UNIT 1

ACCOUNTING STANDARDS

1.1 AS 5- Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies

Introduction

The objective of AS 5 is to prescribe the classification and disclosure of certain items in the statement of profit and loss so that all enterprises prepare and present such a statement on a uniform basis. This enhances the comparability of the financial statements of an enterprise over time and with the financial statements of other enterprises. Accordingly, AS 5 requires the classification and disclosure of extraordinary and prior period items, and the disclosure of certain items within profit or loss from ordinary activities. It also specifies the accounting treatment for changes in accounting estimates and the disclosures to be made in the financial statements regarding changes in accounting policies.

This Statement does not deal with the tax implications of extraordinary items, prior period items, changes in accounting estimates, and changes in accounting policies for which appropriate adjustments will have to be made depending on the circumstances.

Net Profit or Loss for the Period

All items of income and expense which are recognised in a period should be included in the determination of net profit or loss for the period unless an Accounting Standard requires or permits otherwise.

The net profit or loss for the period comprises the following components, each of which should be disclosed on the face of the statement of profit and loss:

1. Profit or loss from ordinary activities: Any  activities which  are undertaken by an enterprise as part of its business and such related activities in which the enterprise engages in furtherance of, incidental to, or arising from, these activities. For example profit on sale of merchandise, loss on sale of unsold inventory at the end of the season.

b.    Extraordinary items: Income or expenses that arise from events or transactions that are clearly distinct from the ordinary activities of the enterprise and, therefore, are not expected to recur frequently or regularly.

Extraordinary items should be disclosed in the statement of profit and loss as a part of net profit or loss for the period.

The nature and the amount of each extraordinary item should be separately disclosed in the statement of profit and loss in a manner that its impact on current profit or loss can be perceived. Whether an event or transaction is clearly distinct from the ordinary activities of the enterprise is determined by the nature of the event or transaction in relation to the business ordinarily carried on by the enterprise rather than by the frequency with which such events are expected to occur. Therefore, an event or transaction may be extraordinary for one enterprise but not so for another enterprise because of the differences between their respective ordinary activities. For example, losses sustained as a result of an earthquake may qualify as an extraordinary item for many enterprises. However, claims from policyholders arising from an earthquake do not qualify as an extraordinary item for an insurance enterprise that insures against such risks.

Examples of events or transactions that generally give rise to extraordinary items for most enterprises are:

• attachment of property of the enterprise
• an earthquake

c.     Exceptional items: When items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately.

Circumstances which may give rise to the separate disclosure of items of income and expense include:

1. The write-down of inventories to net realizable value as well as the reversal  of such write-downs
2. A restructuring of the activities of an enterprise and the reversal of any provisions for the costs of restructuring
3. Disposals of items of fixed assets
4. Disposals of long-term investments
5. Legislative changes having retrospective application
6. Litigation settlements
7. Other reversals of provisions

PRIOR PERIOD ITEMS

Prior period items are income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one  or more prior periods.

Errors in the preparation of the financial statements of one or more prior periods may be discovered in the current period. Errors may occur as a result of mathematical mistakes, mistakes in applying accounting policies, mis- interpretation of facts, or oversight.

The nature and amount of prior period items should be separately disclosed in the statement of profit and loss in a manner that their impact on the current profit or loss can be perceived.

CHANGES IN ACCOUNTING ESTIMATES

An estimate may have to be revised if changes occur in the circumstances based on which the estimate was made, or as a result of new information, more experience or subsequent developments. The revision of the estimate, by its nature, does not bring the adjustment within the definitions of an extraordinary item or a prior period item.

Accounting estimates by their nature are approximations that may need revision as additional information becomes known. For example, income or expense recognised on the outcome of a contingency which previously could not be estimated reliably does not constitute a prior period item.

For example, Sachin purchased a new machine costing Rs 10 lakhs. Useful life was taken to be for 10 years, therefore, depreciation was charged at 10% on original cost each year. After 5 years when carrying amount was Rs 5 lakhs for the machine, management realizes that machine can work for another 2 years only and they decide to write off Rs 2.5 lakhs each year. This is not an example of prior period item but change in accounting estimate. In the same example management by mistake calculates the depreciation in the fifth year as 10% of Rs 6,00,000 i.e. Rs 60,000 instead of Rs 1,00,000 and in the next year decides to write off Rs 1,40,000. In such a case, Rs 1,00,000 current year’s depreciation and Rs 40,000 will be considered as prior period item.

As per AS 10 (Revised), Property, Plant and Equipment, residual value and the useful life of an asset should be reviewed at least at each financial year-end and, if expectations differ from previous estimates, the change should be accounted for as a change in an accounting estimate in accordance with AS 5 ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’.

The effect of a change in an accounting estimate should be included in the determination of net profit or loss in:

1. The period of the change, if the change affects the period only; or
2. The period of the change and future periods, if the change affects both.

For example, a change in the estimate of the amount of bad debts is recognised immediately and therefore affects only the current period. However, a change in the estimated useful life of a depreciable asset affects the depreciation in the current period and in each period during the remaining useful life of the asset.

The effect of a change in an accounting estimate should be classified using the same classification in the statement of profit and loss as was used previously for  the estimate.

To ensure the comparability of financial statements of different periods, the effect of a change in an accounting estimate which was previously included in the profit or loss from ordinary activities is included in that component of net profit or loss

The effect of a change in an accounting estimate that was previously included as  an extraordinary item is reported as an extraordinary item.

The nature and amount of a change in an accounting estimate which has a material effect in the current period, or which is expected to have a material effect in subsequent periods, should be disclosed. If it is impracticable to quantify the amount, this fact should be disclosed.

CHANGES IN ACCOUNTING POLICIES

Accounting policies are the specific accounting principles and the methods of applying those principles adopted by an enterprise in the preparation and presentation of financial statements.

Accounting Policies can be changed only:

• when the adoption of a different accounting policy is required by statute; or
• for compliance with an Accounting Standard; or
• When it is considered that the change would result in a more appropriate presentation of the financial statements of the enterprise.

The following are not changes in accounting policies:

• The adoption of an accounting policy for events or transactions that differ in substance from previously occurring events or transactions, e.g., introduction of a formal retirement gratuity scheme by an employer in place of ad hoc ex- gratia payments to employees on retirement;
• The adoption of a new accounting policy for events or transactions which did not occur previously or that were immaterial.

Any change in an accounting policy which has a material effect should be disclosed. The impact of, and the adjustments resulting from, such change, if material, should be shown in the financial statements of the period in which such change is made,  to reflect the effect of such change. Where the effect of such change 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.

1.2 AS 6- Depreciation Accounting

Introduction

This Statement deals with depreciation accounting and applies to all depreciable assets, except the following items to which special considerations apply:—
 

(i) Forests, plantations and similar regenerative natural resources;

(ii) Wasting assets including expenditure on the exploration for and extraction of minerals, oils, natural gas and similar non-regenerative resources;

(iii) Expenditure on research and development;

(iv) Goodwill;

(v) Livestock.

This statement also does not apply to land unless it has a limited useful life for the enterprise.

Different accounting policies for depreciation are adopted by different enterprises. Disclosure of accounting policies for depreciation followed by an enterprise is necessary to appreciate the view presented in the financial statements of the enterprise.

Definitions
The following terms are used in this Statement with the meanings specified:

Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, passage of time or obsolescence through technology and market changes. Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. Depreciation includes amortisation of assets whose useful life is predetermined.

Depreciable assets are assets which

(i)                are expected to be used during more than one accounting period; and

(ii)              have a limited useful life; an

(iii) Are held by an enterprise for use in the production or supply of goods and services, for rental to others, or for administrative purposes and not for the purpose of sale in the ordinary course of business.
 

Useful life is either

(i)    The period over which a depreciable asset is expected to be used by the enterprise; or

(ii) The number of production or similar unit expected to be obtained from the use of the asset by the enterprise.

Depreciable amount of a depreciable asset is its historical cost, or other amount substituted for historical cost in the financial statements, less the estimated residual value.

Explanation
Depreciation has a significant effect in determining and presenting the financial position and results of operations of an enterprise. Depreciation is charged in each accounting period by reference to the extent of the depreciable amount, irrespective of an increase in the market value of the assets.

Assessment of depreciation and the amount to be charged in respect thereof in an accounting period are usually based on the following three factors:

(i) Historical cost or other amount substituted for the historical cost of the depreciable asset when the asset has been revalued;

(ii) Expected useful life of the depreciable asset; and

(iii) Estimated residual value of the depreciable asset.

Historical cost of a depreciable asset represents its money outlay or its equivalent in connection with its acquisition, installation and commissioning as well as for additions to or 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, changes in duties or similar factors.

The useful life of a depreciable asset is shorter than its physical life and is:

(i) pre-determined by legal or contractual limits, such as the expiry dates of related leases;

(ii) directly governed by extraction or consumption;

(iii) 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

(iv) Reduced by obsolescence arising from such factors as:

(a)  technological changes;

(b) improvement in production methods

(c)  change in market demand for the product or service output of the asset;

(d) Legal or other restrictions.

Determination of the useful life of a depreciable asset is a matter of estimation and is normally based on various factors including experience with similar types of assets. Such estimation is more difficult for an asset using new technology or used in the production of a new product or in the provision of a new service but is nevertheless required on some reasonable basis.

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 remaining useful 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.

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 residual value is likely to be significant, it is estimated at the time of acquisition/installation, or at the time of subsequent revaluation of the asset. One of the bases for determining the residual value would be the realisable 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.

The quantum of depreciation to be provided in an accounting period involves the exercise of judgement by management in the light of technical, commercial, accounting and legal requirements and accordingly may need periodical review. If it is considered that the original estimate of useful life of an asset requires any revision, the unamortised depreciable amount of the asset is charged to revenue over the revised remaining useful life.

There are several methods of allocating depreciation over the useful life of the assets. Those most commonly employed in industrial and commercial enterprises are the straight line method and the reducing balance method. The management of a business selects the most appropriate method(s) 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. In respect of depreciable assets which do not have material value, depreciation is often allocated fully in the accounting period in which they are acquired.

The statute governing an enterprise may provide the basis for computation of the depreciation. For example, the Companies Act, 2013 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 provisions of the relevant statute, the depreciation provision is appropriately computed by applying a higher rate. If the management’s 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 requirements of the statute.

Where depreciable assets are disposed of, discarded, demolished or destroyed, the net surplus or deficiency, if material, is disclosed separately.

The method of depreciation is applied consistently to provide comparability of the results of the operations of the enterprise from period to period. A change from one method of providing depreciation to another is made only if the adoption of the new method is required by statute or for 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.
 

Where the historical cost of an asset has undergone a change due to circumstances specified above, the depreciation on the revised unamortised depreciable amount is provided prospectively over the residual useful life of the asset.

Disclosures Required

The depreciation methods used, the total depreciation for the period for each class of assets, the gross amount of each class of depreciable assets and the related accumulated depreciation are disclosed in the financial statements along with the disclosure of other accounting policies. The depreciation rates or the useful lives of the assets are disclosed only 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.

The depreciable amount of a depreciable asset should be allocated on a systematic basis to each accounting period during the useful life of the asset.

The depreciation method selected should be applied consistently from period to period. A change from one method of providing depreciation to another should be made only if the adoption of the new method is required by statute or for 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 should be 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 should be 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 should be charged in the statement of profit and loss. In case the change in the method results in surplus, the surplus should be credited to the statement of profit and loss. Such a change should be treated as a change in accounting policy and its effect should be quantified and disclosed.

The useful life of a depreciable asset should be estimated after considering the following factors:

(i) expected physical wear and tear;

(ii) Obsolescence;

(iii) Legal or other limits on the use of the asset.

The useful lives of major depreciable assets or classes of depreciable assets may be reviewed periodically. Where there is a revision of the estimated useful life of an asset, the unamortised depreciable amount should be charged over the revised remaining useful life.

Any addition or extension which becomes an integral part of the existing asset should be depreciated over the remaining useful life of that asset. The depreciation on such addition or extension may also be provided at the rate applied to the existing asset. Where an addition or extension retains a separate identity and is capable of being used after the existing asset is disposed of, depreciation should be provided independently on the basis of an estimate of its own useful life.

Where the historical cost of a depreciable asset has undergone a change due to 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 unamortized depreciable amount should be provided prospectively over the residual useful life of the asset.

Where the depreciable assets are revalued, the provision for depreciation should be based on the revalued amount and on the estimate of the remaining useful lives of such assets. In case the revaluation has a material effect on the amount of depreciation, the same should be disclosed separately in the year in which revaluation is carried out.

If any depreciable asset is disposed of, discarded, demolished or destroyed, the net surplus or deficiency, if material, should be disclosed separately.

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.

Accounting for moulds and dies used in the manufacture of components

Facts of the Case

1. A company (hereinafter referred to as ‘the ancillary’) manufactures and supplies certain components to a manufacturer of motor cars (hereinafter referred to as ‘the principal manufacturer’).

2. The manufacture of these components entails the use of moulds/dies. Some of the moulds/dies are supplied by the principal manufacturer while others are arranged by the ancillary.

3. In respect of moulds/dies arranged by the ancillary, the two parties agree on what is termed as ‘tool cost’. The tool cost is agreed to be spread over a certain number of units of the component. For example, the parties may agree that the tool cost of, say, Rs.7,35,000 will be amortised over 1,50,000 units. The amortisation rate in this case works out to Rs. 4.90 per unit.

4. In some cases, a part of the agreed tool cost is paid by the principal manufacturer in lump sum and the balance is amortised in the above manner.

5. While working out the cost of a component, the ancillary includes amortisation of the agreed tool cost as one of the elements of cost. In respect of moulds/dies supplied by the principal manufacturer, no tool cost is included in the cost of the components.
 

Query
The querist has sought the opinion of the Expert Advisory Committee as to whether the
procedure followed by the ancillary in relation to costing of the components is proper.

Opinion
Based on the above, the Committee is of the opinion that from accounting angle, the tool cost relating to moulds/dies to be included in the cost of components manufactured by the ancillary manufacturer is represented by the depreciation charge in respect of the relevant moulds/dies, computed in accordance with the requirements of AS 6. The Committee recognizes that the amount agreed to be paid by the principal manufacturer towards tool cost relating to moulds/dies may be different from the amount of depreciation computed in accordance with AS 6
Opinion finalized by the Committee on 22.4.2000.

1.3 Property, Plant & Equipment

AS 10 Property, Plant and Equipment prescribe the accounting treatment for properties, P&E (Plant and Equipment) so that the users of financial statements could recognize and appreciate the information about the investment made by any enterprise in property, P&E and the also understand the changes made in such investments.

It is also important to note that AS 6 – Accounting for Depreciation stands withdrawn and such matters related to depreciation is included in AS 10.

Applicability of AS 10

AS 10 is to be applied in accounting for property, P&E (Plant and Equipment) and this standard are not applicable to:

(a) Biological assets which are related to agricultural activities except for bearer plants. The Standard is applicable to bearer plants, however, it doesn’t apply to the produce on bearer plants; and

(b) Wasting assets which include mineral rights, expenses related to exploration for and extraction of oil, minerals, natural gas and other non-regenerative resources.

Recognition of Asset under AS 10

The cost of property and P&E should be recognized as an asset only if:

(i) It is apparent that the future economic benefits related to such asset would flow to the business; and

(ii) The cost of such asset could be reliably measured.

Measurement of cost of the asset

An enterprise can select the revaluation model or the cost model as the accounting policy and employ the same to the entire class of its properties and P&E. According to the cost model, after recognizing the asset as an item of property or plant and equipment, it should be carried at the cost less the accumulated depreciation and the accumulated impairment losses (if any). As per revaluation model, once the asset is recognized and its fair value could be measured reliably, then it must be carried at the revalued amount, which is the fair value of such asset at the date of the revaluation as reduced any following accumulated depreciation and accumulated impairment losses (if any). Revaluations must be done at regular intervals for ensuring that the carrying amount doesn’t differ much from that which would be determined using the fair value at balance sheet date.

Depreciation under AS 10

As per the standard, depreciation charge for every period must be recognized in the P/L Statement unless it’s included in carrying the amount of any another asset. Depreciable amount of any asset should be allocated on a methodical basis over the useful life of the asset.

Every part of property or P&E (Plant and Equipment) whose cost is substantial with respect to the overall cost of the item must be depreciated separately.

The standard also prescribes, that the residual value and useful life of an asset must be reviewed at the end of each financial year and, in case the expectations vary from the previous estimates, changes must be accounted for as changes in accounting estimate as per Accounting Standard 5 – Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies.

The method of depreciation employed must reflect the pattern of future economic benefits of the asset consumed by an enterprise. Various depreciation methods could be used for allocating the depreciable amount of an asset on a methodical basis over the useful life of the asset. The methods include SLM (Straight-line Method), diminishing balance method or units of production method.

Major Differences Between AS 10 and Ind AS 16

Ind AS 16 Property, Plant, and Equipment deal with accounting for fixed assets which are covered by AS 10. This Ind AS also deals with the depreciation of property, plant, and equipment that covered by AS 6. The key differences between the existing AS 10 and Ind AS 10 are mentioned below:

ICDS 5 v/s AS 10

• The concept of Materiality for treating an item as the expense is recognized by AS isn’t permissible under ICDS
• ICDS 5 particularly excludes Other Taxes that are consequently recoverable from the cost of an acquired tangible fixed asset
• For assets acquired in exchange for other assets, the actual cost is recognized under ICDS 5, where AS 10 permits determining the cost base on FMV (Fair Market Value) of the asset acquired or given up whichever is apt. AS 10 suggest recording the cost at the NBV (Net Book Value) of asset given up
• For assets acquired in exchange for shares or Securities, the actual cost of the asset is recognized as per ICDS 5. Where AS 10 permits determining the cost base on FMV (Fair Market Value) of the asset acquired or share or securities given up whichever is apt
• Treatment for an expenditure that doesn’t increase the future benefits is not defined in ICDS. However, according to Accounting Standard 10, such expenditure should be treated as an expenditure and recognized in the P/L Statement accordingly
• ICDS has more disclosure requirements including grant or subsidy received on account of a tangible fixed asset, changes in the rate of exchange of currency, etc

1.4 AS 14- Accounting for Amalgamation

Introduction

AS 14 (Revised) deals with the accounting to be made in the books of Transferee company in the case of amalgamation and the treatment of any resultant goodwill or reserve.

An amalgamation may be either in the nature of merger or purchase. The standard specifies the conditions to be satisfied by an amalgamation to be considered as amalgamation in nature of merger or purchase.

An amalgamation in nature of merger is accounted for as per pooling of interests method and in nature of purchase is dealt under purchase method.

The standard describes the disclosure requirements for both types of amalgamations in the first financial statements. We will discuss the other amalgamation aspects in detail in subsequent paragraphs of this unit.

AS 14 (Revised) does not deal with cases of acquisitions. The distinguishing feature of an acquisition is that the acquired company is not dissolved and its separate entity continues to exist.

Definition of the Terms used in the Standard

• Amalgamation means an amalgamation pursuant to the provisions of the Companies Act, 2013 or any other statute which may be applicable to companies and includes ‘merger’.
• Transferor company means the company which is amalgamated into another company.
• Transferee company means the company into which a transferor company  is amalgamated.

Types of Amalgamations

Amalgamations fall into two broad categories. In the first category are those amalgamations where there is a genuine pooling not merely of the assets and liabilities of the amalgamating companies but also of the shareholders’ interests and of the businesses of these companies. These are known as Amalgamation in nature of merger. In the second category are those amalgamations which are in effect a mode by which one company acquires another company and, as a consequence, the shareholders of the company which is acquired normally do not continue to have a proportionate share in the equity of the combined company, or the business of the company which is acquired is not intended to be continued. Such amalgamations are amalgamations in the nature of 'purchase'.

Methods of Accounting for Amalgamation

1. Pooling of Interest Method/Merger Method
2. Purchase Method

Amalgamation in the nature of Merger (Pooling of Interest Method)

Amalgamation in the nature of merger is an amalgamation which satisfies all the following conditions.

1. All the assets and liabilities of the transferor company become, after amalgamation, the assets and liabilities of the transferee company.
2. Shareholders holding not less than 90% of the face value of the equity shares of the transferor company (other than the equity shares already held therein, immediately before the amalgamation, by the transferee company or its subsidiaries or their nominees) become equity shareholders of the transferee company by virtue of the amalgamation.
3. The consideration for the amalgamation receivable by those equity shareholders of the transferor company who agree to become equity shareholders of the transferee company is discharged by the transferee company wholly by the issue of equity shares in the transferee company, except that cash may be paid in respect of any fractional shares.
4. The business of the transferor company is intended to be carried on, after the amalgamation, by the transferee company.
5. No adjustment is intended to be made to the book values of the assets and liabilities of the transferor company when they are incorporated in the financial statements of the transferee company except to ensure uniformity  of accounting policies.

Amalgamation in the nature of Purchase

Amalgamation in the nature of purchase is an amalgamation which does not satisfy any one or more of the conditions specified above.

Methods of Accounting for Amalgamations

There are two main methods of accounting for amalgamations.

• The pooling of interests method and
• The purchase method.

POOLING OF INTERESTS METHOD

Pooling of interests is a method of accounting for amalgamations the object of which is to account for the amalgamation as if the separate businesses of the amalgamating companies were intended to be continued by the transferee company. Accordingly, only minimal changes are made in aggregating the individual financial statements of the amalgamating companies.

Under this method, the assets, liabilities and reserves of the transferor company are recorded by the transferee company at their existing carrying amounts (after making adjustment required in next paragraph).

If, at the time of the amalgamation, the transferor and the transferee companies have conflicting accounting policies, a uniform set of accounting policies is adopted following the amalgamation. The effects on the financial statements of any changes in accounting policies are reported in accordance with AS 5.

PURCHASE METHOD

Under the purchase method, the transferee company accounts for the amalgamation either

• By incorporating the assets and liabilities at their existing carrying amounts  or
• By allocating the consideration to individual identifiable assets and liabilities of the transferor company on the basis of their fair values at the date of amalgamation. The identifiable assets and liabilities may include assets and liabilities not recorded in the financial statements of the transferor company.

CONSIDERATION

Consideration for the amalgamation means the aggregate of the shares and other securities issued and the payment made in the form of cash or other assets by the transferee company to the shareholders of the transferor company. In determining the value of the consideration, an assessment is made of the fair value of its elements.

Many amalgamations recognise that adjustments may have to be made to the consideration in the light of one or more future events. When the additional payment is probable and can reasonably be estimated at the date of amalgamation, it is included in the calculation of the consideration. In all other cases, the adjustment is recognised as soon as the amount is determinable [AS 4].

Treatment of Reserves of the Transferor Company on Amalgamation

If the amalgamation is an ‘amalgamation in the nature of merger’, the identity of the reserves is preserved and they appear in the financial statements of the transferee company in the same form in which they appeared in the financial statements of the transferor company. Thus, for example, the General Reserve of the transferor company becomes the General Reserve of the transferee company, the Capital Reserve of the transferor company becomes the Capital Reserve of the transferee company and the Revaluation Reserve of the transferor company becomes the Revaluation Reserve of the transferee company. As a result of preserving the identity, reserves which are available for distribution as dividend before the amalgamation would also be available for distribution as dividend after the amalgamation.

Adjustments to reserves - Amalgamation in the Nature of Merger

When an amalgamation is accounted for using the pooling of interests method, the reserves of the transferee company are adjusted to give effect to the following:

(i)    Conflicting accounting policies of the transferor and the transferee. A uniform set of accounting policies should be adopted following the amalgamation and, hence, the policies of the transferor and the transferee are aligned. The effects on the financial statements of this change in  the accounting policies  is reported in accordance with AS 5 ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’

(ii) Difference between the amount recorded as share capital issued (plus any additional consideration in the form of cash or other assets) and the amount of share capital of the transferor company.

Adjustments to reserves - Amalgamation in the Nature of Purchase

If the amalgamation is an ‘amalgamation in the nature of purchase’, the identity of the reserves, other than the statutory reserves is not preserved. The amount of the consideration is deducted from the value of the net assets of the transferor company acquired by the transferee company. If the result of the computation is negative, the difference is debited to goodwill arising on amalgamation and if the result of the computation is positive, the difference is credited to Capital Reserve.

Certain reserves may have been created by the transferor company pursuant to the requirements of, or to avail of the benefits under, the Income-tax Act, 1961; for example, Development Allowance Reserve, or Investment Allowance Reserve. The Act requires that the identity of the reserves should be preserved for a specified period. Likewise, certain other reserves may have been created in the financial statements of the transferor company in terms of the requirements of other statutes. Though normally, in an amalgamation in the nature of purchase, the identity of reserves is not preserved, an exception is made in respect of reserves of the aforesaid nature (referred to hereinafter as ‘statutory reserves’) and such reserves retain their identity in the financial statements of the transferee company in the same form in which they appeared in the financial statements of the transferor company, so long as their identity is required to be maintained to comply with the relevant statute. This exception is made only in those amalgamations where the requirements of the relevant statute for recording the statutory reserves in the books of the transferee company are complied with. In such cases the statutory reserves are recorded in the financial statements of the transferee company by a corresponding debit to a suitable account head (e.g., ‘Amalgamation Adjustment Reserve’) which is presented as a separate line item. When the identity of the statutory reserves is no longer required to be maintained, both the reserves and the aforesaid account are reversed.

The Standard gives a title, which reads as "Reserve". This gives rise to following requirements.

1. The corresponding debit is "also" to a Reserve Account
2. That Reserve account will show a negative balance

But it has to be shown as a separate line item - Which implies, that this debit "cannot be set off against Statutory reserve taken over"

Treatment of Goodwill Arising on Amalgamation

Goodwill arising on amalgamation represents a payment made in anticipation of future income and it is appropriate to treat it as an asset to be amortised to income on a systematic basis over its useful life. Due to the nature of goodwill, it is frequently difficult to estimate its useful life with reasonable certainty. Such estimation is, therefore, made on a prudent basis. Accordingly, it is considered appropriate to amortise goodwill over a period not exceeding five years unless a somewhat longer period can be justified.

Factors which may be considered in estimating the useful life of goodwill arising on amalgamation include:

(a)          the foreseeable life of the business or industry

(b)         the effects of product obsolescence, changes in demand and other economic factors

(c)          the service life expectancies of key individuals or groups of employees

(d)         expected actions by competitors or potential competitors

(e)          legal, regulatory or contractual provisions affecting the useful life

Balance of Profit and Loss Account

In the case of an ‘amalgamation in the nature of merger’, the balance of the Profit and Loss Account appearing in the financial statements of the transferor company is aggregated with the corresponding balance appearing in the financial statements of the transferee company. Alternatively, it is transferred to the General Reserve, if any.

In the case of an ‘amalgamation in the nature of purchase’, the balance of the Profit and Loss Account appearing in the financial statements of the transferor company, whether debit or credit, loses its identity.

Disclosures

For all amalgamations, the following disclosures are considered appropriate in the first financial statements following the amalgamation:

1. Names and general nature of business of the amalgamating companies;
2. Effective date of amalgamation for accounting purposes;
3. The method of accounting used to reflect the amalgamation; and
4. Particulars of the scheme sanctioned under a statute.

For amalgamations accounted for under the pooling of interests method, the following additional disclosures are considered appropriate in the first financial statements following the amalgamation:

1. Description and number of shares issued, together with the percentage of each company’s equity shares exchanged to effect the amalgamation;
2. The amount of any difference between the consideration and the value of net identifiable assets acquired, and the treatment thereof.

For amalgamations accounted for under the purchase method, the following additional disclosures are considered appropriate in the first financial statements following the amalgamation:

1. Consideration for the amalgamation and a description of the consideration paid or contingently payable; and
2. The amount of any difference between the consideration and the value of net identifiable assets acquired, and the treatment thereof including the period of amortisation of any goodwill arising on amalgamation.

Amalgamation after the Balance Sheet Date

When an amalgamation is effected after the balance sheet date but before the issuance of the financial statements of either party to the amalgamation, disclosure is made in accordance with AS 4, ‘Contingencies and Events Occurring After the Balance Sheet Date’, but the amalgamation is not incorporated in the financial statements. In certain circumstances, the amalgamation may also provide additional information affecting the financial statements themselves, for instance, by allowing the going concern assumption to be maintained.

1.5 AS 21- Consolidated Financial Statements

AS 21- Consolidated Financial Statements should be applied in preparing and presenting consolidated financial statements for a group of enterprises under the sole control of a parent enterprise.

Applicability of AS 21

 This standard must be applied when accounting for investment in subsidiaries in a separate financial statement of the parent.

It is to be noted that while preparing a consolidated financial statement, other standards also stay relevant in a similar manner as for standalone statements.

This accounting standard doesn’t deal with:

• accounting methods for amalgamations and effects on consolidation, which includes goodwill which arises on amalgamation
• accounting for investments in JVs (joint ventures)
• accounting for investments in associates

Presentation of Consolidated Financial Statements

A parent company presenting its consolidated financial statements must present these statements along with its standalone financial statements.

The users of financial statements of a parent company are typically concerned with and are required to be educated about, the results of operations and financial position of not only the company itself but also of that group together.

This requirement is served by offering the users of financial statements –

(a) standalone financial statements of a parent; and

(b) Consolidated financial statements that provide financial information about the business group as that of a lone enterprise without respect to the legal restrictions of the distinct legal entities

Scope of Consolidated Financial Statements

A parent company which presents its consolidated financial statements must consolidate all of its subsidiaries, foreign as well as domestic. Where a company doesn’t have any subsidiary, however, has associates and/or joint ventures such company also needs to prepare consolidated financial statements as per Accounting Standard 23 – Accounting for Associates in Consolidated Financial Statements and Accounting Standard 27 – Financial Reporting of Interests in JVs respectively.

Exclusion of Subsidiaries

A Subsidiary must be excluded from the consolidation when:

• control is planned to be temporary since the subsidiary was taken over and was held exclusively for disposal in the near future; or
• the subsidiary is operating under severe long-standing restrictions that considerably impair the subsidiary’s ability to transfer funds to its parent

In a consolidated financial statement, investments in such subsidiaries must be accounted for as per AS 13 – Accounting for Investments. Reasons for which a subsidiary isn’t included in the consolidation must be disclosed in such consolidated financial statements.

Consolidation Procedures

While preparing a consolidated financial statement, the parent company’s financial statements and its subsidiaries must be combined line by line by totaling together similar items such as assets, liabilities, income, and expenses.

For consolidating financial statements in a way to present financial information about a group as that of a lone enterprise, the below-motioned steps must be taken:

• Eliminate the cost to the parent of its investment made in each of its subsidiaries and such parent’s equity portion of each of its subsidiaries, at the date when the investment in such subsidiaries are made
• any additional cost to the parent company of the investment in the subsidiary over the parent company’s share of the equity of subsidiary, at the date on which the investment in such subsidiary is done, must be shown as goodwill for recognizing as the asset in its consolidated financial statements
• when the cost to the parent of the investment in the subsidiary is lower than the parent company’s share of the equity of subsidiary, a date on which the investment in such subsidiary is done, the difference must be treated as the capital reserve in its consolidated financial statements
• a portion of minority interests in net income of the consolidated subsidiary for reporting period must be recognized and adjusted against income of the group for arriving at the net income which is attributable to owners of such parent company; and
• a portion of minority interests in net assets of the consolidated subsidiaries must be recognized and provided for in consolidated balance sheet distinctly from the equity and liabilities of the parent company. Minority interests in net assets comprise of:

(i) amount of equity which is attributable to the minorities at the date on which such investment in the subsidiary is done; and

(ii) minorities’ share of the movements in equity from the date the relationship of parent-subsidiary came in to force

Where carrying investment amount in a subsidiary is different from the cost, such carrying amount is to be considered for the above calculations.

Accounting for Investments in the Subsidiaries in Separate Financial Statement of the Parent

In a parent company’s separate financial statements, the investments made in subsidiaries must be accounted for as per AS 13 – Accounting for Investments.

Disclosures in the Financial Statements

Following disclosures must be made w.r.t. AS 21 Consolidated Financial Statements:

(a) in the consolidated financial statements the list of all the subsidiaries of the parent company which includes the name, country of residence or incorporation, the share of ownership interest and, in case different, the share of voting power held

(b) In case the consolidation of particular subsidiary hasn’t been made according to the grounds permissible in the accounting standard, reasons for which such subsidiary isn’t included in the consolidation must be disclosed in such consolidated financial statements

(c) in the consolidated financial statements, where valid:

(i) type of relationship between a parent and its subsidiary, whether direct control or indirect control through the subsidiaries

(ii) effect of acquisition and disposal of the subsidiaries on financial position at the date of reporting results for the reporting period and on corresponding amounts for preceding period; and

(iii) Name of the subsidiary(s) of which reporting date(s) is different

Major Differences between AS 21 and Ind AS 110

1.6 SOLVED EXAMPLES 

Q1) (AS 5)

Fuel surcharge is billed by the State Electricity Board at  provisional rates. Final bill for fuel surcharge of Rs 5.30 lakhs for the period October, 2008 to September, 2015 has been received and paid in February, 2016. However, the same was accounted in the year 2016-17. Comment on the accounting treatment done in the said case.

Solution:

The final bill having been paid in February, 2016 should have been  accounted for  in the annual accounts of the company for the year ended 31st March, 2016. However, it seems that as a result of error or omission in the preparation of the financial statements of prior period i.e., for the year ended 31st March 2016, this material charge has arisen in the current period i.e., year ended 31st March, 2017. Therefore it should be treated as 'Prior period item' as per AS 5. As per AS 5, prior period items are normally included in the determination of net profit or loss for the current period. An alternative approach is to show such items in the statement of profit and loss after determination of current net profit or loss. In either case, the objective is to indicate the effect of such items on the current profit or loss.

It may be mentioned that it is an expense arising from the ordinary course of business. Although abnormal in amount or infrequent in occurrence, such an expense does not qualify an extraordinary item as per AS 5. For better understanding, the fact that power bill is accounted for at provisional rates billed by the state electricity board and final adjustment thereof is made as and when final bill is received may be mentioned as an accounting policy.

Q2) (AS 5)

(i)      During the year 2016-2017, a medium size manufacturing company wrote down its inventories to net realisable value by Rs 5,00,000. Is a separate disclosure necessary?

(ii)    A company signed an agreement with the Employees Union on 1.9.2016 for revision of wages with retrospective effect from 30.9.2015. This would cost the company an additional liability of Rs 5,00,000 per annum. Is a disclosure necessary for the amount paid in 2016-17?

Solution:

1. Although the case under consideration does not relate to extraordinary item, but the nature and amount of such item may be relevant to users of financial statements in understanding the financial position and performance of an enterprise and in making projections about financial position and performance. AS 5 on ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’ states that:

“When items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately.”

Circumstances which may give to separate disclosure of items of income and expense in accordance with AS 5 include the write-down of inventories to net realisable value as well as the reversal of such write-downs.

2.     It is given that revision of wages took place on 1st September, 2016 with retrospective effect from 30.9.2015. Therefore wages payable for the half year from 1.10.2016 to 31.3.2017 cannot be taken as an error or omission in the preparation of financial statements and hence this expenditure cannot be taken as a prior period item.

Additional wages liability of Rs 7,50,000 (for 1½ years @ Rs 5,00,000 per annum) should be included in current year’s wages.

It may be mentioned that additional wages is an expense arising from the ordinary activities of the company. Such an expense does not qualify as an extraordinary item. However, as per AS 5, when items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately.

Q3) (AS 5)

The company finds that the inventory sheets of 31.3.2016 did not include two pages containing details of inventory worth Rs 14.5 lakhs. State, how you will deal with the following matters in the accounts of Omega Ltd. for the year ended 31st March, 2017.

Solution

AS 5 on ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’, defines Prior Period items as "income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods”.

Rectification of error in inventory valuation is a prior period item vide AS 5. Separate disclosure of this item as a prior period item is required as per AS 5.

Q4) (AS 5)

Explain whether the following will constitute a change in accounting policy or not as per AS 5.

(i)             Introduction of a formal retirement gratuity scheme by an employer in place of ad hoc ex-gratia payments to employees on retirement.

(ii)            Management decided to pay pension to those employees who have retired after completing 5 years of service in the organisation. Such employees will get pension of Rs 20,000 per month. Earlier there was no such scheme of pension in the organisation.

Solution

As per AS 5 ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’, the adoption of an accounting policy for events or transactions that differ in substance from previously occurring events or transactions, will not be considered as a change in accounting policy.

1. Accordingly, introduction of a formal retirement gratuity scheme by an employer in place of ad hoc ex-gratia payments to employees on retirement is not a change in an accounting policy.
2. Similarly, the adoption of a new accounting policy for events or transactions which did not occur previously or that were immaterial will not be treated as  a change in an accounting policy.

Q5) (AS 6)

A Ltd. engaged in production of steel, wants to provide for deprecation based on unit of production instead of straight line or written down value method. Can A Ltd do so?

Solution: AS 6, on Depreciation accounting stipulates that minimum depreciation should be provided as made under statute i.e. the Companies Act, 2013. Schedule XIV to the Companies Act, 2013 prescribes various rates to be provided for different assets under straight line and written-down value method. However, where management estimates useful life of an asset shorter than as envisaged under the provisions of statute i.e. schedule XIV, than the depreciation is provided applying a higher rate.

Thus, if A Ltd. contemplates to provide deprecation on production basis and such depreciation happens to be lower than the depreciation worked out under schedule XIV, than A Ltd. would not be complying with the provisions of AS 6. Since, under the Indian Accounting Standard, reference is made to statute, companies in India will be required to provide minimum depreciation at the rates prescribed in schedule XIV. Based on the estimated useful life, if the depreciation rate is lower than the rate prescribed in Schedule XIV, companies will be required to approach central government in this regards.

Note: Under the International accounting standard or for that purpose US GAAP, depreciation is provided considering the best estimate of useful life of the asset. The following abstract from the financial statement of Cathay Pacific Airways will show that enterprise is at liberty to evaluate the estimate useful life of Fixed Asset.

Annual depreciation charges to write down the original cost of aircraft to estimated residual values are based on actual operational usage of the relevant aircraft as a proportion of its total estimated operational life. The useful operational life of an aircraft is determined by reference to its anticipated aircraft flight cycle while in service of the company. However, if the aircraft is held under a finance lease, the depreciable life of the aircraft is limited to the lease term unless a purchase option is held. A flight cycle is defined as one take-off and one landing. The residual value of aircraft and related equipment are 10% of original cost or values guaranteed under forward sales agreements.

Q6) (AS 6)

R. Ltd. a newly incorporated company wants to provide depreciation on Plant and Machinery on straight line method whereas written down value method for the remaining fixed assets? Can R Ltd. do so?

Solution: Depreciation method is selected 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.

AS 6, mentions, a combination of more than one method is some times used, meaning thereby that for few fixed assets straight line method can be adopted whereas for other fixed assets written down value method can also be adopted.

Accordingly R Ltd. can choose straight line method for plant and machinery and written down value method for other fixed assets.

Q7) (AS 6)

P Ltd. is providing deprecation on straight line method. Due to technical evaluation, the estimated useful life of certain fixed assets is less as compared to life of assets as indicated by rates prescribed under Companies Act, 2013. Is P Ltd. required to provide depreciation considering the estimated useful life of asset which is higher than the rates prescribed in the Companies Act, 2013. Is P Ltd. required to recompute depreciation from inception i.e. from the date when such fixed assets were purchased?

Solution: AS 6 stipulates that where the management’s estimate of the useful life of an asset of the enterprise is shorter than that envisaged under the provisions of the relevant statute, the depreciation provision is appropriately computed by applying a higher rate. Hence, P Ltd. will be required to provide depreciation at higher rates than rates prescribed under the act.

Second and important issue that arises is how P Ltd. should compute the depreciation. This gives rise to a change in estimate and not a change in method, so enhanced depreciation should be provided prospectively i.e. over the remaining useful life of the asset.

P. Ltd. will have to provide enhanced depreciation over the residual useful life of the asset.

Q8) (AS 6)

P Ltd. was providing depreciation on Plant and Machinery on written down value method. With effect from 1-4-03, in respect of additions to, plant and machinery, P Ltd. wants to provide depreciation on straight line method, whereas for plant and machinery upto 31-3-03, it will continue to provide depreciation on written down value method. Is contention of P Ltd justified?

Solution: As per AS 6, the method of depreciation is applied consistently to provide comparability of the results of the operation of the enterprise from period to period. A change from one method of providing depreciation to another is made only if the adoption of the new method is required by statute or for 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 method of depreciation is made, depreciation is recalculated in accordance with the new method from the date of the asset coming into use.

Accordingly, P Ltd. would not be justified in providing depreciation on straight line method in respect of additions to plant and machinery with effect from 1-4-03. P Ltd. can change method of providing depreciation from written down value to straight line method and this in compliance to Accounting Standard has to be done retrospectively from the date of the asset coming into use.

Q9) (AS 10)

A company has purchased plant and machinery in the year 2001-2002 for Rs 45 lakhs. A balance of Rs5 lakhs is still payable to the suppliers for the same. The supplier waived off the balance amount during the financial year 2004-2005. The company treated it as income and credited to profit and loss account during 2004-2005.

Whether accounting treatment of the company is correct. If not, state with reasons.

Solution: As per AS 10 the cost of fixed assets may undergo changes subsequent to its acquisition or construction on account of exchange fluctuation, price adjustments, changes in duties or similar factors. The treatment done by the company is not correct. Rs5 lakhs should be deducted from the cost of fixed assets.

Q10) (AS 10)

ABC Ltd. gave 50,000 equity shares of Rs 10 each (fully paid up) in consideration for supply of certain machinery by X & Co. The shares exchanged for machinery are quoted on Bombay Stock Exchange (BSE) at Rs 15 per share, at the time of transaction. In the absence of fair market value of the machinery acquired, how the value of machinery would be recorded in the books of the company?

Solution:

As per AS-10, fixed asset acquired in exchange for shares or other securities should be recorded at its fair market value or the fair market value of the securities issued, whichever is more clearly evident. Since, the market value of the shares exchanged for the asset is more clearly evident, the company should record the value of machinery at Rs 7,50,000. (i.e., 50,000 shares x 15 per share being the market price)

Q11) (AS 10)

Jadu Ltd. purchased certain plant and machinery for Rs 40 lakhs. 20% of the cost net of Cenvat credit is the subsidy component to be realized from a State Government for establishing industry in a backward district. Cost Rs 40 lakhs include excise Rs 5 lakhs against which Cenvat credit can be claimed. Compute depreciable amount.

Solution: In this case, it is first necessary to determine the historical cost of the plant and machinery. This is shown in the following table.

Q12) (AS 10)

On March 01, 2007, X Ltd. purchased Rs 5 lakhs worth of land for a factory site. Company demolished an old building on the property and sold the material for Rs 10,000. Company incurred additional cost and realized salvaged proceeds during the March 2007 as follows:

Compute the balance to be shown in the land account on March 31, 2007 balance sheet.

Solution:

Q13) (AS 10)

Mr. X set up a new factory in the backward area and purchased plant for Rs 500 lakhs for the purpose of his business. Purchases were entitled for the CENVAT credit of Rs 10 lakhs and also Government agreed to extend the 20% subsidy for backward area development. Determine the depreciable value for the asset.

Solution:

**Note: For illustrations on AS 14, refer chapter Amalgamation of Companies

References

1. Corporate Accounting by B.B.Dam

2. Corporate Accounting by K.R.Das