Chapter- GUIDANCE NOTES AND ACCOUNTING STANDARDS GUIDANCE ... · BY CA SURENDRA AGRAWAL(M.com,LL.B,ACA) PH-9313336776 Page 1 GUIDANCE NOTES AND ACCOUNTING STANDARDS GUIDANCE NOTES

BY CA SURENDRA AGRAWAL(M.com,LL.B,ACA) PH-9313336776 Page 1

GUIDANCE NOTES AND ACCOUNTING STANDARDS

GUIDANCE NOTESTreatment of Reservecreated on Revaluation ofFixed Assets

As a statutory auditor of a Public Limited Company, how would you dealwith the following situation: As at the beginning of the year, the companyhas a capital of Rs. 2.50 crores, free reserves of Rs. 0.50 crores andRevaluation Reserve of Rs. 4.50 crores. In the relevant year under audit thecompany has incurred a loss of Rs. 4 crores. The company proposes to adjustthe loss with the Revaluation ReserveAnswer. Adjustment of Loss against Revaluation Reserve:Relevant Provisions: Guidance Note on "Treatment of Reserve created onRevaluation of Fixed Assets" states that where the value of fixed assets iswritten up in the books of account of a company, the corresponding creditappearing as revaluation reserve does not represent a realised gain and is,therefore, not available for distribution as dividend. Therefore anyaccumulated losses/depreciation (including arrears) should not be adjustedagainst revaluation reserve since this would amount to setting off actual lossesagainst unrealized gains.Conclusion: The auditor should explain to the management that accumulatedlosses cannot be adjusted against the revaluation reserve created onrevaluation of the fixed assets. In case the company in question does so, thebalance sheet of the company will not reflect a true and fair view of the state ofaffairs of the company, keeping in view the magnitude of the amountsinvolved, ie., accumulated losses amount to Rs. 4 crores and share capital andreserves amount to Rs. 3 crores (excluding revaluation reserve).If the management does not agree with the opinion of the auditor, the auditormay even issue an adverse report.

Guidance Note onprovision for liability fortaxation

As a Statutory auditor, how would you deal with following: Whilefinalizing its accounts, a company does not provide for Income-tax payableunder the provisions of the Income-tax Act, 1961. A note is however giventhat since adequate tax has been deducted at source, no additional tax ispayable. [Nov. 08 - old (5 marks)]Answer. No provisions for Income Tax Payable:♦ Guidance Note on provision for liability for taxation, provides that theprovision for anticipated tax liability in respect of profits of the company hasto be made while finalizing its accounts.♦ According to it, non-provision for taxation would amount to contraventionof the provisions of sections 209 and 211 of the Companies Act ie. maintenanceof proper books of account and disclosures of true and fair view of the state ofaffairs of the company.Conclusion: Auditor is required to quality his report and such qualificationshould bring out in what manner the accounts do not disclose "True and Fair"view of the state of affairs of the Company and its Profit or loss. However, thequalification should also mention clearly that TDS is in excess of the estimatedtax liability for the year.

Terms used in F.S Comment on the following: S Ltd. issued Bonds to the tune of f 100 lacs andprovided security to the tune of Rs. 80 lacs for the same. It insists that it will

Chapter-


disclose the Bonds as "Secured" in the Balance Sheet of the Company.[may 10 - NEW (5 marks)]Answer.♦ Prima facie, the Bonds issued to the tune of Rs. 100 lacs are provided withsecurity to the tune of Rs. 80 lacs ie. neither fully secured nor unsecured.♦ Guidance Note on the "Terms used in Financial Statements" issued by ICAI,states "Secured Loans" as loan secured wholly or partly against an asset.Conclusion: Bonds should be classified under 'Secured Loans' for the purposeof disclosure in the Balance Sheet. However the nature of security should beclearly specified.

Accounting for Creditavailable in respect of MATunder the IT Act, 1961

As a Statutory Auditor, how would you deal with the following: For the yearended 31 st March, 2011, a company has paid Minimum Alternative Taxunder section 115JB of the Income-tax Act, 1961. The company wants todisclose the same as an 'Asset' since the company is eligible to claim creditfor the same. [Nov. 09 - new (5 marks)]Answer. Disclosure of MAT paid as an Asset:♦ As per Guidance Note on "Accounting for Credit available in respect of MATunder the IT Act, 1961", although MAT credit is not a deferred tax asset underAS 22, yet it give rise to expected future economic benefit in the form of adjustment of future income-tax liability arising within the specified period.♦ The Framework for the Preparation and Presentation of FinancialStatements, issued by the ICAI, defines the term asset' as follows: "An asset isa resource controlled by the enterprise as a result of past events from whichfuture economic benefits are expected to flow to the enterprise."♦ MAT paid in a year in respect of which the credit is allowed during thespecified period under the Income Tax Act is a resource controlled by thecompany as a result of past event, namely the payment of MAT.♦ MAT credit has expected future economic benefits in the form of itsadjustment against the discharge of the normal tax liability if the same arisesduring the specified period. Accordingly, MAT credit is an asset.Conclusion: If the auditor is satisfied that the probability of the company toclaim the said credit is high, it could recognize the same as an asset. In balancesheet it should be shown under the head "Loans & Advances" as "MAT creditentitlement".

Revised Accounts ofCompanies BeforeCirculation to Shareholders

Comment on the following: The statutory audit of Fortune Limited for theyear ended on 31-3-2009 was completed and auditor also submitted hisreport with the audited Financial Statements to the management of thecompany. Thereafter, the management of the company approached theauditor to revise certain items in the Financial Statements.[NOV. 09 - NEW 15 marks)]ORA company wants to amend its accounts after the completion of the auditand adoption of the Accounts by the Board, but before circulation to theshareholders. It requires its statutory auditor to report on the amendedaccounts. State the steps the statutory audit should adopt in such a situation.Answer. Revision of F.S.:As per the Guidance Note on Revised Accounts of Companies BeforeCirculation to Shareholders, Mngt. can revise its accounts after adoption onwhich report has been issued by the Auditors, but before circulation to theshareholders.In the instant case, the statutory auditor should ascertain whether the originalaudit report along with audited accounts has been circulated to the


shareholders.If not, he can issue a revised report on the amended F.S. subject to following:(i) Revised accounts must be re-approved by the Board of Directors of thecompany.(ii) Ask the company to return all the original copies of the earlier audit reportalong with the audited accounts.(iii) The fact of revision of F.S. with reasons should be incorporated in theDirectors' Report. If it is neither included nor found adequately disclosed inthe Director's Report, auditor should include the fact with figures and reasonsin his revised audit report to the shareholders.(iv) Mention specifically that it is a revised audit report.

Audit of Payment ofDividend

State your views as an auditor on the following: During the year under auditZ Ltd. credited to the P & L Account, the entire profit of Rs. 20 lakhs on thesale of land not required for its use. You are informed that the directorswould like to propose dividend out of the above profitAnswer. Payment of dividend out of Capital profits:Profit of Rs. 20 lakhs on the sale of land is a capital profit. It represents theexcess of sale value over the original cost of the asset, ie. capital profits.As per Guidance Note on "Audit of payment of Dividend" the capital profitscan be distributed by a company only if all the following conditions arefulfilled:1. The articles of association should permit distribution of capital profits.2. The capital profit which is sought to be distributed should have actuallybeen realised.3. The capital profit should remain after a proper valuation has been fairlytaken of the whole of the assets and liabilities.Conclusion : The profit arise on sale of land is realized in cash and hencesubject to satisfaction of other conditions can be distributed as dividenddistributable.

Accounting for Derivatives As an auditor, how would you deal with the following: XY Ltd. had enteredinto derivative transactions in foreign currency which were based onprobable export orders. As at the year end on 31st March, 2011, the mark-to-market (MTM) loss on the said derivatives was Rs. 250 lakhs. The companycontends that since the MTM loss is notional and likely to be recouped inthe next year, the same need not be provided for. [NOV. 09 - OLD (5MARKS)]Answer. Derivative transactions (MTM) Loss:As per ICAI announcement on "Accounting for Derivatives" the entity isrequired to provide for losses in respect of all outstanding derivative contractsat the balance sheet date by marking them to market, keeping in view theprinciple of prudence as enunciated in AS 1 "Disclosure of AccountingPolicies".Conclusion: In the given case, XY Ltd. should provide for mark to-market(MTM) losses amounting Rs. 250 Lakhs. Auditors, should consider for makingappropriate disclosures in their reports if the aforesaid accounting treatmentand disclosures are not made by the company.


ACCOUNTING STANDARDS

Applicability of AS ♦ The Preface to the Statements of AS clarifies that the ASs areissued "for use in the presentation of G.P.F.S. issued to thepublic by such commercial, industrial or business enterprises, asmay be specified by the Institute from time to time and subjectto the attest function of its members.♦ The term "G.P.F.S. includes balance sheet, statement of profitand loss and other statements and explanatory notes whichform part thereof, issued for use of shareholders/members,creditors, employees and public at large".♦ As far as companies, whether limited or unlimitedincorporated under the Companies Act, 2013 are concerned, allsuch companies are expected to adhere to specified AS in termsof section 133 of the said Act.♦ The compliance with AS has to be examined by the auditorswhile auditing general purpose F. S. which are statutorilyrequired to be audited under any law. Thus, compliance withAS is required to be examined by an auditor in an audit of F. S.of individuals and noncorporate enterprises (for example:Partnership firms, Societies, trusts, HUF, AOP) only where theF.S. are statutorily required to be audited under any law.♦ The AS are also applicable to commercial, industrial orbusiness activities of even charitable or religious organisations.Accounting Standards do not apply to those organisationswhose entire activities are not of commercial, industrial orbusiness nature, e.g., an organisation collecting donations tofinance education of poor children. However, even if a verysmall proportion of the activities of an entity is commercial,industrial or business in nature, the accounting standards willapply to all its activities.

Q. No. 1 Comment: The AS issued by the ICAI need to be followed onlyby limited companies and not by partnership firms orproprietorships.

Q. No. 2 As an auditor, how would you deal with the following: In theaudit of an organization whose objects are charitable orreligious, the organization holds that the Accounting Standardsare not applicable to it since only a very small proportion of itsactivities are business in nature.[MAY 09 - OLD (5 MARKS;

AS-2Q. No. 1 A company was engaged in the business of buying 1MFL

(Indian Made Foreign Liquor) and beer and selling samethrough retail vending shops and bars run by it. The companysold beer to some of the customers who consumed them inbars run by it and left the bottles behind. (Technically, thesebottles were the property of the customers.) These bottleswere later on disposed off by the company. Answer the


followings:1. Are these bottles left behind by the customers "assets" ofthe company?.2. Are they "inventories"?.3. If they are "inventories", how they should be valued?.4. Can the "bottles" be valued at net realisable value andtreated as "income"?.

Answer. 1. An asset is a resource controlled (not necessarily "owned") byan enterprise as a result of past events from which futureeconomic benefits to the enterprise are expected. In assessingwhether an item meets the above definition of "assets", theconsideration should be given to economic reality and substanceand not merely legal form. Accordingly, the bottles can beconsidered as "assets" of the company.2. The stock of empty bottles is "inventory" as the companyholds them for sale in the ordinary course of its business ofrunning the bars.3. These bottles should be valued at the lower of cost and NRV.However, the cost of purchase and selling price of beer/IMFLare both inclusive of cost of bottles as beer/ IMFL cannot besold without bottles - the primary packing. Practically, theempty bottles do not appear to cost anything to the company (ie.zero cost), if that be the case, the bottles should be reflected atnominal value of Rs. 1.4. It would not be correct to value the bottles at NRV with creditbeing given to "income" as the bottles have not been sold at thebalance sheet date.

Q. No. 4 As an auditor state your views on the following: Includedunder Current Assets of XYZ Ltd. is inventory aggregating toRs. 20 crores. A part of the said inventory manufactured forexport had to be sold earlier at a discounted price offshore dueto moisture content present at the time of delivery. A part ofsimilar inventory is included in Rs. 20 crores.

Answer ♦ Auditor is required to examine what part of the inventory isincluded in the inventory valued at Rs. 20 crores.♦ He will also have to satisfy himself that whether such part leftwith the company has also been damaged on account ofmoisture content.♦ If required, the auditor may obtain a certificate from an expertabout the condition of the inventory.♦ Thereafter, it should be verified whether the principle ofvaluation enunciated in AS 2 "Valuation of Inventories" havebeen followed. The standard requires that the inventoriesshould be valued at the lower of cost or NRV.Conclusion: In the present case the auditor shall satisfy himself whether thebalance inventory lying with the company is carrying the same qualityissue. If yes, than value of inventory will be revised based on its NRV(iflower than cost).


Q. No. 5 The management tells you that WIP is not valued since it isdifficult to know the same in view of multiple processesinvolved and in any case opening and closing WIP would bemore or less the same.

Answer. Valuation of WIP: As per AS-2, "Valuation of inventories"inventories includes any item held in the process of production.This is known as WIP.Company is required to find out the stage of completion ofproducts and value of the same. In certain cases, due to natureof the product and the manufacturing process involved,physical verification of WIP may be impracticable. But in suchcases, the advice of an expert can be taken. The value of suchWIP is normally done by taking the basic raw material cost andadding thereto the proportionate factory overhead cost incurredup to the stage of completion.Valuation of WIP is important due to following:♦ WIP is an item of Manufacturing, Trading & Profit & Loss A/cand also forming part of current assets, is relevant and can notbe ignored. Omitting WIP will result in under or over statementof profit and current assets.♦ Part II of Schedule VI to the Companies Act also prescribesthat the figures of opening and closing balances of stock andWIP be disclosed in the profit & loss account. Part I of the sameschedule requires that the mode of valuation of stock be shownin the Balance Sheet.Conclusion: The argument of the management that the openingand closing WIP would be more or less the same is not justifiedbecause the cost incurred for raw materials and overheadswould be different and would give different value of openingand closing WIP. Taking into consideration all the aboveaspects, management is wrong and if WIP is not valued or takeninto consideration, auditor should qualify his report.

AS - 4Q. No. 6 During the course of audit of D Co. Ltd. you as an auditor

have observed that Inter corporate deposit of f 50 lakhs hasbeen over due. The D Co. Ltd. has disclosed this in the notesto accounts note No. 15 in schedule No. 21 stating that X 50lakhs is over due from XYZ Co. Ltd. and the said company isin the process of liquidation. The management is taking stepsto appoint the liquidator.' [NOV. 10 - NEW (5 MARKS)]

Answer. As per AS 4 "Contingencies and Events occurring after theBalance Sheet Date", adjustments to assets and liabilities arerequired for events occurring after the balance sheet date thatprovide additional information materially affecting thedetermination of the amounts relating to conditions existing atthe balance sheet date.In the instant case, it appears from the note No. 15 that the


overdue of outstanding inter corporate deposit may not berealisable in full. The company is in the process of liquidatio-makes it clear that on the balance sheet date, the amount erfdeposit is not safe and is not likely to be realised.Conclusion: As per AS 4 provision for the loss was required inthe accounts. Accordingly, auditor should qualify the AuditReport.

Q. No. 7 State your views as an auditor on the following: V Ltd. hadannounced a voluntary retirement plan for its employees onJanuary 1,2010. The scheme is scheduled to close on June 30,2010. The scheme envisaged an initial lump sum payment ofmaximum of Rs. 2 lakhs and monthly payments over thebalance period of service of employees coming under the plan.200 employees opted for the scheme as on March 31, 2010. Thetotal lump sum payment for these employees would be Rs. 250lakhs and the aggregate of future payments to them wouldamount to Rs. 1,500 lakhs. However, no payment had beenmade to the employees under the scheme up to March 31,2010. Nor the company made any provision in its accountstowards any liability under the scheme.

Answer Event occurring after the B/S Date:Relevant Provision: As per AS-4 on 'Contingencies and EventsOccurring After the Balance Sheet Date', assets and liabilitiesshould be adjusted for events occurring after the balance sheetdate that provide additional evidence to assist the estimation ofamounts relating to conditions existing at the balance sheet dateor that indicate that the fundamental accounting assumption ofgoing concern is not appropriate.Facts of the case: A condition existed on the balance sheet date(31st March, 2010) regarding the liability towards the VoluntaryRetirement Plan since the management started the scheme in themonth of January, 2010 and 200 employees opted for the schemeas on March 31, 2010.Conclusion: Since it was probable that future events willconfirm that a liability has been incurred on the balance sheetdate and that the amount could be estimated on reasonablebasis, a provision for payments under the scheme would berequired to be made for an appropriate amount for the aforesaidnumber of employees.

Q. No. 8 Arya Ltd. was under audit for the year ended 31-3-2010. Anappeal filed by Arya Ltd. against the demand of Excise Dutyof Rs. 26 crores was pending before the Supreme Court forwhich neither provision was made nor was disclosed in thenotes to the financial statements. On 12th July, 2010, theauditor came to know through paper reports that the pointinvolved in the appeal of Arya Ltd. was adjudicated by theSupreme Court in the case of some other assessee, which is in


favour of the department of Excise Duty. The auditor insistedthat provisions be made of Rs. 26 crores in the financialstatements. The Management was of the view that since itsown case is still pending, no provision is called for. It was alsoof the view that the event does not have any effect on thefinancial position of the company on the date of the BalanceSheet. Is the view of the Management tenable.?

Answer. Subsequent Events: Relevant Provisions:♦ As per AS-4 on 'Contingencies and Events Occurring After theBalance Sheet Date', assets and liabilities should be adjusted forevents occurring after the balance sheet date that provideadditional evidence to assist the estimation of amounts relatingto conditions existing at thebalance sheet date or that indicatethat the fundamental accounting assumption of going concern isnot appropriate.♦ SA 560 on "Subsequent Events" lays down that the "auditorshould consider the effect of subsequent events on the F.S. andon the auditor's report".Explanation:♦ The issue involved in the appeal of Arya Ltd. was similar tothe point in case of some other company and since the appeal ofthat company was decided against that company and in favourof the Excise Department, it is necessary for Arya Ltd. to make aprovision of Rs. 26 crores.Conclusion: The view of the management that its own appeal isundecided or that it has no effect on the financial position as on31-3-2006 is not at all tenable. Since the financial position ismaterially affected, the auditor should express a qualifiedopinion or an adverse opinion as may be appropriate

AS - 5Q. No. 10 As a statutory auditor, how would you deal when PQ Ltd., as

part of overall cost cutting measure announced voluntaryretirement scheme (VRS) to its employees, to reduce theemployee strength. During the first half year ended 30-9-2010the company paid a compensation of Rs. 72 lakhs to those whoavailed the scheme. The Chief Accountant has reflected thispayment as part of regular salaries and wages paid by thecompany. Is this correct?.

Answer. Treatment of Ordinary activity with large amount:♦ As per AS 5, "Net Profit or Loss for the Period, Prior PeriodItems and Changes in Accounting Policies" the payment madeto its employees on account of VRS as an overall cost cuttingmeasure is an ordinary activity.♦ AS 5 requires that when items of income and expense withinprofit or loss from ordinary activities are of such size, nature orincidence that their disclosure is relevant to explain theperformance of the enterprise for the period, the nature and


amount of such items should be disclosed separately.♦ Though this is not an extraordinary item, but the nature andamount of this expenses is such that its separate disclosure isrequired to allow the users to understand the financial positionand performance of the company.Conclusion: Compensation of Rs. 72 lakhs paid towards VRSavailed by employees should be shown separately in the profitand loss account of PQ Ltd.

Q. No. 11 State your views as an auditor on the following: Y Ltd.provided Rs. 25 lakhs for inventory obsolescence in 2009-10.In the subsequent years, it was determined that 50% of suchstock was usable. The company wants to adjust the samethrough prior period adjustment account as the provision wasmade in the earlier year. [NOV. 11 (5 MARKS)

Answer. Prior Period Adjustment:♦ As per AS 5 on "Net Profit or Loss for the Period, Prior PeriodItems and Changes in Accounting Policies", prior period itemsare income or expenses which arise in the current period as aresult of errors or omissions in the preparation of the F.S. of oneor more prior periods.♦ The write-back of provision made in respect of inventories inthe earlier year does not constitute prior period adjustmentsince it neither constitutes error nor omission.♦ An estimate may have to be revised if changes occur regardingthe circumstances on which the estimate was based, or as aresult of new information, more experience or subsequentdevelopments.♦ The revision of the estimate, by its nature, does not bring theadjustment within the definitions of an extraordinary item or aprior period item.Conclusion: Revision of the estimate does not bring theresulting amount of Rs. 12.5 lakhs within the definition either ofa prior period item or of an extraordinary item. The amount,however, involved is material and requires separate disclosureto understand the financial position and performance of anenterprise. Accordingly, adjustment in the value of theinventory through prior period item would not be proper.

AS - 7Q No. 12 Comment: B Co. Ltd. is engaged in the business of developing

mass scale housing projects including development of smallcommercial complexes. The flats/commercial spaces arebooked by the public and are allotted by way of allotmentsletter to each allottee. Major construction activities pertainingto buildings are undertaken of flats/commercial spaces isgiven to allottees by executing legal document. The CEO ofthe B Co. says that AS 7 is not applicable to the company.[nov.09 - new (5 marks)]


Answer Applicability of AS-7:♦ AS 7 (Revised) "Accounting for Construction contracts" statesthat, "This Statement should be applied in accounting forconstruction contracts in the ES. of contractors. The revised AS 7is silent about its applicability to construction activitiesundertaken by enterprises on their own account and not ascontractors.♦ The matter was considered by Expert Advisory committee ofthe Institute and they are of the view that the revised AS 7 is notapplicable to such enterprises.Conclusion: The activity of developing housing projects on itsown account can be considered as a commercial venture by thecompany in the nature of production activity and, therefore,should be construed as such. Accordingly, the flats/commercialspaces should be identified as inventories in accordance with AS2 and revenue should be recognition in accordance with AS 9.

Q. No. 13 A Ltd. prepared an invoice for an export consignment on FOBbasis on 30th March, 2010. The goods were dispatched fromthe factory on 30th March, 2010 and the Bill of Lading wasmade on 3rd April, 2010. A Ltd. had booked the invoice in theSales Register for March, 2010.[may 10 - old (5 marks)]

Answer. Revenue recognition in case of export sale:As per AS-9 'Revenue Recognition' revenue involving sale ofgoods is to be recognized on transfer of significant risk andreward of ownership to the buyer.In the instant case, A Ltd. has invoiced the goods and they haveleft the factory on 30th March, 2011. However the same is forexport and the bill of landing is dated 3rd April 2011.Conclusion: The sale should be therefore, recognized in April2011. The auditor will therefore have to qualify his reportstating that revenues are overstated to that extent.

Q. No. 14 State your views as an auditor on the following: T Ltd.purchased goods on credit for Rs. 5 crores for export fromABC Ltd. Upon the export order being cancelled, T Ltd.decided to sell the same in the domestic market at adiscounted price. Accordingly ABC Ltd. was requested to offera price discount of 25%. ABC Ltd. wants to adjust the salesfigure to the extent of discount requested by T Ltd.

Answer Treatment of discount subsequent to sale:♦ ABC Ltd. had sold goods on credit worth Rs. 5 crores to T Ltd.and, therefore, the sale was complete in all resp T Ltd.' sdecision to sell the same in the domestic market at a discountdoes not affect the amount booked under sales by ABC Ltd. ♦The price discount of 25% offered by ABC Ltd. at the request ofT Ltd. was not in the nature of discount given during theordinary course of trade.♦ As far as ABC Ltd. is concerned, there appears to be an


uncertainty relating to collectability, which has arisensubsequent to the time of sale.♦ Therefore, it would be appropriate to make a separateprovision to reflect the uncertainty relating to collectabilityrather than to adjust the amount of revenue originally recorded.Conclusion: Discount should be charged to the P & L A/cseparately and not shown as deduction from the sales figure.

Q. No. 15 Comment: LM Ltd. has 2 divisions L and M. The finishedproducts of division L are transferred to division M wherefurther processing is carried out before sale to customers. Toachieve transparency and accountability between thedivisions, division L raises an invoice on division M at costplus normal margins. At the year end the unrealized profits oninter-division stocks are eliminated. However, the transfersare recorded at the invoice value as sales and purchases in therespective divisions for the purpose of preparing the Profitand Loss Account. Suitable disclosures, for this are given inthen 'Notes to Accounts'.

Answer. Revenue recognition in case of inter division transfers:♦ The recognition of inter-divisional transfers as sales is aninappropriate accounting treatment and is inconsistent with AS9.♦ In case of inter-divisional transfers, risks and rewards remainwithin the enterprise and also there is no consideration from thepoint of view of the enterprise as a whole. Thus, the recognitioncriteria for revenue recognition has not been fulfilled in respectof inter-divisional transfers.Conclusion: In the instant case, LM Ltd. cannot recognise inter-division transfers from L to M as sales and the same will have tobe eliminated during finalisation. If not so done, the statutoryauditor will have to qualify his report.

0. No. 16 As an auditor, state your view on the following: M Ltd.manufactures machinery used in Steel Plants. It quotes pricesin various tenders issued by Steel Plants. As per terms ofcontract, full price of machinery is not released by the steelplants, but 10% thereof is retained and paid after one year ifthere is satisfactory performance of the machinery supplied.The company accounts for only 90% of the invoice value assales income and the balance amount in the year of receipt tothe extent of actual receipts only.

Answer. Recognition of Revenue:AS 9 on 'Revenue Recognition', states that revenue from sale ofgoods should be recognised as and when sale is made iffollowing conditions are satisfied:♦ Property in the goods has been transferred for a price,♦ all significant risks and rewards of ownership have been


transferred,♦ seller retains no effective control of the goods associated withownership, and♦ no significant uncertainty exists regarding the amount ofconsideration.In the present case, the goods, as well as the risks and rewardsof ownership have been transferred to the steel plants. Theinvoice raised by M Ltd. is for the full price, but 10% less isreceived as the same is kept as 'Retention Money'.Conclusion: Under the circumstances, revenue is required to berecognised at the full invoice price. Depending on the pastexperience of recovering the balance 10% from the steel plants,M Ltd. can, make a provision for sales income which is notlikely to realise. In the absence of the above, the auditor willhave to qualify his report.

Q. No. 17 A infrastructure company has constructed a mall and enteredinto agreement with tenants towards licence fees (monthlyrental) and variable licence fees, a percentage on the turnoverof the tenant (on an annual basis). Chief Finance Officerwants to account/recognize fee as income for 12 monthsduring current year under audit and variable licence fees asincome during next year, since invoice is raised in thesubsequent year. As an auditor, how would you deal and statein the statement of Accounting policies?.[NOV. 11 (6 MARKS)]

Answer. Revenue Recognition:♦ AS 9 on Revenue Recognition, is mainly concerned with thetiming of recognition of revenue in the statement of profit andloss of an enterprise. The amount of revenue arising on atransaction is usually determined by agreement between theparties involved in the transaction. However, whenuncertainties exist regarding the determination of the amount,or its associated costs, these uncertainties may influence thetiming of revenue recognition.♦ Further, as per accrual concept of fundamental accountingassumptions given in AS 1 "Disclosure of Accounting Policies",revenue should be recognised as and when it is accrued ie.recorded in the financial statements of the periods to which theyrelate.♦ In the present case, monthly rental towards licence fees andvariable licence fees as a percentage on the turnover of thetenant though on annual basis is the income related to commonfinancial year. Therefore, recognising the fees as revenue cannotbe deferred simply because the invoice is raised in subsequentperiod. Hence it should be recognised in the financial year ofaccrual.Conclusion: The contention of the Chief Financial Officer is not


in accordance with AS 9 and hence the auditor may qualify thereport indicating the understatement of income/ profit and thatthe profit and loss account does not exhibit a true and fair viewof the profit or loss.

Q. No. 18 A Ltd. is a manufacturer of readymade garments. It sells itsproducts to franchisees located across the country. Readymadegarment industry is subject to change in trends of fashion andas such, some of the goods are returned and A Ltd. acceptsthem back as sales returns. On the basis of past trends suchreturns are estimated to be at 20% of the sales of any year. Forthe financial year 2011-12, A Ltd. had accounted for the actualsales return made upto 31st 2012 but has not reversed thepossible expected return that are likely to happen after 31stMarch 2012, in respect of the sale made for the FY 11 -12.Mr.Xthe auditor of A Ltd. wants this to be considered in theaccounts of for the year ended on 31st March 2012 but thecompany is of the opinion that although there is a probabilityof some goods being returned by the franchisees, there is nosignificant uncertainty regarding the amount of considerationthat will be derived from the sale of goods, since the goods arenot in the possession of the company and risk and rewards ofownership still lie with the franchisees and the companycannot record sales returns in its books of account if respect ofgoods that are likely to be received after the date of balancesheet. Comment.[MAY 12 (5 MARKS)]

Answer: Recognition of Revenue:(a) AS-9 on "Revenue Recognition" states that revenue from saleof goods should be recognised at the time of sale of goodssubject to following conditions:♦ The seller has transferred to the buyer the property in thegoods for a price.♦ Risks and Rewards of ownership have been transferred to thebuyer.♦ Seller retains no effective control of the goods transferredassociated with ownership.♦ No significant uncertainty exists regarding the amount ofconsideration.(b) In the present case, A Ltd. is bearing a risk of sales returnand therefore, the company should not recognise the revenue tothe extent of 20% of its sales. The company is require to makesuitable disclosure of revenue recognition policy in the financialstatements.(c) In the absence of the above, the auditor must qualify thereport. Note: Alternatively, the answer may be given withreference to AS-29, requiring a provision.

Q. No. 19 As a statutory auditor of a company, comment on the


following: The accounting policy on Revenue Recognition fora company engaged in manufacture and sale of chemicalproducts was stated as "Revenue is recognized only when itcan be reliably measured and it is reasonable to expectultimate collection". [NOV. 12 (5 MARKS)]

Answer. (a) AS-9 on "Revenue Recognition" states that revenue from saleof goods should be recognised at the time of sale of goodssubject to following conditions:♦ The seller has transferred to the buyer the property in thegoods for a price.♦ Risks and Rewards of ownership have been transferred to thebuyer.♦ Seller retains no effective control of the goods transferredassociated with ownership.♦ No significant uncertainty exists regarding the amount ofconsideration.(b) If conditions mentioned above not satisfied, then revenuerecognition should be postponed. In the instant case, thecompany is engaged in manufacturing and sale of chemicalproducts and made disclosure that "Revenue is recognized onlywhen it can be reliably measured and it is reasonable to expectultimate collection" is in line with AS-1 and AS-9.

AS – 10Q. No. 20 Comment: In the notes to accounts of C Co. Ltd. as on 31-3-

2011 Note No. 11 states that 'Certain machinery items are lyingat customs warehouses and company has paid Rs. 900 lakhsup to 30-6-2010 as detention charges, out of which a sum of Rs.580 lakhs is written back during the year 2010* 11 based onsettlement with the concerned authorities in respect of a majorspares of machinery. For the remaining machinery itemnegotiations are pending and a provision of Rs. 44 lakhs ismade. As such total amount of Rs. 364 lakhs paid/ provided onaccount of detention charges have been capitalized andincluded in the fixed assets/capital work in progress. Themanagement is of the view that these expenses are directlyattributable to the acquisition of the related Fixed Asset.'[NOV. 10 - NEW (5 MARKS)]

Answer: Capitalisation of Detention Charges:As per AS - 10 "Accounting for Fixed Assets" the cost of an itemof fixed assets comprises its purchase price, including importduties and other non-refundable taxes or levies and any directlyattributable cost of bringing the asset to its working conditionfor its intended use; any trade discounts and rebates arededucted in arriving at the purchase price. Examples of directlyattributable costs are:1. site preparation;2. initial delivery and handling costs;


3. installation cost, such as special foundations for plant; and4. professional fees, for example fees of architects and engineers.Conclusion: Detention charges, being in the nature of penaltylevied by Customs for not removing the articles within specifiedperiod from custom port can not be considered as directlyattributable cost. Treatment done by the company is incorrect.The auditor should qualify the report appropriately mentioningthe effect on Balance sheet and Profit and Loss Account.

Q No. 21 F Limited includes in the Schedule of Inventory, those itemsof Fixed Assets which have not been in active use and held fordisposal, as inventory item. [MAY 10 - NEW (5MARKS)]

Answer. Treatment of assets held for Disposal♦ AS-10 "Accounting for Fixed Assets" requires that the items offixed assets that have been retired from active use and are heldfor disposal be stated at the lower of their net book value andNRVand are shown separately in the financial statements.♦ As per.AS-2 "Valuation of Inventories", "inventories" areassets "held for sale in the ordinary course of business, in theprocess of production for such sale; or in the form c>: materialsor supplies to be consumed in the production process or in therendering of service".Conclusion: Inclusion of fixed assets, not in active use andheld for disposal, as inventory item in the schedule ofinventory is not in line with the requirements of AS-10 andAS-2. Such fixed assets should be stated at lower of net bookvalue and NRV and are shown separately in F.S.

Q. No. 22 Comment: An old car of a company having a nominal bookvalue has found a buyer, who is willing to pay Rs. 1 lakh forit. The company proposes not to sell the car, but to neglect itsvaluation in its accounts at Rs. 1 lakh. Should the auditorpermit the company to do so ?.

Answer. Valuation of Fixed Assets: Relevant provisions:♦ The old car formed part of the fixed assets of the company andordinarily the same should be valued at actual cost lessdepreciation written off. The market price of any of such assetsis not relevant for balance sheet valuation of a going concern.♦ There is no prohibition in law for revaluation of fixed assets.But when all other assets are presumably shown at historicalcost, revaluation only of one motorcar seems illogical and hasthe effect of distorting the overall view of the accounts.♦ AS-10, "Accounting for Fixed Assets" also clarifies, when afixed asset is revalued in F.S., an entire class of assets should berevalued, or the selection of assets for revaluation should bemade on a systematic basis and the basis should be disclosed.Facts of the case:♦ In the present case, there is no proper appraisal and a


revaluation based on one stray bid is not proper to establish aproper replacement value of an item of asset.♦ The willingness of a buyer to pay the particular price is notlogical basis to work out the value of the asset. The companythough proposes not to sell the car at Rs. One lakh yet it hasdecided to neglect its value in the accounts.Conclusion: In view of the fact that the company has beentaking proper step, the auditor should permit the company toneglect the valuation of car in the accounts because it is inaccordance with the relevant requirements of the AS.

Q No. 23 As a statutory auditor of a Public Limited Company, howwould you deal with the following: The company has soldsome old machinery for Rs. 1 crore. The details of the cost ofsuch machinery are not available since the entire recordsrelating to fixed assets have been destroyed in an earthquake.

Answer. Profit/Loss on Sale of Machinery:♦ As per AS 10 "Accounting for Fixed Assets", gains or lossesarising on disposal are generally recognised in the profit andloss statement.♦ In the instant case, since the entire records of fixed assets havebeen destroyed, the WDV of the machinery sold should bedetermined by company on some estimated and reasonablebasis.♦ Such calculation may be done by obtaining old copies ofannual reports, annual accounts filed with ROC, IT Returns etc.A note to that effect would also have to be given by themanagement in the accounts.♦ Under this situation, the auditor will have to see whether the

estimate of cost and WDV arrived at in the above manner by thecompany is reasonable and whether the profit/loss isdetermined accordingly.♦ If the auditor is of the opinion that the said estimates aresatisfactory based on available records and the note given bymanagement explains the said fact, he may not qualify hisreport.♦ If he is not so satisfied, he would have to give disclaimer in theaudit report that in the absence of proper records, the saidprofit/loss has been arrived on an estimated basis and in thatview he has been unable to form an opinion.♦ As far as the report under the CARO, 2003 order is concerned,the auditor would have to point out that proper records of fixedassets showing full particulars as required by that clause are notavailable.

Q. No. 24 As a statutory auditor of a Public Limited Company, how


would you deal with the following situation: As at thebeginning of the year, the company has a capital of Rs. 2.50crores, free reserves of Rs. 0.50 crore and Revaluation Reserveof Rs. 4.50 crores. In the relevant year under audit thecompany has incurred a loss of Rs. 4 crores. The companyproposes to adjust the loss with the Revaluation Reserve.

Answer. Adjustment of Losses against Revaluation Reserve:♦ Accumulated losses cannot be adjusted against the revaluationreserve created on revaluation of the fixed assets.♦ In case the company in question does so, the balance sheet ofthe company will not reflect a true and fair view of the state ofaffairs of the company keeping in view the magnitude of theamounts involved, Le., accumulated losses amount to ^ 4 croresand share capital and reserves amount to Rs. 3 crores (excludingrevaluation reserve).♦ If the management does not agree with the opinion of theauditor, the auditor may even issue an adverse report.

Q. No. 25 As a Statutory auditor, how would you deal with following: Acompany receives a grant from the State Govt, ascompensation for loss of stocks due to unseasonal floods.Entire grant received is credited to "Capital Reserve*.[NOV. 08 - OLD (5 MARKS)]

Answer: Accounting of Government Grants:♦ As per AS-12 "Accounting for Government Grants" grantsrelated to revenue should be recognized on a systematic basis inthe profit and loss account over, the periods necessary to matchthem with the related costs which they are intended tocompensate.♦ Such Grants should either be shown separately under 'OtherIncome' in the profit & loss account or should be deducted inreporting the related expenses or losses, if such Grant isreceived in the same year in which loss is sustained.Conclusion: Accounting Treatment is wrong. In no case, it canbe credited to 'CAPITAL RESERVE'. The Auditorsfcorfi givequalified report.

Q. No. 26 Comment on the following: XYZ Limited received a grant ofRs. 25 lakhs under the Government's Subsidy Scheme, foracquiring an imported machinery for setting up new plant.The entire grant received is credited to Profit and LossAccount. [NOV. 09 - NEW (5 MARKS)]

Answer. Treatment of Capital Grant.As per AS 12, "Accounting for Government Grants" grantsreceived for acquisition of specific fixed asset maybe treated infollowing ways:(a) Deduction from the gross value of the asset; or(b) Treating it as deferred income which should be recognised inthe P & L account on a systematic and rational basis over the


useful life of the asset.By crediting the entire amount of grant to P & L account, thecompany has treated it as a revenue income which is not inaccordance with the requirements of the AS 12.Conclusion: Auditor needs to qualify the report stating the factthat the income has been overstated to the extent of the amountof grant net of proportionate credit that would have beenworked out.

AS-13Q. No. 27 As a statutory auditor of a Public Limited Company, how

would you deal with the following situation: The companyhad subscribed to shares of associate companies amounting toRs. 5 crores. These associate companies have incurredsubstantial losses and have been referred to BIFR for beingdeclared as sick companies. The company does not want tomake any provision for the fall in the value of the investments

Answer. Valuation of Investments: Relevant Provision:♦ AS 13 on "Accounting for Investments" requires that long-terminvestments should be carried in the F.S. at cost. However,provision for diminution shall be made to recognise a decline,other than temporary, in the value of the investments, suchreduction being determined and made for each investmentindividually".Facts of the case:♦ In the present case, the investments made in associatecompanies can be classified as long term investments.♦ These associate companies have incurred substantial lossesand have been referred to BIFR for being declared as sickcompanies. The net worth of these companies would have beenwiped out resulting in a fall in the value of the investments.Conclusion: Such fall in value of investments cannot be merelytemporary as the companies could take a long time to turnaround and again have a positive net worth. The auditor wouldtherefore have to qualify his report by saying that no provisionfor diminution for fall in the value of investments as required byAS 13 has been made and to that extent the profits and reserveshave been overstated.

AS-16Q. No. 28 As a statutory auditor for the year ended 31st March 2011, how

would you deal with the Following: X Ltd., has borrowedRs. 25 crores from financial institutions during the financialyear 2010-11. These borrowings are used to invest in shares ofY Ltd., a subsidiary company which is implementing a newproject estimated to cost Rs. 50 crores. As on 31 st March 2011,since the said project was not yet complete, the directors of XLtd. resolved to capitalize the interest on the borrowingsamounting to Rs. 3 crores and add it to the cost of investments.


Answer. Capitalisation of Interest on Borrowings in respect ofInvestmentsRelevant Provisions:♦ AS-16 "Borrowing Costs" does not consider investment inshares as qualifying assets that can enable a company to add theborrowing costs to investments.♦ In the instant case, X Ltd. has used borrowed funds formaking investment in shares of a subsidiary company. Foracquiring shares of a subsidiary company, apart from any fees,duties etc., there are no cost incurred for investing in shares.♦ Any borrowing costs incurred cannot be treated as part of costof investments and cannot be added to the cost of investments.Conclusion: The statutory auditor is required to qualify hisreport by stating that the borrowing costs have been wronglyadded to the cost of investments. It is required toCharge the borrowing cost to the profit and loss account.The effect of the same on the profit for the year would also haveto be mentioned in the audit report.

Q. No. 29 As a Statutory Auditor, how would you deal with; ABC Ltd.commenced construction of a flyover in Mumbai in January,2010 under BOLT scheme. The same was completed inFebruary, 2011. Due to seasonal heavy rains in July, 2010 in thearea, the work on the flyover had to be suspended for 1month. The company accordingly suspended borrowing costsof Rs. 12.50 lakhs for that month from capitalization

Answer. Capitalization of borrowing costs:♦ As per AS 16, "Borrowing Costs", capitalization of borrowingcosts should be suspended in respect of periods in which activedevelopment is interrupted, except for the situation whentemporary delay is necessary as a part of the process orsubstantial technical and administrative work is being carriedout.♦ Thus, the test as to whether or not to capitalize the borrowingcosts depends primarily upon the nature of interruption ofactivities during "extended periods".♦ In the instant case, it has been mentioned that the constructionactivity was interrupted due to seasonal rain and hence beingregular feature.Conclusion: Borrowing cost of Rs. 12.50 lakhs incurred by ABCLtd. should be capitalized. Suspension of capitalization by thecompany is not a correct treatment and statutory auditor shouldreport accordingly.

AS-170. No. 30 Following is the data regarding six segments of Z Ltd.:

(Rs. in '000s)Particulars A B C D E FSegment Revenue (Rs.) 150 310 40 30 40


50Segment Result (Rs.) 25 (95) 5 5 (5) 15Segment Assets (Rs.) 20 40 15 10 10 5The Finance Director is of the view that it is sufficientsegments A and B alone be reported. Advise

Answer. Identification of Reportable Segments:As per AS 17 on 'Segment Reporting', "a business segment orgeographical segment should be identified as a reportablesegment if:(i) its revenue from sales to external customers and intersegment transfer is 10% or more of the total revenue, externaland internal of all segments, or(ii) its segment result, whether profit or loss, is 10% or more of:a. the combined result of all segments in profit; orb. the combined result of all segments in loss,whichever is greater in absolute amount; or(iii) its segment assets are 10% or more of the total assets of allsegments.AS 17 also requires that if total external revenues attributable toreporting segments constitute less than 75% of the totalenterprise revenue, additional segments should be identifiedeven if they do not meet 10% criteria.Conclusion: On the basis of the above the following conclusionsemerge:♦ Segmental Revenue - A and B will be reportable segmentssince both these segments 10% or more of total revenue ie., Rs.6,00,000.♦ Segmental Results - A, B & F will be reportable segments sincethe result of these segments is 10% or more than (Rs. 1,00,000)the combined results of segments in loss.♦ Segment assets - A,B,C, D and E will be the reportablesegments since there are 10% or more if total segmental assetsie.Rs. 1,00,000.Hence all the segments have to be reported

AS- 180. No. 31 A firm of a father and a son is receiving Rs. 2 lakhs towards

job work done for XYZ Ltd. during the year ended on 31.03.07.The total job work charges paid by XYZ Ltd. during the yearare over Rs. 50 lakhs. The father is a Managing Director ofXYZ Ltd. having substantial holding. The Managing Directortold the auditor that since he is not involved in the activitiesof the firm and since the amount paid to it is insignificant;there is no need to disclose the transaction. He furthercontended that such a payment made in the last year was notdisclosed. Is Managing Director right in his approach?.

Answer Related party Disclosures:♦ AS 18 "Related Party Disclosures" requires disclosure of


related party relationship and transactions between a reportingenterprise and its related parties.♦ In the instant case, the managing director of XYZ Ltd. is apartner in the firm with his son, which has been paid Rs. 2 lakhsas job work charges. The managing director constitutes asubstantial holding in the firm. And hence the transaction iscovered by AS 18.Conclusion: The approach of the managing director is nottenable under the law and accordingly all disclosurerequirements have to be complied. Accordingly, the approachfollowed by the Managing Director is not right. Under thecircumstances, the auditor shall have to modify his report.

AS – 19Q. No. 32 Y Ltd. wishes to obtain a machine tool costing Rs. 20 lakhs by

way of lease. Effective life of the machine tool is 12 years butthe company requires it only for the first five years. It entersinto an agreement with R Ltd. for a lease rental of Rs. 2 lakhsp.a.The Finance Director of Y Ltd. is not sure about the treatmentof these lease rentals and hence requests your assistance inproper disclosure of the same. For calculation purposes, theimplicit rate of interest may be taken at 15%. Discount factors:0.87,0.76,0.66,0.57 and 0.50.

Answer. Accounting Treatment of Lease Rental:The fair value of asset is Rs. 20 lacs and the present value oflease rentals is Rs. 6.72 lacs. The machine is required for 5 yearsonly which is less than 50% of the economic life. As per AS 19,having regard to substance of the transaction, the lease will beclassified as an operating lease. As per AS 19, the following maybe disclosed:♦ Future minimum lease payments - Not later than 1 year Rs. 2lacs♦ Future minimum lease payments - Later than 1 year and notlater than 5 years Rs. 4.98 lacs


would you deal with the following: Ason31/3/2010,the equityshare capital of X Ltd. isRs. 10 crores divided into shares of Rs.10 each. During the financial year 2010-11, it has issued bonusshares in the ratio of 1:1. The net profit after tax for the years2009-10 and 2010-11 is Rs. 8.50 crores and Rs. 11.50 croresrespectively. The EPS disclosed in the accounts for two yearsis Rs. 8.50 and Rs. 5.75 respectively.

Answer. Disclosure of Earnings Per Share: Relevan t Provision:♦ As per AS 20, in the case of a bonus issue, the number ofequity shares outstanding before the event of a bonus issue haveto be adjusted for the proportionate change in the number ofequity shares outstanding as if the event had occurred at the


beginning of the earliest period reported.♦ In view of the above, the EPS for both the years will have to becalculated taking the equity share capital after the bonus issueas the denominator.♦ If the same is done the EPS for 31/3/2010 will be Rs. 4.25 andthat for 31/3/2010 will be Rs. 5.75. Since the above figures ofEPS have not been disclosed, the company has not compliedwith the provisions of the AS 20.Conclusion: As EPS reported is not in compliance with AS 20,auditor is required to qualify his report in terms of Sec.227(3)(of) of the Companies Act, 1956.

Q. No. 34 T Pvt. Ltd. is an unlisted closely held company with turnoverless than Rs. 50 crores. While finalizing the accounts, Mr. Mthe Director (finance) disputed the applicability of AS 20 tothe company.

Answer. Applicability of AS - 20:♦ AS 20 "Earning Per Share", is mandatory in respect olenterprises whose equity shares or potential equitv shares arelisted on a recognised stock exchange in India. Haw-ever, everycompany is required under Part IV. Scheddk VI to theCompanies Act, 1956, to disclose EPS-♦ Accordingly, every company, which is required to giveinformation under Part IV of Schedule VI to the Companies Act,1956, should calculate and disclose EPS in accordance with AS20, whether or not its equity shares or potential equity sharesare listed on a recognised stock exchange in India.Conclusion: The contention of Director (Finance) is incorrect.The auditor will have to ensure that EPS is disclosed as per AS20 or else the auditor should appropriately modify the auditreport


would you deal with the following: X Ltd., a listed company,was incurring heavy losses since the last several years and theindustry in which it was functioning was not expected toperform better in the next few years. While finalising theaccounts for the year ended 31st March 2010, the CFO of thecompany decided to create a Deferred Tax Asset for the taxbenefits that would arise in future years from the earlier yearslosses that had remained unabsorbed in Income tax. OrDo you approve of the following: Shakti Pan Masala (P.) Ltd.was incurring heavy losses in the last several years since itcould not withstand the competition in the market. The Statein which the company had its registered office and also itsmajor sales had moved a bill in the State Assembly to banmanufacture and sale of all kinds of Pan Masalas in the State.While finalizing the accounts for the year ended 31-3-2011, theCFO of the company created a Deferred Tax Asset for the tax


benefits that would arise in future years from the earlier yearslosses that had remained unabsorbed in Income Tax

Answer. Recognition of Deferred Tax Assets:Relevant Provision:♦ AS 22 on "Accounting for Taxes on Income", requires thatdeferred tax should be recognised for all timing differences,subject to the considerations of prudence in respect of deferredtax assets.♦ The standard further states that where an enterprise hasunabsorbed depreciation or carry forward of losses under thetax laws, deferred tax assets should be recognised only to theextent that there is virtual certainty supported by convincingevidence that sufficient future taxable income will be availableagainst which such deferred tax assets can be realised.♦ This implies that there is a reasonable certainty that the carryforward losses would be recouped in the future years.Facts of the case:♦ In the instant case, looking to the fact that the industry inwhich the company was functioning was not expected toperform well in the next few years, getting virtual certainty andconvincing evidence for the same would be almost impossible.♦ Hence, in the absence of virtual certainty for offset of thelosses in future years, creating a deferred tax asset would not bepossible for the company. Conclusion: The statutory auditorwould therefore have to qualify his report by stating thatdeferred tax assets have been created though there is no virtualcertainty for getting the said benefit in income tax.He would also have to mention the amount by which the lossfor the year has been understated and the amount by which thereserves are overstated.

Q. No. 36 Comment: T Ltd. an Indian company, subject to Income taxAct, 1961, discloses advance Income-tax paid (Current taxasset) and provision for Income-tax (Current tax liability),separately in Balance Sheet for the year ended 31.3.2011, ie,, itdoes not offset the amount. [MAY 10 - NEW (5 MARKS)]

Answer. As per AS 22 - Accounting for Taxes in Income, an enterpriseshould offset assets and liabilities representing current tax if theenterprise:(i) has a legally enforceable right to set off the recognizedamounts and(ii) Intends to settle the asset and liability on a net basis.An enterprise will normally have a legally enforceable right toset off an asset and liability representing current tax when theyrelate to income taxes levied under the same governing taxationlaws and the taxation laws permit the enterprise to make orreceive a single net payment.Conclusion: T Ltd. is entitled to set off the advance tax against


provision for tax, and can show only the net amount in thebalance sheet.

Q. No. 37 SRS Ltd. has drawn the financial statement as on 31-3-2011and presented to you along with additional information:Balance Sheet of SRS Ltd. as on 31-3-2011Liabilities Amt. Assets Amt.

Share Capital 50,00,000 Fixed Assets

Reserves & Surplus Gross block

Prolit and Loss A/c 4,00,000 Less: Depreciation 1,00,00,000

Secured Loans 75,00,000 Investments Nil

Current Liabilities andprovisions

Current Assets Loans &Advances

Creditors for trade 3,00,000 Debtors 25,00,000

Advance received 3,00,000 Advance Paid 10,00,000

1,35,00,000 1,35,00,000

Additional Information:(a) Entire pre-operative expenses of Rs. 7,00,000 was charged toProfit and Loss Account whereas for the purpose of Income Tax,only what is allowable is claimed(b) Depreciation as per Books Rs. 35,00,000 Depreciation as perIncome Tax Rs. 50,00,000(c) Losses to be carried forward as per Income Tax Act -Rs.16,00,000(d) Donation disallowed while computing tax -Rs. 50,000Considering the additional information. Can you certify that thecompany has complied with the Accounting Standards andissue an unqualified report?. [NOV. 11(6marks)

Answer. Compliance of Accounting Standards:As per AS 22 - Accounting for Taxes in Income, an enterpriseshould offset assets and liabilities representing current tax if theenterprise:(a) Based on the Additional Information provided in thequestion, it appears that the company had not complied withthe provisions of AS 6, AS 10, AS 22.(b) As per Para 28 of AS 6 "Depreciation Accounting" historicalcost of each assets is required to be disclosed, which is notshown in the balance sheet.(c) As per Para 39 of AS 10 "Accounting for Fixed Assets" GrossBook Value of the fixed assets should be disclosed, which is notshown in the balance sheet.(d) As per requirement of AS 22 "Accounting for Taxes onincome" company was required to recognise the effect of timingdifference as below:♦ Recognise Deferred Tax Asset for Pre-operative Expenses


♦ Recognise Deferred Tax Liability for Depreciation. Conclusion:As the company had not complied with the requirements ofvarious Accounting Standards, an Unqualified report cannot beissued.

AS-25Q. No. 38 As a Statutory Auditor, how would you deal with following: A

company which has presented its quarterly results for alimited review report, has represented that expenditureincurred on heavy repairs carried in that quarter are beingspread over the entire year, since it would otherwise, distortthe quarterly results. [Nov. 08 - old (4 marks)]

Answer. Presentation of Quarterly Results (AS-25):As per AS-25, "Interim Financial Reporting" (which ismandatory for all entities preparing Interim Financial Report),uniform accounting policies are to be applied in interim andannual F.S. It further says that uneven costs can also beanticipated or deferred only if appropriate to do so at the end ofthe year.Conclusion: In the instant case, in view of the above, as stated inAS-25, heavy repairs cannot be deferred to other quarters. If sodone by the company, the limited review report will have tocontain a qualification for the same.

AS-26Q. No. 39 As an auditor, how would you deal with the following: PQR

Ltd. had acquired a Brand from another company for Rs. 100lakhs. PQR Ltd. contends that since the said brand is a verypopular and famous brand, no depreciation or amortisationneeds to be provided. [nov. 09 - old (4 marks)]

Answer. Amortization or Depreciation of Brand:♦ AS 26 "Intangible Assets" provides that an intangible assetshould be measured initially at cost. After initial recognition, anintangible asset should be carried at cost less any accumulatedamortization and any accumulated impairment losses.♦ The depreciable amount of an intangible asset should beallocated on a systematic basis over the best estimate of itsuseful life. There is a rebuttable presumption that the useful lifeof an intangible asset will not exceed ten years from the datewhen the asset is available for use.♦ The auditor should satisfy himself that the value of brand is

amortized in accordance with AS 26, as brand is considered tobe an intangible asset. Conclusion: The contention of PQR Ltd.,that Brand is very popular and famous, no depreciation oramortization needs to be provided, is wrong and hence, theauditor will have to qualify this matterm his report and quantifythe amount of non-amortisation.

AS-29Q. No. 40 Comment: There is a sales-tax demand of Rs. 3 crores against


X Ltd. relating to prior years against which the company hasgone into an appeal. [MAY 10 - OLD (5 MARKS)]

Answer. As per AS 29 "Provisions, contingent Liabilities andContingent Assets", contingent liability is:(a) a possible obligation that arises from past events and theexistence of which will be confirmed only by the occurrence ornon-occurrence of one or more uncertain future events notwholly within the control of the enterprise; or(b) present obligation that arises from past events but is notrecognized because:(c) it is not probable that an outflow of resources embodyingeconomic benefits will be required to settle the obligation; or(D) a reliable estimate of the amount of the obligation cannot bemade.Accordingly in this case, when there is sales tax demand of Rs. 3crores and the company has gone in an appeal, it needsconsiderations as to whether the entire demand is disputed,because it is difficult to presume that the demand by sales taxauthority is without any basis.Conclusion: Therefore, to the extent the company consideredthat the demand is based on some logical basis, that amountmay be provided for and the remaining may be disclosed as thecontingent liability.Note: The answer may also covers the requirement of reportingunder CARO, Para No. 4(ix)(b)- "In case dues of IncomeTax/Sales Tax/Service Tax/Customs Duty /Wealth Tax/Excise Duty/Cess have not been deposited on account of anydispute, then the amounts involved and the forum wheredispute is pending shall be mentioned."

Q. No. 41 As on 31-3-2010, there was a claim for damage from one of thecustomers against the company engaged in selling ofaccounting software for an alleged failure to provide aftersales services in relation to the software purchased from it.Before finalisation of accounts for the year ended 31 -3-2010(the accounts were finalised on 14th June, 2010), the companywon the case and had no liability whatsoever in this regard.The company has made a provision for this contingentliability in its accounts for the year ended 31-3-2010, which itsays, will be reversed in the next year

Answer. Accounting treatment of Contingent Liabilities♦ As per AS-29 'Provisions, Contingent Liabilities andContingent Assets' no provision should be made for a coqod-gent liability. Only disclosures are to be made (in the nose* tothe account) in respect of contingent liabilities even suchdisclosures are not required if the possibility is remote.♦ Thus, the company's accounting treatment - making provision

for a contingent liability violates (AS) 29.


♦ Impact of post balance sheet development-The company wonthe case and had no liability. This development has occurredafter 31-3-2010 but before the date of finalisation of accounts (ie.14-6-2010). It should be taken into account for finalisation ofaccounts as it pertains to the conditions existing at the balancesheet date. The impact of this development is that evendisclosures are not required as it is no longer a continentliability. If this development had not taken place, the companywould be required to make disclosures of the contingentliability.Conclusion: Auditor should ask the company to rectify theaccounts and reverse the provision made as on 31-3-2010 itselfand also ask the company to remove any disclosures regardingthis contingent liability in the notes to the accounts.If company does not do so, he should qualify his opinion on thetruth and fairness of accounts and also quality his remarksregarding compliance with AS which he is required to makepursuant to section 227(3)(eRs.) of the Companies Act, 1956.

Documents

Chapter- GUIDANCE NOTES AND ACCOUNTING STANDARDS GUIDANCE ... · BY CA SURENDRA AGRAWAL(M.com,LL.B,ACA) PH-9313336776 Page 1 GUIDANCE NOTES AND ACCOUNTING STANDARDS GUIDANCE NOTES