Accounting Standards - Final Project Report

Accounting for Managers - Accounting Standards

A PROJECT REPORT

ON

ACCOUNTING

STANDARDS

(AS-1, AS-6, AS-10, AS-

12)

PRESENTED BY:

SUSHIL KUMAR SURANA

GEORGE JOSEPH

PALLAVI DIKXIT

ROBIN JAGWAYAN

RASIKA SATAM

ABHISEKH SINGHAL

PRAKASH BIJOUR

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UNDER GUIDANCE OF:

PROF. ANIL TILAK

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CONTENTS

ACCOUNTING STANDARD-1 3




BIBLIOGRAPHY 53

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ACCOUNTING STANDARD-1

Accounting is the art of recording transactions in the best manner possible, so as

to enable the reader to arrive at judgments/come to conclusions, and in this

regard it is utmost necessary that there are set guidelines. These guidelines are

generally called accounting policies. The intricacies of accounting policies

permitted Companies to alter their accounting principles for their benefit. This

made it impossible to make comparisons. In order to avoid the above and to

have a harmonised accounting principle, Standards needed to be set by

recognised accounting bodies.

This paved the way for Accounting Standards to come into existence.

Accounting Standards in India are issued By the Institute of Chartered

Accountants of India (ICAI). At present there are 30 Accounting Standards

issued by ICAI.

INTRODUCTION

1. This statement deals with the disclosure of significant accounting policies

followed in preparing and presenting financial statements.

2. The view presented in the financial statements of an enterprise of its state of

affairs and of the profit or loss can be significantly affected by the accounting

policies followed in the preparation and presentation of the financial statements.

The accounting policies followed vary from enterprise to enterprise. Disclosure

of significant accounting policies followed is necessary if the view presented is

to be properly appreciated.

3. The disclosure of some of the accounting policies followed in the preparation

and presentation of the financial statements is required by law in some cases.

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4. The Institute of Chartered Accountants of India has, in Statements issued by

it, recommended the disclosure of certain accounting policies, e.g.,translation

policies in respect of foreign currency items.

5.A few enterprises in India have adopted the practice of including in their

annual reports to shareholders a separate statement of accounting policies

followed in preparing and presenting the financial statements.

6. In general, however, accounting policies are not at present regularly and fully

disclosed in all financial statements. Many enterprises include in the Notes on

the Accounts, descriptions of some of the significant accounting policies. But

the nature and degree of disclosure vary considerably between the corporate and

the non-corporate sectors and between units in the same sector.

7. Even among the few enterprises that presently include in their annual reports

a separate statement of accounting policies, considerable variation exists. The

statement of accounting policies forms part of accounts in some cases while in

others it is given as supplementary information.

8. The purpose of this Statement is to promote better understanding of financial

statements by establishing through an accounting standard the disclosure of

significant accounting policies and the manner in which accounting policies are

disclosed in the financial statements. Such disclosure would also facilitate a

more meaningful comparison between financial statements of different

enterprises.

OBJECTIVE OF ACCOUNTING STANDARDS

Objective of Accounting Standards is to standardize the diverse accounting

policies and practices with a view to eliminate to the extent possible the non-

comparability of financial statements and the reliability to the financial

statements.

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Accounting Standards are formulated with a view to harmonise different

accounting policies and practices in use in a country. The objective of

Accounting Standards is, therefore, to reduce the accounting alternatives in the

preparation of financial statements within the bounds of rationality, thereby

ensuring comparability of financial statements of different enterprises with a

view to provide meaningful information to various users of financial statements

to enable them to make informed economic decisions.

The Companies Act, 1956, as well as many other statutes in India require that

the financial statements of an enterprise should give a true and fair view of its

financial position and working results. This requirement is implicit even in the

absence of a specific statutory provision to this effect. The Accounting

Standards are issued with a view to describe the accounting principles and the

methods of applying these principles in the preparation and presentation of

financial statements so that they give a true and fair view. The Accounting

Standards not only prescribe appropriate accounting treatment of complex

business transactions but also foster greater transparency and market discipline.

Accounting Standards also helps the regulatory agencies in benchmarking the

accounting accuracy.

NATURE OF ACCOUNTING POLICIES

1. The accounting policies refer to the specific accounting principles and the

methods of applying those principles adopted by the enterprise in the

preparation and presentation of financial statements.

2. There is no single list of accounting policies which are applicable to all

circumstances. The differing circumstances in which enterprises operate in a

situation of diverse and complex economic activity make alternative accounting

principles and methods of applying those principles acceptable. The choice of

the appropriate accounting principles and the methods of applying those

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principles in the specific circumstances of each enterprise calls for considerable

judgement by the management of the enterprise.

3. The various statements of the Institute of Chartered Accountants of India

combined with the efforts of government and other regulatory agencies and

progressive managements have reduced in recent years the number of

acceptable alternatives particularly in the case of corporate enterprises. While

continuing efforts in this regard in future are likely to reduce the number still

further, the availability of alternative accounting principles and methods of

applying those principles is not likely to be eliminated altogether in view of the

differing circumstances faced by the enterprises.

AREAS IN WHICH DIFFERING ACCOUNTING POLICIES ARE

ENCOUNTERED

The following are examples of the areas in which different accounting policies

may be adopted by different enterprises.

• Methods of depreciation, depletion and amortisation

• Treatment of expenditure during construction

• Conversion or translation of foreign currency items

• Valuation of inventories

• Treatment of goodwill

• Valuation of investments

• Treatment of retirement benefits

• Recognition of profit on long-term contracts

• Valuation of fixed assets

• Treatment of contingent liabilities.

The above list of examples is not intended to be exhaustive.

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Accounting Standards establish rules relating to recognition, measurement and

disclosures, thereby ensuring that all enterprises that follow them are and that

their financial statements are true, fair and transparent. High quality accounting

standards are a necessary and important element of a sound capital market

system. In Public capital markets such as those in United States, high quality

accounting standards reduce uncertainty and increase overall efficiency.

ACCOUNTING STANDARDS-SETTING IN INDIA

The institute of Chartered Accountants of India, recognizing the need to

harmonize the diverse accounting policies and practices, constituted at

Accounting Standard Board (ASB) on 21st April, 1977.

The Institute of Chartered Accountants of India (ICAI) being a member body of

the IASC, constituted the Accounting Standards Board (ASB) on 21st April,

1977, with a view to harmonise the diverse accounting policies and practices in

use in India. After the avowed adoption of liberalization and globalisation as

the corner stones of Indian economic policies in early ‘90s, and the growing

concern about the need of effective corporate governance of late, the

Accounting Standards have increasingly assumed importance. While

formulating accounting standards, the ASB takes into consideration the

applicable laws, customs, usages and business environment prevailing in the

country. The ASB also gives due consideration to International Financial

Reporting Standards (IFRSs)/ International Accounting Standards (IASs) issued

by IASB and tries to integrate them, to the extent possible, in the light of

conditions and practices prevailing in India.

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COMPOSITION OF THE ACCOUNTING STANDARDS BOARD:

The composition of the ASB is broad-based with a view to ensuring

participation of all interest groups in the standard-setting process. These

interest-groups include industry, representatives of various departments of

government and regulatory authorities, financial institutions and academic and

professional bodies. Industry is represented on the ASB by their apex level

associations, viz., Associated Chambers of Commerce & Industry

(ASSOCHAM), Confederation of Indian Industries (CII) and Federation of

Indian Chambers of Commerce and Industry (FICCI). As regards government

departments and regulatory authorities, Reserve Bank of India, Ministry of

Company Affairs, Comptroller & Auditor General of India, Controller General

of Accounts and Central Board of Excise and Customs are represented on the

ASB. Besides these interest-groups, representatives of academic and

professional institutions such as Universities, Indian Institutes of Management,

Institute of Cost and Works Accountants of India and Institute of Company

Secretaries of India are also represented on the ASB. Apart from these interest

groups, certain elected members of the Central Council of ICAI are also on the

ASB.

THE ACCOUNTING STANDARDS-SETTING PROCESS

The accounting standard setting, by its very nature, involves reaching an

optimal balance of the requirements of financial information for various

interest-groups having a stake in financial reporting. With a view to reach

consensus, to the extent possible, as to the requirements of the relevant interest-

groups and thereby bringing about general acceptance of the Accounting

Standards among such groups, considerable research, consultations and

discussions with the representatives of the relevant interest-groups at different

stages of standard formulation becomes necessary. The standard-setting

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procedure of the ASB, as briefly outlined below, is designed in such a way so as

to ensure such consultation and discussions:

Identification of the broad areas by the ASB for formulating the Accounting

Standards.

Constitution of the study groups by the ASB for preparing the preliminary

drafts of the proposed Accounting Standards.

Consideration of the preliminary draft prepared by the study group by the ASB

and revision, if any, of the draft on the basis of deliberations at the ASB.

Circulation of the draft, so revised, among the Council members of the ICAI

and 12 specified outside bodies such as Standing Conference of Public

Enterprises (SCOPE), Indian Banks’ Association, Confederation of Indian

Industry (CII), Securities and Exchange Board of India (SEBI), Comptroller and

Auditor General of India (C& AG), and Department of Company Affairs, for

comments.

Meeting with the representatives of specified outside bodies to ascertain their

views on the draft of the proposed Accounting Standard.

Finalisation of the Exposure Draft of the proposed Accounting Standard

on the basis of comments received and discussion with the representatives of

specified outside bodies.

Issuance of the Exposure Draft inviting public comments.

Consideration of the comments received on the Exposure Draft and finalisation

of the draft Accounting Standard by the ASB for submission to the Council of

the ICAI for its consideration and approval for issuance.

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Consideration of the draft Accounting Standard by the Council of the Institute,

and if found necessary, modification of the draft in consultation with the ASB.

THE PRINCIPLES GOVERNING SELECTION OF AN ACCOUNTING

POLICY:

The primary consideration in the selection of accounting policies by an

enterprise is that the financial statements prepared and presented on the basis of

such accounting policies should present a true and fair view of the state of

affairs of the enterprise as at the balance sheet date and of the profit and loss for

the period ended on that date. For this purpose , the major considerations

governing the selection and application of accounting policies are :

1. PRUDENCE

In the view of the uncertainty attached to future event, profits are not anticipated

but recognised only when realised though not necessarily in cash. Provision is

made for all known liabilities and losses even though the amount cannot be

determined with certainty and represents only a best estimate in the light of

available information.

2. SUBSTANCE AND FORM

The accounting treatment and presentation in financial statements of

transactions and events should be governed by their substance and merely by

the legal form. A typical example where substance takes precedence over form

is in the case of finance leases. In finance leases, the lessee in substance is the

owner of the asset whilst the less or is merely the legal owner. The accounting

of finance leases is based on the substance rather than form of the transaction.

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3. MATERIALITY

Financial statements should disclose all “material” items, i.e. items the

statements. The concept of materiality recognizes that some matters individually

or in the aggregate, are important for the fair presentation of the financial

statements taken as a whole. The IASC (International Accounting Standards

Committee) defines audit materiality as follows: ‘Information is the if its

omission or misstatement could influence the economic decisions of users taken

on the basis of the financial statement.’ Materiality depends on the size of the

item or error judged in the particular circumstances of its omission or

misstatement. Thus materiality provides a threshold or cut-off point rather being

primary qualitative characteristics which information must have, if it is to be

useful. There are no hard and fast rules for determining materiality. What is

material is a matter of professional judgment. For example, an amount material

to the financial statements of one entity may not be material to financial

statements of another entity of a difference size or nature. Further, what is

material to the financial statements of a particular entity might change from one

period to another.

THE FUNDAMENTAL ACCOUNTING ASSUMPTIONS

Certain fundamentals accounting assumptions underlie the preparations and

presentation of financial statements. They are usually not specifically stated

because there acceptance and use are assumed. Disclosure is necessary if they

are not followed, otherwise disclosure is not required. The following have been

generally accepted as fundamental accounting assumptions:

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A. Going Concern

The enterprise is normally viewed as going concern, that is, as continuing in

operation for the foreseeable future. It is assumed the enterprise has neither the

intention nor the necessity of liquidation or of curtailing materiality the scale of

the operations.

B. Consistency

It is assumed that accounting policies are consistent from one period to another.

C. Accrual

Revenues and cost are accrued, that is, recognised as they are earned or incurred

(and not as money received or paid) and recorded in the financial statements of

the period which they relate. The accrual concept forces the matching of

revenues against relevant cost, for example, though warranty expenses are

incurred much after the turnover takes place, it has to be estimated and provided

for when the turnover is affected, as it is a cost incurred to achieve that

turnover.

PRINCIPLES FOLLOWING A “NOT GOING CONCERN”

The company should prepare the accounts on the basis that it is not a going

concern or that it will be closed in the near future. All the assets of such a

company should be valued as its net realisable value. All the liabilities should

be valued at the expected settlement price. In addition, further liabilities may

have to be provided in respect of employee termination or premature

termination of various contracts including the lease of the premises. Adequate

disclosure/adjustments should be made in financial statements about the

impending closure and the fact that accounts are prepared on the basis. Since the

accounts would be true and fair, there no need for the auditor to make a

qualification. The auditor should however add a paragraph in his report

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detailing the going situation (matter of emphasis and not qualification). If the

financial statement is not prepared on the above basis, the auditor will have to

qualify the financial statements.

DIFFERENT ACCOUNTING POLICIES FOR SIMILAR ITEMS

This is the contrary to the fundamental accounting assumptions of consistency,

which require use consistence policies year after year and also in the same year

for all similar items. In the case of depreciation, Expert Advisory Committee

(EAC) of ICAI has given an opinion that different methods of depreciation for

the for the same class of assets used in different plants of company can be

applied if the management considers it appropriate to do so after taking into

account important factors such as the type of assets, the nature of the use of

such assets and circumstances prevailing in the business. Whilst such

exceptions may be justifiable it would be difficult to justify valuing the same

type of inventory at to different factories by applying to different accounting

policies.

DISCLOSURE OF ACCOUNTING STANDARDS

To ensure proper understanding of financial statements, it is necessarythat all

significant accounting policies adopted in the preparation and presentation of

financial statements should be disclosed. Such disclosure should form part of

the financial statements. It would be helpful to the reader of financial statements

if they are all disclosed as such in one place instead of being scattered over

several statements, schedules and notes.

Examples of matters in respect of which disclosure of accounting policies

adopted will be required are contained in paragraph 14. This list of examples is

not, however, intended to be exhaustive. Any change in an accounting policy

which has a material effect should be disclosed. The amount by which any item

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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 a change is made in the accounting policies

which has no material effect on the financial statements for the current period

but which is reasonably expected to have a material effect in later periods, the

fact of such change should be appropriately disclosed in the period in which the

change is adopted.

Disclosure of accounting policies or of changes therein cannot remedy a wrong

or inappropriate treatment of the item in the accounts. 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 Accrual are followed in financial statements, specific disclosure is not

required. If a fundamental accounting assumption is not followed, the fact

should be disclosed

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AS- 6: DEPRECIATION

THE SCOPE AND OBJECTIVE OF AS-6 & DEPRECIABLE ASSETS

Depreciation is a measure of the wearing out, consumption or other loss of

value of a depreciable asset arising from use, efflux of time or obsolescence

through technology and market changes. Depreciation includes amortization of

assets whose useful life is pre-determined. Different accounting policies for

depreciation are adopted by different enterprises. Disclosure of accounting

policies for depreciation followed by enterprise is necessary to appreciate the

view presented in the financial statements of the enterprise. Depreciation has a

significant in determining and presenting the financial position and result of

operation of an enterprise. Depreciable assets are assets which

Are Expected To Be Used More Than One Accounting Period

Have a limited useful life, and

Are held by an enterprise for use in the production or supply of goods and

services for rental and others, or for administrative purpose and not for

the purpose of sale in the ordinary course of business. To qualify as a

depreciable asset all there conditions are required to be fulfilled. Even if a

single condition is not fulfilled the same will not qualify as a depreciable

asset. For e.g. though land will fulfill two of the above conditions, it does

not fulfill the condition of a limited useful life and therefore is not a

depreciable asset AS-6 deals with depreciable accounting and applies to

all depreciable assets except the following items to which special

consideration apply:

Forest plantation and similar regenerative natural resources

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Wasting asset including expenditure on the exploration for an

extraction of minerals, oil, natural gases and similar non-

regenerative resources.

Expenditure on research and development

Goodwill

Livestock

As already stated AS-6 does not apply to Land unless it has a limited useful life

for the Enterprise. Land and Buildings are separable assets and are dealt with

separately for accounting purposes, even when they are acquired together. Land

normally has an unlimited life and therefore is not depreciated. Building has a

limited life and therefore is depreciable asset. An increase in the value of land

on which the building stands does not affect the determination of the useful life

of the building.

DEPRECIATION CHARGES RECOGNIZED IN FINANCIAL

STATEMENTS

The depreciation charges for a period are usually recognized as an expense.

However in some circumstances, the economic benefit embodies in an asset are

absorbed by the enterprise in producing other asset rather than giving rise to an

expense. In this case, the depreciation charged comprises part of the cost of the

other asset as is included in its carrying amount. For e.g. the depreciation of

manufacturing plant and equipment is included in the cost of conversion of

inventories. Simi9larly depreciation of property plant and equipment used for

development activities may be included in the cost of an intangible asset or as a

capital research and development item.

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THE QUANTUM OF DEPRECIATION DETERMINED UNDER AS-6

Depreciation is allotted so as to charge a fair proportion of the depreciable

amount in each accounting period during the expected useful life of the asset.

Depreciable amount of a depreciable asset is its historical cost, or other amount

substituted for historical cost in the financial statement, less the estimated

residual value. Assessment of depreciation and the amount to be charged in

respect thereof in an accounting period are usually based on the following three

factors

Historical cost or other amount substituted for the historical cost of the

depreciable asset when the asset has been revalued

Expected useful value of the depreciable value and

Estimated residual value of the depreciable asset.

The quantum of depreciation is provided in an accounting period involves the

exercise of judgment by management in light of technical, commercial,

accounting and legal requirements and accordingly may need periodical review.

If it is considered that the original useful life of an asset and any revision, the

unamortized depreciable amount of the asset is charged to the revenue over the

revised remaining useful life. The useful life of major depreciable assets or

classes of depreciable asset should therefore be reviewed periodically.

In the case the depreciable assets are revalued, the provision for depreciation is

based on the revalued amount on the estimate of the remaining useful life of

such assets. Depreciation is charged in each accounting period by reference of

the depreciable amount irrespective of an increase in the market value of the

asset. This is based on the concept of historical cost. Historical cost of a

depreciable asset represents its money outlay or its equivalent connection with

its acquisition, installation and commissioning as well as for additions to or

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improvement thereof. The historical cost of a depreciable asset may undergo

subsequent changes arising as a result of increase or decrease in long term

liability on account of exchange fluctuations, price adjustments, change in

duties or similar factors.

DETERMINATION OF AN USEFUL LIFE OF AN ASSET

As the economic benefits embodied in an asset is reduced are consumed by the

enterprise, the carrying amount of an asset is reduced to reflect this

consumption, normally by charging an expense for depreciation .A depreciation

charge is made even if the value of the asset exceeds its carrying amount. The

economic benefits embodied in an item of property, plant and equipment are

consumed by the enterprise principally through the use of the asset. However

other factors such as technical obsolescence and wear and tear while an asset

remains idle often result in diminution of the economic benefits that might have

been expected to be available from the assets.

Useful life is either (1) the period over which a depreciable asset is expected to

be used by the enterprise or (2) the number of production or similar units

expected to be obtained from the use of assets by the enterprise. The useful life

of a depreciable asset is shorter than its physical life and is

1. Predetermined by legal or contractual limits, such as the expiry dates of

related leases,

2. Directly governed by extraction or consumption

3. Dependent on the extent of use and physical deterioration on account of

wear and tear which again depends on operational factors such as the

number of shifts for which the asset is to be used, repair and maintenance

policy of the enterprise etc. and

4. Reduced by obsolescence arising from such factors as:

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a. Technological changes

b. Improvement in production methods

c. Change in market demand for the product or service output of the

assets

d. Legal or other restrictions.

Determination of a useful life of a depreciable asset is a matter of estimation

and is normally based on various facts including experience with similar types

of assets. Such estimation is more difficult for an asset using new technology or

used in the production of new product or in the provision of a new service but is

nevertheless required on some reasonable basis.

The useful life of an asset is defined in terms of the asset’s expected utility to

the enterprise. The asset management policy of an enterprise may involve the

disposal of assets after a specified time or after consumption of a certain

proportion of the economic benefits embodied in the assets. Therefore the useful

life of an asset may be shorter than its economic life. The estimation of the

useful life of an item of property, plant and equipment is a matter of judgment

based on the experience of the enterprise with similar assets

AS-6 OR COMPANIES ACT SHOULD BE FOLLOWED BY

COMPANIES FOR DETERMINING DEPRECIABLE AMOUNT

The statute governing an enterprise may provide the basis for computation of

the depreciation. For example the companies act 1965 lays down the rates of

depreciation in respect of various assets. Where the management’s estimate of

the useful life of an asset of the enterprise is shorter than that envisaged under

the relevant statutes, the depreciation provision is appropriately computed y

applying a higher rate. If the managements estimate of the useful life of the

asset is longer than that envisaged under the statute, depreciation rate lower than

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that envisaged by the statute can be applied only in accordance with

requirements of the statute. In a large number of cases, the rates of depreciation

under schedule 14 of companies are lowland therefore enterprises have a nose

for good corporate governance and accountant practices ,use much higher rates

than that prescribed under schedule 14.for example Infosys uses much higher

rates than that prescribed under schedule 14 on computers owned by them. It is

important for the financial statements to be true and fair that management

estimates the useful lives of assets and determines depreciation at higher rates.

If the useful lives are lower than one set out in schedule 14.

Rates higher than schedule 14 should be used provided such rates are based on

sound commercial and technical considerations. For example a factory building

situated in a coastal area may be subject to higher depreciation due to corrosion.

In such a case the auditor should broadly satisfy himself that the rates are

determined in an appropriate manner. Since the determination of commercial

life of an asset is a technical matter, the decision of the Board of Directors is

normally accepted by the auditors unless he has reason to believe that such

decision is grossly incorrect.

There could be instances where a company adopts accelerated depreciation rates

in respect class of assets i.e. depreciation rates are higher than rates prescribed

under schedule14 of the companies act. For the other assets the company

charges depreciation at the rates lower than the schedule 14 of the companies

act. However aggregate depreciation charge on all assets as per the companies

policy is higher than the aggregate depreciation had the company followed

schedule 14 rates for all the assets.

If the managements estimate of the useful life of the asset is longer than that

envisaged, under the statute, depreciation rate lower than that envisaged by the

statute can be applied only in accordance with requirement of the statute.

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Department of Company affairs vide circular no.2/89 has clarified that:

It may be clarified that the rates as contained in schedule 14 should be

viewed as the minimum rates and therefore a company shall not be permitted to

charge depreciation at rates lower than those specified in schedule in relations to

assets purchased. After the date of applicability of the schedule.

The conclusion is:

Compliance with AS-6 and the companies act should be viewed based on

each type of asset for example buildings, plant and machinery, furniture

etc and not on all the assets taken together.

In the given case, accounting policy followed by the company is not in

agreement with the accounting standard 6 and provisions of the

companies act.

USEFUL LIVES OF ASSETS REQUIRED TO BE REVIEWED

The useful life of an item if property, plant and equipment should be reviewed

periodically and if expectations are significantly different from previous

estimates, the unamortised depreciable amount should be charged over the

revised remaining useful life. During the life of an asset it may become apparent

that the estimate of the useful life is inappropriate. For example the useful life

may be extended by subsequent expenditure on the asset which improves the

condition of the asset beyond its originally assessed standard of performance.

Alternatively, technological changes or changes in the market for the products

may reduce its useful life of the asset. For example due to certain changes in the

design of the finished product, a company may intend to discontinue using the

moulds much before the expiry of their useful life, the repair and maintenance

policy of the enterprise may also affect the useful life of an asset. The policy

may result in an extension of the useful life of the asset or an increase in its

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residual value. However the adoption of such a policy does not negate the need

to charge depreciation. It is important that the above reassessment of useful

does not result in depreciation lower than the required under schedule 14, as that

would result in contravention of section 205(2) of the companies act.

ADDITION OR EXTENSION TO AN EXISTING ASSET

Any addition or extension to an existing asset which is of a capital nature and

which becomes an integral part of the existing asset is depreciated over the

useful remaining life of that asset. As a practical measure, however depreciation

is sometimes provided on such addition or extension at the rate which is applied

to an existing asset. Any addition or extension which retains a separate identity

and is capable of being used after the existing asset is disposed of, is

depreciated independently on the basis of an estimate of its own useful life.

Where the historical cost of a depreciable asset may undergo subsequent

changes arising as a result of increase or decrease in long term liability on

account of exchange fluctuations, price adjustments, changes in duties or similar

factors the depreciation on the revised unamortised depreciable amount is

provided prospectively over the residual useful life of the asset. For example

let’s say the useful life of an asset of Rs. 600000 is 5 years. In the second year

when the net value of the asset was Rs. 480000 an additional amount of Rs.

20000 nibs capitalised on account of foreign exchange difference. The revised

unamortised amount of Rs. 500000 would be depreciated over the remaining

useful life of 4 years. therefore deprecation each year for the next 4 years

would be Rs. 125000.if the company was using the written down value method

then depreciation would be provided on the revised unamortised amount of Rs.

500000 at the WDV depreciation rate.

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DEPRECIATION ON IDLE ASSETS

Sec 205 (2) of the companies act 1956 does not deal with the manner of

provision for depreciation on assets remaining idle owing to labor trouble etc.

However since depreciation also arises out of efflux of time it would be

necessary for the purpose of section 205 to provide for depreciation even in

respect of assets which are not in use during any financial year if it plans to

declare any dividend. It may be possible that due to assets lying idle the

remaining usable life is extended, in which case a reassessment of useful life

can be made. On this basis the unamortised depreciable amount should be

charged over the revised remaining useful life, which would result in a lower

annual charge of depreciation in the future years. However as cautioned above

depreciation amount should not be lower than that determined under schedule

14 for the purposes of section 205 of the companies act. Full depreciation is

provided for even if the asset is kept in the best working condition or its market

price is gone up, since depreciation is also a factor of efflux of time.

RESIDUAL VALUE

Determination of residual value of an asset is normally a difficult matter. If such

value is considered as insignificant, it is normally regarded as nil. On the

contrary, if the value is considered as insignificant, it is estimated at the time of

acquisition / installation, or at the time of subsequent revaluation of the asset.

One of the basis for determining the residual value would be the realizable

value of similar assets, which have reached the end of their useful lives and

have operated under conditions similar to those in which the asset will be used

PRINCIPLE GOVERNING TO CHOOSE THE DEPRECIATION METHOD

There are several methods of allocating depreciation over the useful life of the

assets. Those most commonly employed in industrial and commercial

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enterprises are the straight line method and reducing balance method. The

management of a business selects the most appropriate method based on the

various important factors e.g. (i) type of asset, (ii) the nature of the use of such

asset and (iii) circumstances prevailing in the business. A combination of more

than one method is sometimes used. The method used for an asset is selected

based on the expected pattern of economic benefits and is consistently applied

from period to period unless there is a change in the expected pattern of

economic benefits from that asset. For example, a motor vehicle may provide

uniform economic benefits over several years. Therefore some enterprises may

choose to apply WDV method in the case of motor vehicle and SLM method in

the case of buildings.

DIFFERENT DEPRECIATION METHODS APPLIED FOR THE SAME CLASS OF FIXED ASSETS

The management of a business selects the most appropriate depreciation

methods based on various important factors e.g. , (i) type of asset , (ii) the

nature of the use of such asset and (iii) circumstances prevailing in the business.

A combination of more than one method is sometimes used. It is therefore

possible that plant and machinery be depreciated on WDV basis and all the

other assets on SLM basis. Sometimes different methods of depreciation of the

same class of assets used in different plants of the company can be applied if the

management considers it appropriate to do so, after taking into account

important factors such as type of assets, the nature of the use of such assets and

circumstances prevailing in the business. For example, if an enterprise is in the

business of letting out vehicles on hire it may depreciate the hired vehicles at

higher rate than compared to the vehicles which are used by its employees fro

office purposes.

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CHANGING OF DEPRECIATION METHODS

Compliance with an accounting standard or if it is considered that the change

would result in a more appropriate preparation or presentation of the financial

statements of the enterprise. When such a change in the method of depreciation

is made, depreciation is recalculated in accordance with the new method from

the date of the asset coming into use. The deficiency or surplus arising from

retrospective recomputation of depreciation in accordance with the new method

is adjusted in the accounts in the year in which the method of depreciation is

changed. In case the change in the method results in deficiency in depreciation

in respect of past years, the deficiency is charged in the statement of profit and

loss. In case the change in the method results in surplus, the surplus is credited

to the statement of profit and loss. Such a change is treated as a change in

accounting policy and its effect is quantified and disclosed.

DEPRECAITION PROVIDED ON FIXED ASSETS ADDITION/ DELETION DURING THE YEAR

Schedule XIV to the Companies Act 1956, prescribed that “where during the

year, any addition has been made to any assets, or any asset has been sold,

discarded, demolished or destroyed, the depreciation on such assets shall be

calculated on a pro rata basis from the date of such addition or, as the case may

be, up to the date on which such asset has been sold, discarded, demolished or

destroyed”.

Depreciation should be provided when the asset is installed even though not in

use (but ready to use) for the whole or part of any financial year, due to reasons

like strike, lock-out, shortage of raw materials etc. However, if the asset is not

installed and is thus not ready for being put to use, depreciation should not be

provided on them. If the company has purchased certain equipments which are

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in capital WIP, since civil work has been delayed for along period, the company

should not provide depreciation on the equipments.

PROVISIONS FOR THE DEPRECIATION ON FIXED ASSETS ITEMS BELOW Rs. 5000

As per the Schedule XIV of the Companies Act, individual items below rupees

five thousands (Rs. 5000) should be depreciated 100 %. An item of furniture

such as chair or table is capable of being used independently, therefore each

chair or table will have to be provided 100 % depreciation if its individual value

does not exceed Rs. 5000. The 100 % depreciation provision cannot be avoided

by arguing that the furniture can be used only as a set, for example, asset of

chairs, which cost Rs. 5000 (unless they are attached and fixed to each other

and one chair cannot be moved without simultaneously moving the other).

When these items are purchased during the year, the 100 % depreciation should

be pro- rated based on date of addition. In the case of plant and machinery

where the aggregated actual cost of individual items of plant and machinery

costing Rs. 5000 constituents more than 10 % of the total actual cost of plant

and machinery, normal Schedule XIV rates should be used.

INCOME TAX BASIS OF DETERMINING DEPRECIATION ACCEPTABLE IN THE FINANCIAL ACCOUNTS UNDER COMPANIES ACT 1956

After Schedule XIV coming into the force, rates higher than those under that

schedule can also be adopted on the basis of bona fide determination of the

commercial life of an asset in accordance with AS-6, which is a technical

matter. Also in such a case, proper disclosure has to be made. Therefore, a

company can follow rates prescribed under the Income Tax Act/ rules only if

these rates represent bona fide commercial depreciation.

AS-6 and schedule XIV require pro-rata depreciation to be charged in respect of

addition/ deletion to fixed assets. Therefore for purposes of Companies Act

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financial accounts, it is not appropriate to determine depreciation, after crediting

profit on sale of assets against the concerned block of assets, like it is done for

income-tax purpose. Infact profit on sale of assets needs separate recognition

and disclosure in the Companies Act financial statements.

CONTINUOUS AND NON-CONTINUOUS PRCOCESS PLANT’s DEPRCIATION DISTINGUISH

The distinction between a continuous process and non continuous process plant

is important because the continuous plant carries a depreciation rate of 5.28 %

SLM (15.33 % WDV) without any requirement to provide extra shift

depreciation as the plant has to be continuously in operation. Non continuous

process plant carries depreciation rate of 4.75 % SLM (13.91 % WDV), plus

extra-shift depreciation. Therefore treating the plant as non continuous would

result in high depreciation where a plant has worked extra-shift. Schedule XIV,

note 7 defines continuous process plant which is required and designed to

operate 24 hours a day. Guidance note on schedule XIV issued by ICAI further

clarifies that the technical design of a continuous process plant is such that there

is a requirement to run it continuously for 24 hours a day, if it is not so run,

there are significant energy loss. It is however possible that due to various

reasons, for example, lack of demand, maintenance; etc such a plant may be

shut down for some time. The shut down does not change the inherent technical

nature of the plant , for instance a blast furnace which is required and designed

to operate 24 hours a day may be shut down due to various reasons; it would

still be considered as a continuous process plant. In contrast a textile unit may

be operated for 24 hours a day, yet they are not continuous process plant

because their technical design is not such that they have to be operated for 24

hours.

In integrated steel plants, coke ovens, blast furnace, steel melting shops and

rolling mills are main plants of a steel mill. In coke ovens, blast furnaces, and

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steel melting shops there is a technological compulsion to operate 24 hours a

day, i.e., if such plants are shut down costs also. But there is no such

technological compulsion in case of rolling mills. When this matter was referred

to the EAC for opinion, it gave the following opinion: “the committee is of the

view that whether a particular rolling mill is a continuous prices plant should be

determined on the basis of the facts and technical evaluation that whether it is

both designed and required to operate 24 hours a day. The committee notes that

the argument advanced by the querist primarily emphasize the “technical

compulsion” to operate certain mills 24 hours a day. However apart from

fulfilling the aforesaid condition the plant should also be designed to operate 24

hours a day. Whether a plant is designed to operate 24 hours a day is also a

question of fact of a technical nature.

In case of a cement plant the process are lime stone minning, lime stone crusher,

raw mill/coal mill, klin and cement mill. The lime and stone are heated in the

klin, and the output generated is klinker (small particles). The klin is designed

to operate for 24 hours a day, as it operates under high temperature. Any closure

of the klin results in high power loss and thermal shock. The klinker is

processed in the cement mill too generate cement. The clinker and the cement

mill can be operated separately (non continuous) though since output of one is

input of the other, there capacities and operation have to be balanced. However,

such balancing can be done also by purchasing/selling clinker from/to third

parties the klin is designed to operate for 24 hours a day but not the other plants

in the cement factory, for example, the lime stone crusher, cement mill, coal

mill etc are not designed to operate 24 hours a day, though from capacity

balancing point of view it may be beneficial to operate them for 24 hours a day.

Therefore whereas the kiln plant may satisfy the definition of a continuous

process plant the other plants in the cement fulfill ICAI’s definition of a

continuous process plant.

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DISCLOSURE REQUIRED UNDER AS-6

The following information should be disclosed in the financial statements:

(i) The historical cost or other amount substituted for historical cost of each

class of depreciable assets;

(ii) Total depreciation for the period for each class of assets; and

(iii) The related accumulated depreciation.

The following information should also be disclosed in the financial statements

along with the disclosure of other accounting policies:

(i) depreciation methods used; and

(ii) depreciation rates or the useful lives of the assets, if they are different from

the principal rates specified in the statute governing the enterprise.

In case the depreciable assets are revalued, the provision for depreciation is

based on the revalued amount on the estimate of the remaining useful life of

such assets. In case the revaluation has a material effect on the amount of

depreciation, the same is disclosed separately in the year in which revaluation is

carried out.

A change in the method of depreciation is treated as a change in an accounting

policy and is disclosed accordingly.

Where depreciable assets are disposed of, discarded, demolished or destroyed,

the net surplus or deficiency, if material, is disclosed separately.

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AS-10: ACCOUNTING FOR FIXED ASSETS

OBJECTIVE AND SCOPE OF AS-10

Fixed Assets often comprise a significant portion of the total assets of an

enterprise, and therefore are important in the presentation of financial position.

Furthermore, the determination of whether expenditure represents an assets or

an expense can have a material effect on an enterprise’s reported results of

operations. This standard is mandatory in nature. The provisions relating to

borrowing costs, intangible assets and leases that were originally contained in

this standard were withdrawn once new accounting standards were developed in

these areas. This statement does not deal with accounting for the following

items to which special consideration apply;

Forests, plantations and similar regenerative natural resources;

Wasting assets including mineral rights, expenditure on exploration for

and extraction of minerals, oil, natural gas and similar non-regenerative

resources;

Expenditure on real estate development; and

Livestock

Expenditure on individual items of fixed assets used to develop or maintain the

activities covered in (i) to (iv) above, but separable from those activities, are to

be accounted for in accordance with this statement.

WHAT ARE FIXED ASSETS?

Fixed asset is an asset held with the intention of being used for the purpose of

producing or providing goods or services and is not held for sale in the normal

course of business. This statement deals with accounting for fixed assets such as

land, buildings, plant and machinery, vehicles, furniture and fittings, goodwill,

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patens, trademarks and designs. This statement however does not deal with

specialised aspects of accounting for fixed assets that arise under a

comprehensive system reflecting the effects of changing prices but applies to

financial statements prepared on historical cost bases. It may be appropriate to

aggregate individually insignificant items, such as moulds, tools and dies, and to

apply the criteria to the aggregate value.

ACCOUNTING FOR MACHINERY SPARES

The accounting of machinery spares is done in accordance with this statement

and not in accordance with AS-2 on ‘Inventories”. Stand-by equipment and

servicing equipment are normally capitalized. Machinery spares are usually

charged to the profit and loss statement as and when consumed. However, if

such spares can be used only in connection with an item of fixed asset and their

use is expected to be irregular, it may be appropriate to allocate the total cost on

a systematic basis over a period not exceeding the useful life of the principal

item.

In certain circumstances, the accounting for an item of fixed asset may be

improved if the total expenditure thereon is allocated to its component parts,

provided they are in practice separable, and estimates are made of the useful

lives of these components. For example, rather than treat an aircraft and its

engines as one unit, it may be better to treat the engines as a separate unit if it is

likely that their useful life is shorter than that of the aircraft as a whole

COMPONENTS OF COSTS OF FIXED ASSETS

The cost of an item of fixed asset comprise its purchase price, including import

duties and other non-refundable taxes or levies and any directly attributable cost

of bringing the asset to its working condition for its intended use; any trade

discounts and rebates are deducted in arriving at the purchase price. MODVAT

credit can be considered to be of the nature of a refundable tax. Therefore,

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MODVAT credit should be reduced from the purchase cost of capital goods

concerned. Examples of directly attributable cost are

Sites preparation;

Initial delivery and handling costs;

Installation costs, such as special foundation for plant; and

Professional fees, for example fees of architects and engineers.

The cost of a fixed asset may undergo changes subsequent to its

acquisition or construction on account of exchange fluctuations, price

adjustments, change in duties of similar factors.

Administration and other general overhead expenses are usually excluded from

the cost of fixed assets because they do not relate to a specific fixed asset.

However, in some circumstances, such expenses as are specifically attributable

to construction of a project or to the acquisition of a fixed asset or bringing it to

its working condition, may be included as part of the cost of the construction

project or as a part of the cost of the fixed asset.

The expenditure incurred on start-up and commissioning of the project,

including the expenditure incurred on test runs and experimental production is

usually capitalized as an indirect element of the construction cost. However, the

expenditure incurred after the plant has begun commercial production, i.e.

production intended for sale or captive consumptions, is not capitalised and is

treated as revenue expenditure even though the contract may stipulate that the

plant will not be finally taken over until after the satisfactory completion of the

guarantee period.

Amount paid for know-how for the plans, layout and designs of buildings

and/or design of the machinery should be capitalised under the relevant asset

heads such as buildings, plants and machinery, etc. Depreciation should be

calculated on the total cost of those assets, including the cost of the know-how

capitalised. Know-how related to the manufacturing process is usually expensed

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in the year in which it is incurred. Where the amount paid for know-how is a

composite sum in respect of both the manufacturing process as well as plans,

drawings and designs for buildings, plant and machinery, etc., the management

should apportion such consideration into two parts on a reasonable bases. If the

said costs are not directly attributable to bringing the assets concerned to their

working condition for their intended use, it should not be capitalised as part of

the cost the asset.

SELF-CONSTRUCTED FIXED ASSETS

In arriving at the gross book value of self-constructed fixed assets, the above

principles apply. Included in the gross book value are costs of construction that

relate directly to the specific asset and costs that are attributable to the

construction activity in general and can be allocated to the specific asset. Any

internal profits are eliminated in arriving at such costs.

ACCOUNTING OF COST INCURRED DURING PROJECT DELAYS AND WASTAGES

If the interval between the date a project is ready to commence commercial

production and the date at which commercial production actually begins is

prolonged, all expenses (other than borrowing costs) incurred during this period

are charged to the profit and loss statement. However, the expenditure incurred

during this period is also sometimes treated as deferred revenue expenditure to

be amortised over a period not exceeding to 3 to 5 years after the

commencement of commercial production.

Normal wastages are capitalised. Abnormal wastages are not capitalised but

charged to the profit and loss account.

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NON MONETARY CONSIDERATION FOR FIXED ASSETS:

When a fixed asset is acquired in exchange for another asset, its cost is usually

determined by reference to the fair market value of the consideration given. Fair

market value is the price that would be agreed to in an open and unrestricted

market between knowledgeable and willing parties dealing at arm’s length who

are fully informed and are not under any compulsion to transact. It may be

appropriate to consider also the fair market value of the asset acquired if this is

more clearly evident. An alternative accounting treatment that is sometimes

used for an exchange of assets, particularly when the assets exchanges are

similar, is to record the asset acquired at eh net book value of the asset given up

in each case; an adjustment is made for any balancing receipt or payment of

cash or other consideration. When a fixed asset is acquired in exchange for

share or other securities in the enterprise, it is usually recorded at its fair market

value, or the fair market value of the securities issued, whichever is more

clearly evident.

SUBSEQUENT EXPENDITURE INCURRED ON FIXED ASSETS AFTER INITIAL CAPITALISATION ACCOUNTED

Frequently, it is difficult to determine whether subsequent expenditure related to

fixed asset represents improvements that ought to be added to the gross book

value or repair that ought to be charged to the profit and loss statement. Only

expenditure that increases the future benefits from the existing asset beyond its

previously assessed standard of performance is included in the gross book

value, e.g., an increase in capacity or structural alteration to a building that

increases the strength of the building beyond its original strength. Examples of

improvements which result in increased future economic benefits include:

Modification of an item of plant to extend its useful life, including an

increase in its capacity;

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Upgrading machine parts to achieve a substantial improvement in the

quality of output; and

Adoption of new production processes enabling a substantial

reduction in previously assessed operating costs

While deciding whether subsequent expenditure resulted in an increase in the

future benefits from the asset or not, recognition should be given both to the

increase in the benefits ‘per annum’ as well as increase in benefits through

extension of the life of the asset. Thus, even if there was no increase in the

annual capacity, but the life of the asset was substantially increased, it would be

taken as an increase in the future benefits from the concerned asset beyond its

previously assessed standard of performance. The expenditure on regular

overhauling only results in maintaining the previously estimated standard of

performance and it does not have the effect of improving the previously

assessed of performance. Lets consider an example, where a land right is in

dispute when it was acquired by an enterprise. The enterprise subsequently

incurred legal expenses and got all the land rights transferred in its favour. This

expenditure should be capitalised because it increases the value of the land

beyond its original assessed standard of performance. Lets consider another

example. An enterprise purchases a land on which there is not dispute.

Subsequent to the acquisition there is encroachment of land. The enterprise

incurs legal expenses to vacate the encroachers. This expenditure cannot be

capitalised because it does not increase the value of the land beyond its original

assessed standard of performance.

The cost of an addition or extension to an existing asset which is of a capital

nature and which becomes an integral part of the existing asset is usually added

to its gross books value.

Expenditure on repairs or maintenance of property, plant and equipment is made

to restore or maintain the future economic benefits that an enterprise can expect

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from the originally assessed standard of performance of the asset. As such, it is

usually recognised as an expense when incurred. For example, the cost of

servicing or overhauling plant and equipment is usually an expense since it

restores, rather than increase, the originally assessed standard performance.

BASIS FOR REVALUATION OF FIXED ASSETS AND USE OF REVALUATION RESERVE FOR DECLARING DIVIDENDS OR ISSUING BONUS SHARES

Sometimes financial statements that are otherwise prepared on a historical cost

basis include part or all of the fixed assets at a valuation in substitution for

historical costs and depreciation is calculated accordingly. A commonly

accepted and preferred method of restating assets is by appraisal, normally

undertaken by competent valuer’s. Other methods are used are indexation and

reference o the current prices which when applied across checked periodically

by appraisal method. According to Schedule VI of Companies Act, every

balance sheet susbsequent to revaluation shall disclose the increased figure with

the date of increase in place of original cost for all the first 5 years. The fact of

revaluation will be disclosed in all the future balance sheets till such time the

revalued assets appear in the company’s balance sheet.

Revaluation reserve is a reserve that represents the excess of the estimated

replacement cost or estimated market values over the book values thereof. As

the revaluation reserve is a not a realized gain, it is not available for distribution

of dividends or issue of bonus shares , or writing off accumulated losses or

profit and loss debit balance or clearing backlog of depreciation of arrears etc.

SEBI also prohibits use of revaluation reserve for purpose of declaring bonus

shares.

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PRINCIPLES FOR SELECTION OF FIXED ASSETS FOR REVALUATION

When a fixed asset is revalued in financial statements, an entire class of assets

should be revalued, or the selection of assets for revaluation should be made on

a systematic basis. This basis should be disclosed. Selective revaluation of

assets can lead to unrepresentative amounts being reported in financial

statements. Accordingly, when revaluations do not cover all assets of given

class, it is appropriate that the selection of assets to be made on a systematic

basis. e.g an enterprise may be revalued a whole class of assets within a unit.

ACCOUNTING TREATMENT FOR REVALUATION

It is not appropriate for the revaluation of a class of assets to result in the net

book value of that class being greater than the recoverable amount of the assets

of that class. Therefore revaluation would be restricted to the recoverable

amount of the fixed assets. The revalued amounts of fixed assets are presented

in financial statements either by restating both the gross book value and

accumulated depreciation so as to give a net book value equal to the net

revalued amount or by restating the net book value by adding therein the net

increase on account revaluation. An upward revaluation does not provide a basis

for crediting to the profit and loss statement the accumulated depreciation

existing at the date of revaluation.

As increase in net book value arising on revaluation of fixed assets should

credited directly to owner’s interests under the head of revaluation reserves,

except that, to the extent that such increase is related to and not greater than a

decrease arising on revaluation previously recorded as a charge to the profit and

loss statement, it may be credited to the profit and loss statement. A decrease in

net book value arising on revaluation of fixed asset should be charged directly

to the profit and loss statement except that to the extent that such a decrease is

related to an increase which was previously recorded as a credit to revaluation

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reserve and which has not been subsequently reserved or utilised, it may be

charged directly to that account.

Depreciation under AS-6 should be provided on the total value of the fixed asset

including the revalued protion. Depreciation on the revalued portion of the fixed

asset can either be charged to the profit and loss account or alternatively

charged to the profit and loss account and at the same time compensated from

the revaluation reserve such that the net charge to the profit and loss account is

nil.

ACCOUNTING OF RETIREMENTS AND DISPOSALS

Fixed asset should be eliminated from the financial statements on disposal or

when no further benefit is expected from its use and disposal. Items of fixed

assets that have been retired from active use and are held for disposal are stated

at the lower of their net book value and realisable value and are shown

separately in the financial statements. Any expected loss is recognized

immediately in the profit and loss statements. In historical cost financial

statements, gains or losses arising on disposal are recognised in the profit and

loss statement. Paragraph 24 of Accounting Standard (AS) 10, ‘Accounting for

Fixed Assets’ states that “Material items retired from active use and held for

disposal should be stated at the lower of their net book value and net realisable

value and shown separately in the financial statements.” The fixed assets which

are retired from active use and dismantled and are not actually sold off, should

be disclosed appropriately at the lower of net realisable value and net book

value in the Schedule of Fixed Assets or on the face of the balance sheet under

the head Fixed Assets. These items cannot be disclosed under the caption

‘inventories’

On disposal of a previously revalued item of fixed asset, the difference between

net disposal proceeds and the net book value should be charged or credited to

the profit and loss statement except that to the extent that such a loss is related

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to an increase which was previously recorded or utilised, it may be charged

directly to that account. The amount standing in revaluation reserve following

the retirement or disposal of an asset which relates to that asset may be

transferred to general reserves.

TREATMENT FOR JOINTLY OWNED FIXED ASSETS

Where an enterprise owns fixed assets jointly with other (otherwise than as a

part in a firm), the extent of its share in such assets, and the proportion in the

original cost, accumulated depreciation and written down values are stated in

the balance sheet. Alternatively, the pro rata cost of such jointly owned assets is

grouped together with similar fully owned assets with an appropriate disclosure

thereof. Details of such jointly owned assets are indicated separately in the fixed

assets register.

AMORTISATION/ DEPRECIATION OF GOODWILL

Goodwill, in general, is recorded in the books only when some consideration in

money or money’s worth has been paid for it. Whenever, a business is acquired

for a price (payable either in cash or in shares or otherwise) which is in excess

of the value of the net assets of the business taken over, the excess is termed as

‘goodwill’. Goodwill arises from business connections, trade name or reputation

of an enterprise or from other intangible benefits enjoyed by an enterprises.

Where several fixed assets are purchased for a consolidated price, the

consideration should be apportioned to the various assets on a fair basis as

determined by competent value. As a matter of financial prudence, goodwill is

written off over a period of 3-5 years.

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DISCLOSURES OF FIXED ASSETS

In addition to disclosures required to be made under AS-1 and AS-6, further

disclosures under AS-10 are as follows:

(i) Gross and net book values of fixed assets at the beginning and end of an

accounting period showing additions, disposals, acquisitions and other

movements;

(ii) Expenditure incurred on account of fixed assets in the course of

construction or acquisition; and

(iii) Revalued amount substituted for historical costs of fixed assets, the basis

of selection of fixed assets for revaluation, the method adopted to

compute the revalued amount, the nature of any indices used, the year of

any appraisal made, and whether an external valuer was involved, in case

where fixed assets are stated at revalued amounts.

For purposes of Schedule VI, the revalued amounts of each class of fixed assets

are presented in the balance sheet separately, by restating both the gross book

value and accumulated depreciation so as to give a net book value to a new

revalued amount. It is not correct to net off the increase/decrease in net-book

value arising from revaluation of various classes of fixed assets, for example,

machinery and building.

SIGNIFICANT DIFFERENCES BETWEEN AS-10, IAS AND US GAAP

Fixed assets are more elaborately defined under IAS and US GAAP. For

example according to IAS-16, an item of property, plant and equipment should

be recognised as an asset when (a) it is probable that future economic benefits

associated with the asset will flow to the enterprise; and (b) the cost of the asset

to the enterprise can be measured reliably. Though these provision not

contained in AS-10 it is assumed that they would apply even in the Indian

situation.

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US GAAP does not permit revaluation of fixed assets. As regards upward

revaluation of fixed assets, IAS-16 permits it as an alternative treatment.

Revaluation is also permitted under AS-10, such as (a) IAS provides more detail

guidelines than AS-10 on revaluation principles (b) Under IAS-16, revaluations

are required to be done with sufficient regularity such that their carrying amount

do not differ materially from the fair values. There is no such requirement in

AS-10. IAS-16 also states that annual revaluations are important where fixed

asset fair values are subject to significant volatility, otherwise a revaluation

every three or five year is sufficient.

Under AS-10 if the interval between the date a project is ready to commence

commercial production and the date at which commercial production actually

begins is prolonged, all expenses (other than borrowing costs) incurred during

this period are charged to the profit and loss statement. However, the

expenditure incurred during this period is also sometimes treated as deferred

revenue expenditure to be amortised over a period not exceeding 3 to 5 years

after the commencement of commercial production. Under IAS/US GAAP

deferral of expenditure is not permitted, and all expenses incurred in these

circumstances are charged to the profit and loss account.

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AS-12 : GOVERNMENT GRANTS

Accounting for Government Grants

Capital Approach versus Income Approach

Recognition of Government Grants

Non-monetary Government Grants

Presentation of Grants Related to Specific Fixed Assets

Presentation of Grants Related to Revenue

Presentation of Grants of the nature of Promoters’ contribution

Refund of Government Grants

Disclosure

Statements of Accounting Standards

The following is the text of the Accounting Standard (AS) 12 issued by the

Council of the Institute of Chartered Accountants of India on ‘Accounting for

Government Grants’.

The Standard comes into effect in respect of accounting periods commencing on

or after 1.4.1992 and will be recommendatory in nature for an initial period of

two years.

Accordingly, the Guidance Note on ‘Accounting for Capital Based Grants’

issued by the Institute in 1981 shall stand with drawn from this date. This

Standard will become mandatory in respect of accounts for periods commencing

on or after 1.4.1994.2

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Introduction

1. This Statement deals with accounting for government grants. Government

grants are sometimes called by other names such as subsidies, cash

incentives, duty drawbacks, etc.

2. This Statement does not deal with:

The special problems arising in accounting for government grants in

financial statements reflecting the effects of changing prices.

Accounting Standards are intended to apply only to items which are

material.

Reference may be made to the section titled ‘Announcements of the

Council Regarding status of various documents issued by the Institute

of Chartered Accountants of India’ appearing at the beginning of this

Compendium for a detailed discussion on the implications of the

mandatory status of an accounting standard.

Definitions

The following terms are used in this Statement 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.

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Explanation

The receipt of government grants by an enterprise is significant for Preparation

of the financial statements for two reasons. Firstly, if a government grant has

been received, an appropriate method of accounting there for is necessary.

Secondly, it is desirable to give an indication of the extent to which the

enterprise has benefited from such grant during the reporting period. This

facilitates comparison of an enterprise’s financial statements with those of prior

periods and with those of other enterprises.

Accounting Treatment of Government Grants

Capital Approach versus Income Approach

Two broad approaches may be followed for the accounting treatment of

government grants: the ‘capital approach’, under which a grant is treated

as part of shareholders’ funds, and the ‘income approach’, under which a

grant is taken to income over one or more periods.

Those in support of the ‘capital approach’ argue as follows:

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 should, therefore,

be credited directly to shareholders’ funds.

It is inappropriate to recognise government grants in the profit and loss

statement, since they are not earned but represent an incentive provided

by government without related costs.

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Arguments in support of the ‘income approach’ are as follows:

Government grants are rarely gratuitous. 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.

As income tax and other taxes are charges against income, it is logical to

deal also with government grants, which are an extension of fiscal

policies, in the profit and loss statement.

In case grants are credited to shareholders’ funds, no correlation is done

between the accounting treatment of the grant and the accounting

treatment of the expenditure to which the grant relates.

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 as part of shareholders’ funds. Income approach may be more

appropriate in the case of other grants.

It is fundamental to the ‘income approach’ that government grants be

recognised in the profit and loss statement on a systematic and rational

basis over the periods necessary to match them with the related costs.

Income recognition of government grants on a receipts basis is not in

accordance with the accrual accounting assumption.

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Recognition of Government Grants

Government grants available to the enterprise are considered for inclusion in

accounts:

Where there is reasonable assurance that the enterprise will comply with

the conditions attached to them; and

Where such benefits have been earned by the enterprise and it is

reasonably certain that the ultimate collection will be made.

Mere receipt of a grant is not necessarily a conclusive evidence that

condition attaching to the grant have been or will be fulfilled.

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.

Non-monetary assets given free of cost are recorded at a nominal value.

Presentation of Grants Related to Specific Fixed Assets

Grants related to specific fixed assets are government grants whose

primary condition 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 in financial statements of grants (or the

appropriate portions of grants) related to specific fixed assets are regarded

as acceptable alternatives.

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Under one 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 charge. Where the

grant equals the whole, or virtually the whole, of the cost of the asset, the

asset is shown in the balance sheet at a nominal value.

Under the other method, grants related to depreciable assets are treated 4

AS 5 has been revised in February 1997. The title of revised AS 5 is ‘Net

Profit or Loss for the Period, Prior Period Items and Changes in

Accounting Policies’. 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 under this method, 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’ with a suitable

description.

The purchase of assets and the receipt of related grants can cause major

movements in the cash flow of an enterprise. For this reason and in order

to show the gross investment in assets, such movements are often

disclosed as separate items in the statement of changes in financial

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position regardless of whether or not the grant is deducted from the

related asset for the purpose of balance sheet presentation.

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.

Supporters of the first method claimt hat it is inappropriate to net income

and expense items and that separation of the grant from the expense

facilitate comparison with other expenses not affected by a grant. For the

second method, it is argued that the expense might well not have been

incurred by the enterprise if the grant had not been available and

presentation of the expense without offsetting the grant may therefore be

misleading.

Presentation of Grants of the nature of Promoters’ contribution

Where the government grants are of 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

(for example, central investment subsidy scheme) 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 are not fulfilled. A government grant that becomes refundable

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is treated as an extraordinary item (see Accounting Standard (AS) 5, Prior

Period and Extraordinary Items and Changes in Accounting Policies5).

The amount refundable in respect of a government grant related to

revenue 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.

The amount refundable in respect of a government grant related to a

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 the first alternative, i.e., where

the book value of the asset is increased, depreciation on the revised book

value is provided prospectively over the residual useful life of the asset.

Where a grant which is in the nature of promoters’ contribution becomes

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.

Disclosure

The following disclosures are appropriate:

The accounting policy adopted for government grants, including the

methods of presentation in the financial statements; the nature and extent

of government grants recognised in the financial statements, including

grants of non-monetary assets given at a concessional rate or free of cost.

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Government grants should not be recognised until there is reasonable

assurance that (i) the enterprise will comply with the conditions attached

to them, and (ii) the grants will be received.

Government grants related to specific fixed assets should be presented in

the balance sheet by showing the grant as a deduction from the gross

value of the assets concerned in arriving at their book value. Where the

grant related to a specific fixed asset equals the whole or virtually the

whole, of the cost of the asset, the asset should be shown in the balance

sheet at a nominal value. Alternatively, government grants related to

depreciable fixed assets may be treated as deferred income which should

be recognised in the profit and loss statement on a systematic and rational

basis over the useful life of the asset, i.e., such grants should be allocated

to income over the periods and in the proportions in which depreciation

on those assets is charged. Grants related to non-depreciable assets should

be credited to capital reserve under this method. However, if a grant

related to a non-depreciable asset requires the fulfillment of certain

obligations, the grant should be credited to income over the same period

over which the cost of meeting such obligations is charged to income.

The deferred income balance should be separately disclosed in the

financial statements.

Government grants related to revenue should be recognised on a

systematic basis in the profit and loss statement over the periods

necessary to match them with the related costs which they are intended to

compensate. Such grants should either be shown separately under ‘other

income’ or deducted in reporting the related expense.

Government grants of the nature of promoters’ contribution should be

credited to capital reserve and treated as a part of shareholders’ funds.

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Government grants in the form of non-monetary assets, given at a

concessional rate, should be accounted for on the basis of their

acquisition cost. In case a non-monetary asset is given free of cost, it

should be recorded at a nominal value.

Government grants that are receivable as compensation for expenses or

losses incurred in a previous accounting period or for the purpose of

giving immediate financial support to the enterprise with no further

related costs, should be recognised and disclosed in the profit and loss

statement of the period in which they are receivable, as an extraordinary

item if appropriate.

A contingency related to a government grant, arising after the grant has

been recognised, should be treated in accordance with Accounting

Standard (AS) 4, Contingencies and Events Occurring After the Balance

Sheet Date.7

Government grants that become refundable should be accounted for as an

extraordinary item.

The amount refundable in respect of a grant related to revenue should be

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 should be

charged to profit and loss statement.

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 the capital reserve or the deferred income balance, as

appropriate, by the amount refundable. In the first alternative, i.e., where

the book value of the asset is increased, depreciation on the revised book

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value should be provided prospectively over the residual useful life of the

asset.

Government grants in the nature of promoters’ contribution that become

refundable should be reduced from the capital reserve.

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Bibliography

Compendium of Accounting Standards

ICAI – Institute of Chartered Accountants of India

Student Guide to Indian Accounting Standard & GAAP

www.icai.org

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Documents

Accounting Standards - Final Project Report