuation of inventories are : Determination of cost of inventories. Determination of net realizable value of inventories Comparison between cost and NRV What is cost of Inventories ? Cost of inventory includes Cost of purchase Cost of conversion Other cost

Cost of Purchase : Cost of purchase includes Purchase price (+) Duties & Taxes (+) Freight inward Less : Duties & taxes recoverable by enterprise from taxing authority. Trade Discount Other similar item Cost of Conversion : It consist of cost directly related to the units. (i.e. Direct labour, Direct Material, Direct expenses.) (+) allocation of fixed and variable production overheads incurred in converting material into finished goods.

Conti
Fixed production overhead: Indirect cost of production that remains relatively constant regardless of volume of production.
Variable Production Overhead: Indirect cost of production varies directly with the volume of production. Allocation of Fixed production overhead: Fixed production overhead allocate on normal capacity. However on periods of high production, the amount of fixed production overhead allocated to each unit of production is decreased so that inventories are not measured above cost.

Allocation of variable Overhead: On actual production

Conti..
Other Cost: Cost incurred in bringing the inventories to their present location & condition. Exclusion from the cost of Inventories: Storage Cost Administrative overhead Selling & distribution cost Interest & borrowing cost

Methods of Valuation of Inventories

First in First out (FIFO):
This method is based on the assumption that costs move through an inventory in an unbroken stream, with costs entering and leaving the inventory in the same order. In other words the earliest purchased item is assumed to be first sold. Under this method , the most recent purchases are allocated to the closing inventory. It is possible to calculate the FIFO costs of goods sold directly by adding the cost of the beginning inventory to the purchase of which it is composed and by subtracting the cost of closing inventory. (COGS) = ope.stock + purchase cl.stock

Conti
Last In first Out (LIFO) :
The LIFO method allocates the cost of goods available for sale between closing inventory and cost of goods sold based on the assumption that the most recent purchases are the first to be sold. Under this method, the most recent purchase is allocate to the cost of goods sold and the earliest purchase allotted to closing inventory. The LIFO cost of goods sold is calculated by adding the cost of beginning inventory to purchase and subtracting the cost of closing inventory.

Conti
Weighted Average Method:
The weighted average method allocates the cost of goods available for sale between closing inventory and the cost of goods sold based on single weighted average cost per unit. The weighted average cost per unit is calculated by dividing the cost of goods available for sale by the number of units available for sale. The weighted average cost per unit is then multiplied by the number of units sold to calculate the cost of goods sold and by the number of units in closing inventory to calculate the cost of closing inventory.

Example: 1
Purchases and sales of a certain product during March 2009 are set out below : Purchases : On 1st March 100 units @ Rs 10.00, On 12th March 100 units @ Rs 9.80, On 15th March 50 units @ Rs 9.60, On 20th March 100 units @ Rs 9.40

Sales : On 10th March 80 units, On 14th March 100 units, on 31st March 90 units
There was no opening inventories, Determine the cost of goods sold for March under three different valuation methods. Viz. FIFO, LIFO and Weighted Average Cost.

Techniques for the measurement of cost

Actual Cost : Actual cost of inventories is the preferred technique of measurement for determining their values. Standard Cost Method : It takes into account normal level of consumption of material & supplies, labour, efficiency and capacity utilization. It must be regularly reviewed and revised taking into consideration the current condition. Retail Method : It is generally used in retail business when it is difficult to ascertain cost of individual item. It is applicable when items of inventories are rapidly changing items and have similar margins and for which it is not practical to use other costing method. Under this method the cost of inventory determined by reducing from the sale value of inventories the approx. percentage gross margin. The percentage takes into consideration the inventory that has been marked down to below its original selling price.

Net Realizable Value

Net Realizable Value means the estimated selling price in ordinary course of business less estimated cost of completion and estimated cost necessary to make the sale. Inventories are valued at cost or NRV whichever is lower. The principle of writing down inventories below cost to NRV is in accordance with the prudence that asset should not be carried in the balance sheet in excess of the amount expected to be realized for their sale or use. Circumstances justifying write-down to NRV: In the following circumstances the cost of inventories may not be recoverable on sale and hence their write down below cost to NRV

When their selling prices have been declined. When they are damaged When they have become wholly or partially obsolete. When the estimated cost of completion of inventory or the estimated costs necessary to make the sale have increased.

Conti.
Basis of write-down :
The write-down of inventories below cost to NRV is usually done on an item-by-item basis. In some cases, however, it may be appropriate to group similar or related items.

Factors to be considered in estimating NRV : Fluctuations of price or cost directly relating to events occurring after the balance sheet date to the extent that such events confirm the conditions existing at the balance sheet date. Purpose for which the inventory is held.

Depreciation on Fixed Assets (AS 6)

It is the measure of wearing out, consumption or other loss of value of a depreciable asset arising from use, passage of time. Depreciation is nothing but distribution of total cost of the asset over its useful life. Depreciable assets : Those assets which are expected to be used for more than one accounting period Have a limited useful life Are held for use in production of goods and services. Not applicable to : - Forests & Plantations - Wasting assets, minerals and natural gas - Expenditure on research & development - Goodwill - Live stock

Calculation of Depreciation
The amount of depreciation is calculated as under. Historical cost or other amount ( revalued amount) Estimated useful life of depreciable assets Estimated residual/ scrap value of depreciable assets Historical Cost : Estimated useful life of depreciable assets: It is period over which it is expected to be used by the enterprise. Estimated residual/ scrap value of depreciable asset : It is estimated value of depreciable asset at the end of its useful life.

Methods of Depreciation

Straight line Method Method

Written Down Value

Straight line Method : Under this method, a fixed and equal amount in the form of depreciation, according to a fixed percentage on the original cost, is written off during each accounting period over the useful life of the asset. How to calculate rate of depreciation under SLM? ..

Original cost less Residual

Value

Step 1 Amount of Depreciation =

asset

Expected useful life of the

Step 2 Rate of Depreciation =

Amount of Depreciation Original Cost

100

 Written Down Value Method (WDV): Under this method, depreciation according to a fixed percentage calculated upon the original cost( in the first year) and written down value, ( in subsequent year) of an asset over the expected useful life of the asset. Under this method, the rate of depreciation remains constant year after year whereas the amount of depreciation goes on decreasing. How to calculate rate of Depreciation under WDV method?......

Change in the method of depreciation

The method of depreciation, once adopted, needs to be applied consistently to provide comparability of the results of the operations of the enterprise from period to period. A change from one method to another can be done only: 1. When the statute governing the enterprise requires the adoption of the new method 2. To comply with the requirements of an accounting standard or 3. When change is considered to result in a more appropriate preparation or presentation of the financial statements of the enterprise.

Change in depreciation Method

Changing in Accounting Policy

Retrospective Effect Recalculation of depreciation with new method from the date of pch

New Accumulated Depreciation

Old Accumulated Depreciation Difference between above

Surplus/ deficit
Cr/ Dr to P & l A/c in the year of change Disclosed Separately

Statutory requirements & compliance

The Companies Act, 1956 lays down the rates of depreciation in respect of various asset, to be adopted in the preparation of Financial statements. When depreciation rate as per the Companies Act is higher than as per the statute, the depreciation is computed by applying the higher rate. If depreciation rate lower than the statutory rate it can be applied only in accordance with the requirements of the statute, if any and subject to the disclosure of the fact in the financial statements.

Requirements of the Companies Act

Two sections of the Act, namely Sections 205 and 350, deal with depreciation to be provided by a company in its accounts. Section 205 provides that no company can declare or pay dividend out of its profits without providing for depreciation. Section 350 in turn prescribes that depreciation has to be provided at the rates specified in schedule xiv to the companies Act.

Provisions of the Income Tax Act

Section 32 of the Income Tax Act, Rule 5 of the income Tax Rules deal with depreciation. The features of various provisions regarding depreciations are : 1. Only the WDV method is recognized except in case of power generation and distribution undertakings. 2. Block of assets method is followed. This method allows for grouping of assets that carry the same rate of depreciation 3. Full depreciation is allowed if the asset is used for 180 days or more during the year. In case of use for less than 180 days, the depreciation is restricted to 50 %. 4. Unlike the Companies Act, The Income Tax Act does not allow shift depreciation on plant & machinery.

Revaluation of Fixed Assets

1. 2. The following principles govern the treatment of revaluation and other incidental matters. Different bases of revaluation are used to determine the book value of assets. The most preferred method of restating fixed asset is appraisal by competent valuers. The revalued amounts of fixed assets are presented in financial statements by restating both the gross book value and accumulated depreciation.

Retirements and Disposals

A fixed asset is eliminated from the financial statements on disposal or when no further benefit is expected from its use. A loss arising from the retirement or gain or loss arising from disposal of a fixed asset that is carried at cost is charged / credited to the profit & loss account. Material items retired from active use and held for disposal are stated at the lower of their net book value and net realizable value and shown separately in the financial statements.

Valuation Of Fixed Assets:

The ICAI has issued Accounting Standard ( AS 10) Accounting for fixed Assets which prescribes the principles and norms of standard accounting treatment for various aspects of Fixed assets valuation and accounting. i.e. identification, measurement, valuation, revaluation, retirements & disposals and disclosure requirements in financial statements prepared on historical cost basis.

 It is an Asset which is : Held with intention of being used for the purpose of producing or providing goods & services. Not held for sale in the normal course of business Expected to be used for more than one accounting period. Examples of Fixed assets are : land Building ( Freehold & Leasehold) Plant & Machinery Furniture & Fittings etc. Not Applicable to : Forests, Plantations& similar natural resources Wasting Assets like minerals, oil and natural gas Expenditure on real estate development Live stock

 Fixed assets shall be shown in financial statements either at historical cost or revalue price. What is Historical Cost ?

Purchase Price

(-) Any Trade Discount (+) Import Duties & other non-refundable Taxes (+) Any other cost of bringing asset to the working condition ( Site preparation, Delivery & handling cost, Installation cost, Professional fees, expenditure incurred on start up / test runs, Administrative and other overheads are specifically attributable for construction/ acquisition / installation of fixed assets) (-) Amount of Gov. grant received against fixed assets.

When Fixed asset acquired in exchange of existing asset

Fixed assets exchanged not similar: Asset acquired should be recorded either at fair market value of asset given up or FMV of asset acquired, if this is more clearly evident Fixed Assets exchanged are similar :- Asset acquired should be recorded either at fair market value of asset given up or FMV of asset acquired, if this is more clearly evident or Net Book value of the asset given up. Fixed Asset acquired in exchange of Share or other securities: - When payment of asset is made in shares or securities asset should be recorded at either FMV of asset purchased or FMV of shares ,whichever is more clearly available.

Basket Purchase
Where several fixed assets are purchased for a consolidated price, the consideration is apportioned to the various assets on a fair basis as determined by a valuer.

Accounting Standard 9 Revenue recognition

The standard explains when the revenue should be recognized in profit and loss account and also states the circumstances in which revenue recognition can be postponed. Revenue means gross inflow of cash, receivable or other consideration arising in the course of ordinary activities of an enterprise such as : The sale of goods Rendering he services Use of the enterprise resources by other yielding interest, dividend and royalties.

Timing of revenue recognition

Revenue from sale of rendering services should be recognized at the time of the sale or rendering of services. However, if at the time of rendering services or sale there is significant uncertainty in ultimate collection of the revenue, the revenue recognition is postpones and in such cases revenue should be recognized only when it becomes .

Not applicable..
Revenue arising from construction contracts Revenue arising from hire purchase, lease agreements Revenue arising from Govt. grants and subsidies Revenue of Insurance companies arising from insurance contracts

Revenue from sale of goods

Seller has transferred the ownership of goods o buyers for a price or all significant risk and rewards of ownership have been transferred to buyer Seller does not retain any effective control of ownership of the transferred goods There is no significant uncertainty in collection of the amount of consideration

 Revenue recognition

Valuation of Investments
AS-13

Meaning of Investment
It is the asset held for earning income by way of dividend, interest and rentals for capital appreciation or for other benefits. The standard deals with following aspects : Classification of investment Cost of investment Carrying amount/ valuation of investment Disposal of investments Reclassification of investments Disclosure of investment in financial statements

Not Applicable To : Recognition of interest, dividend and rentals earned on investment. Operating finance lease Investment of retirement benefit plans and life insurance enterprise Mutual funds, venture capital fund and/ or the related AMC, banks & financial institution.

Related Terms
Current Investments : Such investment is readily realizable and is intended to be held for not more than one year from the date on which such investment is made. Long- term Investments : Investments other than current investment is called long term investments. Investment Property : It is an investment in land or building that is not intended to be occupied substantially for use by or in their operation of the investing enterprise.

Cost of Investment
Cost of investment comprises of purchase price and acquisition charges such as brokerage, fees and duties etc. Investment is acquired by issue of shares or other securities: - purchase price of investment is the fair market value of the securities issued. Investment is acquired in exchange for another asset : - Acquisition cost of investment is fair value of the asset given up or Fair value of the investment received/acquired if it is more clearly evident. Pre-acquisition interest : - When interest has accrued in pre-acquisition period and was included in cost of investment at the time of acquisition , then subsequent receipt of such pre- acquisition interest is deducted from the cost of investment. Dividend : When dividend is declared from pre-acquisition profits, and later on received by the purchaser of investment , then such amount of dividend is deducted from the cost of investment.

Right Issue
Under section 81 of the Companies Act, every public limited company, whenever it propose to increase its subscribed capital after expiry of two years from the date of its incorporation or after the expiry of one year from the date of the allotment of shares- whichever is earlier shall be required to offer those shares to the existing shareholders of the equity shares in the proportion of paid-up capital as nearly as possible Special consideration are required for determining cost of investment in case of right issues.

The investor has been holding the shares much before the right issue, i.e. announcement of right issue not foreseen. The investor acquires shares on the announcement of right issue on cum-right basis.

Conti.
Right shares :
If right shares offered are subscribed , then cost of right share is added to the carrying amount of the investment. If right share offered are not subscribed but right is sold in the market, then sale proceeds are taken to profit & loss account provided original share on which right is received is not acquired at cum-right. Investment purchased at cum-right: If investment is acquired at cum-right price and after that it becomes ex-right , the market value of such investment will fall below the acquisition cost of investment. The cost of investment is reduced by the amount received on sale of rights.

Carrying amount of investment (Valuation of investment for the purpose of balance sheet)
Current Investment :
Current investment are carried in the balance sheet at the lower of cost and realizable value.
Any reduction in realizable value is debited in profit & loss a/c , however if realizable value of investment is increased , the increase in value of current investment to the level of cost is credited to profit & loss account. Long term Investment : It is usually valued at cost. If there is decline in the value of investment, but such decline is not temporary then carrying amount of investment is reduced by the amount of such decline. The resultant reduction in carrying amount is charged to profit & loss a/c. This reduction amount reversed when there is a rise in the value of investment but such rise in value should not be temporary.

Conti
Indicators of the value of an investment are obtained by reference to Its market value The investees assets and results The expected cash flow from investment The type and extent of the investors stake in investee Restrictions put by the investee on disposal by the investor.

Reclassification of Investments
Sometimes management decide to carry certain long-term investment as current and current investment as long-term. The cost of investment on such reclassification , is ascertained in following manner. In case of Long-term to current investment : Transfers are made at the lower of cost and carrying amount on the date of transfer. In case of Current to long-term investment : Transfers are made at the lower of cost and fair market value on date of transfer.

Disposal of investment
When an investment is disposed off, the difference between the carrying amount and sale proceeds is charged/ credited to profit and loss a/c. When only a part of total investment is disposed off, the carrying amount of that part of investment is determined on the basis of the average carrying amount of the total holdings of the investments. Disclosure required :
Accounting policies followed for valuation of investments. Classification of investment into current & long term investment. In addition to classification as per schedule VI of the Companies Act..
Government or trust securities Shares , Debentures or bonds Investment properties Other specifying nature (e.g. units of mutual fund)

Conti
Aggregate amount of quoted and unquoted securities. Any significant restrictions on the investment like minimum holding period for sale/disposal, utilization of sale proceeds, investment held outside India.

Amounts included in profit & loss a/c