IMPLICATIONS OF ACCOUNTING STANDARDS

AS-20:- EARNINGS PER SHARE

Earnings per share is the universally accepted measure and indicator of the financial performance of a company. In recent years there have been attempts by the accounting bodies the world over to standardise the measurement and presentation of EPS information. The ICAI has issued AS-20 to deal with the subject, which prescribes the principles and norms of standard accounting treatment of EPS – both basic as well as diluted. The objective of this statement is to prescribe the principles for the determination and presentation of the EPS, which will facilitate a comparison of performance among different enterprises for the same period and among different accounting periods for the same enterprise. AS-20 requires an enterprise to clearly present the basic & diluted earnings per share for all the reported accounting periods, even if the amounts disclosed are negative.

BASIC EPS :- Ratio of profit attributable to equity shareholders & Weighted average no. of equity shares outstanding during the period.

DILUTED EPS :- Ratio of adjusted net profit to weighted average no. of diluted equity shares outstanding during the period.

REASONS FOR DILUTION IN EQUITY• Innovations in capital markets:- E.g. Financial instruments like fully or

partly convertible debentures & preference shares convertible into equity shares at a later date.

• Novel HR compensation policies:- E.g. Employees issued with Share warrants and options (ESOPs) that entitle or may entitle their holders to equity shares in addition to their remuneration.

• Pending Allotment :- Any pending allotment of equity as at balance sheet date.

• Any Advance Share Application Money :- Representing potential equity shares.

MERITS OF TREATMENT OF EPS IN FINANCIAL STATEMENTS • Provides an actual and not exaggerated picture of financial

performance.• Undoes the window dressing.• Enables the users of the financial statements know the EPS likely to be

sustained in future.• Sets the benchmark for meaningful comparison.

COMPLIANCE WITH AS-20

• Para 8:- An enterprise should present basic & diluted EPS on the face of the statement of profit &loss for each class of equity shares that has a different right to share in the net profit for the period. An enterprise should present basic & diluted EPS with equal prominence for all periods presented.

• Para 11:- For the purpose of calculating BEPS, the net profit or loss for the period attributable to equity shareholders should be the net profit or loss for the period after deducting preference dividends and any attributable tax thereto for the period.

• Para 26:- For the purpose of calculating DEPS, the net profit or loss for the period attributable to equity shareholders and the weighted average number of shares outstanding during the period should be adjusted for the effects of all dilutive potential equity shares.

• Para 29:- For the purpose of calculating DEPS, the amount of net profit or loss for the period attributable to equity shareholders, as calculated in accordance with para11, should be adjusted by the following, after taking into account any attributable change in tax expense for the period --

a) Any dividends on dilutive potential equity shares which have been deducted in arriving at the net profit attributable to equity shareholders as calculated in accordance with para11

b) Interest recognised in the period for the dilutive potential equity shares.

c) Any other changes in expenses or income that would result from the conversion of the dilutive potential equity shares.

ACCOUNTING FOR TAXES ON INCOME AS-22As-22 seeks to address the issue of matching the taxes of a period against

the revenue of that period. The mismatch arises due to divergence between accounting income and taxable income. This divergence may be due to Timing Differences and Permanent Differences.

TIMING DIFFERENCES :- These differences originate in one period and capable of reversal in one or more subsequent periods. Examples-

• Difference due to rate of depreciation• Difference due to method of depreciation• Expenses debited in the statement of profit & loss for accounting

purpose but allowed for tax purpose in subsequent year. Like section 43B of Income –Tax Act, 1961.

PERMANENT DIFFERENCES :- These differences originate in one period and do not reverse subsequently i.e. they remain permanently. E.g. Expenses debited in the statement of P&L A/C but not allowed for tax purpose in any year or income credited in P&L A/C exempted from tax.

SCOPE:- Taxes on income include all domestic and foreign taxes, which are based on taxable income. Taxes on income exclude tax payable on distribution of dividends.

• Tax expenses for the period to be recognised consist of current tax and deferred tax.

• CURRENT TAX :- Current tax is the amount of income-tax determined to be payable in respect of the taxable income for a period. Current tax is measured using applicable tax-rates at the time.

• DEFERRED TAX :- Deferred tax is the tax effect of timing difference. Difference between the tax expenses ( which is calculated on accrual basis) and current tax liability to be paid for particular period as per Income –Tax Act is called deferred tax (assets/liability). Deferred tax should be measured using the rates and laws that have been enacted or substantially enacted by the balance sheet date.

Deferred Tax Liability :- It is recognised for temporary differences that will result in taxable amounts in future years. E.g. a temporary difference is created between the depreciation as per the books of account and the depreciation claimed under the tax laws which, in initial years, higher than depreciation claimed as expenses in the financial statements. This would lead to a higher taxable income in future.

Deferred Tax Asset :- It is recognised for temporary differences that will result in deductible amounts in future years and for carry forward.

E.g. A temporary difference is created between the reported amount and the tax basis of a liability for estimated expenses as for tax purpose, those estimated expenses are not deductible until a future year. Settlement of that liability will result in tax deduction in future years, and a deferred tax asset is recognised in the current year for the reduction in taxes payable in future years.

AS-11 EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES

The accounting standard applies to-• In accounting for transactions in foreign currencies.• In translating the financial statement of foreign operation – integral as

well as non-integral• The accounting standard also prescribes the accounting for forward

exchange contracts.

Transactions denominated in a foreign currency or that require settlement in a foreign currency are called foreign currency transactions –

E.g. Buying or selling of goods or services priced in foreign currency.

• Acquisition or disposal of fixed assets denominated in foreign currency.

• Incurs or settles liabilities denominated in foreign currency.• Lending or borrowings when the amounts are denominated in foreign

currency.• Un-performed forward exchange contract.

SOME DEFINITIONS :- • Reporting Currency :- Currency of country where financial statements

are reported.• Foreign Currency :- Currency other than reporting currency.• Exchange Rate :- Rate at which foreign currency is converted into

reporting currency.• Average Rate :- Mean of exchange rate in force during the period.• Forward Rate :- Agreed exchange rate between two parties for

exchange of two currencies at a specified future date.• Closing Rate :- Exchange rate at balance sheet date.• Monetary Items :- These are money held and & liabilities to be received

or paid in fixed or determinable amount of money. E.g. cash, B/R, B/P.

Non-Monetary Items :- These are assets & liabilities other than monetary items. E.g. Fixed Assets, Inventories, equity shares

Foreign Operations :- Operational activities conducted in a country other than the country of the reporting enterprises by the reporting enterprises. E.g. Activities may be in the form of a subsidiary, associate. Joint ventures or a branch of the reporting enterprises.

Foreign exchange transactions can be classified into following categories.Category - I :- Foreign Currency Transactions -• Buying or selling the goods or services• Lending and borrowing in foreign currency• Acquisition and disposition of assets denominated in foreign currency.Category – II :- Foreign Operations –• Foreign Branch• An associate• Joint venture• Foreign subsidiary – Integral & Non-integral operationCategory-III :- Forward Exchange Contracts• For hedging• For trading & speculation

AS -17 SEGMENT REPORTING

Information about multiple products/services and it’s operations in different geographical areas is called segment information. Disclosure of such information is called segment reporting.

Segment reporting helps users of financial statements –• To better understand the performance of the enterprise.• To better assess the risks & returns of the enterprise.• To make more informed judgments about the enterprise as a whole.

TYPES OF SEGMENTS• Business Segment – Segment made on the basis of products/services

which are exposed to different risks and returns. • Geographical Segment – Segment is made on the basis of it’s

operation in different geographical areas, which are exposed to different risks & returns.

Definitions

Enterprise Revenue :- It is revenue from sales to external customers as reported in the statement of profit & loss.

Segment Revenue:- Segment revenue is the aggregate of --

• The portion of enterprise revenue that is directly attributable to a segment.

• The relevant portion of enterprise revenue that can be allocated on a reasonable basis to a segment, and

• Revenue from transactions with other segment of enterprise.Segment Expenses :- segment expense is the aggregate of –• The expenses resulting from the operating activities of a segment that is

directly attributable to the segment.• The relevant portion of enterprise expense that can be allocated on a

reasonable basis to the segment.• Expenses relating to the transactions with other segments of the

enterprise.• Costs sometimes incurred at the enterprise level on behalf of a segment

are part of segment expenses if – -They relate to the operating activities of the segment -They can be directly attributed or allocated to the segment on a

reasonable basis.Segment Result :- Segment result is segment revenue less segment

expenses (segment profit or loss)

Segment Assets :- Segment assets are those operating assets that are –

• Employed by a segment in it’s operating activities, and• Directly attributable to the segment or can be allocated to the segment

on a reasonable basis (i.e. Current Assets, Tangible & Intangible Fixed Assets)

Segment Liabilities :- Segment liabilities are –• Operating liabilities that result from the operating activities of a segment,

either directly attributable to the segment or can be allocated to the segment on a reasonable basis.

• If the segment result of a segment includes interest expense, it’s segment liabilities include the related interest bearing liabilities.

Segment liabilities do not include –• Income–tax liabilities• Borrowing and other liabilities that are incurred for financing rather than

operating purposes.

Reportable Segments

Reporting segments are classified as –• Primary Reportable Segment

• Secondary Reportable Segment

Disclosures as per AS – 17• Revenue from external customers• Revenue from transactions with other segments.• Segment result• Cost to acquire tangible and intangible fixed assets.• Depreciation and amortisation expenses.• Carrying amount of segment assets.• Segment liabilities• Non-cash expenses other than depreciation and amortisation.• Reconciliation of revenue, result, assets and liabilities.

AS-13 ACCOUNTING FOR INVESTMENTS

• Investments are held for earning income by way of dividend, interest and rentals, for capital appreciation or for other benefits. The standard deals with the following aspects.

• Classification of investment• Cost of investment• Carrying amount / valuation of investment• Disposal of investment• Reclassification of Investment• Disclosure of investment in the financial statements.

DEFINITIONS • Current Investments :- Investments which are readily realizable and

intended to be held for not more than one year from the date on which such investment is made.

• Long Term Investment :- Investment other than current investment.• Investment Property :- It is an investment in land or building not intended

to be used as fixed asset of the business.

Cost of Investment :- Comprises of purchase price and acquisition charges such as brokerage, fees and duties etc.

Valuation of Investment for the purpose of Balance Sheet• Current Investment :- Carrying amount of each current investment is

the lower of cost & realisable value. Any reduction in realisable value is debited to P&L A/c and any increase in value subsequently, will be credited.

• Long-Term Investment :- It is valued at cost. If there is a decline in the value of investment which is not temporary, then carrying amount of investment is reduced by the amount of such decline. The resultant reduction is charged to P&L A/C and it is reversed when there is a rise in value of investment.

• Investment Properties:- The cost of shares held in co-operative society is added to cost of investment properties if the shares in co-operative societies are necessary to acquire investment properties.

Disposal of Investment :- • When an investment is disposed off, the difference between the

carrying amount and net sale proceeds (gross sale less expenses) is recognised in the profit & loss account.

•When only a part of total investment is disposed off, the carrying amount of that part of investment is determined on the basis of the average carrying amount of the total investment.

• Reclassification of InvestmentsFrom long term investment to current investment.Transfers are made at the lower of cost and carrying amount at the date

of transfer.From current investment to long-term investment.Transfers are made at the lower of cost and fair value at the date of

transfer.DISCLOSURES• Accounting policies followed for valuation of investment.• Classification of investment into current and long term in addition to

classification as per schedule-VI of Companies Act in case of a company.

• Aggregate amount of quoted & unquoted securities separately.• Any significant restriction on investment like minimum holding period

for sale/disposal, utilisation of sale proceeds of investment held outside India.

AS-19 ACCOUNTING FOR LEASES

• Lease is an arrangement by which the lessor gives the right to use an asset for given period of time to the lessee on rent.

Types of Lease

Financial Lease:- It is a lease, which transfers substantially all the risks and rewards incidental to ownership of an asset to the lessee by the lessor but not the legal ownership. In the following situations, the lease transactions are called the Financial Lease.

• The lessee will get the ownership of leased asset at the end of the lease term.

• The lessee has an option to buy the leased asset at the end of the term at price, which is lower than it’s expected fair value at the date on which option will be exercised.

• The lease term covers the major part of the life of asset.• At the beginning of lease term, present value of minimum lease rental

covers substantially the initial fair value of the leased asset.• The asset given on lease to lessee is of specialised nature and can

only be used by the lessee without major modification.

Operating Lease:- It is a lease which does not transfer substantially all the risk and reward incidental to ownership.The Accounting Standard is not applicable to following types of lease:• Lease agreement to explore natural resources such as oil, gas, timber,

metal, and other mineral rights.• Licensing agreements for motion picture film, video recording, plays,

manuscripts, patents and other rights.• Lease agreement to use land.

Definitions:-

Guaranteed Residual Value –• In respect of lessee :- Such part of the residual value, which is

guaranteed by or on behalf of the lessee.• In respect of lessor :- Such part of the residual value, which is

guaranteed by or on behalf of the lessee or by an independent third party.

Unguaranteed Residual Value – The diference between residual of the asset and it’s guaranteed residual value is unguaranteed residual value.

Gross Investment:- Gross investment in lease is the sum of the following:• Minimum lease payment (from standpoint of lessor)

• Any unguaranteed residual value accruing to the lessor.

• Interest Rate implicit in the lease:- When the lessor gives an asset on lease (particularly on finance lease), the total amount, which he receives over lease period by giving the asset on lease, includes the element of interest plus payment of principal amount of asset. The rate at which the interest amount is calculated is called Implicit Rate of Interest. It can be expressed as ----

Discount rate at which ,Fair Value of leased asset = PV of Minimum lease payment (in respect of lessor) + Any unguaranteed residual value accruing to the lessor

• Contingent Rent:- Lease Rent fixed on the basis of % of sales, amount of usage, price indices, market rate of interest is called contingent rent.

• Minimum Lease Payments:- For Lessor = Total Lease rent to be paid by lessee over the lease terms + Any guaranteed residual value (by or on behalf of lessee) – contingent rent –

cost of service & tax to be paid and reimbursed to lessor + residual value guaranteed by third party.

For Lessee = Total lease rent to be paid by lessee over the lease terms + any guaranteed residual value (for lessee) – contingent rent – cost for service and tax to be paid by and reimbursed to lessor.

• Definition of lease includes agreements for the hire of an asset, which contain a provision giving the hirer an option to acquire title to the asset upon the fulfillment of agreed conditions. These agreements are commonly known as hire-purchase agreements.

• DICLOSURES:- Following disclosures in financial statements of the lessee & lessor should be made as regards lease:

• Disclosure in operating lease by lessor• General description of significant leasing arrangements• Accounting policy for initial direct payment• Future lease payments in aggregate classified as :

- not later than one year

- later than one year and not later than five years

- later than five years• Disclosure in operating lease by the lessee• General description of the significant leasing arrangement

•Total of future minimum lease payments in following period: - not later than one year -later than one year and not later than five years -later than five years

• Lease payments recognised in P&l A/c for the period• Disclosure in finance lease by the lessor –• General description of the significant lease arrangement.• Accounting policy for initial direct cost.• Reconciliation of total gross investment in lease and present value of

minimum lease payment receivable at balance sheet date.• Minimum lease payment receivable in following categories:

- not later than one year

-later than one year and not later than five years

-later than five years• Disclosure in finance lease by the lessee –• Asset under finance lease segregated from the asset owned.• Reconciliation of total MLP with it’s present value on balance sheet date.

•MLP in following categories on balance sheet date- - not later than one year - later than one year and not later than five years - later than five years

AS-3 CASH FLOW STATEMENT

Cash flow statement explains cash movement under the following three different heads namely-

• Cash flow from operating activities• Cash flow from investing activities• Cash flow from financing activities

Sum of these three types of cash flow reflects net increase or decrease of cash and cash equivalents.

Cash : It consists of cash in hand and demand deposits.

Cash Equivalent : It consists of short-term highly liquid investments having maturity less than three months, which can be readily converted, into cash without any decline of it’s value. These investments can be converted into cash without any risk.

OPERATING ACTIVITIES:- Principal revenue producing activities of the enterprises other than investing & financing activities.

• E.g. Cash receipts from the sale of goods and rendering services, Cash receipts from royalties, fees, commissions, Cash payments to suppliers for goods and services, Cash payments to and on behalf of employees.

INVESTING ACTIVITIES:- The activities of acquisition and disposal of long term assets and other investments not included in cash equivalents are investing activities.

• E.g. Cash payments to acquire fixed assets (including intangibles), Cash receipts from disposal of fixed assets (including intangibles), Cash payments to acquire shares, warrants or debt instruments of other enterprises and interests in joint ventures, Cash receipts from disposal of shares, warrants or debt instruments of other enterprises, and interests in joint ventures.

FINANCING ACTIVITIES :- Activities which result in change in size and composition of owners capital and borrowing of the organisation.

E,g. Sale of shares, buy back of shares, redemption of pref.shares, issue/redemption of debentures, Long term loan/payment thereof, Dividend/interest paid.

CASH FLOW FROM FINANCING ACTIVITIES

• Direct Method:- Gross receipts and gross payments of cash are disclosed.

• Indirect Method:- P & L A/C is adjusted for the effects of transactions of non-cash nature.